Summary of CERNER CORP /MO/

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" or the "Company"). This MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes to the financial statements ("Notes") found above.
Except for the historical information and discussions contained herein, statements contained in this Form 10-Q may constitute "forward looking statements" within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended (the "Act"). Forward-looking statements can often be identified by the use of forward-looking terminology, such as "could," "should," "will," "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast," "plan," "guidance" 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: 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; risks associated with our recruitment and retention of key personnel; risks related to our reliance on third party suppliers; risks inherent with business acquisitions; changing political, economic and regulatory influences; government regulation; significant competition and market changes; risks associated with the ongoing adverse financial market environment and uncertainty in global economic conditions; 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; the authority of our Board of Directors to issue preferred stock and anti-takeover provisions contained in our corporate governance documents; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in the Company's other filings with the Securities and Exchange Commission or in materials incorporated therein by reference. Forward looking statements are not guarantees of future performance or results. The Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.
Management Overview
Cerner primarily derives revenue by selling, implementing and supporting software solutions, clinical content, hardware, healthcare devices and services that give healthcare providers secure access to clinical, administrative and financial data in real time, allowing them to improve the quality, safety and efficiency in the delivery of healthcare. We implement the healthcare solutions as stand-alone, combined or enterprise-wide systems. Cerner Millennium® software solutions can be managed by the Company's clients or in the Company's data center via a managed services model.

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Cerner's fundamental strategy centers on creating organic growth by investing in research and development (R&D) to create solutions and services for the healthcare industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 15% or more. This growth has also created a very strategic footprint in healthcare, with Cerner® solutions licensed by over 8,000 facilities, including approximately 2,100 hospitals; 3,300 physician practices with over 30,000 physicians; 500 ambulatory facilities, such as laboratories, ambulatory centers, cardiac facilities, radiology clinics and surgery centers; 600 home health facilities; and 1,500 retail pharmacies. Selling additional solutions back into this client base is an important element of Cerner's future revenue growth. We are also focused on driving growth through market share expansion by replacing competitors in healthcare settings that are looking to replace their current healthcare information technology (HIT) partners or those who have not yet strategically aligned with a supplier. We also expect to drive growth through new initiatives that reflect our ongoing ability to innovate such as our CareAwareTM healthcare device architecture, HealtheSMemployer services, physician practice solutions and solutions and services for the pharmaceutical market. Finally, we are focused on selling our solutions and services outside of the U.S. Many non-U.S. markets have a low penetration of HIT solutions and their governing bodies are in many cases focused on HIT as part of their strategy to improve the quality and lower the cost of healthcare.
Beyond our strategy for driving revenue growth, Cerner is also focused on earnings growth. Similar to our history of growing revenue, our net earnings have increased at more than 20% compound annual rates over five- and ten-year periods. We believe we can continue driving strong levels of earnings growth by leveraging key areas to create operating margin expansion. The primary areas of opportunity for margin expansion include:
• becoming more efficient at implementing our software by leveraging implementation tools and methodologies we have developed;

• leveraging our investments in R&D by addressing new markets (i.e. non-U.S.) that do not require significant incremental R&D but can contribute significantly to revenue growth; and

• leveraging our scalable business infrastructure to reduce the rate of increase in general and administrative spending to below our revenue growth rate.

We are also focused on increasing cash flow by growing earnings, reducing the use of working capital and controlling capital expenditures. Results Overview
The Company delivered good levels of bookings, earnings and cash flows in the third quarter of 2009. New business bookings revenue, which reflects the value of executed contracts for software, hardware and services, was $424.3 million in the third quarter of 2009. Third quarter 2009 bookings increased 10.6% over third quarter 2008's bookings of $383.6 million. Revenues for the third quarter of 2009 decreased 3.1% to $409.4 million compared to $422.7 million in the year-ago quarter. The year-over-year decline in revenue in the third quarter is largely attributable to the challenging economic conditions, which led to a lower level of purchasing activity by the Company's existing and prospective clients.
Third quarter 2009 net earnings were $48.4 million and diluted earnings per share were $0.57. Third quarter 2008 net earnings were $45.0 million and diluted earnings per share were $0.54. Third quarter 2009 and 2008 net earnings and diluted earnings per share reflect the impact of shared-based compensation expense. Share-based compensation expense reduced third quarter 2009 net earnings and diluted earnings per share by $3.0 million and $0.04, respectively, and third quarter 2008 earnings and diluted earnings per share by $2.4 million and $0.03, respectively.
The growth in net earnings and diluted earnings per share was driven primarily by continued progress with the Company's margin expansion initiatives, including leveraging R&D investments and becoming more efficient at selling solutions and providing support and services to our clients. Our third quarter 2009 operating margin was 17.3%, which is 130 basis points higher than the year-ago quarter. We remain on target with our long-term goal of achieving 20% operating margins. The Company had solid cash collections of receivables of $410.6 million in the third quarter of 2009 compared to $436.1 million in the third quarter of 2008. Days sales outstanding (DSO) was 105 days, which is up five days

