CERNER CORP /MO/ - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

		For the quarterly period ended September 28, 2002

OR

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

		For the transition period from ______ to ______


Commission File Number 0-15386


	CERNER CORPORATION

	(Exact name of registrant as specified in its charter)


Delaware		43-1196944

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


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

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

Yes x No o

There were 35,508,307 shares of Common Stock, $.01 par value, outstanding at September 28, 2002.

TABLE OF CONTENTS


Part I. Financial Information:
Item 1. Financial Statements:
	Consolidated Balance Sheets as of September 28, 2002 (unaudited) and December 29, 2001
	Consolidated Statements of Earnings for the three and nine months ended September 28, 2002 and September 29, 2001 (unaudited)
	Consolidated Statements of Cash Flows for the nine months ended September 28, 2002 and September 29, 2001 (unaudited)
	Notes to Condensed Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II. Other Information:
Item 6. Exhibits and Reports on Form 8-K
EX-99.1 Certification Pursuant to 18 U.S.C.
EX-99.2 Certification Pursuant to 18 U.S.C.

CERNER CORPORATION AND SUBSIDIARIES

I N D E X


Part I.	Financial Information:

Item 1.	Financial Statements:

	Consolidated Balance Sheets as of September 28, 2002 (unaudited) and December 29, 2001	1

	Consolidated Statements of Earnings for the three and nine months ended September 28, 2002 and September 29, 2001 (unaudited)	2

	Consolidated Statements of Cash Flows for the nine months ended September 28, 2002 and September 29, 2001 (unaudited)	3

	Notes to Condensed Consolidated Financial Statements	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21

Item 4.	Controls and Procedures	21

Part II.	Other Information:

Item 6.	Exhibits and Reports on Form 8-K	22

Part I. Financial Information
Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS


			September 28,			December 29,
(In thousands)			2002			2001

			(unaudited)
Assets
	Current Assets:
	Cash and cash equivalents		$	88,558		$	107,536
	Receivables			263,731			220,205
	Inventory			8,185			5,834
	Prepaid expenses and other			20,666			14,101

	Total current assets			381,140			347,676
	Property and equipment, net			127,815			94,705
	Software development costs, net			111,058			96,962
	Goodwill, net			33,963			23,879
	Intangible assets, net			18,370			18,015
	Investments			22,719			122,992
	Other assets			9,826			8,073

			$	704,891		$	712,302

Liabilities and Stockholders’ Equity
	Current liabilities:
	Accounts payable		$	36,781		$	20,942
	Current installments of long-term debt			38,127			27,817
	Deferred revenue			33,461			53,304
	Income taxes			20,019			5,661
	Accrued payroll and tax withholdings			34,972			40,565
	Other accrued expenses			11,945			10,529

	Total Current Liabilities			175,305			158,188
	Long-term debt			78,432			92,132
	Deferred income taxes			25,884			62,393
	Deferred revenue			1,750			4,750
	Stockholders’ Equity:
	Common stock, $.01 par value, 150,000,000 shares authorized, 36,711,306 shares issued at September 28, 2002 and 36,564,690 issued in 2001			367			366
	Additional paid-in capital			219,229			216,811
	Retained earnings			226,628			188,550
	Treasury stock, at cost (1,202,999 shares in 2002 and 1,201,625 shares in 2001)			(20,863	)		(20,799	)
	Accumulated other comprehensive income:
		Foreign currency translation adjustment		(1,801	)		(2,095	)
		Unrealized gain/(loss) on available-for-sale equity securities (net of deferred tax benefit of $2 for 2002 and deferred tax liability of $6,810 for 2001)		(40	)		12,006

		Total stockholders’ equity		423,520			394,839

			$	704,891		$	712,302

See notes to condensed consolidated financial statements.

CERNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)


			Three Months Ended						Nine Months Ended

			September 28,			September 29,			September 28,			September 29,

			2002			2001			2002			2001

(In thousands, except per share data)
Revenues:
		System sales	$	84,866		$	66,097		$	239,401		$	175,975
		Support, maintenance and services		105,465			73,772			306,783			214,683

		Total revenues		190,331			139,869			546,184			390,658

Costs and expenses:
		Cost of revenues		37,171			28,354			116,609			83,938
		Sales and client service		82,166			59,173			233,421			162,530
		Software development		33,850			25,532			95,112			73,902
		General and administrative		13,216			9,990			37,558			28,645

		Total costs and expenses		166,403			123,049			482,700			349,015

Operating earnings				23,928			16,820			63,484			41,643
Other income (expense):
	Interest expense, net			(1,245	)		(1,329	)		(4,141	)		(2,964	)
	Other income (expense), net			33			(32	)		64			160
	Gain on sale of investment			—			—			4,308			—
	Loss on sale of investment			—			—			—			(385	)
	Write-down of investment			—			—			—			(127,616	)
	Gain on software license settlement			—			—			—			7,580

	Total			(1,212	)		(1,361	)		231			(123,225	)

Earnings (loss) before income taxes and cumulative effect of a change in accounting principle				22,716			15,459			63,715			(81,582	)
Income taxes				(8,948	)		(6,217	)		(24,851	)		28,170

Earnings (loss) before cumulative effect of a change in accounting principle				13,768			9,242			38,864			(53,412	)
Cumulative effect of a change in accounting for goodwill, net of $486 income tax benefit				—			—			786			—

Net earnings (loss)				13,768			9,242			38,078			(53,412	)

Basic earnings (loss) per share:
Earnings (loss) before cumulative effect of a change in accounting principle			$	.39		$	.26		$	1.10		$	(1.53	)
Cumulative effect of a change in accounting for goodwill				—			—			(.02	)		—

Net earnings (loss) per share			$	.39		$	.26		$	1.08		$	(1.53	)

Basic weighted average shares outstanding				35,496			34,936			35,438			34,863
Diluted earnings (loss) per share:
Earnings (loss) before cumulative effect of a change in accounting principle			$	.37			.25			1.05			(1.53	)
Cumulative effect of a change in accounting for goodwill				—			—			(.02	)		—

Net earnings (loss) per share			$	.37			.25			1.03			(1.53	)

Diluted weighted average shares outstanding				36,913			36,798			37,189			34,863

See notes to condensed consolidated financial statements.

