e10-q
 

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 September 29, 2001

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) with the Commission, and (2) has been subject to such filing requirements for the past 90 days.

Yes  X   No _____

There were 34,963,397 shares of Common Stock, $.01 par value, outstanding at September 29, 2001.


 

CERNER CORPORATION AND SUBSIDIARIES

I N D E X

         
Part I   Financial Information:    
 
Item 1.   Financial Statements:    
 
    Consolidated Balance Sheets as of September 29, 2001 (unaudited) and December 30, 2000   1
 
    Consolidated Statements of Operations for the three months and nine months ended September 29, 2001 and September 30, 2000 (unaudited)   2
 
    Consolidated Statements of Cash Flows for the nine months ended September 29, 2001 and September 30, 2000 (unaudited)   3
 
    Notes to Condensed Consolidated Financial Statements   4
 
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   8
 
Item 3.   Quantitative and Qualitative Disclosures About Market Risk (Not applicable)    
 
Part II   Other Information:    
 
Item 6.   Exhibits and Reports on Form 8-K   17

2


 

Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

                     
        September 29,   December 30,
    2001   2000
   
 
        (unaudited)        
        (In thousands)
Assets
               
 
Current Assets:
               
 
Cash and cash equivalents
  $ 95,969     $ 90,893  
 
Receivables
    202,686       188,036  
 
Inventory
    3,557       2,174  
 
Prepaid expenses and other
    13,246       7,393  
 
   
     
 
 
Total current assets
    315,458       288,496  

 

 
Property and equipment, net
    91,532       82,234  
 
Software development costs, net
    93,020       83,276  
 
Intangible assets, net
    23,993       22,227  
 
Investments
    81,236       130,626  
 
Other assets
    6,202       9,552  
 
   
     
 
 
  $ 611,441     $ 616,411  
 
   
     
 
Liabilities and Stockholders’ Equity
               
 
Current Liabilities:
               
 
Accounts payable
  $ 24,789     $ 20,532  
 
Current installments of long term debt
    12,098       72  
 
Deferred revenue
    39,444       40,212  
 
Income taxes
    18,696       9,718  
 
Accrued payroll and tax withholdings
    32,547       27,338  
 
Other accrued expenses
    6,074       4,443  
 
   
     
 
 
Total current liabilities
    133,648       102,315  
 
   
     
 
 
Long-term debt
    92,405       102,299  
 
Deferred income taxes
    40,596       57,430  
 
Deferred revenue
    7,462       10,650  

 

 
Stockholders’ Equity:
               
 
Common stock, $.01 par value, 150,000,000 shares authorized, 36,165,022 shares issued at September 29, 2001 and 35,967,618 issued in 2000
    362       360  
 
Additional paid-in capital
    196,220       192,715  
 
Retained earnings
    177,504       230,916  
 
Treasury stock, at cost (1,201,625 shares)
  (20,799 )     (20,799 )
 
Accumulated other comprehensive income:
               
   
Foreign currency translation adjustment
    (1,409 )     (743 )
   
Unrealized loss on available-for-sale equity securities (net of deferred tax benefit of $8,128 for 2001 and $33,036 for 2000)
    (14,548 )     (58,732 )
 
   
     
 
   
Total stockholders’ equity
    337,330       343,717  
 
   
     
 
 
  $ 611,441     $ 616,411  
 
   
     
 
See notes to condensed consolidated financial statements
               

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CERNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

                                     
        Three Months Ended   Nine Months Ended
       
 
        September 29,   September 30,   September 29,   September 30,
        2001   2000   2001   2000
       
 
 
 
        (In thousands, except per share data)
 
Revenues:
                               
   
System sales
  $ 97,005     $ 68,700     $ 266,819     $ 181,610  
   
Support and maintenance
    35,053       28,834       103,864       83,624  
   
Other
    7,779       6,791       20,135       19,700  
 
   
     
     
     
 
   
Total revenues
    139,837       104,325       390,819       284,934  
 
   
     
     
     
 
Costs and expenses:
                               
   
Cost of revenues
    28,354       23,903       83,938       61,764  
   
Sales and client service
    59,173       42,975       162,530       122,049  
   
Software development
    25,532       19,064       73,902       56,650  
   
General and administrative
    9,990       7,312       28,645       20,898  
   
Write-off of in-process research and development
        3,200             3,200  
   
Write-down of intangible assets
                      6,687  
 
   
     
     
     
 
   
Total costs and expenses
    123,049       96,454       349,016       271,248  
 
   
     
     
     
 
Operating earnings
    16,788       7,871       41,803       13,686  

 

 
Interest expense, net
    (1,329 )     (937 )     (2,964 )     (2,722 )
 
Loss on sale of investment
                (385 )      
 
Write-down of investment
                (127,616 )      
 
Gain on software license settlement
                7,580        
 
Realized gain on exchange of stock
          188,654             188,654  
 
   
     
     
     
 
Earnings (loss) before income taxes
    15,459       195,588       (81,582 )     199,618  
   
Income taxes
    (6,217 )     (72,252 )     28,170       (76,503 )
 
   
     
     
     
 
Net income (loss)
  $ 9,242     $ 123,336     $ (53,412 )   $ 123,115  
 
   
     
     
     
 
Basic income (loss) per share
  $ .26     $ 3.61     $ (1.53 )   $ 3.63  
 
   
     
     
     
 
Basic weighted average shares outstanding
    34,936       34,188       34,863       33,932  
 
   
     
     
     
 
Diluted income (loss) per share
  $ .25     $ 3.45     $ (1.53 )   $ 3.52  
 
   
     
     
     
 
Diluted weighted average shares outstanding
    36,798       35,757       34,863       35,025  
 
   
     
     
     
 

See notes to consolidated financial statements.

