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EXCEL - IDEA: XBRL DOCUMENT - CERNER CORP /MO/Financial_Report.xls
EX-32.1 - CERTIFICATION OF NEAL L. PATTERSON PURSUANT TO SEC. 906 - CERNER CORP /MO/ex321-ceosec906certq32014.htm
EX-31.2 - CERTIFICATION OF MARC G. NAUGHTON PURSUANT TO SEC. 302 - CERNER CORP /MO/ex312-cfocertq32014.htm
EX-32.2 - CERTIFICATION OF MARC G. NAUGHTON PURSUANT TO SEC. 906 - CERNER CORP /MO/ex322-cfosec906certq32014.htm
EX-2.1 - MASTER SALE AND PURCHASE AGREEMENT BETWEEN SIEMENS AG AND CERNER CORPORATION - CERNER CORP /MO/ex21-siemensexecutedagreem.htm
EX-31.1 - CERTIFICATION OF NEAL L. PATTERSON PURSUANT TO SEC. 302 - CERNER CORP /MO/ex311-ceocertq32014.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X)    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 27, 2014
OR
( )    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________

Commission File Number: 0-15386
CERNER CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
43-1196944
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification
Number)
2800 Rockcreek Parkway
North Kansas City, MO
 
64117
(Address of principal executive offices)
 
(Zip Code)
(816) 201-1024
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]     No [  ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X]     No [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]     Accelerated filer [  ]     Non-accelerated filer [  ]     Smaller reporting company [  ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]       No [X]
Indicate the number of shares outstanding of the issuer's classes of common stock, as of the latest practicable date.
Class
  
Outstanding at October 17, 2014
Common Stock, $0.01 par value per share
  
341,472,242 shares



CERNER CORPORATION

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




Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 27, 2014 (unaudited) and December 28, 2013
(In thousands, except share data)
2014
 
2013
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
496,494

 
$
202,377

Short-term investments
835,269

 
677,004

Receivables, net
617,204

 
582,926

Inventory
28,604

 
32,299

Prepaid expenses and other
181,103

 
175,488

Deferred income taxes, net
76,803

 
91,614

Total current assets
2,235,477

 
1,761,708

 
 
 
 
Property and equipment, net
889,487

 
792,781

Software development costs, net
402,772

 
347,077

Goodwill
322,135

 
307,422

Intangible assets, net
131,790

 
144,132

Long-term investments
226,371

 
554,873

Other assets
184,606

 
190,371

 
 
 
 
Total assets
$
4,392,638

 
$
4,098,364

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
169,227

 
$
145,019

Current installments of long-term debt and capital lease obligations
60,042

 
54,107

Deferred revenue
215,528

 
209,746

Accrued payroll and tax withholdings
145,739

 
147,986

Other accrued expenses
80,584

 
83,574

Total current liabilities
671,120

 
640,432

 
 
 
 
Long-term debt and capital lease obligations
86,756

 
111,717

Deferred income taxes and other liabilities
229,450

 
170,392

Deferred revenue
9,102

 
8,159

Total liabilities
996,428

 
930,700

 
 
 
 
Shareholders’ Equity:
 
 
 
Common stock, $.01 par value, 500,000,000 shares authorized, 346,052,087 shares issued at September 27, 2014 and 344,338,030 shares issued at December 28, 2013
3,461

 
3,443

Additional paid-in capital
890,902

 
812,853

Retained earnings
2,770,609

 
2,393,048

Treasury stock, 4,652,515 shares at September 27, 2014 and 570,616 shares at December 28, 2013
(245,333
)
 
(28,251
)
Accumulated other comprehensive loss, net
(23,429
)
 
(13,429
)
Total shareholders’ equity
3,396,210

 
3,167,664

 
 
 
 
Total liabilities and shareholders’ equity
$
4,392,638

 
$
4,098,364


See notes to condensed consolidated financial statements (unaudited).

1


CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and nine months ended September 27, 2014 and September 28, 2013
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands, except per share data)
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
System sales
$
224,345

 
$
202,632

 
$
665,595

 
$
602,037

Support, maintenance and services
593,068

 
508,520

 
1,738,664

 
1,461,723

Reimbursed travel
22,736

 
16,678

 
72,413

 
51,660

 
 
 
 
 
 
 
 
Total revenues
840,149

 
727,830

 
2,476,672

 
2,115,420

Costs and expenses:
 
 
 
 
 
 
 
Cost of system sales
65,520

 
64,389

 
211,939

 
217,580

Cost of support, maintenance and services
51,809

 
38,510

 
147,181

 
103,366

Cost of reimbursed travel
22,736

 
16,678

 
72,413

 
51,660

Sales and client service
346,417

 
304,665

 
1,020,552

 
853,213

Software development (Includes amortization of $25,372 and $75,410 for the three and nine months ended September 27, 2014; and $24,056 and $69,366 for the three and nine months ended September 28, 2013)
97,026

 
82,998

 
285,897

 
246,343

General and administrative
68,487

 
51,352

 
180,900

 
150,995

 
 
 
 
 
 
 
 
Total costs and expenses
651,995

 
558,592

 
1,918,882

 
1,623,157

 
 
 
 
 
 
 
 
Operating earnings
188,154

 
169,238

 
557,790

 
492,263

 
 
 
 
 
 
 
 
Other income, net
2,181

 
3,509

 
7,908

 
9,286

 
 
 
 
 
 
 
 
Earnings before income taxes
190,335

 
172,747

 
565,698

 
501,549

Income taxes
(61,333
)
 
(57,403
)
 
(188,137
)
 
(163,258
)
 
 
 
 
 
 
 
 
Net earnings
$
129,002

 
$
115,344

 
$
377,561

 
$
338,291

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.38

 
$
0.34

 
$
1.10

 
$
0.98

Diluted earnings per share
$
0.37

 
$
0.33

 
$
1.08

 
$
0.96

Basic weighted average shares outstanding
341,188

 
342,992

 
342,254

 
343,681

Diluted weighted average shares outstanding
349,326

 
351,449

 
350,468

 
352,332

See notes to condensed consolidated financial statements (unaudited).


