Document
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X)    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 29, 2018
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
cernerlogosmalla04.jpg
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) 221-1024
(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 every Interactive Data File required to be submitted 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 such files).
Yes [X]     No [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]    Accelerated filer [  ]    Non-accelerated filer [  ]    Smaller reporting company [  ] Emerging growth company [  ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. [ ]
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 17, 2018
Common Stock, $0.01 par value per share
  
329,488,284 shares

Table of Contents

CERNER CORPORATION

TABLE OF CONTENTS
 
Part I.
Financial Information:
 
 
 
 
Item 1.
Financial Statements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II.
Other Information:
 
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
Signatures
 


Table of Contents

Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 29, 2018 (unaudited) and December 30, 2017
(In thousands, except share data)
2018
 
2017
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
498,614

 
$
370,923

Short-term investments
314,932

 
434,844

Receivables, net
1,210,616

 
1,042,781

Inventory
24,744

 
15,749

Prepaid expenses and other
337,904

 
515,930

Total current assets
2,386,810

 
2,380,227

 
 
 
 
Property and equipment, net
1,697,249

 
1,603,319

Software development costs, net
882,257

 
822,159

Goodwill
848,237

 
853,005

Intangible assets, net
420,542

 
479,753

Long-term investments
338,233

 
196,837

Other assets
212,072

 
134,011

 
 
 
 
Total assets
$
6,785,400

 
$
6,469,311

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
258,431

 
$
218,996

Current installments of long-term debt and capital lease obligations
2,318

 
11,585

Deferred revenue
352,778

 
311,337

Accrued payroll and tax withholdings
233,011

 
183,770

Other accrued expenses
60,487

 
63,907

Total current liabilities
907,025

 
789,595

 
 
 
 
Long-term debt and capital lease obligations
438,781

 
515,130

Deferred income taxes and other liabilities
369,547

 
365,674

Deferred revenue
4,317

 
13,564

Total liabilities
1,719,670

 
1,683,963

 
 
 
 
Shareholders' Equity:
 
 
 
Common stock, $.01 par value, 500,000,000 shares authorized, 361,866,683 shares issued at September 29, 2018 and 359,204,864 shares issued at December 30, 2017
3,619

 
3,592

Additional paid-in capital
1,527,224

 
1,380,371

Retained earnings
5,445,205

 
4,938,866

Treasury stock, 32,436,972 shares at September 29, 2018 and 26,743,517 shares at December 30, 2017
(1,809,309
)
 
(1,464,099
)
Accumulated other comprehensive loss, net
(101,009
)
 
(73,382
)
Total shareholders' equity
5,065,730

 
4,785,348

 
 
 
 
Total liabilities and shareholders' equity
$
6,785,400

 
$
6,469,311


See notes to condensed consolidated financial statements (unaudited).

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Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and nine months ended September 29, 2018 and September 30, 2017
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands, except per share data)
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Revenues
$
1,340,073

 
$
1,276,007

 
$
4,000,661

 
$
3,828,487

Costs and expenses:
 
 
 
 
 
 
 
Costs of revenue
230,332

 
202,904

 
700,393

 
624,960

Sales and client service
605,946

 
564,621

 
1,830,999

 
1,688,208

Software development (Includes amortization of $53,429 and $155,571 for the three and nine months ended September 29, 2018, respectively; and $44,358 and $126,346 for the three and nine months ended September 30, 2017, respectively)
172,297

 
153,834

 
502,192

 
442,570

General and administrative
102,789

 
84,178

 
290,547

 
263,203

Amortization of acquisition-related intangibles
21,553

 
22,564

 
65,872

 
68,126

 
 
 
 
 
 
 
 
Total costs and expenses
1,132,917

 
1,028,101

 
3,390,003

 
3,087,067

 
 
 
 
 
 
 
 
Operating earnings
207,156

 
247,906

 
610,658

 
741,420

 
 
 
 
 
 
 
 
Other income, net
6,943

 
2,509

 
18,404

 
4,054

 
 
 
 
 
 
 
 
Earnings before income taxes
214,099

 
250,415

 
629,062

 
745,474

Income taxes
(44,718
)
 
(72,991
)
 
(130,323
)
 
(215,154
)
 
 
 
 
 
 
 
 
Net earnings
$
169,381

 
$
177,424

 
$
498,739

 
$
530,320

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.51

 
$
0.53

 
$
1.51

 
$
1.60

Diluted earnings per share
$
0.51

 
$
0.52

 
$
1.49

 
$
1.57

Basic weighted average shares outstanding
329,342

 
331,993

 
330,789

 
331,319

Diluted weighted average shares outstanding
332,937

 
338,780

 
334,493

 
337,946

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 29, 2018 and September 30, 2017
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Net earnings
$
169,381

 
$
177,424

 
$
498,739

 
$
530,320

Foreign currency translation adjustment and other (net of taxes (benefit) of $(13) and $572 for the three and nine months ended September 29, 2018; and $(100) and $991 for the three and nine months ended September 30, 2017)
(8,907
)
 
10,806

 
(27,924
)
 
37,369

Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $181 and $97 for the three and nine months ended September 29, 2018; and $(1) and $34 for the three and nine months ended September 30, 2017)
553

 
(2
)
 
297

 
55

 
 
 
 
 
 
 
 
Comprehensive income
$
161,027

 
$
188,228

 
$
471,112

 
$
567,744


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 29, 2018 and September 30, 2017
(unaudited)
 
Nine Months Ended
(In thousands)
2018
 
2017
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
498,739

 
$
530,320

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
473,748

 
425,241

Share-based compensation expense
74,348

 
59,217

Provision for deferred income taxes
16,412

 
36,667

Changes in assets and liabilities:
 
 
 
Receivables, net
(250,042
)
 
(19,080
)
Inventory
(9,006
)
 
(909
)
Prepaid expenses and other
162,053

 
(11,908
)
Accounts payable
21,762

 
(12,651
)
Accrued income taxes
(9,150
)
 
1,984

Deferred revenue
34,316

 
12,749

Other accrued liabilities
33,940

 
(62,865
)
 
 
 
 
Net cash provided by operating activities
1,047,120

 
958,765

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(305,951
)
 
(262,372
)
Capitalized software development costs
(209,122
)
 
(210,033
)
Purchases of investments
(477,156
)
 
(337,010
)
Sales and maturities of investments
454,439

 
237,912

Purchase of other intangibles
(24,304
)
 
(22,186
)
 
 
 
 
Net cash used in investing activities
(562,094
)
 
(593,689
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of long-term debt
(75,000
)
 
—

Proceeds from exercise of stock options
82,001

 
61,688

Payments to taxing authorities in connection with shares directly withheld from associates
(9,749
)
 
(7,989
)
Treasury stock purchases
(345,210
)
 
(23,389
)
Contingent consideration payments for acquisition of businesses
(1,691
)
 
(2,671
)
Other
3,945

 
—

 
 
 
 
Net cash provided by (used in) financing activities
(345,704
)

27,639

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(11,631
)
 
9,478

 
 
 
 
Net increase in cash and cash equivalents
127,691

 
402,193

Cash and cash equivalents at beginning of period
370,923

 
170,861

 
 
 
 
Cash and cash equivalents at end of period
$
498,614

 
$
573,054

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

Basis of Presentation

The condensed consolidated financial statements included herein have been prepared by Cerner Corporation ("Cerner," the "Company," "we," "us" or "our") 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.

Fiscal Period End

Our third fiscal quarter ends on the Saturday closest to September 30. The 2018 and 2017 third quarters ended on September 29, 2018 and September 30, 2017, 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.

Supplemental Disclosures of Cash Flow Information
 
 
 
Nine Months Ended
(In thousands)
 
 
2018
 
2017
Cash paid during the period for:
 
 
 
 
 
Interest (including amounts capitalized of $9,318 and $7,760, respectively)
 
 
$
15,568

 
$
17,175

Income taxes, net of refunds
 
 
(47,462
)
 
167,859


Accounting Pronouncements Adopted in 2018

Revenue Recognition. In the first quarter of 2018, we adopted new revenue guidance. Refer to Note (2) for further details.

Financial Instruments. In January 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which was subsequently amended in February 2018 by ASU 2018-03, Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This new guidance addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Such guidance impacts how we account for our investments reported under the cost method of accounting as follows:

•
Equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are required to be measured at fair value with changes in fair value recognized in net earnings. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.


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•
The impairment assessment of equity investments without readily determinable fair values will require a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value.
We adopted this new guidance effective for our first quarter of 2018. Provisions within the guidance applicable to the Company were required to be applied prospectively. We have elected to measure our cost method investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. At September 29, 2018, we had cost method investments of $277 million, which do not have readily determinable fair values. Such investments are included in long-term investments in our condensed consolidated balance sheets. We did not record any changes in the measurement of such investments during the nine months ended September 29, 2018.
Internal-Use Software. In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract (a consensus of the FASB Emerging Issues Task Force). Such guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 is effective for the Company in the first quarter of 2020, with early adoption permitted, and either prospective or retrospective application accepted. The Company adopted the standard early, in the third quarter of 2018, and elected prospective application. The adoption of such guidance did not have a material impact on our condensed consolidated financial statements and related disclosures.