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CERNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

                     
        Nine Months Ended
       
        September 29, 2001   September 30, 2000
       
 
        (In thousands)
 
Cash flows from operating activities:
               
 
Net earnings (loss)
  $ (53,412 )   $ 123,115  
 
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:
               
   
Depreciation and amortization
    36,507       27,517  
   
Common stock received as consideration of sale of license software
    (750 )     (6,773 )
   
Realized (gain) loss on sale of stock
    385       (11 )
   
Unrealized gain on exchange of stock
          (188,654 )
   
Write down of investment
    127,616        
   
Write-off of acquired in-process technology
          3,200  
   
Gain on software license settlement
    (7,580 )      
   
Write-down of intangible assets
          6,687  
   
Issuance of stock as compensation
          31  
   
Non-employee stock option compensation expense
    142       173  
   
Equity in losses in affiliates
    1,504       641  
   
Provision for deferred income taxes
    (44,832 )     70,525  
   
Tax benefit from disqualifying dispositions of stock options
          712  
   
Loss on disposal of capital equipment
          33  

 

 
Changes in assets and liabilities:
               
   
Receivables, net
    (14,739 )     4,789  
   
Inventory
    (1,383 )     498  
   
Prepaid expenses and other
    (5,700 )     (5,027 )
   
Accounts payable
    (1,590 )     21  
   
Accrued income taxes
    12,067       4,458  
   
Deferred revenue
    (4,771 )     5,448  
   
Other accrued liabilities
    6,472       5,039  
 
   
     
 
 
Total adjustments
    103,348       (70,693 )
 
   
     
 
 
Net cash provided by operating activities
    49,936       52,422  
 
   
     
 
Cash flows from investing activities:
               
   
Purchase of capital equipment
    (14,328 )     (10,598 )
   
Purchase of land, buildings, and improvements
    (4,356 )      
   
Acquisition of business
    (3,350 )     (12,950 )
   
Investment in affiliates
    (1,379 )     (7,764 )
   
Advances to affiliates
          1,000  
   
Proceeds from sale of stock in investee company
    1,572       511  
   
Issuance of notes receivable
    (186 )     (35 )
   
Repayment of notes receivable
    312       221  
   
Capitalized software development costs
    (27,851 )     (22,251 )
 
   
     
 
 
Net cash used in investing activities
    (49,566 )     (51,866 )
 
   
     
 
Cash flows from financing activities:
               
   
Proceeds from issuance of long-term debt
    2,999        
   
Repayment of long-term debt
    (992 )     (919 )
   
Proceeds from exercise of options
    3,366       3,748  
 
   
     
 
 
Net cash provided by financing activities
    5,373       2,829  
 
   
     
 
 
Foreign currency translation adjustment
    (667 )     (863 )
 
   
     
 
 
Net increase in cash and cash equivalents
    5,076       2,522  

 

 
Cash and cash equivalents at beginning of period
    90,893       75,677  
 
   
     
 
 
Cash and cash equivalents at end of period
  $ 95,969     $ 78,199  
 
   
     
 

See notes to consolidated financial statements.

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CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)  Interim Statement Presentation & Accounting Policies

     The consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. 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, although the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s latest annual report on Form 10-K.

     In the opinion of management, the accompanying unaudited 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. The results of the nine-month and three-month periods are not necessarily indicative of the operating results for the entire year.

     The Company has adopted Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income”. This statement establishes requirements for reporting and display of comprehensive income and its components. For the three months ended September 29, 2001 and September 30, 2000, total Comprehensive Income (Loss), which includes foreign currency translation adjustments and unrealized gains and losses on available-for-sale equity security adjustments, amounted to $(17,035,000) and $27,527,000, respectively. For the nine months ended September 29, 2001 and September 30, 2000, total Comprehensive Income (Loss), amounted to $(9,894,000) and $18,146,000, respectively.

     On December 31, 2000, the Company adopted Statement of Financial Accounting Standards No. 133 (“SFAS 133”) “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 137 and SFAS 138. SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities. The adoption of SFAS 133, as amended, had no impact on the Company in the first three quarters of 2001, as the Company had no derivatives.

(2) Earnings Per Share

     Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders 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 the earnings of the Company. A reconciliation of the numerators and denominators of the basic and diluted per-share computations is as follows:

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      Three months ended   Three months ended
      September 29, 2001   September 30, 2000
     
 
      Earnings   Shares   Per-Share   Earnings   Shares   Per-Share
      (Numerator)   (Denominator)   Amount   (Numerator)   (Denominator)   Amount
     
 
 
 
 
 
      (In thousands, except per share data)
 
Basic earnings per share Income available to common stockholders
  $ 9,242       34,936     $ .26     $ 123,336       34,188     $ 3.61  
Effect of dilutive securities Stock options
          1,862                     1,569          
Diluted earnings per share
 
                                   
 
Income available to common stockholders including assumed conversions
  $ 9,242       36,798     $ .25     $ 123,336       35,757     $ 3.45  
 
     
     
     
     
     
     
 

     Options to purchase 241,000 and 189,000 shares of common stock at per share prices ranging from $48.49 to $84.07 and $36.31 to $84.07 were outstanding at the three-months ended September 29, 2001 and September 30, 2000, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during the period.

                                                   
    Nine months ended   Nine months ended
    September 29, 2001   September 30, 2000
   
 
    Earnings (loss)   Shares   Per-Share   Earnings   Shares   Per-Share
    (Numerator)   (Denominator)   Amount   (Numerator)   (Denominator)   Amount
   
 
 
 
 
 
    (In thousands, except per share data)
                     
Basic earnings(loss) per share Income available to common stockholders
$ (53,412 )     34,863     $ (1.53 )   $ 123,115       33,932     $ 3.63  
Effect of dilutive securities Stock options
                            1,093          
Diluted earnings (loss) per share
 
                               
 
Income available to common stockholders including assumed conversions
$ (53,412 )     34,863     $ (1.53 )   $ 123,115       35,025     $ 3.52  
 
   
     
     
     
     
     
 

     Options to purchase 352,000 and 715,000 shares of common stock at per share prices ranging from $46.69 to $84.07 and $29.63 to $84.07 were outstanding at the nine-months ended September 29, 2001 and September 30, 2000, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during the period. Additionally, options to purchase 1,796,000 shares of common stock at per share prices ranging from $1.34 to $84.07 were outstanding at the nine-months ended September 29, 2001, but were not included in the computation of diluted earnings per share because there was a net loss for the period.

