Edgar Filing: CERNER CORP /MO/

Q3 2013 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended: September 28, 2013

( ) 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, MO		64117
(Address of principal executive offices)		(Zip Code)

(816) 201-1024

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

Indicate the number of shares outstanding of the issuer's classes of common stock, as of the latest practicable date.



Class		Outstanding at October 18, 2013
Common Stock, $0.01 par value per share		343,262,922 shares

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CERNER CORPORATION

TABLE OF CONTENTS



Part I.	Financial Information:

Item 1.	Financial Statements:

	Condensed Consolidated Balance Sheets as of September 28, 2013 (unaudited) and December 29, 2012	1

	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 28, 2013 and September 29, 2012 (unaudited)	2

	Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 28, 2013 and September 29, 2012 (unaudited)	3

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 28, 2013 and September 29, 2012 (unaudited)	4

	Notes to Condensed Consolidated Financial Statements (unaudited)	5

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	16

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27

Item 4.	Controls and Procedures	27

Part II.	Other Information:

Item 1.	Legal Proceedings	28

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28

Item 6.	Exhibits	29

Signatures

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Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

As of September 28, 2013 (unaudited) and December 29, 2012



(In thousands, except share data)	2013			2012

Assets
Current assets:
Cash and cash equivalents	$	287,520		$	317,120
Short-term investments	634,308			719,665
Receivables, net	529,303			577,848
Inventory	28,234			23,681
Prepaid expenses and other	181,208			113,572
Deferred income taxes, net	40,521			38,620
Total current assets	1,701,094			1,790,506

Property and equipment, net	724,886			569,708
Software development costs, net	323,843			267,307
Goodwill	307,523			247,616
Intangible assets, net	140,245			132,045
Long-term investments	577,493			509,467
Other assets	191,286			187,819

Total assets	$	3,966,370		$	3,704,468

Liabilities and Shareholders’ Equity

Current liabilities:
Accounts payable	$	147,016		$	141,212
Current installments of long-term debt and capital lease obligations	51,872			59,582
Deferred revenue	195,200			189,652
Accrued payroll and tax withholdings	127,531			125,253
Other accrued expenses	62,821			64,413
Total current liabilities	584,440			580,112

Long-term debt and capital lease obligations	131,030			136,557
Deferred income taxes and other liabilities	162,987			143,212
Deferred revenue	10,523			10,937
Total liabilities	888,980			870,818

Shareholders’ Equity:
Common stock, $.01 par value, 500,000,000 shares authorized, 343,727,041 shares issued at September 28, 2013 and 344,178,702 shares issued at December 29, 2012	3,437			3,442
Additional paid-in capital	782,143			840,769
Retained earnings	2,332,985			1,994,694
Treasury stock, 570,616 shares at September 28, 2013	(28,251		)	—
Accumulated other comprehensive loss, net	(12,924		)	(5,255		)
Total shareholders’ equity	3,077,390			2,833,650

Total liabilities and shareholders’ equity	$	3,966,370		$	3,704,468

See notes to condensed consolidated financial statements (unaudited).

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CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the three and nine months ended September 28, 2013 and September 29, 2012

(unaudited)



	Three Months Ended						Nine Months Ended
(In thousands, except per share data)	2013			2012			2013			2012

Revenues:
System sales	$	202,632		$	229,925		$	602,037		$	651,040
Support, maintenance and services	508,520			432,281			1,461,723			1,262,231
Reimbursed travel	16,678			14,276			51,660			41,781

Total revenues	727,830			676,482			2,115,420			1,955,052
Costs and expenses:
Cost of system sales	64,389			100,668			217,580			318,193
Cost of support, maintenance and services	38,510			34,634			103,366			95,112
Cost of reimbursed travel	16,678			14,276			51,660			41,781
Sales and client service	304,665			259,141			853,213			746,090
Software development (Includes amortization of $24,056 and $69,366 for the three and nine months ended September 28, 2013; and $20,880 and $60,353 for the three and nine months ended September 29, 2012)	82,998			78,094			246,343			222,746
General and administrative	51,352			41,973			150,995			119,912

Total costs and expenses	558,592			528,786			1,623,157			1,543,834

Operating earnings	169,238			147,696			492,263			411,218

Other income, net	3,509			3,351			9,286			8,789

Earnings before income taxes	172,747			151,047			501,549			420,007
Income taxes	(57,403		)	(52,160		)	(163,258		)	(134,583		)

Net earnings	$	115,344		$	98,887		$	338,291		$	285,424

Basic earnings per share	$	0.34		$	0.29		$	0.98		$	0.84
Diluted earnings per share	$	0.33		$	0.28		$	0.96		$	0.81
Basic weighted average shares outstanding	342,992			342,502			343,681			341,287
Diluted weighted average shares outstanding	351,449			351,739			352,332			351,033

See notes to condensed consolidated financial statements (unaudited).

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CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the three and nine months ended September 28, 2013 and September 29, 2012

(unaudited)



	Three Months Ended				Nine Months Ended
(In thousands)	2013		2012		2013			2012

Net earnings	$	115,344	$	98,887	$	338,291		$	285,424
Foreign currency translation adjustment and other (net of taxes (benefit) of $(1,366) and $(1,984) for the three and nine months ended September 28, 2013; and $(843) and $(1,478) for the three and nine months ended September 29, 2012)	10,595		6,240		(7,610		)	5,247
Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $509 and $(34) for the three and nine months ended September 28, 2013; and $321 and $338 for the three and nine months ended September 29, 2012)	801		518		(59		)	546

Comprehensive income	$	126,740	$	105,645	$	330,622		$	291,217

See notes to condensed consolidated financial statements (unaudited).

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CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the nine months ended September 28, 2013 and September 29, 2012

(unaudited)



	Nine Months Ended
(In thousands)	2013			2012

CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings	$	338,291		$	285,424
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization	189,460			162,336
Share-based compensation expense	33,650			26,304
Provision for deferred income taxes	19,573			20,679
Changes in assets and liabilities (net of businesses acquired):
Receivables, net	41,281			(31,102		)
Inventory	(3,887		)	(907		)
Prepaid expenses and other	(48,290		)	(18,322		)
Accounts payable	(19,309		)	30,596
Accrued income taxes	(6,404		)	(36,983		)
Deferred revenue	5,440			26,333
Other accrued liabilities	4,580			63,402

Net cash provided by operating activities	554,385			527,760

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital purchases	(218,406		)	(129,966		)
Capitalized software development costs	(125,951		)	(72,506		)
Purchases of investments	(832,039		)	(999,697		)
Sales and maturities of investments	825,126			663,257
Purchase of other intangibles	(39,797		)	(7,212		)
Acquisition of businesses, net of cash acquired	(67,877		)	—

Net cash used in investing activities	(458,944		)	(546,124		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt and capital lease obligations	(9,756		)	(1,772		)
Proceeds from excess tax benefits from share-based compensation	29,274			36,431
Proceeds from exercise of options	24,049			31,102
Treasury stock purchases	(170,042		)	—
Contingent consideration payments for acquisition of businesses	(800		)	(3,400		)
Other	4,823			—

Net cash provided by (used in) financing activities	(122,452		)	62,361

Effect of exchange rate changes on cash and cash equivalents	(2,589		)	958

Net increase (decrease) in cash and cash equivalents	(29,600		)	44,955
Cash and cash equivalents at beginning of period	317,120			243,146

Cash and cash equivalents at end of period	$	287,520		$	288,101

Summary of acquisition transactions:
Fair value of net tangible assets acquired	$	1,512		$	—
Fair value of intangible assets acquired	25,489			—
Fair value of goodwill	60,511			—
Less: Fair value of contingent liability payable	(18,982		)	—

Cash paid for acquisitions	68,530			—
Cash acquired	(653		)	—

Net cash used	$	67,877		$	—

See notes to condensed consolidated financial statements (unaudited).

