XNAS:CERN Cerner Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 2012

OR

( )    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                          to                             

Commission File Number          0-15386             

CERNER CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
 
43-1196944
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification
Number)

2800 Rockcreek Parkway
North Kansas City, Missouri 64117
(816) 201-1024
(Address of Principal Executive Offices, including zip code; registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]     No [  ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X]     No [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]     Accelerated filer [  ]     Non-accelerated filer [  ]     Smaller reporting company [  ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]       No [X]
Indicate the number of shares outstanding of the issuer’s classes of common stock, as of the latest practicable date.
Class
  
Outstanding at July 23, 2012
Common Stock, $0.01 par value per share
  
171,177,947 shares



CERNER CORPORATION AND SUBSIDIARIES

I N D E X
 
 
 
 
Part I.
Financial Information:
 
 
 
 
Item 1.
Financial Statements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II.
 
 
 
Item 2.
 
 
 
Item 6.




Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of June 30, 2012 (unaudited) and December 31, 2011
(In thousands, except share data)
2012
 
2011
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
302,788

 
$
243,146

Short-term investments
677,214

 
531,635

Receivables, net
492,529

 
563,209

Inventory
22,521

 
23,296

Prepaid expenses and other
118,304

 
94,232

Deferred income taxes, net
47,425

 
46,795

Total current assets
1,660,781

 
1,502,313

 
 
 
 
Property and equipment, net
534,611

 
488,996

Software development costs, net
255,965

 
248,750

Goodwill
211,498

 
211,826

Intangible assets, net
69,663

 
75,366

Long-term investments
412,244

 
359,324

Other assets
154,282

 
113,783

 
 
 
 
Total assets
$
3,299,044

 
$
3,000,358

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
123,869

 
$
85,545

Current installments of long-term debt
50,129

 
39,722

Deferred revenue
163,492

 
153,139

Accrued payroll and tax withholdings
102,397

 
109,227

Other accrued expenses
25,239

 
51,087

Total current liabilities
465,126

 
438,720

 
 
 
 
Long-term debt and other obligations
125,951

 
86,821

Deferred income taxes and other liabilities
127,876

 
150,229

Deferred revenue
11,571

 
13,787

Total liabilities
730,524

 
689,557

 
 
 
 
Shareholders’ Equity:
 
 
 
Cerner Corporation shareholders’ equity:
 
 
 
Common stock, $.01 par value, 250,000,000 shares authorized, 171,161,517 shares issued at June 30, 2012 and 169,565,856 shares issued at December 31, 2011
1,712

 
1,696

Additional paid-in capital
795,621

 
723,490

Retained earnings
1,783,999

 
1,597,462

Accumulated other comprehensive loss, net
(12,932
)
 
(11,967
)
Total Cerner Corporation shareholders’ equity
2,568,400

 
2,310,681

 
 
 
 
Noncontrolling interest
120

 
120

Total shareholders’ equity
2,568,520

 
2,310,801

 
 
 
 
Total liabilities and shareholders’ equity
$
3,299,044

 
$
3,000,358


See notes to condensed consolidated financial statements (unaudited).

1


CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and six months ended June 30, 2012 and July 2, 2011
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
(In thousands, except per share data)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
System sales
$
195,295

 
$
157,145

 
$
421,115

 
$
297,524

Support, maintenance and services
426,046

 
355,330

 
829,950

 
696,324

Reimbursed travel
16,017

 
11,748

 
27,505

 
22,039

 
 
 
 
 
 
 
 
Total revenues
637,358

 
524,223

 
1,278,570

 
1,015,887

Costs and expenses:
 
 
 
 
 
 
 
Cost of system sales
100,570

 
61,887

 
217,525

 
119,986

Cost of support, maintenance and services
30,913

 
24,847

 
60,478

 
47,137

Cost of reimbursed travel
16,017

 
11,748

 
27,505

 
22,039

Sales and client service
241,875

 
210,213

 
486,949

 
411,561

Software development (Includes amortization of $20,084 and $39,473 for the three and six months ended June 30, 2012; and $19,910 and $38,968 for the three and six months ended July 2, 2011)
73,507

 
69,790

 
144,652

 
140,934

General and administrative
38,393

 
37,765

 
77,939

 
72,558

 
 
 
 
 
 
 
 
Total costs and expenses
501,275

 
416,250

 
1,015,048

 
814,215

 
 
 
 
 
 
 
 
Operating earnings
136,083

 
107,973

 
263,522

 
201,672

 
 
 
 
 
 
 
 
Other income, net
2,814

 
2,880

 
5,438

 
4,891

 
 
 
 
 
 
 
 
Earnings before income taxes
138,897

 
110,853

 
268,960

 
206,563

Income taxes
(41,068
)
 
(38,809
)
 
(82,423
)
 
(69,963
)
 
 
 
 
 
 
 
 
Net earnings
$
97,829

 
$
72,044

 
$
186,537

 
$
136,600

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.57

 
$
0.43

 
$
1.10

 
$
0.81

Diluted earnings per share
$
0.56

 
$
0.42

 
$
1.06

 
$
0.79

Basic weighted average shares outstanding
170,713

 
168,299

 
170,336

 
167,706

Diluted weighted average shares outstanding
175,634

 
173,591

 
175,333

 
173,128

See notes to condensed consolidated financial statements (unaudited).


2



CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three and six months ended June 30, 2012 and July 2, 2011
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
(In thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net earnings
$
97,829

 
$
72,044

 
$
186,537

 
$
136,600

Foreign currency translation adjustment and other (net of tax of $96 and $(635) for the three and six months ended June 30, 2012; and $60 and $(838) for the three and six months ended July 2, 2011)
(8,961
)
 
4,202

 
(993
)
 
15,893

Change in net unrealized holding gain (loss) on available-for-sale investments (net of tax of $17 and $17 for the three and six months ended June 30, 2012)
28

 

 
28

 

 
 
 
 
 
 
 
 
Comprehensive income
$
88,896

 
$
76,246

 
$
185,572

 
$
152,493

See notes to condensed consolidated financial statements (unaudited).


