e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended July 2, 2005


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

For the transition period from to

Commission File Number 0-15386

CERNER CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		43-1196944

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

2800 Rockcreek Parkway
North Kansas City, Missouri 64117
(816) 201-1024

(Address of Principal Executive Offices, including zip code;

registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) with the Commission, and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ No o

There were 37,392,757 shares of Common Stock, $.01 par value, outstanding at July 2, 2005.

Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


	July 2,			January 1,
	2005			2005
(In thousands, except share data)	(unaudited)
Assets
Current Assets:
Cash and cash equivalents	$	132,335		$	189,784
Receivables		299,673			282,199
Inventory		11,102			7,373
Prepaid expenses and other		37,401			30,117


Total current assets		480,511			509,473

Property and equipment, net		258,909			230,440
Software development costs, net		165,635			157,765
Goodwill, net		110,375			54,600
Intangible assets, net		60,645			22,690
Other assets		7,707			7,297


Total Assets	$	1,083,782		$	982,265


Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable	$	49,999		$	37,008
Current installments of long-term debt		21,879			21,908
Note payable to bank		40,000			—
Deferred revenue		76,766			77,445
Deferred income taxes		8,383			430
Accrued payroll and tax withholdings		54,518			55,819
Other accrued expenses		17,331			6,634


Total current liabilities		268,876			199,244

Long-term debt		91,043			108,804
Deferred income taxes		71,852			69,863
Deferred revenue		6,006			5,703

Minority owners’ equity interest in subsidiary		1,286			1,166

Stockholders’ Equity:
Common stock, $.01 par value, 150,000,000 shares authorized, 38,895,756 shares issued at July 2, 2005 and 38,139,881 issued at January 1, 2005		389			381
Additional paid-in capital		288,808			271,116
Retained earnings		376,335			344,011
Treasury stock, at cost (1,502,999 shares in 2005 and 2004)		(26,793	)		(26,793	)
Accumulated other comprehensive income:
Foreign currency translation adjustment		5,980			8,770


Total stockholders’ equity		644,719			597,485


	$	1,083,782		$	982,265

See notes to condensed consolidated financial statements.

CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(UNAUDITED)


	Three Months Ended						Six Months Ended
	July 2			July 3,			July 2			July 3,
	2005			2004			2005			2004
(In thousands, except per share data)
Revenues:
System sales	$	105,200		$	84,853		$	205,142		$	169,365
Support, maintenance and services		164,251			133,949			320,252			261,018
Reimbursed travel		8,364			9,588			14,955			16,734

Total revenues		277,815			228,390			540,349			447,117


Costs and expenses:
Cost of revenues		59,601			50,564			115,009			97,237
Sales and client service		114,291			94,232			225,131			187,074
Software development		48,702			42,769			98,031			85,323
General and administrative		21,013			14,919			38,935			29,064
Write off of in-process research and development		—			—			6,382			—

Total costs and expenses		243,607			202,484			483,488			398,698


Operating earnings		34,208			25,906			56,861			48,419

Other income (expense):
Interest expense, net		(1,366	)		(1,792	)		(3,108	)		(3,907	)
Other income		47			(174	)		77			2,840

Total other expense, net		(1,319	)		(1,966	)		(3,031	)		(1,067	)


Earnings before income taxes		32,889			23,940			53,830			47,352
Income taxes		(13,086	)		(9,626	)		(21,507	)		(18,909	)


Net earnings		19,803			14,314			32,323			28,443


Basic earnings per share	$	.53		$	.40		$	.87		$	.79

Basic weighted average shares outstanding		37,157			36,044			36,949			35,799

Diluted earnings per share	$	.51		$	.38		$	.84		$	.76

Diluted weighted average shares outstanding		38,986			37,510			38,673			37,306

See notes to condensed consolidated financial statements.

CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


	Six Months Ended
	July 2, 2005			July 3, 2004
(In thousands)
Cash flows from operating activities:
Net earnings	$	32,323		$	28,443
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		62,581			42,963
Gain on sale of business		—			(3,023	)
Write-off of acquired in process research and development		6,382			—
Provision for deferred income taxes		2,017			3,347
Changes in assets and liabilities, net of business acquired and sold:
Receivables, net		(5,307	)		(3,028	)
Inventory		(3,557	)		823
Prepaid expenses and other		(6,195	)		(10,732	)
Accounts payable		(6,977	)		(123	)
Accrued income taxes		8,368			8,952
Deferred revenue		(8,417	)		(1,811	)
Other accrued liabilities		7,439			1,595

Total adjustments		56,334			38,963

Net cash provided by operating activities		88,657			67,406


Cash flows from investing activities:
Purchase of capital equipment		(29,042	)		(17,738	)
Purchase of land, buildings and improvements		(13,816	)		(9,191	)
Acquisition of business, net of cash acquired		(107,310	)		(238	)
Proceeds from the sale of business		—			12,000
Repayment of notes receivable		21			1,943
Capitalized software development costs		(32,159	)		(30,381	)

Net cash used in investing activities		(182,306	)		(43,605	)


Cash flows from financing activities:
Proceeds from revolving line of credit		55,000			—
Repayment of revolving line of credit and long-term debt		(35,419	)		(19,528	)
Proceeds from exercise of options		18,292			11,775
Associate stock purchase plan discounts		(593	)		(352	)

Net cash provided by (used in) financing activities		37,280			(8,105	)


Effect of exchange rate changes on cash		(1,080	)		(311	)


Net (decrease) increase in cash and cash equivalents		(57,449	)		15,385

Cash and cash equivalents at beginning of period		189,784			121,839


Cash and cash equivalents at end of period	$	132,335		$	137,224


Supplemental disclosures of cash flow information:

Noncash financing activities		—		$	7,500
Issuance of note payable for unused software credits		—		$	7,500
Acquisition of equipment through capital leases		—		$	3,323

See notes to condensed consolidated financial statements.

CERNER CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)

Interim Statement Presentation & Accounting Policies

The condensed consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. 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 have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s latest annual report on Form 10-K.

In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position, and the results of operations and cash flows for the periods presented. The results for the three and six-month periods are not necessarily indicative of the operating results for the entire year.

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” establishes requirements for reporting and display of comprehensive income and its components. Total Comprehensive Income, which includes net earnings and foreign currency translation adjustments amounted to $18,475,000 and $13,707,000 for the three months ended July 2, 2005 and July 3, 2004 and $29,533,000 and $27,735,000 for the six months ended July 2, 2005 and July 3, 2004, respectively.

The terms of the Company’s software license agreements with its clients generally provide for a limited indemnification of such intellectual property against losses, expenses and liabilities arising from third-party claims based on alleged infringement by the Company’s 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, the Company has not had to reimburse any of its clients for any losses related to these indemnification provisions pertaining to third-party intellectual property infringement claims. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the terms of the corresponding agreements with its clients, the Company cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.

(2)

Earnings Per Share

Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. A reconciliation of the numerators and denominators of the basic and diluted per-share computations is as follows:


	Three months ended						Three months ended
	July 2, 2005						July 3, 2004
	Earnings		Shares		Per-Share		Earnings		Shares		Per-Share
	(Numerator)		(Denominator)		Amount		(Numerator)		(Denominator)		Amount
(In thousands, except per share data)
Basic earnings per share Income available to common stockholders	$	19,803		37,157	$	.53	$	14,314		36,044	$	.40

Effect of dilutive securities Stock options		—		1,829				—		1,466

Diluted earnings per share Income available to common stockholders including

Assumed conversions	$	19,803		38,986	$	.51	$	14,314		37,510	$	.38

Options to purchase 135,000 and 2,190,000 shares of common stock at per share prices ranging from $62.15 to $273.72 and $43.14 to $273.72 were outstanding at the three-months ended July 2, 2005 and July 3, 2004, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during the period.


	Six months ended						Six months ended
	July 2, 2005						July 3, 2004
	Earnings		Shares		Per-Share		Earnings		Shares		Per-Share
	(Numerator)		(Denominator)		Amount		(Numerator)		(Denominator)		Amount
(In thousands, except per share data)
Basic earnings per share Income available to common stockholders	$	32,323		36,949	$	.87	$	28,443		35,799	$	.79

Effect of dilutive securities Stock options		—		1,724				—		1,507

Diluted earnings per share Income available to common stockholders including

Assumed conversions	$	32,323		38,673	$	.84	$	28,443		37,306	$	.76

Options to purchase 78,570 and 1,650,000 shares of common stock at per share prices ranging from $57.09 to $273.72 and $43.77 to $273.72 were outstanding at the six-months ended July 2, 2005 and July 3, 2004, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during the period.