(3) Business Acquisitions

     On, July 3, 2001, the Company purchased certain assets and certain liabilities of APACHE Medical Systems, Inc. (APACHE) for approximately $3.5 million. APACHE is a recognized leader in clinical decision support/outcomes management systems and consulting services for the care of high-risk patients. The allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired and liabilities assumed resulted in goodwill of $4,766,000. There will be no amortization of goodwill.

     On April 2, 2000 the Company purchased the remaining 50% of the outstanding common stock of Health Network Ventures, Inc. (HNV) for $8.3 million. HNV develops software solutions that enable transaction

5


 

processing between providers, and other health-related entities. Subsequent to the acquisition, the Company determined that it would shut down the portion of the business focused on individual physician practice connectivity and transaction processing given that it is the Company’s strategy to use CareInsite (now WebMD Corporation) to process transactions. As a result of this decision, the Company recorded a non-recurring charge in the second quarter of 2000 in the amount of $6,687,000 or $.20 per share on a diluted basis related to a write-down of intangible assets.

     The Company also purchased the assets of Mitch Cooper & Associates (MC&A) for $2 million on April 2, 2000. MC&A is a supply chain re-engineering consulting practice. The allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired and liabilities assumed, resulted in goodwill of $1,957,000. The goodwill is being amortized straight-line over five years.

     On August 22, 2000, the Company purchased CITATION Computer Systems, Inc., a market leader in laboratory systems for small to mid-sized hospitals. The purchase price was financed with approximately $2 million in cash and $14 million in stock. $3.2 million of the purchase price was allocated to in-process research and development that had not reached technological feasibility and is reflected as a one-time charge to earning in the third quarter of 2000. The allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired and liabilities assumed, resulted in goodwill of $8,310,000. The goodwill is being amortized straight-line over seven years.

     The amount allocated to purchase in-process research and development was determined through established valuation techniques in the high-technology computer industry and was expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed. Research and development costs to bring the products from Citation to technological feasibility, individually or in the aggregate, are not expected to have a material impact on the Company’s future results of operations or cash flows. The acquired in-process research and development is related to CITATION’s enhanced versions of the C-LAB and C-COM products. C-LAB addresses the complex information needs of the laboratory’s general lab, microbiology, anatomical pathology and blood bank departments with a Windows NT client server solution. C-LAB was approximately 68% complete at the time of the acquisition. When CITATION was acquired, management projected that C-LAB would be completed in 6-9 months at an estimated cost of $700,000. The risks associated with C-LAB are like any other software development project and include changes in technology and competition. The C-LAB project was valued using the income approach with the following assumptions: material net cash inflows are expected to commence in 2001; no material changes from historical pricing, margins, or expense levels are anticipated; and, a 20% risk adjusted discount rate was applied to the estimated net cash flows. C-LAB was approximately 85% complete at the end of the third quarter of 2001. C-COM is also designed for a Windows NT client server user and works with other information systems in healthcare facilities by providing a central data repository for clinical orders and results. It then allows for routing of the patient information to all care-providing centers throughout the healthcare enterprise. C-COM was approximately 75% complete at the time of the acquisition. When CITATION was acquired, management projected that C-COM would be completed in 3-6 months at an estimated cost of $500,000. The risks associated with C-COM are like any other software development project and include changes in technology and competition. The C-COM project was valued using the income approach with the following assumptions: material net cash inflows are expected to commence in 2001; no material changes from historical pricing, margins, or expense levels are anticipated; and, a 20% risk adjusted discount rate was applied to the estimated net cash flows. C-COM is complete.

     The acquisitions were accounted for using the purchase method of accounting with the operating results of APACHE, HNV, MC&A and CITATION included in the Company’s consolidated statement of earnings since the date of acquisition.

     On September 6, 2001, the Company entered into an agreement to acquire Dynamic Healthcare Technologies, Inc. (DHT), for approximately $2.2 million cash plus approximately 363,000 shares of stock. The transaction is expected to close in the fourth quarter this year, pending DHT shareholder and customary regulatory approvals.

6


 

(4) Receivables

     Receivables consist of accounts receivable and contracts receivable. Accounts receivable represent recorded revenues that have been billed. Contracts receivable represent recorded revenues that are billable by the Company at future dates under the terms of a contract with a client. A summary of receivables is as follows:

                 
    September 29,   December 30,
    2001   2000
   
 
    (In thousands)
Accounts receivable
  $ 123,029       96,946  
Contracts receivable
    79,657       91,090  
 
   
     
 
Total receivables
  $ 202,686       188,036  
 
   
     
 

     The Company provides an allowance for estimated uncollectible accounts based upon historical experience and management’s judgment. At September 29, 2001 and December 30, 2000 the allowance for estimated uncollectible accounts was $5,996,000 and $5,999,000, respectively.

(5) Investments

     At September 29, 2001, the Company owned 14,820,527 shares of common stock of WebMD, which have a cost basis of $85,811,000 and a carrying value of $63,135,000 as these shares are accounted for as available-for-sale. 2,000,000 shares of WebMD held by the Company are not registered. At September 29, 2001 the Company also held 1,048,783 warrants of WebMD with an exercise price of $3.08 and a cost basis and carrying value of $4,146,000. The warrants are carried at cost, as they do not have a fair value that is currently available on a securities exchange.

     On June 18, 2001 the Company reached an agreement with WebMD Corporation regarding certain performance metrics related to specified levels of physician usage arising out of the original license transaction between the Company and CareInsite, Inc., which has been merged into WebMD. Under the agreement, the Company received 2,000,000 shares of WebMD stock, valued at $11,580,000, in exchange for $432,000 in cash and the cancellation of various obligations due to the Company by WebMD. As a result of this agreement, the Company recognized a non-recurring gain of $4,836,000, net of $2,744,000 in tax, in gain on software license settlement in the accompanying consolidated statement of operations. The Company’s policy is to review declines in fair value of its marketable equity securities for declines that may be other than temporary. As a result of this policy, during the second quarter of 2001, the Company recorded a write-down of its investment in WebMD from $15.00 to $5.79. Accordingly, the Company recognized a charge to earnings of $81,419,000, net of $46,197,000 in tax.

