2013 CFA Institute Research Challenge Kansas State University

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2013 CFA Institute Research Challenge Kansas State University Target Company: Cerner Corp. Ticker: CERN

2013 CFA Institute Research Challenge Kansas State University Target Company: Cerner Corp. Ticker: CERN (NASDAQ) Industry: Healthcare Information Technology (HCIT) 1

Investment Overview Investment Thesis: Leader in HCIT Industry Solid Core Business Model Significant Growth

Investment Overview Investment Thesis: Leader in HCIT Industry Solid Core Business Model Significant Growth Opportunities Current Price: $90. 76 (as of 3/19/2013)

Investment Overview Investment Thesis: Leader in HCIT Industry Target Price: $102. 46 Recommendation: Solid

Investment Overview Investment Thesis: Leader in HCIT Industry Target Price: $102. 46 Recommendation: Solid Core Business Model Significant Growth Opportunities Current Price: $90. 76 (as of 3/19/2013) BUY Potential Upside: 12. 89%

Company Overview §Founded in 1979, based in Kansas City, MO § 11, 900 employees

Company Overview §Founded in 1979, based in Kansas City, MO § 11, 900 employees worldwide §Provides information technology solutions to healthcare providers §Core product offering is Millennium Software Platform §Sets up Electronic Health Record (EHR) Systems §Combines clinical, financial and general IT system solutions 4 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Regulatory Environment Driving Industry Growth §HITECH Act and Meaningful Use §Passed as part of

Regulatory Environment Driving Industry Growth §HITECH Act and Meaningful Use §Passed as part of ARRA Stimulus Act of 2009 $32. 7 B Total Amount Allocated By HITECH Act Source: Healthcare IT News (Data as of December 2012) 5 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Regulatory Environment Driving Industry Growth §HITECH Act and Meaningful Use §Passed as part of

Regulatory Environment Driving Industry Growth §HITECH Act and Meaningful Use §Passed as part of ARRA Stimulus Act of 2009 $32. 7 B Meaningful Use Stage 1 (2011 -2013): Total Amount Allocated By HITECH Act • EHR System Implementation Meaningful Use Stage 2 (2013 -2015): • Interoperability & Health Information Exchange Meaningful Use Stage 3 (2015 -2021): $10. 3 B • Performance-Based Reimbursement Total Amount Spent as of Dec. 2012 Source: Healthcare IT News (Data as of December 2012) 6 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Regulatory Environment Driving Industry Growth §HITECH Act and Meaningful Use §Passed as part of

Regulatory Environment Driving Industry Growth §HITECH Act and Meaningful Use §Passed as part of ARRA Stimulus Act of 2009 $32. 7 B Meaningful Use Stage 1 (2011 -2013): Total Amount Allocated By HITECH Act • EHR System Implementation Meaningful Use Stage 2 (2013 -2015): • Interoperability & Health Information Exchange Meaningful Use Stage 3 (2015 -2021): $10. 3 B • Performance-Based Reimbursement Total Amount Spent as of Dec. 2012 §Other Regulations Impacting Industry: §ICD-10 and Computerized Physician Order Entry (CPOE) §Affordable Care Act (Obama. Care) Source: Healthcare IT News (Data as of December 2012) 7 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Industry Overview Top 5 EHR Vendors in 2006 Large Hospitals ( >200 Beds) 8

Industry Overview Top 5 EHR Vendors in 2006 Large Hospitals ( >200 Beds) 8 Rank Vendor Market Share 1 Meditech 19% 2 Cerner 16% 3 Mc. Kesson 14% 4 Siemens 9% 5 Epic 7% Industry Overview Core Business Model Growth Opportunities Valuation CERN

CERN & Epic: Becoming Clear Market Leaders Top 5 EHR Vendors in 2006 Large

CERN & Epic: Becoming Clear Market Leaders Top 5 EHR Vendors in 2006 Large Hospitals ( >200 Beds) 9 Top 5 EHR Vendors in 2011 Large Hospitals ( >200 Beds) Rank Vendor Market Share 1 Meditech 19% 1 Epic 24% 2 Cerner 16% 2 Cerner 21% 3 Mc. Kesson 14% 3 Meditech 19% 4 Siemens 9% 4 Mc. Kesson 13% 5 Epic 7% 5 Siemens 8% Growth Opportunities Valuation CERN Industry Overview Core Business Model