(3)

Accounting for Stock Options

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations including FASB Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25,” issued in March 2000, to account for its fixed–plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123. The following is a reconciliation of reported net earnings to adjusted net earnings had the Company recorded compensation expense based on the fair value at the grant date for its stock options under SFAS 123 for the three and six months ended July 2, 2005 and July 3, 2004.


	Three months ended						Six months ended
	July 2,			July 3,			July 2,			July 3,
(In thousands, except per share data)	2005			2004			2005			2004
Reported net earnings	$	19,803			14,314			32,323			28,443
Less: stock-based compensation expense determined under fair-value-based method for all awards		(2,862	)		(1,020	)		(4,900	)		(2,924	)

Pro-forma net earnings		16,941			13,294			27,423			25,519


Basic earnings per share:

Reported net earnings	$	.53			.40			.87			.79
Less: stock-based compensation expense determined under fair-value-based method for all awards, net of tax		(.08	)		(.03	)		(.13	)		(.08	)

Pro-forma net earnings		.45			.37			.74			.71


Diluted earnings per share:

Reported net earnings	$	.51			.38			.84			.76
Less: stock-based compensation expense determined under fair-value-based method for all awards		(.07	)		(.03	)		(.13	)		(.08	)

Pro-forma net earnings		.44			.35			.71			.68

In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share Based Payments (“SFAS No. 123(R)”) which replaces SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees.” SFAS No. 123(R) addresses the accounting for share-based payments transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of earnings. In April 2005, the Securities and Exchange Commission announced the adoption of a new rule that amends the effective date of SFAS 123(R). The effective date of the new standard under these new rules for the Company’s consolidated financial statements is January 1, 2006. The Company is currently assessing the impact that the Statement may have on its consolidated financial statements.

(4)

Business Acquisition and Divestiture

On January 3, 2005, the Company completed the purchase of assets of the medical business division of VitalWorks, Inc. for approximately $100 million, which was funded with existing cash of approximately $65 million and borrowings on the revolving line of credit of approximately $35 million. The medical business consists of delivering and supporting physician practice management, electronic medical record, electronic data interchange and emergency department information solutions and related products and services to physician practices, hospital emergency departments, management service organizations and other related entities. The acquisition of VitalWorks’ medical division will expand the Company’s presence in the physician practice market. $6.4 million of the purchase price was allocated to in-process research and development that had not reached technological feasibility and is reflected as a charge to earnings in

the first quarter of 2005. The preliminary allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired and liabilities assumed, resulted in goodwill of $55.5 million and $43.5 million in intangible assets that will be amortized over five years. The allocation of the purchase price is preliminary until management completes its evaluation of the fair value of the net assets acquired.

The unaudited financial information in the table below summarizes the combined results of operations of Cerner Corporation and the medical business division of VitalWorks, Inc., on a pro forma basis, as though the companies had been combined as of the beginning of the periods presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition and borrowings under the Company’s revolving line of credit had taken place at the beginning of the period presented. The pro forma financial information for the period presented includes the purchase accounting effect of amortization charges from acquired intangible assets and the charge for the write off of acquired in process research and development of $3,941,000, net of a $2,441,000 tax benefit.


	Three months ended		Six months ended
(in thousands, except per share data)	July 3, 2004		July 3, 2004

Total revenues	$	246,234		482,220
Net Income	$	15,351		26,374
Basic earnings per share	$	.43		.74
Diluted earnings per share	$	.41		.71

On March 15, 2004 the Company sold the referential content portion of Zynx Health Incorporated (Zynx) for $12 million. The Company retained the life sciences portion of the business, which is engaged in selling life sciences data to pharmaceutical companies for use in research, and the Company retained rights to use the Zynx content in its solutions going forward. The sale of Zynx resulted in a gain of $1,826,000, net of $1,197,000 of tax.

(5)

Receivables

Receivables consist of accounts receivable and contracts receivable. Accounts receivable represent recorded revenues that have been billed. Contracts receivable represent recorded revenues that are billable by the Company at future dates under the terms of a contract with a client. Billings and other consideration received on contracts in excess of related revenues recognized under the percentage-of – completion method are recorded as deferred revenue. A summary of receivables is as follows:


	July 2,		January 1,
(In thousands)	2005		2005

Accounts receivable	$	198,771		185,290
Contracts receivable		100,902		96,909


Total receivables	$	299,673		282,199

The Company provides general and specific allowances for estimated uncollectible accounts based upon historical experience and management’s judgment. At July 2, 2005 and January 1, 2005 the allowance for estimated uncollectible accounts was $18,296,000 and $17,583,000, respectively.

(6)

Goodwill and Other Intangible Assets

Goodwill and intangible assets with indefinite lives are evaluated for impairment annually or whenever there is an impairment indicator. All goodwill is assigned to a reporting unit, where it is subject to an impairment test based on fair value. The Company’s 2005 review of goodwill was completed in the second quarter of 2005 and indicated that goodwill was not impaired.

The Company’s intangible assets, other than goodwill or intangible assets with indefinite lives, are all subject to amortization and are summarized as follows:


			July 2, 2005				January 1, 2005
	Weighted
	Average		Gross				Gross
	Amortization		Carrying		Accumulated		Carrying		Accumulated
(In thousands)	Period (Yrs)		Amount		Amortization		Amount		Amortization
Purchased software		5.0	$	50,234		25,058		40,966		20,792
Customer lists		5.0		40,266		6,056		3,700		2,240
Patents		14.0		1,170		121		1,080		109
Non-compete agreements		5.0		274		64		125		40

Total		5.11	$	91,944		31,299		45,871		23,181

Aggregate amortization expense for the six months ended July 2, 2005 and July 3, 2004 was $8,118,000 and $2,672,000, respectively. Estimated aggregate amortization expense for each of the next five years is as follows:


For the remaining six months:	2005	$	8,297
For year ended:	2006		15,651
	2007		13,002
	2008		11,748
	2009		10,022

The changes in the carrying amount of goodwill for the six months ended July 2, 2005 are as follows:


Balance as of January 1, 2005	$	54,600
Goodwill acquired		56,747
Foreign currency translation adjustment and other		(972	)

Balance as of July 2, 2005	$	110,375

(7)

Contingencies

As previously disclosed, the Company received notice in April 2003 that three shareholder class action lawsuits were filed against it and five of its officers in the United States District Court for the Western District of Missouri. Subsequently, five additional shareholder class action lawsuits were filed against the Company. All of these lawsuits were filed after a decline in the Company’s stock price following the Company’s announcement on April 3, 2003 that the Company would not meet revenue and earnings estimates for the first quarter of 2003.

On August 20, 2003, the Court ordered that all of the lawsuits be consolidated under Case No. 03-CV-00296-DW and appointed Phil Crabtree as Lead Plaintiff. On December 1, 2003, the Lead Plaintiff filed a Consolidated Class Action Complaint. In general, the consolidated complaint alleges that, during a class period commencing as of July 17, 2002 and ending April 2, 2003, the Company and individually named defendants misrepresented or failed to disclose certain factors, which they allege impacted the Company’s business and anticipated revenue and earnings, all allegedly in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

On June 16, 2004 the Court granted the Company’s and the individual defendants’ Motion to Dismiss and ordered the Consolidated Class Action Complaint dismissed with prejudice against re-filing. On June 30, 2004, the Lead Plaintiff appealed the District Court’s dismissal of the action to the United States Court of Appeals for the Eighth Circuit. The parties filed their appellate briefs and the issues were argued before the Eighth Circuit on January 13, 2005. The matter is now submitted to the Eighth Circuit for decision but the Company does not know when the Court of Appeals will rule on the appeal.

The Company believes that the District Court was correct in dismissing the consolidated complaint and that all the claims asserted in that complaint are without merit. In the event that the Court of Appeals reverses the District Court’s dismissal, the Company intends to continue with its vigorous defense of those claims.