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compared to 100 days in the second quarter of 2009. The increase in DSO reflects slightly longer payment cycles by our client base related to the challenging global economy. This has not had a material impact on liquidity or cash flow, which remain strong. Operating cash flows for the third quarter of 2009 were strong at $73.4 million compared to $47.6 million in the third quarter of 2008. Healthcare Information Technology Market The turbulence in the worldwide economy has impacted almost all industries. While healthcare is not immune to economic cycles, we believe it is generally more resilient than most segments of the economy. The impact of the current economic conditions on our existing and prospective clients has been mixed. We continue to see some organizations doing fairly well operationally, but many are dealing with a reduction in their foundation investment portfolios caused by the general market decline. In addition, organizations with a large dependency on Medicaid populations are being impacted by the challenging financial condition of many state governments.
We believe the result of these challenges is that healthcare organizations are becoming more selective regarding where they invest capital, resulting in a focus on strategic spending that generates a return on their investment. In the current environment, many HIT solutions are often viewed as being more strategic to healthcare organizations than other possible purchases because the solutions can offer quick return on investment. HIT solutions also play an important role in healthcare by improving safety, efficiency and reducing cost. And we believe most healthcare providers also recognize that they must invest in HIT to meet current and future regulatory, compliance and government reimbursement requirements.
Overall, while the economy has certainly impacted and could continue to impact our business, we believe there are several macro trends that are good for the HIT industry. One example is the continued need to curb the growth of U.S. healthcare spending, which is estimated at more than $2 trillion or 17 percent of our Gross Domestic Product. In the U.S., politicians and policy makers agree that the current rate of growth of the cost of our healthcare system is unsustainable. Leaders of both political parties say the intelligent use of information systems will improve health outcomes and, correspondingly, drive down costs, citing a 2005 study by RAND Corp., which found that the widespread adoption of HIT in the U.S. could cut annual healthcare costs by $162 billion. Although policy experts have different opinions on the rates of HIT adoption and how quickly benefits can be realized, there seems to be consensus that HIT has the potential to contribute to significant cost savings.
Another positive for the U.S. healthcare and the HIT industry is the Obama administration's continuing pursuit of broad healthcare reform aimed at improving healthcare's systemic issues. The American Recovery and Reinvestment Act, which became law on February 17, 2009, includes more than $35 billion of incentives to help healthcare organizations modernize operations through the acquisition and wide-spread use of HIT. We believe our large footprint in hospitals and physician practices, together with our proven ability to deliver value, positions us well to benefit from these incentives.
It is also important to note that most other countries are also grappling with rising healthcare spending, safety concerns and inefficient care, a fact that creates a favorable international market for HIT solutions and related services. In summary, while the current economic environment has impacted our business, we believe the fundamental value proposition of HIT remains intact, and the HIT industry will likely benefit from the increased recognition by healthcare providers and governments that HIT contributes to safer and more efficient healthcare.

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Results of Operations
Three Months Ended October 3, 2009 Compared to Three Months Ended September 27, 2008.
The Company's net earnings increased 7.5% to $48.4 million in the third quarter of 2009 from $45.0 million for the same period in 2008. Third quarter 2009 and 2008 net earnings include the impact of share-based compensation expense, which reduced net earnings in the third quarter of 2009 and 2008 by $3.0 million, net of $1.7 million tax benefit, and $2.4 million, net of $1.4 million tax benefit, respectively.
Revenues decreased 3.1% to $409.4 million for the third quarter 2009 from $422.7 million for the same period in 2008. The revenue composition for the third quarter of 2009 was $118.3 million in system sales, $122.1 million in support and maintenance, $162.1 million in services and $6.9 million in reimbursed travel.
• System sales revenues decreased 14.0% to $118.3 million for the third quarter of 2009 from $137.5 million for the same period in 2008. Included in system sales are revenues from the sale of software, technology resale (hardware and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions. The decrease in system sales was driven by a decline in technology resale and software revenue, which has been pressured by the challenging economic conditions.

• Support, maintenance and services revenues increased 3.1% to $284.2 million during the third quarter of 2009 from $275.7 million during the same period in 2008. Included in support, maintenance and services revenues are support and maintenance of software and hardware, professional services excluding installation, and managed services. Below is a summary of support, maintenance and services revenues for the third quarters of 2009 and 2008.