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CERNER CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(1) Interim Statement Presentation

The condensed consolidated financial statements included herein have been prepared by Cerner Corporation (we or the Company) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our latest annual report on Form 10-K.

In management’s opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position and the results of operations and cash flows for the periods presented. Our interim results as presented in this Form 10-Q are not necessarily indicative of the operating results for the entire year.

The condensed consolidated financial statements were prepared using GAAP. These principles require us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.

Our third fiscal quarter ends on the Saturday closest to September 30. The 2013 and 2012 third quarters ended on September 28, 2013 and September 29, 2012, respectively. All references to years in these notes to condensed consolidated financial statements represent the respective three or nine months ended on such dates, unless otherwise noted.

Stock Split

On May 24, 2013, the Board of Directors of the Company approved a two-for-one split of our common stock in the form of a 100% stock dividend, which was distributed on or about June 28, 2013 to shareholders of record as of June 17, 2013. In connection with the stock split, 3.0 million treasury shares, which represented the amount held in treasury on June 28, 2013, 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

Comprehensive Income. In the first quarter of 2013, we adopted Financial Accounting Standards Board Accounting Standards Update (ASU) No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (AOCI). ASU 2013-02 requires an entity to disclose, either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of AOCI into net income and the income statement line items affected by the reclassification. If a component is not required to be reclassified to net income in its entirety, an entity would instead cross reference to the related footnote for additional information. The adoption of this standard did not impact disclosures in these condensed consolidated financial statements, as AOCI reclassification amounts are not material to the Company.

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(2) Business Acquisitions

PureWellness

On March 4, 2013, we purchased the net assets of Kaufman & Keen, LLC (doing business as PureWellness). PureWellness is a health and wellness company that develops solutions for the administration and management of wellness programs, and to enable plan member engagement strategies. Our acquisition of PureWellness will further expand what we believe to be a robust offering of solutions to manage and improve the health of populations.

Consideration for the acquisition of PureWellness is expected to total $69.2 million consisting of up-front cash plus contingent consideration, which is payable if we achieve certain revenue milestones from PureWellness solutions and services during the period commencing on August 1, 2013 and ending April 30, 2015. We valued the contingent consideration at $19.0 million based on a probability-weighted assessment of potential contingent consideration payment scenarios.

The acquisition of PureWellness is being treated as a purchase in accordance with ASC 805, Business Combinations, which requires allocation of the purchase price to the estimated fair values of assets and liabilities acquired in the transaction. The final allocation of purchase price is summarized below:



(In thousands)	Allocation Amount

Tangible assets and liabilities
Current assets	$	1,443
Property and equipment	240
Current liabilities	(1,315		)
Total net tangible assets	368

Intangible assets
Customer relationships	10,464
Existing technologies	9,805
Total intangible assets	20,269

Goodwill	48,555

Total purchase price	$	69,192

The fair values of the acquired intangible assets 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, and client attrition rates, among others. See Note (3) for further information about the fair value level hierarchy.

The goodwill of $48.6 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 PureWellness. All of the goodwill was allocated to our Domestic operating segment and is expected to be deductible for tax purposes. Identifiable intangible assets are being amortized over a weighted-average period of seven years. The operating results of PureWellness were combined with our operating results subsequent to the purchase date of March 4, 2013. 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.

Labotix

On March 18, 2013, we purchased 100% of the outstanding stock of Labotix Corporation (together with its wholly owned subsidiary Labotix Automation, Inc., Labotix). Labotix is a developer of laboratory automation solutions for clinical laboratories. We believe the combination of Cerner Millennium, Cerner Copath, and Labotix allows us to offer a comprehensive set of capabilities to support high volume laboratory testing.

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Consideration for the acquisition of Labotix was $18.0 million, which was paid in cash. The preliminary allocation of purchase price to the estimated fair value of the identified tangible and intangible assets acquired and liabilities assumed resulted in goodwill of $11.7 million and $5.2 million in intangible assets related to the value of existing technologies. The allocation of purchase price is subject to changes as a working capital adjustment is finalized and additional information becomes available; however, we do not expect material changes. The goodwill was allocated to our Domestic operating segment and is not expected to be deductible for tax purposes. Identifiable intangible assets are being amortized over a period of five years.

The operating results of Labotix were combined with our operating results subsequent to the purchase date of March 18, 2013. Pro-forma results of operations 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 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.

The following table details our financial assets measured and recorded at fair value on a recurring basis at September 28, 2013:



(In thousands)
		Fair Value Measurements Using
Description	Balance Sheet Classification	Level 1		Level 2		Level 3

Money market funds	Cash equivalents	$	66,400	$	—	$	—
Time deposits	Cash equivalents	—		9,785		—
Government and corporate bonds	Cash equivalents	—		6,210		—
Time deposits	Short-term investments	—		81,524		—
Commercial paper	Short-term investments	—		43,757		—
Government and corporate bonds	Short-term investments	—		509,027		—
Time deposits	Long-term investments	—		491		—
Government and corporate bonds	Long-term investments	—		569,840		—

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The following table details our financial assets measured and recorded at fair value on a recurring basis at December 29, 2012:



(In thousands)
		Fair Value Measurements Using
Description	Balance Sheet Classification	Level 1		Level 2		Level 3

Money market funds	Cash equivalents	$	68,267	$	—	$	—
Time deposits	Cash equivalents	—		24,068		—
Time deposits	Short-term investments	—		90,550		—
Commercial paper	Short-term investments	—		86,458		—
Government and corporate bonds	Short-term investments	—		542,657		—
Time deposits	Long-term investments	—		6,197		—
Government and corporate bonds	Long-term investments	—		496,770		—

We estimate the fair value of our long-term, fixed rate debt using a Level 3 discounted cash flow analysis based on current borrowing rates for debt with similar maturities. The fair value of our long-term debt, including current maturities, at September 28, 2013 and December 29, 2012 was approximately $48.1 million and $59.0 million, respectively. The carrying amount of such fixed-rate debt at September 28, 2013 and December 29, 2012 was $45.0 million and $54.8 million, respectively.