CERN Capitalizing on Displacement Opportunities % Bookings from Outside of Installed Client Base 10

CERN Capitalizing on Displacement Opportunities % Bookings from Outside of Installed Client Base 10 Industry Overview Core Business Model Growth Opportunities Valuation CERN

CERN Capitalizing on Displacement Opportunities % Bookings from Outside of Installed Client Base Cerner’s

CERN Capitalizing on Displacement Opportunities % Bookings from Outside of Installed Client Base Cerner’s Key Competitive Strengths: §User satisfaction/Ease-of-Use §Single-Vendor capability §Meaningful Use attestation §Interoperability 11 Industry Overview Core Business Model Growth Opportunities Valuation CERN

CERN Capitalizing on Displacement Opportunities % Bookings from Outside of Installed Client Base Cerner’s

CERN Capitalizing on Displacement Opportunities % Bookings from Outside of Installed Client Base Cerner’s Key Competitive Strengths: §User satisfaction/Ease-of-Use §Single-Vendor capability §Meaningful Use attestation §Interoperability §Continued displacement opportunities §Potential to capture additional 15 -25% market share over next 3 -5 years 12 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Porter’s Five Forces Analysis Competitive Rivalry Within Industry 4 = Most Favorable to CERN

Porter’s Five Forces Analysis Competitive Rivalry Within Industry 4 = Most Favorable to CERN 1 = Least Favorable to CERN 3 Bargaining Power of Clients 4 4 Bargaining Power of Suppliers 13 Industry Overview 3 Core Business Model 4 Growth Opportunities Threat of Substitute Products/Services Threat of New Entrants Valuation CERN

CERN Core Business Segments Support, Maintenance & Services: 66% 14 Industry Overview Core Business

CERN Core Business Segments Support, Maintenance & Services: 66% 14 Industry Overview Core Business Model System Sales: 34% Growth Opportunities Valuation CERN

Revenue Mix Breakdown 15 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Revenue Mix Breakdown 15 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Business Model Generates Recurring Revenue 45% Recurring 16 Industry Overview Core Business Model Growth

Business Model Generates Recurring Revenue 45% Recurring 16 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Projected Revenue Mix 13% = R G A C ue r a e Y

Projected Revenue Mix 13% = R G A C ue r a e Y 5 - 17 Industry Overview en v e R l a t To Core Business Model Growth Opportunities Valuation CERN

Projected Revenue Mix G A C ue 15% = R en v e g.

Projected Revenue Mix G A C ue 15% = R en v e g. R r a e Y 5 - 45% 55% 18 Industry Overview in r r u Rec 49% 48% 46% 54% Core Business Model Recurring 47% 53% 52% Growth Opportunities 51% Valuation Non-Recurring CERN

Operating Leverage Driving Margin Expansion §Projecting margin expansion of 100 -200 bps per year

Operating Leverage Driving Margin Expansion §Projecting margin expansion of 100 -200 bps per year §Leveraging R&D and SG&A expenses §Increasing proportion of revenue from higher-margin segments Total Revenue 19 Industry Overview Core Business Model Operating Expenses Growth Opportunities Valuation CERN

Strong Financial Position from Significant Excess Cash Current Cash Deployment Initiatives §Stock Repurchase Plan

Strong Financial Position from Significant Excess Cash Current Cash Deployment Initiatives §Stock Repurchase Plan authorized for up to $170 M Total Cash & Investments: $1. 5 B §Spending approx. $150 M per year to construct new campus §Investing heavily in organic growth opportunities Potential Additional Cash Deployment Initiatives §Expanding Stock Repurchase Plan §Continuing to pursue strategic acquisitions §Low probability of dividend in foreseeable future New Kansas City, KS campus construction as of Dec. 2013 20 Industry Overview Core Business Model Artist’s rendering of completed campus Growth Opportunities Valuation CERN