3


CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2012 and July 2, 2011
(unaudited)
 
 
Six Months Ended
(In thousands)
2012
 
2011
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
186,537

 
$
136,600

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
106,215

 
102,670

Share-based compensation expense
16,583

 
13,131

Provision for deferred income taxes
(10,480
)
 
7,869

Changes in assets and liabilities (net of businesses acquired):
 
 
 
Receivables, net
31,282

 
(35,718
)
Inventory
878

 
(1,969
)
Prepaid expenses and other
(13,898
)
 
(11,185
)
Accounts payable
15,059

 
2,913

Accrued income taxes
(29,459
)
 
477

Deferred revenue
8,140

 
14,494

Other accrued liabilities
34,690

 
19,346

 
 
 
 
Net cash provided by operating activities
345,547

 
248,628

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(78,164
)
 
(51,677
)
Capitalized software development costs
(46,847
)
 
(41,055
)
Purchases of investments
(655,310
)
 
(628,686
)
Sales and maturities of investments
446,861

 
447,009

Purchase of other intangibles
(5,586
)
 
(5,098
)
Acquisition of businesses, net of cash acquired

 
(28,069
)
 
 
 
 
Net cash used in investing activities
(339,046
)
 
(307,576
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of long-term debt
(1,438
)
 
(454
)
Proceeds from excess tax benefits from stock compensation
30,101

 
26,570

Proceeds from exercise of options
25,044

 
29,972

Contingent consideration payments for acquisition of business

 
(779
)
 
 
 
 
Net cash provided by financing activities
53,707


55,309

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(566
)
 
3,184

 
 
 
 
Net increase (decrease) in cash and cash equivalents
59,642

 
(455
)
Cash and cash equivalents at beginning of period
243,146

 
214,511

 
 
 
 
Cash and cash equivalents at end of period
$
302,788

 
$
214,056

See notes to condensed consolidated financial statements (unaudited).


4


CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
(1)
Interim Statement Presentation
The condensed consolidated financial statements included herein have been prepared by Cerner Corporation (we or the Company) 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.
Our second fiscal quarter ends on the Saturday closest to June 30. The 2012 and 2011 second quarters ended on June 30, 2012 and July 2, 2011, respectively. All references to years in these notes to condensed consolidated financial statements represent the respective three or six months ended on such dates, unless otherwise noted.
Recently Adopted Accounting Pronouncements
Comprehensive Income. On January 1, 2012, we adopted Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2011-05, Presentation of Comprehensive Income. ASU 2011-05 requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in equity. These condensed consolidated financial statements include separate Condensed Consolidated Statements of Comprehensive Income.
Goodwill Impairment. On January 1, 2012, we adopted FASB ASU 2011-08, Testing for Goodwill Impairment. ASU 2011-08 amends existing guidance by giving an entity the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than the carrying amount. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then it is necessary to perform the two-step goodwill impairment test, as currently prescribed by FASB Accounting Standards Codification Topic 350. Otherwise, the two-step goodwill impairment test is not required. The adoption of this standard did not have a material effect on our condensed consolidated financial statements.
 
(2)
Fair Value Measurements
We determine fair value measurements used in our condensed 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.

5


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 June 30, 2012: 
(In thousands)
 
 
 
June 30, 2012
 
 
Balance Sheet
 
Fair Value Measurements Using
Description
 
Classification
 
Level 1
 
Level 2
 
Level 3
Money market funds
 
Cash equivalents
 
$
68,859

 
$

 
$

Time deposits
 
Cash equivalents
 

 
11,907

 

Time deposits
 
Short-term investments
 

 
77,459

 

Commercial paper
 
Short-term investments
 

 
48,221

 

Government and corporate bonds
 
Short-term investments
 

 
551,534

 

Government and corporate bonds
 
Long-term investments
 

 
406,244

 


The following table details our financial assets measured, but not recorded, at fair value on a recurring basis at December 31, 2011:
(In thousands)
 
 
 
December 31, 2011
 
 
Balance Sheet
 
Fair Value Measurements Using
Description
 
Classification
 
Level 1
 
Level 2
 
Level 3
Money market funds
 
Cash equivalents
 
$
123,919

 
$

 
$

Time deposits
 
Cash equivalents
 

 
7,358

 

Time deposits
 
Short-term investments
 

 
67,632

 

Commercial paper
 
Short-term investments
 

 
23,250

 

Government and corporate bonds
 
Short-term investments
 

 
440,753

 

Time deposits
 
Long-term investments
 

 
19,579

 

Government and corporate bonds
 
Long-term investments
 

 
337,245

 

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. The fair value of our long-term debt, including current maturities, at June 30, 2012 and December 31, 2011 was approximately $73.2 million and $72.6 million, respectively. The carrying amount of such fixed-rate debt at June 30, 2012 and December 31, 2011 was $68.1 million and $67.5 million, respectively.
 
(3)
Investments

Cash equivalents consist of short-term marketable securities with original maturities less than 90 days. Short-term investments primarily consist of time deposits, commercial paper, and government and corporate bonds with maturities of less than one year. Long-term investments primarily consist of government and corporate bonds with maturities of less than two years.

Effective April 1, 2012, we began reporting all securities in our investment portfolio as available-for-sale. The change resulted in the transfer of investments with an aggregate carrying amount of $1.0 billion from held-to-maturity to available-for-sale, with gross unrealized gains of $0.7 million and gross unrealized losses of $0.7 million. The unrealized gains and losses, net of the related tax effects, were recorded to accumulated other comprehensive income. The decision to transfer the securities to available-for-sale is intended to provide us with financial flexibility in determining whether to hold our investment securities to maturity. Such change contemplates the possibility that securities may be liquidated prior to maturity as we manage through changing market conditions.