7


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

Three Months Ended September 29, 2001 Compared to Three Months Ended September 30, 2000

     The Company’s revenues increased to $139,837,000 for the three-month period ended September 29, 2001 from $104,325,000 for the three-month period ended September 30, 2000. Net earnings, before non-recurring items, increased 50% to $9,242,000 in the 2001 period from $6,174,000 for the 2000 period. The increase in net earnings, before non-recurring items, is due primarily to an increase in new contract bookings in the three-month period ended September 29, 2001 compared to the three-month period ended September 30, 2000. After non-recurring items, the Company had net earnings of $9,242,000 and $123,336,000 for the three month periods ended September 29, 2001 and September 30, 2000, respectively.

     System sales revenues increased 41% to $97,005,000 for the three-month period ended September 29, 2001 from $68,700,000 for the corresponding period in 2000. The increase in system sales is due to an increase in new contract bookings in the quarter ended September 29, 2001 compared to the prior year quarter. Hardware revenues were $16,889,000 for the quarter ended September 29, 2001 compared to $15,091,000 for the quarter ended September 30, 2000.

     Support and maintenance revenues increased 22% to $35,053,000 during the third quarter of 2001 from $28,834,000 during the same period in 2000. This increase was due primarily to the increase in the Company’s installed and converted client base.

     At September 29, 2001, the Company had $532,568,000 in contract backlog and $216,554,000 in support and maintenance backlog, compared to $413,001,000 in contract backlog and $179,078,000 in support and maintenance backlog at September 30, 2000.

     Other revenues, consisting primarily of subscriptions and services to clients, increased 15% to $7,779,000 in the third quarter of 2001 from $6,791,000 in the same period of 2000.

     The cost of revenues includes the cost of third party consulting services, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to manufacturers. The cost of revenue was 20% of total revenues in the third quarter of 2001 and 23% in the same period of 2000. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, and support) components carrying different margin rates changes from period to period.

     Sales and client service expenses include salaries of client service personnel, communications expenses and unreimbursed travel expenses. Also included are sales and marketing salaries, trade show costs and advertising costs. These expenses as a percent of total revenues were 42% and 41% in the third quarter of 2001 and 2000, respectively. The increase in total sales and client service expenses to $59,173,000 in 2001 from $42,975,000 in 2000 was attributable to the cost of a larger field sales and services organization and marketing of new products.

     Software development expenses include salaries, documentation and other direct expenses incurred in product development, and amortization of software development costs. Total expenditures for software development, including both capitalized and noncapitalized portions, for the first quarter of 2001 and 2000 were $29,172,000 and $22,001,000, respectively. These amounts exclude amortization. Capitalized software costs were $9,672,000 and $7,545,000 for the third quarter of 2001 and 2000, respectively. The increase in aggregate expenditures for software development in 2001 is due to development of HNA Millennium ® products and development of community care products.

     General and administrative expenses include salaries for corporate, financial, and administrative staffs, utilities, communications expenses, and professional fees. These expenses as a percent of total revenues were 7% in the third quarter of both 2001 and 2000. Total general and administrative expenses

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for the third quarter of 2001 and 2000 were $9,990,000 and $7,312,000, respectively. The increase is due to the growth of the Company’s core business and as a result of acquisitions.

     On August 22, 2000, the Company purchased CITATION Computer Systems, Inc., a market leader in laboratory systems for small to mid-sized hospitals. The purchase price was financed with approximately $2 million in cash and $14 million in stock. $3.2 million of the purchase price was allocated to in-process research and development that had not reached technological feasibility and is reflected as a one-time charge to earning in the third quarter of 2000. The allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired and liabilities assumed, resulted in goodwill of $8,310,000. The goodwill is being amortized straight-line over seven years.

     The amount allocated to purchase in-process research and development was determined through established valuation techniques in the high-technology computer industry and was expensed upon acquisition because technological feasibility had not been established an not future alternative uses existed. Research and development costs to bring the products from Citation to technological feasibility, individually or in the aggregate, are not expected to have a material impact on the Company’s future results of operations or cash flows. The acquired in-process research and development is related to CITATION’s enhanced versions of the C-LAB and C-COM products. C-LAB addresses the complex information needs of the laboratory’s general lab, microbiology, anatomical pathology and blood bank departments with a Windows NT client server solution. C-LAB was approximately 68% complete at the time of the acquisition. When CITATION was acquired, management projected that C-LAB would be completed in 6-9 months at an estimated cost of $700,000. The risks associated with C-LAB are like any other software development project and include changes in technology and competition. The C-LAB project was valued using the income approach with the following assumptions: material net cash inflows are expected to commence in 2001; no material changes from historical pricing, margins, or expense levels are anticipated; and, a 20% risk adjusted discount rate was applied to the estimated net cash flows. C-LAB was approximately 85% complete at the end of the third quarter of 2001. C-COM is also designed for a Windows NT client server user and works with other information systems in healthcare facilities by providing a central data repository for clinical orders and results. It then allows for routing of the patient information to all care-providing centers throughout the healthcare enterprise. C-COM was approximately 75% complete at the time of the acquisition. When CITATION was acquired, management projected that C-COM would be completed in 3-6 months at an estimated cost of $500,000. The risks associated with C-COM are like any other software development project and include changes in technology and competition. The C-COM project was valued using the income approach with the following assumptions: material net cash inflows are expected to commence in 2001; no material changes from historical pricing, margins, or expense levels are anticipated; and, a 20% risk adjusted discount rate was applied to the estimated net cash flows. C-COM is complete.

     Net interest expense was $1,329,000 in the third quarter of 2001 compared to $937,000 in the third quarter of 2000.

     On February 13, 2000 CareInsite entered into an agreement to merge with Healtheon/WebMD Corporation (“Merger Agreement”). As part of the Merger Agreement, the Company received 1.3 shares of Healtheon/WebMD Corporation (WebMD) in exchange for each common share of CareInsite held by the Company. The warrants were also converted at the same exchange ratio. The merger of CareInsite and WebMD (“Merger”) closed on September 12, 2000. Accordingly, the Company recorded a non-recurring investment gain of $120,362,000, net of $68,292,000 in tax in the third quarter of 2000.

     After adjusting for non-recurring items, the Company’s effective tax rates were 40.2% and 39.1% for the third quarter of 2001 and 2000, respectively.