2


CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three and nine months ended September 27, 2014 and September 28, 2013
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net earnings
$
129,002

 
$
115,344

 
$
377,561

 
$
338,291

Foreign currency translation adjustment and other (net of tax benefit of $922 and $603 for the three and nine months ended September 27, 2014; and $1,366 and $1,984 for the three and nine months ended September 28, 2013)
(17,672
)
 
10,595

 
(9,603
)
 
(7,610
)
Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $(259) and $(252) for the three and nine months ended September 27, 2014; and $509 and $(34) for the three and nine months ended September 28, 2013)
(409
)
 
801

 
(397
)
 
(59
)
 
 
 
 
 
 
 
 
Comprehensive income
$
110,921

 
$
126,740

 
$
367,561

 
$
330,622


See notes to condensed consolidated financial statements (unaudited).


3


CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 27, 2014 and September 28, 2013
(unaudited)
 
Nine Months Ended
(In thousands)
2014
 
2013
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
377,561

 
$
338,291

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
217,212

 
189,460

Share-based compensation expense
43,330

 
33,650

Provision for deferred income taxes
21,712

 
19,573

Changes in assets and liabilities (net of businesses acquired):
 
 
 
Receivables, net
(36,562
)
 
41,281

Inventory
3,515

 
(3,887
)
Prepaid expenses and other
9,862

 
(48,290
)
Accounts payable
20,137

 
(19,309
)
Accrued income taxes
(2,038
)
 
(6,404
)
Deferred revenue
7,361

 
5,440

Other accrued liabilities
(38,511
)
 
4,580

 
 
 
 
Net cash provided by operating activities
623,579

 
554,385

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(200,372
)
 
(218,406
)
Capitalized software development costs
(130,761
)
 
(125,951
)
Purchases of investments
(1,069,938
)
 
(832,039
)
Sales and maturities of investments
1,224,063

 
825,126

Purchase of other intangibles
(10,238
)
 
(39,797
)
Acquisition of businesses, net of cash acquired
(7,476
)
 
(67,877
)
 
 
 
 
Net cash used in investing activities
(194,722
)
 
(458,944
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of long-term debt and capital lease obligations
(75
)
 
(9,756
)
Proceeds from excess tax benefits from share-based compensation
26,079

 
29,274

Proceeds from exercise of options
19,423

 
24,049

Treasury stock purchases
(217,082
)
 
(170,042
)
Contingent consideration payments for acquisition of businesses
(10,617
)
 
(800
)
Cash grants
48,000

 

Other
2,894

 
4,823

 
 
 
 
Net cash used in financing activities
(131,378
)

(122,452
)
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(3,362
)
 
(2,589
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
294,117

 
(29,600
)
Cash and cash equivalents at beginning of period
202,377

 
317,120

 
 
 
 
Cash and cash equivalents at end of period
$
496,494

 
$
287,520

 
 
 
 
Summary of acquisition transactions:
 
 
 
Fair value of net tangible assets acquired
$
(1,509
)
 
$
1,512

Fair value of intangible assets acquired
3,800

 
25,489

Fair value of goodwill
16,785

 
60,511

Less: Fair value of contingent liability payable
(11,600
)
 
(18,982
)
 
 
 
 
Cash paid for acquisitions
7,476

 
68,530

Cash acquired

 
(653
)
 
 
 
 
Net cash used
$
7,476

 
$
67,877

See notes to condensed consolidated financial statements (unaudited).

4


CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
(1) Interim Statement Presentation

The condensed consolidated financial statements included herein have been prepared by Cerner Corporation (Cerner, the Company, we, us or our) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our latest annual report on Form 10-K.
 
In management’s opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position and the results of operations and cash flows for the periods presented. Our interim results as presented in this Form 10-Q are not necessarily indicative of the operating results for the entire year.

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

Our third fiscal quarter ends on the Saturday closest to September 30. The 2014 and 2013 third quarters ended on September 27, 2014 and September 28, 2013, respectively. All references to years in these notes to condensed consolidated financial statements represent the respective three or nine months ended on such dates, unless otherwise noted.

Available-for-sale Investments

Our short-term investments are primarily invested in time deposits, commercial paper, government and corporate bonds, with maturities of less than one year. Our long-term investments are primarily invested in government and corporate bonds with maturities of less than two years.

Recently Issued Accounting Pronouncements
Revenue Recognition. In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. This new guidance is effective for the Company in the first quarter of 2017, with no early adoption permitted. The standard permits the use of either the retrospective or cumulative effect transition method. At this time we have not selected a transition method. We are currently evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures.


5


(2) Business Acquisitions

Siemens Health Services

On August 5, 2014, we entered into a Master Sale and Purchase Agreement (the "Agreement") with Siemens AG, a stock corporation under the laws of Germany ("Siemens"), pursuant to which Cerner will acquire substantially all of the assets, and assume certain liabilities of Siemens' health information technology business unit, Siemens Health Services.