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


			Nine Months Ended

			September 28, 2002			September 29, 2001
(In thousands)
Cash flows from operating activities:
	Net earnings (loss)		$	38,078		$	(53,412	)
	Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:
		Depreciation and amortization		41,521			36,507
		Common stock received as consideration for sale of license software		—			(750	)
		Write-off of goodwill impairment		1,272			—
		Gain on sale of investment		(4,308	)		—
		Realized loss on sale of stock		—			385
		Write-down of investment		—			127,616
		Gain on software license settlement		—			(7,580	)
		Non-employee stock option compensation expense		34			142
		Equity in losses of affiliates		—			1,504
		Provision for deferred income taxes		1,519			(44,832	)
		Payment of tax on non-recurring gain from the sale of WebMD		(31,200	)		—
	Changes in assets and liabilities (net of business acquired):
		Receivables, net		(42,489	)		(14,739	)
		Inventory		(2,351	)		(1,383	)
		Prepaid expenses and other		(7,948	)		(5,700	)
		Accounts payable		14,613			(1,590	)
		Accrued income taxes		14,326			12,067
		Deferred revenue		(23,343	)		(4,771	)
		Other accrued liabilities		(5,356	)		6,472

	Total adjustments			(43,710	)		103,348

	Net cash provided by (used in) operating activities			(5,632	)		49,936

Cash flows from investing activities:
		Purchase of capital equipment		(29,279	)		(14,328	)
		Purchase of land, buildings and improvements		(18,822	)		(4,356	)
		Acquisition of businesses, net of cash acquired		(19,129	)		(3,350	)
		Investment in investee companies		—			(1,379	)
		Proceeds from sale of available-for-sale securities		90,119			1,572
		Issuance of notes receivable		—			(186	)
		Repayment of notes receivable		—			312
		Capitalized software development costs		(36,089	)		(27,851	)

	Net cash used in investing activities			(13,200	)		(49,566	)

Cash flows from financing activities:
		Proceeds from issuance of long-term debt		10,102			2,999
		Repayment of long-term debt		(12,808	)		(992	)
		Proceeds from exercise of options		2,296			3,366

	Net cash provided by (used in) financing activities			(410	)		5,373

	Foreign currency translation adjustment			264			(667	)

	Net increase (decrease) in cash and cash equivalents			(18,978	)		5,076
	Cash and cash equivalents at beginning of period			107,536			90,893

	Cash and cash equivalents at end of period		$	88,558		$	95,969

See notes to condensed consolidated financial statements.

CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) Interim Statement Presentation & Accounting Policies

The consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s latest annual report on Form 10-K.

In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position, and the results of operations and cash flows for the periods presented. The results of the three and nine-month periods are not necessarily indicative of the operating results for the entire year. Certain prior year amounts have been reclassified to conform with current year presentation.

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” establishes requirements for reporting and display of comprehensive income and its components. For the nine months ended September 28, 2002 and September 29, 2001, total Comprehensive Income, which includes net earnings, foreign currency translation adjustments and unrealized gain and losses on available-for-sale equity security adjustments, amounted to $26,326,000 and ($9,894,000), respectively.

The Company incurs out-of-pocket expenses in connection with its client service activities, which are reimbursed by its clients. The amounts of “out-of-pocket” expenses and equal amounts of related reimbursements were $6,658,000 and $4,649,000 for the three months and $19,051,000 and $13,029,000 for the nine months ended September 28, 2002 and September 29, 2001, respectively. These amounts have been reclassified from sales and client service expense to revenue and cost of revenues. The Company then reclassified these amounts from revenue and cost of revenues to other income and expense.

(2) Earnings Per Share

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


	Three months ended						Three months ended
	September 28, 2002						September 29, 2001

	Earnings		Shares		Per-Share		Earnings		Shares		Per-Share
	(Numerator)		(Denominator)		Amount		(Numerator)		(Denominator)		Amount

(In thousands, except per share data)

Basic earnings per share Income available to common stockholders	$	13,768		35,496	$	.39	$	9,242		34,936	$	.26
Effect of dilutive securities
Stock options		—		1,417				—		1,862
Diluted earnings per share

Income available to Common stockholders including assumed conversions	$	13,768		36,913	$	.37	$	9,242		36,798	$	.25

Options to purchase 2,868,000 and 241,000 shares of common stock at per share prices ranging from $39.95 to $574.82 and $48.49 to $84.07 were outstanding at the three-months ended September 28, 2002 and September 29, 2001, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during the period.


