UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

OR

Commission File Number 0-15386

CERNER CORPORATION

2800 Rockcreek Parkway
North Kansas City, Missouri 64117
(816) 201-1024

     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( )

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes (X)      No( )

     There were 36,337,419 shares of Common Stock, $.01 par value, outstanding at October 2, 2004.

CERNER CORPORATION AND SUBSIDIARIES

I N D E X

Part I. Financial Information

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

See notes to condensed consolidated financial statements.

1

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)

See notes to condensed consolidated financial statements.

2

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

See notes to condensed consolidated financial statements.

3

CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)

Interim Statement Presentation & Accounting Policies

The condensed 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 condensed 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 for the three and nine-month periods are not necessarily indicative of the operating results for the entire year.

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” establishes requirements for reporting and display of comprehensive income and its components. Total Comprehensive Income, which includes net earnings and foreign currency translation adjustments and unrealized gains and losses on available-for-sale equity security adjustments, amounted to $15,651,000 and $12,334,000 for the three months ended October 2, 2004 and September 27,2003 and $43,386,000 and $29,503,000 for the nine months ended October 2, 2004 and September 27,2003, respectively.

The terms of the Company’s software license agreements with its clients generally provide for a limited indemnification of such intellectual property against losses, expenses and liabilities arising from third-party claims based on alleged infringement by the Company’s 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, the Company has not had to reimburse any of its clients for any losses related to these indemnification provisions pertaining to third-party intellectual property infringement claims. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the terms of the corresponding agreements with its clients, the Company cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.

On September 27, 2003, the Company adopted Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities an Interpretation of APB No. 51.” The Interpretation provides guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities’” or “VIEs”) and how to determine when and which business enterprises should consolidate the VIE (the “primary beneficiary”). In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures.

The Company began consolidating the operations of Cerner Arabia Ltd (“Cerner Arabia”) in September 2003. Cerner Arabia is a software company located in Riyadh, Saudi Arabia. Revenues are derived primarily from the sale of clinical, financial and administrative information systems and solutions. The consolidation of Cerner Arabia resulted in an increase to revenues of $250,000 and $291,000 and a decrease of $19,000 and an increase of $39,000 in net earnings for the three months ended October 2, 2004 and September 27, 2003, respectively. The consolidation of Cerner Arabia resulted in an increase to revenues of $1,064,000 and $291,000 and an increase in net earnings of $108,000 and $39,000 for the nine months ended October 2, 2004 and September 27, 2003, respectively.

4

(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:

Options to purchase 1,532,000 and 2,961,000 shares of common stock at per share prices ranging from $44.40 to $273.72 and $31.50 to $273.72 were outstanding at the three-months ended October 2, 2004 and September 27, 2003, 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.

Options to purchase 1,668,000 and 3,683,000 shares of common stock at per share prices ranging from $43.62 to $273.72 and $29.15 to $273.72 were outstanding at the nine-months ended October 2, 2004 and September 27, 2003, 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.

5

(3)

Accounting for Stock Options

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations including FASB Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25,” issued in March 2000, to account for its fixed–plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123. The following is a reconciliation of reported net earnings to adjusted net earnings had the Company recorded compensation expense based on the fair value at the grant date for its stock options under SFAS 123 for the three and nine months ended October 2, 2004 and September 27, 2003.

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 adjusted 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.

(4)

Business Divestiture and Acquisition

On March 15, 2004 the Company sold the referential content portion of Zynx Health Incorporated (Zynx) for $12 million. The Company retained the life sciences portion of the business, which is engaged in selling life sciences data to pharmaceutical companies for use in research, and the Company retained rights to use the Zynx content in its solutions going forward. The sale of Zynx resulted in a gain of $1,826,000, net of $1,197,000 of tax.

On September 29, 2003, the Company completed the purchase of BeyondNow Technologies, Inc. (“BeyondNow”) for approximately $7.5 million in cash. BeyondNow develops home care technologies that reduce administrative paperwork, provide clinicians with remote access to charts, accelerate third-party reimbursement and share information between the home care setting and hospitals. Cerner is integrating the BeyondNow technology into the Cerner Millennium ® technology platform. This acquisition did not have a material impact on operations. The allocation of the purchase price included $3,154,000 of acquired technology and $3,080,000 of goodwill.

(5)

Receivables

6

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:

The Company provides an allowance for estimated uncollectible accounts based upon historical experience and management’s judgment. At October 2, 2004 and January 3, 2004 the allowance for estimated uncollectible accounts was $15,644,000 and $12,056,000, respectively.

(6)

Goodwill and Other Intangible Assets

Goodwill and intangible assets with indefinite lives 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’s 2004 review of goodwill was completed in the second quarter of 2004 and indicated that goodwill was not impaired.