(8)

Segment Reporting

Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” establishes annual and interim reporting standards for operating segments of a company. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues, and its major clients. In 2003, the Company organized geographically. The Company’s six geographic business segments are: Great Lakes, Mid-America, North Atlantic, Southeast, West 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 and sublicensed software purchased from computer and software manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such. “Other” includes revenues not generated by the operating segments and expenses such as software development, marketing, general and administrative and depreciation that have not been allocated to the operating segments. Also included in “Other” are revenues and expenses related to the recently acquired medical business division of VitalWorks, Inc. The Company does not track assets by geographical business segment. Certain prior year amounts have been reclassified to conform with current year presentation.

Accounting policies for each of the reportable segments are the same as those used on a consolidated basis. The following table presents a summary of the operating information for the three and six-months ended July 2, 2005 and July 3, 2004:


	Operating Segments
	Great		Mid-		North		South-
	Lakes		America		Atlantic		east		West		Global		Other			Total

Three months ended July 2, 2005

Revenues	$	41,928	$	54,695	$	47,205	$	36,872	$	48,026	$	32,205	$	16,884		$	277,815


Cost of revenues		10,726		11,281		10,116		8,802		9,590		4,920		4,166			59,601
Operating expenses		6,910		9,831		8,435		8,827		9,659		10,340		130,004			184,006

Total costs and expenses		17,636		21,112		18,551		17,629		19,249		15,260		134,170			243,607


Operating earnings/(loss)	$	24,292	$	33,583	$	28,654	$	19,243	$	28,777	$	16,945	$	(117,286	)	$	34,208


	Operating Segments
	Great		Mid-		North		South-
	Lakes		America		Atlantic		east		West		Global		Other			Total

Three months ended July 3, 2004

Revenues	$	38,662	$	52,267	$	37,773	$	39,258	$	43,939	$	9,624	$	6,867		$	228,390


Cost of revenues		9,002		11,840		8,070		8,823		8,369		1,395		3,065			50,564
Operating expenses		6,791		7,983		7,641		8,241		8,186		7,246		105,832			151,920

Total costs and expenses		15,793		19,823		15,711		17,064		16,555		8,641		108,897			202,484


Operating earnings/(loss)	$	22,869	$	32,444	$	22,062	$	22,194	$	27,384	$	983	$	(102,030	)	$	25,906


	Operating Segments
	Great		Mid-		North		South-
	Lakes		America		Atlantic		east		West		Global		Other			Total

Six months ended July 2, 2005

Revenues	$	76,545	$	109,345	$	88,960	$	72,931	$	97,857	$	55,389	$	39,322		$	540,349


Cost of revenues		18,278		22,252		19,362		17,854		20,301		7,405		9,557			115,009
Operating expenses		14,107		19,416		16,842		18,035		19,253		19,708		261,118			368,479

Total costs and expenses		32,385		41,668		36,204		35,889		39,554		27,113		270,675			483,488


Operating earnings/(loss)	$	44,160	$	67,677	$	52,756	$	37,042	$	58,303	$	28,276	$	(231,353	)	$	56,861


	Operating Segments
	Great		Mid-		North		South-
	Lakes		America		Atlantic		east		West		Global		Other			Total

Six months ended July 3, 2004

Revenues	$	75,735	$	100,356	$	83,552	$	74,380	$	78,321	$	21,655	$	13,118		$	447,117


Cost of revenues		17,149		19,858		18,535		17,809		16,464		2,766		4,656			97,237
Operating expenses		13,988		15,125		15,374		16,473		16,366		16,753		207,382			301,461

Total costs and expenses		31,137		34,983		33,909		34,282		32,830		19,519		212,038			398,698

Operating earnings/(loss)	$	44,598	$	65,373	$	49,643	$	40,098	$	45,491	$	2,136	$	(198,920	)	$	48,419

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

Introduction

Cerner Corporation (“Cerner” or the “Company”) is headquartered in North Kansas City, Missouri. The Company derives revenue by selling, implementing and supporting software solutions and hardware that gives healthcare 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 healthcare. Cerner implements these solutions as stand-alone, combined or enterprise-wide systems. Cerner Millennium® software solutions can be managed by the Company’s clients or in the Company’s data center via a managed services model.

Results Overview

The Company delivered strong results in the second quarter of 2005. Total new business bookings, which reflect the value of contracts for software, hardware, services and managed services (hosting of software in the Company’s data center), were at record levels at $284,372,000 in the second quarter of 2005, an increase of 18% compared to $240,391,000 in the second quarter of 2004.

Total revenues in the second quarter were $277,815,000, an increase of 22% compared to the second quarter of 2004. The revenue composition for the second quarter of 2005 was $105,200,000 in system sales, $73,129,000 in support and maintenance, $91,122,000 in services and $8,364,000 in reimbursed travel. Revenues for the second quarter of 2005 included $17,699,000, split fairly evenly between system sales and support, maintenance and services, from the acquisition of the medical business division of VitalWorks, Inc., which closed on January 3, 2005.

The Company’s record bookings drove a 25% year-over-year increase in contract backlog, which reflects new business bookings that have not yet been recognized as revenue, and ended the second quarter at $1,336,143,000. Backlog continues to grow faster than revenue as the Company is experiencing strong growth in managed services, which are recognized as revenue over a longer period of time than other types of bookings, such as software and hardware.

Net earnings were $19,803,000 in the second quarter of 2005 compared to $14,314,000 in the second quarter of 2004. The increase in net earnings in the second quarter of 2005 was driven both by revenue growth and margin expansion. Operating margins were 12.3% in the second quarter of 2005 compared to 11.3% in the year-ago quarter. Going forward, management believes the Company can continue to increase operating margins by expanding margins on services, leveraging investments in research and development, and controlling sales and general and administrative spending.

The Company’s operational performance was also strong in the second quarter of 2005. The Company brought 347 Cerner Millennium solutions live in the second quarter of 2005, bringing the cumulative number of solutions implemented to over 4,300 at nearly 860 client facilities. These results included significant progress at implementing computerized physician order entry (CPOE), which is the application generating the highest level of industry attention.

The Company’s strong operational performance is also reflected in its cash flow results. In the second quarter of 2005, the Company generated $44,333,000 of cash flow from operations, with near record cash collections of $277,550,000 and days sales outstanding decreasing from 103 days at the end of the second quarter of 2004 to 98 days at the end of the second quarter of 2005.

Healthcare Information Technology Market

The second quarter of 2005 was again full of positive activity in the healthcare information technology marketplace. The Company has communicated in the past the government’s increasing commitment to healthcare information technology. Recent legislative activity illustrates the strength of the government’s commitment. There have now been at least eighteen Healthcare Information Technology (“HIT”) bills introduced with broad bipartisan representation. These recently introduced bills propose facilitating HIT investments by offering incentives such as direct grants, favorable tax treatment, reduced Stark and anti-kickback rules, HIT loans, and differential reimbursement. Recently, the supporters of two of these bipartisan bills indicated they would be combining their bills to consolidate support for common goals. While it is unclear exactly how these legislative measures will unfold, it appears that there is strong

support for HIT initiatives, and the Company believes any of these measures has the potential to positively impact its industry.

In addition to legislative activity, on June 6, 2005, Health and Human Services Secretary, Michael Leavitt, announced the formation of a national collaboration in an effort to advance President Bush’s goal for most Americans to have an electronic health record within 10 years. This private-public collaboration, called the American Health Information Community (“AHIC”), will focus on privacy, standards, certification, and architecture.

Also worth noting is the fact that Moody’s Investors Services has commented on HIT with a May 2005 report in which they conclude there are several benefits to providers who invest in clinical information technology that allows them to increase safety and quality while becoming more efficient. Moody’s also indicates that HIT investments will be necessary for providers to remain competitive. Having a major rating service support HIT investment is important to providers, so the Company views this as another positive for HIT.

Results of Operations

Three Months Ended July 2, 2005 Compared to Three Months Ended July 3, 2004

The Company’s revenues increased 22% to $277,815,000 for the three-month period ended July 2, 2005 from $228,390,000 for the three-month period ended July 3, 2004. Revenues for the second quarter of 2005 included $17,699,000 from the acquisition of the medical business division of VitalWorks, Inc., which closed on January 3, 2005. Net earnings increased 38% to $19,803,000 in the 2005 period from $14,314,000 for the 2004 period.