Available-for-sale securities are recorded at fair value with the unrealized gains and losses reflected in accumulated other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis.

We regularly review investment securities for impairment based on both quantitative and qualitative criteria that include the extent to which cost exceeds fair value, the duration of any market decline, and the financial health of and specific prospects for the issuer. Unrealized losses that are other than temporary are recognized in earnings.


6


Available-for-sale investments at June 30, 2012 were as follows:
 
 
June 30, 2012
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
68,859

 
$

 
$

 
$
68,859

Time deposits
 
11,907

 

 

 
11,907

Total cash equivalents
 
80,766

 

 

 
80,766

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
77,475

 

 
(16
)
 
77,459

Commercial paper
 
48,250

 
1

 
(30
)
 
48,221

Government and corporate bonds
 
551,284

 
442

 
(192
)
 
551,534

Total short-term investments
 
677,009

 
443

 
(238
)
 
677,214

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
406,404

 
149

 
(309
)
 
406,244

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
1,164,179

 
$
592

 
$
(547
)
 
$
1,164,224


At December 31, 2011, we held cash equivalents, short-term investments and long-term investments of $131.3 million, $531.6 million and $359.3 million, respectively. Investments at December 31, 2011 were classified as held-to-maturity and stated at amortized cost.

We sold available-for-sale investments for proceeds of $8.5 million in the second quarter of 2012, resulting in an insignificant gain.

(4)
Receivables
A summary of net receivables is as follows:
 
(In thousands)
June 30, 2012
 
December 31, 2011
Gross accounts receivable
$
475,798

 
$
496,706

Less: Allowance for doubtful accounts
28,435

 
24,270

 
 
 
 
Accounts receivable, net of allowance
447,363

 
472,436

 
 
 
 
Contracts receivable
24,878

 
81,776

Current portion of lease receivables
20,288

 
8,997

 
 
 
 
Total receivables, net
$
492,529

 
$
563,209


During the second quarter of 2008, Fujitsu Services Limited’s (Fujitsu) contract as the prime contractor in the National Health Service (NHS) initiative to automate clinical processes and digitize medical records in the Southern region of England was terminated by the NHS. This had the effect of automatically terminating our subcontract for the project. We are in dispute with Fujitsu regarding Fujitsu’s obligation to pay the amounts comprised of accounts receivable and contracts receivable related to that subcontract, and we are working with Fujitsu to resolve these issues based on processes provided for in the contract. Part of that process requires resolution of disputes between Fujitsu and the NHS regarding the contract termination. As of June 30, 2012, it remains unlikely that the matter will be resolved in the next 12 months. Therefore, these receivables have been classified as long-term and represent less than the majority of other long-term assets as of the quarter ended June 30, 2012. While the ultimate collectability of the receivables pursuant to this process is uncertain, we believe that we have valid and equitable grounds for recovery of such amounts and that collection of recorded amounts is probable.


7


During the first six months of 2012 and 2011, we received total client cash collections of $1.4 billion and $1.0 billion, respectively, of which $32.5 million and $35.1 million were received from third party arrangements with non-recourse payment assignments.
 
(5)
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. We classify interest and penalties associated with unrecognized tax benefits as income tax expense in our Condensed Consolidated Statements of Operations.
Our effective tax rate was 30.6% and 33.9% for the first six months of 2012 and 2011, respectively. This decrease was primarily due to an increase in net favorable discrete items recorded in 2012 relative to 2011, partially offset by the expiration of the research and development tax credit on December 31, 2011.
During the second quarter of 2012, we increased our estimate of a tax deduction available for 2011 and recorded the related benefit as a favorable discrete item, which reduced our effective tax rate. Absent this discrete item, our effective tax rate for the second quarter of 2012 would be approximately 35%.
We recorded an adjustment to our unrecognized tax benefits during the first quarter of 2012, resulting from the settlement of an ongoing tax audit, which favorably impacted our income tax provision by $12.0 million. We do not anticipate recognition of any material unrecognized tax benefits in the next twelve months. In the first quarter of 2012, we also recognized $5.6 million of tax expense as a discrete item in connection with the license of certain intellectual property rights to a wholly owned foreign subsidiary.
 
(6)
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
 
 
2012
 
2011
 
 
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
 
$
97,829

 
170,713

 
$
0.57

 
$
72,044

 
168,299

 
$
0.43

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

 
4,921

 
 
 

 
5,292

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
 
$
97,829

 
175,634

 
$
0.56

 
$
72,044

 
173,591

 
$
0.42


For the three months ended June 30, 2012 and July 2, 2011, options to purchase 2.4 million and 2.2 million shares, respectively, of common stock at per share prices ranging from $55.24 to $85.96 and $38.99 to $60.62, respectively, were not included in the computation of diluted earnings per share because the options were anti-dilutive.

 
 
Six Months Ended
 
 
2012
 
2011
 
 
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
 
$
186,537

 
170,336

 
$
1.10

 
$
136,600

 
167,706

 
$
0.81

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

 
4,997

 
 
 

 
5,422

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
 
$
186,537

 
175,333

 
$
1.06

 
$
136,600

 
173,128

 
$
0.79



8


For the six months ended June 30, 2012 and July 2, 2011, options to purchase 2.0 million and 1.8 million shares, respectively, of common stock at per share prices ranging from $51.60 to $85.96 and $38.06 to $60.62, respectively, were not included in the computation of diluted earnings per share because the options were anti-dilutive.