(4) Investments

Available-for-sale investments at September 28, 2013 were as follows:



(In thousands)	Adjusted Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

Cash equivalents:
Money market funds	$	66,400	$	—	$	—		$	66,400
Time deposits	9,785		—		—			9,785
Government and corporate bonds	6,210		—		—			6,210
Total cash equivalents	82,395		—		—			82,395

Short-term investments:
Time deposits	81,515		12		(3		)	81,524
Commercial paper	43,750		7		—			43,757
Government and corporate bonds	508,623		432		(28		)	509,027
Total short-term investments	633,888		451		(31		)	634,308

Long-term investments:
Time deposits	490		1		—			491
Government and corporate bonds	570,028		208		(396		)	569,840
Total long-term investments	570,518		209		(396		)	570,331

Total available-for-sale investments	$	1,286,801	$	660	$	(427	)	$	1,287,034

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Available-for-sale investments at December 29, 2012 were as follows:



(In thousands)	Adjusted Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

Cash equivalents:
Money market funds	$	68,267	$	—	$	—		$	68,267
Time deposits	24,068		—		—			24,068
Total cash equivalents	92,335		—		—			92,335

Short-term investments:
Time deposits	90,535		17		(2		)	90,550
Commercial paper	86,500		15		(57		)	86,458
Government and corporate bonds	542,236		497		(76		)	542,657
Total short-term investments	719,271		529		(135		)	719,665

Long-term investments:
Time deposits	6,190		10		(3		)	6,197
Government and corporate bonds	496,845		324		(399		)	496,770
Total long-term investments	503,035		334		(402		)	502,967

Total available-for-sale investments	$	1,314,641	$	863	$	(537	)	$	1,314,967

Investments reported under the cost method of accounting as of September 28, 2013 and December 29, 2012 were $7.2 million and $6.5 million, respectively.

We sold available-for-sale investments for proceeds of $109.9 million and $8.5 million during the nine months ended September 28, 2013 and September 29, 2012, respectively, resulting in insignificant gains in each period.

(5) Receivables

A summary of net receivables is as follows:



(In thousands)	September 28, 2013		December 29, 2012

Gross accounts receivable	$	532,857	$	581,386
Less: Allowance for doubtful accounts	38,142		33,230

Accounts receivable, net of allowance	494,715		548,156

Current portion of lease receivables	34,588		29,692

Total receivables, net	$	529,303	$	577,848

During the second quarter of 2008, Fujitsu Services Limited’s (Fujitsu) contract as the prime contractor in the National Health Service (NHS) initiative to automate clinical processes and digitize medical records in the Southern region of England was terminated by the NHS. This had the effect of automatically terminating our subcontract for the project. We are in dispute with Fujitsu regarding Fujitsu’s obligation to pay the amounts comprised of accounts receivable and contracts receivable related to that subcontract, and we are working with Fujitsu to resolve these issues based on processes provided for in the contract. Part of that process requires resolution of disputes between Fujitsu and the NHS regarding the contract termination. As of September 28, 2013, it remains unlikely that our matter with Fujitsu will be resolved in the next 12 months. Therefore, these receivables have been classified as long-term and represent less than the majority of other long-term assets at September 28, 2013 and December 29, 2012. 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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During the first nine months of 2013 and 2012, we received total client cash collections of $2.3 billion and $2.0 billion, respectively, of which $44.9 million and $56.2 million were received from third party arrangements with non-recourse payment assignments.

(6) 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.

Our effective tax rate was 32.6% and 32.0% for the first nine months of 2013 and 2012, respectively. This increase was primarily due to a decrease in net favorable discrete items recorded in 2013 relative to 2012, partially offset by reinstatement of the research and development credit in 2013.

In January 2013, the American Taxpayer Relief Act of 2012 (Act) became law. The Act reinstates the research and development tax credit retroactively from January 1, 2012 to December 31, 2013. In the first quarter of 2013, we recognized the research and development tax credit related to 2012 as a favorable discrete item. Research and development tax credits generated in 2013 are being recognized pro-rata as a component of the overall 2013 effective tax rate.

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(7) Earnings Per Share

A reconciliation of the numerators and the denominators of the basic and diluted per share computations are as follows:



	Three Months Ended
	2013					2012
	Earnings		Shares	Per-Share		Earnings		Shares	Per-Share
(In thousands, except per share data)	(Numerator)		(Denominator)	Amount		(Numerator)		(Denominator)	Amount

Basic earnings per share:
Income available to common shareholders	$	115,344	342,992	$	0.34	$	98,887	342,502	$	0.29
Effect of dilutive securities:
Stock options and non-vested shares	—		8,457			—		9,237
Diluted earnings per share:
Income available to common shareholders including assumed conversions	$	115,344	351,449	$	0.33	$	98,887	351,739	$	0.28

For the three months ended September 28, 2013 and September 29, 2012, options to purchase 7.2 million and 5.6 million shares of common stock at per share prices ranging from $36.92 to $50.54 and $27.62 to $42.98, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.



	Nine Months Ended
	2013					2012
	Earnings		Shares	Per-Share		Earnings		Shares	Per-Share
(In thousands, except per share data)	(Numerator)		(Denominator)	Amount		(Numerator)		(Denominator)	Amount

Basic earnings per share:
Income available to common shareholders	$	338,291	343,681	$	0.98	$	285,424	341,287	$	0.84
Effect of dilutive securities:
Stock options and non-vested shares	—		8,651			—		9,746
Diluted earnings per share:
Income available to common shareholders including assumed conversions	$	338,291	352,332	$	0.96	$	285,424	351,033	$	0.81

For the nine months ended September 28, 2013 and September 29, 2012, options to purchase 5.8 million and 4.3 million shares of common stock at per share prices ranging from $32.92 to $50.54 and $27.62 to $42.98, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.

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(8) Share-Based Compensation and Equity

Stock Options

Options activity for the nine months ended September 28, 2013 was as follows:



(In thousands, except per share data)	Number of Shares		Weighted- Average Exercise Price		Aggregate Intrinsic Value		Weighted-Average Remaining Contractual Term (Yrs)
Outstanding at beginning of year	24,072		$	16.99
Granted	3,596		47.66
Exercised	(2,472	)	10.11
Forfeited and expired	(239	)	37.77
Outstanding as of September 28, 2013	24,957		21.89		$	766,741	6.40

Exercisable as of September 28, 2013	14,255		$	10.40	$	601,743	4.92

The weighted-average assumptions used to estimate the fair value of stock options granted in 2013 were as follows:



Expected volatility (%)	30.4		%
Expected term (yrs)	9.1
Risk-free rate (%)	1.9		%
Fair value per option	$	19.46

As of September 28, 2013, there was $130.2 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 3.37 years.

Non-vested Shares

Non-vested share activity for the nine months ended September 28, 2013 was as follows:



(In thousands, except per share data)	Number of Shares		Weighted-Average Grant Date Fair Value

Outstanding at beginning of year	602		$	28.41
Granted	238		46.66
Vested	(276	)	24.00
Forfeited	(10	)	22.73

Outstanding as of September 28, 2013	554		$	38.54

As of September 28, 2013, there was $13.6 million of total unrecognized compensation cost related to non-vested share awards granted under all plans. That cost is expected to be recognized over a weighted-average period of 1.74 years.