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

Aggregate amortization expense for the nine months ended October 3, 2004 and September 27, 2003 was $4,532,000 and $4,582,000 respectively. Estimated aggregate amortization expense for each of the next five years is as follows:

7

The changes in the carrying amount of goodwill for the nine months ended October 2, 2004 are as follows:

(7)

Contingencies

As previously disclosed, the Company received notice in April 2003 that three shareholder class action lawsuits were filed against it and five of its officers in the United States District Court for the Western District of Missouri. Subsequently, five additional shareholder class action lawsuits were filed against the Company. All of these lawsuits were filed after a decline in the Company’s stock price following the Company’s announcement on April 3, 2003 that the Company would not meet revenue and earnings estimates for the first quarter of 2003.

On August 20, 2003, the Court ordered that all of the lawsuits be consolidated under Case No. 03-CV-00296-DW and appointed Phil Crabtree as Lead Plaintiff. On December 1, 2003, the Lead Plaintiff filed a Consolidated Class Action Complaint. In general, the consolidated complaint alleges that, during a class period commencing as of July 17, 2002 and ending April 2, 2003, the Company and individual named defendants misrepresented or failed to disclose certain factors, which they allege impacted the Company’s business and anticipated revenue and earnings, all allegedly in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The Company believes that all the claims asserted in the Consolidated Amended Complaint are without merit and intends to vigorously defend those claims.

On June 16, 2004 the Court granted the Company’s and the individual defendants’ Motion To Dismiss and ordered the Consolidated Class Action Complaint dismissed with prejudice against re-filing. On June 30, 2004, the Lead Plaintiff appealed the District Court’s dismissal of the action to the United States Court of Appeals for the Eighth Circuit. The parties have filed their appellate briefs but the Court of Appeals has not yet scheduled the appeal for oral argument. The Company does not know when the Court of Appeals will schedule oral arguments or rule on the appeal.

(8)

Segment Reporting

Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” establishes annual and interim reporting standards for operating segments of a company. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues, and its major clients. In 2003, the Company organized geographically. The Company’s six geographic business segments are: Great Lakes, Mid-America, North Atlantic, Southeast, West and Global.

Revenues are derived primarily from the sale of clinical, financial and administrative information systems and solutions. The cost of revenues includes the cost of third party consulting services, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such. “Other” includes revenues not generated by the operating segments and expenses such as software development, marketing, general and administrative and depreciation that have not been allocated to the operating segments. The Company does not track assets by geographical business segment.

8

Accounting policies for each of the reportable segments are the same as those used on a consolidated basis. The following table presents a summary of the operating information for the three and nine-months ended October 2, 2004 and September 27, 2003:

9

(9)

Accrued Vacation Pay Adjustment

In conjunction with a review of the process for calculating the liability for accrued vacation pay at the end of the third quarter of 2004, the Company determined that the liability on the balance sheet relating to periods prior to 2004 was understated by $3,346,000. While the Company was fully accrued for all vested vacation that would be subject to payout upon termination, the Company understated the liability for accumulated vacation that could be used in subsequent periods by associates in excess of the vested amount payable upon termination.

The expense, if properly recorded in 2000 through 2003, would have increased 2003 net earnings by $0.1 million and would have decreased net earnings by $0.4 million in 2002, $0.6 million in 2001, and $1.2 million in 2000. The cumulative impact on net earnings is a decrease of $2.1 million for this four-year period. The impact on 2004 net earnings is a positive $8 thousand. As the impact to prior year’s annual financial statements was not material, Cerner recorded additional expense of $3,346,000, $2,076,000 million after-tax ($0.06 per share), in the 2004 third quarter to appropriately reflect the liability as of October 2, 2004. The Company has revised its process for calculating the liability for accumulated vacation to accurately report this information in the future.

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

Introduction

Cerner Corporation (“Cerner” or the “Company”) is headquartered in North Kansas City, Missouri. The Company derives revenue by selling, implementing and supporting software solutions and hardware that gives healthcare providers secure access to clinical, administrative and financial data in real time, allowing them to improve the quality, safety and efficiency in the delivery of healthcare. Cerner implements these solutions as stand-alone, combined or enterprise-wide systems. Cerner Millennium® software solutions can be managed by the Company’s clients or in the Company’s data center via a managed services model.

Results Overview

The Company delivered strong results in the third quarter of 2004. Total new business bookings, which reflect the value of contracts for software, hardware, services and managed services (hosting of software in the Company’s data center), were a record for the third quarter at $215,820,000 in the third quarter of 2004, an increase of 6% compared to $203,910,000 in the third quarter of 2003. The Company’s solid bookings drove a 34% year-over-year increase in contract backlog, which reflects new business bookings that have not yet been recognized as revenue, and ended the third quarter at $1,125,665,000. Total revenues in the third quarter were $231,067,000, an increase of 12% compared to the third quarter of 2003.