(7)
Share-Based Compensation
Stock Options
Options activity for the six months ended June 30, 2012 was as follows:
 
(In thousands, except per share data)
Six Months Ended June 30, 2012
Options
Number of
Shares
 
Weighted-
Average
Exercise 
Price
 
Aggregate
Intrinsic 
Value
 
Weighted-Average      
Remaining      
Contractual
 Term (Yrs)      
Outstanding at beginning of year
12,909

 
$
23.78

 
 
 
 
Granted
1,663

 
81.71

 
 
 
 
Exercised
(1,556
)
 
16.48

 
 
 
 
Forfeited and expired
(176
)
 
46.26

 
 
 
 
Outstanding as of June 30, 2012
12,840

 
$
31.86

 
$
652,462

 
6.49
 
 
 
 
 
 
 
 
Exercisable as of June 30, 2012
7,966

 
$
16.88

 
$
523,941

 
5.25

We valued options granted in 2012 under the Cerner Corporation 2011 Omnibus Equity Incentive Plan using the following weighted average assumptions: 
Expected volatility (%)
 
34.7

Expected term (yrs)
 
9.1

Risk-free rate (%)
 
2.1

Fair value per option
 
$
37.4

As of June 30, 2012, there was $107.6 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 3.52 years.
Non-vested Shares
Non-vested share activity for the six months ended June 30, 2012 was as follows: 
 
Six Months Ended
(In thousands, except per share data)
June 30, 2012
Restricted Stock
Number of Shares
 
Weighted-Average
Grant Date Fair Value
Outstanding at beginning of year
254

 
$
47.75

Granted
58

 
77.11

Vested
(48
)
 
50.85

Forfeited

 

Outstanding as of June 30, 2012
264

 
$
53.72

As of June 30, 2012, there was $8.5 million of total unrecognized compensation cost related to non-vested share awards granted under all plans. That cost is expected to be recognized over a weighted-average period of 1.54 years.


9


The following table presents the total compensation expense recognized in the Condensed Consolidated Statements of Operations with respect to stock options, non-vested shares and our Associate Stock Purchase Plan: 

 
 
Three Months Ended
 
Six Months Ended
(In thousands)
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
 
Stock option and non-vested share compensation expense
 
$
8,252

 
$
6,187

 
$
16,583

 
$
13,131

Associate stock purchase plan expense
 
613

 
566

 
1,345

 
1,048

Amounts capitalized in software development costs, net of amortization
 
(268
)
 
(185
)
 
(382
)
 
(250
)
 
 
 
 
 
 
 
 
 
Amounts charged against earnings, before income tax benefit
 
$
8,597

 
$
6,568

 
$
17,546

 
$
13,929

 
 
 
 
 
 
 
 
 
Amount of related income tax benefit recognized in earnings
 
$
3,288

 
$
2,502

 
$
6,711

 
$
5,307

 
(8)
Hedging Activities
The following table represents the fair value of our net investment hedge included within the Condensed Consolidated Balance Sheets:
(In thousands)
 
 
Fair Value
Derivatives Designated
Balance Sheet Classification
 
June 30, 2012
 
December 31, 2011
 
 
 
 
 
 
Net investment hedge
Short-term liabilities
 
$
14,582

 
$
14,421

Net investment hedge
Long-term liabilities
 
43,747

 
43,262

 
 
 
 
 
 
Total net investment hedge
 
$
58,329

 
$
57,683

 
The following table represents the related unrealized gain or loss, net of related income tax effects, on the net investment hedge recognized in comprehensive income: 

(In thousands)
Net Unrealized Gain (Loss)
 
Net Unrealized Gain (Loss)
 
For the Three Months Ended
 
For the Six Months Ended
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net investment hedge - S/T
$
176

 
$
(20
)
 
$
(100
)
 
$
272

Net investment hedge - L/T
528

 
(78
)
 
(299
)
 
1,090

 
 
 
 
 
 
 
 
Total net investment hedge
$
704

 
$
(98
)
 
$
(399
)
 
$
1,362


(9)
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 losses related to these indemnification provisions pertaining to third party intellectual property infringement claims. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the terms of the corresponding agreements with our clients, we cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.
 
(10)
Segment Reporting

We have two operating segments, Domestic and Global. Revenues are derived primarily from the sale of clinical, financial and administrative information systems and solutions. The cost of revenues includes the cost of third party consulting services, computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Performance of the segments is

10


assessed at the operating earnings level and, therefore, the segment operations have been presented as such. “Other” includes expenses that have not been allocated to the operating segments, such as software development, marketing, general and administrative, share-based compensation expense and depreciation. We manage our operating segments to the operating earnings level. Items such as interest, income taxes, capital expenditures and total assets are managed at the consolidated level and thus are not included in our operating segment disclosures.

Accounting policies for each of the reportable segments are the same as those used on a consolidated basis. The following table presents a summary of our operating segments and other expense for the three and six months ended June 30, 2012 and July 2, 2011:
 
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
Three Months Ended 2012
 
 
 
 
 
 
 
Revenues
$
561,658

 
$
75,700

 
$

 
$
637,358

 
 
 
 
 
 
 
 
Cost of revenues
137,652

 
9,848

 

 
147,500

Operating expenses
120,443

 
32,071

 
201,261

 
353,775

Total costs and expenses
258,095

 
41,919


201,261

 
501,275

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
303,563

 
$
33,781

 
$
(201,261
)
 
$
136,083

 
 
 
 
 
 
 
 
(In thousands)
Domestic        
 
Global        
 
Other        
 
Total        
Three Months Ended 2011
 
 
 
 
 
 
 
Revenues
$
450,254

 
$
73,969

 
$

 
$
524,223

 
 
 
 
 
 
 
 
Cost of revenues
87,413

 
11,069

 

 
98,482

Operating expenses
106,126

 
31,671

 
179,971

 
317,768

Total costs and expenses
193,539

 
42,740

 
179,971

 
416,250

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
256,715

 
$
31,229

 
$
(179,971
)
 
$
107,973


(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
Six Months Ended 2012
 
 
 
 
 
 
 
Revenues
$
1,115,932

 
$
162,638

 
$

 
$
1,278,570

 
 
 
 
 
 
 
 
Cost of revenues
271,955

 
33,553

 

 
305,508

Operating expenses
240,881

 
64,822

 
403,837

 
709,540

Total costs and expenses
512,836

 
98,375

 
403,837

 
1,015,048

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
603,096

 
$
64,263

 
$
(403,837
)
 