Recently Issued Accounting Pronouncements

Leases. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which introduces a new model that requires most leases to be reported on the balance sheet and aligns many of the underlying principles of the new lessor model with those in the new revenue recognition standard. The standard requires the use of the modified retrospective (cumulative effect) transition approach. ASU 2016-02 is effective for the Company in the first quarter of 2019, with early adoption permitted. We are currently evaluating the effect that ASU 2016-02 will have on our consolidated financial statements and related disclosures, and we do not expect to early adopt.

In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which includes new transition guidance for the adoption of ASU 2016-02. Such guidance creates an additional transition method allowing entities to use the effective date of ASU 2016-02 as the date of initial application on transition. Under this method, entities will not be required to recast comparative periods when transitioning to the new guidance. Entities will also not be required to present comparative period disclosures under the new guidance in the period of adoption. We expect to select this new transition method upon our adoption in the first quarter of 2019.

In the third quarter of 2018, we continued our analysis of contractual arrangements that may qualify as leases under the new standard. We currently expect the most significant impact of this new guidance will be the recognition of right-of-use assets and lease liabilities for our operating leases of office space. At December 30, 2017, we disclosed aggregate minimum future payments under these arrangements of $124 million within Note 16, Commitments in our most recent Form 10-K. We do not expect the new standard to have a significant impact on our consolidated statements of operations.

Our analysis and evaluation of the new standard will continue through the effective date in the first quarter of 2019. We must complete our analysis of contractual arrangements, quantify all impacts of this new guidance, and evaluate related disclosures. We must also implement any necessary changes/modifications to processes, accounting systems, and internal controls.

Credit Losses on Financial Instruments. In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which provides new guidance regarding the measurement and recognition of credit impairment for certain financial assets. Such guidance will impact how we determine our allowance for estimated uncollectible receivables and evaluate our available-for-sale investments for impairment. ASU 2016-13 is effective for the Company in the first quarter of 2020, with early adoption permitted in the first quarter of 2019. We are currently evaluating the effect that ASU 2016-13 will have on our consolidated financial statements and related disclosures, and we have not determined if we will early adopt.

Callable Debt Securities. In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities, which shortens the amortization period for certain investments in callable debt securities purchased at a premium by requiring the premium be amortized to

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the earliest call date. Such guidance will impact how premiums are amortized on our available-for-sale investments. ASU 2017-08 is effective for the Company in the first quarter of 2019, with early adoption permitted. The standard requires the use of the modified retrospective (cumulative effect) transition approach. We do not expect ASU 2017-08 to have a material impact on our consolidated financial statements and related disclosures, and we do not expect to early adopt.

Accumulated Other Comprehensive Income. In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income ("AOCI") to retained earnings for "stranded tax effects" resulting from certain U.S. tax reform enacted in December 2017. Such "stranded tax effects" were created when deferred tax assets and liabilities related to items in AOCI were remeasured at the lower U.S. corporate tax rate in the period of enactment. ASU 2018-02 is effective for the Company in the first quarter of 2019, with early adoption permitted. The guidance in this ASU is to be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. corporate tax rate was recognized. We are currently evaluating the effect that ASU 2018-02 will have on our consolidated financial statements and related disclosures, and we do not expect to early adopt.

Shareholders' Equity. In August 2018, the Securities and Exchange Commission ("SEC") issued SEC Final Rule Release No. 33-10532, Disclosure Update and Simplification. Such guidance, among other things, extends to interim periods the annual requirement in SEC Regulation S-X, Rule 3-04 to disclose changes in shareholders' equity. Under the requirements in SEC Regulation S-X, Rules 8-03(a)(5) and 10-01(a)(7), as amended by this new guidance, registrants must now analyze changes in shareholders' equity, in the form of a reconciliation, for the current and comparative year-to-date interim periods, with subtotals for each interim period. This guidance is effective for filings submitted on or after November 5, 2018. We expect to satisfy this new disclosure requirement in future Form 10-Q filings by presenting a separate condensed consolidated statement of shareholders' equity.

(2) Revenue Recognition

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 replaced most existing revenue recognition guidance in U.S. GAAP. The new standard introduces a five-step process to be followed in determining the amount and timing of revenue recognition. It also provides guidance on accounting for costs incurred to obtain or fulfill contracts with customers, and establishes disclosure requirements which are more extensive than those required under prior U.S. GAAP.

ASU 2014-09, as amended ("Topic 606"), was effective for the Company in the first quarter of 2018. We selected the modified retrospective (cumulative effect) transition method of adoption. Such method provides that the cumulative effect from prior periods upon applying the new guidance to contracts which were not complete as of the adoption date, be recognized in our condensed consolidated balance sheets as of December 31, 2017, including an adjustment to retained earnings. A summary of such cumulative effect adjustment is as follows:

(In thousands)
 
 
Increase /
(Decrease)
 
 
 
 
Receivables, net
 
 
$
(79,492
)
Prepaid expenses and other
 
 
(2,253
)
Other assets
 
 
81,157

Accounts payable
 
 
(9,361
)
Deferred income taxes and other liabilities
 
 
1,173

Retained earnings
 
 
7,600


Prior periods were not retrospectively adjusted. The impact of applying Topic 606 (versus prior U.S. GAAP) increased revenues by $44 million and $108 million, and earnings before income taxes by $24 million and $37 million, for the three and nine months ended September 29, 2018, respectively. This impact is primarily driven by certain new contracts in 2018, which include certain specified upgrades for which we are allowed to estimate stand-alone selling price when allocating transaction consideration to performance obligations. Under prior U.S. GAAP, we would not have been able to establish vendor specific

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objective evidence of fair value for such items, as further discussed in our most recent annual report on Form 10-K, and thus would have had to delay the timing of revenue recognition for such contracts.

The application of Topic 606 (versus prior U.S. GAAP) did not have a significant impact on other line items in our condensed consolidated statements of operations, statements of comprehensive income, and statements of cash flows for the three and nine month periods ended September 29, 2018. Additionally, the application of Topic 606 did not have a significant impact on our condensed consolidated balance sheet as of September 29, 2018.

Revenue Recognition Policy

We enter into contracts with customers that may include various combinations of our software solutions and related services, which are generally capable of being distinct and accounted for as separate performance obligations. The predominant model of customer procurement involves multiple deliverables and includes a software license agreement, project-related implementation and consulting services, software support, hosting services, and computer hardware. We allocate revenues to each performance obligation within an arrangement based on estimated relative stand-alone selling price. Revenue is then recognized for each performance obligation upon transfer of control of the software solution or services to the customer in an amount that reflects the consideration we expect to receive.

Generally, we recognize revenue under Topic 606 for each of our performance obligations as follows:

•
Perpetual software licenses - We recognize perpetual software license revenues when control of such licenses are transferred to the client ("point in time"). We determine the amount of consideration allocated to this performance obligation using the residual approach.

•
Software as a service - We recognize software as a service ratably over the related hosting period ("over time").

•
Time-based software and content license fees - We recognize a license component of time-based software and content license fees upon delivery to the client ("point in time") and a non-license component (i.e. support) ratably over the respective contract term ("over time").

•
Hosting - Remote hosting recurring services are recognized ratably over the hosting service period ("over time"). Certain of our hosting arrangements contain fees deemed to be a "material right" under Topic 606. We recognize such fees over the term that will likely affect the client's decision about whether to renew the related hosting service ("over time").

•
Services - We recognize revenue for fixed fee services arrangements over time, utilizing a labor hours input method. For fee-for-service arrangements, we recognize revenue over time as hours are worked at the rates clients are invoiced, utilizing the "as invoiced" practical expedient available in Topic 606. For stand-ready services arrangements, we recognize revenue ratably over the related service period.

•
Support and maintenance - We recognize support and maintenance fees ratably over the related contract period ("over time").

•
Hardware - We recognize hardware revenues when control of such hardware/devices is transferred to the client ("point in time").

•
Transaction processing - We recognize transaction processing revenues ratably as we provide such services ("over time").

Such revenues are recognized net of any taxes collected from customers and subsequently remitted to governmental authorities.


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Disaggregation of Revenue

The following tables present revenues disaggregated by our business models:

 
Three Months Ended
 
2018
 
2017(1)
(In thousands)
Domestic
Segment
Global
Segment
Total
 
Domestic
Segment
Global
Segment
Total
 
 
 
 
 
 
 
 
Licensed software
$
132,447

$
7,441

$
139,888

 
$
133,339

$
11,176

$
144,515

Technology resale
51,097

9,281

60,378

 
49,793

7,153

56,946

Subscriptions
73,792

5,323

79,115

 
116,144

6,416

122,560

Professional services
400,695

56,030

456,725

 
354,390

46,494

400,884

Managed services
278,019

23,981

302,000

 
243,454

20,130

263,584

Support and maintenance
229,202

48,578

277,780

 
213,728

49,633

263,361

Reimbursed travel
22,902

1,285

24,187

 
23,123

1,034

24,157

 
 
 
 
 
 
 
 
Total revenues
$
1,188,154

$
151,919

$
1,340,073

 
$
1,133,971

$
142,036

$
1,276,007

 
 
 
 
 
 
 
 
(1)As noted above, prior period amounts were not adjusted upon our adoption of Topic 606.

