10-Q 1 q3201610-q.htm Q3 2016 FORM 10-Q Document

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: October 1, 2016
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 27, 2016
Common Stock, $0.01 par value per share
  
339,496,327 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 October 1, 2016 (unaudited) and January 2, 2016
(In thousands, except share data)
2016
 
2015
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
431,497

 
$
402,122

Short-term investments
261,185

 
111,059

Receivables, net
985,164

 
1,034,084

Inventory
19,705

 
15,788

Prepaid expenses and other
300,764

 
264,780

Total current assets
1,998,315

 
1,827,833

 
 
 
 
Property and equipment, net
1,476,126

 
1,309,214

Software development costs, net
690,972

 
562,559

Goodwill
848,452

 
799,182

Intangible assets, net
591,447

 
688,058

Long-term investments
143,859

 
173,073

Other assets
199,356

 
202,065

 
 
 
 
Total assets
$
5,948,527

 
$
5,561,984

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
219,531

 
$
215,510

Current installments of long-term debt and capital lease obligations
36,619

 
41,797

Deferred revenue
308,713

 
278,443

Accrued payroll and tax withholdings
204,774

 
184,225

Other accrued expenses
58,423

 
57,891

Total current liabilities
828,060

 
777,866

 
 
 
 
Long-term debt and capital lease obligations
535,920

 
563,353

Deferred income taxes and other liabilities
292,769

 
324,516

Deferred revenue
13,743

 
25,865

Total liabilities
1,670,492

 
1,691,600

 
 
 
 
Shareholders’ Equity:
 
 
 
Common stock, $.01 par value, 500,000,000 shares authorized, 353,581,189 shares issued at October 1, 2016 and 350,323,367 shares issued at January 2, 2016
3,536

 
3,503

Additional paid-in capital
1,205,075

 
1,075,782

Retained earnings
3,944,636

 
3,457,843

Treasury stock, 14,109,095 shares at October 1, 2016 and 10,364,691 shares at January 2, 2016
(790,465
)
 
(590,390
)
Accumulated other comprehensive loss, net
(84,747
)
 
(76,354
)
Total shareholders’ equity
4,278,035

 
3,870,384

 
 
 
 
Total liabilities and shareholders’ equity
$
5,948,527

 
$
5,561,984


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 October 1, 2016 and October 3, 2015
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands, except per share data)
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
System sales
$
301,252

 
$
325,084

 
$
913,710

 
$
899,762

Support, maintenance and services
861,085

 
783,878

 
2,561,474

 
2,295,075

Reimbursed travel
22,220

 
18,925

 
63,470

 
55,136

 
 
 
 
 
 
 
 
Total revenues
1,184,557

 
1,127,887

 
3,538,654

 
3,249,973

Costs and expenses:
 
 
 
 
 
 
 
Cost of system sales
93,275

 
105,760

 
296,336

 
309,761

Cost of support, maintenance and services
67,475

 
65,898

 
204,313

 
186,668

Cost of reimbursed travel
22,220

 
18,925

 
63,470

 
55,136

Sales and client service
512,671

 
465,881

 
1,534,763

 
1,349,498

Software development (Includes amortization of $35,552 and $102,429 for the three and nine months ended October 1, 2016; and $29,743 and $88,450 for the three and nine months ended October 3, 2015)
136,755

 
132,814

 
405,451

 
398,536

General and administrative
87,071

 
98,705

 
267,232

 
329,061

Amortization of acquisition-related intangibles
22,865

 
24,550

 
68,104

 
67,311

 
 
 
 
 
 
 
 
Total costs and expenses
942,332

 
912,533

 
2,839,669

 
2,695,971

 
 
 
 
 
 
 
 
Operating earnings
242,225

 
215,354

 
698,985

 
554,002

 
 
 
 
 
 
 
 
Other income (expense), net
(417
)
 
317

 
3,734

 
(554
)
 
 
 
 
 
 
 
 
Earnings before income taxes
241,808

 
215,671

 
702,719

 
553,448

Income taxes
(71,829
)
 
(68,389
)
 
(215,926
)
 
(180,194
)
 
 
 
 
 
 
 
 
Net earnings
$
169,979

 
$
147,282

 
$
486,793

 
$
373,254

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.50

 
$
0.43

 
$
1.44

 
$
1.09

Diluted earnings per share
$
0.49

 
$
0.42

 
$
1.41

 
$
1.06

Basic weighted average shares outstanding
338,684

 
344,040

 
338,675

 
343,933

Diluted weighted average shares outstanding
344,817

 
351,364

 
344,917

 
351,891

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 October 1, 2016 and October 3, 2015
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net earnings
$
169,979

 
$
147,282

 
$
486,793

 
$
373,254

Foreign currency translation adjustment and other (net of taxes (benefit) of $1,282 and $3,437 for the three and nine months ended October 1, 2016; and $(824) and $(3,053) for the three and nine months ended October 3, 2015)
(2,085
)
 
(7,944
)
 
(8,557
)
 
(20,838
)
Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $(188) and $101 for the three and nine months ended October 1, 2016; and $73 and $186 for the three and nine months ended October 3, 2015)
(308
)
 
118

 
164

 
292

 
 
 
 
 
 
 
 
Comprehensive income
$
167,586

 
$
139,456

 
$
478,400

 
$
352,708


See notes to condensed consolidated financial statements (unaudited).