	Nine months ended						Nine months ended
	September 28, 2002						September 29, 2001

	Earnings		Shares		Per-Share		Earnings			Shares		Per-Share
	(Numerator)		(Denominator)		Amount		(Numerator)			(Denominator)		Amount

(In thousands, except per share data)
Earnings (loss) per share before cumulative effect of a change in accounting principle
Basic earnings (loss) per share
Income available to common stockholders	$	38,864		35,438	$	1.10	$	(53,412	)		34,863	$	(1.53	)
Effect of dilutive securities
Stock options		—		1,751				—			—
Diluted earnings (loss) per share

Income available to common stockholders including assumed conversions	$	38,864		37,189	$	1.05	$	(53,412	)		34,863	$	(1.53	)

Net earnings (loss) per share
Basic earnings (loss) per share
Income available to common stockholders	$	38,078		35,438	$	1.08	$	(53,412	)		34,863	$	(1.53	)
Effect of dilutive securities
Stock options		—		1,751				—			—
Diluted earnings (loss) per share

Income available to common stockholders including assumed conversions	$	38,078		37,189	$	1.03	$	(53,412	)		34,863	$	(1.53	)

Options to purchase 1,334,000 and 352,000 shares of common stock at per share prices ranging from $46.23 to $574.82 and $46.69 to $84.07 were outstanding at the nine-months ended September 28, 2002 and September 29, 2001, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during the period. Additionally, options to purchase 1,796,000 shares of common stock at per share prices ranging from $1.34 to $46.69 were outstanding at the nine-months ended September 29, 2001 but were not included in the computation of diluted earnings per share because there was a net loss for the period.

(3) Business Acquisitions

On October 1, 2002, the Company completed the purchase of Image Devices GmbH (“Image Devices”) for approximately $14.3 million in cash. Approximately $5.7 million was paid in the third quarter of 2002; approximately $7.2 million will be paid in the fourth quarter of 2002; and approximately $1.4 million will be paid in the third quarter of 2004. Image Devices is a picture archiving and communication system software developer based near Frankfurt, Germany. A Cerner component supplier since 1999, Image Devices develops and supplies the image archive component for Cerner ProVision ™ PACS. This acquisition is not expected to have a material impact on operations. The Company is in the process of obtaining information to determine the allocation of the purchase price to the net assets acquired.

On April 30, 2002, the Company purchased Zynx Health, Incorporated (Zynx) for $15 million in cash and $8.5 million in software credits. The Company will not recognize revenues related to the utilization of these software credits as the Company considered the exchange of software credits for Zynx content as an exchange of similar productive assets, which will be accounted for at book value. In the event the software credits are not utilized over the next five years, the Company will make additional cash payments of up to $7.5 million depending on the level of the credits used. Those additional payments, if made, will result in additional goodwill. Zynx assists in advancing evidence-based medicine through solutions and services that deliver the latest scientific knowledge and best practices. Cerner intends to integrate the evidence-based content from Zynx into the Cerner Millennium ™ technology platform. The allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired and liabilities assumed, resulted in goodwill of $10.4 million and $3.3 million in intangible assets. The $3.3 million in intangible assets will be amortized over five years.

On, July 3, 2001, the Company purchased certain assets and certain liabilities of APACHE Medical Systems, Inc. (APACHE) for approximately $3.5 million. APACHE provides clinical decision support/outcomes management systems and consulting services for the care of high-risk patients. APACHE also provides advanced clinical data collection tools, registry management and analytical services for federal government research, as well as in support of clinical trial design and product-effectiveness evaluations for the pharmaceutical and medical device industries. The allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired and liabilities assumed resulted in goodwill of $4,766,000.

(4) Receivables

Receivables consist of accounts receivable and contracts receivable. Accounts receivable represent recorded revenues that have been billed. Contracts receivable represent recorded revenues that are billable by the Company at future dates under the terms of a contract with a client. Billings and other consideration received on contracts in excess of related revenues recognized under the percentage-of —completion method are recorded as deferred revenue. A summary of receivables is as follows:


(In thousands)	September 28,		December 29,
	2002		2001

Accounts receivable	$	171,375		139,491
Contracts receivable		92,356		80,714

Total receivables	$	263,731		220,205

(5) Investments

At September 28, 2002 the Company held 1,048,783 warrants of WebMD with an exercise price of $3.08 and a cost basis and carrying value of $4,146,000. The warrants are carried at cost, as they do not have a fair value that is currently available on a securities exchange. The warrants expire on January 26, 2003.

various obligations due to the Company by WebMD. As a result of this agreement, the Company recognized a non-recurring gain of $4,836,000, net of $2,744,000 in tax. The Company’s policy is to review declines in fair value of its marketable equity securities for declines that may be other than temporary. As a result of this policy, during the second quarter of 2001, the Company recorded a write-down of its investment in WebMD from $15.00 to $5.79. Accordingly, the Company recognized a charge to earnings of $81,419,000, net of $46,197,000 in tax.

In the second quarter of 2002, the Company sold its remaining 14,820,527 shares of WebMD for $90,119,000. Accordingly, the Company recorded a non-recurring investment gain of $2,736,000, net of $1,572,000 in tax, as a result of the sale. Since the shares sold had a lower income tax basis, the sale resulted in the transfer of approximately $29,638,000 of deferred tax liabilities to income taxes payable in the second quarter of 2002. In the third quarter of 2002, the Company made cash payment of tax in the amount of $31,200,000 related to the non-recurring investment gain.

(6) Goodwill and Other Intangible Assets

Effective December 30, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” As a result, goodwill and intangible assets with indefinite lives are no longer amortized but are evaluated for impairment annually or whenever there is an impairment indicator. All goodwill is assigned to a reporting unit, where it is subject to an impairment test based on fair value. The Company completed its review of the Company’s goodwill values in the second quarter of 2002. As a result of this review, the Company determined that goodwill arising from the acquisition of Mitch Cooper and Associates was impaired due to declining demand and margins in this business. Mitch Cooper and Associates was a supply chain re-engineering consulting practice. The impairment charge to reflect this goodwill at fair value was $786,000, net of tax and is reflected as a cumulative effect of a change in accounting principle as of the beginning of 2002. The Company used a discounted cash flow analysis to determine the fair value of the reporting units.

