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: March 31, 2018
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
CERNERLOGOSMALLA03.JPG
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) 221-1024
(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, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]    Accelerated filer [  ]    Non-accelerated filer [  ] (do not check if smaller reporting company)    Smaller reporting company [  ] Emerging growth company [  ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. [ ]
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 26, 2018
Common Stock, $0.01 par value per share
  
331,814,218 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 March 31, 2018 (unaudited) and December 30, 2017
(In thousands, except share data)
2018
 
2017
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
413,399

 
$
370,923

Short-term investments
507,965

 
434,844

Receivables, net
1,040,741

 
1,042,781

Inventory
14,301

 
15,749

Prepaid expenses and other
388,809

 
515,930

Total current assets
2,365,215

 
2,380,227

 
 
 
 
Property and equipment, net
1,600,876

 
1,603,319

Software development costs, net
847,984

 
822,159

Goodwill
853,834

 
853,005

Intangible assets, net
460,564

 
479,753

Long-term investments
172,007

 
196,837

Other assets
211,158

 
134,011

 
 
 
 
Total assets
$
6,511,638

 
$
6,469,311

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
210,046

 
$
218,996

Current installments of long-term debt and capital lease obligations
6,804

 
11,585

Deferred revenue
311,015

 
311,337

Accrued payroll and tax withholdings
211,716

 
183,770

Other accrued expenses
63,361

 
63,907

Total current liabilities
802,942

 
789,595

 
 
 
 
Long-term debt and capital lease obligations
438,773

 
515,130

Deferred income taxes and other liabilities
362,538

 
365,674

Deferred revenue
6,891

 
13,564

Total liabilities
1,611,144

 
1,683,963

 
 
 
 
Shareholders' Equity:
 
 
 
Common stock, $.01 par value, 500,000,000 shares authorized, 359,872,263 shares issued at March 31, 2018 and 359,204,864 shares issued at December 30, 2017
3,599

 
3,592

Additional paid-in capital
1,413,637

 
1,380,371

Retained earnings
5,106,467

 
4,938,866

Treasury stock, 28,134,161 shares at March 31, 2018 and 26,743,517 shares at December 30, 2017
(1,551,723
)
 
(1,464,099
)
Accumulated other comprehensive loss, net
(71,486
)
 
(73,382
)
Total shareholders' equity
4,900,494

 
4,785,348

 
 
 
 
Total liabilities and shareholders' equity
$
6,511,638

 
$
6,469,311


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 March 31, 2018 and April 1, 2017
(unaudited)
 
 
Three Months Ended
(In thousands, except per share data)
2018
 
2017
 
 
 
 
Revenues
$
1,292,861

 
$
1,260,486

Costs and expenses:
 
 
 
Costs of revenue
231,278

 
198,993

Sales and client service
589,948

 
560,200

Software development (Includes amortization of $50,001 and $40,561, respectively)
161,617

 
145,901

General and administrative
92,294

 
88,392

Amortization of acquisition-related intangibles
22,509

 
22,874

 
 
 
 
Total costs and expenses
1,097,646

 
1,016,360

 
 
 
 
Operating earnings
195,215

 
244,126

 
 
 
 
Other income (expense), net
4,864

 
(1,116
)
 
 
 
 
Earnings before income taxes
200,079

 
243,010

Income taxes
(40,078
)
 
(69,797
)
 
 
 
 
Net earnings
$
160,001

 
$
173,213

 
 
 
 
Basic earnings per share
$
0.48

 
$
0.52

Diluted earnings per share
$
0.48

 
$
0.52

Basic weighted average shares outstanding
332,395

 
329,973

Diluted weighted average shares outstanding
336,534

 
336,190

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 March 31, 2018 and April 1, 2017
(unaudited)
 
 
Three Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Net earnings
$
160,001

 
$
173,213

Foreign currency translation adjustment and other (net of taxes of $920 and $187, respectively)
2,794

 
10,405

Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $(293) and $68, respectively)
(898
)
 
111

 
 
 
 
Comprehensive income
$
161,897

 
$
183,729


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 March 31, 2018 and April 1, 2017
(unaudited)
 
Three Months Ended
(In thousands)
2018
 
2017
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
160,001

 
$
173,213

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
152,592

 
134,833

Share-based compensation expense
24,935

 
17,500

Provision for deferred income taxes
(3,047
)
 
11,214

Changes in assets and liabilities:
 
 
 
Receivables, net
(70,608
)
 
(34,236
)
Inventory
1,445

 
(4,266
)
Prepaid expenses and other
125,550

 
27,270

Accounts payable
7,608

 
(21,908
)
Accrued income taxes
7,195

 
768

Deferred revenue
(7,205
)
 
24,269

Other accrued liabilities
10,499

 
(25,072
)
 
 
 
 
Net cash provided by operating activities
408,965

 
303,585

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(79,711
)
 
(88,065
)
Capitalized software development costs
(73,602
)
 
(71,092
)
Purchases of investments
(151,387
)
 
(53,340
)
Sales and maturities of investments
101,674

 
115,030

Purchase of other intangibles
(8,472
)
 
(6,385
)
 
 
 
 
Net cash used in investing activities
(211,498
)
 
(103,852
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of long-term debt
(75,000
)
 

Proceeds from exercises of stock options

10,036

 
10,683

Payments to taxing authorities in connection with shares directly withheld from associates

(1,723
)
 
(5,314
)
Treasury stock purchases
(87,624
)
 

Contingent consideration payments for acquisition of businesses

 
(1,000
)
 
 
 
 
Net cash provided by (used in) financing activities
(154,311
)

4,369

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(680
)
 
3,489

 
 
 
 
Net increase in cash and cash equivalents
42,476

 
207,591

Cash and cash equivalents at beginning of period
370,923

 
170,861

 
 
 
 
Cash and cash equivalents at end of period
$
413,399

 
$
378,452

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 first fiscal quarter ends on the Saturday closest to March 31. The 2018 and 2017 first quarters ended on March 31, 2018 and April 1, 2017, 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.

