10-Q 1 q2201510-q.htm Q2 2015 FORM 10-Q Q2 2015 10-Q
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: July 4, 2015
OR
( )    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________

Commission File Number: 0-15386
CERNER CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
43-1196944
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification
Number)
2800 Rockcreek Parkway
North Kansas City, MO
 
64117
(Address of principal executive offices)
 
(Zip Code)
(816) 201-1024
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]     No [  ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X]     No [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]     Accelerated filer [  ]     Non-accelerated filer [  ]     Smaller reporting company [  ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]       No [X]
Indicate the number of shares outstanding of the issuer's classes of common stock, as of the latest practicable date.
Class
  
Outstanding at July 28, 2015
Common Stock, $0.01 par value per share
  
345,074,144 shares



CERNER CORPORATION

TABLE OF CONTENTS
 
Part I.
Financial Information:
 
 
 
 
Item 1.
Financial Statements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II.
Other Information:
 
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
Signatures
 




Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of July 4, 2015 (unaudited) and January 3, 2015
(In thousands, except share data)
2015
 
2014
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
293,979

 
$
635,203

Short-term investments
264,074

 
785,663

Receivables, net
1,003,143

 
672,778

Inventory
28,633

 
23,789

Prepaid expenses and other
272,368

 
209,278

Deferred income taxes, net
21,510

 
22,075

Total current assets
1,883,707

 
2,348,786

 
 
 
 
Property and equipment, net
1,155,153

 
924,260

Software development costs, net
491,838

 
420,199

Goodwill
766,046

 
320,538

Intangible assets, net
720,583

 
126,636

Long-term investments
298,501

 
231,147

Other assets
169,005

 
158,999

 
 
 
 
Total assets
$
5,484,833

 
$
4,530,565

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
208,734

 
$
160,285

Current installments of long-term debt and capital lease obligations
55,448

 
67,460

Deferred revenue
274,223

 
209,655

Accrued payroll and tax withholdings
179,508

 
140,230

Other accrued expenses
59,938

 
56,685

Total current liabilities
777,851

 
634,315

 
 
 
 
Long-term debt and capital lease obligations
567,312

 
62,868

Deferred income taxes and other liabilities
250,825

 
256,601

Deferred revenue
24,852

 
10,813

Total liabilities
1,620,840

 
964,597

 
 
 
 
Shareholders’ Equity:
 
 
 
Common stock, $.01 par value, 500,000,000 shares authorized, 349,496,088 shares issued at July 4, 2015 and 346,985,811 shares issued at January 3, 2015
3,495

 
3,470

Additional paid-in capital
1,018,194

 
933,446

Retained earnings
3,144,453

 
2,918,481

Treasury stock, 4,652,515 shares at July 4, 2015 and January 3, 2015
(245,333
)
 
(245,333
)
Accumulated other comprehensive loss, net
(56,816
)
 
(44,096
)
Total shareholders’ equity
3,863,993

 
3,565,968

 
 
 
 
Total liabilities and shareholders’ equity
$
5,484,833

 
$
4,530,565


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 July 4, 2015 and June 28, 2014
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
(In thousands, except per share data)
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
System sales
$
315,109

 
$
234,563

 
$
574,678

 
$
441,250

Support, maintenance and services
792,827

 
588,167

 
1,511,197

 
1,145,596

Reimbursed travel
18,061

 
29,032

 
36,211

 
49,677

 
 
 
 
 
 
 
 
Total revenues
1,125,997

 
851,762

 
2,122,086

 
1,636,523

Costs and expenses:
 
 
 
 
 
 
 
Cost of system sales
112,502

 
81,306

 
204,001

 
146,419

Cost of support, maintenance and services
61,759

 
52,031

 
120,770

 
95,372

Cost of reimbursed travel
18,061

 
29,032

 
36,211

 
49,677

Sales and client service
463,435

 
343,234

 
883,617

 
674,135

Software development (Includes amortization of $29,618 and $58,707 for the three and six months ended July 4, 2015; and $24,937 and $50,038 for the three and six months ended June 28, 2014)
138,451

 
97,326

 
265,722

 
188,871

General and administrative
135,545

 
53,971

 
230,356

 
105,957

Amortization of acquisition-related intangibles
24,508

 
3,229

 
42,761

 
6,456

 
 
 
 
 
 
 
 
Total costs and expenses
954,261

 
660,129

 
1,783,438

 
1,266,887

 
 
 
 
 
 
 
 
Operating earnings
171,736

 
191,633

 
338,648

 
369,636

 
 
 
 
 
 
 
 
Other income (expense), net
(1,079
)
 
2,737

 
(871
)
 
5,727

 
 
 
 
 
 
 
 
Earnings before income taxes
170,657

 
194,370

 
337,777

 
375,363

Income taxes
(55,619
)
 
(65,337
)
 
(111,805
)
 
(126,804
)
 
 
 
 
 
 
 
 
Net earnings
$
115,038

 
$
129,033

 
$
225,972

 
$
248,559

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.33

 
$
0.38

 
$
0.66

 
$
0.73

Diluted earnings per share
$
0.33

 
$
0.37

 
$
0.64

 
$
0.71

Basic weighted average shares outstanding
344,431

 
341,788

 
343,880

 
342,787

Diluted weighted average shares outstanding
352,450

 
349,794

 
352,162

 
351,049

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 July 4, 2015 and June 28, 2014
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
(In thousands)
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Net earnings
$
115,038

 
$
129,033

 
$
225,972

 
$
248,559

Foreign currency translation adjustment and other (net of taxes (benefit) of $(863) and $(2,229) for the three and six months ended July 4, 2015; and $(48) and $319 for the three and six months ended June 28, 2014)
5,616

 
5,042

 
(12,894
)
 
8,069

Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $(132) and $113 for the three and six months ended July 4, 2015; and $(55) and $7 for the three and six months ended June 28, 2014)
(212
)
 
(85
)
 
174

 
12

 
 
 
 
 
 
 
 
Comprehensive income
$
120,442

 
$
133,990

 
$
213,252

 
$
256,640


See notes to condensed consolidated financial statements (unaudited).