The Company’s intangible assets, other than goodwill or intangible assets with indefinite lives, are all subject to amortization and are summarized as follows:

(In thousands)


			September 28, 2002				December 29, 2001

	Weighted
	Average		Gross				Gross
	Amortization		Carrying		Accumulated		Carrying		Accumulated
	Period (Yrs)		Amount		Amortization		Amount		Amortization

Purchased software		5.0	$	22,474		7,108		19,140		4,508
Customer lists		7.0		3,700		1,051		3,700		654
Patents		14.0		375		57		336		40
Non-compete agreements		7.0		50		13		50		9

Total		5.41	$	26,599		8,229		23,226		5,211

Aggregate amortization expense for the three months and nine months ended September 28, 2002 was $1,193,000 and $3,018,000, respectively. Estimated aggregate amortization expense for each of the next five years is as follows:


For year ended:	2002	$	4,127
	2003		4,247
	2004		4,101
	2005		3,673
	2006		2,690

The changes in the carrying amount of goodwill for the nine months ended September 28, 2002 are as follows:


Balance as of December 29, 2001	$	23,879
Goodwill acquired during the nine months ended September 28, 2002		11,356
Goodwill impaired during the nine months ended September 28, 2002		(1,272	)

Balance as of September 28, 2002	$	33,963

The following is a reconciliation of reported net earnings (loss) to adjusted net earnings (loss) to exclude the effect of amortization expense in the three-month and nine-month periods of 2001 for goodwill that is no longer being amortized.

(In thousands, except per share data)


	Three months ended				Nine months ended

	September		September		September		September
	28, 2002		29, 2001		28, 2002		29, 2001

Reported net earnings (loss)	$	13,768		9,242		38,078		(53,412	)
Add back: Goodwill amortization		—		456		—		1,371

Adjusted net earnings (loss)		13,768		9,698		38,078		(52,041	)

Basic earnings per share:
Reported net earnings (loss)	$	.39		.26		1.08		(1.53	)
Add back: Goodwill amortization		—		.02		—		.04

Adjusted net earnings (loss)		.39		.28		1.08		(1.49	)

Diluted earnings per share:
Reported net earnings (loss)	$	.37		.25		1.03		(1.53	)
Add back: Goodwill amortization		—		.01		—		.04

Adjusted net earnings (loss)		.37		.26		1.03		(1.49	)

(7) Stock Options

The Company accounts for associate stock options in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. On December 31, 1995, the Company adopted Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (FAS 123), which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, FAS 123 allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net earnings and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in FAS 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of FAS 123.

Since the Company applies APB Opinion No. 25 in accounting for its plans, no compensation cost has been recognized for its stock options issued to employees. Had the Company recorded compensation expense based on the fair value at the grant date for its stock options under FAS 123, the Company’s net earnings and earnings per share on a diluted basis would have been reduced by approximately $4,395,000 or $.12 per share for the third quarter of 2002 and $3,159,000 or $.09 per share in the third quarter 2001, and approximately $12,906,000 or $.35 per share in the first nine months of 2002 and $7,380,000 or $.21 in the first nine months of 2001.

Pro forma net earnings reflect only options granted since January 1, 1995. Therefore, the full impact of calculating compensation expense for stock options under FAS 123 is not reflected in the pro forma net earnings amounts presented above, because compensation cost is reflected over the options’ vesting period of ten years for these options. Compensation expense for options granted prior to January 1, 1995 is not considered.


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

Results of Operations

Three Months Ended September 28, 2002 Compared to Three Months Ended September 29, 2001

The Company’s revenues increased 36% to $190,331,000 for the three-month period ended September 28, 2002 from $139,869,000 for the three-month period ended September 29, 2001. Net earnings increased 49% to $13,768,000 in the 2002 period from $9,242,000 for the 2001 period. For the three-month period ended September 29, 2001, earnings included $456,000 of amortization of goodwill, net of tax.

System sales revenues increased 28% to $84,866,000 for the three-month period ended September 28, 2002 from $66,097,000 for the corresponding period in 2001. Included in system sales are revenues primarily from the sale of software, hardware, sublicensed software and for the services required to install them. The increase in system sales is due to an increase in new contract bookings in the quarter ended September 28, 2002 compared to the prior year quarter.

Support, maintenance and service revenues increased 43% to $105,465,000 during the third quarter of 2002 from $73,772,000 during the same period in 2001. Support and maintenance revenues were $42,720,000 and $35,054,000 for the third quarter of 2002 and 2001, respectively. Services revenues were $62,745,000 and $38,718,000 for the third quarter of 2002 and 2001, respectively. Included in support, maintenance and service revenues are support and maintenance of software and hardware, and professional services excluding installation. This increase was due primarily to the increase in professional services, resulting from an increase in services related to and services provided into the Company’s installed and converted client base.

At September 28, 2002, the Company had $691,887,000 in contract backlog and $263,688,000 in support and maintenance backlog, compared to $532,568,000 in contract backlog and $216,554,000 in support and maintenance backlog at September 29, 2001.

The cost of revenues includes the cost of third party consulting services, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients and commissions. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to manufacturers. The cost of revenue was 20% of total revenues in the third quarter of 2002 and 2001. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, and support) components carrying different margin rates changes from period to period.

Sales and client service expenses include salaries of client service personnel, communications expenses and unreimbursed travel expenses. Also included are sales and marketing salaries, trade show costs and advertising costs. These expenses as a percent of total revenues were 43% and 42% in the third quarter of 2002 and 2001, respectively. The increase in total sales and client service expenses to $82,166,000 in the third quarter of 2002 from $59,173,000 in the same period of 2001 was attributable to the cost of a larger field sales and services organization and marketing of new products.

