Summary of CERNER CORP /MO/

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following Management Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Cerner Corporation 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-

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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.

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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:

                                         % of                     % of
(In thousands)                2012     Revenue       2011       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.

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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

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• 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.

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• 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:

                                          % of                      % of
(In thousands)                 2012     Revenue        2011       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 %      814,215         80 %       25 %

Operating earnings            263,522       21 %      201,672         20 %       31 %

Other income, net               5,438                   4,891
Income taxes                  (82,423 )               (69,963 )

Net earnings               $  186,537              $  136,600                    37 %

Revenues & Backlog
Revenues increased 26% to $1.3 billion for the first six months of 2012 from $1.0 billion for the same period in 2011.

• System sales increased 42% to $421.1 million for the first six months of 2012 from $297.5 million for the same period in 2011. The increase in system sales was driven by strong growth in technology resale.

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• Support and maintenance revenues increased 10% to $296.3 million during the first six months of 2012 from $270.0 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 increased 25% to $533.7 million from $426.3 million for the same period in 2011. This increase was driven by growth in CernerWorks 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.

Costs of Revenue
Cost of revenues was 24% of total revenues in the first six months 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.
Operating Expenses
Total operating expenses increased 14% to $709.5 million in the first six months of 2012, compared with $625.1 million for the same period in 2011.

• Sales and client service expenses as a percent of total revenues were 38% in the first six months of 2012, compared to 41% in the same period of 2011. These expenses increased 18% to $486.9 million in the first six months of 2012, from $411.6 million in the same period of 2011. 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 11% in the first six months 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 first six months of 2012 and 2011 is as follows:

                                                      Six Months Ended
(In thousands)                                       2012          2011

Software development costs                        $ 152,026     $ 143,021
Capitalized software costs                          (45,834 )     (40,345 )
Capitalized costs related to share-based payments    (1,013 )        (710 )
Amortization of capitalized software costs           39,473        38,968

Total software development expense                $ 144,652     $ 140,934

• General and administrative expenses as a percent of total revenues were 6% in the first six months of 2012, compared to 7% in the same period of 2011. These expenses increased 7% to $77.9 million in the first six months . . .