3


CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended July 4, 2015 and June 28, 2014
(unaudited)
 
Six Months Ended
(In thousands)
2015
 
2014
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
225,972

 
$
248,559

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
213,513

 
141,806

Share-based compensation expense
34,451

 
28,269

Provision for deferred income taxes
2,866

 
2,687

Changes in assets and liabilities (net of businesses acquired):
 
 
 
Receivables, net
(130,242
)
 
(15,218
)
Inventory
423

 
579

Prepaid expenses and other
(37,951
)
 
11,717

Accounts payable
(4,069
)
 
(518
)
Accrued income taxes
(4,667
)
 
(4,864
)
Deferred revenue
1,139

 
17,801

Other accrued liabilities
21,476

 
(26,760
)
 
 
 
 
Net cash provided by operating activities
322,911

 
404,058

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(167,134
)
 
(131,997
)
Capitalized software development costs
(132,864
)
 
(86,666
)
Purchases of investments
(317,890
)
 
(500,903
)
Sales and maturities of investments
766,017

 
572,293

Purchase of other intangibles
(6,895
)
 
(7,190
)
Acquisition of businesses
(1,372,014
)
 
(7,476
)
 
 
 
 
Net cash used in investing activities
(1,230,780
)
 
(161,939
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Long-term debt issuance
500,000

 

Repayment of long-term debt and capital lease obligations

 
(69
)
Proceeds from excess tax benefits from share-based compensation
52,075

 
20,642

Proceeds from exercise of options
32,832

 
14,175

Treasury stock purchases

 
(217,082
)
Contingent consideration payments for acquisition of businesses
(11,012
)
 

Cash grants

 
48,000

Other
(791
)
 
2,894

 
 
 
 
Net cash provided by (used in) financing activities
573,104


(131,440
)
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(6,459
)
 
2,204

 
 
 
 
Net increase (decrease) in cash and cash equivalents
(341,224
)
 
112,883

Cash and cash equivalents at beginning of period
635,203

 
202,377

 
 
 
 
Cash and cash equivalents at end of period
$
293,979

 
$
315,260

 
 
 
 
Summary of acquisition transactions:
 
 
 
Fair value of tangible assets acquired
$
451,881

 
$
184

Fair value of intangible assets acquired
637,980

 
3,800

Fair value of goodwill
449,023

 
16,785

Less: Fair value of liabilities assumed
(166,870
)
 
(1,693
)
Less: Fair value of contingent liability payable

 
(11,600
)
 
 
 
 
Net cash used
$
1,372,014

 
$
7,476

See notes to condensed consolidated financial statements (unaudited).

4


CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
(1) Interim Statement Presentation

Basis of Presentation

The condensed consolidated financial statements included herein have been prepared by Cerner Corporation (Cerner, the Company, we, us or our) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our latest annual report on Form 10-K.
 
In management’s opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position and the results of operations and cash flows for the periods presented. Our interim results as presented in this Form 10-Q are not necessarily indicative of the operating results for the entire year.

The condensed consolidated financial statements were prepared using GAAP. These principles require us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.

Fiscal Period End

Our 2015 and 2014 second quarters ended on July 4, 2015 and June 28, 2014, 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.

Factors Impacting Comparability of Interim Financial Statements

Siemens Health Services

On February 2, 2015, we acquired Siemens Health Services, as further described in Note (2). The addition of the Siemens Health Services business has a significant impact on the comparability of our condensed consolidated financial statements as of and for the three and six months ended July 4, 2015, in relation to the comparative periods presented herein.

Amortization of Acquisition-related Intangibles

Amortization of acquisition-related intangibles includes the amortization of customer relationships, acquired technology, trade names, and non-compete agreements recorded in connection with our business acquisitions. Historically, such amounts were included in general and administrative expense in our condensed consolidated statements of operations. Effective for our second quarter of 2015, amortization of acquisition-related intangibles is presented on a separate line within our condensed consolidated statements of operations. While this reporting change did not impact our consolidated results, prior period reclassifications have been made to conform to the current period presentation.

Acquisition Transactions within our Condensed Consolidated Statements of Cash Flows

Historically, the fair value of tangible assets acquired and liabilities assumed in business acquisitions were presented on a net basis within our condensed consolidated statements of cash flows. Effective for our first quarter of 2015, the fair value of tangible assets acquired and the fair value of liabilities assumed are presented separately. While this reporting change did not impact our consolidated results, prior period reclassifications have been made to conform to the current period presentation.

Voluntary Separation Plan

In the first quarter of 2015, the Company adopted a voluntary separation plan ("VSP") for eligible associates. Generally, the VSP was available to U.S. associates who met a minimum level of combined age and tenure, excluding, among others, our

5


executive officers. Associates who elected to participate in the VSP receive financial benefits commensurate with their tenure and position, along with vacation payout and medical benefits.

We account for voluntary separation benefits in accordance with the provisions of Accounting Standards Codification (ASC) Topic 712, Compensation-Nonretirement Postemployment Benefits. Voluntary separation benefits are recorded to expense when the associates irrevocably accept the offer and the amount of the termination liability is reasonably estimable. The irrevocable acceptance period for most associates electing to participate in the VSP ended in May 2015. In the second quarter of 2015, we recorded a pre-tax charge for the VSP of $42 million, which is included in general and administrative expense in our condensed consolidated statements of operations. We expect to record additional pre-tax charges for the VSP during the remainder of 2015 of approximately $4 million, in the aggregate.

Recently Issued Accounting Pronouncements
Revenue Recognition. In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP. The new standard is effective for the Company in the first quarter of 2018. The standard permits the use of either the retrospective or cumulative effect transition method. At this time, we have not selected a transition method. We are currently evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures.

Debt Issuance Costs. In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying value of the debt liability. ASU 2015-03 is effective for the Company in the first quarter of 2016, with early adoption permitted, and retrospective application required. The Company has chosen to adopt the standard early, effective in the first quarter of 2015. The adoption of ASU 2015-03 did not have a material impact on our condensed consolidated financial statements. Refer to Note (9) for further information regarding debt issuance costs.

Consolidation. In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which provides guidance when evaluating whether to consolidate certain legal entities. The updated guidance modifies evaluation criteria of limited partnerships and similar legal entities, eliminates the presumption that a general partner should consolidate a limited partnership, and affects the consolidation analysis of reporting entities that are involved with variable interest entities, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective for the Company in the first quarter of 2016, with early adoption permitted. We are currently evaluating the effect that ASU 2015-02 will have on our consolidated financial statements and related disclosures.

