Table of Contents

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: April 2, 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 April 28, 2016
Common Stock, $0.01 par value per share
  
338,081,824 shares


Table of Contents

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
 



Table of Contents

Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of April 2, 2016 (unaudited) and January 2, 2016
(In thousands, except share data)
2016
 
2015
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
295,589

 
$
402,122

Short-term investments
207,860

 
111,059

Receivables, net
941,792

 
1,034,084

Inventory
22,579

 
15,788

Prepaid expenses and other
260,818

 
264,780

Total current assets
1,728,638

 
1,827,833

 
 
 
 
Property and equipment, net
1,366,479

 
1,309,214

Software development costs, net
605,931

 
562,559

Goodwill
849,490

 
799,182

Intangible assets, net
640,235

 
688,058

Long-term investments
203,268

 
173,073

Other assets
200,451

 
202,065

 
 
 
 
Total assets
$
5,594,492

 
$
5,561,984

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
209,388

 
$
215,510

Current installments of long-term debt and capital lease obligations
41,762

 
41,797

Deferred revenue
279,906

 
278,443

Accrued payroll and tax withholdings
191,105

 
184,225

Other accrued expenses
53,771

 
57,891

Total current liabilities
775,932

 
777,866

 
 
 
 
Long-term debt and capital lease obligations
553,680

 
563,353

Deferred income taxes and other liabilities
336,491

 
324,516

Deferred revenue
12,062

 
25,865

Total liabilities
1,678,165

 
1,691,600

 
 
 
 
Shareholders’ Equity:
 
 
 
Common stock, $.01 par value, 500,000,000 shares authorized, 351,077,433 shares issued at April 2, 2016 and 350,323,367 shares issued at January 2, 2016
3,511

 
3,503

Additional paid-in capital
1,112,743

 
1,075,782

Retained earnings
3,608,203

 
3,457,843

Treasury stock, 13,171,038 shares at April 2, 2016 and 10,364,691 shares at January 2, 2016
(740,446
)
 
(590,390
)
Accumulated other comprehensive loss, net
(67,684
)
 
(76,354
)
Total shareholders’ equity
3,916,327

 
3,870,384

 
 
 
 
Total liabilities and shareholders’ equity
$
5,594,492

 
$
5,561,984


See notes to condensed consolidated financial statements (unaudited).

1

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended April 2, 2016 and April 4, 2015
(unaudited)
 
 
Three Months Ended
(In thousands, except per share data)
2016
 
2015
 
 
 
 
Revenues:
 
 
 
System sales
$
279,354

 
$
259,569

Support, maintenance and services
839,638

 
718,370

Reimbursed travel
19,143

 
18,150

 
 
 
 
Total revenues
1,138,135

 
996,089

Costs and expenses:
 
 
 
Cost of system sales
89,225

 
91,499

Cost of support, maintenance and services
67,225

 
59,011

Cost of reimbursed travel
19,143

 
18,150

Sales and client service
501,827

 
420,182

Software development (Includes amortization of $32,614 and $29,089, respectively)
133,532

 
127,271

General and administrative
90,134

 
94,811

Amortization of acquisition-related intangibles
21,601

 
18,253

 
 
 
 
Total costs and expenses
922,687

 
829,177

 
 
 
 
Operating earnings
215,448

 
166,912

 
 
 
 
Other income, net
1,681

 
208

 
 
 
 
Earnings before income taxes
217,129

 
167,120

Income taxes
(66,769
)
 
(56,186
)
 
 
 
 
Net earnings
$
150,360

 
$
110,934

 
 
 
 
Basic earnings per share
$
0.44

 
$
0.32

Diluted earnings per share
$
0.43

 
$
0.32

Basic weighted average shares outstanding
339,518

 
343,216

Diluted weighted average shares outstanding
345,900

 
351,659

See notes to condensed consolidated financial statements (unaudited).


2

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended April 2, 2016 and April 4, 2015
(unaudited)
 
 
Three Months Ended
(In thousands)
2016
 
2015
 
 
 
 
Net earnings
$
150,360

 
$
110,934

Foreign currency translation adjustment and other (net of taxes (benefits) of $2,122 and $(1,366), respectively)
8,290

 
(18,510
)
Unrealized holding gain on available-for-sale investments (net of taxes of $233 and $245, respectively)
380

 
386

 
 
 
 
Comprehensive income
$
159,030

 
$
92,810


See notes to condensed consolidated financial statements (unaudited).