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Nine Months Ended September 29, 2001 Compared to Nine Months Ended September 30, 2000

     The Company’s revenues increased to $390,819,000 for the nine-month period ended September 29, 2001 from $284,934,000 for the nine-month period ended September 30, 2000. Net earnings, before non-recurring items, increased 83% to $23,171,000 in the 2001 period from $12,640,000 for the 2000 period. The increase in net earnings, before non-recurring items, is due to an increase in new contract bookings in the nine-month period ended September 29, 2001 compared to the nine-month period ended September 30, 2000. After the non-recurring items, net loss was $53,412,000 for the first nine months of 2001 and net earnings were $123,115,000 for the first nine months of 2000. The increase in net loss is due primarily to the other-than-temporary write-down of WebMD shares of the $127,616,000 in 2001 and the realized gain on the exchange of CareInsite stock for WebMD stock of $188,654,000 in 2000, offset by the gain on the software license settlement with WebMD of $7,580,000 in 2001 and $6,687,000 write-down of intangibles related to HNV in 2000.

     System sales revenues increased 47% to $266,819,000 for the nine-month period ended September 29, 2001 from $181,610,000 for the corresponding period in 2000. The increase in system sales is due to an increase in new contract bookings in the nine months ended September 29, 2001 compared to the prior year period and an increase in hardware revenues to $47,322,000 from $30,152,000 in the nine months ended September 29, 2001 and September 30, 2000, respectively.

     Support and maintenance revenues increased 24% to $103,865,000 during the first nine months of 2001 from $83,624,000 during the same period in 2000. This increase was due primarily to the increase in the Company’s installed and converted client base.

     At September 29, 2001, the Company had $532,568,000 in contract backlog and $216,554,000 in support and maintenance backlog, compared to $413,001,000 in contract backlog and $179,078,000 in support and maintenance backlog at September 30, 2000.

     Other revenues, consisting primarily of subscriptions and services to clients, increased 2% to $20,135,000 in the first nine months of 2001 from $19,700,000 in the same period of 2000.

     The cost of revenues includes the cost of third party consulting services, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to manufacturers. The cost of revenue was 21% of total revenues in the first nine months of 2001 and 22% in the same period of 2000. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, and support) components carrying different margin rates changes from period to period. The increase in the cost of revenues for the first nine months of 2001 is due primarily to the increase in the sale of hardware compared to the first nine months of 2000.

     Sales and client service expenses include salaries of client service personnel, communications expenses and unreimbursed travel expenses. Also included are sales and marketing salaries, trade show costs and advertising costs. These expenses as a percent of total revenues were 42% and 43% in the first nine months of 2001 and 2000, respectively. The increase in total sales and client service expenses to $162,530,000 in 2001 from $122,049,000 in 2000 was attributable to the cost of a larger field sales and consulting organization and marketing of new products.

     Software development expenses include salaries, documentation and other direct expenses incurred in product development, and amortization of software development costs. Total expenditures for software development, including both capitalized and noncapitalized portions, for the first nine months of 2001 and 2000 were $83,647,000 and $65,124,000, respectively. These amounts exclude amortization. Capitalized software costs were $27,851,000 and $22,251,000 for the first nine months of 2001 and 2000, respectively. The increase in aggregate expenditures for software development in 2001 is due to development of HNA Millennium ® products and development of community care products.

     General and administrative expenses include salaries for corporate, financial, and administrative staffs, utilities, communications expenses, and professional fees. These expenses as a percent of total revenues were 7% in the first nine months of 2001 and 2000. Total general and administrative expenses

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for the first nine months of 2001 and 2000 were $28,645,000 and $20,898,000, respectively. The increase is due to the growth of the Company’s core business and as a result of acquisitions.

     On August 22, 2000, the Company purchased CITATION Computer Systems, Inc., a market leader in laboratory systems for small to mid-sized hospitals. The purchase price was financed with approximately $2 million in cash and $14 million in stock. $3.2 million of the purchase price was allocated to in-process research and development that had not reached technological feasibility and is reflected as a one-time charge to earning in the third quarter of 2000. The allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired and liabilities assumed, resulted in goodwill of $8,310,000. The goodwill is being amortized straight-line over seven years.

     The amount allocated to purchase in-process research and development was determined through established valuation techniques in the high-technology computer industry and was expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed. Research and development costs to bring the products from Citation to technological feasibility, individually or in the aggregate, are not expected to have a material impact on the Company’s future results of operations or cash flows. The acquired in-process research and development is related to CITATION’s enhanced versions of the C-LAB and C-COM products. C-LAB addresses the complex information needs of the laboratory’s general lab, microbiology, anatomical pathology and blood bank departments with a Windows NT client server solution. C-LAB was approximately 68% complete at the time of the acquisition. When CITATION was acquired, management projected that C-LAB would be completed in 6-9 months at an estimated cost of $700,000. The risks associated with C-LAB are like any other software development project and include changes in technology and competition. The C-LAB project was valued using the income approach with the following assumptions: material net cash inflows are expected to commence in 2001; no material changes from historical pricing, margins, or expense levels are anticipated; and, a 20% risk adjusted discount rate was applied to the estimated net cash flows. C-LAB was approximately 85% complete at the end of the third quarter of 2001. C-COM is also designed for a Windows NT client server user and works with other information systems in healthcare facilities by providing a central data repository for clinical orders and results. It then allows for routing of the patient information to all care-providing centers throughout the healthcare enterprise. C-COM was approximately 75% complete at the time of the acquisition. When CITATION was acquired, management projected that C-COM would be completed in 3-6 months at an estimated cost of $500,000. The risks associated with C-COM are like any other software development project and include changes in technology and competition. The C-COM project was valued using the income approach with the following assumptions: material net cash inflows are expected to commence in 2001; no material changes from historical pricing, margins, or expense levels are anticipated; and, a 20% risk adjusted discount rate was applied to the estimated net cash flows. C-COM is complete.

     On April 2, 2000 the Company purchased the remaining 50% of the outstanding common stock of Health Network Ventures, Inc. (HNV) for $8.3 million. HNV develops software solutions that enable transaction processing between providers, and other health-related entities. Subsequent to the acquisition, the Company determined that it would shut down the portion of the business focused on individual physician practice connectivity and transaction processing given that it is the Company’s strategy to use CareInsite (now WebMD Corporation) to process transactions. As a result of this decision, the Company recorded a non-recurring charge in the second quarter of 2000 in the amount of $6,687,000 or $.20 per share on a diluted basis related to a write-down of intangible assets.