(2) Business Acquisitions

Siemens Health Services

On February 2, 2015, we acquired substantially all of the assets, and assumed certain liabilities of Siemens Health Services, the health information technology business unit of Siemens AG, a stock corporation established under the laws of Germany, and its affiliates. Siemens Health Services offered a portfolio of enterprise-level clinical and financial health care information technology solutions, as well as departmental, connectivity, population health, and care coordination solutions globally. Solutions were offered on the Soarian®, Invision®, and i.s.h.med® platforms, among others. Siemens Health Services also offered a range of complementary services including support, hosting, managed services, implementation services, and strategic consulting.

We believe the acquisition enhances our organic growth opportunities as it provides us a larger base into which we can sell our combined portfolio of solutions and services. The acquisition also augments our non-U.S. footprint and growth opportunities, increases our scale for R&D investment, and adds over 5,000 highly-skilled associates that will enhance our capabilities. These factors, combined with the synergies and economies of scale expected from combining the operations of Cerner and Siemens Health Services, are the basis for the acquisition and comprise the resulting goodwill recorded.

Consideration for the acquisition was $1.37 billion of cash, consisting of the $1.3 billion agreed upon purchase price plus working capital adjustments. The purchase price is subject to certain post-closing adjustments for working capital and pension obligations, as specified in the Master Sale and Purchase Agreement dated August 5, 2014, as amended.


6


During the six months ended July 4, 2015, we incurred $20 million of pre-tax acquisition costs in connection with the acquisition of Siemens Health Services, which are included in general and administrative expenses in our condensed consolidated statements of operations.

The acquisition of Siemens Health Services is being treated as a purchase in accordance with ASC Topic 805, Business Combinations, which requires allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed in the transaction. Our allocation of purchase price is based on management's judgment after evaluating several factors, including a preliminary valuation assessment. The allocation of purchase price is preliminary and subject to changes, which could be significant, as appraisals of tangible and intangible assets are finalized, working capital and pension obligation adjustments are agreed upon and finalized, and additional information becomes available.

The preliminary allocation of purchase price is as follows:
(in thousands)
 
Allocation Amount
 
Estimated Weighted Average Useful Life
Receivables, net of allowances of $33,674
 
$
236,491

 
 
Other current assets
 
56,859

 
 
Property and equipment
 
158,298

 
20 years
Goodwill
 
449,023

 
 
Intangible assets:
 
 
 
 
Customer relationships
 
396,000

 
10 years
Existing technologies
 
201,990

 
5 years
Trade names
 
39,990

 
8 years
Total intangible assets
 
637,980

 
 
Other non-current assets
 
233

 
 
Accounts payable
 
(42,076
)
 
 
Deferred revenue (current)
 
(90,148
)
 
 
Other current liabilities
 
(19,716
)
 
 
Deferred revenue (non-current)
 
(14,930
)
 
 
 
 
 
 
 
Total purchase price
 
$
1,372,014

 
 

The intangible assets in the table above are being amortized on a straight-line basis over their estimated useful lives, with such amortization included in amortization of acquisition-related intangibles in our condensed consolidated statements of operations.

The fair value measurements of tangible and intangible assets and liabilities were based on significant inputs not observable in the market and thus represent Level 3 measurements within the fair value measurement hierarchy. Level 3 inputs included, among others, discount rates that we estimated would be used by a market participant in valuing these assets and liabilities, projections of revenues and cash flows, client attrition rates, royalty rates, and market comparables.

Property and equipment was valued primarily using the sales comparison method, a form of the market approach, in which the value is derived by evaluating the market prices of assets with comparable features such as size, location, condition and age. Our analysis included multiple property categories, including land, buildings, and personal property and included assumptions for market prices of comparable assets, and physical and economic obsolescence, among others.

Customer relationship intangible assets were valued using the excess earnings method, a form of the income approach, in which the value is derived by estimation of the after-tax cash flows specifically attributable to the customer relationships. Our analysis consisted of two customer categories, order backlog and existing customer relationships and included assumptions for projections of revenues and expenses, contributory asset charges, discount rates, and a tax amortization benefit, among others.

Existing technology and trade name intangible assets were valued using the relief from royalty method, a form of the income approach, in which the value is derived by estimation of the after-tax royalty savings attributable to owning the assets.

7


Assumptions in these analyses included projections of revenues, royalty rates representing costs avoided due to ownership of the assets, discount rates, and a tax amortization benefit.

Deferred revenue was valued using an income approach, in which the value was derived by estimation of the fulfillment cost, plus a normal profit margin (which excludes any selling margin), for performance obligations assumed in the acquisition. Assumptions included estimations of costs incurred to fulfill the obligations, profit margins a market participant would expect to receive, and a discount rate.

The goodwill of $449 million was allocated among our Domestic and Global operating segments, as shown below, and is expected to be deductible for tax purposes.

The changes in the carrying amounts of goodwill for the six months ended July 4, 2015 were as follows:

(In thousands)
 
Domestic
 
Global
 
Total
 
 
 
 
 
 
 
Beginning balance
 
$
311,170

 
$
9,368

 
$
320,538

Goodwill recorded in connection with the Siemens Health Services acquisition
 
386,663

 
62,360

 
449,023

Foreign currency translation adjustments and other
 

 
(3,515
)
 
(3,515
)
Ending balance at July 4, 2015
 
$
697,833

 
$
68,213

 
$
766,046


Our condensed consolidated statements of operations for the three and six months ended July 4, 2015 include revenues of approximately $260 million and $435 million, respectively, attributable to the acquired business (now referred to as "Cerner Health Services") since the February 2, 2015 acquisition date. Disclosure of the earnings contribution from the Cerner Health Services business is not practicable, as we have already integrated operations in many areas.

The following table provides unaudited pro forma results of operations for the three and six months ended July 4, 2015 and June 28, 2014, as if the acquisition had been completed on the first day of our 2014 fiscal year.

 
 
Three Months Ended
 
Six Months Ended
(In thousands, except per share data)
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
 
Pro forma revenues
 
$
1,125,997

 
$
1,144,861

 
$
2,215,766

 
$
2,210,662

Pro forma net earnings
 
117,047

 
115,043

 
231,379

 
213,132

Pro forma diluted earnings per share
 
0.33

 
0.33

 
0.66

 
0.61


These pro forma results are based on estimates and assumptions, which we believe are reasonable. They are not the results that would have been realized had we been a combined company during the periods presented, nor are they indicative of our consolidated results of operations in future periods. The pro forma results for the three months ended July 4, 2015 include a pre-tax adjustment to eliminate $3 million of acquisition costs. The pro forma results for the six months ended July 4, 2015 include pre-tax adjustments for amortization of intangible assets, fair value adjustments for deferred revenue, and the elimination of acquisition costs of $7 million, $6 million and $20 million, respectively. Pro forma results for the three months ended June 28, 2014 include pre-tax adjustments for amortization of intangible assets and fair value adjustments for deferred revenue of $22 million and $7 million, respectively. The pro forma results for the six months ended June 28, 2014 include pre-tax adjustments for amortization of intangible assets and fair value adjustments for deferred revenue of $43 million and $25 million, respectively.