Supplemental Disclosures of Cash Flow Information
 
 
 
Three Months Ended
(In thousands)
 
 
2018
 
2017
Cash paid during the period for:
 
 
 
 
 
Interest (including amounts capitalized of $2,811 and $3,074, respectively)
 
 
$
8,199

 
$
8,347

Income taxes, net of refunds
 
 
(97,506
)
 
40,224


Accounting Pronouncements Adopted in 2018

Revenue Recognition. In the first quarter of 2018, we adopted new revenue guidance. Refer to Note (2) for further details.

Financial Instruments . In January 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities , which was subsequently amended in February 2018 by ASU 2018-03, Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . This new guidance addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments . Such guidance impacts how we account for our investments reported under the cost method of accounting as follows:

Equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are required to be measured at fair value with changes in fair value recognized in net earnings. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.


5


The impairment assessment of equity investments without readily determinable fair values will require a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value.
We adopted this new guidance effective for our first quarter of 2018. Provisions within the guidance applicable to the Company were required to be applied prospectively. The adoption of such guidance did not have a material impact on our condensed consolidated financial statements and related disclosures.
Recently Issued Accounting Pronouncements

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

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

Callable Debt Securities. In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities , which shortens the amortization period for certain investments in callable debt securities purchased at a premium by requiring the premium be amortized to the earliest call date. Such guidance will impact how premiums are amortized on our available-for-sale investments. ASU 2017-08 is effective for the Company in the first quarter of 2019, with early adoption permitted. The standard requires the use of the modified retrospective (cumulative effect) transition approach. We are currently evaluating the effect that ASU 2017-08 will have on our consolidated financial statements and related disclosures, and we have not determined if we will early adopt .

Accumulated Other Comprehensive Income. In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income , which allows a reclassification from accumulated other comprehensive income ("AOCI") to retained earnings for "stranded tax effects" resulting from certain U.S. tax reform enacted in December 2017. Such "stranded tax effects" were created when deferred tax assets and liabilities related to items in AOCI were remeasured at the lower U.S. corporate tax rate in the period of enactment. ASU 2018-02 is effective for the Company in the first quarter of 2019, with early adoption permitted. The guidance in this ASU is to be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. corporate tax rate was recognized. We are currently evaluating the effect that ASU 2018-02 will have on our consolidated financial statements and related disclosures, and we have not determined if we will early adopt .

6


(2) Revenue Recognition

In May 2014, the FASB issued ASU 2014-09 , Revenue from Contracts with Customers (Topic 606) , 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 replaced most existing revenue recognition guidance in U.S. GAAP. The new standard introduces a five-step process to be followed in determining the amount and timing of revenue recognition. It also provides guidance on accounting for costs incurred to obtain or fulfill contracts with customers, and establishes disclosure requirements which are more extensive than those required under prior U.S. GAAP .

ASU 2014-09, as amended ("Topic 606"), was effective for the Company in the first quarter of 2018. We selected the modified retrospective (cumulative effect) transition method of adoption. Such method provides that the cumulative effect from prior periods upon applying the new guidance to contracts which were not complete as of the adoption date, be recognized in our condensed consolidated balance sheets as of December 31, 2017, including an adjustment to retained earnings . A summary of such cumulative effect adjustment is as follows:

(In thousands)
 
 
Increase /
(Decrease)
 
 
 
 
Receivables, net
 
 
$
(79,492
)
Prepaid expenses and other
 
 
(2,253
)
Other assets
 
 
81,157

Accounts payable
 
 
(9,361
)
Deferred income taxes and other liabilities
 
 
1,173

Retained earnings
 
 
7,600


Prior periods were not retrospectively adjusted. The impact of applying Topic 606 (versus prior U.S. GAAP) increased revenues by $43 million and decreased earnings before income taxes by $2 million for the three months ended March 31, 2018 . The impact of applying Topic 606 (versus prior U.S. GAAP) did not have a significant impact on other line items in our condensed consolidated statement of operations, statement of comprehensive income, and statement of cash flows for the three months ended March 31, 2018 . Additionally, the impact of applying Topic 606 did not have a significant impact on our condensed consolidated balance sheet as of March 31, 2018 .

Revenue Recognition Policy

We enter into contracts with customers that may include various combinations of our software solutions and related services, which are generally capable of being distinct and accounted for as separate performance obligations. The predominant model of customer procurement involves multiple deliverables and includes a software license agreement, project-related implementation and consulting services, software support, hosting services, and computer hardware. We allocate revenues to each performance obligation within an arrangement based on estimated relative stand-alone selling price. Revenue is then recognized for each performance obligation upon transfer of control of the software solution or services to the customer in an amount that reflects the consideration we expect to receive.

Generally, we recognize revenue under Topic 606 for each of our performance obligations as follows:

Perpetual software licenses - We recognize perpetual software license revenues when control of such licenses are transferred to the client ("point in time"). We determine the amount of consideration allocated to this performance obligation using the residual approach .

Software as a service - We recognize software as a service ratably over the related hosting period ("over time") .

Time-based software and content license fees - We recognize a license component of time-based software and content license fees upon delivery to the client ("point in time") and a non-license component (i.e. support) ratably over the respective contract term ("over time") .

Hosting - Remote hosting recurring services are recognized ratably over the hosting service period ("over time"). Certain of our hosting arrangements contain fees deemed to be a "material right" under Topic 606. We recognize

7


such fees over the term that will likely affect the client's decision about whether to renew the related hosting service ("over time") .