Software development expenses include salaries, documentation and other direct expenses incurred in product development and amortization of software development costs. Total expenditures for software development, including both capitalized and noncapitalized portions, for the third quarter of 2002 and 2001 were $39,730,000 and $29,172,000, respectively. These amounts exclude amortization. Capitalized software costs were $13,174,000 and $9,672,000 for the third quarter of 2002 and 2001, respectively. The increase in aggregate expenditures for software development in 2002 is due to development of Cerner Millennium ™ products and development of community care products.

General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, and professional fees. These expenses as a percent of total revenues were 7% in the third quarter of 2002 and 2001. Total general and administrative expenses for the third quarter of 2002 and 2001 were $13,216,000 and $9,990,000, respectively. The increase is due to the growth of the Company’s core business and as a result of acquisitions.

Net interest expense was $1,245,000 in the third quarter of 2002 compared to $1,329,000 in the third quarter of 2001. This decrease is primarily due to a decrease in interest rates on borrowings.

The Company’s effective tax rates were 39.4% and 40.2% for the third quarter of 2002 and 2001, respectively.

Nine Months Ended September 28, 2002 Compared to Nine Months Ended September 29, 2001

The Company’s revenues increased 40% to $546,184,000 for the nine-month period ended September 28, 2002 from $390,658,000 for the nine-month period ended September 29, 2001. Net earnings, before non-recurring items, increased 56% to $36,128,000 in the 2002 period from $23,172,000 for the 2001 period. After non-recurring items, the company had net earnings of $38,078,000 and a net loss of ($53,412,000) for the nine months ended September 28, 2002 and September 29, 2001, respectively. For the nine months ended September 28, 2002, the Company recorded a non-recurring gain of $4,308,000 from the sale of 14,820,527 shares of WebMD common stock. The Company also recorded non-recurring charge of $786,000, due to the cumulative effect of a change in accounting for goodwill. For the nine months ended September 29, 2001, the Company recorded a non-recurring charge of $127,616,000 from the other-than-temporary write-down of the WebMD shares and a non-recurring gain of $7,580,000 from the gain on the software license settlement with WebMD. For the nine-month period ended September 29, 2001, earnings included $1,371,000 of amortization of goodwill, net of tax.

System sales revenues increased 36% to $239,401,000 for the nine-month period ended September 28, 2002 from $175,975,000 for the corresponding period in 2001. Included in system sales are revenues primarily from the sale of software, hardware, sublicensed software and for the services required to install them. The increase in system sales is due to an increase in new contract bookings in the nine months ended September 28, 2002 compared to the prior year quarter.

Support, maintenance and service revenues increased 43% to $306,783,000 during the first nine months of 2002 from $214,683,000 during the same period in 2001. Support and maintenance revenues were $126,833,000 and $103,865,000 for the first nine months of 2002 and 2001, respectively. Services revenues were $179,950,000 and $110,818,000 for the first nine months of 2002 and 2001, respectively. Included in support, maintenance and service revenues are support and maintenance of software and hardware, and professional services excluding installation. This increase was due primarily to the increase in professional services, resulting from an increase in services related to and services provided into the Company’s installed and converted client base.

The cost of revenues includes the cost of third party consulting services, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients and commissions. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to manufacturers. The cost of revenue was 21% of total revenues in the first nine months of 2002 and 2001. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, and support) components carrying different margin rates changes from period to period.

Sales and client service expenses include salaries of client service personnel, communications expenses and unreimbursed travel expenses. Also included are sales and marketing salaries, trade show costs and advertising costs. These expenses as a percent of total revenues were 43% and 42% in the first nine months of 2002 and 2001, respectively. The increase in total sales and client service expenses to $233,421,000 in the first nine months of 2002 from $162,530,000 in the same period of 2001 was attributable to the cost of a larger field sales and services organization and marketing of new products.

Software development expenses include salaries, documentation and other direct expenses incurred in product development and amortization of software development costs. Total expenditures for software development, including both capitalized and noncapitalized portions, for the first nine months of 2002 and 2001 were $109,208,000 and $83,647,000, respectively. These amounts exclude amortization. Capitalized software costs were $36,089,000 and $27,851,000 for the first nine months of 2002 and 2001,

respectively. The increase in aggregate expenditures for software development in 2002 is due to development of Cerner Millennium ™ products and development of community care products.

General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, and professional fees. These expenses as a percent of total revenues were 7% in the first nine months of 2002 and 2001. Total general and administrative expenses for the first nine months of 2002 and 2001 were $37,558,000 and $28,645,000, respectively. The increase is due to the growth of the Company’s core business and as a result of acquisitions.

Net interest expense was $4,141,000 in the first nine months of 2002 compared to $2,964,000 in the first nine months of 2001. This increase is primarily due to an increase in borrowings and a decrease in interest earned on invested cash.

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

After adjusting for non-recurring items, the Company’s effective tax rate was 39.1% and 39.7% for the first nine months of 2002 and 2001, respectively.

Capital Resources and Liquidity

The Company’s liquidity position remains strong with total cash and cash equivalents of $88,558,000 at September 28, 2002 and working capital of $205,835,000. The Company generated cash in operating activities of $25,568,000, excluding a $31,200,000 tax payment, primarily related to the sale of WebMD, during the nine-month period ended September 28, 2002 and generated net cash in operating activities of $49,936,000 during the nine-month period ended September 29, 2001. Cash flow from operations decreased in the first nine months of 2002, primarily due to an increase in receivables, which is attributable to record levels of sales.

In June, 2002, the Company expanded its credit facility by entering into an unsecured revolving credit agreement with a group of banks led by US Bank. The new credit facility increases the amount the Company may borrow from $45,000,000 to $90,000,000. The fee rate on the new facility is approximately the same as the prior facility. The commitment terminates June, 2005. At September 28, 2002, the Company had $25,000,000 in outstanding borrowings under this agreement.