3


CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended October 1, 2016 and October 3, 2015
(unaudited)
 
Nine Months Ended
(In thousands)
2016
 
2015
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
486,793

 
$
373,254

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
371,385

 
329,075

Share-based compensation expense
56,896

 
53,326

Provision for deferred income taxes
(25,922
)
 
4,671

Changes in assets and liabilities (net of businesses acquired):
 
 
 
Receivables, net
43,699

 
(176,120
)
Inventory
(5,590
)
 
5,165

Prepaid expenses and other
(33,801
)
 
(41,741
)
Accounts payable
(19,566
)
 
(7,632
)
Accrued income taxes
6,191

 
2,596

Deferred revenue
(1,780
)
 
(3,008
)
Other accrued liabilities
(55,931
)
 
54,845

 
 
 
 
Net cash provided by operating activities
822,374

 
594,431

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(327,861
)
 
(255,375
)
Capitalized software development costs
(228,803
)
 
(204,708
)
Purchases of investments
(387,809
)
 
(460,128
)
Sales and maturities of investments
262,100

 
962,760

Purchase of other intangibles
(13,222
)
 
(18,092
)
Acquisition of businesses

 
(1,372,014
)
 
 
 
 
Net cash used in investing activities
(695,595
)
 
(1,347,557
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Long-term debt issuance

 
500,000

Proceeds from excess tax benefits from share-based compensation
47,202

 
57,689

Proceeds from exercise of options
60,486

 
42,481

Treasury stock purchases
(200,075
)
 
(200,064
)
Contingent consideration payments for acquisition of businesses
(2,074
)
 
(11,012
)
Other

 
(792
)
 
 
 
 
Net cash provided by (used in) financing activities
(94,461
)

388,302

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(2,943
)
 
(8,622
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
29,375

 
(373,446
)
Cash and cash equivalents at beginning of period
402,122

 
635,203

 
 
 
 
Cash and cash equivalents at end of period
$
431,497

 
$
261,757

 
 
 
 
Summary of acquisition transactions:
 
 
 
Fair value of tangible assets acquired
$
(10,200
)
 
$
450,662

Fair value of intangible assets acquired
(25,000
)
 
637,980

Fair value of goodwill
46,940

 
472,476

Less: Fair value of liabilities assumed
(11,740
)
 
(167,989
)
Less: Fair value of working capital settlement payable

 
(21,115
)
 
 
 
 
Net cash used
$

 
$
1,372,014

See notes to condensed consolidated financial statements (unaudited).

4


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

Basis of Presentation

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

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

Fiscal Period End

Our third fiscal quarter ends on the Saturday closest to September 30. The 2016 and 2015 third quarters ended on October 1, 2016 and October 3, 2015, 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.

Siemens Health Services

On February 2, 2015, we acquired Siemens Health Services, as further described in Note (2). The addition of the Siemens Health Services business impacts the comparability of our condensed consolidated financial statements for the nine months ended October 1, 2016, in relation to the nine months ended October 3, 2015, presented herein.

Voluntary Separation Plan

In the first quarter of 2015, the Company adopted a voluntary separation plan ("VSP") for eligible associates. Generally, the VSP was available to U.S. associates who met a minimum level of combined age and tenure, excluding, among others, our executive officers. Associates who elected to participate in the VSP received financial benefits commensurate with their tenure and position, along with vacation payout and medical benefits. During the nine months ended October 3, 2015, we recorded pre-tax charges for the VSP of $45 million, which is included in general and administrative expense in our condensed consolidated statements of operations. As of January 2, 2016, this program was complete.

In the fourth quarter of 2016, the Company adopted a new voluntary separation plan ("2016 VSP") for eligible associates. This 2016 VSP is available to U.S. associates who meet a minimum level of combined age and tenure. Associates who elect to participate in the 2016 VSP will receive financial benefits commensurate with their tenure and position, along with vacation payout and medical benefits. The irrevocable acceptance period for most associates electing to participate in the 2016 VSP ends in December 2016. Based on the number of eligible associates, and our estimate of participation, we expect the corresponding pre-tax charge in the fourth quarter of 2016 to approximate $35 million.

Recently Issued Accounting Pronouncements
Revenue Recognition. In May 2014, the Financial Accounting Standards Board (FASB) 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 GAAP. The new standard is effective for the Company in the first quarter of 2018, with early adoption permitted in the first quarter of 2017. The standard permits the use of either the retrospective or cumulative effect transition method. We expect to use the cumulative effect transition method, and we do not expect to early adopt. We

5


are currently evaluating the effect that ASU 2014-09, and its subsequent amendments discussed below, will have on our consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). ASU 2016-08 amends the principal versus agent guidance in ASU 2014-09, and clarifies that the analysis must focus on whether the entity has control of the goods or services before they are transferred to the customer.