Services - We recognize revenue for fixed fee services arrangements over time, utilizing a labor hours input method. For fee-for service arrangements, we recognize revenue over time as hours are worked at the rates clients are invoiced, utilizing the "as invoiced" practical expedient available in Topic 606. For stand-ready services arrangements, we recognize revenue ratably over the related service period .

Support and maintenance - We recognize support and maintenance fees ratably over the related contract period ("over time") .

Hardware - We recognize hardware revenues when control of such hardware/devices is transferred to the client ("point in time") .

Transaction processing - We recognize transaction processing revenues ratably as we provide such services ("over time") .

Such revenues are recognized net of any taxes collected from customers and subsequently remitted to governmental authorities.

Disaggregation of Revenue

The following table presents revenues disaggregated by our business models:

 
Three Months Ended
 
2018
 
2017 (1)
(In thousands)
Domestic
Segment
Global
Segment
Total
 
Domestic
Segment
Global
Segment
Total
 
 
 
 
 
 
 
 
Licensed software
$
124,094

$
10,725

$
134,819

 
$
132,532

$
9,796

$
142,328

Technology resale
58,249

5,127

63,376

 
60,513

3,594

64,107

Subscriptions
69,852

6,784

76,636

 
108,252

5,169

113,421

Professional services
379,844

61,424

441,268

 
348,864

47,451

396,315

Managed services
246,145

22,160

268,305

 
242,633

17,186

259,819

Support and maintenance
234,236

50,328

284,564

 
217,744

44,360

262,104

Reimbursed travel
22,676

1,217

23,893

 
21,266

1,126

22,392

 
 
 
 
 
 
 
 
Total revenues
$
1,135,096

$
157,765

$
1,292,861

 
$
1,131,804

$
128,682

$
1,260,486

 
 
 
 
 
 
 
 
(1) As noted above, prior period amounts were not adjusted upon our adoption of Topic 606.

The following table presents our revenues disaggregated by timing of revenue recognition:

 
 
 
 
 
Three Months Ended
 
 
 
2018
(In thousands)
 
 
 
 
Domestic
Segment
Global
Segment
Total
 
 
 
 
 
 
 
 
Revenue recognized over time
 
 
 
 
$
1,028,495

$
144,135

$
1,172,630

Revenue recognized at a point in time
 
 
 
 
106,601

13,630

120,231

 
 
 
 
 
 
 
 
Total revenues
 
 
 
 
$
1,135,096

$
157,765

$
1,292,861



8


Transaction Price Allocated to Remaining Performance Obligations

As of March 31, 2018 , the aggregate amount of transaction price allocated to performance obligations that are unsatisfied (or partially unsatisfied) for executed contracts approximates $14.63 billion of which we expect to recognize approximately 31% of the revenue over the next 12 months and the remainder thereafter .

Contract Liabilities

Our payment arrangements with clients typically include an initial payment due upon contract signing and date-based licensed software payment terms and payments based upon delivery for services, hardware and sublicensed software. Customer payments received in advance of satisfaction of the related performance obligations are deferred as contract liabilities. Such amounts are classified in our condensed consolidated balance sheets as either current or long-term deferred revenue. During the three months ended March 31, 2018, we recognized $189 million of revenues that were included in our contract liability balance at the beginning of such period.

Costs to Obtain or Fulfill a Contract

We have determined the only significant incremental costs incurred to obtain contracts with clients within the scope of Topic 606 are sales commissions paid to our associates. We record sales commissions as an asset, and amortize to expense ratably over the remaining performance periods of the related contracts with remaining performance obligations. At March 31, 2018 , our condensed consolidated balance sheet includes an $81 million asset related to sales commissions to be expensed in future periods, which is included in other assets.

During the three months ended March 31, 2018 , we recognized $8 million of amortization related to this sales commissions asset, which is included in costs of revenue in our condensed consolidated statements of operations.

Significant Judgments when Applying Topic 606

Our contracts with clients typically include various combinations of our software solutions and related services. Determining whether such software solutions and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Specifically, judgment is required to determine whether software licenses are distinct from services and hosting included in an arrangement .

Contract transaction price is allocated to performance obligations using estimated stand-alone selling price. Judgment is required in estimating stand-alone selling price for each distinct performance obligation. We determine stand-alone selling price maximizing observable inputs such as stand-alone sales when they exist or substantive renewal price charged to clients. In instances where stand-alone selling price is not observable, we utilize an estimate of stand-alone selling price. Such estimates are derived from various methods that include: cost plus margin, historical pricing practices, and the residual approach, which requires a considerable amount of judgment.

The labor hours input method used for our fixed fee services performance obligation is dependent on our ability to reliably estimate the direct labor hours to complete a project, which may span several years. We utilize our historical project experience and detailed planning process as a basis for our future estimates to complete current projects.

Certain of our arrangements contain variable consideration. We do not believe our estimates of variable consideration to be significant to our determination of revenue recognition.

Practical Expedients

We have reflected the aggregate effect of all contract modifications occurring prior to the Topic 606 adoption date when (i) identifying the satisfied and unsatisfied performance obligations, (ii) determining the transaction price, and (iii) allocating the transaction price to the satisfied and unsatisfied performance obligations.


9


(3) Receivables

Receivables consist of client receivables and the current portion of amounts due under sales-type leases.

Client receivables represent recorded revenues that have either been billed, or for which we have an unconditional right to invoice and receive payment in the future. We periodically provide long-term financing options to creditworthy clients through extended payment terms. Generally, these extended payment terms provide for date-based payments over a fixed period, not to exceed the term of the overall arrangement. Thus, our portfolio of client contracts contains a financing component, which is recognized over time as a component of other income (expense), net in our condensed consolidated statements of operations.

Lease receivables represent our net investment in sales-type leases resulting from the sale of certain health care devices to our clients.