Consideration for this acquisition is expected to total $1.3 billion in cash, subject to certain adjustments for working capital and pension obligations. We expect to enter into a transition services agreement pursuant to which Siemens will provide certain transitional services to Cerner for an initial period of up to six months after the acquisition closing.

In September 2014, the U.S. Federal Trade Commission granted early termination of the waiting period under the Hart-Scott-Rodino (HSR) Antitrust Improvements Act of 1976, as amended, in connection with our purchase of Siemens Health Services. The early termination of the HSR waiting period satisfies one of the conditions to closing of the pending acquisition. The transaction remains subject to other customary closing conditions and is expected to close in our first fiscal quarter of 2015.

Concurrently with the execution of the Agreement, the parties entered into an agreement to create a strategic alliance to jointly invest in innovative projects that integrate health IT with medical technologies for the purpose of enhancing workflows and improving clinical outcomes. After closing, each company will contribute up to $50.0 million to fund projects of shared importance to both companies and their clients.

During the three months ended September 27, 2014, we incurred $9.4 million of costs in connection with our pending acquisition of Siemens Health Services, which are included in general and administrative expense in our condensed consolidated statements of operations.

InterMedHx

On April 1, 2014, we purchased 100% of the outstanding membership interests of InterMedHx, LLC (InterMedHx). InterMedHx is a provider of health technology solutions in the areas of preventive care, patient administration, and medication history. We believe the addition of InterMedHx solutions provides additional capabilities in the market.

Consideration for the acquisition of InterMedHx is expected to total $19.1 million consisting of up-front cash plus contingent consideration, which is payable at a percentage of the revenue contribution from InterMedHx solutions and services. We valued the contingent consideration at $11.6 million based on projections of revenue over the assessment period.

The allocation of purchase price to the estimated fair value of the identified tangible and intangible assets acquired and liabilities assumed resulted in goodwill of $16.8 million and $3.8 million in intangible assets related to the value of existing technologies. The goodwill was allocated to our Domestic operating segment and is expected to be deductible for tax purposes. Identifiable intangible assets are being amortized over a period of five years.

The operating results of InterMedHx were combined with our operating results subsequent to the purchase date of April 1, 2014. Pro-forma results of operations have not been presented because the effect of this acquisition was not material to our results.

(3) Fair Value Measurements

We determine fair value measurements used in our consolidated financial statements based upon the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
 
Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.

6


Level 2 – Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
Level 3 – Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table details our financial assets measured and recorded at fair value on a recurring basis at September 27, 2014: 
(In thousands)
 
 
 
 
 
 

 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
213,003

 
$

 
$

Time deposits
 
Cash equivalents
 

 
11,354

 

Commercial paper
 
Cash equivalents
 

 
62,575

 

Government and corporate bonds
 
Cash equivalents
 

 
2,500

 

Time deposits
 
Short-term investments
 

 
83,395

 

Commercial paper
 
Short-term investments
 

 
441,365

 

Government and corporate bonds
 
Short-term investments
 

 
310,509

 

Government and corporate bonds
 
Long-term investments
 

 
213,704

 


The following table details our financial assets measured and recorded at fair value on a recurring basis at December 28, 2013:
(In thousands)
 
 
 
 
 
 
 
 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
57,254

 
$

 
$

Time deposits
 
Cash equivalents
 

 
7,771

 

Commercial paper
 
Cash equivalents
 

 
3,000

 

Government and corporate bonds
 
Cash equivalents
 

 
410

 

Time deposits
 
Short-term investments
 

 
70,315

 

Commercial paper
 
Short-term investments
 

 
33,742

 

Government and corporate bonds
 
Short-term investments
 

 
572,947

 

Government and corporate bonds
 
Long-term investments
 

 
542,711

 

We estimate the fair value of our long-term, fixed rate debt using a Level 3 discounted cash flow analysis based on current borrowing rates for debt with similar maturities. The fair value of our long-term debt, including current maturities, at September 27, 2014 and December 28, 2013 was approximately $33.3 million and $32.6 million, respectively. The carrying amount of such fixed-rate debt at September 27, 2014 and December 28, 2013 was $30.2 million and $30.6 million, respectively.
 

7


(4) Investments

Available-for-sale investments at September 27, 2014 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
213,003

 
$

 
$

 
$
213,003

Time deposits
 
11,354

 

 

 
11,354

Commercial paper
 
62,575

 

 

 
62,575

Government and corporate bonds
 
2,500

 

 

 
2,500

Total cash equivalents
 
289,432

 

 

 
289,432

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
83,402

 
1

 
(8
)
 
83,395

Commercial paper
 
441,455

 
8

 
(98
)
 
441,365

Government and corporate bonds
 
310,426

 
131

 
(48
)
 
310,509

Total short-term investments
 
835,283

 
140

 
(154
)
 
835,269

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
213,992

 
48

 
(336
)
 
213,704

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
1,338,707


$
188


$
(490
)

$
1,338,405


Available-for-sale investments at December 28, 2013 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
57,254

 
$

 
$

 
$
57,254

Time deposits
 
7,771

 

 

 
7,771

Commercial paper
 
3,000

 

 

 
3,000

Government and corporate bonds
 
410

 

 

 
410

Total cash equivalents
 
68,435

 

 

 
68,435

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
70,303

 
12

 

 
70,315

Commercial paper
 
33,750

 
1

 
(9
)
 
33,742

Government and corporate bonds
 
572,670

 
356

 
(79
)
 
572,947

Total short-term investments
 
676,723

 
369

 
(88
)
 
677,004

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
542,644

 
346

 
(279
)
 
542,711

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
1,287,802

 
$
715

 
$
(367
)
 
$
1,288,150


Investments reported under the cost method of accounting as of September 27, 2014 and December 28, 2013 were $8.7 million and $7.2 million, respectively. Investments reported under the equity method of accounting as of September 27, 2014 and December 28, 2013 were $4.0 million and $5.0 million, respectively.