System sales revenues increased 24% to $105,200,000 for the three-month period ended July 2, 2005 from $84,853,000 for the corresponding period in 2004. Included in system sales are revenues primarily from the sale of software, hardware, sublicensed software, installation fees and subscriptions. This increase is due primarily to an increase in new business bookings and the inclusion of revenue from the medical business division of VitalWorks, Inc. in the second quarter of 2005 compared to the second quarter of 2004.

Support, maintenance and service revenues increased 23% to $164,251,000 during the second quarter of 2005 from $133,949,000 during the same period in 2004. Included in support, maintenance and service revenues are support and maintenance of software and hardware, professional services excluding installation, and managed services. Support and maintenance revenues were $73,129,000 and $59,766,000 for the second quarter of 2005 and 2004, respectively. Service revenues were $91,122,000 and $74,183,000 for the second quarter of 2005 and 2004, respectively. These increases were driven by strong performance in delivering Cerner Millennium solutions to clients and the inclusion of revenue from the acquisition of VitalWorks’ medical business division.

At July 2, 2005, the Company had $1,336,143,000 in contract backlog and $379,994,000 in support and maintenance backlog, compared to $1,071,732,000 in contract backlog and $324,002,000 in support and maintenance backlog at July 3, 2004.

The cost of revenue was 21% and 22% of total revenues in the second quarter of 2005 and 2004, respectively. The cost of revenues includes the cost of reimbursed travel expense, third party consulting services, subscription content, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients, and commissions. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, support, services and reimbursed travel) components carrying different margin rates changes from period to period.

Sales and client service expenses as a percent of total revenues were 41% in the second quarter of 2005 and 2004. Sales and client service expenses include salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Also included are sales and marketing salaries, trade show costs and advertising costs. The increase in total sales and client service expenses to $114,291,000 in the second quarter of 2005 from $94,232,000 in the same period of 2004 was primarily

attributable to an increase in personnel expense and marketing related expenses and the inclusion of expenses from VitalWorks’ medical business division.

Software development expenses include salaries, documentation and other direct expenses incurred in product development and amortization of software development costs. Total expenditures for software development, including both capitalized and noncapitalized portions, for the second quarter of 2005 and 2004 were $52,189,000 and $47,378,000, respectively. These amounts exclude amortization. Capitalized software costs were $15,649,000 and $15,155,000 for the second quarter of 2005 and 2004, respectively. The increase in aggregate expenditures for software development in 2004 is due to continued development of Cerner Millennium software solutions and the inclusion of expenses from VitalWorks’ medical business division.

General and administrative expenses as a percent of total revenues were 8% and 7% in the second quarter of 2005 and 2004, respectively. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses and professional fees. Total general and administrative expenses for the second quarter of 2005 and 2004 were $21,013,000 and $14,919,000, respectively. This increase is due primarily to the growth of the Company’s core business, a result of acquisitions and increased presence in the global market.

Net interest expense was $1,366,000 in the second quarter of 2005 compared to $1,792,000 in the second quarter of 2004. This decrease in interest expense is due to an increase in invested funds and a decrease in long-term debt.

Operations by Segment

In 2003, the Company organized geographically. The Company’s six geographic business segments are: Great Lakes, Mid-America, North Atlantic, Southeast, West 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 and sublicensed software purchased from computer and software manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such. “Other” includes revenues not generated by the operating segments and expenses such as software development, marketing, general and administrative and depreciation that have not been allocated to the operating segments. Also included in “Other” are revenues and expenses related to the recently acquired medical business division of VitalWorks, Inc. The Company does not track assets by geographical business segment. Certain prior year amounts have been reclassified to conform with current year presentation.

The following table presents a summary of the operating information for the three months ended July 2, 2005 and July 3, 2004:


	Operating Segments
	Great		Mid-		North		South-
	Lakes		America		Atlantic		east		West		Global		Other			Total

Three months ended July 2, 2005

Revenues	$	41,928	$	54,695	$	47,205	$	36,872	$	48,026	$	32,205	$	16,884		$	277,815


Cost of revenues		10,726		11,281		10,116		8,802		9,590		4,920		4,166			59,601
Operating expenses		6,910		9,831		8,435		8,827		9,659		10,340		130,004			184,006

Total costs and expenses		17,636		21,112		18,551		17,629		19,249		15,260		134,170			243,607


Operating earnings/(loss)	$	24,292	$	33,583	$	28,654	$	19,243	$	28,777	$	16,945	$	(117,286	)	$	34,208


	Operating Segments
	Great		Mid-		North		South-
	Lakes		America		Atlantic		east		West		Global		Other			Total

Three months ended July 3,2004

Revenues	$	38,662	$	52,267	$	37,773	$	39,258	$	43,939	$	9,624	$	6,867		$	228,390

Cost of revenues		9,002		11,840		8,070		8,823		8,369		1,395		3,065			50,564
Operating expenses		6,791		7,983		7,641		8,241		8,186		7,246		105,832			151,920

Total costs and expenses		15,793		19,823		15,711		17,064		16,555		8,641		108,897			202,484


Operating earnings/(loss)	$	22,869	$	32,444	$	22,062	$	22,194	$	27,384	$	983	$	(102,030	)	$	25,906

Operating earnings in the Great Lakes segment increased 6% for the three months ended July 2, 2005 compared to the three months ended July 3, 2004. Total revenues increased 8% in the second quarter of 2005 compared to the second quarter of 2004. The increase in revenues was primarily driven by an increase in managed services, hardware and support and maintenance revenues in the second quarter of 2005 compared to the second quarter of 2004. Costs of revenues were 26% and 23% of total revenues of the Great Lakes segment for the second quarter of 2005 and 2004, respectively. The increase in the cost of revenues as a percent of revenues is due primarily to an increase in hardware sales in the second quarter of 2005 compared to 2004.

Operating earnings in the Mid-America segment increased 4% for the three months ended July 2, 2005 compared to the three months ended July 3, 2004. Total revenues increased 5% in the second quarter 2005 compared to the second quarter of 2004. The increase in revenues was driven primarily by an increase in managed services and support and maintenance revenue in the second quarter of 2005 compared to the second quarter of 2004. Cost of revenues were 21% and 23% of total Mid-America segment revenues for the second quarter of 2005 and the second quarter of 2004, respectively. The decrease in the cost of revenues as a percent of revenues is due primarily to a decrease in hardware sales in the second quarter of 2005 compared to 2004. Operating expenses increased 23% in the second quarter of 2005 compared to 2004, due primarily to an increase in personnel related expenses.

Operating earnings in the North Atlantic segment increased 30% for the three months ended July 2, 2005 compared to the three months ended July 3, 2004. Total revenues increased 25% in the second quarter of 2005 compared to the second quarter of 2004, due primarily to an increase in licensed software, managed service and hardware revenues in the second quarter of 2005 compared to the second quarter of 2004. Cost of revenues were 21% of total North Atlantic segment revenues for the second quarter of 2005 and 2004, respectively. Operating expenses increased 10% in the second quarter of 2005 compared to 2004, due primarily to an increase in personnel related expenses.

Operating earnings in the Southeast segment decreased 13% for the three months ended July 2, 2005 compared to the three months ended July 3, 2005. Revenues decreased 6% in the second quarter of 2005 compared to the second quarter of 2004. This decrease was driven primarily by a decrease in licensed software revenue. Cost of revenues were 24% and 22% of total Southeast segment revenues for the second quarter of 2005 and the second quarter of 2004, respectively. Operating expenses increased 7% in the second quarter of 2005 compared to 2004, this increase is due primarily to an increase in personnel related expenses.

Operating earnings in the West segment increased 5% for the three months ended July 2, 2005 compared to the three months ended July 3, 2004. Total revenues increased 9% in the second quarter of 2005 compared to the second quarter of 2004, due to increases in managed and support and maintenance revenue. Cost of revenues were 20% and 19% of total West segment revenues for the second quarter of 2005 and 2004, respectively. Operating expenses increased 18% in the second quarter of 2005 compared to the second quarter of 2004, due primarily to an increase in personnel related expenses.

Operating earnings in the Global segment increased 1,624% for the three months ended July 2, 2005 compared to the three months ended July 3, 2004. Total revenues increased 235% in the second quarter of 2005 compared to the second quarter of 2004. The increase in revenues is due primarily to a strong increases in licensed software, professional services and hardware revenues in the second quarter of 2005 compared to the second quarter of 2004. Cost of revenues were 15% and 14% of total Global segment revenues for the second quarter of 2005 and 2004, respectively. Operating expenses increased 43% in the second quarter of 2005 compared to 2004, this increase is due to an increase in the Company’s presence in the global market.