8


(3) Fair Value Measurements

We determine fair value measurements used in our consolidated financial statements based upon the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
 
Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2 – Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
Level 3 – Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table details our financial assets measured and recorded at fair value on a recurring basis at July 4, 2015:
(In thousands)
 
 
 
 
 
 

 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
67,104

 
$

 
$

Time deposits
 
Cash equivalents
 

 
9,412

 

Government and corporate bonds
 
Cash equivalents
 

 
2,100

 

Time deposits
 
Short-term investments
 

 
51,230

 

Commercial paper
 
Short-term investments
 

 
4,600

 

Government and corporate bonds
 
Short-term investments
 

 
208,244

 

Government and corporate bonds
 
Long-term investments
 

 
282,450

 


The following table details our financial assets measured and recorded at fair value on a recurring basis at January 3, 2015:
(In thousands)
 
 
 
 
 
 
 
 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
189,137

 
$

 
$

Time deposits
 
Cash equivalents
 

 
9,989

 

Commercial paper
 
Cash equivalents
 

 
115,638

 

Time deposits
 
Short-term investments
 

 
52,829

 

Commercial paper
 
Short-term investments
 

 
435,544

 

Government and corporate bonds
 
Short-term investments
 

 
297,290

 

Government and corporate bonds
 
Long-term investments
 

 
218,965

 

We estimate the fair value of our long-term, fixed rate debt using a Level 3 discounted cash flow analysis based on current borrowing rates for debt with similar maturities. We estimate the fair value of our long-term, variable rate debt using a Level 3 discounted cash flow analysis based on LIBOR rate forward curves. The fair value of our long-term debt, including current maturities, at July 4, 2015 and January 3, 2015 was approximately $525 million and $15 million, respectively. The carrying amount of such debt at July 4, 2015 and January 3, 2015 was $514 million and $14 million, respectively.

9


(4) Available-for-sale Investments

Available-for-sale investments at July 4, 2015 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
67,104

 
$

 
$

 
$
67,104

Time deposits
 
9,412

 

 

 
9,412

Government and corporate bonds
 
2,100

 

 

 
2,100

Total cash equivalents
 
78,616

 

 

 
78,616

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
51,230

 

 

 
51,230

Commercial paper
 
4,600

 

 

 
4,600

Government and corporate bonds
 
208,202

 
75

 
(33
)
 
208,244

Total short-term investments
 
264,032

 
75

 
(33
)
 
264,074

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
282,713

 
79

 
(342
)
 
282,450

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
625,361


$
154


$
(375
)

$
625,140


Available-for-sale investments at January 3, 2015 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
189,137

 
$

 
$

 
$
189,137

Time deposits
 
9,989

 

 

 
9,989

Commercial paper
 
115,638

 

 

 
115,638

Total cash equivalents
 
314,764

 

 

 
314,764

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
52,830

 

 
(1
)
 
52,829

Commercial paper
 
435,555

 
1

 
(12
)
 
435,544

Government and corporate bonds
 
297,311

 
69

 
(90
)
 
297,290

Total short-term investments
 
785,696

 
70

 
(103
)
 
785,663

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Government and corporate bonds
 
219,439

 
26

 
(500
)
 
218,965

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
1,319,899

 
$
96

 
$
(603
)
 
$
1,319,392


We sold available-for-sale investments for proceeds of $57 million and $156 million during the six months ended July 4, 2015 and June 28, 2014, respectively, resulting in insignificant gains in each period.

10


(5) Receivables

A summary of net receivables is as follows:
(In thousands)
July 4, 2015
 
January 3, 2015
 
 
 
 
Gross accounts receivable
$
1,009,179

 
$
641,160

Less: Allowance for doubtful accounts
50,808

 
25,531

 
 
 
 
Accounts receivable, net of allowance
958,371

 
615,629

 
 
 
 
Current portion of lease receivables
44,772

 
57,149

 
 
 
 
Total receivables, net
$
1,003,143

 
$
672,778


During the second quarter of 2008, Fujitsu Services Limited’s (Fujitsu) contract as the prime contractor in the National Health Service (NHS) initiative to automate clinical processes and digitize medical records in the Southern region of England was terminated by the NHS.  This had the effect of automatically terminating our subcontract for the project. We continue to be in dispute with Fujitsu regarding Fujitsu’s obligation to pay the amounts comprised of accounts receivable and contracts receivable related to that subcontract, and we are working with Fujitsu to resolve these issues based on processes provided for in the contract.  Part of that process requires final resolution of disputes between Fujitsu and the NHS regarding the contract termination. As of July 4, 2015, it remains unlikely that our matter with Fujitsu will be resolved in the next 12 months. Therefore, these receivables have been classified as long-term and represent less than the majority of other long-term assets at July 4, 2015 and January 3, 2015. While the ultimate collectability of the receivables pursuant to this process is uncertain, we believe that we have valid and equitable grounds for recovery of such amounts and that collection of recorded amounts is probable. Nevertheless, it is reasonably possible that our estimates regarding collectability of such amounts might materially change in the near term, considering that we do not have complete knowledge of the status of the proceedings between Fujitsu and NHS and their effect on our claim.

During the first six months of 2015 and 2014, we received total client cash collections of $2.1 billion and $1.7 billion, respectively.
 
(6) Income Taxes

We determine the tax provision for interim periods using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment.

Our effective tax rate was 33.1% and 33.8% for the first six months of 2015 and 2014, respectively. The decrease in the 2015 effective tax rate results principally from the favorability of net discrete items recorded in 2015 as compared to 2014.