Backlog continues to grow faster than revenue as the Company is experiencing strong growth in managed services and subscription bookings, which are recognized as revenue over a longer period of time than other types of bookings, such as software and hardware. For the full-year 2003 and the first three quarters of 2004, managed service and subscription bookings represented more than 20% of total bookings compared to approximately 15% in 2002. The strong growth in managed services bookings has led to a decline in hardware bookings as clients electing managed services do not need to make the upfront hardware purchase that they would make in a transaction that does not include managed services. This shift in bookings mix has led to declines in hardware revenue of more than 30% year to date. While licensed software revenue has grown at a strong rate of more than 20%, this growth has been offset by the declines in hardware revenue, resulting in lower System Sales growth of 4% year to date. Despite the near-term impact on System Sales, the Company views this mix shift favorably because the higher level of managed services bookings improves the visibility of future revenue streams.

Net earnings increased from $12,047,000 in the third quarter of 2003 to $14,779,000 in the third quarter of 2004. The third quarter of 2004 includes an adjustment related to prior period vacation pay accrual (see note 9 to condensed consolidated financial statements) that reduced net earnings by $2,076,000, net of $1,270,000 million of tax. Net earnings in the third quarter of 2004 without this adjustment were $16,855,000. The increase in net earnings was driven both by revenue growth and margin expansion. Operating margins were 11.4% (12.9% prior to the vacation accrual adjustment) in the third quarter of 2004 compared to 10.5% in the year-ago quarter. Going forward, management believes the Company can continue to increase operating margins by expanding margins on services, leveraging investments in research and development, and controlling sales, general and administrative spending.

The Company’s operational performance was also very strong in the third quarter of 2004. The Company brought 293 Cerner Millennium solutions live in the third quarter of 2004, bringing the cumulative number of solutions implemented to more than 3,400 at more than 670 client facilities. These results included significant progress at implementing computerized physician order entry (CPOE), which is the application generating the highest level of industry attention.

The Company’s strong operational performance is also reflected in its cash flow results. In the third quarter of 2004, the Company generated $45,218,000 of cash flow from operations, with days sales outstanding decreasing from 112 days at the end of the third quarter of 2003 to 104 days at the end of the third quarter of 2004.

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Healthcare Information Technology Market

The Company believes the market for healthcare information technology remains strong. The healthcare information technology industry and Cerner specifically, continues to benefit from the focus healthcare providers have placed on using CPOE to drive major patient safety and quality initiatives into their organizations with the ultimate goal of becoming completely digital or paperless. In addition, the Company continues to benefit from its clients’ increased desire to have a common architecture spanning clinical, management and financial solutions.

There are also several emerging drivers that the Company believes have the potential to accelerate demand for healthcare information technology. These include:

•

The creation of the sub-cabinet position of National Health Information Technology Coordinator inside The Department of Health and Human Services that was filled by Dr. David Brailer which indicates the U.S. Government’s recognition of the value information technology should play in modernizing our healthcare system.

•

The bipartisan coalitions that are gaining momentum, such as with Senator Clinton and Majority Leader Frist, who placed an editorial in the August 25, 2004, Washington Post that focused on the important role information technology needs to play in lowering costs, improving quality and empowering consumers.

•

President Bush’s goal that every American have a Personal Medical Record at the end of ten years and his recent comment in the presidential debates that 20% of the cost of health care could be eliminated through wide spread adoption of information technology in healthcare.

•

More widespread adoption of Pay-For-Performance compensation systems that could drive near complete digitization of medical records for both hospitals and physician offices; and

•

Increasing activity by employers, such as General Motors, Delta Airlines, UPS, Verizon, General Electric, and Boeing who are helping drive wider-spread adoption of The Leapfrog Group’s standards, including CPOE.

Results of Operations

Three Months Ended October 2, 2004 Compared to Three Months Ended September 27, 2003

The Company’s revenues increased 12% to $231,067,000 for the three-month period ended October 2, 2004 from $206,292,000 for the three-month period ended September 27, 2003. Net earnings increased 23% to $14,779,000 in the 2004 period from $12,047,000 for the 2003 period. Net earnings for the three-month period ended October 2, 2004 included a prior period adjustment increasing accrued vacation pay by $2,076,000, net of $1,270,000 of tax.

System sales revenues increased 3% to $82,882,000 for the three-month period ended October 2, 2004 from $80,193,000 for the corresponding period in 2003. Included in system sales are revenues primarily from the sale of software, hardware, sublicensed software and installation fees. This increase is due primarily to an increase in new business bookings in the third quarter of 2004 period compared to the third quarter of 2003. System sales grew at a lower rate than new business bookings primarily because declining hardware revenue largely offset increases in software revenue. The lower level of hardware sales is primarily attributable to clients choosing the Company’s managed service offering.