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The following table presents total compensation expense recognized with respect to stock options, non-vested shares and our associate stock purchase plan:



	Three Months Ended						Nine Months Ended
(In thousands)	2013			2012			2013			2012

Stock option and non-vested share compensation expense	$	12,527		$	9,721		$	33,650		$	26,304
Associate stock purchase plan expense	1,168			719			2,867			2,064
Amounts capitalized in software development costs, net of amortization	(237		)	(218		)	(900		)	(600		)

Amounts charged against earnings, before income tax benefit	$	13,458		$	10,222		$	35,617		$	27,768

Amount of related income tax benefit recognized in earnings	$	5,221		$	3,910		$	13,819		$	10,621

Treasury Stock

In December 2012, our Board of Directors authorized a stock repurchase program of up to $170.0 million, excluding transaction costs, of our common stock. The repurchases were to be effectuated in the open market, by block purchase, or possibly through other transactions managed by broker-dealers.

During the nine months ended September 28, 2013, we repurchased 3.6 million shares for total consideration of $170.0 million. These shares were recorded as treasury stock and accounted for under the cost method. Repurchased shares at the time of the stock split were utilized to settle a portion of the stock split distribution, as further described in Note 1 of these notes to condensed consolidated financial statements. As of September 28, 2013, the program is complete.

Authorized Shares

Effective May 24, 2013, we amended our Second Restated Certificate of Incorporation of Cerner Corporation to increase the number of authorized shares of our common stock from 250,000,000 to 500,000,000 shares.

(9) Hedging Activities

The following table represents the fair value of our net investment hedge included within the condensed consolidated balance sheets:



(In thousands)		Fair Value
Derivatives Designated	Balance Sheet Classification	September 28, 2013		December 29, 2012

Net investment hedge	Short-term liabilities	$	14,986	$	15,015
Net investment hedge	Long-term liabilities	29,973		30,030

Total net investment hedge		$	44,959	$	45,045

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



(In thousands)		Net Unrealized Gain (Loss) For the Three Months Ended						Net Unrealized Gain (Loss) For the Nine Months Ended
Derivatives Designated	Balance Sheet Classification	2013			2012			2013		2012

Net investment hedge	Short-term liabilities	$	(523	)	$	(262	)	$	2	$	(362	)
Net investment hedge	Long-term liabilities	(1,058		)	(786		)	2		(1,085		)

Total net investment hedge		$	(1,581	)	$	(1,048	)	$	4	$	(1,447	)

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(10) Contingencies

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

(11) 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. “Other” includes expenses that have not been allocated to the operating segments, such as software development, marketing, general and administrative, share-based compensation expense and depreciation. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such. Items such as interest, income taxes, capital expenditures and total assets are managed at the consolidated level and thus are not included in our operating segment disclosures. Accounting policies for each of the reportable segments are the same as those used on a consolidated basis.

The following table presents a summary of our operating segments and other expense for the three and nine months ended September 28, 2013 and September 29, 2012:



(In thousands)	Domestic		Global		Other			Total

Three Months Ended 2013
Revenues	$	641,541	$	86,289	$	—		$	727,830

Cost of revenues	107,560		12,017		—			119,577
Operating expenses	148,478		34,078		256,459			439,015
Total costs and expenses	256,038		46,095		256,459			558,592

Operating earnings (loss)	$	385,503	$	40,194	$	(256,459	)	$	169,238



(In thousands)	Domestic		Global		Other			Total

Three Months Ended 2012
Revenues	$	591,327	$	85,155	$	—		$	676,482

Cost of revenues	131,663		17,915		—			149,578
Operating expenses	131,787		32,794		214,627			379,208
Total costs and expenses	263,450		50,709		214,627			528,786

Operating earnings (loss)	$	327,877	$	34,446	$	(214,627	)	$	147,696



(In thousands)	Domestic		Global		Other			Total

Nine Months Ended 2013
Revenues	$	1,837,171	$	278,249	$	—		$	2,115,420

Cost of revenues	327,356		45,250		—			372,606
Operating expenses	439,345		84,685		726,521			1,250,551
Total costs and expenses	766,701		129,935		726,521			1,623,157

Operating earnings (loss)	$	1,070,470	$	148,314	$	(726,521	)	$	492,263

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(In thousands)	Domestic		Global		Other			Total

Nine Months Ended 2012
Revenues	$	1,707,259	$	247,793	$	—		$	1,955,052

Cost of revenues	403,618		51,468		—			455,086
Operating expenses	372,668		97,616		618,464			1,088,748
Total costs and expenses	776,286		149,084		618,464			1,543,834

Operating earnings (loss)	$	930,973	$	98,709	$	(618,464	)	$	411,218

(12) Related Party Transactions

On July 30, 2013, our wholly owned subsidiary, Cerner Property Development, Inc., entered into a Real Estate Purchase Agreement (the "Agreement") with Trails Properties II, Inc., a Missouri corporation ("Trails"), to purchase approximately 237 acres of land located in Kansas City, Missouri. Trails is an entity controlled by Neal Patterson, Chairman of the Board of Directors and Chief Executive Officer of Cerner Corporation, and Clifford Illig, Vice Chairman of the Board of Directors of Cerner Corporation. The total purchase price of the property is $45.5 million, subject to adjustment under the Agreement. The transaction is expected to close, on or about December 27, 2013, subject to certain conditions defined in the Agreement. The property is being acquired as a site for future office space development to accommodate our anticipated growth.

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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 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 2013 and 2012 third quarters ended on September 28, 2013 and September 29, 2012, respectively. All references to years in this MD&A represent the respective three or nine months ended on such dates, unless otherwise noted.

Except for the historical information and discussions contained herein, statements contained in this quarterly report on Form 10-Q may constitute “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements can often be identified by the use of forward-looking terminology, such as "could," "should," “will,” "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast," “plan,” “guidance” or “estimate” or the negative of these words, variations thereof or similar expressions. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including without limitation: the possibility of product-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities; our proprietary technology may be subject to claims for infringement or misappropriation of intellectual property rights of others, or may be infringed or misappropriated by others; risks associated with our non-U.S. operations; risks associated with our ability to effectively hedge exposure to fluctuations in foreign currency exchange rates; the potential for tax legislation initiatives that could adversely affect our tax position and/or challenges to our tax positions in the United States and non-U.S. countries; risks associated with our recruitment and retention of key personnel; risks related to our reliance on third party suppliers; risks inherent with business acquisitions; the potential for losses resulting from asset impairment charges; risks associated with the uncertainty in global economic conditions; managing growth in the new markets in which we offer solutions, health care devices and services; changing political, economic, regulatory and judicial influences; government regulation; significant competition and market changes; variations in our quarterly operating results; potential inconsistencies in our sales forecasts compared to actual sales; volatility in the trading price of our common stock and the timing and volume of market activity; the authority of our Board of Directors to issue preferred stock and anti-takeover provisions contained in our corporate governance documents; material adverse resolution of legal proceedings; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials incorporated herein or therein by reference. Forward looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as to the date they are made. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.