 
Nine Months Ended
 
2018
 
2017(1)
(In thousands)
Domestic
Segment
Global
Segment
Total
 
Domestic
Segment
Global
Segment
Total
 
 
 
 
 
 
 
 
Licensed software
$
417,761

$
29,334

$
447,095

 
$
412,766

$
29,963

$
442,729

Technology resale
171,135

27,876

199,011

 
176,664

17,521

194,185

Subscriptions
220,063

18,639

238,702

 
336,914

17,857

354,771

Professional services
1,168,079

177,232

1,345,311

 
1,050,567

142,795

1,193,362

Managed services
785,951

69,906

855,857

 
728,760

56,322

785,082

Support and maintenance
693,217

148,083

841,300

 
646,114

138,925

785,039

Reimbursed travel
69,108

4,277

73,385

 
69,644

3,675

73,319

 
 
 
 
 
 
 
 
Total revenues
$
3,525,314

$
475,347

$
4,000,661

 
$
3,421,429

$
407,058

$
3,828,487

 
 
 
 
 
 
 
 
(1)As noted above, prior period amounts were not adjusted upon our adoption of Topic 606.

The following table presents our revenues disaggregated by timing of revenue recognition:

 
Three Months Ended
 
Nine Months Ended
 
2018
 
2018
(In thousands)
Domestic
Segment
Global
Segment
Total
 
Domestic
Segment
Global
Segment
Total
 
 
 
 
 
 
 
 
Revenue recognized over time
$
1,078,029

$
137,594

$
1,215,623

 
$
3,169,402

$
425,991

$
3,595,393

Revenue recognized at a point in time
110,125

14,325

124,450

 
355,912

49,356

405,268

 
 
 
 
 
 
 
 
Total revenues
$
1,188,154

$
151,919

$
1,340,073

 
$
3,525,314

$
475,347

$
4,000,661




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Transaction Price Allocated to Remaining Performance Obligations

As of September 29, 2018, the aggregate amount of transaction price allocated to performance obligations that are unsatisfied (or partially unsatisfied) for executed contracts approximates $14.70 billion of which we expect to recognize approximately 30% of the revenue over the next 12 months and the remainder thereafter.

Contract Liabilities

Our payment arrangements with clients typically include an initial payment due upon contract signing and date-based licensed software payment terms and payments based upon delivery for services, hardware and sublicensed software. Customer payments received in advance of satisfaction of the related performance obligations are deferred as contract liabilities. Such amounts are classified in our condensed consolidated balance sheets as either current or long-term deferred revenue. During the nine months ended September 29, 2018, substantially all of our contract liability balance at the beginning of such period was recognized in revenues.

Costs to Obtain or Fulfill a Contract

We have determined the only significant incremental costs incurred to obtain contracts with clients within the scope of Topic 606 are sales commissions paid to our associates. We record sales commissions as an asset, and amortize to expense ratably over the remaining performance periods of the related contracts with remaining performance obligations. At September 29, 2018, our condensed consolidated balance sheet includes an $84 million asset related to sales commissions to be expensed in future periods, which is included in other assets.

During the three and nine months ended September 29, 2018, we recognized $12 million and $30 million, respectively, of amortization related to this sales commissions asset, which is included in costs of revenue in our condensed consolidated statements of operations.

Significant Judgments when Applying Topic 606

Our contracts with clients typically include various combinations of our software solutions and related services. Determining whether such software solutions and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Specifically, judgment is required to determine whether software licenses are distinct from services and hosting included in an arrangement.

Contract transaction price is allocated to performance obligations using estimated stand-alone selling price. Judgment is required in estimating stand-alone selling price for each distinct performance obligation. We determine stand-alone selling price maximizing observable inputs such as stand-alone sales when they exist or substantive renewal prices charged to clients. In instances where stand-alone selling price is not observable, we utilize an estimate of stand-alone selling price. Such estimates are derived from various methods that include: cost plus margin, historical pricing practices, and the residual approach, which requires a considerable amount of judgment.

The labor hours input method used for our fixed fee services performance obligation is dependent on our ability to reliably estimate the direct labor hours to complete a project, which may span several years. We utilize our historical project experience and detailed planning process as a basis for our future estimates to complete current projects.

Certain of our arrangements contain variable consideration. We do not believe our estimates of variable consideration to be significant to our determination of revenue recognition.

Practical Expedients

We have reflected the aggregate effect of all contract modifications occurring prior to the Topic 606 adoption date when (i) identifying the satisfied and unsatisfied performance obligations, (ii) determining the transaction price, and (iii) allocating the transaction price to the satisfied and unsatisfied performance obligations.


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(3) Receivables

Receivables consist of client receivables and the current portion of amounts due under sales-type leases.

Client receivables represent recorded revenues that have either been billed, or for which we have an unconditional right to invoice and receive payment in the future. We periodically provide long-term financing options to creditworthy clients through extended payment terms. Generally, these extended payment terms provide for date-based payments over a fixed period, not to exceed the term of the overall arrangement. Thus, our portfolio of client contracts contains a financing component, which is recognized over time as a component of other income, net in our condensed consolidated statements of operations.

Lease receivables represent our net investment in sales-type leases resulting from the sale of certain health care devices to our clients.

We perform ongoing credit evaluations of our clients and generally do not require collateral from our clients. We provide an allowance for estimated uncollectible accounts based on specific identification, historical experience and our judgment.

A summary of net receivables is as follows:
(In thousands)
September 29, 2018
 
December 30, 2017
 
 
 
 
Client receivables
$
1,256,678

 
$
1,082,886

Less: Allowance for doubtful accounts
59,318

 
52,786

 
 
 
 
Client receivables, net of allowance
1,197,360

 
1,030,100

 
 
 
 
Current portion of lease receivables
13,256

 
12,681

 
 
 
 
Total receivables, net
$
1,210,616

 
$
1,042,781


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. This gave rise to the termination of our subcontract for the project. We continue to be in dispute with Fujitsu regarding Fujitsu's obligation to pay amounts due upon termination, including our client receivables and damages for pre-termination losses. We are working with Fujitsu to resolve these issues based on processes provided for in the subcontract. Part of that process required final resolution of disputes between Fujitsu and the NHS regarding the prime contract termination, which has now occurred. As of September 29, 2018, it remains unlikely that our matter with Fujitsu will be resolved in the next 12 months. Therefore, these client receivables have been classified as long-term and represent less than the majority of other long-term assets at September 29, 2018 and December 30, 2017. While the ultimate collectability of the client 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. Nevertheless, it is reasonably possible that our estimates regarding collectability of such amounts might materially change.

During the first nine months of 2018 and 2017, we received total client cash collections of $3.99 billion and $4.06 billion, respectively.
 

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(4) Investments

Available-for-sale investments at September 29, 2018 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
151,635

 
$
—

 
$
—

 
$
151,635

Time deposits
 
59,869

 
—

 
—

 
59,869

Commercial paper
 
14,350

 
—

 
—

 
14,350

Total cash equivalents
 
225,854

 
—

 
—

 
225,854

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
30,485

 
—

 
—

 
30,485

Commercial paper
 
34,450

 
—

 
(24
)
 
34,426

Government and corporate bonds
 
251,060

 
—

 
(1,039
)
 
250,021

Total short-term investments
 
315,995

 
—

 
(1,063
)
 
314,932

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
57,043

 
5

 
(187
)
 
56,861

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
598,892


$
5


$
(1,250
)

$
597,647


Available-for-sale investments at December 30, 2017 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
99,472

 
$
—

 
$
—

 
$
99,472

Time deposits
 
60,226

 
—

 
—

 
60,226

Government and corporate bonds
 
850

 
—

 
—

 
850

Total cash equivalents
 
160,548

 
—

 
—

 
160,548

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
40,186

 
—

 
—

 
40,186

Commercial paper
 
147,646

 
2

 
(139
)
 
147,509

Government and corporate bonds
 
247,626

 
—

 
(477
)
 
247,149

Total short-term investments
 
435,458

 
2

 
(616
)
 
434,844

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
185,478

 
—

 
(1,026
)
 
184,452

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
781,484

 
$
2

 
$
(1,642
)
 
$
779,844


We sold available-for-sale investments for proceeds of $45 million and $29 million during the nine months ended September 29, 2018 and September 30, 2017, respectively, resulting in insignificant gains/losses in each period.

Other Investments

On July 27, 2018 we acquired a minority interest in Essence Group Holdings Corporation ("Essence Group") for cash consideration of $266 million under a Stock Purchase Agreement ("SPA") dated July 9, 2018. Such investment is presented in long-term investments in our condensed consolidated balance sheets and is accounted for under the cost method of accounting.


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Concurrently with the execution of the SPA, we announced a strategic operating relationship with Lumeris Healthcare Outcomes, LLC ("Lumeris"), a subsidiary of Essence Group, pursuant to which we will collaborate to bring to market an EHR-agnostic offering, Maestro AdvantageTM, designed to help providers who participate in value-based arrangements, including Medicare Advantage and provider-sponsored health plans, control costs and improve outcomes. Additionally, we sold certain solutions to Lumeris for an aggregate contract value of $28 million, most of which is to be recognized as revenue ratably over the next two years.