In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. ASU 2016-10 amends the revenue guidance in ASU 2014-09 on identifying performance obligations and accounting for licenses of intellectual property.

In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. ASU 2016-12 amends the revenue guidance in ASU 2014-09 regarding (1) assessing collectability, (2) presentation of sales taxes, (3) non-cash consideration, and (4) completed contracts and contract modifications at transition.

Consolidation. In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which provides guidance when evaluating whether to consolidate certain legal entities. The updated guidance modifies evaluation criteria of limited partnerships and similar legal entities, eliminates the presumption that a general partner should consolidate a limited partnership, and affects the consolidation analysis of reporting entities that are involved with variable interest entities, particularly those that have fee arrangements and related party relationships. ASU 2015-02 was effective for the Company in the first quarter of 2016. The adoption of ASU 2015-02 did not have a material impact on our consolidated financial statements and related disclosures.

Financial Instruments. In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 is effective for the Company in the first quarter of 2018, with early adoption permitted. We are currently evaluating the effect that ASU 2016-01 will have on our consolidated financial statements and related disclosures, and we have not determined if we will early adopt.

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

Share-Based Compensation. In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 changes several aspects of the accounting for share-based payment award transactions, including: (1) accounting and cash flow classification for excess tax benefits and deficiencies, (2) forfeitures, and (3) tax withholding requirements and cash flow classification. ASU 2016-09 is effective for the Company in the first quarter of 2017, with early adoption permitted. We are currently evaluating the effect that ASU 2016-09 will have on our consolidated financial statements and related disclosures, and we do not expect to early adopt.

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

Cash Flow Presentation. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which includes clarifying guidance regarding the cash flow statement presentation of contingent consideration payments made after business combinations. The standard requires use of the retrospective transition method, however entities may apply the guidance prospectively if retrospective application would be

6


impracticable. ASU 2016-15 is effective for the Company in the first quarter of 2018, with early adoption permitted. At this time, we have not selected a transition method, nor have we determined if we will early adopt. We are currently evaluating the effect that ASU 2016-15 will have on our consolidated financial statements and related disclosures.

Income Taxes. In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory, which provides new guidance regarding when an entity should recognize the income tax consequences of certain intra-entity asset transfers. The standard requires the use of the modified retrospective transition approach. ASU 2016-16 is effective for the Company in the first quarter of 2018, with early adoption permitted in the first quarter of 2017. We are currently evaluating the effect that ASU 2016-16 will have on our consolidated financial statements and related disclosures, and we have not determined if we will early adopt.

7


(2) Business Acquisitions

On February 2, 2015, we acquired substantially all of the assets, and assumed certain liabilities of Siemens Health Services (now referred to as "Cerner Health Services"), the health information technology business unit of Siemens AG, a stock corporation established under the laws of Germany, and its affiliates. In the first quarter of 2016, we finalized our allocation of purchase price as appraisals of tangible and intangible assets were completed:
(in thousands)
 
 
Receivables, net of allowances
 
$
226,207

Other current assets
 
46,682

Property and equipment
 
158,324

Goodwill
 
532,327

Intangible assets:
 
 
Customer relationships
 
371,000

Existing technologies
 
201,990

Trade names
 
39,990

Total intangible assets
 
612,980

Other non-current assets
 
5,212

Accounts payable
 
(42,306
)
Deferred revenue (current)
 
(85,314
)
Other current liabilities
 
(12,853
)
Deferred revenue (non-current)
 
(48,130
)
 
 
 
Total purchase price
 
$
1,393,129


The changes in the carrying amounts of goodwill for the nine months ended October 1, 2016 were as follows:

(In thousands)
 
Domestic
 
Global
 
Total
 
 
 
 
 
 
 
Beginning balance
 
$
730,837

 
$
68,345

 
$
799,182

Purchase price allocation adjustments for Cerner Health Services
 
51,827

 
(4,887
)
 
46,940

Foreign currency translation adjustments and other
 

 
2,330

 
2,330

Ending balance at October 1, 2016
 
$
782,664

 
$
65,788

 
$
848,452


The following table provides unaudited pro forma results of operations for the nine months ended October 3, 2015 as if acquisition of the Cerner Health Services business had been completed on the first day of our 2015 fiscal year.

(In thousands, except per share data)
 
 
 
 
 
Pro forma revenues
 
$
3,343,653

Pro forma net earnings
 
379,059

Pro forma diluted earnings per share
 
1.08


These pro forma results are based on estimates and assumptions, which we believe are reasonable. They are not the results that would have been realized had we been a combined company during the period presented, nor are they indicative of our consolidated results of operations in future periods. The pro forma results for the nine months ended October 3, 2015 include pre-tax adjustments for amortization of intangible assets, fair value adjustments for deferred revenue, and the elimination of acquisition costs of $7 million, $6 million and $20 million, respectively.

During the nine months ended October 3, 2015, we incurred $20 million of pre-tax costs in connection with our acquisition of the Cerner Health Services business, which are included in general and administrative expense in our condensed consolidated statements of operations.