Management Overview

Our revenues are primarily derived by selling, implementing and supporting software solutions, clinical content, hardware, devices and services that give health care providers secure access to clinical, administrative and financial data in real time, allowing them to improve quality, safety and efficiency in the delivery of health care.

Our fundamental strategy centers on creating organic growth by investing in research and development (R&D) to create solutions and services for the health care industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 12% or more. This growth has also created an important strategic footprint in health care, with Cerner^® solutions licensed by approximately 10,000 facilities around the world, including more than 2,700 hospitals; 4,150 physician practices; 45,000 physicians; 550 ambulatory facilities, such as laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics and surgery centers; 800 home health facilities; 45 employer sites and 1,750 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

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aligning with health care providers that have not yet selected a supplier and by displacing competitors in health care settings that are looking to replace their current supplier.

We expect to drive growth through new initiatives and services that reflect our ongoing ability to innovate and expand our reach into health care. Examples of these include our CareAware^® health care device architecture and devices, employer services, Cerner ITWorks^SM services, revenue cycle solutions, such as Cerner RevWorks^SM services, and population health solutions and services. Finally, we believe there is significant opportunity for growth outside of the United States, with many non-U.S. markets focused on health care information technology 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 compound annual rates of more than 20% over the most recent five- and ten-year periods. We expect to drive continued earnings growth through ongoing revenue growth coupled with margin expansion, which we expect to achieve through efficiencies in our implementation and operational processes and by leveraging R&D investments and controlling general and administrative expenses.

We are also focused on continuing to deliver strong levels of cash flow, which we expect to accomplish by continuing to grow earnings and prudently managing capital expenditures.

Results Overview

The Company delivered strong levels of bookings and earnings, and solid revenue and operating cash flow in the third quarter of 2013.

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $928.0 million in the third quarter of 2013, which is an increase of 21% compared to $769.9 million in the third quarter of 2012. Revenues for the third quarter of 2013 increased 8% to $727.8 million compared to $676.5 million in the third quarter of 2012. The year-over-year increase in revenue reflects ongoing demand for Cerner's core solutions and services driven by the HITECH Act and other regulatory requirements, and increased contributions from newer areas, such as Cerner ITWorks and Cerner revenue cycle solutions and services.

Third quarter 2013 net earnings increased 17% to $115.3 million compared to $98.9 million in the third quarter of 2012. Diluted earnings per share increased 18% to $0.33 compared to $0.28 in the third quarter of 2012. The growth in net earnings and diluted earnings per share was driven by strong growth in services and higher margin components of system sales that more than offset a decline in technology resale. Additionally, our margin expansion initiatives, which include creating efficiencies in our implementation and operational processes, have contributed to our earnings growth.

Third quarter 2013 and 2012 net earnings and diluted earnings per share reflect the impact of stock-based compensation expense. The effect of these expenses reduced the third quarter 2013 net earnings and diluted earnings per share by $8.2 million and $0.02, respectively, and the third quarter 2012 net earnings and diluted earnings per share by $6.3 million and $0.02, respectively.

Our third quarter 2013 operating margin of 23% reflects an increase of 140 basis points compared to 2012, which was driven by the previously discussed margin expansion efforts and a lower mix of low-margin technology resale revenue.

We had cash collections of receivables of $766.1 million in the third quarter of 2013 compared to $661.7 million in the third quarter of 2012. Days sales outstanding was 66 days for the third quarter of 2013 compared to 68 days for the second quarter of 2013 and 73 days for the third quarter of 2012. Operating cash flows for the third quarter of 2013 were $164.2 million compared to $182.2 million in the third quarter of 2012.

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Results of Operations

Three Months Ended September 28, 2013 Compared to Three Months Ended September 29, 2012

The following table presents a summary of the operating information for the third quarters of 2013 and 2012:



(In thousands)	2013			% of Revenue		2012			% of Revenue		% Change
Revenues
System sales	$	202,632		28	%	$	229,925		34	%	(12	)%
Support and maintenance	166,308			23	%	154,333			23	%	8	%
Services	342,212			47	%	277,948			41	%	23	%
Reimbursed travel	16,678			2	%	14,276			2	%	17	%

Total revenues	727,830			100	%	676,482			100	%	8	%

Costs of revenue
Costs of revenue	119,577			16	%	149,578			22	%	(20	)%

Total margin	608,253			84	%	526,904			78	%	15	%

Operating expenses
Sales and client service	304,665			42	%	259,141			38	%	18	%
Software development	82,998			11	%	78,094			12	%	6	%
General and administrative	51,352			7	%	41,973			6	%	22	%

Total operating expenses	439,015			60	%	379,208			56	%	16	%

Total costs and expenses	558,592			77	%	528,786			78	%	6	%

Operating earnings	169,238			23	%	147,696			22	%	15	%

Other income, net	3,509					3,351
Income taxes	(57,403		)			(52,160		)

Net earnings	$	115,344				$	98,887				17	%

Revenues & Backlog

Revenues increased 8% to $727.8 million in the third quarter of 2013, as compared to $676.5 million in the third quarter of 2012.

•

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, decreased 12% to $202.6 million in the third quarter of 2013 from $229.9 million for the same period in 2012. The decrease in system sales was driven by lower levels of technology resale, which more than offset growth in subscriptions and software as a service.

•

Support and maintenance revenues increased 8% to $166.3 million in the third quarter of 2013 compared to $154.3 million during the same period in 2012. This increase was attributable to continued success at selling Cerner Millennium® applications and implementing them at client sites. We expect that support and maintenance revenues will continue to grow as the base of installed Cerner Millennium systems grows.

•

Services revenue, which includes professional services, excluding installation, and managed services, increased 23% to $342.2 million in the third quarter of 2013 from $277.9 million for the same period in 2012. This increase was driven by growth in CernerWorks^SMmanaged services as a result of continued demand for our hosting services and an increase in professional services due to increased implementation and consulting activities and growth in Cerner ITWorks and Cerner RevWorks services.

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Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 26% in the third quarter of 2013 when compared to the same period in 2012. 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 and Cerner RevWorks services bookings that typically have longer contract terms. A summary of our total backlog follows:



(In thousands)	September 28, 2013		September 29, 2012

Contract backlog	$	7,627,181	$	6,061,500
Support and maintenance backlog	769,847		723,687

Total backlog	$	8,397,028	$	6,785,187

Costs of Revenue

Cost of revenues as a percentage of total revenues was 16% in the third quarter of 2013, compared to 22% in the same period of 2012. The lower cost of revenues as a percent of revenue was driven by a lower mix of technology resale, which carries a higher cost of revenue.

Cost of revenues includes the cost of reimbursed travel expense, sales commissions, third party consulting services and subscription content and computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, devices, maintenance, support, services and reimbursed travel) carrying different margin rates changes from period to period. Cost of revenues does not include the costs of our client service personnel who are responsible for delivering our service offerings. Such costs are included in sales and client service expense.