We perform ongoing credit evaluations of our clients and generally do not require collateral from our clients. We provide an allowance for estimated uncollectible accounts based on specific identification, historical experience and our judgment.
A summary of net receivables is as follows:
(In thousands)
March 31, 2018
 
December 30, 2017
 
 
 
 
Client receivables
$
1,083,794

 
$
1,082,886

Less: Allowance for doubtful accounts
54,377

 
52,786

 
 
 
 
Client receivables, net of allowance
1,029,417

 
1,030,100

 
 
 
 
Current portion of lease receivables
11,324

 
12,681

 
 
 
 
Total receivables, net
$
1,040,741

 
$
1,042,781


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. This gave rise to the termination of our subcontract for the project. We continue to be in dispute with Fujitsu regarding Fujitsu's obligation to pay amounts due upon termination, including our client receivables and damages for pre-termination losses. We are working with Fujitsu to resolve these issues based on processes provided for in the subcontract. Part of that process required final resolution of disputes between Fujitsu and the NHS regarding the prime contract termination, which has now occurred. As of March 31, 2018 , it remains unlikely that our matter with Fujitsu will be resolved in the next 12 months. Therefore, these client receivables have been classified as long-term and represent less than the majority of other long-term assets at March 31, 2018 and December 30, 2017 . While the ultimate collectability of the client 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.

During the first three months of 2018 and 2017 , we received total client cash collections of $1.27 billion and $1.33 billion , respectively.
 

10


(4) Available-for-sale Investments

Available-for-sale investments at March 31, 2018 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
33,424

 
$

 
$

 
$
33,424

Time deposits
 
84,055

 

 

 
84,055

Commercial paper
 
101,130

 

 

 
101,130

Total cash equivalents
 
218,609

 

 

 
218,609

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
97,058

 

 

 
97,058

Commercial paper
 
124,530

 

 
(286
)
 
124,244

Government and corporate bonds
 
287,807

 

 
(1,144
)
 
286,663

Total short-term investments
 
509,395

 

 
(1,430
)
 
507,965

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
160,354

 

 
(1,402
)
 
158,952

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
888,358


$


$
(2,832
)

$
885,526


Available-for-sale investments at December 30, 2017 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
99,472

 
$

 
$

 
$
99,472

Time deposits
 
60,226

 

 

 
60,226

Government and corporate bonds
 
850

 

 

 
850

Total cash equivalents
 
160,548

 

 

 
160,548

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
40,186

 

 

 
40,186

Commercial paper
 
147,646

 
2

 
(139
)
 
147,509

Government and corporate bonds
 
247,626

 

 
(477
)
 
247,149

Total short-term investments
 
435,458

 
2

 
(616
)
 
434,844

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
185,478

 

 
(1,026
)
 
184,452

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
781,484

 
$
2

 
$
(1,642
)
 
$
779,844


We sold available-for-sale investments for proceeds of $20 million during the three months ended April 1, 2017 , resulting in insignificant gains.


11


(5) 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 March 31, 2018 :
(In thousands)
 
 
 
 
 
 

 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
33,424

 
$

 
$

Time deposits
 
Cash equivalents
 

 
84,055

 

Commercial paper
 
Cash equivalents
 

 
101,130

 

Time deposits
 
Short-term investments
 

 
97,058

 

Commercial paper
 
Short-term investments
 

 
124,244

 

Government and corporate bonds
 
Short-term investments
 

 
286,663

 

Government and corporate bonds
 
Long-term investments
 

 
158,952

 


The following table details our financial assets measured and recorded at fair value on a recurring basis at December 30, 2017 :
(In thousands)
 
 
 
 
 
 
 
 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
99,472

 
$

 
$

Time deposits
 
Cash equivalents
 

 
60,226

 

Government and corporate bonds
 
Cash equivalents
 

 
850

 

Time deposits
 
Short-term investments
 

 
40,186

 

Commercial paper
 
Short-term investments
 

 
147,509

 

Government and corporate bonds
 
Short-term investments
 

 
247,149

 

Government and corporate bonds
 
Long-term investments
 

 
184,452

 

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 March 31, 2018 and December 30, 2017 was approximately $431 million and $519 million , respectively. The carrying amount of such debt at March 31, 2018 and December 30, 2017 was $425 million and $500 million , respectively.
 

12


(6) Long-term Debt and Capital Lease Obligations

The following is a summary of indebtedness outstanding:
(In thousands)
March 31, 2018
 
December 30, 2017
 
 
 
 
Senior Notes
$
425,000

 
$
500,000

Capital lease obligations
6,905

 
13,068

Other
14,162

 
14,162

 
 
 
 
  Debt and capital lease obligations
446,067

 
527,230

Less: debt issuance costs
(490
)
 
(515
)
 
 
 
 
  Debt and capital lease obligations, net
445,577

 
526,715

Less: current portion
(6,804
)
 
(11,585
)
 
 
 
 
  Long-term debt and capital lease obligations
$
438,773

 
$
515,130


In March 2018, we repaid our $75 million floating rate Series 2015-C Notes due February 15, 2022 .

(7) 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.

H.R. 1, An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018 ("U.S. Tax Reform"), was enacted on December 22, 2017. U.S. Tax Reform provides for, among other things, the reduction of the U.S. corporate tax rate from 35% to 21% , effective January 1, 2018. Relevant accounting guidance provides that the impact of U.S. Tax Reform, as of the date of enactment, may be provisionally recorded and adjusted during a measurement period of up to one year. As of December 30, 2017, we provisionally recorded certain impacts of U.S. Tax Reform including an adjustment to our net deferred tax liability arising from the reduction in the federal tax rate as well as the impact of mandatory deemed repatriation. Additional analysis and computations are being performed with respect to these provisional amounts. The ultimate impact as of the enactment date may differ from the provisional amounts we have recorded, possibly materially, due to among other things, additional regulatory guidance that may be issued and changes to our assumptions and interpretations. No measurement period adjustments were recorded during the three months ended March 31, 2018 .