8


(3) Fair Value Measurements

We determine fair value measurements used in our consolidated financial statements based upon the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
 
Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2 – Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
Level 3 – Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table details our financial assets measured and recorded at fair value on a recurring basis at October 1, 2016:
(In thousands)
 
 
 
 
 
 

 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
108,378

 
$

 
$

Time deposits
 
Cash equivalents
 

 
9,199

 

Commercial paper
 
Cash equivalents
 

 
2,500

 

Time deposits
 
Short-term investments
 

 
44,980

 

Commercial paper
 
Short-term investments
 

 
37,775

 

Government and corporate bonds
 
Short-term investments
 

 
178,430

 

Government and corporate bonds
 
Long-term investments
 

 
130,292

 


The following table details our financial assets measured and recorded at fair value on a recurring basis at January 2, 2016:
(In thousands)
 
 
 
 
 
 
 
 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
126,752

 
$

 
$

Time deposits
 
Cash equivalents
 

 
5,677

 

Government and corporate bonds
 
Cash equivalents
 

 
73

 

Time deposits
 
Short-term investments
 

 
30,989

 

Commercial paper
 
Short-term investments
 

 
1,498

 

Government and corporate bonds
 
Short-term investments
 

 
78,572

 

Government and corporate bonds
 
Long-term investments
 

 
155,972

 

We estimate the fair value of our long-term, fixed rate debt using a Level 3 discounted cash flow analysis based on current borrowing rates for debt with similar maturities. We estimate the fair value of our long-term, variable rate debt using a Level 3 discounted cash flow analysis based on LIBOR rate forward curves. The fair value of our long-term debt, including current maturities, at October 1, 2016 and January 2, 2016 was approximately $531 million and $505 million, respectively. The carrying amount of such debt at both October 1, 2016 and January 2, 2016 was $500 million.

9


(4) Available-for-sale Investments

Available-for-sale investments at October 1, 2016 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
108,378

 
$

 
$

 
$
108,378

Time deposits
 
9,199

 

 

 
9,199

Commercial paper
 
2,500

 

 

 
2,500

Total cash equivalents
 
120,077

 

 

 
120,077

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
44,980

 

 

 
44,980

Commercial paper
 
37,825

 

 
(50
)
 
37,775

Government and corporate bonds
 
178,551

 
12

 
(133
)
 
178,430

Total short-term investments
 
261,356

 
12

 
(183
)
 
261,185

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
130,496

 
17

 
(221
)
 
130,292

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
511,929


$
29


$
(404
)

$
511,554


Available-for-sale investments at January 2, 2016 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
126,752

 
$

 
$

 
$
126,752

Time deposits
 
5,677

 

 

 
5,677

Government and corporate bonds
 
73

 

 

 
73

Total cash equivalents
 
132,502

 

 

 
132,502

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
30,989

 

 

 
30,989

Commercial paper
 
1,500

 

 
(2
)
 
1,498

Government and corporate bonds
 
78,655

 
20

 
(103
)
 
78,572

Total short-term investments
 
111,144

 
20

 
(105
)
 
111,059

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
156,527

 
14

 
(569
)
 
155,972

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
400,173

 
$
34

 
$
(674
)
 
$
399,533


We sold available-for-sale investments for proceeds of $92 million and $157 million during the nine months ended October 1, 2016 and October 3, 2015, respectively, resulting in insignificant gains in each period.

10


(5) Receivables

A summary of net receivables is as follows:
(In thousands)
October 1, 2016
 
January 2, 2016
 
 
 
 
Gross accounts receivable
$
991,816

 
$
1,043,069

Less: Allowance for doubtful accounts
41,267

 
48,119

 
 
 
 
Accounts receivable, net of allowance
950,549

 
994,950

 
 
 
 
Current portion of lease receivables
34,615

 
39,134

 
 
 
 
Total receivables, net
$
985,164

 
$
1,034,084


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 October 1, 2016, 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 October 1, 2016 and January 2, 2016. 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 2016 and 2015, we received total client cash collections of $3.8 billion and $3.2 billion, respectively.
 
(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 30.7% and 32.6% for the first nine months of 2016 and 2015, respectively. The decrease in the 2016 effective tax rate is primarily the result of the permanent reinstatement of the U.S. research and development tax credit in December 2015.


11


(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
 
2016
 
2015
 
Earnings
 
Shares
 
Per-Share
 
Earnings
 
Shares
 
Per-Share
(In thousands, except per share data)
(Numerator)
 
(Denominator)
 
Amount
 
(Numerator)
 
(Denominator)
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders
$
169,979

 
338,684

 
$
0.50

 
$
147,282

 
344,040

 
$
0.43

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

 
6,133

 
 
 

 
7,324

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
169,979

 
344,817

 
$
0.49

 
$
147,282

 
351,364

 
$
0.42


For the three months ended October 1, 2016 and October 3, 2015, options to purchase 8.1 million and 3.9 million shares of common stock at per share prices ranging from $47.84 to $73.40 and $48.39 to $73.40, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.
 