     Net interest expense was $2,964,000 in the first nine months of 2001 compared to $2,722,000 in the first nine months of 2000.

     At September 29, 2001, the Company owned 14,820,527 shares of common stock of WebMD, which have a cost basis of $85,811,000 and a carrying value of $63,135,000 as these shares are accounted for as available-for-sale. 2,000,000 shares of WebMD held by the Company are not registered. At September 29, 2001 the Company also held 1,048,783 warrants of WebMD with an exercise price of $3.08 and a cost basis and carrying value of $4,146,000. The warrants are carried at cost, as they do not have a fair value that is currently available on a securities exchange.

     On June 18, 2001 the Company reached an agreement with WebMD Corporation regarding certain performance metrics related to specified levels of physician usage arising out of the original license

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transaction between the Company and CareInsite, Inc., which has been merged into WebMD. Under the agreement, the Company received 2,000,000 shares of WebMD stock, valued at $11,580,000, in exchange for $432,000 in cash and the cancellation of various obligations due to the Company by WebMD. As a result of this agreement, the Company recognized a non-recurring gain of $4,836,000, net of $2,744,000 in tax. The Company’s policy is to review declines in fair value of its marketable equity securities for declines that may be other than temporary. As a result of this policy, during the second quarter of 2001, the Company recorded a write-down of its investment in WebMD from $15.00 to $5.79. Accordingly, the Company recognized a charge to earnings of $81,419,000, net of $46,197,000 in tax.

     On February 13, 2000 CareInsite entered into an agreement to merge with Healtheon/WebMD Corporation (“Merger Agreement”). As part of the Merger Agreement, the Company received 1.3 shares of Healtheon/WebMD Corporation (WebMD) in exchange for each common share of CareInsite held by the Company. The warrants were also converted at the same exchange ratio. The merger of CareInsite and WebMD (“Merger”) closed on September 12, 2000. Accordingly, the Company recorded a non-recurring investment gain of $120,362,000, net of $68,292,000 in tax in the third quarter of 2000.

     After adjusting for non-recurring items, the Company’s effective tax rates were 39.7% and 39.4% for the first nine months of 2001 and 2000, respectively.

Capital Resources and Liquidity

     The Company’s liquidity position remains strong with total cash and cash equivalents of $95,969,000 at September 29, 2001 and working capital of $181,810,000. The Company generated net cash from operations of $49,936,000 and $52,422,000 during the nine-month periods ended September 29, 2001 and September 30, 2000, respectively. Cash flow from operations decreased for the first nine months of 2001, due to primarily to an increase in receivables. The Company has $30,000,000 of long-term, revolving credit from banks, all of which was available as of September 29, 2001.

     Cash used in investing activities consisted primarily of capitalized software development costs of $27,851,000 and $22,251,000 and capital expenditures of $18,684,000 and $10,598,000, in the first nine months of 2001 and 2000, respectively. The Company also spent $3,350,000 and $12,950,000 on business acquisitions in the first nine months of 2001 and 2000, respectively.

     Revenues provided under the Company’s support and maintenance agreements represent recurring cash flows. Support and maintenance revenues increased 22% in the third quarter of 2001 over the third quarter of 2000, and the Company expects these revenues to continue to grow as the base of installed systems grows.

     The Company’s liquidity is influenced by many factors, including the amount and timing of the Company’s revenues, its cash collections from its clients as implementation of its products proceed and the amounts the Company invests in software development and capital expenditures. The Company believes that its present cash position, together with cash generated from operations, will be sufficient to meet anticipated cash requirements during 2001.

     The effects of inflation were minimal on the Company’s business during the period discussed herein.

Recent Accounting Pronouncements

     On June 30, 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) 141, “Business Combinations”, and SFAS 142, “Goodwill and Intangible Assets”. Major provisions of these Statements are as follows: all business combinations initiated after June 30, 2001 must use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001; Intangible assets acquired in a business combinations must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, retired or exchanged, either individually or as part of a related contract, asset or liability; goodwill and intangible assets with indefinite lives are not amortized but are tested for impairment annually, and whenever there is an impairment indicator; all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting; and effective January 1, 2002, goodwill from previous acquisitions will no

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longer be subject to amortization. Management is currently reviewing the impact that the provisions of these statements will have on the Company’s financial statements and results of operations.

Factors that may Affect Future Results of Operations, Financial Condition or Business

     Statements made in this report, other reports and proxy statements filed with the Securities and Exchange Commission, communications to stockholders, press releases and oral statements made by representatives of the Company that are not historical in nature, or that state the Company’s or management’s intentions, hopes, beliefs, expectations, or predictions of the future, are “forward-looking statements” within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended, and involve risks and uncertainties. The words “could”, “should,” “will be,” “will lead,” “will assist,” “intended,” “continue,” “believe,” “may,” “expect,” “hope,” “anticipate,” “goal,” “forecast” and similar expressions are intended to identify such forward-looking statements. It is important to note that any such performance, and actual results, financial condition or business could differ materially from those expressed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below as well as those discussed elsewhere in reports filed with the Securities and Exchange Commission. The Company undertakes 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.

     Quarterly Operating Results May Vary - The Company’s quarterly operating results have varied in the past and may continue to vary in future periods. Quarterly operating results may vary for a number of reasons including demand for the Company’s products and services, the Company’s long sales cycle, the long installation and implementation cycle for these larger, more complex and costlier systems and other factors described in this section and elsewhere in this report. As a result of healthcare industry trends and the market for the Company’s HNA Millennium products, a large percentage of the Company’s revenues are generated by the sale and installation of larger, more complex and costlier systems. The sales process for these systems is lengthy and involves a significant technical evaluation and commitment of capital and other resources by the client. The sale may be subject to delays due to clients’ internal budgets and procedures for approving large capital expenditures and by competing needs for other capital expenditures and deploying new technologies or personnel resources. Delays in the expected sale or installation of these large contracts may have a significant impact on the Company’s anticipated quarterly revenues and consequently its earnings, since a significant percentage of the Company’s expenses are relatively fixed.