(5) 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 29, 2018:
(In thousands)
 
 
 
 
 
 

 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
151,635

 
$
—

 
$
—

Time deposits
 
Cash equivalents
 
—

 
59,869

 
—

Commercial paper
 
Cash equivalents
 
—

 
14,350

 
—

Time deposits
 
Short-term investments
 
—

 
30,485

 
—

Commercial paper
 
Short-term investments
 
—

 
34,426

 
—

Government and corporate bonds
 
Short-term investments
 
—

 
250,021

 
—

Government and corporate bonds
 
Long-term investments
 
—

 
56,861

 
—



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The following table details our financial assets measured and recorded at fair value on a recurring basis at December 30, 2017:
(In thousands)
 
 
 
 
 
 
 
 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
99,472

 
$
—

 
$
—

Time deposits
 
Cash equivalents
 
—

 
60,226

 
—

Government and corporate bonds
 
Cash equivalents
 
—

 
850

 
—

Time deposits
 
Short-term investments
 
—

 
40,186

 
—

Commercial paper
 
Short-term investments
 
—

 
147,509

 
—

Government and corporate bonds
 
Short-term investments
 
—

 
247,149

 
—

Government and corporate bonds
 
Long-term investments
 
—

 
184,452

 
—

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. We estimate the fair value of our long-term, variable rate debt using a Level 3 discounted cash flow analysis based on LIBOR rate forward curves. The fair value of our long-term debt, including current maturities, at September 29, 2018 and December 30, 2017 was approximately $426 million and $519 million, respectively. The carrying amount of such debt at September 29, 2018 and December 30, 2017 was $425 million and $500 million, respectively.

(6) Long-term Debt and Capital Lease Obligations

The following is a summary of indebtedness outstanding:
(In thousands)
September 29, 2018
 
December 30, 2017
 
 
 
 
Senior Notes
$
425,000

 
$
500,000

Capital lease obligations
2,318

 
13,068

Other
14,162

 
14,162

 
 
 
 
  Debt and capital lease obligations
441,480

 
527,230

Less: debt issuance costs
(381
)
 
(515
)
 
 
 
 
  Debt and capital lease obligations, net
441,099

 
526,715

Less: current portion
(2,318
)
 
(11,585
)
 
 
 
 
  Long-term debt and capital lease obligations
$
438,781

 
$
515,130


In March 2018, we repaid our $75 million floating rate Series 2015-C Notes due February 15, 2022.

(7) 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.

H.R. 1, An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018 ("U.S. Tax Reform"), was enacted on December 22, 2017. U.S. Tax Reform provides for, among other things, the reduction of the U.S. corporate tax rate from 35% to 21%, effective January 1, 2018. Relevant accounting guidance provides that the impact of U.S. Tax Reform, as of the date of enactment, may be provisionally recorded and adjusted during a measurement period of up to one year. As of December 30, 2017, we provisionally recorded certain impacts of U.S. Tax Reform including an adjustment to our net deferred tax liability arising from the reduction in the federal tax rate as well as the impact of mandatory deemed repatriation. Additional analysis and computations are being performed with respect to these provisional amounts. The ultimate impact as of the enactment date may differ from the provisional amounts we have

14
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recorded, possibly materially, due to among other things, additional regulatory guidance that may be issued and changes to our assumptions and interpretations. Measurement period adjustments recorded during the nine months ended September 29, 2018 did not have a significant impact on our condensed consolidated financial statements.

Our effective tax rate was 20.7% and 28.9% for the first nine months of 2018 and 2017, respectively. The decrease in the effective tax rate in 2018 is primarily due to the aforementioned reduction in the U.S. corporate statutory tax rate from 35% to 21%.

(8) 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
 
2018
 
2017
 
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
$
169,381

 
329,342

 
$
0.51

 
$
177,424

 
331,993

 
$
0.53

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

 
3,595

 
 
 
—

 
6,787

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
169,381

 
332,937

 
$
0.51

 
$
177,424

 
338,780

 
$
0.52


For the three months ended September 29, 2018 and September 30, 2017, options to purchase 13.0 million and 11.0 million shares of common stock at per share prices ranging from $50.04 to $73.40 and $50.04 to $73.40, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.
 
Nine Months Ended
 
2018
 
2017
 
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
$
498,739

 
330,789

 
$
1.51

 
$
530,320

 
331,319

 
$
1.60

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

 
3,704

 
 
 
—

 
6,627

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
498,739

 
334,493

 
$
1.49

 
$
530,320

 
337,946

 
$
1.57


For the nine months ended September 29, 2018 and September 30, 2017, options to purchase 12.7 million and 10.4 million shares of common stock at per share prices ranging from $50.04 to $73.40 and $47.38 to $73.40, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.


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Table of Contents

(9) Share-Based Compensation and Equity

Stock Options

Stock option activity for the nine months ended September 29, 2018 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
21,332

 
$
49.40

 
 
 
 
Granted
3,582

 
58.34

 
 
 
 
Exercised
(2,316
)
 
35.71

 
 
 
 
Forfeited and expired
(378
)
 
62.75

 
 
 
 
Outstanding as of September 29, 2018
22,220

 
52.04

 
$
287,526

 
6.49
 
 
 
 
 
 
 
 
Exercisable as of September 29, 2018
11,235

 
$
44.07

 
$
234,623

 
4.66

The weighted-average assumptions used to estimate the fair value, under the Black-Scholes-Merton pricing model, of stock options granted during the nine months ended September 29, 2018 were as follows:
Expected volatility (%)
 
27.0
%
Expected term (yrs)
 
7

Risk-free rate (%)
 
2.8
%
Fair value per option
 
$
20.12

As of September 29, 2018, there was $164 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 3.41 years.
Non-vested Shares and Share Units

Non-vested share and share unit activity for the nine months ended September 29, 2018 was as follows:
(In thousands, except per share data)
Number of Shares
 
Weighted-Average
Grant Date Fair Value
 
 
 
 
Outstanding at beginning of year
799

 
$
66.76

Granted
531

 
59.34

Vested
(426
)
 
65.93

Forfeited
(20
)
 
63.43

 
 
 
 
Outstanding as of September 29, 2018
884

 
$
62.77

As of September 29, 2018, there was $38 million of total unrecognized compensation cost related to non-vested share and share unit awards granted under all plans. That cost is expected to be recognized over a weighted-average period of 2.10 years.

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Share-Based Compensation Cost

The following table presents total compensation expense recognized with respect to stock options, non-vested shares and share units, and our associate stock purchase plan:
 
Three Months Ended
 
Nine Months Ended
(In thousands)
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Stock option and non-vested share and share unit compensation expense
$
25,209

 
$
19,858

 
$
74,348

 
$
59,217

Associate stock purchase plan expense
1,407

 
1,546

 
4,685

 
4,516

Amounts capitalized in software development costs, net of amortization
266

 
(45
)
 
587

 
(365
)
 
 
 
 
 
 
 
 
Amounts charged against earnings, before income tax benefit
$
26,882

 
$
21,359

 
$
79,620

 
$
63,368

 
 
 
 
 
 
 
 
Amount of related income tax benefit recognized in earnings
$
5,615

 
$
6,226

 
$
16,483

 
$
18,289


Treasury Stock

In May 2017, our Board of Directors authorized a share repurchase program that allows the Company to repurchase up to $500 million of shares of our common stock, excluding transaction costs. The repurchases are to be effectuated in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers. No time limit was set for the completion of the program. In May 2018, our Board of Directors approved an amendment to the repurchase program that was authorized in May 2017. Under the amendment, the Company was authorized to repurchase up to an additional $500 million of shares of our common stock, for an aggregate of $1 billion, excluding transaction costs. During the nine months ended September 29, 2018, we repurchased 5.7 million shares for total consideration of $345 million under the program. The shares were recorded as treasury stock and accounted for under the cost method. No repurchased shares have been retired. At September 29, 2018, $582 million remains available for repurchase under the program.

(10) Contingencies

We accrue estimates for resolution of any legal and other contingencies when losses are probable and reasonably estimable, in accordance with Accounting Standards Codification Topic 450, 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 judgments or settlements to third parties related to these indemnification provisions pertaining to intellectual property infringement claims. For several reasons, including the lack of a sufficient number 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.

In addition to commitments and obligations in the ordinary course of business, we are subject to various legal proceedings and claims that arise in the ordinary course of business, including for example, employment and client disputes and litigation alleging solution and implementation defects, personal injury, intellectual property infringement, violations of law and breaches of contract and warranties. Many of these proceedings are at preliminary stages and many seek an indeterminate amount of damages. At this time, we do not believe the range of potential losses under these claims to be material to our condensed consolidated financial statements.