3

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended April 2, 2016 and April 4, 2015
(unaudited)
 
Three Months Ended
(In thousands)
2016
 
2015
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
150,360

 
$
110,934

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
119,126

 
100,445

Share-based compensation expense
17,811

 
15,161

Provision for deferred income taxes
7,978

 
4,498

Changes in assets and liabilities (net of businesses acquired):
 
 
 
Receivables, net
101,787

 
(71,575
)
Inventory
(8,452
)
 
7,676

Prepaid expenses and other
(4,751
)
 
(7,346
)
Accounts payable
(23,060
)
 
6,300

Accrued income taxes
2,498

 
(4,641
)
Deferred revenue
(32,309
)
 
30,138

Other accrued liabilities
(3,905
)
 
22,657

 
 
 
 
Net cash provided by operating activities
327,083

 
214,247

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(99,351
)
 
(82,264
)
Capitalized software development costs
(75,340
)
 
(63,067
)
Purchases of investments
(157,744
)
 
(87,411
)
Sales and maturities of investments
32,473

 
602,240

Purchase of other intangibles
(3,592
)
 
(3,296
)
Acquisition of businesses

 
(1,372,014
)
 
 
 
 
Net cash used in investing activities
(303,554
)
 
(1,005,812
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Long-term debt issuance

 
500,000

Proceeds from excess tax benefits from share-based compensation
8,703

 
34,939

Proceeds from exercise of options
10,421

 
19,037

Treasury stock purchases
(150,056
)
 

Other

 
(792
)
 
 
 
 
Net cash provided by (used in) financing activities
(130,932
)

553,184

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
870

 
(6,487
)
 
 
 
 
Net decrease in cash and cash equivalents
(106,533
)
 
(244,868
)
Cash and cash equivalents at beginning of period
402,122

 
635,203

 
 
 
 
Cash and cash equivalents at end of period
$
295,589

 
$
390,335

 
 
 
 
Summary of acquisition transactions:
 
 
 
Fair value of tangible assets acquired
$
(10,200
)
 
$
441,993

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

Fair value of goodwill
46,940

 
450,001

Less: Fair value of liabilities assumed
(11,740
)
 
(157,960
)
 
 
 
 
Net cash used
$

 
$
1,372,014

See notes to condensed consolidated financial statements (unaudited).

4

Table of Contents

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 2016 and 2015 first quarters ended on April 2, 2016 and April 4, 2015, respectively. All references to years in these notes to condensed consolidated financial statements represent the respective three months ended on such dates, unless otherwise noted.

Factors Impacting Comparability of Interim Financial Statements

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 three months ended April 2, 2016 , in relation to the three months ended April 4, 2015 , presented herein.

Amortization of Acquisition-related Intangibles. 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. Historically, such amounts were included in general and administrative expense in our condensed consolidated statements of operations. Effective for our second quarter of 2015, amortization of acquisition-related intangibles is presented on a separate line within our condensed consolidated statements of operations. While this reporting change did not impact our consolidated results, prior period reclassifications have been made to conform to the current period presentation.

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. At this time, we have not selected a transition method, nor have we determined if we will adopt early. We 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.

5



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.
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 condensed 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.
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. 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 2019-09 will have on our consolidated financial statements and related disclosures, and we have not determined if we will early adopt.

6


(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 three months ended April 2, 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 adjustment and other
 

 
3,368

 
3,368

Ending balance at April 2, 2016
 
$
782,664

 
$
66,826

 
$
849,490


The following table provides unaudited pro forma results of operations for the three months ended April 4, 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
 
$
1,089,769

Pro forma net earnings
 
114,333

Pro forma diluted earnings per share
 
0.33


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 three months ended April 4, 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 $17 million , respectively.

During the three months ended April 4, 2015 , we incurred $17 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.

7


(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 April 2, 2016 :
(In thousands)
 
 
 
 
 
 

 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
55,405

 
$

 
$

Time deposits
 
Cash equivalents
 

 
6,394

 

Government and corporate bonds
 
Cash equivalents
 

 
88

 

Time deposits
 
Short-term investments
 

 
30,700

 

Commercial paper
 
Short-term investments
 

 
9,987

 

Government and corporate bonds
 
Short-term investments
 

 
167,173

 

Government and corporate bonds
 
Long-term investments
 

 
186,229

 


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 April 2, 2016 and January 2, 2016 was approximately $524 million and $505 million , respectively. The carrying amount of such debt at both April 2, 2016 and January 2, 2016 was $500 million .
 