                                                                   Three Months Ended        Three Months Ended
(In thousands)                                                      October 3, 2009          September 27, 2008

Support and maintenance revenues                                   $        122,067          $        118,185
Services revenues                                                           162,122                   157,517

Total support, maintenance and services revenues                   $        284,189          $        275,702

The $3.9 million, or 3.3%, increase in support and maintenance revenues is attributable to continued success at selling Cerner Millennium applications, implementing them at client sites, and initiating billing for support and maintenance fees. The $4.6 million, or 2.9%, increase in services revenue was attributable to an increase in managed services revenue, partially offset by a decline in professional services revenue. The decrease in professional services revenue is attributable to a lower level of billable headcount compared to the year-ago period and the challenging economic conditions.

• Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 15.0% in the third quarter of 2009 compared to the same period in 2008. This increase was driven by new business bookings exceeding revenue taken from those bookings during the past four quarters, including continued strong levels of managed services bookings that typically have longer contract terms. A summary of the Company's total backlog follows:

                                              As of                 As of
      (In thousands)                     October 3, 2009      September 27, 2008

      Contract backlog                   $     3,246,797      $       2,822,996
      Support and maintenance backlog            604,389                570,670

      Total backlog                      $     3,851,186      $       3,393,666

• The cost of revenues was 17.0% of total revenues in the third quarter of 2009 and 17.1% in the same period of 2008. The cost of revenues includes the cost of reimbursed travel expense, third party

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consulting services and subscription content, computer hardware and sublicensed software purchased from hardware and software 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, maintenance, support, services and reimbursed travel)
carrying different margin rates changes from period to period.

• Total operating expenses decreased 4.8% to $269.2 million in the third quarter of 2009, compared with $282.7 million for the same period in 2008. Share-based compensation expense recognized impacted expenses as indicated below:

                                           Three Months Ended      Three Months Ended
 (In thousands)                              October 3, 2009       September 27, 2008

 Sales and client service expenses          $         2,315         $         2,033
 Software development expense                         1,132                     830
 General and administrative expenses                  1,258                   1,017

 Total stock-based compensation expense     $         4,705         $         3,880

• Sales and client service expenses were $171.4 million, which as a percent of total revenues were 41.9% in the third quarter of 2009 as compared to $178.8 million and 42.3%, respectively, in the same period of 2008. Sales and client service expenses include salaries of sales and client service personnel, communications expenses, unreimbursed travel expenses, expense for share-based payment, sales and marketing salaries, depreciation on hardware used in the hosting business and trade show and advertising costs. The lower level of sales and client services expense is due primarily to a lower level of professional services expense in the third quarter of 2009 compared to 2008.

• Total expense for software development decreased 2.0% to $66.8 million for the third quarter of 2009 compared to $68.1 million for the same period in 2008. The decrease was primarily the result of ongoing efforts by the Company to control spending. The aggregate expenditures for software development are for continued development and enhancement of the Cerner Millennium platform and software solutions. A summary of the Company's total software development expense is as follows:

                                                                   Three Months Ended        Three Months Ended
(In thousands)                                                      October 3, 2009          September 27, 2008

Software development costs                                         $         69,940          $         71,966
Capitalized software costs                                                  (19,878 )                 (16,844 )
Capitalized costs related to share-based payments                              (232 )                    (227 )
Amortization of capitalized software costs                                   16,922                    13,197

Total software development expense                                 $         66,752          $         68,092

• General and administrative expenses were $31.1 million, which as a percent of total revenues were 7.6%, in the third quarter of 2009 as compared to $35.8 million and 8.5%, respectively, for the same period in 2008. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, transaction gains or losses on foreign currency and expense for share based payments. The Company realized a foreign currency gain of $0.03 million and a loss of $5.6 million during the three months ended October 3, 2009 and September 27, 2008, respectively.

Net interest income was $0.2 million in the third quarter of 2009 compared to net interest income of $0.4 million in the third quarter of 2008.
The Company's effective tax rate was 32% for the third quarter of 2009 and 34% for the third quarter of 2008. This decrease is primarily due to the decrease in the unrecognized tax benefits, partially offset by an additional tax

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expense recorded by the Company during the third quarter 2009 relating to adjustments from prior period tax returns. The impact to any one of these tax years was not material.
Operations by Segment
The Company has two operating segments, Domestic and Global. The following table presents a summary of the operating information for the third quarters of 2009 and 2008:

                                                        Operating Segments
   (In thousands)                       Domestic       Global        Other          Total
   Three months ended October 3, 2009
   Revenues                             $ 338,508     $ 70,907     $        -     $ 409,415