Our effective tax rate was 20.0% and 28.7% for the first three months of 2018 and 2017 , respectively. The decrease in the effective tax rate in 2018 is primarily due to the aforementioned reduction in the U.S. corporate statutory tax rate from 35% to 21%.



13


(8) 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
 
2018
 
2017
 
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
$
160,001

 
332,395

 
$
0.48

 
$
173,213

 
329,973

 
$
0.52

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

 
4,139

 
 
 

 
6,217

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
160,001

 
336,534

 
$
0.48

 
$
173,213

 
336,190

 
$
0.52


For the three months ended March 31, 2018 and April 1, 2017 , options to purchase 11.2 million and 10.6 million shares of common stock at per share prices ranging from $51.19 to $73.40 and $44.05 to $73.40 , respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.

(9) Share-Based Compensation and Equity

Stock Options

Stock option activity for the three months ended March 31, 2018 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
21,332

 
$
49.40

 
 
 
 
Granted
744

 
62.41

 
 
 
 
Exercised
(581
)
 
18.02

 
 
 
 
Forfeited and expired
(63
)
 
60.14

 
 
 
 
Outstanding as of March 31, 2018
21,432

 
50.67

 
$
214,619

 
6.44
 
 
 
 
 
 
 
 
Exercisable as of March 31, 2018
10,213

 
$
40.57

 
$
192,179

 
4.57

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 March 31, 2018 were as follows:
Expected volatility (%)
 
28.5
%
Expected term (yrs)
 
7

Risk-free rate (%)
 
2.7
%
Fair value per option
 
$
22.11

As of March 31, 2018 , there was $154 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 3.33 years.

14


Non-vested Shares and Share Units

Non-vested share and share unit activity for the three months ended March 31, 2018 was as follows:
(In thousands, except per share data)
Number of Shares
 
Weighted-Average
Grant Date Fair Value
 
 
 
 
Outstanding at beginning of year
799

 
$
66.76

Granted
122

 
62.14

Vested
(40
)
 
57.47

Forfeited
(3
)
 
64.64

 
 
 
 
Outstanding as of March 31, 2018
878

 
$
66.55

As of March 31, 2018 , there was $30 million of total unrecognized compensation cost related to non-vested share and share unit awards granted under all plans. That cost is expected to be recognized over a weighted-average period of 1.74 years.

Share-Based Compensation Cost

The following table presents total compensation expense recognized with respect to stock options, non-vested shares and share units, and our associate stock purchase plan:
 
Three Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Stock option and non-vested share and share unit compensation expense
$
24,935

 
$
17,500

Associate stock purchase plan expense
1,362

 
1,475

Amounts capitalized in software development costs, net of amortization
160

 
(120
)
 
 
 
 
Amounts charged against earnings, before income tax benefit
$
26,457

 
$
18,855

 
 
 
 
Amount of related income tax benefit recognized in earnings
$
5,300

 
$
5,416


Treasury Stock

In May 2017, our Board of Directors authorized a share repurchase program that allows the Company to repurchase up to $500 million of shares of our common stock, excluding transaction costs. The repurchases are to be effectuated in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers. No time limit was set for the completion of the program. During the three months ended March 31, 2018 , we repurchased 1.4 million shares for total consideration of $88 million under the program. The shares were recorded as treasury stock and accounted for under the cost method. No repurchased shares have been retired. At March 31, 2018 , $339 million remains available for repurchase under the program.

(10) Contingencies

We accrue estimates for resolution of any legal and other contingencies when losses are probable and estimable, in accordance with Accounting Standards Codification Topic 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 a sufficient number 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.


15


In addition to commitments and obligations in the ordinary course of business, we are subject to various legal proceedings and claims that arise in the ordinary course of business, including for example, employment and client disputes and litigation alleging solution and implementation defects, personal injury, intellectual property infringement, violations of law and breaches of contract and warranties. In addition, we are a defendant in lawsuits filed in federal and state courts brought as putative class or collective actions on behalf of various groups of current and former associates in the U.S. alleging that we misclassified associates as exempt from overtime pay under the Fair Labor Standards Act and state wage and hour laws. These proceedings are at various procedural stages and seek unspecified monetary damages, injunctive relief, costs and attorneys' fees. Given the substantial uncertainties, such as the impact of discovery and the extent to which significant factual issues are resolved, the disposition of pre-trial motions, the extent of potential damages that are often unspecified or indeterminate, and the status of settlement discussions, we cannot predict with any reasonable certainty the timing or outcome of such contingencies. At this time, we do not believe any material losses under these claims to be probable or estimable.

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 one or a combination of these matters, we may be required to pay substantial sums, become subject to the entry of an injunction or be forced to change the manner in which we operate our business, which could have a material adverse impact on our business, results of operations, cash flows or financial condition.

(11) Segment Reporting

We have two operating segments, Domestic and Global. Revenues are derived primarily from the sale of clinical, financial and administrative information solutions and services. 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 March 31, 2018 and April 1, 2017 :
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2018
 
 
 
 
 
 
 
Revenues
$
1,135,096

 
$
157,765

 
$

 
$
1,292,861

 
 
 
 
 
 
 
 
Costs of revenue
206,674

 
24,604

 

 
231,278

Operating expenses
519,871

 
69,144

 
277,353

 
866,368

Total costs and expenses
726,545

 
93,748


277,353

 
1,097,646

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
408,551

 
$
64,017

 
$
(277,353
)
 
$
195,215


16


(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2017
 
 
 
 
 
 
 
Revenues
$
1,131,804

 
$
128,682

 
$

 
$
1,260,486

 
 
 
 
 
 
 
 
Costs of revenue
176,361

 
22,632

 

 
198,993

Operating expenses
483,380

 
63,523

 
270,464

 
817,367

Total costs and expenses
659,741

 
86,155

 
270,464

 
1,016,360

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
472,063

 
$
42,527

 
$
(270,464
)
 
$
244,126



17


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 condensed consolidated financial statements and the accompanying notes to condensed consolidated financial statements ("Notes") found above.