Cerner. Works Solutions Create Up-Selling Opportunity § CERN currently captures only 17% of clients’

Cerner. Works Solutions Create Up-Selling Opportunity § CERN currently captures only 17% of clients’ total IT spending § Increasing integration of clinical, financial and IT solutions § Significant up-selling opportunity within existing client base ▫ ITWorks ▫ Rev. Works ITWorks Revenue Rev. Works Revenue +71% +23% +110% +106% +60% +580% 21 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Population Health Management is Future of HCIT §Major client priority as reimbursement structure shifts

Population Health Management is Future of HCIT §Major client priority as reimbursement structure shifts §Seeking to develop first comprehensive PHM solution with Healthe. Intent platform ▫ Predictive algorithms ▫ Integrated decision support tools §Expecting significant earnings impact in 2 -3 years §Per-member-per-month subscription fee is probable monetization model §Potential new market with Employee Health Management 22 Industry Overview Core Business Model Growth Opportunities Valuation CERN

CERN Positioned for International Growth § 13% of total revenue from international segment §Presence

CERN Positioned for International Growth § 13% of total revenue from international segment §Presence in 25+ countries Current International Footprint 23 Industry Overview Core Business Model Growth Opportunities Valuation CERN

CERN Positioned for International Growth § 13% of total revenue from international segment §Presence

CERN Positioned for International Growth § 13% of total revenue from international segment §Presence in 25+ countries §Global economic recovery will stimulate industry growth §Leader in adapting software to foreign languages Potential Future International Footprint 24 Industry Overview Core Business Model Growth Opportunities Valuation CERN

CERN Positioned for International Growth 25 Industry Overview Core Business Model Growth Opportunities Valuation

CERN Positioned for International Growth 25 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Pro-Forma Earnings Expectations § Revenue growth to remain between 12. 50 -14. 50% through

Pro-Forma Earnings Expectations § Revenue growth to remain between 12. 50 -14. 50% through 2017 § Earnings growth at 5 -Year CAGR of 19. 28% from 2012 -2017 § 2013 Basic EPS projection of $2. 71 ▫ 16. 81% growth over 2012 EPS 26 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Weighted Average Price Target Regression Analysis: CERN Price Change vs. S&P 500 R 2

Weighted Average Price Target Regression Analysis: CERN Price Change vs. S&P 500 R 2 = 0. 40 40% of Price § Short-Term Perspective 60% of Price § Long-Term Perspective § Driven by Market Sentiment § Value-Oriented Investors Method P/E Multiple DCF Valuation $100. 38 $103. 84 Weight 40% 60% Target Price = $102. 46 27 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Relative Valuation Summary: P/E Bands Average P/E Band x EPS 2013 = Target Price

Relative Valuation Summary: P/E Bands Average P/E Band x EPS 2013 = Target Price 37 x $2. 71 = $100. 38 28 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Relative Valuation Summary: P/E Valuation HIGH MEAN LOW Current Price: $90. 76 29 Industry

Relative Valuation Summary: P/E Valuation HIGH MEAN LOW Current Price: $90. 76 29 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Intrinsic Valuation Summary: DCF Model (DCFF) WACC = kd(wd) + ke(we) 7. 83% =

Intrinsic Valuation Summary: DCF Model (DCFF) WACC = kd(wd) + ke(we) 7. 83% = 4. 02%(4. 76%) + 8. 02%(95. 24%) 5 -Year FCF Stage 2 Growth Terminal Value 25% FCF CAGR Stair-Step Growth Rate (7%-2%) FY 2018 - 2027 2% Terminal Growth Rate Based on Real GDP Growth $15. 13 15% $35. 91 35% $52. 80 50% Target Price = $103. 84 30 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Other Valuation Methods Analyzed Comp Group P/E Multiple Comp Group EV/EBITDA Multiple CERN Historic

Other Valuation Methods Analyzed Comp Group P/E Multiple Comp Group EV/EBITDA Multiple CERN Historic P/E Multiple Residual Income Model DCF Model (DCFF) Target Price: $102. 46 Current Price: $90. 76 31 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Moderate Minor Impact Significant Comprehensive Risk Overview §Significant regulatory changes §Further system crashes §Slower