Nine Months Ended
 
2016
 
2015
 
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
$
486,793

 
338,675

 
$
1.44

 
$
373,254

 
343,933

 
$
1.09

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

 
6,242

 
 
 

 
7,958

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
486,793

 
344,917

 
$
1.41

 
$
373,254

 
351,891

 
$
1.06


For the nine months ended October 1, 2016 and October 3, 2015, options to purchase 7.2 million and 2.5 million shares of common stock at per share prices ranging from $47.38 to $73.40 and $51.97 to $73.40, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.


12


(8) Share-Based Compensation and Equity

Stock Options

Options activity for the nine months ended October 1, 2016 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
24,267

 
$
34.46

 
 
 
 
Granted
4,038

 
55.20

 
 
 
 
Exercised
(3,905
)
 
17.23

 
 
 
 
Forfeited and expired
(427
)
 
54.47

 
 
 
 
Outstanding as of October 1, 2016
23,973

 
40.41

 
$
531,419

 
6.28
 
 
 
 
 
 
 
 
Exercisable as of October 1, 2016
12,642

 
$
25.96

 
$
452,445

 
4.41

The weighted-average assumptions used to estimate the fair value, under the Black-Scholes-Merton pricing model, of stock options granted during the nine months ended October 1, 2016 were as follows:
Expected volatility (%)
 
29.4
%
Expected term (yrs)
 
7

Risk-free rate (%)
 
1.5
%
Fair value per option
 
$
18.35

As of October 1, 2016, there was $168 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 3.32 years.
Non-vested Shares

Non-vested share activity for the nine months ended October 1, 2016 was as follows:
(In thousands, except per share data)
Number of Shares
 
Weighted-Average
Grant Date Fair Value
 
 
 
 
Outstanding at beginning of year
557

 
$
59.42

Granted
55

 
57.68

Vested
(216
)
 
53.74

Forfeited
(44
)
 
70.49

 
 
 
 
Outstanding as of October 1, 2016
352

 
$
61.25

As of October 1, 2016, there was $10 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 1.88 years.

13


Share-Based Compensation Cost

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)
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Stock option and non-vested share compensation expense
$
18,942

 
$
18,875

 
$
56,896

 
$
53,326

Associate stock purchase plan expense
1,503

 
1,485

 
4,722

 
4,238

Amounts capitalized in software development costs, net of amortization
(95
)
 
(183
)
 
(486
)
 
(483
)
 
 
 
 
 
 
 
 
Amounts charged against earnings, before income tax benefit
$
20,350

 
$
20,177

 
$
61,132

 
$
57,081

 
 
 
 
 
 
 
 
Amount of related income tax benefit recognized in earnings
$
6,045

 
$
6,398

 
$
18,793

 
$
18,595


Treasury Stock

In March 2016, our Board of Directors authorized a share repurchase program that allows the Company to repurchase shares of our common stock up to $300 million, 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 October 1, 2016, we repurchased 3.7 million shares for consideration of $200 million. These shares were recorded as treasury stock and accounted for under the cost method. No repurchased shares have been retired. At October 1, 2016, $100 million remains available for repurchase under the program.

(9) Contingencies

We accrue estimates for resolution of any legal and other contingencies when losses are probable and estimable, in accordance with ASC 450, Contingencies.

The terms of our software license agreements with our clients generally provide for a limited indemnification of such clients against losses, expenses and liabilities arising from third party claims based on alleged infringement by our solutions of an intellectual property right of such third party. The terms of such indemnification often limit the scope of and remedies for such indemnification obligations and generally include a right to replace or modify an infringing solution. To date, we have not had to reimburse any of our clients for any judgments or settlements to third parties related to these indemnification provisions pertaining to intellectual property infringement claims. For several reasons, including the lack of 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, including for example, employment disputes and litigation alleging solution defects, personal injury, intellectual property infringement, violations of law and breaches of contract and warranties.  Many of these proceedings are at preliminary stages and many seek an indeterminate amount of damages.

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 business, results of operations, cash flows or financial condition.


14


(10) Segment Reporting

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

The following table presents a summary of our operating segments and other expense for the three and nine months ended October 1, 2016 and October 3, 2015:
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2016
 
 
 
 
 
 
 
Revenues
$
1,055,037

 
$
129,520

 
$

 
$
1,184,557

 
 
 
 
 
 
 
 
Cost of revenues
161,625

 
21,345

 

 
182,970

Operating expenses
446,704

 
60,430

 
252,228

 
759,362

Total costs and expenses
608,329

 
81,775


252,228

 
942,332

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
446,708

 
$
47,745

 
$
(252,228
)
 
$
242,225

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2015
 
 
 
 
 
 
 
Revenues
$
997,954

 
$
129,933

 
$

 
$
1,127,887

 
 
 
 
 
 
 
 
Cost of revenues
169,181

 
21,402

 

 
190,583

Operating expenses
403,371

 
60,448

 
258,131

 
721,950

Total costs and expenses
572,552

 
81,850

 
258,131

 
912,533

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
425,402

 
$
48,083

 
$
(258,131
)
 
$
215,354


15


(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Nine Months Ended 2016
 
 
 