Support, maintenance and service revenues increased 18% to $140,123,000 during the third quarter of 2004 from $118,774,000 during the same period in 2003. Included in support, maintenance and service revenues are support and maintenance of software and hardware, professional services excluding installation, and managed services. Support and maintenance revenues were $61,874,000 and $51,916,000 for the third quarter of 2004 and 2003, respectively. Service revenues were $78,249,000 and $66,858,000 for the third quarter of 2004 and 2003, respectively. These increases were driven by strong performance in delivering Cerner Millennium solutions to clients.

At October 2, 2004, the Company had $1,125,665,000 in contract backlog and $335,600,000 in support and maintenance backlog, compared to $843,000,000 in contract backlog and $294,307,000 in support and maintenance backlog at September 27, 2003.

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The cost of revenue was 19% and 22% of total revenues in the third quarter of 2004 and 2003, respectively. The cost of revenues includes the cost of reimbursed travel expense, third party consulting services, subscription content, 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. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, support, services and reimbursed travel) components carrying different margin rates changes from period to period. The decrease in the cost of revenue as a percent of total revenues resulted principally from a decrease in the percent of revenue from computer hardware and sublicensed software, which carry a higher cost of revenue percentage. The Company believes this trend could continue because of strong demand for its managed service offering, which results in lower hardware sales because the client does not pay for hardware upfront when it chooses this offering.

Sales and client service expenses as a percent of total revenues were 43% and 41% in the third quarter of 2004 and 2003, respectively. Sales and client service expense include salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Also included are sales and marketing salaries, trade show costs and advertising costs. The increase in total sales and client service expenses to $98,919,000 in the third quarter of 2004 from $84,794,000 in the same period of 2003 was primarily attributable to an increase in personnel expense related to a change in the review cycle where the majority of our associates receive their annual compensation increase.

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 2004 and 2003 were $46,558,000 and $45,431,000, respectively. These amounts exclude amortization. Capitalized software costs were $14,281,000 and $14,971,000 for the third quarter of 2004 and 2003, respectively. The increase in aggregate expenditures for software development in 2004 is due to continued development of Cerner Millennium software solutions.

General and administrative expenses as a percent of total revenues were 8% and 7% in the third quarter of 2004 and 2003, respectively. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses and professional fees. General and administrative expenses for the third quarter of 2004 include a prior period adjustment to increase vacation pay accrual of $3,346,000. Total general and administrative expenses for the third quarter of 2004 and 2003 were $17,942,000 and $15,083,000, respectively. Excluding the adjustment to increase vacation pay accrual, general and administrative expenses as a percent of total revenues were 6% in the third quarter of 2004.

Operations by Segment

In 2003, the Company organized geographically. The Company’s six geographic business segments are: Great Lakes, Mid-America, North Atlantic, Southeast, West and Global. Revenues are derived primarily from the sale of clinical, financial and administrative information systems and solutions. The cost of revenues includes the cost of third party consulting services, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such. “Other” includes revenues not generated by the operating segments and expenses such as software development, marketing, general and administrative and depreciation that have not been allocated to the operating segments. The Company does not track assets by geographical business segment.

The following table presents a summary of the operating information for the three months ended October 2, 2004 and September 27, 2003:

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Operating earnings in the Great Lakes segment increased 34% for the three months ended October 2, 2004 compared to the three months ended September 27, 2003. Total revenues increased 24% in the third quarter of 2004 compared to the third quarter of 2003. The increase in revenues was primarily driven by a strong increase in licensed software revenues in the third quarter of 2004 compared to the third quarter of 2003. Costs of revenues were 15% and 19% of total revenues of the Great Lakes segment for the third quarter of 2004 and 2003, respectively. The decrease in the cost of revenues as a percent of revenue is due primarily to lower hardware sales in the third quarter of 2004 as compared to 2003. Costs of revenues, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, support, services and reimbursed travel) components carrying different margin rates changes from period to period.

Operating earnings in the Mid-America segment increased 31% for the three months ended October 2, 2004 compared to the three months ended September 27, 2003. Total revenues increased 13% in the third quarter 2004 compared to the third quarter of 2003. The increase in revenues was driven primarily by a strong increase in professional services in the third quarter of 2004 compared to the third quarter of 2003. Cost of revenues were 15% and 27% of total Mid-America segment revenues for the third quarter of 2004 and the third quarter of 2003, respectively. The decrease in the cost of revenues as a percent of revenues is due primarily to lower hardware sales in the third quarter of 2004 as compared to 2003. Operating expenses increased 36% in the third quarter of 2004 compared to 2003, due primarily to an increase in personnel related expense.

Operating earnings in the North Atlantic segment increased 9% for the three months ended October 2, 2004 compared to the three months ended September 27, 2003. Total revenues increased 10% in the third quarter of 2004 compared to the third quarter of 2003, due primarily to an increase in hardware and professional services revenues in the third quarter of 2004 compared to the third quarter of 2003. Cost of revenues were 22% and 20% of total North Atlantic segment revenues for the third quarter of 2004 and the third quarter of 2003, respectively. Operating expenses increased 5% in the third quarter of 2004 compared to 2003, due primarily to an increase in personnel related expense.