Moderate Minor Impact Significant Comprehensive Risk Overview §Significant regulatory changes §Further system crashes §Slower margin expansion §Slower growth in new initiatives §Abrupt executive turnover Low Medium High Probability 32 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Risk Analysis: Monte Carlo Simulation H O BUY L 15% D 71% 14% SELL

Risk Analysis: Monte Carlo Simulation H O BUY L 15% D 71% 14% SELL # of Simulations 5, 000 Key Variables Revenue Growth Margin Expansion Terminal Growth WACC Shares Outstanding Probability of Future Service Outages 33 Industry Overview Core Business Model Growth Opportunities Valuation CERN

Conclusion Investment Thesis: Leader in HCIT Industry § Regulation Driving Industry Growth § Displacement

Conclusion Investment Thesis: Leader in HCIT Industry § Regulation Driving Industry Growth § Displacement Opportunities Solid Core Business Model § Recurring Revenue Growth § Operating Margin Expansion § Cash Deployment Initiatives Significant Growth Opportunities Current Price: $90. 76 (as of 3/19/2013) § Significant Up-Selling Opportunity § Population Health Management § International Expansion

Conclusion Investment Thesis: Leader in HCIT Industry Target Price: $102. 46 Recommendation: Solid Core

Conclusion Investment Thesis: Leader in HCIT Industry Target Price: $102. 46 Recommendation: Solid Core Business Model Significant Growth Opportunities Current Price: $90. 76 (as of 3/19/2013) BUY Potential Upside: 12. 89%

Presentation Slide Navigator §Industry Overview ▫Company Overview ▫Industry Overview ▫Regulatory Environment Driving Industry Growth

Presentation Slide Navigator §Industry Overview ▫Company Overview ▫Industry Overview ▫Regulatory Environment Driving Industry Growth ▫CERN Competitive Positioning §Core Business Model ▫Business Model Overview ▫Projected Revenue Mix ▫Operating Leverage Driving Margin Expansion ▫Cash Deployment Options §Growth Opportunities ▫Cerner. Works Solutions Create Up-Selling Opportunity ▫Population Health Management Is Future of HCIT Industry ▫CERN Positioned for International Growth ▫Potential International Market Opportunity ▫Pro-Forma Earnings Expectations §Valuation ▫Weighted Average Price Target ▫Relative Valuation Summary: P/E Bands ▫Intrinsic Valuation Summary ▫Other Valuation Methods ▫Comprehensive Risk Overview ▫Risk Analysis: Monte Carlo Simulation

Appendix §Pro-Forma Financial Statements ▫Pro-Forma Income Statement ▫Pro-Forma Balance Sheet ▫Pro-Forma Statement of Cash

Appendix §Pro-Forma Financial Statements ▫Pro-Forma Income Statement ▫Pro-Forma Balance Sheet ▫Pro-Forma Statement of Cash Flows §Intrinsic Valuation ▫DCFF Analysis ▫WACC Calculation ▫Sensitivity Analysis §Industry Overview ▫EP Payment Adjustments ▫Meaningful Use Timeline ▫Medicaid Adoption §Business Overview ▫CERN Business Model ▫Business Segment Revenue Mix ▫Jargon Buster ▫Historic Stock Price

Appendix 1: Pro-Forma Income Statement

Appendix 1: Pro-Forma Income Statement

Appendix 2: Pro-Forma Balance Sheet

Appendix 2: Pro-Forma Balance Sheet

Appendix 3: Pro-Forma Statement of Cash Flows

Appendix 3: Pro-Forma Statement of Cash Flows

Appendix 4: DCF Analysis

Appendix 4: DCF Analysis

Appendix 5: WACC Calculation

Appendix 5: WACC Calculation

Appendix 6: Sensitivity Analysis

Appendix 6: Sensitivity Analysis

Appendix 7: CERN Business Model

Appendix 7: CERN Business Model

Appendix 8: EP Payment Adjustments

Appendix 8: EP Payment Adjustments

Appendix 9: Meaningful Use Timeline

Appendix 9: Meaningful Use Timeline

Appendix 10: Medicaid Adoption

Appendix 10: Medicaid Adoption

Appendix 11: Business Segment Revenue Mix

Appendix 11: Business Segment Revenue Mix

Appendix 12: “Jargon Buster” (AAFP – HIPAA) HCIT Useful Terms [AAFP – HIPAA] AAFP:

Appendix 12: “Jargon Buster” (AAFP – HIPAA) HCIT Useful Terms [AAFP – HIPAA] AAFP: American Academy of Family Physicians ACO: Accountable Care Organization AHA: American Hospital Association AHRQ: Agency for Healthcare Research and Quality AHIP: America’s Health Insurance Plans – national trade association representing the health insurance industry AMA: American Medical Association ARRA: American Recovery and Reinvestment Act – law that directed approximately $150 B in new funding to the healthcare industry. CCHIT: Certification Commission for Health Information Technology CDS: Clinical Decision Support – process to enhance health related decisions with pertinent clinic and patient information to improve healthcare delivery CHIME: College of Healthcare Information Management Executives Cloud Computing: delivering hosted services over the internet. CMS: Centers for Medicare & Medicaid Services CPOE: Computerized Physician Order Entry CAHs: Critical Access Hospitals – organizations certified to receive cost-based reimbursement from Medicare. ECM: Enterprise Content Management - strategies, methods and tools used to capture, manage, store, preserve and deliver content and documents related to organizational processes EDI: Electronic Data Interchange EDIS: Emergency Department Information Systems – EHR systems designed to specifically manage data and workflow in support of Emergency Department patient care. EHR: Electronic Health Record - collection of patient health information generated by one or more meetings in any care delivery setting EMR: Electronic Medical Record ERP: Enterprise Resource Planning – business management software that allows organizations to use an integrated system HCIT: Healthcare Information Technology HHS: Department of Health & Human Services HIE: Health Information Exchange – transmission of healthcare-related date among facilities, organizations, and government agencies. HIMMS: Healthcare Information and Management Systems Society HIPAA 5010: Health Insurance Portability and Accountability Act – requires Medicare and all other health insurance payers to comply with EDI standards.

Appendix 13: “Jargon Buster” (HITECH Act – VBPP) HCIT Useful Terms [HITECH Act –

Appendix 13: “Jargon Buster” (HITECH Act – VBPP) HCIT Useful Terms [HITECH Act – VBPP] HITECH Act: Health Information Technology for Economic and Clinical Health – part of the 2009 ARRA , promoting the adoption and meaningful use of health information technology ICD-10: International Classification of Diseases, 10 th Revision. IHE: Integrating the Healthcare Enterprise - global initiative that creates framework for passing vital health information, whether from application to application or system to system, seamlessly IDN: Integrated Delivery Network - network of facilities and providers that work together to offer a continuum of care to a specific geographic area or market. Interoperability: ability of health information systems to work together within and across organizational boundaries in order to advance the effective delivery of healthcare Medicare vs. Medicaid MU: Meaningful Use – guidelines for receiving compensation upon implementation of EHR MDI: Medical Device Integration NHIN: Nationwide Health Information Network - set of standards, services and policies that enable secure health information exchange over the Internet PHM: Population Health Management RCM: Revenue Cycle Management - process that manages claims processing, payment and revenue generation Stage 7 Hospitals: completely paperless facilities VBPP: Value Based Purchasing Program Cerner Product Offerings: Ambulatory EHR: system designed by physicians to minimize clicks, provide comprehensive yet flexible documentation, and automate reporting processes. Care. Aware i. Bus: next generation solution that connects medical devices to the electronic health record to support the entire care process. Healthe Intent: bundle providing access to three powerful cloud based services ITWorks: business unit that provides a full suite of strategic and information technology sercvices to Cerner clients Rev. Works Services: provide a unique combination of health care finance experience and information technology intelligence to examine and optimize your operations. Smart Room: incorporates technology and workflow solutions to improve patient care and clinician efficiency

Appendix 14: Historic Stock Price Chart

Appendix 14: Historic Stock Price Chart