   Cost of revenues                        57,759       11,720              -        69,479
   Operating expenses                      90,093       32,658        146,475       269,226

   Total costs and expenses               147,852       44,378        146,475       338,705


   Operating earnings (loss)            $ 190,656     $ 26,529     $ (146,475 )   $  70,710




                                                         Operating Segments
 (In thousands)                          Domestic       Global        Other          Total
 Three months ended September 27, 2008
 Revenues                                $ 331,448     $ 91,280     $        -     $ 422,728


 Cost of revenues                           55,860       16,457              -        72,317
 Operating expenses                         89,948       39,260        153,452       282,660

 Total costs and expenses                  145,808       55,717        153,452       354,977


 Operating earnings (loss)               $ 185,640     $ 35,563     $ (153,452 )   $  67,751

Domestic Segment
The Company's Domestic segment includes revenue contributions and expenditures linked to business activity within the United States.
• Revenue increased 2.1% in the third quarter of 2009, compared to the same period in 2008. This increase was primarily driven by growth in managed services and support and maintenance, which was partially offset by a decrease in professional services.

• Cost of revenues was 17.1% of total Domestic revenue in the third quarter of 2009, compared to 16.9% in the same period in 2008.

• Operating expenses increased 0.2% for the third quarter of 2009, as compared to the same period in 2008.

• Operating earnings increased 2.7% for the third quarter of 2009, compared to the same period in 2008.

Global Segment
The Company's Global segment includes revenue contributions and expenditures linked to business activity in Aruba, Australia, Austria, Belgium, Canada, Cayman Islands, Chile, China (Hong Kong), Egypt, England, France, Germany, India, Ireland, Malaysia, Puerto Rico, Saudi Arabia, Singapore, Spain, Sweden, Switzerland, and the United Arab Emirates.

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• Revenues decreased 22.3% to $70.9 million in the third quarter of 2009 from $91.3 million in the same period in 2008. This decrease was driven by lower professional services, hardware and software revenue, which were all impacted by the challenging global economic conditions.

• Cost of revenues was 16.5% in the third quarter of 2009, compared with 18.0% in the same period of 2008. The lower cost of revenues in the third quarter of 2009 was driven by a decrease in global hardware sales.

• Operating expenses for the third quarter of 2009 decreased 16.8% compared to the same period in 2008, primarily due to a lower level of professional services expense.

• Operating earnings decreased 25.4% for the third quarter of 2009, compared to the same period in 2008. The decline in operating earnings was driven primarily by the lower software revenue in the third quarter of 2009 compared to 2008.

Other Segment
The Company's Other segment includes revenue and expenses which are not tracked by geographic segment.
Operating losses decreased by 4.5% in the third quarter of 2009 as compared to the same period in 2008. This decrease is primarily due to the foreign currency loss that increased expense in the third quarter of 2008 compared to a minimal gain in the third quarter of 2009.
Nine Months Ended October 3, 2009 Compared to Nine Months Ended September 27, 2008.
The Company's net earnings increased 13.5% to $133.0 million in the first nine months of 2009 from $117.1 million for the same period in 2008. The first nine months of 2009 and 2008 net earnings include the impact share-based compensation expense, which reduced net earnings in the first nine months of 2009 and 2008 by $7.7 million, net of $4.5 million tax benefit, and $6.8 million, net of $4.0 million tax benefit, respectively.
Revenues decreased 0.4% to $1,205.5 million in the first nine months of 2009 from $1,210.3 million for the same period in 2008. The revenue composition for the first nine months of 2009 was $332.8 million in system sales, $370.2 million in support and maintenance, $479.3 million in services and $23.3 million in reimbursed travel.
• System sales revenues decreased 11.1% to $332.8 million in the first nine months of 2009 from $374.4 million for the same period in 2008. Included in system sales are revenues from the sale of software, technology resale (hardware and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions. The decrease in system sales was driven by lower licensed software sales related to the impact of the challenging economic conditions on our end markets.

• Support, maintenance and services revenues increased 5.3% to $849.5 million during the first nine months of 2009 from $807.0 million during the same period in 2008. Included in support, maintenance and services revenues are support and maintenance of software and hardware, professional services excluding installation, and managed services. Below is a summary of support, maintenance and services revenues for the first nine months of 2009 and 2008.

                                                                   Nine Months Ended          Nine Months Ended
(In thousands)                                                      October 3, 2009          September 27, 2008

Support and maintenance revenues                                   $        370,210           $        335,791
Services revenues                                                           479,251                    471,175

Total support, maintenance and services revenues                   $        849,461           $        806,966

The $34.4 million, or 10.3%, increase in support and maintenance revenues is . . .