 
 
 
 
Revenues
$
3,132,566

 
$
406,088

 
$

 
$
3,538,654

 
 
 
 
 
 
 
 
Cost of revenues
488,404

 
75,715

 

 
564,119

Operating expenses
1,304,731

 
183,824

 
786,995

 
2,275,550

Total costs and expenses
1,793,135

 
259,539

 
786,995

 
2,839,669

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
1,339,431

 
$
146,549

 
$
(786,995
)
 
$
698,985

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Nine Months Ended 2015
 
 
 
 
 
 
 
Revenues
$
2,863,207

 
$
386,766

 
$

 
$
3,249,973

 
 
 
 
 
 
 
 
Cost of revenues
480,087

 
71,478

 

 
551,565

Operating expenses
1,157,762

 
170,846

 
815,798

 
2,144,406

Total costs and expenses
1,637,849

 
242,324

 
815,798

 
2,695,971

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
1,225,358

 
$
144,442

 
$
(815,798
)
 
$
554,002



16


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.

The 2016 and 2015 third quarters ended on October 1, 2016 and October 3, 2015, respectively. All references to years in this MD&A represent the respective three or nine months ended on such dates, unless otherwise noted.
 
Except for the historical information and discussions contained herein, statements contained in this quarterly report on Form 10-Q may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements are based on the current beliefs, expectations and assumptions of Cerner's management with respect to future events and are subject to a number of significant risks and uncertainties. It is important to note that Cerner's performance, and actual results, financial condition or business could differ materially from those expressed in such forward-looking statements. These statements can often be identified by the use of forward-looking terminology, such as "could," "should," "will," "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast," "plan," "guidance," "opportunity," "prospects" 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; the possibility of increased expenses, exposure to claims and regulatory actions and reputational harm associated with a cyberattack or other breach in our IT security; our proprietary technology may be subject to claims for infringement or misappropriation of intellectual property rights of others, or may be infringed or misappropriated by others; material adverse resolution of legal proceedings; risks associated with our global operations; risks associated with 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 U.S. and non-U.S. countries; risks associated with our recruitment and retention of key personnel; risks related to our dependence on third party suppliers; difficulties and operational and financial risks associated with successfully completing the integration of the Cerner Health Services (formerly Siemens Health Services) business into our business or the failure to realize the synergies and other benefits expected from the acquisition; risks inherent with business acquisitions and combinations and the integration thereof; the potential for losses resulting from asset impairment charges; risks associated with volatility and disruption resulting from global economic or market conditions; managing growth in the new markets in which we offer solutions, health care devices and services; continuing to incur significant expenses relating to the integration of the Cerner Health Services business into Cerner; risks inherent in contracting with government clients; risks associated with our outstanding and future indebtedness, such as compliance with restrictive covenants, which may limit our flexibility to operate our business; changing political, economic, regulatory and judicial influences, which could impact the purchasing practices and operations of our clients and increase costs to deliver compliant solutions and services; government regulation; significant competition and our ability to respond to market changes and changing technologies; 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; our directors' authority to issue preferred stock and the anti-takeover provisions in our corporate governance documents; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission, including those under the caption "Risk Factors" in our latest annual report on Form 10-K, or in materials incorporated herein or therein by reference. Forward-looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as of the date they are made. Except as required by law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in our results of operations, financial condition or business over time.

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 or near-real time, helping them 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 14% or more. This growth has also created an important strategic footprint in health care, with Cerner® solutions in more than 25,000 facilities worldwide, including hospitals, physician

17


practices, laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics, surgery centers, extended care facilities, retail pharmacies, and employer sites. 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 looking to replace their current supplier. We may also supplement organic growth with acquisitions.

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 17% or more 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.

Siemens Health Services
On February 2, 2015, we acquired Siemens Health Services (now referred to as "Cerner Health Services"), as further described in Note (2) of the notes to condensed consolidated financial statements. The addition of the Cerner Health Services business impacts the comparability of our condensed consolidated financial statements for the nine months ended October 1, 2016, in relation to the nine months ended October 3, 2015, presented herein.

Results Overview
The Company delivered strong levels of bookings, revenues, earnings, and operating cash flow in the third quarter of 2016.

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $1.4 billion in the third quarter of 2016, which is a decrease of 10% compared to $1.6 billion in the third quarter of 2015, when bookings grew 44% year-over-year.

Revenues for the third quarter of 2016 increased 5% to $1.2 billion compared to $1.1 billion in the third quarter of 2015. The year-over-year increase in revenue reflects ongoing demand for Cerner's core solutions and services driven by our clients' needs to keep up with regulatory requirements; contributions from Cerner ITWorksSM and revenue cycle solutions and services; and attaining new clients.

Third quarter 2016 net earnings increased 15% to $170 million compared to $147 million in the third quarter of 2015. Diluted earnings per share increased 17% to $0.49 compared to $0.42 in the third quarter of 2015. The growth in net earnings and diluted earnings per share was primarily a result of increased revenues, combined with a decline in costs associated with our acquisition of the Cerner Health Services business in 2015.