8


(4) Available-for-sale Investments

Available-for-sale investments at April 2, 2016 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
55,405

 
$

 
$

 
$
55,405

Time deposits
 
6,394

 

 

 
6,394

Government and corporate bonds
 
88

 

 

 
88

Total cash equivalents
 
61,887

 

 

 
61,887

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
30,700

 

 

 
30,700

Commercial paper
 
10,000

 

 
(13
)
 
9,987

Government and corporate bonds
 
167,215

 
48

 
(90
)
 
167,173

Total short-term investments
 
207,915

 
48

 
(103
)
 
207,860

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
186,201

 
134

 
(106
)
 
186,229

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
456,003


$
182


$
(209
)

$
455,976


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 $20 million during the three months ended April 2, 2016 , resulting in insignificant losses.


9


(5) Receivables

A summary of net receivables is as follows:
(In thousands)
April 2, 2016
 
January 2, 2016
 
 
 
 
Gross accounts receivable
$
941,915

 
$
1,043,069

Less: Allowance for doubtful accounts
40,023

 
48,119

 
 
 
 
Accounts receivable, net of allowance
901,892

 
994,950

 
 
 
 
Current portion of lease receivables
39,900

 
39,134

 
 
 
 
Total receivables, net
$
941,792

 
$
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 April 2, 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 April 2, 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 three months of 2016 and 2015 , we received total client cash collections of $1.3 billion and $981 million , 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 30.8% and 33.6% for the first three months of 2016 and 2015 , respectively. The decrease in the effective tax rate in 2016 is a result of the permanent reinstatement of the U.S. research and development tax credit in December 2015 and the favorability of net discrete items recorded in the first quarter of 2016 as compared to the first quarter of 2015.


10


(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
$
150,360

 
339,518

 
$
0.44

 
$
110,934

 
343,216

 
$
0.32

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

 
6,382

 
 
 

 
8,443

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
150,360

 
345,900

 
$
0.43

 
$
110,934

 
351,659

 
$
0.32


For the three months ended April 2, 2016 and April 4, 2015 , options to purchase 7.2 million and 1.0 million shares of common stock at per share prices ranging from $44.05 to $73.40 and $51.97 to $70.98 , respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.

(8) Share-Based Compensation and Equity

Stock Options

Options activity for the three months ended April 2, 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
886

 
53.96

 
 
 
 
Exercised
(802
)
 
13.56

 
 
 
 
Forfeited and expired
(127
)
 
51.11

 
 
 
 
Outstanding as of April 2, 2016
24,224

 
35.78

 
$
494,193

 
6.02
 
 
 
 
 
 
 
 
Exercisable as of April 2, 2016
13,436

 
$
20.87

 
$
447,627

 
4.36

The weighted-average assumptions used to estimate the fair value, under the Black-Scholes-Merton pricing model, of stock options granted during the three months ended April 2, 2016 were as follows:
Expected volatility (%)
 
29.4
%
Expected term (yrs)
 
7

Risk-free rate (%)
 
1.7
%
Fair value per option
 
$
18.14

As of April 2, 2016 , there was $153 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 3.16 years.

11


Non-vested Shares

Non-vested share activity for the three months ended April 2, 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
2

 
54.80

Vested
(25
)
 
65.48

Forfeited
(42
)
 
70.62

 
 
 
 
Outstanding as of April 2, 2016
492

 
$
58.14

As of April 2, 2016 , there was $12 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 2.07 years.

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
(In thousands)
2016
 
2015
 
 
 
 
Stock option and non-vested share compensation expense
$
17,811

 
$
15,161

Associate stock purchase plan expense
1,756

 
1,388

Amounts capitalized in software development costs, net of amortization
(201
)
 
(92
)
 
 
 
 
Amounts charged against earnings, before income tax benefit
$
19,366

 
$
16,457

 
 
 
 
Amount of related income tax benefit recognized in earnings
$
5,955

 
$
5,533


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 three months ended April 2, 2016 , we repurchased 2.8 million shares for consideration of $150 million . These shares were recorded as treasury stock and accounted for under the cost method. No repurchased shares have been retired. At April 2, 2016 , $150 million remains available for purchase 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.


12


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 or financial condition.