Operating earnings in the Southeast segment decreased 7% for the three months ended October 2, 2004 compared to the three months ended September 27, 2003. The decrease in operating earnings is due primarily to a decrease in total revenues of 6% in the third quarter of 2004 compared to the third quarter of 2003. The decrease in revenues is due primarily to a decrease in professional services and hardware revenues. Cost of revenues were 26% and 29% of total Southeast segment revenues for the third quarter of 2004 and the third quarter of 2003, respectively. The decrease in cost of revenues is due primarily to lower hardware revenue in the third quarter of 2004 as compared to 2003.

Operating earnings in the West segment decreased 4% for the three months ended October 2, 2004 compared to the three months ended September 27, 2003. Total revenues increased 6% in the third quarter of 2004 compared to the third quarter of 2003, due primarily to an increase in support and hardware revenues. Cost of revenues were 20% and 16% of total West segment revenues for the third quarter of 2004 and 2003, respectively. Operating expenses increased 19% in the third quarter of 2004 compared to the third quarter of 2003, due primarily to an increase in personnel related expenses.

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Operating earnings in the Global segment increased 189% for the three months ended October 2, 2004 compared to the three months ended September 27, 2003. Total revenues increased 79% in the third quarter of 2004 compared to the third quarter of 2003. The increase in revenues is due primarily to strong increases in licensed software and professional services revenues in the third quarter of 2004 compared to the third quarter of 2003. Cost of revenues were 14% and 18% of total Global segment revenues for the third quarter of 2004 and 2003, respectively. Operating expenses increased 67% in the third quarter of 2004 compared to the third quarter of 2003, due to an increase in personnel and projected related expenses.

Operating losses in Other increased 15% for the three months ended October 2, 2004 compared to the three months ended September 27, 2003. This increase is due to an increase in operating expenses of 11% in third quarter of 2004 compared to the third quarter of 2003. This increase in operating expenses is due to an increase in expenses such as software development, marketing, general and administrative and depreciation in the third quarter of 2004 compared to the third quarter of 2003. Operating expenses in the third quarter of 2004 includes a prior period adjustment to increase the vacation pay accrual of $3,346,000.

Nine months Ended October 2, 2004 Compared to Nine months Ended September 27, 2003

The Company’s revenues increased 11% to $678,184,000 for the nine-month period ended October 2, 2004 from $612,178,000 for the nine-month period ended September 27, 2003. Net earnings increased 63% to $43,222,000 in the 2004 period from $26,583,000 for the 2003 period. Net earnings for the nine-month period ended October 2, 2004 included a gain on the sale of Zynx Health Incorporated of $1,826,000, net of $1,197,000 of tax and a prior period adjustment to increase the vacation pay of $2,076,000, net of $1,270,000 of tax.

System sales revenues increased 4% to $252,247,000 for the nine-month period ended October 2, 2004 from $241,529,000 for the corresponding period in 2003. Included in system sales are revenues primarily from the sale of software, hardware, sublicensed software and installation fees. This increase is due primarily to an increase in new business bookings in the nine-month period of 2004 compared to the nine-month period of 2003. System sales grew at a lower rate than new business bookings primarily because declining hardware revenue largely offset increases in software revenue. The lower level of hardware sales is primarily attributable to clients choosing the Company’s managed services offering.

Support, maintenance and service revenues increased 15% to $401,141,000 during the first nine months of 2004 from $347,946,000 during the same period in 2003. This increase was driven by strong performance in delivering Cerner Millennium solutions to clients. Included in support, maintenance and service revenues are support and maintenance of software and hardware, professional services excluding installation, and managed services. Support and maintenance revenues were $179,485,000 and $149,956,000 for the first nine months of 2004 and 2003, respectively. Service revenues were $221,656,000 and $197,990,000 for the first nine months of 2004 and 2003, respectively.

At October 2, 2004, the Company had $1,125,665,000 in contract backlog and $335,600,000 in support and maintenance backlog, compared to $843,000,000 in contract backlog and $294,307,000 in support and maintenance backlog at September 27, 2003.

The cost of revenue was 21% and 24% of total revenues in the first nine-month period of 2004 and 2003, respectively. The cost of revenues includes the cost of reimbursed travel expense, third party consulting services and subscription content, 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. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, support, services and reimbursed travel) components carrying different margin rates changes from period to period. The decrease in the cost of revenue as a percent of total revenues resulted principally from a decrease in the percent of revenue from computer hardware and sublicensed software, which carry a higher cost of revenue percentage. The Company believes this trend could continue because of strong demand for its managed service offering, which results in lower hardware sales because the client does not pay for hardware upfront when it chooses this offering.