We had cash collections of receivables of $1.3 billion in the third quarter of 2016 compared to $1.1 billion in the third quarter of 2015. Days sales outstanding was 76 days for the third quarter of 2016 compared to 74 days for the second quarter of 2016 and 85 days for the third quarter of 2015. Operating cash flows for the third quarter of 2016 were $240 million compared to $272 million in the third quarter of 2015.


18


Results of Operations
Three Months Ended October 1, 2016 Compared to Three Months Ended October 3, 2015
The following table presents a summary of the operating information for the third quarters of 2016 and 2015:
(In thousands)
2016
% of
Revenue
 
2015
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
301,252

25
%
 
$
325,084

 
29
%
 
(7
)%
Support and maintenance
253,425

21
%
 
245,118

 
22
%
 
3
 %
Services
607,660

51
%
 
538,760

 
48
%
 
13
 %
Reimbursed travel
22,220

2
%
 
18,925

 
2
%
 
17
 %
 
 
 
 
 
 
 
 
 
Total revenues
1,184,557

100
%
 
1,127,887

 
100
%
 
5
 %
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
Costs of revenue
182,970

15
%
 
190,583

 
17
%
 
(4
)%
 
 
 
 
 
 
 
 
 
Total margin
1,001,587

85
%
 
937,304

 
83
%
 
7
 %
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Sales and client service
512,671

43
%
 
465,881

 
41
%
 
10
 %
Software development
136,755

12
%
 
132,814

 
12
%
 
3
 %
General and administrative
87,071

7
%
 
98,705

 
9
%
 
(12
)%
Amortization of acquisition-related intangibles
22,865

2
%
 
24,550

 
2
%
 
(7
)%
 
 
 
 
 
 
 
 
 
Total operating expenses
759,362

64
%
 
721,950

 
64
%
 
5
 %
 
 
 
 
 
 
 
 
 
Total costs and expenses
942,332

80
%
 
912,533

 
81
%
 
3
 %
 
 
 
 
 
 
 
 
 
Operating earnings
242,225

20
%
 
215,354

 
19
%
 
12
 %
 
 
 
 
 
 
 
 
 
Other income (expense), net
(417
)
 
 
317

 
 
 
 
Income taxes
(71,829
)
 
 
(68,389
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
169,979

 
 
$
147,282

 
 
 
15
 %
Revenues & Backlog
Revenues increased 5% to $1.2 billion in the third quarter of 2016, as compared to $1.1 billion in the third quarter of 2015.
 
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, decreased 7% to $301 million in the third quarter of 2016 from $325 million for the same period in 2015. The decrease in system sales was primarily driven by declines in licensed software and technology resale of $18 million and $17 million, respectively.
Support and maintenance revenues increased 3% to $253 million in the third quarter of 2016 compared to $245 million during the same period in 2015. This increase was primarily attributable to continued success selling Cerner Millennium® applications and implementing them at client sites.
Services revenue, which includes professional services, excluding installation, and managed services, increased 13% to $608 million in the third quarter of 2016 from $539 million for the same period in 2015. This increase was driven by a $39 million increase in professional services due to growth in implementation and consulting activities and growth in managed services of $30 million as a result of continued demand for our hosting services.

Revenue backlog, which reflects contracted revenue that has not yet been recognized as revenue, increased 11% to $15.5 billion in the third quarter of 2016 compared to $13.9 billion for the same period in 2015. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services, Cerner ITWorksSM and revenue cycle services bookings that typically have longer contract terms.

19


Costs of Revenue
Cost of revenues as a percent of total revenues was 15% in the third quarter of 2016 compared with 17% in the same period of 2015. The lower cost of revenues as a percent of revenue was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue.
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 5% to $759 million in the third quarter of 2016 compared with $722 million in the third quarter of 2015.
 
Sales and client service expenses as a percent of total revenues were 43% in the third quarter of 2016 compared to 41% in the same period of 2015. These expenses increased 10% to $513 million in the third quarter of 2016, from $466 million in the same period of 2015. Sales and client service expenses include salaries and benefits of sales, marketing, support, and services personnel, depreciation and other expenses associated with our managed services business, communications expenses, unreimbursed travel expenses, expense for share-based payments, and trade show and advertising costs. The increase as a percent of revenues reflects a higher mix of services during the quarter that was driven by services revenue growth.
Software development expenses as a percent of total revenues were 12% in the third quarter of both 2016 and 2015. Expenditures for software development include ongoing development and enhancement of the Cerner Millennium® and HealtheIntentTM 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 2016 and 2015 is as follows:
 
Three Months Ended
(In thousands)
2016
 
2015
 
 
 
 
Software development costs
$
174,831

 
$
174,915

Capitalized software costs
(72,943
)
 
(71,186
)
Capitalized costs related to share-based payments
(685
)
 
(658
)
Amortization of capitalized software costs
35,552

 
29,743

 
 
 
 
Total software development expense
$
136,755

 
$
132,814

 
General and administrative expenses as a percent of total revenues were 7% in the third quarter of 2016, compared to 9% in the same period of 2015. These expenses decreased 12% to $87 million in the third quarter of 2016, from $99 million for the same period in 2015. General and administrative expenses include salaries and benefits for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency, expense for share-based payments, acquisition costs and related adjustments. The decrease as a percent of revenues was primarily the result of expenses incurred in 2015 related to our voluntary separation plan and acquisition costs and related adjustments associated with our acquisition of the Cerner Health Services business of $4 million and $6 million, respectively. We expect to record expenses in the fourth quarter of 2016 in connection with a new voluntary separation plan, as further discussed in Note (1) of the notes to condensed consolidated financial statements.