We sold available-for-sale investments for proceeds of $659.7 million and $109.9 million during the nine months ended September 27, 2014 and September 28, 2013, respectively, resulting in insignificant gains in each period.


8


(5) Receivables

A summary of net receivables is as follows:
(In thousands)
September 27, 2014
 
December 28, 2013
 
 
 
 
Gross accounts receivable
$
605,069

 
$
583,312

Less: Allowance for doubtful accounts
25,372

 
36,286

 
 
 
 
Accounts receivable, net of allowance
579,697

 
547,026

 
 
 
 
Current portion of lease receivables
37,507

 
35,900

 
 
 
 
Total receivables, net
$
617,204

 
$
582,926


During the second quarter of 2008, Fujitsu Services Limited’s (Fujitsu) contract as the prime contractor in the National Health Service (NHS) initiative to automate clinical processes and digitize medical records in the Southern region of England was terminated by the NHS.  This had the effect of automatically terminating our subcontract for the project. We continue to be in dispute with Fujitsu regarding Fujitsu’s obligation to pay the amounts comprised of accounts receivable and contracts receivable related to that subcontract, and we are working with Fujitsu to resolve these issues based on processes provided for in the contract.  Part of that process requires final resolution of disputes between Fujitsu and the NHS regarding the contract termination. As of September 27, 2014, it remains unlikely that our matter with Fujitsu will be resolved in the next 12 months. Therefore, these receivables have been classified as long-term and represent less than the majority of other long-term assets at September 27, 2014 and December 28, 2013. While the ultimate collectability of the receivables pursuant to this process is uncertain, we believe that we have valid and equitable grounds for recovery of such amounts and that collection of recorded amounts is probable. Nevertheless, it is reasonably possible that our estimates regarding collectability of such amounts might materially change in the near term, considering that we do not have complete knowledge of the status of the proceedings between Fujitsu and NHS and their effect on our claim.

During the first nine months of 2014 and 2013, we received total client cash collections of $2.6 billion and $2.3 billion, respectively, of which $61.1 million and $44.9 million were received from third party arrangements with non-recourse payment assignments.
 
(6) Income Taxes

We determine the tax provision for interim periods using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment.

Our effective tax rate was 33.3% and 32.6% for the first nine months of 2014 and 2013, respectively.

In January 2013, the American Taxpayer Relief Act of 2012 (Act) became law. The Act reinstated the research and development tax credit retroactively from January 1, 2012. In the first quarter of 2013, we recognized the research and development tax credit related to 2012 as a favorable discrete item and the credit related to 2013 as a component of the overall 2013 effective tax rate. This credit expired on December 31, 2013. The increase in our effective tax rate through the first nine months of 2014 relative to the same period in 2013 is primarily due to the favorable discrete item recorded in the first quarter of 2013 for the retroactive extension of the 2012 credit and the expiration of the credit in 2014.


9


(7) Earnings Per Share

A reconciliation of the numerators and the denominators of the basic and diluted per share computations are as follows:
 
Three Months Ended
 
2014
 
2013
 
Earnings
 
Shares
 
Per-Share
 
Earnings
 
Shares
 
Per-Share
(In thousands, except per share data)
(Numerator)
 
(Denominator)
 
Amount
 
(Numerator)
 
(Denominator)
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders
$
129,002

 
341,188

 
$
0.38

 
$
115,344

 
342,992

 
$
0.34

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

 
8,138

 
 
 

 
8,457

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
129,002

 
349,326

 
$
0.37

 
$
115,344

 
351,449

 
$
0.33


For the three months ended September 27, 2014 and September 28, 2013, options to purchase 6.7 million and 7.2 million shares of common stock at per share prices ranging from $38.66 to $60.37 and $36.92 to $50.54, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.
 
Nine Months Ended
 
2014
 
2013
 
Earnings
 
Shares
 
Per-Share
 
Earnings
 
Shares
 
Per-Share
(In thousands, except per share data)
(Numerator)
 
(Denominator)
 
Amount
 
(Numerator)
 
(Denominator)
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders
$
377,561

 
342,254

 
$
1.10

 
$
338,291

 
343,681

 
$
0.98

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

 
8,214

 
 
 

 
8,651

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
377,561

 
350,468

 
$
1.08

 
$
338,291

 
352,332

 
$
0.96


For the nine months ended September 27, 2014 and September 28, 2013, options to purchase 5.4 million and 5.8 million shares of common stock at per share prices ranging from $38.66 to $60.37 and $32.92 to $50.54, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.