(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 months ended April 2, 2016 and April 4, 2015 :
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2016
 
 
 
 
 
 
 
Revenues
$
1,004,965

 
$
133,170

 
$

 
$
1,138,135

 
 
 
 
 
 
 
 
Cost of revenues
149,269

 
26,324

 

 
175,593

Operating expenses
425,559

 
58,871

 
262,664

 
747,094

Total costs and expenses
574,828

 
85,195


262,664

 
922,687

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
430,137

 
$
47,975

 
$
(262,664
)
 
$
215,448

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2015
 
 
 
 
 
 
 
Revenues
$
870,507

 
$
125,582

 
$

 
$
996,089

 
 
 
 
 
 
 
 
Cost of revenues
142,717

 
25,943

 

 
168,660

Operating expenses
361,086

 
50,571

 
248,860

 
660,517

Total costs and expenses
503,803

 
76,514

 
248,860

 
829,177

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
366,704

 
$
49,068

 
$
(248,860
)
 
$
166,912



13


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

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

Our 2016 and 2015 first quarters ended on April 2, 2016 and April 4, 2015 , respectively. All references to years in this MD&A represent the respective three 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 (formerly Siemens 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 restrict 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 future operating results, financial condition or business over time.

Management Overview
Our revenues are primarily derived by selling, implementing and supporting software solutions, clinical content, hardware, devices and services that give health care providers secure access to clinical, administrative and financial data in real 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

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strategic footprint in health care, with Cerner ® solutions in more than 20,000 facilities worldwide, including hospitals, physician 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 ITWorks SM 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 three months ended April 2, 2016 , in relation to the three months ended April 4, 2015 , presented herein.

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

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $1.2 billion in the first quarter of 2016 , which was flat compared to $1.2 billion in the first quarter of 2015 .

Revenues for the first quarter of 2016 increased 14% to $1.1 billion compared to $996 million in the first quarter of 2015 . The year-over-year increase in revenue reflects strong growth in services combined with the additional month of contributions from the Cerner Health Services business in the first quarter of 2016, as compared to the same period in 2015.

First quarter 2016 net earnings increased 36% to $150 million compared to $111 million in the first quarter of 2015 . Diluted earnings per share increased 34% to $0.43 compared to $0.32 in the first 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 expenses associated with the acquisition and integration of the Cerner Health Services business.

First quarter 2016 and 2015 net earnings and diluted earnings per share reflect the impact of stock-based compensation expense. The effect of these expenses reduced the first quarter 2016 net earnings and diluted earnings per share by $13 million and $0.04 , respectively, and the first quarter 2015 net earnings and diluted earnings per share by $11 million and $0.03 , respectively.

First quarter 2016 and 2015 net earnings and diluted earnings per share also reflect the impact of amortization of acquisition-related intangibles and acquisition costs and related adjustments, both associated with our acquisition and integration of the Cerner Health Services business. Amortization of acquisition-related intangibles related to the Cerner Health Services business reduced first quarter 2016 net earnings and diluted earnings per share by $13 million and $0.04, respectively; and first quarter 2015 net earnings and diluted earnings per share by $10 million and $0.03, respectively. Acquisition costs and related adjustments related to the Cerner Health Services business reduced first quarter 2016 net earnings and diluted

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earnings per share by $2 million and $0.01, respectively; and first quarter 2015 net earnings and diluted earnings per share by $17 million and $0.05, respectively.

We had cash collections of receivables of $1.3 billion in the first quarter of 2016 compared to $981 million in the first quarter of 2015 . Days sales outstanding was 76 days for the first quarter of 2016 , compared to 80 days in the 2015 fourth quarter and 79 days for the 2015 first quarter. Operating cash flows for the first quarter of 2016 were $327 million compared to $214 million in the first quarter of 2015 .




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Results of Operations
Three Months Ended April 2, 2016 Compared to Three Months Ended April 4, 2015
The following table presents a summary of the operating information for the first quarters of 2016 and 2015 :
(In thousands)
2016
 
% of
Revenue
 
2015
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
 
System sales
$
279,354

 
25
%
 
$
259,569

 
26
%
 
8
 %
Support and maintenance
250,911

 
22
%
 
228,765

 
23
%
 
10
 %
Services
588,727

 
52
%
 
489,605

 
49
%
 
20
 %
Reimbursed travel
19,143

 
2
%
 
18,150

 
2
%
 
5
 %
 
 
 
 
 
 
 
 
 
 
Total revenues
1,138,135

 
100
%
 
996,089

 
100
%
 
14
 %
 
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
 
Costs of revenue
175,593

 
15
%
 
168,660

 
17
%
 
4
 %
 
 
 