No less than quarterly, we review the status of each significant matter and assess our potential financial exposure. We accrue a liability for an estimated loss if the potential loss from any legal proceeding or claim is considered probable and the amount can be reasonably estimated. Significant judgment is required in both the determination of probability and the determination as to whether the amount of an exposure is reasonably estimable, and accruals are based only on the information available to our management at the time the judgment is made. Furthermore, the outcome of legal proceedings is inherently uncertain, and we may incur substantial defense costs and expenses defending any of these matters. Should any one or a combination of more than one of these proceedings be successful, or should we determine to settle any one or a combination of these matters, we may be required to pay substantial sums, become subject to the entry of an injunction or be forced to change

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Table of Contents

the manner in which we operate our business, which could have a material adverse impact on our business, results of operations, cash flows or financial condition.

(11) Segment Reporting

We have two operating segments, Domestic and Global. Revenues are derived primarily from the sale of clinical, financial and administrative information solutions and services. 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, expenses associated with our managed services business, marketing expenses, communications expenses and unreimbursed travel expenses. "Other" includes expenses that have not been allocated to the operating segments, such as software development, general and administrative expenses, acquisition costs and related adjustments, share-based compensation expense, and certain amortization and depreciation. Performance of the segments is assessed at the operating earnings level by our chief operating decision maker, who is our Chief Executive Officer. Items such as interest, income taxes, capital expenditures and total assets are managed at the consolidated level and thus are not included in our operating segment disclosures. Accounting policies for each of the reportable segments are the same as those used on a consolidated basis.

The following table presents a summary of our operating segments and other expense for the three and nine months ended September 29, 2018 and September 30, 2017:
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2018
 
 
 
 
 
 
 
Revenues
$
1,188,154

 
$
151,919

 
$
—

 
$
1,340,073

 
 
 
 
 
 
 
 
Costs of revenue
202,980

 
27,352

 
—

 
230,332

Operating expenses
532,958

 
67,220

 
302,407

 
902,585

Total costs and expenses
735,938

 
94,572


302,407

 
1,132,917

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
452,216

 
$
57,347

 
$
(302,407
)
 
$
207,156

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2017
 
 
 
 
 
 
 
Revenues
$
1,133,971

 
$
142,036

 
$
—

 
$
1,276,007

 
 
 
 
 
 
 
 
Costs of revenue
176,198

 
26,706

 
—

 
202,904

Operating expenses
502,256

 
68,229

 
254,712

 
825,197

Total costs and expenses
678,454

 
94,935

 
254,712

 
1,028,101

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
455,517

 
$
47,101

 
$
(254,712
)
 
$
247,906

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Nine Months Ended 2018
 
 
 
 
 
 
 
Revenues
$
3,525,314

 
$
475,347

 
$
—

 
$
4,000,661

 
 
 
 
 
 
 
 
Costs of revenue
617,839

 
82,554

 
—

 
700,393

Operating expenses
1,604,297

 
209,771

 
875,542

 
2,689,610

Total costs and expenses
2,222,136

 
292,325

 
875,542

 
3,390,003

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
1,303,178

 
$
183,022

 
$
(875,542
)
 
$
610,658


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(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Nine Months Ended 2017
 
 
 
 
 
 
 
Revenues
$
3,421,429

 
$
407,058

 
$
—

 
$
3,828,487

 
 
 
 
 
 
 
 
Costs of revenue
549,895

 
75,065

 
—

 
624,960

Operating expenses
1,474,591

 
197,333

 
790,183

 
2,462,107

Total costs and expenses
2,024,486

 
272,398

 
790,183

 
3,087,067

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
1,396,943

 
$
134,660

 
$
(790,183
)
 
$
741,420



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

The following Management Discussion and Analysis ("MD&A") is intended to help the reader understand the results of operations and financial condition of Cerner Corporation ("Cerner," the "Company," "we," "us" or "our"). This MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes to condensed consolidated financial statements ("Notes") found above.

Our third fiscal quarter ends on the Saturday closest to September 30. The 2018 and 2017 third quarters ended on September 29, 2018 and September 30, 2017, 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 are based on the current beliefs, expectations and assumptions of Cerner's management with respect to future events and are subject to a number of significant risks and uncertainties. It is important to note that Cerner's performance, and actual results, financial condition or business could differ materially from those expressed in such forward-looking statements. These statements can often be identified by the use of forward-looking terminology, such as "could," "should," "will," "believe," "may," "expect," "positioned," "anticipate," "forecast," "guidance," "opportunity," "outlook" 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 significant costs and reputational harm related to product-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities that could expose us to significant costs and reputational harm; the possibility of increased expenses, exposure to legal claims and regulatory actions and reputational harm associated with a cyberattack or other breach in our IT security; 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; potential claims or other risks associated with relying on open source software in our proprietary software solutions or technology-enabled services; material adverse resolution of legal proceedings; risks associated with our global operations, including without limitation, greater difficulty in collecting accounts receivable; risks associated with fluctuations in foreign currency exchange rates; changes in tax laws, regulations or guidance that could adversely affect our tax position and/or challenges to our tax positions in the U.S. and non-U.S. countries; the uncertainty surrounding the impact of the United Kingdom's vote to leave the European Union (commonly referred to as Brexit) on our global business; risks associated with the unexpected loss or recruitment and retention of key personnel or the failure to successfully develop and execute succession planning to assure transitions of key associates and their knowledge, relationships and expertise; risks related to our dependence on strategic relationships and third party suppliers; risks inherent with business acquisitions and combinations and the integration thereof into our business; risks associated with volatility and disruption resulting from global economic or market conditions; significant competition and our ability to quickly respond to market changes and changing technologies and to bring competitive new solutions, devices, features and services to market in a timely fashion; managing growth in the new markets in which we offer solutions, health care devices or services; long sales cycles for our solutions and services; risks inherent in contracting with government clients, including without limitation, complying with strict compliance and disclosure obligations, navigating complex procurement rules and processes and defending against bid protests; risks associated with our outstanding and future indebtedness, such as compliance with restrictive covenants, which may limit our flexibility to operate our business; changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies may adversely affect our financial statements; the potential for losses resulting from asset impairment charges; changing political, economic, regulatory and judicial influences, which could impact the purchasing practices and operations of our clients and increase costs to deliver compliant solutions and services; non-compliance with laws, government regulation or certain industry initiatives or failure to deliver solutions or services that enable our clients to comply with laws or regulations applicable to their businesses; variations in our quarterly operating results; potential variations 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; our directors' authority to issue preferred stock and the anti-takeover provisions in our corporate governance documents; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission, including those under the caption "Risk Factors" in our latest annual report on Form 10-K, 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 of the date they are made. Except as required by law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in our results of operations, financial condition or business over time.


20
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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 and other stakeholders secure access to clinical, administrative and financial data in real or near-real time, helping them to improve quality, safety and efficiency in the delivery of health care.

Our core strategy is to create 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 14% and 13%, respectively. This growth has also created an important strategic footprint in health care, with Cerner® solutions in more than 27,500 contracted provider facilities worldwide, including hospitals, physician practices, laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics, surgery centers, extended care facilities, retail pharmacies, and employer sites. Selling additional solutions and services back into this client base is an important element of our future revenue growth. We are also focused on driving growth by strategically 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 suppliers. We may also supplement organic growth with acquisitions or strategic investments.

We expect to drive growth through solutions and services that reflect our ongoing ability to innovate and expand our reach into health care. Examples of these include our CareAware® health care device architecture and devices, Cerner ITWorksSM services, revenue cycle solutions and services, and HealtheIntent® 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 17% and 21% over the most recent five- and ten-year periods, respectively. We expect to drive earnings growth as we continue to grow our revenue. We also have opportunities to expand our operating margins over time. In the near term, we expect growth in non-cash expenses, such as amortization and depreciation, and a mix of lower margin revenue associated with some of our rapidly growing services businesses will limit our margin expansion. Longer-term, we expect to generate margin expansion as the growth rate of non-cash expenses slows, we achieve economies of scale and efficiencies in our services businesses, control general and administrative expenses, and get more contributions to our growth from solutions on our HealtheIntent platform, which we expect to be accretive to our overall margins.

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
Bookings, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $1.59 billion in the third quarter of 2018, which is an increase of 43% compared to $1.11 billion in the third quarter of 2017.

Revenues for the third quarter of 2018 increased 5% to $1.34 billion, compared to $1.28 billion in the third quarter of 2017. The increase in revenue reflects ongoing demand from new and existing clients for Cerner's solutions and services driven by their needs to keep up with regulatory requirements, adapt to changing reimbursement models, and deliver safer and more efficient care.

Net earnings for the third quarter of 2018 decreased 5% to $169 million, compared to $177 million in the third quarter of 2017. Diluted earnings per share decreased 2% to $0.51, compared to $0.52 in the third quarter of 2017. The overall decrease in net earnings and diluted earnings per share was primarily a result of increased operating expenses, which reflects the hiring of personnel to support revenue growth. The increase in operating expenses was partially offset by a lower effective tax rate, stemming from certain U.S. income tax reform enacted in December 2017.

We had cash collections of receivables of $1.40 billion in the third quarter of 2018, compared to $1.42 billion in the third quarter of 2017. Days sales outstanding was 82 days for the third quarter of 2018 compared to 77 days for the second quarter of 2018 and 73 days for the third quarter of 2017. Operating cash flows for the third quarter of 2018 were $338 million compared to $363 million in the third quarter of 2017.