Operating Expenses

Total operating expenses increased 16% to $439.0 million in the third quarter of 2013, compared with $379.2 million in the third quarter of 2012.

•

Sales and client service expenses as a percent of total revenues were 42% in the third quarter of 2013, compared to 38% in the same period of 2012. These expenses increased 18% to $304.7 million in the third quarter of 2013, from $259.1 million in the same period of 2012. 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 as a percent of revenue reflects a higher mix of services during the quarter that was driven by strong services revenue growth and the decline in technology resale revenue.

•

Software development expenses as a percent of revenue were 11% in the third quarter of 2013, compared to 12% in the same period of 2012. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium platform, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. A summary of our total software development expense in the third quarters of 2013 and 2012 is as follows:



	Three Months Ended
(In thousands)	2013			2012

Software development costs	$	106,986		$	82,873
Capitalized software costs	(47,492		)	(25,126		)
Capitalized costs related to share-based payments	(552		)	(533		)
Amortization of capitalized software costs	24,056			20,880

Total software development expense	$	82,998		$	78,094

•

General and administrative expenses as a percent of total revenues were 7% in the third quarter of 2013, compared to 6% in the same period of 2012. These expenses increased 22% to $51.4 million in 2013, from $42.0 million for the same period in 2012. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency and expense for share-based payments. The increase in general

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and administrative expenses was primarily driven by an increase in corporate personnel costs, as we have continued to increase such personnel to support our overall revenue growth, and an increase in amortization expense due to acquired intangibles.

Non-Operating Items


•	Other income was $3.5 million in the third quarter of 2013 and $3.4 million in the same period of 2012.


•	Our effective tax rate was 33.2% for the third quarter of 2013 and 34.5% for the third quarter of 2012. This decrease was primarily due to reinstatement of the research and development credit in 2013. Refer to Note (6) of the notes to condensed consolidated financial statements.

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, Brazil, Canada, Cayman Islands, Chile, Egypt, England, France, Germany, Guam, India, Ireland, Israel, Malaysia, Mexico, Qatar, Saudi Arabia, Singapore, Spain, Switzerland and the United Arab Emirates.

The following table presents a summary of the operating information for the third quarters of 2013 and 2012:



(In thousands)	2013			% of Revenue	2012			% of Revenue	% Change

Domestic Segment
Revenues	$	641,541		100%	$	591,327		100%	8%

Costs of revenue	107,560			17%	131,663			22%	(18)%
Operating expenses	148,478			23%	131,787			22%	13%
Total costs and expenses	256,038			40%	263,450			45%	(3)%

Domestic operating earnings	385,503			60%	327,877			55%	18%

Global Segment
Revenues	86,289			100%	85,155			100%	1%

Costs of revenue	12,017			14%	17,915			21%	(33)%
Operating expenses	34,078			39%	32,794			39%	4%
Total costs and expenses	46,095			53%	50,709			60%	(9)%

Global operating earnings	40,194			47%	34,446			40%	17%

Other, net	(256,459		)		(214,627		)		19%

Consolidated operating earnings	$	169,238			$	147,696			15%

Domestic Segment


•	Revenues increased 8% to $641.5 million in the third quarter of 2013 from $591.3 million in the same period of 2012. This increase was driven by strong growth across most of our business, offset by lower levels of technology resale.


•	Cost of revenues was 17% of revenues in the third quarter of 2013, compared to 22% of revenues in the same period of 2012. The lower cost of revenues as a percent of revenue was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue.


•	Operating expenses increased 13% to $148.5 million in the third quarter of 2013 from $131.8 million in the same period of 2012, due primarily to growth in professional services expenses.

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Global Segment


•	Revenues increased 1% to $86.3 million in the third quarter of 2013 from $85.2 million in the same period of 2012. This increase was primarily driven by growth in professional services.


•	Cost of revenues was 14% in the third quarter of 2013 and 21% in the same period of 2012. The lower cost of revenues in 2013 was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue.


•	Operating expenses were at $34.1 million in the third quarter of 2013, compared to $32.8 million in the same period of 2012, primarily due to an increase in bad debt 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 $256.5 million in the third quarter of 2013 from $214.6 million in the same period of 2012. This increase was primarily due to growth in corporate and development personnel costs, along with increased depreciation and amortization related to acquired assets. This was partially offset by increased software capitalization.

Nine Months Ended September 28, 2013 Compared to Nine Months Ended September 29, 2012

The following table presents a summary of the operating information for the first nine months of 2013 and 2012:



(In thousands)	2013			% of Revenue		2012			% of Revenue		% Change
Revenues
System sales	$	602,037		28	%	$	651,040		33	%	(8	)%
Support and maintenance	491,824			23	%	450,584			23	%	9	%
Services	969,899			46	%	811,647			42	%	19	%
Reimbursed travel	51,660			2	%	41,781			2	%	24	%

Total revenues	2,115,420			100	%	1,955,052			100	%	8	%

Costs of revenue
Costs of revenue	372,606			18	%	455,086			23	%	(18	)%

Total margin	1,742,814			82	%	1,499,966			77	%	16	%

Operating expenses
Sales and client service	853,213			40	%	746,090			38	%	14	%
Software development	246,343			12	%	222,746			11	%	11	%
General and administrative	150,995			7	%	119,912			6	%	26	%

Total operating expenses	1,250,551			59	%	1,088,748			56	%	15	%

Total costs and expenses	1,623,157			77	%	1,543,834			79	%	5	%

Operating earnings	492,263			23	%	411,218			21	%	20	%

Other income, net	9,286					8,789
Income taxes	(163,258		)			(134,583		)

Net earnings	$	338,291				$	285,424				19	%

Revenues & Backlog

Revenues increased 8% to $2.1 billion in the first nine months of 2013, as compared to $2.0 billion in the first nine months of 2012.


•	System sales decreased 8% to $602.0 million in the first nine months of 2013 from $651.0 million for the same period in 2012. The decrease in system sales was driven by lower levels of technology resale, which more than offset growth in subscriptions and software as a service.

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•

Support and maintenance revenues increased 9% to $491.8 million in the first nine months of 2013 compared to $450.6 million during the same period in 2012. This increase was attributable to continued success at selling Cerner Millennium applications and implementing them at client sites. We expect that support and maintenance revenues will continue to grow as the base of installed Cerner Millennium systems grows.

•

Services revenue increased 19% to $969.9 million in the first nine months of 2013 from $811.6 million for the same period in 2012. This increase was driven by growth in CernerWorksmanaged services as a result of continued demand for our hosting services and an increase in professional services due to increased implementation and consulting activities and growth in Cerner ITWorks and Cerner RevWorks services.

Costs of Revenue

Cost of revenues as a percentage of total revenues was 18% in the first nine months of 2013, compared to 23% in the same period of 2012. The lower cost of revenues as a percent of revenue was driven by a lower mix of technology resale, which carries a higher cost of revenue.

Operating Expenses

Total operating expenses increased 15% to $1.3 billion in the first nine months of 2013, compared with $1.1 billion in the same period of 2012.