10


(8) Share-Based Compensation and Equity

Stock Options

Options activity for the nine months ended September 27, 2014 was as follows:
(In thousands, except per share data)
Number of
Shares
 
Weighted-
Average
Exercise 
Price
 
Aggregate
Intrinsic 
Value
 
Weighted-Average      
Remaining      
Contractual
 Term (Yrs)      
Outstanding at beginning of year
24,407

 
$
22.24

 
 
 
 
Granted
3,200

 
51.94

 
 
 
 
Exercised
(1,784
)
 
11.95

 
 
 
 
Forfeited and expired
(255
)
 
41.98

 
 
 
 
Outstanding as of September 27, 2014
25,568

 
26.48

 
$
823,590

 
6.17
 
 
 
 
 
 
 
 
Exercisable as of September 27, 2014
14,946

 
$
13.99

 
$
667,501

 
4.65

The weighted-average assumptions used to estimate the fair value of stock options granted in 2014 were as follows: 
Expected volatility (%)
 
29.7
%
Expected term (yrs)
 
9.2

Risk-free rate (%)
 
2.9
%
Fair value per option
 
$
22.54

As of September 27, 2014, there was $148.1 million of total unrecognized compensation cost related to stock options granted under all plans. That cost is expected to be recognized over a weighted-average period of 3.30 years.
Non-vested Shares

Non-vested share activity for the nine months ended September 27, 2014 was as follows:
(In thousands, except per share data)
Number of Shares
 
Weighted-Average
Grant Date Fair Value
 
 
 
 
Outstanding at beginning of year
552

 
$
38.54

Granted
166

 
55.38

Vested
(206
)
 
33.33

Forfeited
(3
)
 
33.22

 
 
 
 
Outstanding as of September 27, 2014
509

 
$
46.17

As of September 27, 2014, there was $13.3 million of total unrecognized compensation cost related to non-vested share awards granted under all plans. That cost is expected to be recognized over a weighted-average period of 1.55 years.


11


The following table presents total compensation expense recognized with respect to stock options, non-vested shares and our associate stock purchase plan:
 
Three Months Ended
 
Nine Months Ended
(In thousands)
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Stock option and non-vested share compensation expense
$
15,061

 
$
12,527

 
$
43,330

 
$
33,650

Associate stock purchase plan expense
1,109

 
1,168

 
3,486

 
2,867

Amounts capitalized in software development costs, net of amortization
(171
)
 
(237
)
 
(845
)
 
(900
)
 
 
 
 
 
 
 
 
Amounts charged against earnings, before income tax benefit
$
15,999

 
$
13,458

 
$
45,971

 
$
35,617

 
 
 
 
 
 
 
 
Amount of related income tax benefit recognized in earnings
$
5,616

 
$
5,221

 
$
16,136

 
$
13,819


Treasury Stock

In May 2014, our Board of Directors approved an amendment to the stock repurchase program that was authorized in December 2013. Under the amendment, the Company may repurchase shares of our common stock up to an additional $100.0 million. This increase authorizes repurchases of up to $317.0 million, in the aggregate, excluding transaction costs. The repurchases are to be effectuated in the open market, by block purchase, or possibly through other transactions managed by broker-dealers. No time limit was set for completion of the program.

During the nine months ended September 27, 2014, we repurchased 4.1 million shares for consideration of $217.0 million, excluding transaction costs. These shares were recorded as treasury stock and accounted for under the cost method. No repurchased shares have been retired. At September 27, 2014, $100.0 million remains available for purchases under the program.


(9) Hedging Activities

The following table represents the fair value of our net investment hedge included within the condensed consolidated balance sheets:
(In thousands)
 
Fair Value
Derivatives Designated
Balance Sheet Classification
September 27, 2014
 
December 28, 2013
 
 
 
 
 
Net investment hedge
 Short-term liabilities
$
15,084

 
$
15,304

Net investment hedge
 Long-term liabilities
15,084

 
15,304

 
 
 
 
 
Total net investment hedge
 
$
30,168

 
$
30,608


The following table represents the related unrealized gain or loss, net of related income tax effects, on the net investment hedge recognized in comprehensive income:
(In thousands)
 
Net Unrealized Gain (Loss)
For the Three Months Ended
 
Net Unrealized Gain (Loss)
For the Nine Months Ended
Derivatives Designated
Balance Sheet Classification
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
Net investment hedge
 Short-term liabilities
$
448

 
$
(523
)
 
$
134

 
$
2

Net investment hedge
 Long-term liabilities
448

 
(1,058
)
 
134

 
2

 
 
 
 
 
 
 
 
 
Total net investment hedge
 
$
896

 
$
(1,581
)
 
$
268

 
$
4



12


(10) Contingencies    

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

In addition to commitments and obligations in the ordinary course of business, we are subject to various legal proceedings and claims.  Many of these proceedings are at preliminary stages and many seek an indeterminate amount of damages. 
 
No less than quarterly, we review the status of each significant matter and assess our potential financial exposure. We accrue a liability for an estimated loss if the potential loss from any legal proceeding or claim is considered probable and the amount can be reasonably estimated. Significant judgment is required in both the determination of probability and the determination as to whether the amount of an exposure is reasonably estimable, and accruals are based only on the information available to our management at the time the judgment is made. Furthermore, the outcome of legal proceedings is inherently uncertain, and we may incur substantial defense costs and expenses defending any of these matters.   Should any one or a combination of more than one of these proceedings be successful, or should we determine to settle any or a combination of these matters, we may be required to pay substantial sums, become subject to the entry of an injunction or be forced to change the manner in which we operate our business, which could have a material adverse impact on our financial position or results of operations.

RLIS, Inc., a non-practicing entity, filed a complaint in the Southern District of Texas against the Company alleging that certain of the Company’s electronic medical record solutions infringe two patents owned by the plaintiff.  Plaintiff is requesting unspecified damages, trebling of those damages due to willful infringement, attorneys’ fees, costs, an ongoing royalty and an injunction enjoining the sale and use of certain capabilities of the allegedly infringing solutions.  The plaintiff’s expert estimates damages of between $35.3 million and $38.2 million and an ongoing royalty.  The Company disputes these claims and intends to vigorously defend itself in this matter.  The trial is now set for the first quarter of 2015.