Operating losses in Other increased 15% for the three months ended July 2, 2005 compared to the three months ended July 3, 2004. Included in Other are revenues and expenses related to the recently acquired medical business division of VitalWorks, Inc. Operating expenses increased 23% in second quarter of 2005 compared to the second quarter of 2004. This increase in operating expenses is due to the acquisition of the medical business division of VitalWorks, Inc., and an increase in expenses such as software development, marketing, general and administrative and depreciation in the second quarter of 2005 compared to the second quarter of 2004.

Six Months Ended July 2, 2005 Compared to Six Months Ended July 3, 2004

The Company’s revenues increased 21% to $540,349,000 for the six-month period ended July 2, 2005 from $447,117,000 for the six-month period ended July 3, 2004. Revenues for the six-month period of 2005 included $35,028,000 from the acquisition of the medical business division of VitalWorks, Inc., which closed on January 3, 2005. Net earnings increased 14% to $32,323,000 in the 2005 period from $28,443,000 for the 2004 period. Net earnings for the six-month period ended July 2, 2005 included a write off of acquired in-process research and development of $3,941,000, net of a $2,441,000 tax benefit. Net earnings for the six-month period ended July 3, 2004 included a gain on the sale of Zynx Health Incorporated of $1,826,000, net of a $1,197,000 tax expense. Excluding these two items, net earnings increased 36% in the first six months of 2005 compared to the first six months of 2004.

System sales revenues increased 21% to $205,142,000 for the six-month period ended July 2, 2005 from $169,365,000 for the corresponding period in 2004. Included in system sales are revenues primarily from the sale of software, hardware, sublicensed software, installation fees and subscriptions. This increase is due primarily to an increase in new business bookings and the inclusion of revenue from the medical business division of VitalWorks, Inc. in the first six months of 2005 compared to the first six months of 2004.

Support, maintenance and service revenues increased 23% to $320,252,000 during the first six months of 2005 from $261,018,000 during the same period in 2004. Included in support, maintenance and service revenues are support and maintenance of software and hardware, professional services excluding installation, and managed services. Support and maintenance revenues were $144,355,000 and $117,611,000 for the six-month period of 2005 and 2004, respectively. Service revenues were $175,897,000 and $143,407,000 for the six-month period of 2005 and 2004, respectively. These increases were driven by strong performance in delivering Cerner Millennium solutions to clients and the inclusion of revenue from the acquisition of VitalWorks’ medical business division.

The cost of revenue was 21% and 22% of total revenues in the six-month period of 2005 and 2004, respectively. The cost of revenues includes the cost of reimbursed travel expense, third party consulting services, subscription content, computer hardware and sublicensed software purchased from computer and software manufacturers for delivery to clients, and commissions. It also includes the cost of hardware

maintenance and sublicensed software support subcontracted to manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, maintenance, support, services and reimbursed travel) components carrying different margin rates changes from period to period.

Sales and client service expenses as a percent of total revenues were 42% in the six-month period of 2005 and 2004, respectively. Sales and client service expenses include salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Also included are sales and marketing salaries, trade show costs and advertising costs. The increase in total sales and client service expenses to $225,131,000 in the six-month of 2005 from $187,074,000 in the same period of 2004 was primarily attributable to an increase in personnel expense and marketing related expenses and the inclusion of expenses from VitalWorks’ medical business division.

Software development expenses include salaries, documentation and other direct expenses incurred in product development and amortization of software development costs. Total expenditures for software development, including both capitalized and noncapitalized portions, for the first six months of 2005 and 2004 were $105,901,000 and $94,475,000, respectively. These amounts exclude amortization. Capitalized software costs were $32,159,000 and $30,381,000 for the first six months of 2005 and 2004, respectively. The increase in aggregate expenditures for software development in 2004 is due to continued development of Cerner Millennium software solutions and the inclusion of expenses from VitalWorks’ medical business division.

General and administrative expenses as a percent of total revenues were 7% in the six-month period of 2005 and 2004, respectively. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses and professional fees. Total general and administrative expenses for the six-month period of 2005 and 2004 were $38,935,000 and $29,064,000, respectively. This increase is due primarily to the growth of the Company’s core business, as a result of acquisitions and an increased presence in the global market.

The write-off of in-process research and development is an expense resulting from the acquisition of the medical business division of VitalWorks, Inc.

Net interest expense was $3,108,000 in the six-month period of 2005 compared to $3,907,000 in the six-month period of 2004. This decrease is due to an increase in invested funds and a decrease in long-term debt.

Other income was $77,000 in the six-month of 2005 compared to $2,840,000 in the six-month of 2004. This decrease is due to the gain on the sale of Zynx Health Incorporated which was included in other income in the first quarter of 2004.

Operations by Segment

The following table presents a summary of the operating information for the six months ended July 2, 2005 and July 3, 2004:


	Operating Segments
	Great		Mid-		North		South-
	Lakes		America		Atlantic		east		West		Global		Other			Total

Six months ended July 2, 2005

Revenues	$	76,545	$	109,345	$	88,960	$	72,931	$	97,857	$	55,389	$	39,322		$	540,349


Cost of revenues		18,278		22,252		19,362		17,854		20,301		7,405		9,557			115,009
Operating expenses		14,107		19,416		16,842		18,035		19,253		19,708		261,118			368,479

Total costs and expenses		32,385		41,668		36,204		35,889		39,554		27,113		270,675			483,488

Operating earnings/(loss)	$	44,160	$	67,677	$	52,756	$	37,042	$	58,303	$	28,276	$	(231,353	)	$	56,861


	Operating Segments
	Great		Mid-		North		South-
	Lakes		America		Atlantic		east		West		Global		Other			Total

Six months ended July 3, 2004

Revenues	$	75,735	$	100,356	$	83,552	$	74,380	$	78,321	$	21,655	$	13,118		$	447,117


Cost of revenues		17,149		19,858		18,535		17,809		16,464		2,766		4,656			97,237
Operating expenses		13,988		15,125		15,374		16,473		16,366		16,753		207,382			301,461

Total costs and expenses		31,137		34,983		33,909		34,282		32,830		19,519		212,038			398,698

Operating earnings/(loss)	$	44,598	$	65,373	$	49,643	$	40,098	$	45,491	$	2,136	$	(198,920	)	$	48,419

Operating earnings in the Great Lakes segment remained flat for the six months ended July 2, 2005 compared to the six months ended July 3, 2004. Total revenues also remained flat in the first six months of 2005 compared to the first six months of 2004. Costs of revenues were 24% and 23% of total revenues of the Great Lakes segment for the first six months of 2005 and 2004, respectively.

Operating earnings in the Mid-America segment increased 4% for the six months ended July 2, 2005 compared to the six months ended July 3, 2004. Total revenues increased 9% in the first six months of 2005 compared to the first six months of 2004. The increase in revenues was driven primarily by an increase in professional services, hardware and managed services revenue in the first six months of 2005 compared to the first six months of 2004. Cost of revenues were 20% of total Mid-America segment revenues for the first six months of 2005 and 2004. Operating expenses increased 28% in the first six months of 2005 compared to 2004, due primarily to an increase in personnel related expenses.

Operating earnings in the North Atlantic segment increased 6% for the six months ended July 2, 2005 compared to the six months ended July 3, 2004. Total revenues increased 6% in the first six months of 2005 compared to the first six month of 2004, due primarily to an increase in professional services, support and maintenance and managed services revenues in the first six months of 2005 compared to the first six months of 2004. Cost of revenues were 22% of total North Atlantic segment revenues for the first six months of 2005 and 2004, respectively. Operating expenses increased 10% in the first six months of 2005 compared to 2004, due primarily to an increase in personnel related expenses.

Operating earnings in the Southeast segment decreased 8% for the six months ended July 2, 2005 compared to the six months ended July 3, 2005. Revenues decreased 2% in the first six of 2005 compared to the first six months of 2004. Cost of revenues were 24% of total Southeast segment revenues for the first six months of 2005 and the first six months of 2004, respectively. Operating expenses increased 9% in the first six months of 2005 compared to 2004, this increase is due primarily to an increase in personnel related expenses.