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Revenue Recognition

In the first quarter of 2018, we adopted new revenue recognition guidance as further discussed in Note (2) of the notes to condensed consolidated financial statements. The impact of applying this new guidance (versus prior U.S. GAAP) increased revenues by $44 million and $108 million, and earnings before income taxes by $24 million and $37 million, for the three and nine months ended September 29, 2018, respectively. This impact is primarily driven by certain new contracts in 2018, for which the new revenue guidance provides flexibility in how we do business such as committing to specified upgrades and allows us to estimate stand-alone selling price when allocating transaction consideration to performance obligations. Under prior U.S. GAAP, we minimized commitments for specified upgrades as we would have been required to establish vendor specific objective evidence of fair value, as further described in our most recent annual report on Form 10-K, which would have delayed the timing of revenue recognition.

Results of Operations
Three Months Ended September 29, 2018 Compared to Three Months Ended September 30, 2017
The following table presents a summary of the operating information for the third quarters of 2018 and 2017:
(In thousands)
2018
 
% of
Revenue
 
2017
 
% of
Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Revenues
$
1,340,073

 
100
%
 
$
1,276,007

 
100
%
 
5
 %
Costs of revenue
230,332

 
17
%
 
202,904

 
16
%
 
14
 %
 
 
 
 
 
 
 
 
 
 
Margin
1,109,741

 
83
%
 
1,073,103

 
84
%
 
3
 %
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
Sales and client service
605,946

 
45
%
 
564,621

 
44
%
 
7
 %
Software development
172,297

 
13
%
 
153,834

 
12
%
 
12
 %
General and administrative
102,789

 
8
%
 
84,178

 
7
%
 
22
 %
Amortization of acquisition-related intangibles
21,553

 
2
%
 
22,564

 
2
%
 
(4
)%
 
 
 
 
 
 
 
 
 
 
Total operating expenses
902,585

 
67
%
 
825,197

 
65
%
 
9
 %
 
 
 
 
 
 
 
 
 
 
Total costs and expenses
1,132,917

 
85
%
 
1,028,101

 
81
%
 
10
 %
 
 
 
 
 
 
 
 
 
 
Operating earnings
207,156

 
15
%
 
247,906

 
19
%
 
(16
)%
 
 
 
 
 
 
 
 
 
 
Other income, net
6,943

 
 
 
2,509

 
 
 
 
Income taxes
(44,718
)
 
 
 
(72,991
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
169,381

 
 
 
$
177,424

 
 
 
(5
)%
Revenues & Backlog
Revenues increased 5% to $1.34 billion in the third quarter of 2018, as compared to $1.28 billion in the same period of 2017. The growth in revenues includes a $56 million increase in professional services revenue, driven by increased contributions from Cerner ITWorks and revenue cycle services. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models.
Backlog, which reflects contracted revenue that has not yet been recognized as revenue, was $14.70 billion as of September 29, 2018, of which we expect to recognize approximately 30% as revenue over the next 12 months. In the first quarter of 2018, we adopted new revenue recognition guidance as further discussed in Note (2) of the notes to condensed consolidated financial statements. In connection with the adoption of such guidance, we modified our calculation of backlog as previously determined under Regulation S-K to represent the aggregate amount of transaction price allocated to performance obligations that are unsatisfied (or partially satisfied) to conform to the new revenue recognition guidance. Backlog amounts disclosed prior to the adoption of the new revenue recognition guidance have not been adjusted, and are not comparable to, the current period presentation.
We believe that backlog may not necessarily be a comprehensive indicator of future revenue as certain of our arrangements may be canceled (or conversely renewed) at our clients’ option, thus contract consideration related to such cancellable

22
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periods has been excluded from our calculation of backlog. However, historically our experience has been that such cancellation provisions are rarely executed.
Costs of Revenue
Costs of revenue as a percent of revenues were 17% in the third quarter of 2018, compared to 16% in the same period of 2017. The higher costs of revenue as a percent of revenues was primarily driven by higher third-party costs associated with services revenue.
Costs of revenue include 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, and services) carrying different margin rates changes from period to period. Costs of revenue 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 9% to $903 million in the third quarter of 2018, as compared to $825 million in the same period of 2017.
 
•
Sales and client service expenses as a percent of revenues were 45% in the third quarter of 2018, compared to 44% in the same period of 2017. These expenses increased 7% to $606 million in the third quarter of 2018, from $565 million in the same period of 2017. Sales and client service expenses include salaries and benefits of sales, marketing, support, and services personnel, depreciation and other expenses associated with our managed services business, communications expenses, unreimbursed travel expenses, expense for share-based payments, and trade show and advertising costs. The growth in sales and client service expenses is primarily due to the hiring of services personnel to support growth in services revenue.
•
Software development expenses as a percent of revenues were 13% in the third quarter of 2018, compared to 12% in the same period of 2017. Expenditures for software development include ongoing development and enhancement of the Cerner Millennium® and HealtheIntent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. A summary of our total software development expense in the third quarters of 2018 and 2017 is as follows:
 
Three Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Software development costs
$
185,039

 
$
176,543

Capitalized software costs
(65,682
)
 
(66,404
)
Capitalized costs related to share-based payments
(489
)
 
(663
)
Amortization of capitalized software costs
53,429

 
44,358

 
 
 
 
Total software development expense
$
172,297

 
$
153,834

 
•
General and administrative expenses as a percent of revenues were 8% in the third quarter of 2018, compared to 7% in the same period of 2017. These expenses increased 22% to $103 million in the third quarter of 2018, from $84 million in the same period in 2017. General and administrative expenses include salaries and benefits for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency, expense for share-based payments, acquisition costs and related adjustments. The increase in general and administrative expenses as a percent of revenues is primarily due to expenses incurred in the third quarter of 2018 in connection with our president's upcoming separation from the Company.

•
Amortization of acquisition-related intangibles as a percent of revenues was 2% in the third quarter of both 2018 and 2017. These expenses remained relatively flat at $22 million in the third quarter of 2018, and $23 million in the same period in 2017. Amortization of acquisition-related intangibles includes the amortization of customer relationships, acquired technology, trade names, and non-compete agreements recorded in connection with our business acquisitions.

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Non-Operating Items
 
•
Other income, net was $7 million in the third quarter of 2018, compared to $3 million in the same period of 2017. The increase is primarily attributable to increased interest income on our cash and investment balances, due to a combination of increased holdings and rising interest rates.

•
Our effective tax rate was 20.9% for the third quarter of 2018, compared to 29.1% in the same period of 2017. The decrease in the effective tax rate in 2018 is primarily due to a reduction in the U.S. corporate statutory tax rate from 35% to 21%, effective January 1, 2018. Refer to Note (7) of the notes to condensed consolidated financial statements for further discussion regarding our effective tax rate.

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 primarily includes revenue contributions and expenditures linked to business activity in Aruba, Australia, Austria, the Bahamas, Belgium, Bermuda, Brazil, Canada, Cayman Islands, Chile, Denmark, Egypt, England, Finland, France, Germany, India, Ireland, Kuwait, Luxembourg, Malaysia, Mexico, Netherlands, Norway, Portugal, Qatar, Romania, Saudi Arabia, Singapore, Slovakia, Spain, Sweden, Switzerland and the United Arab Emirates. Refer to Note (11) of the notes to condensed consolidated financial statements for further information regarding our reportable segments.

The following table presents a summary of our operating segment information for the third quarters of 2018 and 2017:  
(In thousands)
2018
 
% of Revenue
 
2017
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
1,188,154

 
100%
 
$
1,133,971

 
100%
 
5%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
202,980

 
17%
 
176,198

 
16%
 
15%
Operating expenses
532,958

 
45%
 
502,256

 
44%
 
6%
Total costs and expenses
735,938

 
62%
 
678,454

 
60%
 
8%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
452,216

 
38%

455,517

 
40%
 
(1)%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
151,919

 
100%
 
142,036

 
100%
 
7%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
27,352

 
18%
 
26,706

 
19%
 
2%
Operating expenses
67,220

 
44%
 
68,229

 
48%
 
(1)%
Total costs and expenses
94,572

 
62%
 
94,935

 
67%
 
—%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
57,347

 
38%
 
47,101

 
33%
 
22%
 
 
 
 
 
 
 
 
 
 
Other, net
(302,407
)
 
 
 
(254,712
)
 
 
 
19%
 
 
 
 
 
 
 
 
 
 
Consolidated operating earnings
$
207,156

 
 
 
$
247,906

 
 
 
(16)%
Domestic Segment
•
Revenues increased 5% to $1.19 billion in the third quarter of 2018, from $1.13 billion in the same period of 2017. The growth in revenues includes a $46 million increase in professional services revenue, driven by increased contributions from Cerner ITWorks and revenue cycle services. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models.
•
Costs of revenue as a percent of revenues were 17% in the third quarter of 2018, compared to 16% in the same period of 2017. The higher costs of revenue as a percent of revenues was primarily driven by higher third-party costs associated with services revenue.

24
Table of Contents

•
Operating expenses as a percent of revenues were 45% in the third quarter of 2018, compared to 44% in the same period of 2017. The higher operating expenses as a percent of revenues reflects the hiring of personnel to support revenue growth.