$
263,522

 
 
 
 
 
 
 
 
(In thousands)
Domestic        
 
Global        
 
Other        
 
Total        
Six Months Ended 2011
 
 
 
 
 
 
 
Revenues
$
871,244

 
$
144,643

 
$

 
$
1,015,887

 
 
 
 
 
 
 
 
Cost of revenues
165,338

 
23,824

 

 
189,162

Operating expenses
211,475

 
60,770

 
352,808

 
625,053

Total costs and expenses
376,813

 
84,594

 
352,808

 
814,215

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
494,431

 
$
60,049

 
$
(352,808
)
 
$
201,672



11


(11)
Related Party Transactions

During 2009, as part of our long-term space planning analysis, we determined that we would require additional office space for associates to accommodate our anticipated growth. We evaluated various sites in the Kansas City metropolitan area and negotiated with several different governmental entities regarding available incentives. Upon completion of this review, we decided to proceed with an office development in Wyandotte County, Kansas, which is part of the “Village West” development. In order to maximize available incentives, we agreed to pursue the Village West office development in conjunction with the development of an 18,000 seat, multi-sport stadium and related recreational athletic complex.

The Village West stadium complex was developed by Kansas Unified Development, LLC (the “Developer”), an entity controlled by Neal Patterson, Chairman of the Board of Directors, Chief Executive Officer and President of Cerner Corporation, and Clifford Illig, Vice Chairman of the Board of Directors of Cerner Corporation. Sporting Kansas City (“Sporting KC”) is the principal tenant of the stadium complex. OnGoal LLC (“OnGoal”), the owner of the Sporting KC professional soccer club, is also controlled by Messrs. Patterson and Illig.

The total construction and development cost of the office complex has initially been estimated to be approximately $160.0 million. The Company currently believes it will receive incentives totaling approximately $80.0 million from the Developer, the Unified Government of Wyandotte County/Kansas City, Kansas (the “Unified Government”) and the Kansas Department of Commerce. Incentives from the Kansas Department of Commerce will include cash grants, tax exemptions and tax credits. The value of some of these incentives may ultimately increase or decrease depending upon the final capital invested and the number of new jobs created. We currently expect our net investment in the Village West office complex, after applying expected government incentives and payments from the Developer, to be approximately $80.0 million.

In connection with the Village West office complex development and the related incentives, we have entered into three agreements:

Land Transfer and Specific Venture Agreement (the “Land Transfer Agreement”) dated January 19, 2010 with the Unified Government and the Developer,
Workforce Services Training Agreement (the “Workforce Agreement”) dated January 20, 2010 with the Kansas Department of Commerce, as amended by the First Amendment to Workforce Services Training Agreement dated June 7, 2011, and
Interparty Agreement dated January 19, 2010 with OnGoal and the Developer.

Pursuant to the Land Transfer Agreement, we acquired the land from the Unified Government with certain contingencies upon which the office complex is being constructed. The purchase price, equal to the site’s fair market value, is being paid by the Developer. In the second quarter of 2012, vertical construction began on the Village West office development. In connection with the commencement of vertical construction, contingencies were resolved and we recorded land contributed to the Company from the Unified Government at its appraisal value.

Pursuant to the Workforce Agreement, as amended, we agreed to establish positions for 4,500 employees with an average annual wage of at least $31.00 per hour. In consideration of this commitment, we have elected to receive up to $48.5 million from the Kansas Department of Commerce for project investment costs and employee training (the “IMPACT Award”). We can specify the date when the IMPACT Award will be distributed by the Kansas Department of Commerce, which must be by December 31, 2015. The State of Kansas has issued bonds in order to fund these incentives to us and has incurred costs of issuance and debt service obligations. We may be obligated to repay the Kansas Department of Commerce under the following circumstances:

If we do not request distribution of all or part of the IMPACT Award, we must pay $64.9 million (which represents the Impact Award amount plus the state’s estimated issuance costs)(the “Gross Funded Amount”) less an amount equal to any IMPACT Award amount not received,
If we fail to establish new jobs for at least 4,275 full time employees at the Village West office complex prior to December 31, 2017, we will repay an amount equal to $48.0 million multiplied by the shortfall of total new jobs created by us, which is 4,500 less the number of jobs created as of December 31, 2017, divided by 4,500 (the “MPI Repayment Amount”), and

12


If we have not generated aggregate Kansas state tax withholdings from wages earned by new jobs at the Village West office complex of at least the Gross Funded Amount within 10 years after receiving the IMPACT Award, then we will repay the difference (the “Withholding Tax Repayment Amount”).

The MPI Repayment Amount is not due until 10 years after we first receive the IMPACT Award. Our total repayment obligations under the Workforce Agreement will not exceed the Gross Funded Amount less the aggregate Kansas state tax withholdings from wages earned by new jobs at the Village West complex during the 10-year period after the IMPACT Award is received.

The Interparty Agreement provides that the Developer and OnGoal will be responsible for the repayment of any issuance costs plus the MPI Repayment Amount owed by us under the Workforce Agreement. The Developer and OnGoal will also indemnify and hold us harmless from and against any and all losses, costs, expenses, penalties and damages arising as a result of: a) the Developer’s failure to pay any sum that it has agreed to pay, or b) the Developer’s breach of any agreement with us which creates an obligation on our part for which the Developer has agreed to be responsible.

The Interparty Agreement further provides that the Developer or OnGoal will pay us a success fee of $4.0 million if the terms and conditions of the Workforce Agreement are satisfied so that no MPI Repayment Amounts or issuance costs are due by the Developer under the Workforce Agreement.