Our first fiscal quarter ends on the Saturday closest to March 31. The 2018 and 2017 first quarters ended on March 31, 2018 and April 1, 2017 , 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 significant costs and reputational harm related to product-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities that could expose us to significant costs and reputational harm; the possibility of increased expenses, exposure to legal 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; potential claims or other risks associated with relying on open source software in our proprietary software, solutions or services; material adverse resolution of legal proceedings; risks associated with our global operations, including without limitation greater difficulty in collecting accounts receivable; risks associated with fluctuations in foreign currency exchange rates; changes in tax laws, regulations or guidance that could adversely affect our tax position and/or challenges to our tax positions in the U.S. and non-U.S. countries; the uncertainty surrounding the impact of the United Kingdom's vote to leave the European Union (commonly referred to as Brexit) on our global business; risks associated with the unexpected loss or recruitment and retention of key personnel or the failure to successfully develop and execute succession planning to assure transitions of key associates and their knowledge, relationships and expertise; risks related to our dependence on strategic relationships and third party suppliers; risks inherent with business acquisitions and combinations and the integration thereof into our business; risks associated with volatility and disruption resulting from global economic or market conditions; significant competition and our ability to quickly respond to market changes and changing technologies and to bring competitive new solutions, devices, features and services to market in a timely fashion; managing growth in the new markets in which we offer solutions, health care devices or services; long sales cycles for our solutions and services; risks inherent in contracting with government clients, including without limitation, complying with strict compliance and disclosure obligations, navigating complex procurement rules and processes and defending against bid protests; risks associated with our outstanding and future indebtedness, such as compliance with restrictive covenants, which may limit our flexibility to operate our business; changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies may adversely affect our financial statements; the potential for losses resulting from asset impairment charges; 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; non-compliance with laws, government regulation or certain industry initiatives; variations in our quarterly operating results; potential variations in our sales forecasts compared to actual sales; volatility in the trading price of our common stock and the timing and volume of market activity; our directors' authority to issue preferred stock and the anti-takeover provisions in our corporate governance documents; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission, including those under the caption "Risk Factors" in our latest annual report on Form 10-K, or in materials incorporated herein or therein by reference. Forward-looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as of the date they are made. Except as required by law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in our results of operations, financial condition or business over time.


18

Table of Contents

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 and other stakeholders secure access to clinical, administrative and financial data in real or near-real time, helping them to improve quality, safety and efficiency in the delivery of health care.

Our fundamental strategic focus is the creation of organic growth by investing in research and development ("R&D") to create solutions and services for the health care industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 14% and 13%, respectively. This growth has also created an important strategic footprint in health care, with Cerner ® solutions in more than 27,000 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 and services 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 suppliers. We may also supplement organic growth with acquisitions or strategic investments.

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 HealtheIntent SM 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% and 21% over the most recent five- and ten-year periods, respectively. We expect to drive earnings growth as we continue to grow our revenue. We also have opportunities to expand our operating margins over time. In the near term, we expect growth in non-cash expenses, such as amortization and depreciation, and a mix of lower margin revenue associated with some of our rapidly growing services businesses will limit our margin expansion. Longer-term, we expect to generate margin expansion as the growth rate of non-cash expenses slows, we achieve economies of scale and efficiencies in our services businesses, control general and administrative expenses, and get more contributions to our growth from solutions on our HealtheIntent platform, which we expect to be accretive to our overall margins.

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

Results Overview
Bookings, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $1.40 billion in the first quarter of 2018 , which is an increase of 12% compared to $1.25 billion in the first quarter of 2017 .

Revenues for the first quarter of 2018 increased 3% to $1.29 billion , compared to $1.26 billion in the first quarter of 2017 . The increase in revenue reflects ongoing demand from new and existing clients for Cerner's solutions and services driven by their needs to keep up with regulatory requirements, adapt to changing reimbursement models, and deliver safer and more efficient care.

Net earnings for the first quarter of 2018 decreased 8% to $160 million , compared to $173 million in the first quarter of 2017 . Diluted earnings per share decreased 8% to $0.48 , compared to $0.52 in the first quarter of 2017 . The overall decrease in net earnings and diluted earnings per share was primarily a result of increased operating expenses, which reflects the hiring of personnel to support revenue growth. The increase in operating expenses was partially offset by a lower effective tax rate, stemming from certain U.S. income tax reform enacted in December 2017.

We had cash collections of receivables of $1.27 billion in the first quarter of 2018 , compared to $1.33 billion in the first quarter of 2017 . Days sales outstanding was 73 days for the first quarter of 2018 , compared to 72 days in the 2017 fourth quarter and 71 days for the 2017 first quarter. Operating cash flows for the first quarter of 2018 were $409 million compared to $304 million in the first quarter of 2017 .