Global Segment
•
Revenues increased 7% to $152 million in the third quarter of 2018, from $142 million in the same period of 2017. This increase was primarily driven by growth in professional services revenue. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models.
•
Costs of revenue as a percent of revenues were 18% in the third quarter of 2018, compared to 19% in the same period of 2017. The lower costs of revenue as a percent of revenues was primarily driven by a lower amount of third party resources utilized for support and services.
•
Operating expenses as a percent of revenues were 44% in the third quarter of 2018, compared to 48% in the same period of 2017. The decrease as a percent of revenues is primarily due to a decrease in non-personnel expenses.

Other, net
Operating results not attributed to an operating segment include expenses such as software development, general and administrative expenses, acquisition costs and related adjustments, share-based compensation expense, and certain amortization and depreciation. These expenses increased 19% to $302 million in the third quarter of 2018, from $255 million in the same period of 2017. The increase is primarily due to increased software development expenses, including increased amortization of capitalized software costs resulting from releases of new and enhanced solutions over the last four quarters.

Nine Months Ended September 29, 2018 Compared to Nine Months Ended September 30, 2017
The following table presents a summary of our operating information for the first nine months of 2018 and 2017:
(In thousands)
2018
 
% of
Revenue
 
2017
 
% of
Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Revenues
$
4,000,661

 
100
%
 
$
3,828,487

 
100
%
 
4
 %
Costs of revenue
700,393

 
18
%
 
624,960

 
16
%
 
12
 %
 
 
 
 
 
 
 
 
 
 
Margin
3,300,268

 
82
%
 
3,203,527

 
84
%
 
3
 %
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
Sales and client service
1,830,999

 
46
%
 
1,688,208

 
44
%
 
8
 %
Software development
502,192

 
13
%
 
442,570

 
12
%
 
13
 %
General and administrative
290,547

 
7
%
 
263,203

 
7
%
 
10
 %
Amortization of acquisition-related intangibles
65,872

 
2
%
 
68,126

 
2
%
 
(3
)%
 
 
 
 
 
 
 
 
 
 
Total operating expenses
2,689,610

 
67
%
 
2,462,107

 
64
%
 
9
 %
 
 
 
 
 
 
 
 
 
 
Total costs and expenses
3,390,003

 
85
%
 
3,087,067

 
81
%
 
10
 %
 
 
 
 
 
 
 
 
 
 
Operating earnings
610,658

 
15
%
 
741,420

 
19
%
 
(18
)%
 
 
 
 
 
 
 
 
 
 
Other income, net
18,404

 
 
 
4,054

 
 
 
 
Income taxes
(130,323
)
 
 
 
(215,154
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
498,739

 
 
 
$
530,320

 
 
 
(6
)%
Revenues
Revenues increased 4% to $4.00 billion in the first nine months of 2018, as compared to $3.83 billion in the same period of 2017. The growth in revenues includes a $152 million increase in professional services revenue, driven by increased contributions from Cerner ITWorks and revenue cycle services. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models.

25
Table of Contents

Costs of Revenue
Costs of revenue as a percent of revenues were 18% in the first nine months of 2018, compared to 16% in the same period of 2017. The higher costs of revenue as a percent of revenues was primarily driven by higher third-party costs associated with services revenue.

Operating Expenses
Total operating expenses increased 9% to $2.69 billion in the first nine months of 2018, as compared to $2.46 billion in the same period of 2017.
 
•
Sales and client service expenses as a percent of revenues were 46% in the first nine months of 2018, compared to 44% in the same period of 2017. These expenses increased 8% to $1.83 billion in the first nine months of 2018, from $1.69 billion in the same period of 2017. The growth in sales and client service expenses is primarily due to the hiring of services personnel to support growth in services revenue.
•
Software development expenses as a percent of revenues were 13% in the first nine months of 2018, compared to 12% in the same period of 2017. Expenditures for software development include ongoing development and enhancement of the Cerner Millennium and HealtheIntent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. A summary of our total software development expense in the first nine months of 2018 and 2017 is as follows:
 
Nine Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Software development costs
$
555,743

 
$
526,257

Capitalized software costs
(207,539
)
 
(207,910
)
Capitalized costs related to share-based payments
(1,583
)
 
(2,123
)
Amortization of capitalized software costs
155,571

 
126,346

 
 
 
 
Total software development expense
$
502,192

 
$
442,570

 
•
General and administrative expenses as a percent of revenues were 7% in the first nine months of both 2018 and 2017. These expenses increased 10% to $291 million in the first nine months of 2018, from $263 million in the same period of 2017. The increase in general and administrative expenses includes expenses incurred in the third quarter of 2018 in connection with our president's upcoming separation from the Company.

•
Amortization of acquisition-related intangibles as a percent of revenues was 2% in the first nine months of both 2018 and 2017. These expenses remained relatively flat at $66 million in the first nine months of 2018, and $68 million in the same period of 2017.

Non-Operating Items
 
•
Other income, net was $18 million in the first nine months of 2018, compared to $4 million in the same period of 2017. The increase is primarily attributable to increased interest income on our cash and investment balances, due to a combination of increased holdings and rising interest rates.

•
Our effective tax rate was 20.7% for the first nine months of 2018, compared to 28.9% in the same period of 2017. The decrease in the effective tax rate in 2018 is primarily due to a reduction in the U.S. corporate statutory tax rate from 35% to 21%, effective January 1, 2018. Refer to Note (7) of the notes to condensed consolidated financial statements for further discussion regarding our effective tax rate.



26
Table of Contents

Operations by Segment

The following table presents a summary of our operating segment information for the first nine months of 2018 and 2017:
(In thousands)
2018
 
% of Revenue
 
2017
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
3,525,314

 
100%
 
$
3,421,429

 
100%
 
3%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
617,839

 
18%
 
549,895

 
16%
 
12%
Operating expenses
1,604,297

 
46%
 
1,474,591

 
43%
 
9%
Total costs and expenses
2,222,136

 
63%
 
2,024,486

 
59%
 
10%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
1,303,178

 
37%

1,396,943

 
41%
 
(7)%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
475,347

 
100%
 
407,058

 
100%
 
17%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
82,554

 
17%
 
75,065

 
18%
 
10%
Operating expenses
209,771

 
44%
 
197,333

 
48%
 
6%
Total costs and expenses
292,325

 
61%
 
272,398

 
67%
 
7%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
183,022

 
39%
 
134,660

 
33%
 
36%
 
 
 
 
 
 
 
 
 
 
Other, net
(875,542
)
 
 
 
(790,183
)
 
 
 
11%
 
 
 
 
 
 
 
 
 
 
Consolidated operating earnings
$
610,658

 
 
 
$
741,420

 
 
 
(18)%
Domestic Segment
•
Revenues increased 3% to $3.53 billion in the first nine months of 2018, from $3.42 billion in the same period of 2017. The growth in revenues includes a $118 million increase in professional services revenue, driven by increased contributions from Cerner ITWorks and revenue cycle services. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models.
•
Costs of revenue as a percent of revenues were 18% in the first nine months of 2018, compared to 16% in the same period of 2017. The higher costs of revenue as a percent of revenues was primarily driven by higher third-party costs associated with services revenue.
•
Operating expenses as a percent of revenues were 46% in the first nine months of 2018, compared to 43% in the same period of 2017. The higher operating expenses as a percent of revenues reflects the hiring of personnel to support revenue growth.

Global Segment
•
Revenues increased 17% to $475 million in the first nine months of 2018, from $407 million in the same period of 2017. This increase was driven by growth across most of our business. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models.
•
Costs of revenue as a percent of revenues were 17% in the first nine months of 2018, compared to 18% in the same period of 2017. The lower costs of revenue as a percent of revenues was primarily driven by a lower amount of third party resources utilized for support and services.
•
Operating expenses as a percent of revenues were 44% in the first nine months of 2018, compared to 48% in the same period in 2017. The decrease as a percent of revenues is primarily a reflection of increased revenue in proportion to the amount of our fixed operating expenses.

Other, net
These expenses increased 11% to $876 million in the first nine months of 2018, from $790 million in the same period of 2017. The increase is primarily due to increased software development expenses, including increased amortization of capitalized software costs resulting from releases of new and enhanced solutions over the last four quarters.

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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, capital expenditures, and in recent years, our share repurchase programs.
Our principal sources of liquidity are our cash, cash equivalents, which primarily consist of money market funds, commercial paper and time deposits with original maturities of less than 90 days, and short-term investments. At September 29, 2018, we had cash and cash equivalents of $499 million and short-term investments of $315 million, as compared to cash and cash equivalents of $371 million and short-term investments of $435 million at December 30, 2017.