•

Sales and client service expenses as a percent of total revenues were 40% in the first nine months of 2013, compared to 38% in the same period of 2012. These expenses increased 14% to $853.2 million in the first nine months of 2013, from $746.1 million in the same period of 2012. The increase as a percent of revenue reflects a higher mix of services in 2013 that has been driven by strong services revenue growth and the decline in technology resale revenue.

•

Software development expenses as a percent of revenue were 12% in the first nine months of 2013, compared to 11% in the same period of 2012. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium platform, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. A summary of our total software development expense in the first nine months of 2013 and 2012 is as follows:



	Nine Months Ended
(In thousands)	2013			2012

Software development costs	$	302,928		$	234,899
Capitalized software costs	(124,105		)	(70,960		)
Capitalized costs related to share-based payments	(1,846		)	(1,546		)
Amortization of capitalized software costs	69,366			60,353

Total software development expense	$	246,343		$	222,746

•

General and administrative expenses as a percent of total revenues were 7% in the first nine months of 2013, compared to 6% in the same period of 2012. These expenses increased 26% to $151.0 million in 2013, from $119.9 million for the same period in 2012. The increase in general and administrative expenses was primarily driven by an increase in corporate personnel costs, as we have continued to increase such personnel to support our overall revenue growth, and an increase in amortization expense due to acquired intangibles.

Non-Operating Items


•	Other income increased to $9.3 million in the first nine months of 2013 from $8.8 million in the same period of 2012. The increase is primarily due to lower interest expense as a result of payments on our long-term debt and capitalized interest related to the construction of our new campus in Kansas City, Kansas.


•	Our effective tax rate was 32.6% for the first nine months of 2013 and 32.0% for the first nine months of 2012. This increase was primarily due to a decrease in net favorable discrete items recorded in 2013 relative to 2012, partially offset by reinstatement of the research and development credit in 2013. Refer to Note (6) of the notes to condensed consolidated financial statements.

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Operations by Segment

The following table presents a summary of the operating information for the first nine months of 2013 and 2012:



(In thousands)	2013			% of Revenue	2012			% of Revenue	% Change

Domestic Segment
Revenues	$	1,837,171		100%	$	1,707,259		100%	8%

Costs of revenue	327,356			18%	403,618			24%	(19)%
Operating expenses	439,345			24%	372,668			22%	18%
Total costs and expenses	766,701			42%	776,286			45%	(1)%

Domestic operating earnings	1,070,470			58%	930,973			55%	15%

Global Segment
Revenues	278,249			100%	247,793			100%	12%

Costs of revenue	45,250			16%	51,468			21%	(12)%
Operating expenses	84,685			30%	97,616			39%	(13)%
Total costs and expenses	129,935			47%	149,084			60%	(13)%

Global operating earnings	148,314			53%	98,709			40%	50%

Other, net	(726,521		)		(618,464		)		17%

Consolidated operating earnings	$	492,263			$	411,218			20%

Domestic Segment


•	Revenues increased 8% to $1.8 billion in the first nine months of 2013 from $1.7 billion in the first nine months of 2012. This increase was driven by strong growth across most of our business, offset by lower levels of technology resale.


•	Cost of revenues was 18% of revenues in the first nine months of 2013, compared to 24% of revenues in the same period of 2012. The lower cost of revenues as a percent of revenue was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue.


•	Operating expenses increased 18% to $439.3 million in the first nine months of 2013 from $372.7 million in the same period of 2012, due primarily to growth in managed services and professional services expenses.

Global Segment


•	Revenues increased 12% to $278.2 million in the first nine months of 2013 from $247.8 million in the same period of 2012. This increase was driven by growth across most of our business, offset by lower levels of technology resale.


•	Cost of revenues was 16% in the first nine months of 2013 and 21% in the same period of 2012, due to a lower mix of technology resale.


•	Operating expenses were at $84.7 million in the first nine months of 2013, compared to $97.6 million in the same period of 2012, primarily due to a decrease in bad debt expense.

Other, net

These expenses increased 17% to $726.5 million in the first nine months of 2013 from $618.5 million in the same period of 2012. This increase was primarily due to growth in corporate and development personnel costs, along with increased depreciation and amortization related to acquired assets. This was partially offset by increased software capitalization.

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 amount we invest in software development, acquisitions and capital expenditures.

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Our principal sources of liquidity are our cash, cash equivalents, which primarily consist of money market funds and time deposits with original maturities of less than 90 days, and short-term investments. At September 28, 2013, we had cash and cash equivalents of $287.5 million and short-term investments of $634.3 million, as compared to cash and cash equivalents of $317.1 million and short-term investments of $719.7 million at December 29, 2012.

Approximately 17% of our aggregate cash, cash equivalents and short-term investments at September 28, 2013 were held outside of the United States. As part of our business strategy, we plan to indefinitely reinvest the earnings of our foreign operations; however, should the earnings of our foreign operations be repatriated, we would accrue and pay tax on such earnings, which may be material.

Additionally, we maintain a $100.0 million multi-year revolving credit facility, which expires in February 2017. The facility provides an unsecured revolving line of credit for working capital purposes, along with a letter of credit facility. Interest is payable at a rate based on prime, LIBOR, or the U.S. federal funds rate, plus a spread that varies depending on the leverage ratios maintained. The agreement provides certain restrictions on our ability to borrow, incur liens, sell assets and pay dividends and contains certain cash flow and liquidity covenants. As of September 28, 2013, we were in compliance with all debt covenants. As of September 28, 2013, we had no outstanding borrowings under this agreement; however, we had $17.2 million of outstanding letters of credit, which reduced our available borrowing capacity to $82.8 million.

We believe that our present cash position, together with cash generated from operations, short-term investments and, if necessary, our available line of credit, will be sufficient to meet anticipated cash requirements for the next twelve months.

The following table summarizes our cash flows in the first nine months of 2013 and 2012:



	Nine Months Ended
(In thousands)	2013			2012

Cash flows from operating activities	$	554,385		$	527,760
Cash flows from investing activities	(458,944		)	(546,124		)
Cash flows from financing activities	(122,452		)	62,361
Effect of exchange rate changes on cash	(2,589		)	958
Total change in cash and cash equivalents	(29,600		)	44,955

Cash and cash equivalents at beginning of period	317,120			243,146

Cash and cash equivalents at end of period	$	287,520		$	288,101

Free cash flow (non-GAAP)	$	210,028		$	325,288

Cash from Operating Activities



	Nine Months Ended
(In thousands)	2013			2012

Cash collections from clients	$	2,268,812		$	2,024,529
Cash paid to employees and suppliers and other	(1,545,440		)	(1,364,643		)
Cash paid for interest	(4,677		)	(3,790		)
Cash paid for taxes, net of refunds	(164,310		)	(128,336		)

Total cash from operations	$	554,385		$	527,760

Cash flow from operations increased $26.6 million in the first nine months of 2013 when compared to the same period of 2012 due primarily to the increase in cash impacting earnings, partially offset by cash used to fund working capital requirements. During the first nine months of 2013 and 2012, we received total client cash collections of $2.3 billion and $2.0 billion, of which 2% and 3%, respectively, were received from third party client financing arrangements and non-recourse payment assignments. Days sales outstanding was 66 days in the third quarter of 2013, 68 days in the second quarter of 2013 and 73 days in the third quarter of 2012. Revenues provided under support and maintenance agreements represent recurring cash flows. Support and maintenance revenues increased 9% in the first nine months of 2013 compared to the same period of 2012. We expect these revenues to continue to grow as the base of installed Cerner Millennium systems grows.