We are currently unable to estimate a range of reasonably possible losses for the proceeding described above because of the extreme complexity of calculating damages in connection with these types of cases and the vastly disparate damage calculations that can result from the ultimate resolution of the many outstanding legal and factual issues of the case. In the opinion of our management, while there is a reasonable possibility that we may incur losses with respect to the aforementioned matter, we do not believe a loss is probable at this time. Our management will continue to evaluate the potential exposure related to this matter in future periods.

(11) Segment Reporting

We have two operating segments, Domestic and Global. Our Chief Executive Officer is our chief operating decision maker ("CODM"). Revenues are derived primarily from the sale of clinical, financial and administrative information systems and solutions. The cost of revenues includes the cost of third party consulting services, computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. “Other” includes expenses that have not been allocated to the operating segments, such as software development, marketing, general and administrative, share-based compensation expense and depreciation. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such, as our CODM reviews segment performance exclusive of these charges. Items such as interest, income taxes, capital expenditures and total assets are managed at the consolidated level and thus are not included in our operating segment disclosures. Accounting policies for each of the reportable segments are the same as those used on a consolidated basis.




13


The following table presents a summary of our operating segments and other expense for the three and nine months ended September 27, 2014 and September 28, 2013: 
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2014
 
 
 
 
 
 
 
Revenues
$
741,830

 
$
98,319

 
$

 
$
840,149

 
 
 
 
 
 
 
 
Cost of revenues
126,223

 
13,842

 

 
140,065

Operating expenses
170,709

 
30,531

 
310,690

 
511,930

Total costs and expenses
296,932

 
44,373


310,690

 
651,995

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
444,898

 
$
53,946

 
$
(310,690
)
 
$
188,154

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2013
 
 
 
 
 
 
 
Revenues
$
641,541

 
$
86,289

 
$

 
$
727,830

 
 
 
 
 
 
 
 
Cost of revenues
107,560

 
12,017

 

 
119,577

Operating expenses
148,478

 
34,078

 
256,459

 
439,015

Total costs and expenses
256,038

 
46,095

 
256,459

 
558,592

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
385,503

 
$
40,194

 
$
(256,459
)
 
$
169,238

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Nine Months Ended 2014
 
 
 
 
 
 
 
Revenues
$
2,206,297

 
$
270,375

 
$

 
$
2,476,672

 
 
 
 
 
 
 
 
Cost of revenues
389,344

 
42,189

 

 
431,533

Operating expenses
497,428

 
98,835

 
891,086

 
1,487,349

Total costs and expenses
886,772

 
141,024

 
891,086

 
1,918,882

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
1,319,525

 
$
129,351

 
$
(891,086
)
 
$
557,790

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Nine Months Ended 2013
 
 
 
 
 
 
 
Revenues
$
1,837,171

 
$
278,249

 
$

 
$
2,115,420

 
 
 
 
 
 
 
 
Cost of revenues
327,356

 
45,250

 

 
372,606

Operating expenses
439,345

 
84,685

 
726,521

 
1,250,551

Total costs and expenses
766,701

 
129,935

 
726,521

 
1,623,157

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
1,070,470

 
$
148,314

 
$
(726,521
)
 
$
492,263



14


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

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

Our third fiscal quarter ends on the Saturday closest to September 30. The 2014 and 2013 third quarters ended on September 27, 2014 and September 28, 2013, respectively. All references to years in this MD&A represent the respective three or nine months ended on such dates, unless otherwise noted.
 
Except for the historical information and discussions contained herein, statements contained in this quarterly report on Form 10-Q may constitute “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements can often be identified by the use of forward-looking terminology, such as "could," "should," “will,” "intends," "continue," "believe," "may," "expect," "anticipate," "goal," "forecast," “plan,” or “estimate” or the negative of these words, variations thereof or similar expressions. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including without limitation: the possibility of product-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities; our proprietary technology may be subject to claims for infringement or misappropriation of intellectual property rights of others, or may be infringed or misappropriated by others; risks associated with our non-U.S. operations; risks associated with our ability to effectively hedge exposure to fluctuations in foreign currency exchange rates; the potential for tax legislation initiatives that could adversely affect our tax position and/or challenges to our tax positions in the United States and non-U.S. countries; risks associated with our recruitment and retention of key personnel; risks related to our reliance on third party suppliers; risks inherent with business acquisitions and other combinations; and the integration thereof, such as difficulties and operational and financial risks associated with integrating Cerner and Siemens Health Services; the potential for losses resulting from asset impairment charges; risks associated with volatility and disruption resulting from global economic conditions; managing growth in the new markets in which we offer solutions, health care devices and services; changing political, economic, regulatory and judicial influences; government regulation; significant competition and market changes; variations in our quarterly operating results; potential inconsistencies in our sales forecasts compared to actual sales; volatility in the trading price of our common stock and the timing and volume of market activity; the authority of our Board of Directors to issue preferred stock and anti-takeover provisions contained in our corporate governance documents; material adverse resolution of legal proceedings; the risk of uncertainty as to timing of the consummation of an acquisition; risks that any of the closing conditions to the proposed acquisition of Siemens Health Services may not be satisfied or may not be satisfied in a timely manner; risks related to disruption of management time from ongoing business operations due to the proposed acquisition of Siemens Health Services; failure to realize the synergies and other benefits expected from the proposed acquisition of Siemens Health Services; risk that the assets and business acquired may not continue to be commercially successful; the effect of the proposed acquisition of Siemens Health Services on the ability of Cerner to retain customers and retain and hire key personnel and maintain relationships with key suppliers; unexpected costs, charges or expenses resulting from the acquisition of Siemens Health Services; litigation or claims relating to the transaction or the acquired assets and business; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials incorporated herein or therein by reference. Forward looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as to the date they are made. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.