Pursuant to the Multi-Sport Stadium Specific Venture Agreement, the Developer, recognizing that the Unified Government relied on our jobs creation goals in its decision to provide incentives for the stadium complex, agreed to make ten annual “Office Payment Installments” to the Unified Government, each in the amount of approximately $3.0 million, commencing in 2017. The Office Payment Installments are intended to supplement the purchase prices paid to the Unified Government by the Developer for the stadium site and the office site. The Office Payment Installments may be reduced if the Developer meets certain conditions and if we commence construction of the office complex and meet the job creation goals.

We believe that the amount of government incentives that the Developer and OnGoal received, as well as the government incentives received by us, were materially increased due to the fact that we agreed to build our office complex in close proximity to the stadium complex. The independent members of our Board of Directors, acting as a committee, reviewed and unanimously approved the decision to proceed with the development of the Village West office complex in 2009. The independent Directors received advice from outside legal counsel, retained a consultant with real estate expertise regarding the transaction and were briefed on the structure of the various expansion options by members of management (other than Messrs. Patterson and Illig) at six separate meetings.

We entered into a Construction Coordinator Agreement dated January 20, 2012, as amended by Amendment No. 1 to the Construction Coordinator Agreement dated May 31, 2012, with GRAND Construction, LLC (“Coordinator”), a limited liability company owned in part by an entity controlled by Messers. Patterson and Illig, to coordinate, supervise, schedule and assist with managing the development, design and construction of the Cerner Kansas Campus Phase 1 and 2 Buildings and site at the Village West development. Under the agreement, we will pay Coordinator 2% of the total cost of the project (as specified in the agreement). Based on management’s projected scope of services, it is anticipated that the fees will be approximately $3.2 million, and paid over two years. The independent members of the Company’s Board of Directors, acting as a committee, reviewed and unanimously approved the Construction Coordinator Agreement dated January 20, 2012.

Additionally, in June 2012, the Company entered into an agreement with Coordinator for a separate project to make improvements to a parking facility for future use by one of our office campuses. Under the agreement we expect to pay Coordinator approximately $0.3 million.

13




Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Cerner Corporation and subsidiaries (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 the financial statements (Notes) found above.
Our second fiscal quarter ends on the Saturday closest to June 30. The 2012 and 2011 second quarters ended on June 30, 2012 and July 2, 2011, respectively. All references to years in this MD&A represent the respective three or six 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 can often be identified by the use of forward-looking terminology, such as "could," "should," “will,” "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast," “plan,” “guidance” or “estimate” or the negative of these words, variations thereof or similar expressions. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including without limitation: the possibility of product-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities; our proprietary technology may be subject to claims for infringement or misappropriation of intellectual property rights of others, or may be infringed or misappropriated by others; risks associated with our non-U.S. operations; risks associated with our ability to effectively hedge exposure to fluctuations in foreign currency exchange rates; the potential for tax legislation initiatives that could adversely affect our tax position and/or challenges to our tax positions in the United States and non-U.S. countries; risks associated with our recruitment and retention of key personnel; risks related to our reliance on third party suppliers; risks inherent with business acquisitions; the potential for losses resulting from asset impairment charges; risks associated with the uncertainty in global economic conditions; changing political, economic, regulatory and judicial influences; government regulation; significant competition and market changes; variations in our quarterly operating results; potential inconsistencies in our sales forecasts compared to actual sales; volatility in the trading price of our common stock and the timing and volume of market activity; the authority of our Board of Directors to issue preferred stock and anti-takeover provisions contained in our corporate governance documents; material adverse resolution of legal proceedings; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission 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 to the date they are made. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.
Management Overview
Our revenues are primarily derived by selling, implementing and supporting software solutions, clinical content, hardware, health care devices and services that give health care providers secure access to clinical, administrative and financial data in real time, allowing them to improve the quality, safety and efficiency in the delivery of health care.
Our fundamental strategy centers on creating 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 10% or more. This growth has also created an important strategic footprint in health care, with Cerner® solutions licensed by approximately 9,300 facilities around the world, including more than 2,650 hospitals; 3,750 physician practices; 40,000 physicians; 500 ambulatory facilities, such as laboratories, ambulatory centers, cardiac facilities, radiology clinics and surgery centers; 800 home health facilities; 40 employer sites and 1,600 retail pharmacies. Selling additional solutions back into this client base is an important element of our future revenue growth. We are also focused on driving growth through market share expansion by strategically aligning with health care providers that have not yet selected a supplier and by displacing competitors in health care settings that are planning to replace their current supplier.
We expect to drive growth through new initiatives 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 HealtheSM employer services, Cerner ITWorksSM services, Cerner RevWorksSM services, and solutions on our Healthe IntentSM platform. Finally, we believe there is significant opportunity for growth outside of the United States, with many non-

14


U.S. markets focused on health care information technology (HCIT) 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 more than 20% over the most recent five- and ten-year periods. We expect to drive continued earnings growth through ongoing revenue growth coupled with margin expansion, which we expect to achieve through efficiencies in our implementation and operational processes and by leveraging R&D investments and controlling general and administrative expenses.
We are also focused on continuing to deliver strong levels of cash flow, which we expect to do by continuing to grow earnings and prudently managing capital expenditures.
Results Overview
The Company delivered strong levels of bookings, revenues, earnings and cash flows in the second quarter of 2012.
New business bookings, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $700.5 million in the second quarter of 2012, which was an increase of 8% compared to $649.9 million in the second quarter of 2011. Revenues for the second quarter of 2012 increased 22% to $637.4 million compared to $524.2 million in the year-ago quarter. The year-over-year increase in revenue reflects ongoing demand related to “meaningful use” incentives that we believe are increasing the focus of health care providers on improving the efficiency and quality of health care through the use of information technology and related services. In addition, new initiatives, such as DeviceWorks and Cerner ITWorks, are contributing to growth.
Second quarter 2012 net earnings increased 36% to $97.8 million compared to $72.0 million in the second quarter of 2011. Diluted earnings per share increased 33% to $0.56 compared to $0.42 in the second quarter of 2011. Second quarter 2012 and 2011 net earnings and diluted earnings per share reflect the impact of stock-based compensation expense. The effect of these expenses reduced the second quarter 2012 net earnings and diluted earnings per share by $5.3 million and $0.03, respectively, and second quarter 2011 net earnings and diluted earnings per share by $4.1 million and $0.02, respectively.
The growth in net earnings and diluted earnings per share was driven primarily by strong revenue growth and continued progress with our margin expansion initiatives, including driving efficiencies in our services businesses, leveraging R&D investments and controlling selling, general and administrative expenses. Our second quarter 2012 operating margin was 21.4%, which is 80 basis points higher than the year-ago quarter.