11


(7) Earnings Per Share

A reconciliation of the numerators and the denominators of the basic and diluted per share computations are as follows:
 
Three Months Ended
 
2015
 
2014
 
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
$
115,038

 
344,431

 
$
0.33

 
$
129,033

 
341,788

 
$
0.38

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

 
8,019

 
 
 

 
8,006

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
115,038

 
352,450

 
$
0.33

 
$
129,033

 
349,794

 
$
0.37


For the three months ended July 4, 2015 and June 28, 2014, options to purchase 2.8 million and 5.9 million shares of common stock at per share prices ranging from $54.09 to $73.40 and $38.66 to $60.37, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.
 
Six Months Ended
 
2015
 
2014
 
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
$
225,972

 
343,880

 
$
0.66

 
$
248,559

 
342,787

 
$
0.73

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

 
8,282

 
 
 

 
8,262

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
225,972

 
352,162

 
$
0.64

 
$
248,559

 
351,049

 
$
0.71


For the six months ended July 4, 2015 and June 28, 2014, options to purchase 1.9 million and 4.8 million shares of common stock at per share prices ranging from $53.17 to $73.40 and $38.66 to $60.37, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.


12


(8) Share-Based Compensation

Stock Options

Options activity for the six months ended July 4, 2015 was as follows:
(In thousands, except per share data)
Number of
Shares
 
Weighted-
Average
Exercise 
Price
 
Aggregate
Intrinsic 
Value
 
Weighted-Average      
Remaining      
Contractual
 Term (Yrs)      
Outstanding at beginning of year
24,629

 
$
27.00

 
 
 
 
Granted
3,154

 
68.22

 
 
 
 
Exercised
(2,900
)
 
14.20

 
 
 
 
Forfeited and expired
(228
)
 
47.51

 
 
 
 
Outstanding as of July 4, 2015
24,655

 
33.59

 
$
862,290

 
6.30
 
 
 
 
 
 
 
 
Exercisable as of July 4, 2015
14,213

 
$
19.32

 
$
698,720

 
4.71

The weighted-average assumptions used to estimate the fair value, under the Black-Scholes-Merton pricing model, of stock options granted during the six months ended July 4, 2015 were as follows:
Expected volatility (%)
 
27.4
%
Expected term (yrs)
 
7

Risk-free rate (%)
 
1.8
%
Fair value per option
 
$
21.85

As of July 4, 2015, there was $170 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 3.58 years.
Non-vested Shares

Non-vested share activity for the six months ended July 4, 2015 was as follows:
(In thousands, except per share data)
Number of Shares
 
Weighted-Average
Grant Date Fair Value
 
 
 
 
Outstanding at beginning of year
506

 
$
46.21

Granted
293

 
69.21

Vested
(172
)
 
44.78

Forfeited
(55
)
 
42.72

 
 
 
 
Outstanding as of July 4, 2015
572

 
$
58.82

As of July 4, 2015, there was $23 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 1.89 years.


13


The following table presents total compensation expense recognized with respect to stock options, non-vested shares and our associate stock purchase plan:
 
Three Months Ended
 
Six Months Ended
(In thousands)
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Stock option and non-vested share compensation expense
$
19,290

 
$
14,620

 
$
34,451

 
$
28,269

Associate stock purchase plan expense
1,365

 
1,094

 
2,753

 
2,377

Amounts capitalized in software development costs, net of amortization
(208
)
 
(510
)
 
(300
)
 
(674
)
 
 
 
 
 
 
 
 
Amounts charged against earnings, before income tax benefit
$
20,447

 
$
15,204

 
$
36,904

 
$
29,972

 
 
 
 
 
 
 
 
Amount of related income tax benefit recognized in earnings
$
6,664

 
$
5,336

 
$
12,197

 
$
10,520



(9) Long-Term Debt and Capital Lease Obligations

The following is a summary of indebtedness outstanding:
(In thousands)
July 4, 2015
 
January 3, 2015
 
 
 
 
Note agreement, 5.54%
$
14,471

 
$
14,233

Senior Notes
500,000

 

Capital lease obligations
109,055

 
116,095

 
 
 
 
Debt and capital lease obligations
623,526

 
130,328

Less: debt issuance costs
(766
)
 

 
 
 
 
Debt and capital lease obligations, net
622,760

 
130,328

Less: current portion
(55,448
)
 
(67,460
)
 
 
 
 
Long-term debt and capital lease obligations
$
567,312

 
$
62,868


In January 2015, we issued $500 million aggregate principal amount of unsecured Senior Notes ("Notes"), pursuant to a Master Note Purchase Agreement dated December 4, 2014. The issuance consisted of $225 million of 3.18% Series 2015-A Notes due February 15, 2022, $200 million of 3.58% Series 2015-B Notes due February 14, 2025, and $75 million in floating rate Series 2015-C Notes due February 15, 2022. Interest is payable semiannually on February 15th and August 15th in each year, commencing on August 15, 2015, for the Series 2015-A Notes and Series 2015-B Notes. The Series 2015-C Notes will accrue interest at a floating rate equal to the Adjusted LIBOR Rate (as defined in the Master Note Purchase Agreement), payable quarterly on February 15th, May 15th, August 15th and November 15th in each year, commencing on May 15, 2015. As of July 4, 2015, the interest rate was 1.28% for the current interest period based on the three-month floating LIBOR rate. The debt issuance costs in the table above relate to the issuance of these Notes. The Master Note Purchase Agreement contains certain leverage and interest coverage ratio covenants and provides certain restrictions on our ability to borrow, incur liens, sell assets, and other customary terms. Proceeds from the Notes are available for general corporate purposes.

As of July 4, 2015, we were in compliance with all debt covenants.

(10) Contingencies    

We accrue estimates for resolution of any legal and other contingencies when losses are probable and estimable, in accordance with ASC 450, Contingencies.

The terms of our software license agreements with our clients generally provide for a limited indemnification of such clients against losses, expenses and liabilities arising from third party claims based on alleged infringement by our solutions of an intellectual property right of such third party. The terms of such indemnification often limit the scope of and remedies for such indemnification obligations and generally include a right to replace or modify an infringing solution. To date, we have not had to reimburse any of our clients for any judgments or settlements to third parties related to these indemnification provisions pertaining to intellectual property infringement claims. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the terms of the corresponding agreements with

14


our clients, we cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.

In addition to commitments and obligations in the ordinary course of business, we are subject to various legal proceedings and claims, including for example, employment disputes and litigation alleging solution defects, personal injury, intellectual property infringement, violations of law and breaches of contract and warranties.  Many of these proceedings are at preliminary stages and many seek an indeterminate amount of damages.
 