     These larger, more complex and costlier systems are installed and implemented over time periods ranging from approximately six months to three years and involve significant efforts both by the Company and the client. In addition, implementation of the Company’s HNA Millennium products is a new and evolving process. The Company recognizes revenue upon the completion of standard milestone conditions and the amount of revenue recognized in any quarter depends upon the Company’s and the client’s ability to meet these project milestones. Delays in meeting these milestone conditions or modification of the contract relating to one or more of these systems could result in a shift of revenue recognition from one quarter to another and could have a material adverse effect on results of operations for a particular quarter. In addition, support payments by clients for the Company’s products do not commence until the product is in use.

     The Company’s revenues from system sales historically have been lower in the first quarter of the year and greater in the fourth quarter of the year.

     Stock Price May Be Volatile - The trading price of the Company’s common stock may be volatile. The market for the Company’s common stock may experience significant price and volume fluctuations in response to a number of factors including actual or anticipated quarterly variations in operating results, changes in expectations of future financial performance or changes in estimates of securities analysts, governmental regulatory action, healthcare reform measures, client relationship developments and other factors, many of which are beyond the Company’s control.

     Furthermore, the stock market in general, and the market for software, healthcare and high technology companies in particular, has experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of the Company’s common stock, regardless of actual operating performance.

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     Market Risk of Investments - The Company accounts for its investments in equity securities which have readily determinable fair values as available-for-sale. Available-for-sale securities are reported at fair value with unrealized gains and losses reported, net of tax, as a separate component of accumulated other comprehensive income. Investments in the common stock of certain affiliates over which the Company exerts significant influence are accounted for by the equity method. Investments in other equity securities are reported at cost. All equity securities are reviewed by the Company for declines in fair value. If such declines are considered to be other than temporary, the cost basis of the individual security is written down to fair value as a new cost basis, and the amount of the write-down is included in earnings.

     At September 29, 2001, the Company owned 14,820,527 shares of common stock of WebMD, which have a cost basis of $85,811,000 and a carrying value of $63,135,000 as these shares are accounted for as available-for-sale. 2,000,000 shares of WebMD held by the Company are not registered. At September 29, 2001 the Company also held 1,048,783 warrants of WebMD with an exercise price of $3.08 and a cost basis and carrying value of $4,146,000. The warrants are carried at cost, as they do not have a fair value that is currently available on a securities exchange.

     On June 18, 2001 the Company reached an agreement with WebMD Corporation regarding certain performance metrics related to specified levels of physician usage arising out of the original license transaction between the Company and CareInsite, Inc., which has been merged into WebMD. Under the agreement, the Company received 2,000,000 shares of WebMD stock, valued at $11,580,000, in exchange for $432,000 in cash and the cancellation of various obligations due to the Company by WebMD. As a result of this agreement, the Company recognized a non-recurring gain of $4,836,000, net of $2,744,000 in tax. The Company’s policy is to review declines in fair value of its marketable equity securities for declines that may be other than temporary. As a result of this policy, during the second quarter of 2001, the Company recorded a write-down of its investment in WebMD from $15.00 to $5.79. Accordingly, the Company recognized a charge to earnings of $81,419,000, net of $46,197,000 in tax.

     At September 29, 2001, marketable securities (which consist of money market and commercial paper) of the Company were recorded at cost, which approximates fair value of approximately $96 million, with an overall average return of approximately 5% and an overall weighted maturity of less than 90 days. The marketable securities held by the Company are not subject to price risk as a result of the short-term nature of the investments.

     The Company is not exposed to material future earnings or cash flow exposures from changes in interest rates on long-term debt since 100% of its long-term debt is at a fixed rate. To date, the Company has not entered into any derivative financial instruments to manage interest rate risk.

     The Company conducts business in several foreign jurisdictions. However, the business transacted is in the local functional currency and the Company does not currently have any material exposure to foreign currency transaction gains or losses. All other business transactions are in U.S. dollars. To date, the Company has not entered into any derivative financial instrument to manage foreign currency risk.

     Changes in the Healthcare Industry - The healthcare industry is highly regulated and is subject to changing political, economic and regulatory influences. For example, the Balanced Budget Act of 1997 (Public Law 105-32) contains significant changes to Medicare and Medicaid and began to have its initial impact in 1998 due to limitations on reimbursement, resulting cost containment initiatives, and effects on pricing and demand for capital intensive systems. In addition, the final rules under the Health Information Portability and Accountability Act of 1996 (HIPAA), will have a direct impact on the healthcare industry by requiring identifiers and standardized transactions/code sets and necessary security and privacy measures in or to ensure the protection of patient health information. These factors affect the purchasing practices and operation of healthcare organizations. Federal and state legislatures have periodically considered programs to reform or amend the U.S. healthcare system at both the federal and state level and to change healthcare financing and reimbursement systems. These programs may contain proposals to increase governmental involvement in healthcare, lower reimbursement rates or otherwise change the environment in which healthcare industry participants operate. Healthcare industry participants may respond by reducing their investments or postponing investment decisions, including investments in the Company’s products and services.

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     Many healthcare providers are consolidating to create integrated healthcare delivery systems with greater market power. These providers may try to use their market power to negotiate price reductions for the Company’s products and services. As the healthcare industry consolidates, the Company’s client base could be eroded, competition for clients could become more intense and the importance of acquiring each client becomes greater.

     Significant Competition - The market for healthcare information systems is intensely competitive, rapidly evolving and subject to rapid technological change. The Company believes that the principal competitive factors in this market include the breadth and quality of system and product offerings, the stability of the information systems provider, the features and capabilities of the information systems, the ongoing support for the system, and the potential for enhancements and future compatible products.

     Certain of the Company’s competitors have greater financial, technical, product development, marketing and other resources than the Company and some of its competitors offer products that it does not offer. The Company’s principal existing competitors include Siemens Medical Solutions Health Services Corporation, IDX Systems Corporation, McKesson HBOC, Inc. and Eclipsys Corporation, each of which offers a suite of products that compete with many of the Company’s products. There are other competitors that offer a more limited number of competing products.