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

Our fundamental strategic focus is the creation of organic growth by investing in research and development (R&D) to create solutions and services for the health care industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 12% or more. This growth has also created an important strategic footprint in health care, with Cerner® solutions licensed by approximately 14,000 facilities around the world, including more than 3,000 hospitals; 4,900 physician practices; 60,000 physicians; 590 ambulatory facilities, such as laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics and surgery centers; 3,500 extended care

15


facilities; 150 employer sites and 1,790 retail pharmacies. Selling additional solutions back into this client base is an important element of our future revenue growth. We are also focused on driving growth through market share expansion by strategically aligning with health care providers that have not yet selected a supplier and by displacing competitors in health care settings that are open to replacing their current supplier.

We expect to drive growth through solutions and services that reflect our ongoing ability to innovate and expand our reach into health care. Examples of these include our CareAware® health care device architecture and devices, Cerner ITWorksSM services, revenue cycle solutions and services, and population health solutions and services. Finally, we believe there is significant opportunity for growth outside of the United States, with many non-U.S. markets focused on health care information technology as part of their strategy to improve the quality and lower the cost of health care.

Beyond our strategy for driving revenue growth, we are also focused on earnings growth. Similar to our history of growing revenue, our net earnings have increased at compound annual rates of more than 16% over the most recent five- and ten-year periods. We expect to drive continued earnings growth through ongoing revenue growth coupled with margin expansion, which we expect to achieve through efficiencies in our implementation and operational processes and by leveraging R&D investments and controlling general and administrative expenses.

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

Results Overview
The Company delivered strong levels of bookings, revenues, earnings and operating cash flows in the third quarter of 2014.

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $1.1 billion in the third quarter of 2014, which was an increase of 19% compared to $928.0 million in the third quarter of 2013. Revenues for the third quarter of 2014 increased 15% to $840.1 million compared to $727.8 million in the third quarter of 2013. The year-over-year increase in revenue reflects ongoing demand for Cerner's core solutions and services driven by the HITECH Act and other regulatory requirements, and increased contributions from Cerner ITWorks and Cerner revenue cycle solutions and services.

Third quarter 2014 net earnings increased 12% to $129.0 million compared to $115.3 million in the third quarter of 2013. Diluted earnings per share increased 12% to $0.37 compared to $0.33 in the third quarter of 2013. The growth in net earnings and diluted earnings per share was driven by strong growth in services and higher margin components of system sales.

Third quarter 2014 and 2013 net earnings and diluted earnings per share reflect the impact of stock-based compensation expense. The effect of these expenses reduced the third quarter 2014 net earnings and diluted earnings per share by $10.4 million and $0.03, respectively, and the third quarter 2013 net earnings and diluted earnings per share by $8.2 million and $0.02, respectively. The third quarter 2014 net earnings and diluted earnings per share also reflect the impact of acquisition costs related to our pending acquisition of Siemens Health Services, as further described in Note (2) of our notes to condensed consolidated financial statements. These costs reduced net earnings and diluted earnings per share by $5.9 million and $0.02, respectively.

We had cash collections of receivables of $858.3 million in the third quarter of 2014 compared to $766.1 million in the third quarter of 2013. Days sales outstanding was 67 days for the third quarter of 2014 compared to 66 days for the second quarter of 2014 and the third quarter of 2013. Operating cash flows for the third quarter of 2014 were $219.5 million compared to $164.2 million in the third quarter of 2013.


16


Results of Operations
Three Months Ended September 27, 2014 Compared to Three Months Ended September 28, 2013
The following table presents a summary of the operating information for the third quarters of 2014 and 2013:
(In thousands)
2014
% of
Revenue
 
2013
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
224,345

27
%
 
$
202,632

 
28
%
 
11
%
Support and maintenance
177,450

21
%
 
166,308

 
23
%
 
7
%
Services
415,618

49
%
 
342,212

 
47
%
 
21
%
Reimbursed travel
22,736

3
%
 
16,678

 
2
%
 
36
%
 
 
 
 
 
 
 
 
 
Total revenues
840,149

100
%
 
727,830

 
100
%
 
15
%
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
Costs of revenue
140,065

17
%
 
119,577

 
16
%
 
17
%
 
 
 
 
 
 
 
 
 
Total margin
700,084

83
%
 
608,253

 
84
%
 
15
%
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Sales and client service
346,417

41
%
 
304,665

 
42
%
 
14
%
Software development
97,026

12
%
 
82,998

 
11
%
 
17
%
General and administrative
68,487

8
%
 
51,352

 
7
%
 
33
%
 
 
 
 
 
 
 
 
 
Total operating expenses
511,930

61
%
 
439,015

 
60
%
 
17
%
 
 
 
 
 
 
 
 
 
Total costs and expenses
651,995

78
%
 
558,592

 
77
%
 
17
%
 
 
 
 
 
 
 
 
 
Operating earnings
188,154

22
%
 
169,238

 
23
%
 
11
%
 
 
 
 
 
 
 
 
 
Other income, net
2,181

 
 
3,509

 
 
 
 
Income taxes
(61,333
)
 
 
(57,403
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
129,002

 
 
$
115,344

 
 
 
12
%
Revenues & Backlog
Revenues increased 15% to $840.1 million in the third quarter of 2014, as compared to $727.8 million in the third quarter of 2013.
 