Cash used in investing activities consisted primarily of purchases of capital equipment of $29,279,000 and $14,328,000, purchases of land, buildings, and improvements of $18,822,000 and $4,356,000, and capitalized software development costs of $36,089,000 and $27,851,000, in the first nine months of 2002

and 2001, respectively. The Company utilized cash for the acquisition of businesses in the second and third quarters of 2002 for $19,129,000. Cash provided from investing activities in 2002 came from the proceeds of $90,119,000 from the sale of WebMD shares.

The Company’s liquidity is influenced by many factors, including the amount and timing of the Company’s revenues, its cash collections from its clients as implementation of its products proceed and the amounts the Company invests in software development and capital expenditures. The Company believes that its present cash position, together with cash generated from operations, and the Company’s line of credit will be sufficient to meet anticipated cash requirements during 2002.

At September 28, 2002, the Company was committed to spending between $61,000,000 to $66,000,000 under construction contracts for two new buildings at its Kansas City headquarters complex. At September 28, 2002, the Company had spent $18,822,000. The construction will be financed by the Company’s line of credit and cash generated from operations.

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

Critical Accounting Policies

The Company believes that there are several accounting policies that are critical to understanding the Company’s historical and future performance, as these policies affect the reported amount of revenue and other significant areas involving management’s judgments and estimates. These significant accounting policies relate to revenue recognition, software development costs, other than temporary declines in the market value of investments, allowance for doubtful accounts, and potential impairments of goodwill. These policies and the Company’s procedures related to these policies are described in detail below and under specific areas within the discussion and analysis of the Company’s financial condition and results of operations.

Revenue Recognition

Revenues are derived primarily from the sale of clinical and financial information systems and solutions. The components of the system sales revenues are the licensing of computer software, installation, subscription content and the sale of computer hardware and sublicensed software. The components of support, maintenance and services revenues are software support and hardware maintenance, remote hosting and outsourcing, training, consulting and implementation services.

The Company recognizes revenue in accordance with the provisions of Statement of Position (SOP) No. 97-2, “Software Revenue Recognition,” as amended by SOP No. 98-4, SOP 98-9 and clarified by Staff Accounting Bulletin (SAB) 101 “Revenue Recognition in Financial Statements.” SOP No 97-2, as amended, generally requires revenue earned on software arrangements involving multiple-elements to be allocated to each element based on the relative fair values of those elements. Revenue from multiple-element software arrangements is recognized using the residual method. Under the residual method, revenue is recognized in a multiple-element arrangement when Company-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement (i.e. professional services, maintenance, hardware and sublicensed software), but does not exist for one or more of the delivered elements in the arrangement (i.e. software products). The Company allocates revenue to each element in a multiple-element arrangement based on the element’s respective fair value, with the fair value determined by the price charged when that element is sold separately. Specifically, the Company determines the fair value of the maintenance portion of the arrangement based on the renewal price of the maintenance charged to clients, professional services portion of the arrangement, other than installation services, based on hourly rates which the Company charges for these services when sold apart from a software license, and the hardware and sublicense software based on the prices for these elements when they are sold separately from the software. If evidence of the fair value cannot be established for the undelivered elements of a license agreement, the entire amount of revenue under the arrangement is deferred until these elements have been delivered or objective evidence can be established.

Inherent in the revenue recognition process are significant management estimates and judgments, which influence the timing and the amount of revenue recognition. The Company provides several models for the procurement of its clinical and financial information systems. The predominant method is a perpetual software license agreement, project-related installation services, implementation and consulting services, computer hardware and sublicensed software, and software support. For those arrangements involving

the use of services, the Company uses the percentage of completion method of accounting, following the guidance in the AICPA Statement of Position No. 81-1 (SOP 81-1), Accounting for Performance of Construction-Type and Certain Production-Type Contracts.

The Company provides installation services, which include project-scoping services, conducting pre-installation audits and creating initial environments. Because installation services are deemed to be essential to the functionality of the software, software license and installation services fees are recognized over the software installation period using output measures which reflect direct labor hours incurred, beginning at software delivery and culminating at completion of installation, typically a three-to-six month process.

The Company also provides implementation and consulting services, which include consulting activities that fall outside of the scope of the standard installation services. These services vary depending on the scope and complexity requested by the client. Examples of such services may include additional database consulting, system configuration, project management, testing assistance, network consulting and post conversion review services. Implementation and consulting services generally are not deemed to be essential to the functionality of the software, and thus, do not impact the timing of the software license recognition, unless software license fees are tied to implementation milestones. In those instances, the portion of the software license fee tied to implementation milestones is deferred until the related milestone is accomplished and related fees become billable and non-forfeitable. Implementation fees are recognized over the service period, which may extend from six months to three years.

Remote hosting and outsourcing services are marketed under long-term arrangements generally over periods of five to 10 years. Revenues from these arrangements are recognized as the services are performed.

Software maintenance fees are marketed under annual and multi-year arrangements and are recognized as revenue ratably over the contracted maintenance term. Hardware maintenance revenues are billed and recognized monthly over the contracted maintenance term.

Subscription and content fees are generally marketed under annual and multi-year agreements and are recognized ratably over the contracted terms.

Hardware and sublicensed software sales are generally recognized upon delivery to the customer.

The Company also offers its products on an application service provider (“ASP”) or a term license basis, making available Company software functionality on a remote processing basis from the Company’s data centers. The data centers provide system and administrative support as well as processing services. Revenue on software and services provided on an ASP or term license basis is recognized on a monthly basis over the term of the contract. The Company capitalizes related direct costs consisting of third-party costs and direct software installation and implementation costs. These costs are amortized over the term of the arrangement.