     In addition, the Company expects that major software information systems companies, large information technology consulting service providers and system integrators, internet-based start-up companies and others specializing in the healthcare industry may offer competitive products or services. The pace of change in the healthcare information systems market is rapid and there are frequent new product introductions, product enhancements and evolving industry standards and requirements. As a result, the Company’s success will depend upon its ability to keep pace with technological change and to introduce, on a timely and cost-effective basis, new and enhanced products that satisfy changing client requirements and achieve market acceptance.

     Proprietary Technology May Be Subjected to Infringement Claims or May Be Infringed Upon - The Company relies upon a combination of trade secret, copyright and trademark laws, license agreements, confidentiality procedures, employee nondisclosure agreements and technical measures to maintain the trade secrecy of its proprietary information. The Company recently initiated a patent program but currently has a very limited patent portfolio. As a result, the Company may not be able to protect against misappropriation of its intellectual property.

     In addition, the Company could be subject to intellectual property infringement claims as the number of competitors grows and the functionality of its products overlaps with competitive offerings. These claims, even if not meritorious, could be expensive to defend. If the Company becomes liable to third parties for infringing their intellectual property rights, it could be required to pay a substantial damage award and to develop noninfringing technology, obtain a license or cease selling the products that contain the infringing intellectual property.

     Government Regulation - The United States Food and Drug Administration (the “FDA”) has declared that software products intended for the maintenance of data used in making decisions regarding the suitability of blood donors and the release of blood or blood components for transfusion are medical devices under the Federal Food, Drug and Cosmetic Act (“Act”) and amendments to the Act. As a consequence, the Company is subject to extensive regulation by the FDA with regard to its blood bank software. If other of the Company’s products are deemed to be actively regulated medical devices by the FDA, the Company could be subject to extensive requirements governing pre- and post-marketing requirements including premarket notification clearance prior to marketing. Complying with these FDA regulations would be time consuming and expensive. It is possible that the FDA may become more active in regulating computer software that is used in healthcare.

     Following an inspection by the FDA in March of 1998, the Company received a Form FDA 483 (Notice of Inspectional Observations) alleging non-compliance with certain aspects of FDA’s Quality System Regulation with respect to the Company’s PathNet HNAC Blood Bank Transfusion and Donor products (the “Blood Bank Products”). The Company subsequently received a Warning Letter, dated April 29, 1998, as a result of the same inspection. The Company responded promptly to the FDA and undertook a number of actions in response to the Form 483 and Warning Letter including an audit by a third party of the Company’s Blood Bank Products and improvements to Cerner’s Quality System. A copy of the third

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party audit was submitted to the FDA in October of 1998 and, at the request of the FDA, additional information and clarification was submitted to the FDA in January of 1999.

     There can be no assurance, however, that the Company’s actions taken in response to the Form 483 and Warning Letter will be deemed adequate by the FDA or that additional actions on behalf of the Company will not be required. In addition, the Company remains subject to periodic FDA inspections and there can be no assurances that the Company will not be required to undertake additional actions to comply with the Act and any other applicable regulatory requirements. Any failure by the Company to comply with the Act and any other applicable regulatory requirements could have a material adverse effect on the Company’s ability to continue to manufacture and distribute its products. FDA has many enforcement tools including recalls, seizures, injunctions, civil fines and/or criminal prosecutions. Any of the foregoing would have a material adverse effect on the Company’s business, results of operations or financial condition.

     Product Related Liabilities - Many of the Company’s products provide data for use by healthcare providers in providing care to patients. Although no such claims have been brought against the Company to date regarding injuries related to the use of its products, such claims may be made in the future. Although the Company maintains product liability insurance coverage in an amount that it believes is sufficient for its business, there can be no assurance that such coverage will prove to be adequate or that such coverage will continue to remain available on acceptable terms, if at all. A successful claim brought against the Company which is uninsured or under-insured could materially harm its business, results of operations or financial condition.

     System Errors and Warranties - The Company’s systems, particularly the HNA Millennium versions, are very complex. As with complex systems offered by others, the Company’s systems may contain errors, especially when first introduced. Although the Company conducts extensive testing, it has discovered software errors in its products after their introduction. The Company’s systems are intended for use in collecting and displaying clinical information used in the diagnosis and treatment of patients. Therefore, users of the Company products have a greater sensitivity to system errors than the market for software products generally. The Company’s agreements with its clients typically provide warranties against material errors and other matters. Failure of a client’s system to meet these criteria could constitute a material breach under such contracts allowing the client to cancel the contract, or could require the Company to incur additional expense in order to make the system meet these criteria. The Company’s contracts with its clients generally limit the Company’s liability arising from such claims but such limits may not be enforceable in certain jurisdictions.

     Anti-Takeover Defenses - The Company’s charter, bylaws, shareholders’ rights plan and certain provisions of Delaware law contain certain provisions that may have the effect of delaying or preventing an acquisition of the Company. Such provisions are intended to encourage any person interested in acquiring the Company to negotiate with and obtain the approval of the Board of Directors in connection with any such transaction. These provisions include (i) a Board of Directors that is staggered into three classes to serve staggered three-year terms, (ii) blank check preferred stock, (iii) supermajority voting provisions, (iv) inability of stockholders to act by written consent or call a special meeting, (v) limitations on the ability of stockholders to nominate directors or make proposals at stockholder meetings, and (vi) triggering the exercisability of stock purchase rights on a discriminatory basis, which may invoke extensive economic and voting dilution of a potential acquirer if its beneficial ownership of the Company’s common stock exceeds a specified threshold. Certain of these provisions may discourage a future acquisition of the Company not approved by the Board of Directors in which shareholders might receive a premium value for their shares.

Part II. Other Information

Item 6. Exhibits and Reports on Form 8-K.

   
(a) Exhibits
 
  10.1 Indemnification Agreement between William B. Neaves and, Registrant

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  10.2 Indemnification Agreement between Nancy-Ann DeParle and, Registrant
 
(b) Reports on Form 8-K
  Report on Form 8-K was filed on September 12, 2001.

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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
 
November 13, 2001

Date
  By:   \s\ Marc G. Naughton

Marc G. Naughton
Chief Financial Officer

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