 
 
 
 
 
 
 
Total margin
962,542

 
85
%
 
827,429

 
83
%
 
16
 %
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
Sales and client service
501,827

 
44
%
 
420,182

 
42
%
 
19
 %
Software development
133,532

 
12
%
 
127,271

 
13
%
 
5
 %
General and administrative
90,134

 
8
%
 
94,811

 
10
%
 
(5
)%
Amortization of acquired-related intangibles
21,601

 
2
%
 
18,253

 
2
%
 
18
 %
 
 
 
 
 
 
 
 
 
 
Total operating expenses
747,094

 
66
%
 
660,517

 
66
%
 
13
 %
 
 
 
 
 
 
 
 
 
 
Total costs and expenses
922,687

 
81
%
 
829,177

 
83
%
 
11
 %
 
 
 
 
 
 
 
 
 
 
Operating earnings
215,448

 
19
%
 
166,912

 
17
%
 
29
 %
 
 
 
 
 
 
 
 
 
 
Other income, net
1,681

 
 
 
208

 
 
 
 
Income taxes
(66,769
)
 
 
 
(56,186
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
150,360

 
 
 
$
110,934

 
 
 
36
 %
Revenues & Backlog
Revenues increased 14% to $1.1 billion in the first quarter of 2016 , as compared to $996 million in the first 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, increased 8% to $279 million in the first quarter of 2016 from $260 million for the same period in 2015 . The increase in system sales was primarily driven by the additional month of contributions from the Cerner Health Services business in the first quarter of 2016 as compared to the same period in 2015.
Support and maintenance revenues increased 10% to $251 million in the first quarter of 2016 compared to $229 million during the same period in 2015 . This increase was primarily driven by the additional month of contributions from the Cerner Health Services business in the first quarter of 2016 as compared to the same period in 2015.
Services revenue, which includes professional services, excluding installation, and managed services, increased 20% to $589 million in the first quarter of 2016 from $490 million for the same period in 2015 . This increase was driven by growth in managed services of $40 million, primarily as a result of continued demand for our hosting services, and an increase in professional services of $59 million, primarily due to growth in implementation and consulting activities.
Revenue backlog, which reflects contracted revenue that has not yet been recognized as revenue, increased 12% to $14.6 billion in the first quarter of 2016 compared to $13.0 billion for the same period in 2015 . This increase was driven by growth

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in new business bookings during the past four quarters, including continued strong levels of managed services, Cerner ITWorks and Cerner revenue cycle services bookings that typically have longer contract terms.
Costs of Revenue
Cost of revenues as a percentage of total revenues was 15% in the first quarter of 2016 , compared to 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 13% to $747 million in the first quarter of 2016 , compared with $661 million in the first quarter of 2015 .
 
Sales and client service expenses as a percent of total revenues were 44% in first quarter of 2016 compared to 42% in the same period of 2015 . These expenses increased 19% to $502 million in the first quarter of 2016 , from $420 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 revenue reflects a higher mix of services during the quarter that was driven by strong services revenue growth.
Software development expenses as a percent of revenue were 12% in the first quarter of 2016 , compared to 13% in the same period of 2015 . Expenditures for software development include ongoing development and enhancement of the Cerner Millennium ® and HealtheIntent™ 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 first quarters of 2016 and 2015 is as follows:
 
Three Months Ended
(In thousands)
2016
 
2015
 
 
 
 
Software development costs
$
176,258

 
$
161,249

Capitalized software costs
(74,612
)
 
(62,524
)
Capitalized costs related to share-based payments
(728
)
 
(543
)
Amortization of capitalized software costs
32,614

 
29,089

 
 
 
 
Total software development expense
$
133,532

 
$
127,271

 
General and administrative expenses as a percent of total revenues were 8% in the first quarter of 2016 , compared to 10% in the same period of 2015 . These expenses decreased 5% to $90 million in the first quarter of 2016 , from $95 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 driven by a decline in expenses associated with the acquisition and integration of the Cerner Health Services business.

Amortization of acquisition-related intangibles increased 18% to $22 million in the first quarter of 2016 , compared to $18 million in 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 increase was primarily driven by the additional month of amortization on intangibles recorded in connection with the acquisition of the Cerner Health Services business, as compared to the same period in 2015.

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Non-Operating Items
 
Other income was $2 million in the first quarter of 2016 and less than $1 million in the first quarter of 2015 .