Operating earnings in the West segment increased 28% for the six months ended July 2, 2005 compared to the six months ended July 3, 2004. Total revenues increased 25% in the first six months of 2005 compared to the first six months of 2004, due to a strong increase in licensed software revenue. Cost of revenues were 21% of total West segment revenues for the first six months of 2005 and 2004, respectively. Operating expenses increased 18% in the first six months of 2005 compared to the first six months of 2004, due primarily to an increase in personnel related expenses.

Operating earnings in the Global segment increased 1,224% for the six months ended July 2, 2005 compared to the six months ended July 3, 2004. Total revenues increased 156% in the first six months of

2005 compared to the first six months of 2004. The increase in revenues is due primarily to increases in licensed software and professional services in the first six months of 2005 compared to the first six months of 2004. Cost of revenues were 13% of total Global segment revenues for the first six months of 2005 and 2004.

Operating losses in Other increased 16% for the six months ended July 2, 2005 compared to the six months ended July 3, 2004. Included in Other are revenues and expenses related to the recently acquired medical business division of VitalWorks, Inc. Operating expenses increased 26% in first six months of 2005 compared to the first six months of 2004. This increase in operating expenses is due to the acquisition of the medical business division of VitalWorks, Inc., and an increase in expenses such as software development, marketing, general and administrative and depreciation in the first six months of 2005 compared to the first six months of 2004. Operating expenses in the first six months of 2005 includes the write-off of acquired in-process research and development of $6,382,000.

Capital Resources and Liquidity

The Company’s liquidity is influenced by many factors, including the amount and timing of the Company’s revenues, its cash collections from its clients and the amounts the Company invests in software development, acquisitions and capital expenditures.

The Company’s principal source of liquidity is its cash and cash equivalents. The majority of the Company’s cash and cash equivalents consist of U.S. Government Federal Agency Securities, short-term marketable securities and overnight repurchase agreements. At July 2, 2005 the Company had cash and cash equivalents of $132,335,000 and working capital of $211,635,000.

The Company generated cash of $88,657,000 and $67,406,000 from operations for the six months ended July 2, 2005 and July 3, 2004, respectively. This increase is primarily due to a stronger performance in net earnings and increased depreciation and amortization. The Company has periodically provided long-term financing options to creditworthy clients through third party financing institutions and has on occasion directly provided extended payment terms from contract date. Some of these payment streams have been assigned on a non-recourse basis to third party financing institutions. The Company has provided its usual and customary performance guarantees to the third party financing institutions in connection with its on-going obligations under the client contract. During the first six months of 2005 and 2004, the Company received total client cash collections of $556,500,000 and $453,550,000, respectively, of which 6.8% and 5.6% were received from third party client financing arrangements and non-recourse payment assignments. Days sales outstanding decreased from 104 days at the end of 2004 to 98 days on July 2, 2005. Revenues under support and maintenance agreements represent recurring cash flows. Support and maintenance revenues increased 23% in the first six months of 2005 compared to the first six months of 2004, and the Company expects these revenues to continue to grow as the base of installed systems grows.

Cash used in investing activities consisted primarily of the acquisition of businesses of $107,310,000 in 2005, capitalized software development costs of $32,159,000 and $30,381,000 and purchases of capital equipment, land and buildings of $42,858,000 and $26,929,000 in the six months ended July 2, 2005 and July 3, 2004, respectively. The Company completed the sale of Zynx Healthcare Incorporated in the first quarter of 2004 for $12,000,000.

The Company’s financing activities for the first six months of 2005 primarily consisted of proceeds of debt of $55,000,000, repayment of debt of $35,419,000 and of the proceeds from the exercise of stock options of $18,292,000. For the first six months of 2004 the Company’s financing activities consisted primarily of the repayment of debt of $19,528,000 and the proceeds from the exercise of stock options of $11,775,000.

The Company believes that its present cash position, together with cash generated from operations and, if necessary, the line of credit will be sufficient to meet anticipated cash requirements during 2005. The Company has $90,000,000 of long-term, revolving credit from banks. At July 2, 2005 the Company had outstanding borrowings of $40,000,000 under the agreement.

The effects of inflation on the Company’s business during the period discussed herein were minimal.

Recent Accounting Pronouncements

Factors that may Affect Future Results of Operations, Financial Condition or Business

Statements made in this report, other reports and proxy statements filed with the Securities and Exchange Commission, communications to shareholders, press releases and oral statements made by representatives of the Company that are not historical in nature, or that state the Company’s or management’s intentions, hopes, beliefs, expectations or predictions of the future, may constitute “forward-looking statements” within the meaning of 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. Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. It is important to note that any such performance and actual results, financial condition or business, could differ materially from those expressed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below as well as those discussed elsewhere herein or in other reports filed with the Securities and Exchange Commission. Other unforeseen factors not identified herein could also have such an effect. The Company undertakes 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.

Quarterly Operating Results May Vary — The Company’s quarterly operating results have varied in the past and may continue to vary in future periods, including, variations from guidance, expectations or historical results or trends. Quarterly operating results may vary for a number of reasons including accounting policy changes mandated by regulating entities, demand for the Company’s software solutions and services, the Company’s long sales cycle, potentially long installation and implementation cycles for larger, more complex and costlier systems and other factors described in this section and elsewhere in this report. As a result of healthcare industry trends and the market for the Company’s Cerner Millennium solutions, a large percentage of the Company’s revenues are generated by the sale and installation of larger, more complex and costlier systems. The sales process for these systems is lengthy and involves a significant technical evaluation and commitment of capital and other resources by the client. Sales may be subject to delays due to changes in clients’ internal budgets, procedures for approving large capital expenditures, competing needs for other capital expenditures, availability of personnel resources and by actions undertaken by competitors. Delays in the expected sale or installation of these large systems may have a significant impact on the Company’s anticipated quarterly revenues and consequently its earnings, since a significant percentage of the Company’s expenses are relatively fixed.

The Company recognizes revenue upon the completion of standard milestone conditions and the amount of revenue recognized in any quarter depends upon the Company’s and the client’s ability to meet these project milestones. Delays in meeting these milestone conditions or modification of the contract relating to one or more of these systems could result in a shift of revenue recognition from one quarter to another and could have a material adverse effect on results of operations for a particular quarter. The Company’s revenues from system sales historically have been lower in the first quarter of the year and greater in the fourth quarter of the year, primarily as a result of the clients’ year-end efforts to make all final capital expenditures for the then current year.

Stock Price May Be Volatile — The trading price of the Company’s common stock may be volatile. The market for the Company’s common stock may experience significant price and volume fluctuations in response to a number of factors including actual or anticipated quarterly variations in operating results,

rumors about the Company’s performance or software solutions, changes in expectations of future financial performance or changes in estimates of securities analysts, governmental regulatory action, healthcare reform measures, client relationship developments, changes occurring in the securities markets in general and other factors, many of which are beyond the Company’s control. As a matter of policy, the Company does not generally comment on rumors.

Furthermore, the stock market in general, and the market for software and healthcare and information technology companies in particular, has experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of the Company’s common stock, regardless of actual operating performance.

Changes in the Healthcare Industry — The healthcare industry is highly regulated and is subject to changing political, economic and regulatory influences. For example, the Balanced Budget Act of 1997 (Public Law 105-32) contained significant changes to Medicare and Medicaid and had an impact for several years on healthcare providers’ ability to invest in capital intensive systems. In addition, the Health Insurance Portability and Accountability Act of 1996 (HIPAA) is having a direct impact on the healthcare industry by requiring identifiers and standardized transactions/code sets and necessary security and privacy measures in order to ensure the protection of patient health information. These factors affect the purchasing practices and operation of healthcare organizations. Federal and state legislatures have periodically considered programs to reform or amend the U.S. healthcare system at both the federal and state level and to change healthcare financing and reimbursement systems. These programs may contain proposals to increase governmental involvement in healthcare, lower reimbursement rates or otherwise change the environment in which healthcare industry participants operate. Healthcare industry participants may respond by reducing their investments or postponing investment decisions, including investments in the Company’s software solutions and services.

Many healthcare providers are consolidating to create integrated healthcare delivery systems with greater market power. These providers may try to use their market power to negotiate price reductions for the Company’s software solutions and services. As the healthcare industry consolidates, the Company’s client base could be eroded, competition for clients could become more intense and the importance of acquiring each client becomes greater.