No less than quarterly, we review the status of each significant matter and assess our potential financial exposure. We accrue a liability for an estimated loss if the potential loss from any legal proceeding or claim is considered probable and the amount can be reasonably estimated. Significant judgment is required in both the determination of probability and the determination as to whether the amount of an exposure is reasonably estimable, and accruals are based only on the information available to our management at the time the judgment is made. Furthermore, the outcome of legal proceedings is inherently uncertain, and we may incur substantial defense costs and expenses defending any of these matters. Should any one or a combination of more than one of these proceedings be successful, or should we determine to settle any or a combination of these matters, we may be required to pay substantial sums, become subject to the entry of an injunction or be forced to change the manner in which we operate our business, which could have a material adverse impact on our financial position or results of operations.

(11) Segment Reporting

We have two operating segments, Domestic and Global. Revenues are derived primarily from the sale of clinical, financial and administrative information systems and solutions. The cost of revenues includes the cost of third party consulting services, computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, expenses associated with our managed services business, marketing expenses, communications expenses and unreimbursed travel expenses. “Other” includes expenses that have not been allocated to the operating segments, such as software development, general and administrative expenses, acquisition costs and related adjustments, share-based compensation expense, and certain amortization and depreciation. Performance of the segments is assessed at the operating earnings level by our chief operating decision maker, who is our Chief Executive Officer. Items such as interest, income taxes, capital expenditures and total assets are managed at the consolidated level and thus are not included in our operating segment disclosures. Accounting policies for each of the reportable segments are the same as those used on a consolidated basis.

In connection with our acquisition of the Cerner Health Services business, we commenced an evaluation of our methodology for allocating operating expenses to our reportable segments. Effective for our first quarter of 2015, certain expenses historically reported in “Other” have been allocated to the geographic segments. This new allocation reflects the manner in which the business is now managed, subsequent to the acquisition. While this reporting change did not impact our consolidated results, the segment data has been recast to be consistent for all periods presented.


15


The following table presents a summary of our operating segments and other expense for the three and six months ended July 4, 2015 and June 28, 2014:
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2015
 
 
 
 
 
 
 
Revenues
$
994,746

 
$
131,251

 
$

 
$
1,125,997

 
 
 
 
 
 
 
 
Cost of revenues
168,189

 
24,133

 

 
192,322

Operating expenses
393,305

 
59,827

 
308,807

 
761,939

Total costs and expenses
561,494

 
83,960


308,807

 
954,261

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
433,252

 
$
47,291

 
$
(308,807
)
 
$
171,736

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2014
 
 
 
 
 
 
 
Revenues
$
766,763

 
$
84,999

 
$

 
$
851,762

 
 
 
 
 
 
 
 
Cost of revenues
147,776

 
14,593

 

 
162,369

Operating expenses
283,609

 
47,849

 
166,302

 
497,760

Total costs and expenses
431,385

 
62,442

 
166,302

 
660,129

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
335,378

 
$
22,557

 
$
(166,302
)
 
$
191,633

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Six Months Ended 2015
 
 
 
 
 
 
 
Revenues
$
1,865,253

 
$
256,833

 
$

 
$
2,122,086

 
 
 
 
 
 
 
 
Cost of revenues
310,906

 
50,076

 

 
360,982

Operating expenses
754,391

 
110,398

 
557,667

 
1,422,456

Total costs and expenses
1,065,297

 
160,474

 
557,667

 
1,783,438

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
799,956

 
$
96,359

 
$
(557,667
)
 
$
338,648

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Six Months Ended 2014
 
 
 
 
 
 
 
Revenues
$
1,464,467

 
$
172,056

 
$

 
$
1,636,523

 
 
 
 
 
 
 
 
Cost of revenues
263,121

 
28,347

 

 
291,468

Operating expenses
557,599

 
92,918

 
324,902

 
975,419

Total costs and expenses
820,720

 
121,265

 
324,902

 
1,266,887

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
643,747

 
$
50,791

 
$
(324,902
)
 
$
369,636



16


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

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

The 2015 and 2014 second quarters ended on July 4, 2015 and June 28, 2014, 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 are based on the current beliefs, expectations and assumptions of Cerner's management with respect to future events and are subject to a number of significant risks and uncertainties. It is important to note that Cerner's performance, and actual results, financial condition or business could differ materially from those expressed in such forward-looking statements. These statements can often be identified by the use of forward-looking terminology, such as "could," "should," "will," "intends," "continue," "believe," "may," "expect," "anticipate," "goal," "forecast," "plan," 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; material adverse resolution of legal proceedings; 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 dependence on third party suppliers; risks inherent with business acquisitions and combinations and the integration thereof, such as difficulties and operational and financial risks associated with integrating Cerner and the Siemens Health Services business acquired from Siemens AG (the "Acquisition"); risks related to disruption of management time from ongoing business operations due to the integration of the business acquired in the Acquisition; failure to realize the synergies and other benefits expected from the Acquisition; risk that the assets and business acquired in the Acquisition may not continue to be commercially successful; the effect of the Acquisition on the ability of Cerner to retain customers and retain and hire key personnel and maintain relationships with key suppliers; litigation, claims or post-closing disputes relating to the Acquisition or the acquired assets and business; the potential for losses resulting from asset impairment charges; risks associated with volatility and disruption resulting from global economic conditions; managing growth in the new markets in which we offer solutions, health care devices and services; incurring significant additional expenses relating to the integration of the Siemens Health Services business into Cerner; compliance with restrictive covenants in our debt agreements, which may restrict our flexibility to operate our business; 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; our directors' authority to issue preferred stock and the anti-takeover provisions in our corporate governance documents; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission, including those under the caption "Risk Factors" in our latest annual report on Form 10-K, or in materials incorporated herein or therein by reference. Forward-looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as of the date they are made. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.

Management Overview
Our revenues are primarily derived by selling, implementing and supporting software solutions, clinical content, hardware, devices and services that give health care providers secure access to clinical, administrative and financial data in real or near-real time, helping them improve quality, safety and efficiency in the delivery of health care.

Our fundamental strategic focus is the creation of organic growth by investing in research and development (R&D) to create solutions and services for the health care industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 14% or more. This growth has also created an important strategic footprint in health care, with Cerner® solutions in more than 18,000 facilities worldwide, including hospitals, physician

17


practices, laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics, surgery centers, extended care facilities, retail pharmacies, and employer sites. Selling additional solutions back into this client base is an important element of our future revenue growth. We are also focused on driving growth through market share expansion by strategically aligning with health care providers that have not yet selected a supplier and by displacing competitors in health care settings that are looking to replace their current supplier. We may also supplement organic growth with acquisitions.