Sales and client service expenses as a percent of total revenues were 42% in the nine-month periods of 2004 and 2003. Sales and client service expense include salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Also included are sales and marketing

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salaries, trade show costs and advertising costs. The increase in total sales and client service expenses to $285,993,000 in the nine-month period of 2004 from $259,531,000 in the same period of 2003 was primarily attributable to an increase in personnel expenses.

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 nine-month periods of 2004 and 2003 were $141,033,000 and $132,663,000, respectively. These amounts exclude amortization. Capitalized software costs were $44,662,000 and $43,720,000 for the nine month periods of 2004 and 2003, respectively. The increase in aggregate expenditures for software development in 2004 is due to continued development of Cerner Millennium software solutions.

General and administrative expenses as a percent of total revenues were 7% in the first nine months of 2004 and 2003, respectively. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses and professional fees. General and administrative expenses for the first nine months of 2004 include a prior period adjustment to increase the vacation pay accrual of $3,346,000. Total general and administrative expenses for the first nine months of 2004 and 2003 were $47,006,000 and $41,374,000, respectively. The increase is due primarily to the growth of the Company’s core business and as a result of acquisitions.

Net interest expense was $5,492,000 in the nine month period of 2004 compared to $5,152,000 in the nine month period of 2003.

Other income was $2,892,000 in the first nine months of 2004 compared to $167,000 in the first nine months of 2003. This increase is due to the gain on the sale of Zynx Health Incorporated of $3,023,000.

Operations by Segment

In 2003, the Company organized geographically. The Company’s six geographic business segments are: Great Lakes, Mid-America, North Atlantic, Southeast, West and Global. Revenues are derived primarily from the sale of clinical, financial and administrative information systems and solutions. The cost of revenues includes the cost of third party consulting services, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such. “Other” includes revenues not generated by the operating segments and expenses such as software development, marketing, general and administrative and depreciation that have not been allocated to the operating segments. The Company does not track assets by geographical business segment.

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The following table presents a summary of the operating information for the nine months ended October 2, 2004 and September 27, 2003:

Operating earnings in the Great Lakes segment increased 7% for the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003. Total revenues increased 2% in the nine month period of 2004 compared to the nine month period of 2003. The increase in total revenues is due primarily to a strong increase in licensed software and support revenues, that were largely offset by a decrease in hardware and professional services revenues in the first nine months of 2004 compared to the first nine months of 2003. Cost of revenues were 20% and 25% of total revenues of the Great Lakes segment for the nine month period of 2004 and the nine month period of 2003, respectively. The decrease in the cost of revenues as a percent of revenue is due primarily to lower hardware sales in the first nine months of 2004 as compared to 2003. Costs of revenues, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, support, services and reimbursed travel) components carrying different margin rates changes from period to period.

Operating earnings in the Mid-America segment increased 58% for the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003. Total revenues increased 41% in the nine month period of 2004 compared to the nine month period of 2003. The increase in total revenues is due primarily to a strong increase in licensed software and professional services revenues in the first nine month of 2004 compared to the first nine months of 2003. Cost of revenues were 19% and 25% of total Mid-America segment revenues for the nine month period of 2004 and the nine month period of 2003, respectively. The decrease in the cost of revenues as a percent of revenue is due primarily to lower hardware sales in the first nine months of 2004 as compared to 2003.

Operating earnings in the North Atlantic segment increased 6% for the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003. Total revenues increased 5% in the nine month period of 2004 compared to the nine month period of 2003. The increase in revenues is due primarily to an increase in licensed software and professional services revenues in the first nine months of 2004 compared to the first nine months of 2003. Cost of revenues were 21% and 24% of total North Atlantic segment revenues for the 2004 period and the 2003 period, respectively.

Operating earnings in the Southeast segment remained flat for the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003. Total revenues decreased 3% in the nine month period of 2004 compared to the nine month period of 2003. Cost of revenues were 24% and 29% of total Southeast segment revenues for the nine month period of 2004 and the nine month period of 2003, respectively. The decrease in total revenues and cost of revenues is due primarily to a decrease in hardware and professional services revenues in the first nine months of 2004 compared to the first nine months of 2003.

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Operating earnings in the West decreased 1% for the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003. Total revenues increased 6% in the nine month period of 2004 compared to the nine month period of 2003. The increase in total revenues is due primarily to an increase in support and hardware revenues in the first nine months of 2004 compared to the first nine months of 2003. Cost of revenues were 20% and 18% of total West segment revenues for the nine month period of 2004 and 2003, respectively. Operating expenses increased 19% in the first nine months of 2004 compared to the first nine months of 2003, due primarily to an increase in personnel related expenses.

Operating earnings in the Global segment increased 61% for the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003. Total revenues increased 19% in the first nine months of 2004 compared to the first nine months of 2003. The increase in total revenues is due primarily to an increase in professional services in the first nine months of 2004 compared to the first nine months of 2003. Operating expenses increased 41% in the first nine months of 2004 compared to the first nine months of 2003. This increase is due primarily to an increased presence in the global market.