Significant Competition — The market for healthcare information systems is intensely competitive, rapidly evolving and subject to rapid technological change. The Company believes that the principal competitive factors in this market include the breadth and quality of system and software solution offerings, the stability of the information systems provider, the features and capabilities of the information systems, the ongoing support for the system and the potential for enhancements and future compatible software solutions.

Certain of the Company’s competitors have greater financial, technical, product development, marketing and other resources than the Company and some of its competitors offer software solutions that it does not offer. The Company’s principal existing competitors include; Eclipsys Corporation, Epic Systems Corporation, GE Medical Systems, IDX Systems Corporation, iSoft Corporation, McKesson Corporation, Medical Information Technology, Inc. (“Meditech”), Misys Healthcare Systems and Siemens Medical Solutions Health Services Corporation, each of which offers a suite of software solutions that compete with many of the Company’s software solutions and services. There are other competitors that offer a more limited number of competing software solutions.

In addition, the Company expects that major software information systems companies, large information technology consulting service providers and system integrators, Internet-based start-up companies and others specializing in the healthcare industry may offer competitive software/solutions or services. The pace of change in the healthcare information systems market is rapid and there are frequent new software solution introductions, software solution enhancements and evolving industry standards and requirements. As a result, the Company’s success will depend upon its ability to keep pace with technological change and to introduce, on a timely and cost-effective basis, new and enhanced software solutions and services that satisfy changing client requirements and achieve market acceptance.

Proprietary Technology May Be Subjected to Infringement Claims or May Be Infringed Upon –The Company relies upon a combination of license agreements, confidentiality procedures, employee nondisclosure agreements and technical measures to maintain the confidentiality and trade secrecy of its proprietary information. The Company also relies on trademark and copyright laws to protect its

intellectual property. The Company has initiated a patent program but currently has a limited patent portfolio. As a result, the Company may not be able to protect against misappropriation of its intellectual property.

In addition, the Company could be subject to intellectual property infringement claims as the number of competitors grows and the functionality of its software solutions and services expands. These claims, even if not meritorious, could be expensive to defend. If the Company becomes liable to third parties for infringing their intellectual property rights, it could be required to pay a substantial damage award and to develop noninfringing technology, obtain a license or cease selling the software solutions that contain the infringing intellectual property.

Government Regulation — The healthcare industry is highly regulated at the local, state and federal level. Consequently, the Company may be subject to such regulations, which include regulation in the areas of healthcare fraud, medical devices and the security and privacy of patient data, and the risk of changes in the various local, state and federal laws.

Healthcare Fraud. The federal government continues to strengthen its position and scrutiny over practices involving healthcare fraud affecting healthcare providers whose services are reimbursed by Medicare, Medicaid and other government healthcare programs. Healthcare providers who are clients of the Company are subject to laws and regulations on fraud and abuse which, among other things, prohibit the direct or indirect payment or receipt of any remuneration for patient referrals, or arranging for or recommending referrals or other business paid for in whole or in part by these federal or state healthcare programs. Legislative provisions relating to healthcare fraud and abuse give federal enforcement personnel substantial funding, powers and remedies to pursue suspected fraud and abuse. The effect of this government regulation of the Company’s clients is difficult to predict. While the Company believes that it is in substantial compliance with any applicable laws, many of the regulations applicable to the Company’s clients and that may be applicable to the Company, are vague or indefinite and have not been interpreted by the courts. They may be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that could require the Company’s clients to make changes in their operations or the way that they deal with the Company. If such laws and regulations are determined to be applicable to the Company and if the Company fails to comply with any applicable laws and regulations, it could be subject to sanctions or liability, including exclusion from government health programs and could have a material adverse effect on the Company’s business, results of operations or financial condition.

Regulation of Medical Devices. The United States Food and Drug Administration (the “FDA”) has declared that certain of the Company’s software solutions are medical devices that are actively regulated under the Federal Food, Drug and Cosmetic Act (“Act”) and amendments to the Act. As a consequence, the Company is subject to extensive regulation by the FDA with regard to those software solutions that are actively regulated. If other of the Company’s software solutions are deemed to be actively regulated medical devices by the FDA, the Company could be subject to extensive requirements governing pre- and post-marketing requirements including pre-market notification clearance prior to marketing. Complying with these FDA regulations would be time consuming and expensive. It is possible that the FDA may become more active in regulating computer software that is used in healthcare.

There have been five FDA inspections since 1999 at various Cerner sites. Inspections conducted at the Company’s World Headquarters in 1999 and its Lake Mary facility in 2003 each resulted in the issuance of an FDA Form 483 that the Company responded to promptly. The FDA has taken no further action with respect to either of the Form 483s that were issued in 1999 and 2003. The remaining three FDA inspections, including an inspection at the Company’s World Headquarters in 2004, resulted in no issuance of a Form 483. The Company, however, remains subject to periodic FDA inspections and there can be no assurances that the Company will not be required to undertake additional actions to comply with the Act and any other applicable regulatory requirements. Any failure by the Company to comply with the Act and any other applicable regulatory requirements could have a material adverse effect on the Company’s ability to continue to manufacture and distribute its software solutions. The FDA has many enforcement tools including recalls, seizures, injunctions, civil fines and/or criminal prosecutions. Any of the foregoing could have a material adverse effect on the Company’s business, results of operations or financial condition.

Security and Privacy of Patient Information. State and federal laws regulate the confidentiality of patient records and the circumstances under which those records may be released. These regulations govern both the disclosure and use of confidential patient medical record information and require the users of such information to implement specified security measures. Regulations currently in place governing electronic health data transmissions continue to evolve and are often unclear and difficult to apply.

The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) requires national standards for some types of electronic health information transactions and the data elements used in those transactions, security standards to ensure the integrity and confidentiality of health information and standards to protect the privacy of individually identifiable health information. Covered entities under HIPAA, which include healthcare organizations such as the Company’s clients, were required to comply with the privacy standards by April 2003 and additional transaction regulations by October 2003. Such organizations must also be in compliance with security regulations by April 2005. As a business associate of the covered entities, the Company, in most instances, must also ensure compliance with the HIPAA regulations.

The effect of HIPAA on the Company’s business is difficult to predict, and there can be no assurances that the Company will adequately address the business risks created by HIPAA and its implementation, or that the Company will be able to take advantage of any resulting business opportunities. Furthermore, the Company is unable to predict what changes to HIPAA, or the regulations issued pursuant to HIPAA, might be made in the future or how those changes could affect the Company’s business or the costs of compliance with HIPAA. Evolving HIPAA-related laws or regulations could restrict the ability of the Company’s clients to obtain, use or disseminate patient information. This could adversely affect demand for the Company’s solutions if they are not re-designed in a timely manner in order to meet the requirements of any new regulations that seek to protect the privacy and security of patient data or enable the Company’s clients to execute new or modified healthcare transactions. The Company may need to expend additional capital, research and development and other resources to modify its solutions to address these evolving data security and privacy issues.

Product Related Liabilities — Many of the Company’s software solutions provide data for use by healthcare providers in providing care to patients. Although no such claims have been brought against the Company to date regarding injuries related to the use of its software solutions, such claims may be made in the future. Although the Company maintains product liability insurance coverage in an amount that it believes is sufficient for its business, there can be no assurance that such coverage will cover a particular claim that may be brought in the future, prove to be adequate or that such coverage will continue to remain available on acceptable terms, if at all. A successful claim brought against the Company, which claim is uninsured or under-insured, could materially harm the Company’s business, results of operations or financial condition.

System Errors and Warranties — The Company’s systems, particularly the Cerner Millennium versions, are very complex. As with complex systems offered by others, the Company’s systems may contain errors, especially when first introduced. Although the Company conducts extensive testing, it has discovered software errors in its software solutions after their introduction. The Company’s systems are intended for use in collecting and displaying clinical information used in the diagnosis and treatment of patients. Therefore, users of the Company software solutions have a greater sensitivity to system errors than the market for software products generally. The Company’s agreements with its clients typically provide warranties against material errors and other matters. Failure of a client’s system to meet these criteria could constitute a material breach under such contracts allowing the client to cancel the contract and obtain a refund and/or damages, or could require the Company to incur additional expense in order to make the system meet these criteria. The Company’s contracts with its clients generally limit the Company’s liability arising from such claims but such limits may not be enforceable in certain jurisdictions or circumstances. A successful claim brought against the Company, which claim is uninsured or under-insured, could materially harm the Company’s business, results of operations or financial condition.