Amortization of acquisition-related intangibles as a percent of total revenues was 2% in the third quarter of both 2016 and 2015. These expenses decreased 7% to $23 million in the third quarter of 2016, from $25 million for the same period in 2015. Amortization of acquisition-related intangibles includes the amortization of customer relationships, acquired technology, trade names, and non-compete agreements recorded in connection with our business acquisitions. The decrease in amortization of acquisition-related intangibles includes the impact of certain intangible assets becoming fully amortized.


20


Non-Operating Items
 
Other income (expense), net was less than $(1 million) in the third quarter of 2016 and less than $1 million in the same period of 2015.

Our effective tax rate was 29.7% for the third quarter of 2016 and 31.7% for the third quarter of 2015. The decrease in the 2016 effective tax rate is primarily the result of the permanent reinstatement of the U.S. research and development tax credit in December 2015.

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, Belgium, Brazil, Canada, Cayman Islands, Chile, Denmark, Egypt, England, Finland, France, Germany, Guam, India, Ireland, Kuwait, Luxembourg, Malaysia, Mexico, Netherlands, Norway, Portugal, Qatar, Romania, Saudi Arabia, Singapore, Slovakia, Spain, Sweden, Switzerland and the United Arab Emirates. Refer to Note (10) of the notes to condensed consolidated financial statements for further information regarding our reportable segments.

The following table presents a summary of the operating segment information for the third quarters of 2016 and 2015:  
(In thousands)
2016
 
% of Revenue
 
2015
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
1,055,037

 
100%
 
$
997,954

 
100%
 
6%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
161,625

 
15%
 
169,181

 
17%
 
(4)%
Operating expenses
446,704

 
42%
 
403,371

 
40%
 
11%
Total costs and expenses
608,329

 
58%
 
572,552

 
57%
 
6%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
446,708

 
42%

425,402

 
43%
 
5%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
129,520

 
100%
 
129,933

 
100%
 
—%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
21,345

 
16%
 
21,402

 
16%
 
—%
Operating expenses
60,430

 
47%
 
60,448

 
47%
 
—%
Total costs and expenses
81,775

 
63%
 
81,850

 
63%
 
—%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
47,745

 
37%
 
48,083

 
37%
 
(1)%
 
 
 
 
 
 
 
 
 
 
Other, net
(252,228
)
 
 
 
(258,131
)
 
 
 
(2)%
 
 
 
 
 
 
 
 
 
 
Consolidated operating earnings
$
242,225

 
 
 
$
215,354

 
 
 
12%
Domestic Segment
Revenues increased 6% to $1.1 billion in the third quarter of 2016 from $998 million in the same period of 2015. This increase was primarily driven by growth in services revenue.
Cost of revenues as a percent of revenues was 15% in the third quarter of 2016 compared to 17% in the same period of 2015. This lower cost of revenues as a percent of revenue was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue.
Operating expenses as a percent of revenues were 42% in the third quarter of 2016 compared to 40% in the same period of 2015. The increase as a percent of revenues reflects a higher mix of services during the quarter that was driven by services revenue growth.

Global Segment
Revenues were flat period-over-period at $130 million in the third quarter of both 2016 and 2015.

21


Cost of revenues as a percent of revenues was 16% in the third quarter of both 2016 and 2015.
Operating expenses as a percent of revenues were 47% in the third quarter of both 2016 and 2015.

Other, net
Operating results not attributed to an operating segment include expenses such as software development, general and administrative expenses, acquisition costs and related adjustments, share-based compensation expense, and certain amortization and depreciation. These expenses decreased 2% to $252 million in the third quarter of 2016 from $258 million in the same period of 2015. The decrease was primarily the result of expenses incurred in 2015 related to our voluntary separation plan and acquisition costs and related adjustments associated with our acquisition of the Cerner Health Services business of $4 million and $6 million, respectively.

Nine Months Ended October 1, 2016 Compared to Nine Months Ended October 3, 2015
The following table presents a summary of the operating information for the first nine months of 2016 and 2015:
(In thousands)
2016
% of
Revenue
 
2015
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
913,710

26
%
 
$
899,762

 
28
%
 
2
 %
Support and maintenance
761,165

22
%
 
728,546

 
22
%
 
4
 %
Services
1,800,309

51
%
 
1,566,529

 
48
%
 
15
 %
Reimbursed travel
63,470

2
%
 
55,136

 
2
%
 
15
 %
 
 
 
 
 
 
 
 
 
Total revenues
3,538,654

100