Our effective tax rate was 30.8% for the first quarter of 2016 and 33.6% for the first quarter of 2015 . The decrease in the effective tax rate in 2016 is a result of the permanent reinstatement of the U.S. research and development tax credit in December 2015 and the favorability of net discrete items recorded in the first quarter of 2016 as compared to the first quarter of 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, 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 our operating segment information for the first quarters of 2016 and 2015 :  
(In thousands)
2016
 
% of Revenue
 
2015
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
1,004,965

 
100%
 
$
870,507

 
100%
 
15%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
149,269

 
15%
 
142,717

 
16%
 
5%
Operating expenses
425,559

 
42%
 
361,086

 
41%
 
18%
Total costs and expenses
574,828

 
57%
 
503,803

 
58%
 
14%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
430,137

 
43%

366,704

 
42%
 
17%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
133,170

 
100%
 
125,582

 
100%
 
6%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
26,324

 
20%
 
25,943

 
21%
 
1%
Operating expenses
58,871

 
44%
 
50,571

 
40%
 
16%
Total costs and expenses
85,195

 
64%
 
76,514

 
61%
 
11%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
47,975

 
36%
 
49,068

 
39%
 
(2)%
 
 
 
 
 
 
 
 
 
 
Other, net
(262,664
)
 
 
 
(248,860
)
 
 
 
6%
 
 
 
 
 
 
 
 
 
 
Consolidated operating earnings
$
215,448

 
 
 
$
166,912

 
 
 
29%
Domestic Segment
Revenues increased 15% to $1.0 billion in the first quarter of 2016 from $871 million in the same period of 2015 . This increase was primarily driven by growth in managed services of $42 million, primarily as a result of continued demand for our hosting services, and an increase in professional services of $52 million, primarily due to growth in implementation and consulting activities.
Cost of revenues was 15% of revenues in the first quarter of 2016 , compared to 16% of revenues in the same period of 2015 . The lower cost of revenues as a percent of revenue was driven by a lower mix of technology resale, which carries a higher cost of revenue.
Operating expenses were 42% of revenues in the first quarter of 2016 , compared to 41% of revenues in the same period of 2015 . The increase as a percent of revenue was primarily attributable to an increase in costs related to our managed services and professional services offerings, consistent with the higher mix of services revenue in the first quarter of 2016, compared to the same period in 2015.

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Global Segment
Revenues increased 6% to $133 million in the first quarter of 2016 from $126 million in the same period of 2015 . The increase was primarily driven by the additional month of contributions from the Cerner Health Services business in the first quarter of 2016 as compared to the same period in 2015.
Cost of revenues was 20% of revenues in the first quarter of 2016 , compared to 21% of revenues in the same period of 2015 . The lower cost of revenues as a percent of revenue was driven by a lower mix of technology resale, which carries a higher cost of revenue.
Operating expenses were $59 million in the first quarter of 2016 , compared to $51 million in the same period of 2015 . The increase was primarily driven by the additional month of expenses from the Cerner Health Services business in the first quarter of 2016 as compared to the same period in 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 increased 6% to $263 million in the first quarter of 2016 from $249 million in the same period of 2015 . The increase is primarily due to the additional month of corporate and development personnel expenses from the Cerner Health Services business in the first quarter of 2016 as compared to the same period in 2015. This is partially offset by a $23 million decline in expenses associated with the acquisition and integration of the Cerner Health Services business.


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Liquidity and Capital Resources
Our liquidity is influenced by many factors, including the amount and timing of our revenues, our cash collections from our clients and the amount we invest in software development, acquisitions and capital expenditures.
Our principal sources of liquidity are our cash, cash equivalents, which primarily consist of money market funds and time deposits with original maturities of less than 90 days, and short-term investments. At April 2, 2016 , we had cash and cash equivalents of $296 million and short-term investments of $208 million , as compared to cash and cash equivalents of $402 million and short-term investments of $111 million at January 2, 2016 .
The non-U.S. subsidiaries for which we have elected to indefinitely reinvest earnings outside of the U.S. held approximately 34% of our aggregate cash, cash equivalents, and short-term investments at April 2, 2016 . As part of our current business strategy, we plan to indefinitely reinvest the earnings of these foreign operations; however, should the earnings of these foreign operations be repatriated, we would accrue and pay tax on such earnings, which may be material.