System sales, which include revenues from the sale of licensed software (including perpetual license sales and software as a service), technology resale (hardware, devices, and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions, increased 11% to $224.3 million in the third quarter of 2014 from $202.6 million for the same period in 2013. The increase in system sales was primarily driven by strong growth in software of $18.1 million.
Support and maintenance revenues increased 7% to $177.5 million in the third quarter of 2014 compared to $166.3 million during the same period in 2013. This increase was attributable to continued success at selling Cerner Millennium® applications and implementing them at client sites. We expect that support and maintenance revenues will continue to grow as the base of installed Cerner Millennium systems grows.
Services revenue, which includes professional services, excluding installation, and managed services, increased 21% to $415.6 million in the third quarter of 2014 from $342.2 million for the same period in 2013. This increase was driven by growth in CernerWorksSM managed services of $14.1 million as a result of continued demand for our hosting services and a $59.3 million increase in professional services due to growth in implementation and consulting activities.

17


Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 22% in the third quarter of 2014 when compared to the same period in 2013. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services, Cerner ITWorks, and Cerner revenue cycle services bookings that typically have longer contract terms. A summary of our total backlog follows:
(In thousands)
September 27, 2014
 
September 28, 2013
 
 
 
 
Contract backlog
$
9,342,069

 
$
7,627,181

Support and maintenance backlog
814,008

 
769,847

 
 
 
 
Total backlog
$
10,156,077

 
$
8,397,028

Costs of Revenue
Cost of revenues as a percentage of total revenues was 17% in the third quarter of 2014, compared to 16% in the same period of 2013. The higher cost of revenues as a percent of revenue was driven by a higher amount of third party resources being utilized for support and services.
Cost of revenues includes the cost of reimbursed travel expense, sales commissions, third party consulting services and subscription content and computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, devices, maintenance, support, services and reimbursed travel) carrying different margin rates changes from period to period. Cost of revenues does not include the costs of our client service personnel who are responsible for delivering our service offerings. Such costs are included in sales and client service expense.
Operating Expenses
Total operating expenses increased 17% to $511.9 million in the third quarter of 2014, compared with $439.0 million in the third quarter of 2013.
 
Sales and client service expenses as a percent of total revenues were 41% in the third quarter of 2014, compared to 42% in the same period of 2013. These expenses increased 14% to $346.4 million in the third quarter of 2014, from $304.7 million in the same period of 2013. Sales and client service expenses include salaries of sales and client service personnel, depreciation and other expenses associated with our CernerWorks managed service business, communications expenses, unreimbursed travel expenses, expense for share-based payments, sales and marketing salaries and trade show and advertising costs. The increase was driven by strong services growth.
Software development expenses as a percent of revenue were 12% in the third quarter of 2014, compared to 11% in the same period of 2013. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium and Healthe Intent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. A summary of our total software development expense in the third quarters of 2014 and 2013 is as follows:
 
Three Months Ended
(In thousands)
2014
 
2013
 
 
 
 
Software development costs
$
115,749

 
$
106,986

Capitalized software costs
(43,523
)
 
(47,492
)
Capitalized costs related to share-based payments
(572
)
 
(552
)
Amortization of capitalized software costs
25,372

 
24,056

 
 
 
 
Total software development expense
$
97,026

 
$
82,998

 
General and administrative expenses as a percent of total revenues were 8% in the third quarter of 2014, compared to 7% in the same period of 2013. These expenses increased 33% to $68.5 million in 2014, from $51.4 million for the same period in 2013. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency, expense for share-based payments and acquisition costs. The increase in general and administrative expenses was primarily driven by $9.4 million of acquisition costs related to

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our pending acquisition of Siemens Health Services and a $3.1 million increase in corporate personnel costs, as we have continued to increase such personnel to support our overall revenue growth.

Non-Operating Items
 
Other income was $2.2 million in the third quarter of 2014 and $3.5 million in the same period of 2013. This decrease is primarily due to the 2013 period included a gain recognized on the sale of one of our cost method investments.

Our effective tax rate was 32.2% for the third quarter of 2014 and 33.2% for the third quarter of 2013. This decrease is primarily due to an increase in net favorable discrete items recorded in 2014 relative to 2013, partially offset by the expiration of the research and development tax credit in 2014. Refer to Note (6) of the notes to condensed consolidated financial statements.

Operations by Segment
We have two operating segments: Domestic and Global. The Domestic segment includes revenue contributions and expenditures associated with business activity in the United States. The Global segment includes revenue contributions and expenditures linked to business activity in Aruba, Australia, Austria, Brazil, Canada, Cayman Islands, Chile, Egypt, England, France, Germany, Guam, India, Ireland, Israel, Malaysia, Mexico, Qatar, Saudi Arabia, Singapore, Spain, Switzerland and the United Arab Emirates.

The following table presents a summary of the operating information for the third quarters of 2014 and 2013:  
(In thousands)
2014
 
% of Revenue
 
2013
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
741,830

 
100%
 
$
641,541

 
100%
 
16%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
126,223

 
17%
 
107,560

 
17%
 
17%
Operating expenses
170,709

 
23%
 
148,478

 
23%
 
15%
Total costs and expenses
296,932

 
40%
 
256,038

 
40%
 
16%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
444,898

 
60%

385,503

 
60%
 
15%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
98,319

 
100%
 
86,289

 
100%
 
14%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
13,842

 
14%
 
12,017

 
14%
 
15%
Operating expenses
30,531

 
31%
 
34,078

 
39%
 
(10)%
Total costs and expenses
44,373

 
45%
 
46,095

 
53%
 
(4)%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
53,946

 
55%
 
40,194

 
47%
 
34%