We maintain a $100 million multi-year revolving credit facility, which expires in October 2020. The facility provides an unsecured revolving line of credit for working capital purposes, along with a letter of credit facility. We have the ability to increase the maximum capacity to $200 million at any time during the facility's term, subject to lender participation. As of September 29, 2018, we had no outstanding borrowings under this facility; however, we had $48 million of outstanding letters of credit, which reduced our available borrowing capacity to $52 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 12 months.
The following table summarizes our cash flows in the first nine months of 2018 and 2017:
 
Nine Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Cash flows from operating activities
$
1,047,120

 
$
958,765

Cash flows from investing activities
(562,094
)
 
(593,689
)
Cash flows from financing activities
(345,704
)
 
27,639

Effect of exchange rate changes on cash
(11,631
)
 
9,478

Total change in cash and cash equivalents
127,691

 
402,193

 
 
 
 
Cash and cash equivalents at beginning of period
370,923

 
170,861

 
 
 
 
Cash and cash equivalents at end of period
$
498,614

 
$
573,054

 
 
 
 
Free cash flow (non-GAAP)
$
532,047

 
$
486,360



Cash from Operating Activities
 
Nine Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Cash collections from clients
$
3,992,200

 
$
4,060,904

Cash paid to employees and suppliers and other
(2,976,974
)
 
(2,917,105
)
Cash paid for interest
(15,568
)
 
(17,175
)
Cash paid for taxes, net of refunds
47,462

 
(167,859
)
 
 
 
 
Total cash from operations
$
1,047,120

 
$
958,765

Cash flows from operations increased $88 million in the first nine months of 2018 when compared to the same period of 2017, due primarily to net refunds of taxes. Days sales outstanding was 82 days in the third quarter of 2018, compared to 77 days for the second quarter of 2018 and 73 for the third quarter of 2017. Revenues provided under support and maintenance agreements represent recurring cash flows. We expect these revenues to continue to grow as the base of our installed systems grows.

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Cash from Investing Activities
 
Nine Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Capital purchases
$
(305,951
)
 
$
(262,372
)
Capitalized software development costs
(209,122
)
 
(210,033
)
Sales and maturities of investments, net of purchases
(22,717
)
 
(99,098
)
Purchases of other intangibles
(24,304
)
 
(22,186
)
 
 
 
 
Total cash flows from investing activities
$
(562,094
)
 
$
(593,689
)
Cash flows from investing activities consist primarily of capital spending and short-term investment activities.

Our capital spending in the first nine months of 2018 was driven by capitalized equipment purchases primarily to support growth in our managed services business, investments in a cloud infrastructure to support cloud-based solutions, building and improvement purchases to support our facilities requirements and capitalized spending to support our ongoing software development initiatives. Total capital spending for 2018 is expected to exceed 2017 levels, primarily driven by an increase in spending to support our facilities requirements, including commencement of construction on the next two phases of our Innovations Campus (office space development located in Kansas City, Missouri); along with increased capital purchases to support the growth in our managed services business.

Short-term investment activity historically consists of the investment of cash generated by our business in excess of what is necessary to fund operations. The 2017 activity was impacted by a change in investment mix, where we invested more heavily in cash equivalents versus short-term and long-term investments. The 2018 activity is impacted by excess cash being used to repurchase shares of our common stock, as discussed further below. Additionally, on July 27, 2018 we acquired a minority interest in Essence Group Holdings Corporation for cash consideration of $266 million. Refer to Note (4) of the notes to condensed consolidated financial statements for further information regarding this investment.

Cash from Financing Activities
 
Nine Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Repayment of long-term debt
$
(75,000
)
 
$
—

Cash from option exercises (net of taxes paid in connection with shares surrendered by associates)
72,252

 
53,699

Treasury stock purchases
(345,210
)
 
(23,389
)
Contingent consideration payments for acquisition of businesses
(1,691
)
 
(2,671
)
Other
3,945

 
—

 
 
 
 
Total cash flows from financing activities
$
(345,704
)
 
$
27,639

In March 2018, we repaid our $75 million floating rate Series 2015-C Notes due February 15, 2022. Refer to Note (6) of the notes to condensed consolidated financial statements for further information regarding our outstanding indebtedness.

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 net cash inflows from stock option exercises to continue throughout 2018 based on the number of exercisable options as of September 29, 2018 and our current stock price.

During the nine months ended September 29, 2018, we repurchased 5.7 million shares of our common stock for total consideration of $345 million. At September 29, 2018, $582 million remains available for repurchase under our current program. We may continue to repurchase shares under this program in 2018, which will be dependent on a number of factors, including the price of our common stock. Although we may continue to repurchase shares, there is no assurance that we will repurchase up to the full amount remaining under the program. Refer to Note (9) of the notes to condensed consolidated financial statements for further information regarding our share repurchase program.


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Table of Contents

During the nine months ended September 30, 2017, we repurchased 0.4 million shares of our common stock under our share repurchase programs for total consideration of $23 million.

Free Cash Flow (Non-GAAP)
 
Three Months Ended
 
Nine Months Ended
(In thousands)
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Cash flows from operating activities (GAAP)
$
338,454

 
$
362,937

 
$
1,047,120

 
$
958,765

Capital purchases
(116,957
)
 
(73,000
)
 
(305,951
)
 
(262,372
)
Capitalized software development costs
(66,171
)
 
(67,067
)
 
(209,122
)
 
(210,033
)
 
 
 
 
 
 
 
 
Free cash flow (non-GAAP)
$
155,326

 
$
222,870


$
532,047

 
$
486,360


Free cash flow increased $46 million in the first nine months of 2018 compared to the same period in 2017, primarily due to an increase in cash from operations. 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. We define free cash flow as cash flows from operating activities reduced by capital purchases and capitalized software development costs. The table above sets forth a reconciliation of free cash flow to cash flows from operating activities, which we believe is the GAAP financial measure most directly comparable to free cash flow. 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 and understanding of our overall financial, operational and economic performance, because free cash flow takes into account certain capital expenditures necessary to operate our business.


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Table of Contents

Item 3. Quantitative and Qualitative Disclosures about Market Risk

No material changes.

Item 4. Controls and Procedures

a)
Evaluation of Disclosure Controls and Procedures.

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of our 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"). Based upon that evaluation, our CEO and CFO have concluded that, as of the Evaluation Date, our disclosure controls and procedures were designed, and were effective, to provide reasonable assurance that the information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in SEC rules and forms and is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding required disclosure.

b)
Changes in Internal Control over Financial Reporting.

During the fiscal quarter ended September 29, 2018, progress continued on a plan that calls for modifications and enhancements to our internal controls over financial reporting in relation to our upcoming adoption of the new lease standard effective in the first quarter of 2019. Such plan resulted in changes to certain processes and procedures during the quarter. Specifically, we implemented/modified internal controls to address:

•Monitoring of the adoption process; and
•
The gathering of information and evaluation of analysis used in the development of disclosures required prior to the new standard's adoption.

As we continue the implementation process, we expect that there will be additional changes in internal controls over financial reporting.

Except as disclosed above, there were no other changes in our internal controls over financial reporting during the fiscal quarter ended September 29, 2018, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

c)
Limitations on Controls.

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

(c) Issuer Purchases of Equity Securities

The table below provides information with respect to Common Stock purchases by the Company during the third fiscal quarter of 2018.
 
 
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
 
 
 
 
July 1, 2018 - July 28, 2018
 
—

 
$
—

 
—

 
$
639,091,129

July 29, 2018 - August 25, 2018
 
—

 
—

 
—

 
639,091,129

August 26, 2018 - September 29, 2018
 
900,463

 
63.97

 
900,000

 
581,522,399

 
 
 
 
 
 
 
 
 
Total
 
900,463

 
$
63.97

 
900,000

 
 
(a)
Of the 900,463 shares of common stock, par value $0.01 per share, presented in the table above, 463 were originally granted to employees as restricted stock pursuant to our 2011 Omnibus Equity Incentive Plan (the "Omnibus Plan"). The Omnibus Plan allows for the withholding of shares to satisfy the minimum tax obligations due upon the vesting of restricted stock. Pursuant to the Omnibus Plan, the 463 shares reflected above were relinquished by employees in exchange for our agreement to pay U.S. federal and state withholding obligations resulting from the vesting of the Company’s restricted stock.

(b)
As announced on May 25, 2017, our Board of Directors authorized a share repurchase program that allows the Company to repurchase up to $500 million of shares of our common stock, excluding transaction costs. The repurchases are to be effectuated in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers. No time limit was set for the completion of the program. As announced on May 21, 2018, our Board of Directors approved an amendment to the repurchase program that was authorized in May 2017. Under the amendment, the Company was authorized to repurchase up to an additional $500 million of shares of our common stock, for an aggregate of $1 billion, excluding transaction costs. During the nine months ended September 29, 2018, we repurchased 5.7 million shares for total consideration of $345 million under the program pursuant to Rule 10b5-1 plans. At September 29, 2018, $582 million remains available for repurchase under the program. Refer to Note (9) of the notes to condensed consolidated financial statements for further information regarding our share repurchase program.



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Table of Contents

Item 6. Exhibits
(a)
 
Exhibits
 
 
 
10.1
 
 
 
 
10.2
 
 
 
 
31.1
 
 
 
 
31.2
 
 
 
 
32.1
 
 
 
 
32.2
 
 
 
 
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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Table of Contents

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 26, 2018
 
By:
/s/ Marc G. Naughton
 
 
  
Marc G. Naughton
 
 
  
Executive Vice President and Chief
 
 
  
Financial Officer (duly authorized
 
 
 
officer and principal financial officer)