We maintain a $100 million multi-year revolving credit facility, which expires in October 2020. The facility provides an unsecured revolving line of credit for working capital purposes, which includes a letter of credit facility. We have the ability to increase the maximum capacity to $200 million at any time during the facility's term, subject to lender participation. As of April 2, 2016 , we had no outstanding borrowings under this facility; however, we had $18 million of outstanding letters of credit, which reduced our available borrowing capacity to $82 million .

We believe that our present cash position, together with cash generated from operations, short-term investments and, if necessary, our available line of credit, will be sufficient to meet anticipated cash requirements during 2016 .
The following table summarizes our cash flows in the first three months of 2016 and 2015 :
 
Three Months Ended
(In thousands)
2016
 
2015
 
 
 
 
Cash flows from operating activities
$
327,083

 
$
214,247

Cash flows from investing activities
(303,554
)
 
(1,005,812
)
Cash flows from financing activities
(130,932
)
 
553,184

Effect of exchange rate changes on cash
870

 
(6,487
)
Total change in cash and cash equivalents
(106,533
)
 
(244,868
)
 
 
 
 
Cash and cash equivalents at beginning of period
402,122

 
635,203

 
 
 
 
Cash and cash equivalents at end of period
$
295,589

 
$
390,335

 
 
 
 
Free cash flow (non-GAAP)
$
152,392

 
$
68,916


Cash from Operating Activities
 
Three Months Ended
(In thousands)
2016
 
2015
 
 
 
 
Cash collections from clients
$
1,257,886

 
$
981,202

Cash paid to employees and suppliers and other
(880,542
)
 
(762,506
)
Cash paid for interest
(8,243
)
 
(983
)
Cash paid for taxes, net of refunds
(42,018
)
 
(3,466
)
 
 
 
 
Total cash from operations
$
327,083

 
$
214,247

Cash flow from operations increased $113 million in the first quarter of 2016 when compared to the same period of 2015 due to an increase in cash impacting earnings, along with an increase in cash from working capital reductions. During the first quarter of 2016 and 2015 , we received total client cash collections of $1.3 billion and $981 million , respectively. Days sales outstanding was 76 days in the first quarter of 2016 , compared to 80 days for the 2015 fourth quarter and 79 days for the 2015 first quarter. Revenues provided under support and maintenance agreements represent recurring cash flows. We expect these revenues to continue to grow as the base of our installed systems grows.

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Cash from Investing Activities
 
Three Months Ended
(In thousands)
2016
 
2015
 
 
 
 
Capital purchases
$
(99,351
)
 
$
(82,264
)
Capitalized software development costs
(75,340
)
 
(63,067
)
Purchases of investments, net of sales and maturities
(125,271
)
 
514,829

Purchases of other intangibles
(3,592
)
 
(3,296
)
Acquisition of businesses

 
(1,372,014
)
 
 
 
 
Total cash flows from investing activities
$
(303,554
)
 
$
(1,005,812
)
Cash flows from investing activities consist primarily of capital spending, short-term investment, and acquisition activities.

Our capital spending in the first quarter of 2016 was driven by capitalized equipment purchases primarily to support growth in our CernerWorks SM managed services business, investments in a cloud infrastructure to support cloud-based solutions, building and improvement purchases to support our facilities requirements and capitalized spending to support our ongoing software development initiatives. Capital spending in 2016 is expected to remain elevated as we continue our current capital and software development initiatives, including the construction of our Trails Campus (office space development located in Kansas City, Missouri).
Short-term investment activity historically consists of the investment of cash generated by our business in excess of what is necessary to fund operations. In the first quarter of 2015 we had a net cash inflow from investments due to the use of proceeds from investment sales and maturities to partially fund our February 2, 2015 acquisition of the Cerner Health Services business. In the first quarter of 2016, we returned to net purchases of investments, which we expect to continue in subsequent periods, as we expect strong levels of cash flow.

On February 2, 2015, we acquired the Cerner Health Services business, and paid cash consideration of $1.37 billion in the first quarter of 2015. We used a combination of cash on hand and proceeds from the maturities of investments to fund the acquisition. We expect to continue seeking and completing strategic business acquisitions that are complementary to our business. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding acquisition of the Cerner Health Services business.

Cash from Financing Activities
 
Three Months Ended
(In thousands)
2016
 
2015
 
 
 
 
Long-term debt issuance
$

 
$
500,000

Cash from option exercises (including excess tax benefits)
19,124

 
53,976

Treasury stock purchases
(150,056
)
 

Other, net

 
(792
)
 
 
 
 
Total cash flows from financing activities
$
(130,932
)
 
$
553,184

In January 2015, we issued $500 million in aggregate principal amount of Senior Notes. Proceeds from the Senior Notes are available for general corporate purposes. We do not expect to issue additional long-term debt in 2016 .