Operating losses in Other increased 8% for the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003. This increase is due to an increase in total costs and expenses of 9% in first nine months of 2004 compared to the first nine months of 2003. The increase in operating expenses is due to an increase in expenses such as software development, marketing, general and administrative and depreciation in the nine month period of 2004 compared to the nine month period of 2003.

Capital Resources and Liquidity

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 and the amounts the Company invests in software development, acquisitions and capital expenditures.

The Company’s principal source of liquidity is its cash and cash equivalents. The majority of the Company’s cash and cash equivalents consist of U.S. Government Federal Agency Securities, short-term marketable securities and overnight repurchase agreements. At October 2, 2004 the Company had cash and cash equivalents of $160,947,000 and working capital of $282,215,000.

The Company generated cash of $112,624,000 and $91,825,000 from operations for the nine months ended October 2, 2004 and September 27, 2003, respectively. The Company has periodically provided long-term financing options to creditworthy clients through third party financing institutions and has on occasion directly provided extended payment terms from contract date. Some of these payment streams have been assigned on a non-recourse basis to third party financing institutions. The Company has provided its usual and customary performance guarantees to the third party financing institutions in connection with its on-going obligations under the client contract. During the third quarter of 2004 and 2003, the Company received total client cash collections of $228,112,000 and $214,000,000, respectively, of which 5.4% and 7.0% were received from third party client financing arrangements and non-recourse payment assignments.

Cash used in investing activities consisted primarily of capitalized software development costs of $44,662,000 and $43,720,000 and purchases of capital equipment, land and buildings of $38,622,000 and $58,096,000 in the nine months ended October 2, 2004 and September 27, 2003, respectively. The Company completed the sale of Zynx Healthcare Incorporated in the first quarter of 2004 for $12,000,000.

The Company’s financing activities for the first nine months of 2004 primarily consisted of repayment of debt of $20,251,000 and of the proceeds from the exercise of stock options of $18,033,000. For the first nine months of 2003 the Company’s financing activities primarily consisted of the repayment of long term debt of $13,084,000 and the purchase of treasury stock of $5,930,000.

The Company believes that its present cash position, together with cash generated from operations and if necessary the line of credit, will be sufficient to meet anticipated cash requirements during 2004. The Company has $90,000,000 of long-term, revolving credit from banks. At October 2, 2004 the Company had no outstanding borrowings under the agreement.

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

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

Statements made in this report, the Annual Report to Shareholders in which this report is made a part, other reports and proxy statements filed with the Securities and Exchange Commission, communications to shareholders, 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,” “intended,” “continue,” “believe,” “may,” “expect,” “hope,” “anticipate,” “goal,” “forecast,” “plan,” or “estimate” or the negative of these words, variations thereof or similar expressions. Forward-looking statements are not guarantees of future performance or 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 herein or in other reports filed with the Securities and Exchange Commission. Other unforeseen 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, demand for the Company’s software solutions and services, the Company’s long sales cycle, potentially long installation and implementation cycles for these larger, more complex and costlier systems and other factors described in this section and elsewhere in this report. As a result of healthcare industry trends and the market for the Company’s Cerner Millennium solutions, 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. 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.

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, primarily as a result of the clients’ year-end efforts to make all final capital expenditures for the then current 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 software solutions, changes in expectations of future financial performance or changes in estimates of securities analysts, governmental regulatory action, healthcare 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, healthcare and information technology companies in particular, has experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of the Company’s common stock, regardless of actual operating performance.

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Market Risks - 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. The Company reviews all equity securities 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 at 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 carrying value of these investments at October 2, 2004 and January 3, 2004 was $320,000 and $680,000, 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. 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.

At October 2, 2004, marketable securities (which consist of money market and commercial paper) of the Company were recorded at cost, which approximates fair value of approximately $161 million, with an overall average return of approximately 1.56% and an overall weighted maturity of less than 90 days. The marketable securities held by the Company are not subject to significant 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. The Company also had no borrowings outstanding under its working capital line of credit, which has a variable interest rate based on prime (4.75% at October 2, 2004) or LIBOR (1.84% at October 2, 2004) plus 2%. 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 instruments to manage foreign currency risk.

Changes in the Healthcare Industry - The healthcare industry is highly regulated and is subject to changing political, economic and regulatory influences. For example, the Balanced Budget Act of 1997 (Public Law 105-32) contains significant changes to Medicare and Medicaid and began to have its initial impact in 1998 due to limitations on reimbursement, resulting cost containment initiatives, and effects on pricing and demand for capital intensive systems. In addition, the Health Insurance Portability and Accountability Act of 1996 (HIPAA) is having a direct impact on the healthcare 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 healthcare organizations. Federal and state legislatures have periodically considered programs to reform or amend the U.S. healthcare system at both the federal and state level and to change healthcare financing and reimbursement systems. These programs may contain proposals to increase governmental involvement in healthcare, lower reimbursement rates or otherwise change the environment in which healthcare industry participants operate. Healthcare industry participants may respond by reducing their investments or postponing investment decisions, including investments in the Company’s software solutions and services.