We had strong cash collections of receivables of $679.6 million in the second quarter of 2012 compared to $509.0 million in the second quarter of 2011. Days sales outstanding was 71 days in the second quarter of 2012 compared to 76 days in the first quarter of 2012 and 88 days in the second quarter of 2011. Operating cash flows for the second quarter of 2012 were strong at $182.8 million compared to $122.1 million in the second quarter of 2011.


15


Results of Operations
Three Months Ended June 30, 2012 Compared to Three Months Ended July 2, 2011
The following table presents a summary of the operating information for the second quarters of 2012 and 2011:
 
(In thousands)
2012
% of
Revenue
 
2011
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
195,295

31
%
 
$
157,145

 
30
%
 
24
%
Support and maintenance
150,497

24
%
 
138,180

 
26
%
 
9
%
Services
275,549

43
%
 
217,150

 
42
%
 
27
%
Reimbursed travel
16,017

3
%
 
11,748

 
2
%
 
36
%
 
 
 
 
 
 
 
 
 
Total revenues
637,358

100
%
 
524,223

 
100
%
 
22
%
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
Costs of revenue
147,500

23
%
 
98,482

 
19
%
 
50
%
 
 
 
 
 
 
 
 
 
Total margin
489,858

77
%
 
425,741

 
81
%
 
15
%
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Sales and client service
241,875

38
%
 
210,213

 
40
%
 
15
%
Software development
73,507

12
%
 
69,790

 
14
%
 
5
%
General and administrative
38,393

6
%
 
37,765

 
7
%
 
2
%
 
 
 
 
 
 
 
 
 
Total operating expenses
353,775

56
%
 
317,768

 
61
%
 
11
%
 
 
 
 
 
 
 
 
 
Total costs and expenses
501,275

79
%
 
416,250

 
79
%
 
20
%
 
 
 
 
 
 
 
 
 
Operating earnings
136,083

21
%
 
107,973

 
21
%
 
26
%
 
 
 
 
 
 
 
 
 
Other income, net
2,814

 
 
2,880

 
 
 
 
Income taxes
(41,068
)
 
 
(38,809
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
97,829

 
 
$
72,044

 
 
 
36
%
Revenues & Backlog
Revenues increased 22% to $637.4 million for the second quarter of 2012 from $524.2 million for the same period in 2011.
 
System sales, which include revenues from the sale of licensed software, software as a service, technology resale (hardware, devices, and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions, increased 24% to $195.3 million for the second quarter of 2012 from $157.1 million for the same period in 2011. The increase in system sales was driven by strong growth in technology resale.
Support and maintenance revenues increased 9% to $150.5 million during the second quarter of 2012 from $138.2 million during the same period in 2011. This increase was attributable to continued success at selling Cerner Millennium® applications and implementing them at client sites. We expect that support and maintenance revenues will continue to grow as the base of installed Cerner Millennium systems grows.
Services revenue, which includes professional services, excluding installation, and managed services, increased 27% to $275.5 million from $217.2 million for the same period in 2011. This increase was driven by growth in CernerWorksSM managed services as a result of continued demand for our hosting services and an increase in professional services due to increased implementation activities and growth in Cerner ITWorks services.

16


Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, at June 30, 2012 increased 22% when compared to July 2, 2011. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services and Cerner ITWorks services bookings that typically have longer contract terms. A summary of our total backlog follows:
(In thousands)
June 30, 2012
 
July 2, 2011
 
 
 
 
Contract backlog
$
5,799,449

 
$
4,736,253

Support and maintenance backlog
713,939

 
678,626

 
 
 
 
Total backlog
$
6,513,388

 
$
5,414,879

Costs of Revenue
Cost of revenues was 23% of total revenues in the second quarter of 2012, compared to 19% in the same period of 2011. The higher cost of revenues as a percent of revenue was driven by a higher mix of technology resale, which carries a higher cost of revenue, and a slightly higher level of third party consulting costs.
Cost of revenues includes the cost of reimbursed travel expense, sales commissions, third party consulting services and subscription content and computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, devices, maintenance, support, services and reimbursed travel) carrying different margin rates changes from period to period. Cost of revenues does not include the costs of our client service personnel who are responsible for delivering our service offerings. Such costs are included in sales and client service expense.
Operating Expenses
Total operating expenses increased 11% to $353.8 million in the second quarter of 2012, compared with $317.8 million for the same period in 2011.
 
Sales and client service expenses as a percent of total revenues were 38% in the second quarter of 2012, compared to 40% in the same period of 2011. These expenses increased 15% to $241.9 million in the second quarter of 2012, from $210.2 million in the same period of 2011. Sales and client service expenses include salaries of sales and client service personnel, depreciation and other expenses associated with our CernerWorks managed service business, communications expenses, unreimbursed travel expenses, expense for share-based payments, sales and marketing salaries and trade show and advertising costs. The decrease as a percent of revenue reflects ongoing efficiencies in our implementation and operational processes.
Software development expenses as a percent of revenue were 12% in the second quarter of 2012, compared to 14% in the same period of 2011. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium platform, including investments in the next evolution of Cerner Millennium, Millennium+™, which leverages the cloud and enables greater mobility. The reduction as a percentage of revenue reflects our ongoing efforts to control spending relative to revenue growth. Because of the strong platform we have built, we are able to continue advancing our solutions and investing in new solutions without large increases in spending. A summary of our total software development expense in the second quarters of 2012 and 2011 is as follows:
 