In the event the Company contractually agrees to develop new or customized software code for a client, the Company will utilize percentage of completion accounting in accordance with SOP 81-1.

Deferred revenue comprises deferrals for license fees, maintenance and other services for which payment has been received and for which the service has not yet been performed. Long-term deferred revenue, at September 28, 2002, represents amounts received from license fees, maintenance and other services to be earned or provided beginning in periods on or after September 29, 2003.

Software Development Costs

Costs incurred internally in creating computer software products are expensed until technological feasibility has been established upon completion of a detailed program design. Thereafter, all software development costs are capitalized and subsequently reported at the lower of amortized cost or net realizable value. Capitalized costs are amortized based on current and expected future revenue for each product with minimum annual amortization equal to the straight-line amortization over the estimated economic life of the product. The Company is amortizing capitalized costs over five years. During the first nine months of 2002 and 2001, the Company capitalized $36,089,000 and $27,851,000, respectively, of total software development costs of $109,208,000 and $83,647,000, respectively.

The Company expects that major software information systems companies, large information technology consulting service providers and systems integrators, internet-based start-up companies and others specializing in the health care industry may offer competitive products or services. The pace of change in the health care information systems market is rapid and there are frequent new product introductions, product enhancements and evolving industry standards and requirements. As a result, the capitalized software may become less valuable or obsolete and could be subject to impairment.

Investments

The Company accounts for its investments in equity securities, which have readily determinable fair values as available-for-sale. Available-for-sale securities are reported at fair value with unrealized gains and losses reported, net of tax, as a separate component of accumulated other comprehensive income. For realized gains and losses on available-for-sale investments, the Company utilizes the specific identification method as the basis to determine cost. Investments in the common stock of certain affiliates over which the Company exerts significant influence are accounted for by the equity method.

All equity securities are reviewed by the Company for declines in fair value. If such declines are considered to be other than temporary, the cost basis of the individual security is written down to fair value as a new cost basis, and the amount of the write-down is included in earnings.

The Company also has certain other minority equity investments in non-publicly traded securities. These investments are generally carried at cost as the Company owns less than 20% of the voting equity and does not have the ability to exercise significant influence over these companies. The balance of these investments at September 28, 2002 and December 29, 2001 was $16,588,000 and $18,212,000, respectively. These investments are inherently high risk as the market for technologies and content by these companies are usually early stage at the time of the investment by the Company and such markets may never be significant. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future. The Company could lose its entire investment in certain or all of these companies. The Company monitors these investments for impairment and makes appropriate reductions in carrying values when necessary.

Concentrations

Substantially all of the Company’s cash and cash equivalents and short-term investments are held at two major U.S. financial institutions. The majority of the Company’s cash equivalents consist of U.S. Federal Government Agency Securities, short-term marketable securities, and overnight repurchase agreements. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally these deposits may be redeemed upon demand and, therefore, bear minimal risk.

Substantially all of the Company’s clients are integrated delivery networks, hospitals, and other health care-related organizations. If significant adverse macro-economic factors were to impact these organizations, it could materially adversely affect the Company. The Company’s access to certain software and hardware components are dependent upon single and sole source suppliers. The inability of any supplier to fulfill supply requirements of the Company could affect future results.

Allowance for Doubtful Accounts

The Company performs ongoing credit evaluations of its clients and generally does not require collateral from its clients. The Company maintains an allowance for potential losses on a specific identification basis and based on historical experience and management’s judgments. The Company’s allowance for doubtful accounts as of September 28, 2002 and December 29, 2001 was $7,838,000 and $6,880,000, respectively.

Goodwill

impairment test based on fair value. The Company completed its review of the Company’s goodwill values in the second quarter of 2002. As a result of this review, the Company determined that goodwill arising from the acquisition of Mitch Cooper and Associates was impaired due to declining demand and margins in this business. Mitch Cooper and Associates was a supply chain re-engineering consulting practice. The impairment charge to reflect this goodwill at fair value was $786,000, net of tax and is reflected as a cumulative effect of a change in accounting principle as of the beginning of 2002. The Company used a discounted cash flow analysis to determine the fair value of the reporting units. The Company completed three acquisitions subsequent to June 30, 2001, which resulted in approximately, $24.8 million of goodwill that was not amortized in accordance with SFAS 142. For the three and nine-month periods ended September 29, 2001, earnings included $456,000 and $1,371,000 of amortization of goodwill, net of tax, respectively.

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

Statements made in this report, and other reports and proxy statements filed with the Securities and Exchange Commission, communications to stockholders, press releases and oral statements made by representatives of the Company that are not historical in nature, or that state the Company’s or management’s intentions, hopes, beliefs, expectations or predictions of the future, may constitute “forward-looking statements” within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”),. Forward-looking statements can often be identified by the use of forward-looking terminology, such as “could,” “should,” “will,” “will be,” “will lead,” “will assist,” “intended,” “continue,” “believe,” “may,” “expect,” “hope,” “anticipate,” “goal,” “forecast,” “plan,” or “estimate” or variations thereof or similar expressions. Forward-looking statements are not guarantees of future performance of results. They involve risks, uncertainties and assumptions. It is important to note that any such performance and actual results, financial condition or business, could differ materially from those expressed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below as well as those discussed elsewhere in reports filed with the Securities and Exchange Commission. Other factors not identified herein could also have such an effect. The Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.