We expect to drive growth through solutions and services that reflect our ongoing ability to innovate and expand our reach into health care. Examples of these include our CareAware® health care device architecture and devices, Cerner ITWorksSM services, revenue cycle solutions and services, and population health solutions and services. Finally, we believe there is significant opportunity for growth outside of the United States, with many non-U.S. markets focused on health care information technology as part of their strategy to improve the quality and lower the cost of health care.

Beyond our strategy for driving revenue growth, we are also focused on earnings growth. Similar to our history of growing revenue, our net earnings have increased at compound annual rates of 20% or more over the most recent five- and ten-year periods. We expect to drive continued earnings growth through ongoing revenue growth coupled with margin expansion, which we expect to achieve through efficiencies in our implementation and operational processes and by leveraging R&D investments and controlling general and administrative expenses.

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

Siemens Health Services
On February 2, 2015, we acquired substantially all of the assets, and assumed certain liabilities of Siemens Health Services, as further described in Note (2) of the notes to condensed consolidated financial statements. The acquired business (now referred to as "Cerner Health Services") offers a portfolio of enterprise-level clinical and financial health care information technology solutions, as well as departmental, connectivity, population health, and care coordination solutions globally. Solutions are offered on the Soarian, Invision, and i.s.h.med platforms, among others. Cerner Health Services also offers a range of complementary services including support, hosting, managed services, implementation services, and strategic consulting.

We believe the acquisition enhances our organic growth opportunities as it provides us a larger base into which we can sell our combined portfolio of solutions and services. The acquisition also augments our non-U.S. footprint and growth opportunities, increases our scale for R&D investment, and adds over 5,000 highly-skilled associates that will enhance our capabilities.

The addition of this business has a significant impact on the comparability of our condensed consolidated financial statements as of and for the three and six months ended July 4, 2015, in relation to the comparative periods presented herein.

Results Overview
The Company delivered strong levels of bookings, revenues and earnings in the second quarter of 2015.

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $1.3 billion in the second quarter of 2015, which is an increase of 20% compared to $1.1 billion in the second quarter of 2014.

Revenues for the second quarter of 2015 increased 32% to $1.1 billion compared to $852 million in the second quarter of 2014. Second quarter 2015 revenues include approximately $260 million attributable to the acquired Cerner Health Services business. The remaining year-over-year increase in revenue reflects ongoing demand for Cerner's core solutions and services driven by our clients' needs to keep up with regulatory requirements, contributions from Cerner ITWorks and revenue cycle solutions and services, and attaining new clients.

Second quarter 2015 net earnings decreased 11% to $115 million compared to $129 million in the second quarter of 2014. Diluted earnings per share decreased 11% to $0.33 compared to $0.37 in the second quarter of 2014. Disclosure of the earnings contribution from the Cerner Health Services business is not practicable, as we have already integrated operations in many areas. The overall decrease in net earnings and diluted earnings per share was primarily a result of elevated operating expenses associated with our voluntary separation plan, and the acquisition and integration of the Cerner Health Services business, as discussed further below.

18



Second quarter 2015 and 2014 net earnings and diluted earnings per share reflect the impact of share-based compensation expense. The effect of these expenses reduced the second quarter 2015 net earnings and diluted earnings per share by $14 million and $0.04, respectively, and the second quarter 2014 net earnings and diluted earnings per share by $10 million and $0.03, respectively.

Second quarter 2015 net earnings and diluted earnings per share also reflect the impact of amortization of acquisition-related intangibles and acquisition costs and related adjustments, both associated with our acquisition and integration of the Cerner Health Services business, as well as costs related to the voluntary separation plan, as further described in Note (1) of the notes to condensed consolidated financial statements. Amortization of acquisition-related intangibles related to the Cerner Health Services business reduced net earnings and diluted earnings per share by $14 million and $0.04, respectively. Acquisition costs and related adjustments related to the Cerner Health Services business reduced net earnings and diluted earnings per share by $6 million and $0.01, respectively. Costs related to the voluntary separation plan reduced net earnings and diluted earnings per share by $28 million and $0.08, respectively.

We had cash collections of receivables of $1.1 billion in the second quarter of 2015 compared to $844 million in the second quarter of 2014. Days sales outstanding was 81 days for the second quarter of 2015 compared to 79 days for the first quarter of 2015 and 66 days for the second quarter of 2014. Operating cash flows for the second quarter of 2015 were $109 million compared to $248 million in the second quarter of 2014.


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Results of Operations
Three Months Ended July 4, 2015 Compared to Three Months Ended June 28, 2014
The following table presents a summary of the operating information for the second quarters of 2015 and 2014:
(In thousands)
2015
% of
Revenue
 
2014
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
315,109

28
%
 
$
234,563

 
28
%
 
34
 %
Support and maintenance
254,663

23
%
 
175,274

 
21
%
 
45
 %
Services
538,164

48
%
 
412,893

 
48
%
 
30
 %
Reimbursed travel
18,061

2
%
 
29,032

 
3
%
 
(38
)%
 
 
 
 
 
 
 
 
 
Total revenues
1,125,997

100
%
 
851,762

 
100
%
 
32
 %
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
Costs of revenue
192,322

17
%
 
162,369

 
19
%
 
18
 %
 
 
 
 
 
 
 
 
 
Total margin
933,675

83
%
 
689,393

 
81
%
 
35
 %
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Sales and client service
463,435

41
%
 
343,234

 
40
%
 
35
 %
Software development
138,451

12
%
 
97,326

 
11
%
 
42
 %
General and administrative
135,545

12
%
 
53,971

 
6
%
 
151
 %
Amortization of acquisition-related intangibles
24,508

2
%
 
3,229

 
%
 
659
 %
 
 
 
 
 
 
 
 
 
Total operating expenses
761,939

68
%
 
497,760

 
58
%
 
53
 %
 
 
 
 
 
 
 
 
 
Total costs and expenses
954,261

85
%
 
660,129

 
78
%
 
45
 %
 
 
 
 
 
 
 
 
 
Operating earnings
171,736

15
%
 
191,633

 
22
%
 
(10
)%
 
 
 
 
 
 
 
 
 
Other income (expense), net
(1,079
)
 
 
2,737

 
 
 
 
Income taxes
(55,619
)
 
 
(65,337
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
115,038

 
 
$
129,033

 
 
 
(11
)%
Revenues & Backlog
Revenues increased 32% to $1.1 billion in the second quarter of 2015, as compared to $852 million in the second quarter of 2014.
 