Cash inflows from stock option exercises are dependent on a number of factors, including the price of our common stock, grant activity under our stock option and equity plans, and overall market volatility. We expect cash inflows from stock option exercises to continue throughout 2016 based on the number of exercisable options as of April 2, 2016 and our current stock price.
During the first quarter of 2016, we repurchased 2.8 million shares of our common stock for total consideration of $150 million. As of April 2, 2016 , $150 million remains available for repurchase under the program. We may continue to repurchase shares under this program in 2016 , which will be dependent on a number of factors, including the price of our common stock. Refer to Note (8) of the notes to condensed consolidated financial statements for further information regarding our share repurchase program.


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Table of Contents

Free Cash Flow
 
 
Three Months Ended
(In thousands)
 
2016
 
2015
 
 
 
 
 
Cash flows from operating activities (GAAP)
 
$
327,083

 
$
214,247

Capital purchases
 
(99,351
)
 
(82,264
)
Capitalized software development costs
 
(75,340
)
 
(63,067
)
 
 
 
 
 
Free cash flow (non-GAAP)
$
83,476

$
152,392

 
$
68,916


Free cash flow increased $83 million in the first quarter of 2016 compared to the same period in 2015 . This increase is primarily due to increased cash from operations, partially offset by both capital spending to support our growth initiatives and facilities requirements, and increased capitalized spending to support our ongoing software development initiatives. We believe our free cash flow levels reflect continued strength in our earnings. Free cash flow is a non-GAAP financial measure used by management along with GAAP results to analyze our earnings quality and overall cash generation of the business. We define free cash flow as cash flows from operations reduced by capital purchases and capitalized software development costs. The table above sets forth a reconciliation of free cash flow to cash flows from operating activities, which we believe to be the GAAP financial measure most directly comparable to free cash flow. The presentation of free cash flow is not meant to be considered in isolation, nor as a substitute for, or superior to, GAAP results, and investors should be aware that non-GAAP measures have inherent limitations and should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP. Free cash flow may also be different from similar non-GAAP financial measures used by other companies and may not be comparable to similarly titled captions of other companies due to potential inconsistencies in the method of calculation. We believe free cash flow is important to enable investors to better understand and evaluate our ongoing operating results and allows for greater transparency in the review of our overall financial, operational and economic performance, because free cash flow takes into account the capital expenditures necessary to operate our business.


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Table of Contents

Item 3. Quantitative and Qualitative Disclosures about Market Risk

No material changes.

Item 4. Controls and Procedures

a)
Evaluation of Disclosure Controls and Procedures.

The Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report on Form 10-Q (the Evaluation Date). They have concluded that, as of the Evaluation Date, these disclosure controls and procedures were effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities and would be disclosed on a timely basis. The CEO and CFO have concluded that the Company’s disclosure controls and procedures are designed, and are effective, to give reasonable assurance that the information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the rules and forms of the SEC. They have also concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that are filed or submitted under the Exchange Act are accumulated and communicated to the Company’s management to allow timely decisions regarding required disclosure.

b)
Changes in Internal Control over Financial Reporting.

On February 2, 2015, we acquired Siemens Health Services, as further described in Note (2) of the notes to condensed consolidated financial statements. We continue to integrate policies, processes, people, technology and operations for our combined operations, and we will continue to evaluate the impact of any related changes to internal control over financial reporting during this 2016 fiscal year. Except for any changes in internal controls related to the integration of the Siemens Health Services business into Cerner, there were no other changes in the Company’s internal controls over financial reporting during the three months ended April 2, 2016 , that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

c)
Limitations on Controls.

The Company’s management, including its CEO and CFO, has concluded that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at that reasonable assurance level. However, the Company’s management can provide no assurance that our disclosure controls and procedures or our internal control over financial reporting can prevent all errors and all fraud under all circumstances. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been or will be detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.


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Table of Contents

Part II. Other Information

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(c) Issuer Purchases of Equity Securities

The table below provides information with respect to Common Stock purchases by the Company during the first fiscal quarter of 2016 .
 
 
Total Number of Shares Purchased (a)
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (b)
 
Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (b)
Period
 
 
 
 
January 3, 2016 - January 30, 2016
 

 
$

 

 
$

January 31, 2016 - February 27, 2016
 
982

 
57.62