19

Table of Contents

Results of Operations
Three Months Ended March 31, 2018 Compared to Three Months Ended April 1, 2017
The following table presents a summary of the operating information for the first quarters of 2018 and 2017 :
(In thousands)
2018
 
% of
Revenue
 
2017
 
% of
Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Revenues
$
1,292,861

 
100
%
 
$
1,260,486

 
100
%
 
3
 %
Costs of revenue
231,278

 
18
%
 
198,993

 
16
%
 
16
 %
 
 
 
 
 
 
 
 
 
 
Margin
1,061,583

 
82
%
 
1,061,493

 
84
%
 
 %
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
Sales and client service
589,948

 
46
%
 
560,200

 
44
%
 
5
 %
Software development
161,617

 
13
%
 
145,901

 
12
%
 
11
 %
General and administrative
92,294

 
7
%
 
88,392

 
7
%
 
4
 %
Amortization of acquired-related intangibles
22,509

 
2
%
 
22,874

 
2
%
 
(2
)%
 
 
 
 
 
 
 
 
 
 
Total operating expenses
866,368

 
67
%
 
817,367

 
65
%
 
6
 %
 
 
 
 
 
 
 
 
 
 
Total costs and expenses
1,097,646

 
85
%
 
1,016,360

 
81
%
 
8
 %
 
 
 
 
 
 
 
 
 
 
Operating earnings
195,215

 
15
%
 
244,126

 
19
%
 
(20
)%
 
 
 
 
 
 
 
 
 
 
Other income (expense), net
4,864

 
 
 
(1,116
)
 
 
 
 
Income taxes
(40,078
)
 
 
 
(69,797
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
160,001

 
 
 
$
173,213

 
 
 
(8
)%
Revenues & Backlog
Revenues increased 3% to $1.29 billion in the first quarter of 2018 , as compared to $1.26 billion in the first quarter of 2017 . The growth in revenues was primarily due to a $45 million increase in professional services revenue, driven by increased implementation and consulting activities.
Backlog, which reflects contracted revenue that has not yet been recognized as revenue, was $14.63 billion as of March 31, 2018 . In the first quarter of 2018 , we adopted new revenue recognition guidance as further discussed in Note (2) of the notes to condensed consolidated financial statements. As of March 31, 2018 , we have modified the calculation of backlog as previously determined under Regulation S-K to represent the aggregate amount of transaction price allocated to performance obligations that are unsatisfied (or partially satisfied) to conform to the new revenue recognition guidance. Backlog amounts disclosed in prior periods have not been adjusted, and are not comparable to, the current period presentation.

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Costs of Revenue
Costs of revenue as a percent of revenues were 18% in the first quarter of 2018 , compared to 16% in the same period of 2017 . The higher costs of revenue as a percent of revenues was primarily driven by higher third-party costs associated with services revenue.
Costs of revenue include 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, and services) carrying different margin rates changes from period to period. Costs of revenue 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 6% to $866 million in the first quarter of 2018 , as compared to $817 million in the first quarter of 2017 .
 
Sales and client service expenses as a percent of revenues were 46% in the first quarter of 2018 , compared to 44% in the first quarter of 2017 . These expenses increased 5% to $590 million in the first quarter of 2018 , from $560 million in the same period of 2017 . 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 growth in sales and client service expenses reflects the hiring of services personnel to support growth in services revenue.
Software development expenses as a percent of revenues were 13% in the first quarter of 2018 , compared to 12% in the first quarter of 2017 . 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 2018 and 2017 is as follows:
 
Three Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Software development costs
$
185,218

 
$
176,432

Capitalized software costs
(73,071
)
 
(70,419
)
Capitalized costs related to share-based payments
(531
)
 
(673
)
Amortization of capitalized software costs
50,001

 
40,561

 
 
 
 
Total software development expense
$
161,617

 
$
145,901

 
General and administrative expenses as a percent of revenues were 7% in the first quarter of both 2018 and 2017 . These expenses increased 4% to $92 million in the first quarter of 2018 , from $88 million for the same period in 2017 . 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 increase in general and administrative expenses is primarily due to increased expense associated with share-based payment awards.

Amortization of acquisition-related intangibles as a percent of revenues was 2% in the first quarter of both 2018 and 2017 . These expenses remained flat at $23 million in the first quarter of both 2018 and 2017 . 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.


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Non-Operating Items
 
Other income (expense), net was $5 million in income in the first quarter of 2018 , compared to $1 million in expense in the same period of 2017 . The increase was primarily attributable to an impairment loss recognized on one of our investments accounted for under the cost method in the first quarter of 2017.

Our effective tax rate was 20.0% for the first quarter of 2018 , compared to 28.7% for the same period of 2017 . The decrease in the effective tax rate in 2018 is primarily due to a reduction in the U.S. corporate statutory tax rate from 35% to 21%, effective January 1, 2018. Refer to Note (7) of the notes to condensed consolidated financial statements for further discussion regarding our effective tax rate.

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, the Bahamas, Belgium, Bermuda, Brazil, Canada, Cayman Islands, Chile, Denmark, Egypt, England, Finland, France, Germany, Guam, India, Ireland, Kuwait, Luxembourg, Malaysia, Mexico, Netherlands, Norway, Portugal, Qatar, Romania, Saudi Arabia, Singapore, Slovakia, Spain, Sweden, Switzerland and the United Arab Emirates. Refer to Note (11) 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 2018 and 2017 :  
(In thousands)
2018
 
% of Revenue
 
2017
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
1,135,096

 
100%
 
$
1,131,804

 
100%
 
—%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
206,674

 
18%
 
176,361

 
16%
 
17%
Operating expenses
519,871

 
46%
 
483,380

 
43%
 
8%
Total costs and expenses
726,545

 
64%
 
659,741

 
58%
 
10%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
408,551

 
36%

472,063

 
42%
 
(13)%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
157,765

 
100%
 
128,682

 
100%
 
23%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
24,604

 
16%
 
22,632

 
18%
 
9%
Operating expenses
69,144

 
44%
 
63,523

 
49%
 
9%
Total costs and expenses
93,748

 
59%
 
86,155

 
67%
 
9%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
64,017

 
41%
 
42,527

 
33%
 
51%
 
 
 
 
 
 
 
 
 
 
Other, net
(277,353
)
 
 
 
(270,464
)
 
 
 
3%
 
 
 
 
 
 
 
 
 
 
Consolidated operating earnings
$
195,215

 
 
 
$
244,126

 
 
 
(20)%
Domestic Segment
Revenues were basically flat at $1.14 billion in the first quarter of 2018 , and $1.13 billion in the same period of 2017 .
Costs of revenue as a percent of revenues were 18% in the first quarter of 2018 , compared to 16% in the same period of 2017 . The higher costs of revenue as a percent of revenues was primarily driven by higher third-party costs associated with services revenue.
Operating expenses as a percent of revenues were 46% in the first quarter of 2018 , compared to 43% in the same period of 2017 . The higher operating expenses as a percent of revenues reflects the hiring of personnel to support revenue growth.