System sales, which include revenues from the sale of licensed software (including perpetual license sales and software as a service), technology resale (hardware, devices, and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions, increased 34% to $315 million in the second quarter of 2015 from $235 million for the same period in 2014. The increase in system sales was primarily driven by contributions from the Cerner Health Services business.
Support and maintenance revenues increased 45% to $255 million in the second quarter of 2015 compared to $175 million during the same period in 2014. This increase was primarily attributable to contributions from the Cerner Health Services business.
Services revenue, which includes professional services, excluding installation, and managed services, increased 30% to $538 million in the second quarter of 2015 from $413 million for the same period in 2014. This increase was primarily driven by contributions from the Cerner Health Services business.
Revenue backlog, which reflects contracted revenue that has not yet been recognized as revenue, increased 37% to $13.3 billion in the second quarter of 2015 compared to $9.7 billion for the same period in 2014. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services, Cerner ITWorks and revenue cycle services bookings that typically have longer contract terms, coupled with contributions from the Cerner Health Services business.

20


Costs of Revenue
Cost of revenues as a percentage of total revenues was 17% in the second quarter of 2015, compared to 19% in the same period of 2014. The lower cost of revenues as a percent of revenue was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue, combined with the prior period quarter including a higher amount of third party resources being utilized for support and services related to a significant amount of systems going live during that quarter.
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 53% to $762 million in the second quarter of 2015, compared with $498 million in the second quarter of 2014.
 
Sales and client service expenses as a percent of total revenues were 41% in the second quarter of 2015, compared to 40% in the same period of 2014. These expenses increased 35% to $463 million in the second quarter of 2015, from $343 million in the same period of 2014. Sales and client service expenses include salaries and benefits of sales, marketing, support, and services personnel, depreciation and other expenses associated with our managed services business, communications expenses, unreimbursed travel expenses, expense for share-based payments, and trade show and advertising costs. The increase was primarily driven by addition of the Cerner Health Services business.
Software development expenses as a percent of revenue were 12% in the second quarter of 2015, compared to 11% in the same period of 2014. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium® and HealtheIntentSM platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. The second quarter of 2015 also includes expenditures related to Cerner Health Services solutions. A summary of our total software development expense in the second quarters of 2015 and 2014 is as follows:
 
Three Months Ended
(In thousands)
2015
 
2014
 
 
 
 
Software development costs
$
178,630

 
$
114,511

Capitalized software costs
(69,116
)
 
(41,225
)
Capitalized costs related to share-based payments
(681
)
 
(897
)
Amortization of capitalized software costs
29,618

 
24,937

 
 
 
 
Total software development expense
$
138,451

 
$
97,326

 
General and administrative expenses as a percent of total revenues were 12% in the second quarter of 2015, compared to 6% in the same period of 2014. These expenses increased 151% to $136 million in 2015, from $54 million for the same period in 2014. General and administrative expenses include salaries and benefits for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency, expense for share-based payments, acquisition costs and related adjustments. The increase in general and administrative expenses as a percent of total revenues was primarily driven by expenses related to our voluntary separation plan and expenses associated with the acquisition and integration of the Cerner Health Services business. Specifically, the second quarter of 2015 includes costs associated with the voluntary separation plan and acquisition costs and related adjustments of $42 million and $9 million, respectively. We expect costs related to our voluntary separation plan and acquisition costs and related adjustments to significantly decline in future periods. Refer to Note (1) of the notes to condensed consolidated financial statements for further detail regarding the voluntary separation plan.

Amortization of acquisition-related intangibles increased 659% to $25 million in the second quarter of 2015, from $3 million for the same period in 2014. Amortization of acquisition-related intangibles includes the amortization of customer relationships, acquired technology, trade names, and non-compete agreements recorded in connection

21


with our business acquisitions. The increase in amortization of acquisition-related intangibles was driven by the acquisition of the Cerner Health Services business in the first quarter of 2015. Refer to Note (2) of the notes to condensed consolidated financial statements for further detail regarding intangible assets recorded in connection with our acquisition of the Cerner Health Services business.

Non-Operating Items
 
Other income (expense) was $(1) million in the second quarter of 2015 and $3 million in the same period of 2014. This decline is primarily due to increased interest expense as a result of the issuance of Notes in January 2015, as further discussed in Note (9) of the notes to condensed consolidated financial statements.

Our effective tax rate was 32.6% for the second quarter of 2015 and 33.6% for the second quarter of 2014. The decrease in 2015 results principally from the favorability of net discrete items recorded in the second quarter of 2015 as compared to the second quarter of 2014.

Operations by Segment
We have two operating segments: Domestic and Global. The Domestic segment includes revenue contributions and expenditures associated with business activity in the United States. The Global segment includes revenue contributions and expenditures linked to business activity in Aruba, Australia, Austria, Belgium, Brazil, Canada, Cayman Islands, Chile, Denmark, Egypt, England, Finland, France, Germany, Guam, India, Ireland, Israel, Luxembourg, Malaysia, Mexico, Netherlands, Norway, Portugal, Qatar, Romania, Saudi Arabia, Singapore, Slovakia, Spain, Sweden, Switzerland and the United Arab Emirates. Refer to Note (11) of the notes to condensed consolidated financial statements for further information regarding our reportable segments.

The following table presents a summary of the operating segment information for the second quarters of 2015 and 2014:  
(In thousands)
2015
 
% of Revenue
 
2014
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
994,746

 
100%
 
$
766,763

 
100%
 
30%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
168,189

 
17%
 
147,776

 
19%
 
14%
Operating expenses
393,305

 
40%
 
283,609

 
37%
 
39%
Total costs and expenses
561,494

 
56%
 
431,385

 
56%
 
30%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
433,252

 
44%

335,378

 
44%
 
29%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
131,251

 
100%
 
84,999

 
100%
 
54%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
24,133

 
18%
 
14,593

 
17%
 
65%
Operating expenses
59,827

 
46%
 
47,849

 
56%
 
25%
Total costs and expenses
83,960

 
64%