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Cash from Investing Activities



	Nine Months Ended
(In thousands)	2013			2012

Capital purchases	$	(218,406	)	$	(129,966	)
Capitalized software development costs	(125,951		)	(72,506		)
Purchases of investments, net of sales and maturities	(6,913		)	(336,440		)
Purchases of other intangibles	(39,797		)	(7,212		)
Acquisition of businesses, net of cash acquired	(67,877		)	—

Total cash flows from investing activities	$	(458,944	)	$	(546,124	)

Cash flows from investing activities consist primarily of capital spending and our short-term investment activities. The increased level of capital spending has been driven by capitalized equipment purchases primarily to support growth in our CernerWorks managed services business, building and improvement purchases to support our facilities requirements and capitalized spending to support our ongoing software development initiatives. Capital spending is expected to remain at elevated levels for the remainder of 2013, primarily due to capital purchases associated with new office space and spending related to software development initiatives; however, we still expect solid levels of free cash flow.

Short-term investment activity consists of the investment of cash generated by our business in excess of what is necessary to fund operations. The decline in net investment activity from 2012 is primarily due to the increased capital spending discussed above, along with cash used in the first quarter of 2013 to acquire businesses, and cash used for the stock repurchase program described below.

During 2013, we acquired the net assets of PureWellness and 100% of the outstanding stock of Labotix for $67.5 million, net of cash acquired. We expect to continue seeking and completing strategic business acquisitions that are complementary to our business.

Cash from Financing Activities



	Nine Months Ended
(In thousands)	2013			2012

Repayment of long-term debt and capital lease obligations	$	(9,756	)	$	(1,772	)
Cash from option exercises (including excess tax benefits)	53,323			67,533
Treasury stock purchases	(170,042		)	—
Other, net	4,023			(3,400		)

Total cash flows from financing activities	$	(122,452	)	$	62,361

Cash inflows from stock option exercises are dependent on a number of factors, including the price of our common stock, grant activity under our stock option and equity plans, and overall market volatility. We expect cash inflows from stock option exercises to continue throughout 2013 based on the number of exercisable options as of September 28, 2013 and our current stock price.

In December 2012, our Board of Directors authorized a stock repurchase program of up to $170.0 million of our common stock. During the nine months ended September 28, 2013, we repurchased 3.6 million shares for total consideration of $170.0 million. All of the repurchased shares at the time of the stock split were utilized to settle a portion of the stock split distribution, as further described in Note 1 of the notes to condensed consolidated financial statements. As of September 28, 2013, the program is complete.

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Free Cash Flow



	Three Months Ended						Nine Months Ended
(In thousands)	2013			2012			2013			2012

Cash flows from operating activities (GAAP)	$	164,230		$	182,213		$	554,385		$	527,760
Capital purchases	(83,419		)	(51,802		)	(218,406		)	(129,966		)
Capitalized software development costs	(48,044		)	(25,659		)	(125,951		)	(72,506		)

Free cash flow (non-GAAP)	$	32,767		$	104,752		$	210,028		$	325,288

Free cash flow decreased $115.3 million in the first nine months of 2013 compared to the same period in 2012. This decrease is primarily due to increased capital spending in 2013 to support our facilities requirements and capitalized spending to support our ongoing software development initiatives. 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 and 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, because free cash flow takes into account the capital expenditures necessary to operate our business.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

No material changes.

Item 4. Controls and Procedures

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 this quarterly report on Form 10-Q (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 to allow timely decisions regarding required disclosure.


b)	There were no changes in the Company’s internal controls over financial reporting during the fiscal quarter ended September 28, 2013, that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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 1. Legal Proceedings

On April 19, 2012, Trinity Medical Center in Minot, North Dakota (Trinity) advised that it was transitioning away from Cerner’s patient accounting software solution and certain IT services provided by Cerner, alleging that the patient accounting solution purchased in 2008 was defective and did not deliver the promised benefits. Cerner disputes the allegations. Trinity is continuing as a client of Cerner for its clinical solutions. Trinity has alleged damages totaling approximately $240 million and has provided an expert witness report that purports to support such damage claim. Cerner's expert witness, however, has estimated Trinity's total damages, assuming any liability by Cerner, of up to $4 million. Following discussions, the parties agreed to arbitrate the dispute, including Cerner's counterclaim, and a hearing commenced October 9, 2013.

Cerner believes that a material loss related to this matter is remote. Cerner currently has 147 hospitals and 735 clinics using its patient accounting solution. Cerner's assessment is based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause Cerner to change those estimates and assumptions. Cerner is vigorously defending the claims asserted against Cerner by Trinity, for which Cerner believes it has meritorious defenses, but there can be no assurances as to the arbitration’s outcome.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The table below provides information with respect to Common Stock purchases by the Company during the third fiscal quarter of 2013.



(In thousands, except per share data)	Total Number of Shares Purchased (a)	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (b)	Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (b)
Period	Total Number of Shares Purchased (a)	Average Price Paid per Share
June 30, 2013 - July 27, 2013	—	—		—	$	28,209
July 28, 2013 - August 24, 2013	571	$	49.49	571	—
August 25, 2013 - September 28, 2013	1	46.91		—	—

Total	572	$	49.48	571

(a)

Of the 572 thousand shares of common stock, par value $0.01 per share, presented on the table above, one thousand were originally granted to employees as restricted stock pursuant to our 2011 Omnibus Equity Incentive Plan (the Plan). The Plan allows for the withholding of shares to satisfy minimum tax obligations due upon the vesting of restricted stock, and pursuant to the Plan, the shares reflected above were relinquished by employees in exchange for our agreement to pay federal and state withholding obligations resulting from the vesting of the Company’s restricted stock.

(b)

As announced on December 12, 2012, our Board of Directors authorized a stock repurchase program for an aggregate purchase of up to $170.0 million of our Common Stock. During the nine months ended September 28, 2013, the Company repurchased 3.6 million shares for total consideration of $170.0 million pursuant to a Rule 10b5-1 plan. Refer to Note (8) of the notes to condensed consolidated financial statements for further information regarding our stock repurchase program.

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Item 6. Exhibits



(a)		Exhibits

31.1		Certification of Neal L. Patterson pursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2		Certification of Marc G. Naughton pursuant to Section 302 of Sarbanes-Oxley Act of 2002

32.1		Certification of Neal L. Patterson pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002

32.2		Certification of Marc G. Naughton pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of 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

Date: October 25, 2013	By:	/s/ Marc G. Naughton
		Marc G. Naughton
		Executive Vice President and Chief
		Financial Officer (duly authorized
		officer and principal financial officer)