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Global Segment
Revenues increased 23% to $158 million in the first quarter of 2018 , from $129 million in the same period of 2017 . This increase was driven by strong growth across most of our business.
Costs of revenue as a percent of revenues were 16% in the first quarter of 2018 , compared to 18% in the same period of 2017 . The lower costs of revenue as a percent of revenues was primarily driven by a lower amount of third party resources utilized for support and services.
Operating expenses as a percent of revenues were 44% in the first quarter of 2018 , compared to 49% in the same period of 2017 . The decrease as a percent of revenues is primarily a reflection of increased revenue in proportion to the amount of our fixed operating expenses.

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 3% to $277 million in the first quarter of 2018 , from $270 million in the same period of 2017 . The increase is primarily due to increased amortization of capitalized software costs, resulting from releases of new and enhanced solutions over the last four quarters.


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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, capital expenditures, and in recent years, our share repurchase programs.
Our principal sources of liquidity are our cash, cash equivalents, which primarily consist of money market funds, commercial paper and time deposits with original maturities of less than 90 days, and short-term investments. At March 31, 2018 , we had cash and cash equivalents of $413 million and short-term investments of $508 million , as compared to cash and cash equivalents of $371 million and short-term investments of $435 million at December 30, 2017 .

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 March 31, 2018 , we had no outstanding borrowings under this facility; however, we had $47 million of outstanding letters of credit, which reduced our available borrowing capacity to $53 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 for the next 12 months.
The following table summarizes our cash flows in the first three months of 2018 and 2017 :
 
Three Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Cash flows from operating activities
$
408,965

 
$
303,585

Cash flows from investing activities
(211,498
)
 
(103,852
)
Cash flows from financing activities
(154,311
)
 
4,369

Effect of exchange rate changes on cash
(680
)
 
3,489

Total change in cash and cash equivalents
42,476

 
207,591

 
 
 
 
Cash and cash equivalents at beginning of period
370,923

 
170,861

 
 
 
 
Cash and cash equivalents at end of period
$
413,399

 
$
378,452

 
 
 
 
Free cash flow (non-GAAP)
$
255,652

 
$
144,428


Cash from Operating Activities
 
Three Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Cash collections from clients
$
1,274,497

 
$
1,325,596

Cash paid to employees and suppliers and other
(954,839
)
 
(973,440
)
Cash paid for interest
(8,199
)
 
(8,347
)
Cash paid for taxes, net of refunds
97,506

 
(40,224
)
 
 
 
 
Total cash from operations
$
408,965

 
$
303,585

Cash flow from operations increased $105 million in the first quarter of 2018 when compared to the same period of 2017 due primarily to net refunds of taxes. Days sales outstanding was 73 days in the first quarter of 2018 , compared to 72 days for the 2017 fourth quarter and 71 days for the 2017 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)
2018
 
2017
 
 
 
 
Capital purchases
$
(79,711
)
 
$
(88,065
)
Capitalized software development costs
(73,602
)
 
(71,092
)
Purchases of investments, net of sales and maturities
(49,713
)
 
61,690

Purchases of other intangibles
(8,472
)
 
(6,385
)
 
 
 
 
Total cash flows from investing activities
$
(211,498
)
 
$
(103,852
)
Cash flows from investing activities consist primarily of capital spending and short-term investment activities.

Our capital spending in the first quarter of 2018 was driven by capitalized equipment purchases primarily to support growth in our 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. Total capital spending for the remainder of 2018 is expected to exceed 2017 levels, primarily driven by an increase in spending to support our facilities requirements, including commencement of construction on the next two phases of our Innovations Campus (office space development located in Kansas City, Missouri); along with increased capital purchases to support the growth in our managed services business.
Short-term investment activity historically consists of the investment of cash generated by our business in excess of what is necessary to fund operations. The 2017 activity is impacted by a change in investment mix, whereas we invested more heavily in cash equivalents versus short-term and long-term investments. In 2018, we returned to net purchases of investments.

Cash from Financing Activities
 
Three Months Ended
(In thousands)
2018
 
2017
 
 
 
 
Repayment of long-term debt
$
(75,000
)
 
$

Cash from option exercises (net of taxes paid in connection with shares surrendered by associates)
8,313

 
5,369

Treasury stock purchases
(87,624
)
 

Contingent consideration payments for acquisition of businesses

 
(1,000
)
 
 
 
 
Total cash flows from financing activities
$
(154,311
)
 
$
4,369

In March 2018, we repaid our $75 million floating rate Series 2015-C Notes due February 15, 2022.

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 2018 based on the number of exercisable options as of March 31, 2018 and our current stock price.
During the three months ended March 31, 2018 , we repurchased 1.4 million shares of our common stock for total consideration of $88 million . At March 31, 2018 , $339 million remains available for repurchase under our current program. We may continue to repurchase shares under this program in 2018 , which will be dependent on a number of factors, including the price of our common stock. Although we may continue to repurchase shares, there is no assurance that we will repurchase up to the full amount remaining under the program. Refer to Note (9) of the notes to condensed consolidated financial statements for further information regarding our share repurchase program.


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Free Cash Flow
 
 
Three Months Ended
(In thousands)
 
2018
 
2017
 
 
 
 
 
Cash flows from operating activities (GAAP)
 
$
408,965