Three Months Ended
(In thousands)
2012
 
2011
 
 
 
 
Software development costs
$
77,190

 
$
70,469

Capitalized software costs
(23,183
)
 
(20,174
)
Capitalized costs related to share-based payments
(584
)
 
(415
)
Amortization of capitalized software costs
20,084

 
19,910

 
 
 
 
Total software development expense
$
73,507

 
$
69,790

 

17



General and administrative expenses as a percent of total revenues were 6% in the second quarter of 2012, compared to 7% in the same period of 2011. These expenses increased 2% to $38.4 million in the second quarter of 2012, from $37.8 million for the same period in 2011. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, transaction gains or losses on foreign currency and expense for share based payments. The increase in general and administrative expenses was primarily driven by an increase in corporate personnel costs, as we have increased such personnel to support our overall revenue growth.

Non-Operating Items
 
Interest income increased to $4.2 million in the second quarter of 2012 from $3.9 million for the same period in 2011 due primarily to growth in investments. Interest expense was $1.4 million for the second quarter of 2012 compared to $1.0 million for the same period in 2011.
Our effective tax rate was 29.6% for the second quarter of 2012 and 35.0% for the second quarter of 2011. This decrease was primarily due to an increase in net favorable discrete items recorded in 2012 relative to 2011, partially offset by the expiration of the research and development tax credit on December 31, 2011. Refer to Note (5) of the notes to the condensed consolidated financial statements for further information 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 Argentina, Aruba, Australia, Austria, Canada, Cayman Islands, Chile, China (Hong Kong), Egypt, England, France, Germany, Guam, India, Ireland, Italy, Japan, Malaysia, Mexico, Morocco, Puerto Rico, Qatar, Saudi Arabia, Singapore, Spain, Sweden, Switzerland and the United Arab Emirates.

The following table presents a summary of the operating information for the second quarters of 2012 and 2011:
 
(In thousands)
2012
 
% of Revenue
 
2011
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
561,658

 
100%
 
$
450,254

 
100%
 
25%
Costs of revenue
137,652

 
25%
 
87,413

 
19%
 
57%
Operating expenses
120,443

 
21%
 
106,126

 
24%
 
13%
Total costs and expenses
258,095

 
46%
 
193,539

 
43%
 
33%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
303,563

 
54%

256,715

 
57%
 
18%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
75,700

 
100%
 
73,969

 
100%
 
2%
Costs of revenue
9,848

 
13%
 
11,069

 
15%
 
(11)%
Operating expenses
32,071

 
42%
 
31,671

 
43%
 
1%
Total costs and expenses
41,919

 
55%
 
42,740

 
58%
 
(2)%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
33,781

 
45%
 
31,229

 
42%
 
8%
 
 
 
 
 
 
 
 
 
 
Other, net
(201,261
)
 
 
 
(179,971
)
 
 
 
12%
 
 
 
 
 
 
 
 
 
 
Consolidated operating earnings
$
136,083

 
 
 
$
107,973

 
 
 
26%
Domestic Segment
Revenues increased 25% to $561.7 million in the second quarter of 2012 from $450.3 million in the same period in 2011. This increase was primarily driven by strong growth in technology resale and professional services.
Cost of revenues was 25% of revenues in the second quarter of 2012, compared to 19% of revenues in the same period in 2011. The higher cost of revenues as a percent of revenue was primarily driven by a higher mix of technology resale, which carries a higher cost of revenue, and a slightly higher level of third party consulting costs.

18


Operating expenses increased 13% to $120.4 million in the second quarter of 2012, from $106.1 million in the same period in 2011, due primarily to growth in managed services and professional services expenses.

Global Segment
Revenues increased 2% to $75.7 million in the second quarter of 2012 from $74.0 million in the same period in 2011. This increase was primarily driven by growth in managed services.
Cost of revenues was 13% of revenues in the second quarter of 2012, compared with 15% in the same period of 2011. The lower cost of revenues as a percent of revenue was primarily driven by a lower use of third-party professional services.
Operating expenses were relatively flat at $32.1 million for the second quarter of 2012, compared to $31.7 million for the same period in 2011.

Other, net
Operating results not attributed to an operating segment include expenses, such as centralized professional services costs, software development, marketing, general and administrative, stock-based compensation, depreciation, and amortization. These expenses increased 12% to $201.3 million in the second quarter of 2012 from $180.0 million in the same period in 2011. This increase was primarily due to growth in corporate and development personnel costs.

Six Months Ended June 30, 2012 Compared to Six Months Ended July 2, 2011
The following table presents a summary of the operating information for the first six months of 2012 and 2011:
(In thousands)
2012
% of
Revenue
 
2011
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
421,115

33
%
 
$
297,524

 
29
%
 
42
%
Support and maintenance
296,251

23
%
 
270,007

 
27
%
 
10
%
Services
533,699

42
%
 
426,317

 
42
%
 
25
%
Reimbursed travel
27,505

2
%
 
22,039

 
2
%
 
25
%
 
 
 
 
 
 
 
 
 
Total revenues
1,278,570

100
%
 
1,015,887

 
100
%
 
26
%
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
Costs of revenue
305,508

24
%
 
189,162

 
19
%
 
62
%
 
 
 
 
 
 
 
 
 
Total margin
973,062

76
%
 
826,725

 
81
%
 
18
%
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Sales and client service
486,949

38
%
 
411,561

 
41
%
 
18
%
Software development
144,652

11
%
 
140,934

 
14
%
 
3
%
General and administrative
77,939

6
%
 
72,558

 
7
%
 
7
%
 
 
 
 
 
 
 
 
 
Total operating expenses
709,540

55
%
 
625,053

 
62
%
 
14
%
 
 
 
 
 
 
 
 
 
Total costs and expenses
1,015,048

79
%