Quarterly Operating Results May Vary — The Company’s quarterly operating results have varied in the past and may continue to vary in future periods. Quarterly operating results may vary for a number of reasons including accounting policy changes mandated by regulating entities (including, but not limited to, an accounting policy change concerning the expensing of options), demand for the Company’s products and services, the Company’s long sales cycle, potentially long installation and implementation cycle for these larger, more complex and costlier systems and other factors described in this section and elsewhere in this report. As a result of health care industry trends and the market for the Company’s Cerner Millennium ™ products, a large percentage of the Company’s revenues are generated by the sale and installation of larger, more complex and costlier systems. The sales process for these systems is lengthy and involves a significant technical evaluation and commitment of capital and other resources by the client.

The sale may be subject to delays due to clients’ internal budgets and procedures for approving large capital expenditures and by competing needs for other capital expenditures and deploying new technologies or personnel resources. Delays in the expected sale or installation of these large contracts may have a significant impact on the Company’s anticipated quarterly revenues and consequently its earnings, since a significant percentage of the Company’s expenses are relatively fixed.

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

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

Stock Price May Be Volatile — The trading price of the Company’s common stock may be volatile. The market for the Company’s common stock may experience significant price and volume fluctuations in response to a number of factors including actual or anticipated quarterly variations in operating results, rumors about the Company’s performance or products, changes in expectations of future financial performance or changes in estimates of securities analysts, governmental regulatory action, health care reform measures, client relationship developments, changes occurring in the securities markets in general and other factors, many of which are beyond the Company’s control. As a matter of policy, the Company does not generally comment on rumors.

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

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

The Company is exposed to market risk from changes in marketable securities (which consist of money market and commercial paper). At September 28, 2002, marketable securities of the Company were recorded at cost, which approximates fair value of approximately $89 million, with an overall average return of approximately 2.3% and an overall weighted maturity of less than 90 days. The marketable securities held by the Company are not subject to price risk as a result of the short-term nature of the investments.

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

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

Changes in the Health Care Industry — The health care industry is highly regulated and is subject to changing political, economic and regulatory influences. For example, the Balanced Budget Act of 1997 (Public Law 105-32) contains significant changes to Medicare and Medicaid and began to have its initial impact in 1998 due to limitations on reimbursement, resulting cost containment initiatives, and effects on

pricing and demand for capital intensive systems. In addition, the issued and pending rules under the Health Information Portability and Accountability Act of 1996 (HIPAA), will have a direct impact on the health care industry by requiring identifiers and standardized transactions/code sets and necessary security and privacy measures in order to ensure the protection of patient health information. These factors affect the purchasing practices and operation of health care organizations. Federal and state legislatures have periodically considered programs to reform or amend the U.S. health care system at both the federal and state level and to change health care financing and reimbursement systems. These programs may contain proposals to increase governmental involvement in health care, lower reimbursement rates or otherwise change the environment in which health care industry participants operate. Health care industry participants may respond by reducing their investments or postponing investment decisions, including investments in the Company’s products and services.

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

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

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

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

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

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

Government Regulation — The United States Food and Drug Administration (the “FDA”) has declared that software products intended for the maintenance of data used in making decisions regarding the suitability of blood donors and the release of blood or blood components for transfusion are medical devices under the Federal Food, Drug and Cosmetic Act (“Act”) and amendments to the Act. As a consequence, the Company is subject to extensive regulation by the FDA with regard to its blood bank software. If other of the Company’s products are deemed to be actively regulated medical devices by the FDA, the Company could be subject to extensive requirements governing pre- and post-marketing requirements including pre-

market notification clearance prior to marketing. Complying with these FDA regulations would be time- consuming and expensive. It is possible that the FDA may become more active in regulating computer software that is used in health care.

Following an inspection by the FDA in March of 1998, the Company received a Form FDA 483 (Notice of Inspectional Observations) alleging non-compliance with certain aspects of FDA’s Quality System Regulation with respect to the Company’s PathNet ® HNAC Blood Bank Transfusion and Donor products (the “Blood Bank Products”). The Company subsequently received a Warning Letter, dated April 29, 1998, as a result of the same inspection. The Company responded promptly to the FDA and undertook a number of actions in response to the Form 483 and Warning Letter including an audit by a third party of the Company’s Blood Bank Products and improvements to Cerner’s Quality System. A copy of the third- party audit was submitted to the FDA in October 1998. At the request of the FDA, additional information and clarification were submitted to the FDA in January 1999.

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

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

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

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Information contained under the caption “Factors That May Affect Future Results of Operations, Financial Condition or Business — Market Risk of Investments” set forth under the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 is incorporated herein by reference.

Item 4. Controls and Procedures

Within the 90-day period prior to the filing of this Quarterly Report on Form 10-Q, the Company’s Chairman of the Board and Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-14(c)). The principal executive officer and principal financial officer have concluded, based on their review, that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. No significant changes were made to the Company’s internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation.

Part II. Other Information

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

(a) Exhibits

99.1 Certification pursuant to 18 U.S.C. Section. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

99.2 Certification pursuant to 18 U.S.C. Section. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K

An 8-K was filed on August 13, 2002.

SIGNATURES

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


		CERNER CORPORATION Registrant


November 5, 2002 Date			By:/s/Marc G. Naughton Marc G. Naughton Chief Financial Officer

CERTIFICATIONS

I, Neal L. Patterson, Chairman of the Board and Chief Executive Officer of Cerner Corporation, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Cerner Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


Date: November 5, 2002

		/s/ Neal L. Patterson Neal L. Patterson Chairman of the Board and Chief Executive Officer

I, Marc G. Naughton, Chief Financial Officer of Cerner Corporation, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Cerner Corporation;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and


Date: November 5, 2002

		/s/ Marc G. Naughton Marc G. Naughton Chief Financial Officer

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(a)	Exhibits

	99.1	Certification pursuant to 18 U.S.C. Section. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	99.2	Certification pursuant to 18 U.S.C. Section. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)	Reports on Form 8-K

	An 8-K was filed on August 13, 2002.