Risks Associated with the Company’s Global Operations – The Company markets, sells and services its software solutions globally. The Company has established offices around the world, including in the Americas, Europe, in the Middle East and in the Asia Pacific region. The Company will continue to expand its global operations and enter new global markets. This expansion will require significant management attention and financial resources to develop successful direct and indirect global sales and support channels. The business transacted is in the local functional currency and the Company does not currently have any material exposure to foreign currency transaction gains or losses. All other business transactions are in U.S. dollars. To date, the Company has not entered into any derivative financial instruments to manage foreign currency risk. In some countries, the Company’s success will depend in part on its ability to form relationships with local partners. There is a risk that the Company may sometimes choose the wrong partner. For these reasons, the Company may not be able to maintain or increase global market demand for its software solutions.

Global operations are subject to inherent risks, and the Company’s future results could be adversely affected by a variety of uncontrollable and changing factors. These include:

	•		Greater difficulty in collecting accounts receivable and longer collection periods;

	•		Difficulties and costs of staffing and managing global operations;

	•		The impact of economic conditions outside the United States;

	•		Unexpected changes in regulatory requirements;

	•		Certification or regulatory requirements;

	•		Reduced protection of intellectual property rights in some countries;

	•		Potentially adverse tax consequences;

	•		Different or additional functionality requirements;

	•		Trade protection measures and other regulatory requirements;

	•		Service provider and government spending patterns;

	•		Natural disasters, war or terrorist acts;

	•		Poor selection of a partner in a country; and

	•		Political conditions which may impact sales or threaten the safety of associates or the continued presence of the Company in these countries.

Recruitment and Retention of Key Personnel – To remain competitive in the healthcare information technology industry, the Company must attract, motivate and retain highly skilled managerial, sales, marketing, consulting and technical personnel, including executives, consultants, programmers and systems architects skilled in the healthcare information technology industry and the technical environments in which the Company’s solutions operate. Competition for such personnel in this industry is intense. The Company’s failure to attract additional qualified personnel could have a material adverse effect on the Company’s prospects for long-term growth. The success of the Company is dependent to a significant degree on the continued contributions of key management, sales, marketing, consulting and technical personnel. The Company has succession plans in place; however, the unexpected loss of key personnel could have a material adverse impact to the Company’s business and results of operations, and could potentially inhibit solution development and market share advances.

Third-Party Suppliers – The Company licenses or purchases intellectual property and technology (such as software, hardware and content) from third parties, including some competitors, and incorporates it into or sells it in conjunction with the Company’s software solutions and services, some of which intellectual property or technology is critical to the operation of the Company’s solutions. If any of the third party suppliers were to change product offerings, increase prices or terminate the Company’s licenses or supply contracts, the Company might need to seek alternative suppliers and incur additional internal or external development costs to ensure continued performance of the Company’s solutions. Such alternatives may not be available on attractive terms, or may not be as widely accepted or as effective as the intellectual property or technology provided by the Company’s existing suppliers. If the cost of licensing, purchasing or maintaining these third party intellectual property or technology solutions significantly increases, the Company’s gross margin levels could significantly decrease. In addition, interruption in functionality of the Company’s solutions could adversely affect future sales of licenses and services.

Sales Forecasts – The Company’s sales forecasts may vary from actual sales in a particular quarter. The Company uses a “pipeline” system, a common industry practice, to forecast sales and trends in its business. The Company’s sales associates monitor the status of all sales opportunities, such as the date when they estimate that a client will make a purchase decision and the potential dollar amount of the sale. These estimates are aggregated periodically to generate a sales pipeline. The Company compares this pipeline at various points in time to evaluate trends in its business. This analysis provides guidance in business planning and forecasting, but these pipeline estimates are by their nature speculative. The Company’s pipeline estimates are not necessarily reliable predictors of revenues in a particular quarter or over a longer period of time, partially because of changes in the pipeline and in conversion rates of the pipeline into contracts that can be very difficult to estimate. A variation in the expected conversion rate or timing of the pipeline into contracts, or in the pipeline itself, could cause the Company’s plan or forecast to be inaccurate and thereby adversely affect business results. For example, a slowdown in information technology spending, or economic conditions or a variety of other reasons can cause purchasing decisions to be delayed, reduced in amount or cancelled, which would reduce the overall pipeline conversion rate in a particular period of time. Because a substantial portion of the Company’s contracts are completed in the latter part of a quarter, the Company may not be able to adjust its cost structure promptly in response to a revenue shortfall resulting from a decrease in its pipeline conversion rate in any given fiscal quarter(s).

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company does not have any significant market risk.

Item 4. Controls and Procedures

	a)		Evaluation of disclosure controls and procedures. The Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by the Quarterly Report (the “Evaluation Date”). They have concluded that, as of the Evaluation Date, these disclosure controls and procedures were effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities and would be disclosed on a timely basis.

	b)		There were no changes in the Company’s internal controls over financial reporting during the three months ended July 2, 2005 that have materially affected, or are reasonably likely to materially affect, its internal controls over financial reporting.

	c)		The Company’s management, including its Chief Executive Officer and Chief Financial Officer, cannot provide complete assurance that its disclosure controls and procedures or the Company’s internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Cerner have been detected.

Part II. Other Information

Item 1. Legal Proceedings

Refer to Note 7 to the condensed financial statements included in Item 1 of this Quarterly Report on Form 10-Q for a discussion of recent developments related to the Company’s legal proceedings.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

On April 6, 2005, the Company issued 72,536 shares of its outstanding stock to University of Pittsburgh Medical Center upon exercise of a warrant granted in 2000. The aggregate exercise price was $3,277,720.50, or $45.1875 per share. The shares were issued by the Company without registration in reliance on the exemption provided by Section 4(2) of the Securities Act.

Item 4. Submission of Matters to a Vote of Security Holders

At the Company’s annual shareholders meeting held on May 27, 2005, John C. Danforth and Neal L. Patterson were re-elected as Class I directors and William D. Zollars was elected as a Class I director. Clifford W. Illig, William B. Neaves, Ph.D, Gerald E. Bisbee, Jr., Ph.D. Nancy-Ann DeParle and Michael E. Herman continued as directors after the meeting. At the shareholders meeting, the selection of KPMG LLP as independent registered public accounting firm of the Company for 2005 was ratified.


	For		Withheld

John C. Danforth		26,953,968		8,039,093
Neal L. Patterson		34,562,188		430,873
William D. Zollars		31,793,885		3,199,176


	For		Against		Abstain

KPMG LLP		34,486,629		458,692		47,740


Part I. Financial Information:

Item 1. Financial Statements:

Condensed Consolidated Balance Sheets as of July 2, 2005 (unaudited) and January 1, 2005			1

Condensed Consolidated Statements of Earnings for the three and six months ended July 2, 2005 and July 3, 2004 (unaudited)			2

Condensed Consolidated Statements of Cash Flows for the six months ended July 2, 2005 and July 3, 2004 (unaudited)			3

Notes to Condensed Consolidated Financial Statements (unaudited)			4

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			11

Item 3. Quantitative and Qualitative Disclosures About Market Risk			24

Item 4. Controls and Procedures			24

Part II. Other Information:			24

Item 1. Legal Proceedings			25

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			25

Item 4. Submission of Matters to a Vote of Security Holders			25
Certification of Neal L. Patterson Pursuant to Section 302
Certification of Marc G. Naughton Pursuant to Section 302
Certification Pursuant to 18 U.S.C. Section 1350
Certification Pursuant to 18 U.S.C. Section 1350

	31.1		Certification of Neal L. Patterson, Chairman of the Board and Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2		Certification of Marc G. Naughton, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	32.1		Certification pursuant to 18 U.S.C. Section. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	32.2		Certification pursuant to 18 U.S.C. Section. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


	CERNER CORPORATION Registrant

August 11, 2004		By:	/s/Marc G. Naughton

Date		Marc G. Naughton
		Chief Financial Officer


		/s/Neal L. Patterson

		Neal L. Patterson, Chairman of the Board
		and Chief Executive Officer

		August 11, 2005


		/s/Marc G. Naughton

		Marc G. Naughton, Senior Vice President,
		Treasurer and Chief Financial Officer

		August 11, 2005

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		/s/Neal L. Patterson

		Neal L. Patterson
		Chief Executive Officer