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

Significant Competition - The market for healthcare information systems is intensely competitive, rapidly evolving and subject to rapid technological change. The Company believes that the principal competitive factors in this market include the breadth and quality of system and software solution offerings, the

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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 software solutions.

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 software solutions 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 software solutions that compete with many of the Company’s software solutions and services. There are other competitors that offer a more limited number of competing software solutions.

In addition, the Company expects that major software information systems companies, large information technology consulting service providers and system integrators, Internet-based start-up companies and others specializing in the healthcare industry may offer competitive software/solutions or services. The pace of change in the healthcare information systems market is rapid and there are frequent new software solution introductions, software solution 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 software solutions and services 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 confidentiality and trade secrecy of its proprietary information. The Company also relies on trademark and copyright laws to protect its intellectual property. The Company has 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 software solutions and services expands. 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 software solutions 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 solutions. If other of the Company’s software solutions 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 healthcare.

There have been four FDA inspections since 1998 at various Cerner sites. Three of the FDA inspections resulted in no FDA Form 483 being issued while one of the four inspections resulted in the issuance of a one item FDA Form 483 that the Company responded to promptly. There can be no assurance, however, that the Company’s actions taken in response to the Form 483 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 software solutions. The 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.

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Product Related Liabilities - Many of the Company’s software solutions provide data for use by healthcare providers in providing care to patients. Although no such claims have been brought against the Company to date regarding injuries related to the use of its software solutions, 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 cover a particular claim that may be brought in the future, 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 software solutions 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 software solutions 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 and obtain a refund and/or damages, 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 or circumstances.

Risks Associated with the Company’s Global Operations – The Company markets, sells and services its software solutions globally. The Company has established offices around the world, including in North America, Europe and in the Asia Pacific region. The Company will continue to expand its global operations and enter new global markets. This expansion will require significant management attention and financial resources to develop successful direct and indirect global sales and support channels. In some countries, the Company’s success will depend in part on its ability to form relationships with local partners. There is a risk that the Company may sometimes choose the wrong partner. For these reasons, the Company may not be able to maintain or increase global market demand for its software solutions.

Global operations are subject to inherent risks, and the Company’s future results could be adversely affected by a variety of uncontrollable and changing factors. These include:

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Greater difficulty in collecting accounts receivable and longer collection periods;

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Difficulties and costs of staffing and managing foreign operations;

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The impact of economic conditions outside the United States;

•

Unexpected changes in regulatory requirements;

•

Certification or regulatory requirements;

•

Reduced protection of intellectual property rights in some countries;

•

Potentially adverse tax consequences;

•

Different or additional functionality requirements;

•

Trade protection measures and other regulatory requirements;

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Service provider and government spending patterns;

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Natural disasters, war or terrorist acts;

•

Poor selection of a partner in a country; and

•

Political conditions which may impact sales or threaten the safety of associates or the continued presence of the Company in these countries.

Recruitment and Retention of Key Personnel – To remain competitive in the healthcare information technology industry, the Company must attract, motivate and retain highly skilled managerial, sales, marketing, consulting and technical personnel, including executives, consultants, programmers and systems architects skilled in the healthcare information technology industry and the technical environments in which the Company’s solutions operate. Competition for such personnel in this industry is intense. The Company’s failure to attract additional qualified personnel could have a material adverse effect on the Company’s prospects for long-term growth. The success of the Company is dependent to a significant degree on the continued contributions of key management, sales, marketing, consulting and technical personnel. The Company has succession plans in place; however, the unexpected loss of key

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personnel could have a material adverse impact to the Company’s business and results of operations, and could potentially inhibit solution development and market share advances.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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. The Company also had no borrowings outstanding under its working capital line of credit, which has a variable interest rate based on prime (4.75% at October 2, 2004) or LIBOR (1.84% at October 2, 2004) plus 2%. 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 instruments to manage foreign currency risk.

Item 4. Controls and Procedures

a)		Evaluation of disclosure controls and procedures. The Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by the Quarterly Report (the “Evaluation Date”). They have concluded that, as of the Evaluation Date, these disclosure controls and procedures were effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities and would be disclosed on a timely basis.
b)		Changes in internal control over financial reporting. As of the end of the period covered by this Quarterly Report, there were no changes in the Company’s internal control over financial reporting that occurred during the three and nine months ended October 2, 2004 that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
c)		Limitations on the effectiveness of controls. The Company’s management, including the CEO and CFO, does not expect that the Company’s disclosure controls and procedures will prevent all error and fraud. 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.