Q3 2013 10-Q
Table of Contents

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: September 28, 2013
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 October 18, 2013
Common Stock, $0.01 par value per share
  
343,262,922 shares


Table of Contents

CERNER CORPORATION

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



Table of Contents

Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 28, 2013 (unaudited) and December 29, 2012
(In thousands, except share data)
2013
 
2012
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
287,520

 
$
317,120

Short-term investments
634,308

 
719,665

Receivables, net
529,303

 
577,848

Inventory
28,234

 
23,681

Prepaid expenses and other
181,208

 
113,572

Deferred income taxes, net
40,521

 
38,620

Total current assets
1,701,094

 
1,790,506

 
 
 
 
Property and equipment, net
724,886

 
569,708

Software development costs, net
323,843

 
267,307

Goodwill
307,523

 
247,616

Intangible assets, net
140,245

 
132,045

Long-term investments
577,493

 
509,467

Other assets
191,286

 
187,819

 
 
 
 
Total assets
$
3,966,370

 
$
3,704,468

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
147,016

 
$
141,212

Current installments of long-term debt and capital lease obligations
51,872

 
59,582

Deferred revenue
195,200

 
189,652

Accrued payroll and tax withholdings
127,531

 
125,253

Other accrued expenses
62,821

 
64,413

Total current liabilities
584,440

 
580,112

 
 
 
 
Long-term debt and capital lease obligations
131,030

 
136,557

Deferred income taxes and other liabilities
162,987

 
143,212

Deferred revenue
10,523

 
10,937

Total liabilities
888,980

 
870,818

 
 
 
 
Shareholders’ Equity:
 
 
 
Common stock, $.01 par value, 500,000,000 shares authorized, 343,727,041 shares issued at September 28, 2013 and 344,178,702 shares issued at December 29, 2012
3,437

 
3,442

Additional paid-in capital
782,143

 
840,769

Retained earnings
2,332,985

 
1,994,694

Treasury stock, 570,616 shares at September 28, 2013
(28,251
)
 

Accumulated other comprehensive loss, net
(12,924
)
 
(5,255
)
Total shareholders’ equity
3,077,390

 
2,833,650

 
 
 
 
Total liabilities and shareholders’ equity
$
3,966,370

 
$
3,704,468


See notes to condensed consolidated financial statements (unaudited).

1

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and nine months ended September 28, 2013 and September 29, 2012
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands, except per share data)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
System sales
$
202,632

 
$
229,925

 
$
602,037

 
$
651,040

Support, maintenance and services
508,520

 
432,281

 
1,461,723

 
1,262,231

Reimbursed travel
16,678

 
14,276

 
51,660

 
41,781

 
 
 
 
 
 
 
 
Total revenues
727,830

 
676,482

 
2,115,420

 
1,955,052

Costs and expenses:
 
 
 
 
 
 
 
Cost of system sales
64,389

 
100,668

 
217,580

 
318,193

Cost of support, maintenance and services
38,510

 
34,634

 
103,366

 
95,112

Cost of reimbursed travel
16,678

 
14,276

 
51,660

 
41,781

Sales and client service
304,665

 
259,141

 
853,213

 
746,090

Software development (Includes amortization of $24,056 and $69,366 for the three and nine months ended September 28, 2013; and $20,880 and $60,353 for the three and nine months ended September 29, 2012)
82,998

 
78,094

 
246,343

 
222,746

General and administrative
51,352

 
41,973

 
150,995

 
119,912

 
 
 
 
 
 
 
 
Total costs and expenses
558,592

 
528,786

 
1,623,157

 
1,543,834

 
 
 
 
 
 
 
 
Operating earnings
169,238

 
147,696

 
492,263

 
411,218

 
 
 
 
 
 
 
 
Other income, net
3,509

 
3,351

 
9,286

 
8,789

 
 
 
 
 
 
 
 
Earnings before income taxes
172,747

 
151,047

 
501,549

 
420,007

Income taxes
(57,403
)
 
(52,160
)
 
(163,258
)
 
(134,583
)
 
 
 
 
 
 
 
 
Net earnings
$
115,344

 
$
98,887

 
$
338,291

 
$
285,424

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.34

 
$
0.29

 
$
0.98

 
$
0.84

Diluted earnings per share
$
0.33

 
$
0.28

 
$
0.96

 
$
0.81

Basic weighted average shares outstanding
342,992

 
342,502

 
343,681

 
341,287

Diluted weighted average shares outstanding
351,449

 
351,739

 
352,332

 
351,033

See notes to condensed consolidated financial statements (unaudited).


2

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three and nine months ended September 28, 2013 and September 29, 2012
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Net earnings
$
115,344

 
$
98,887

 
$
338,291

 
$
285,424

Foreign currency translation adjustment and other (net of taxes (benefit) of $(1,366) and $(1,984) for the three and nine months ended September 28, 2013; and $(843) and $(1,478) for the three and nine months ended September 29, 2012)
10,595

 
6,240

 
(7,610
)
 
5,247

Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $509 and $(34) for the three and nine months ended September 28, 2013; and $321 and $338 for the three and nine months ended September 29, 2012)
801

 
518

 
(59
)
 
546

 
 
 
 
 
 
 
 
Comprehensive income
$
126,740

 
$
105,645

 
$
330,622

 
$
291,217


See notes to condensed consolidated financial statements (unaudited).


3

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 28, 2013 and September 29, 2012
(unaudited)
 
Nine Months Ended
(In thousands)
2013
 
2012
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
338,291

 
$
285,424

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
189,460

 
162,336

Share-based compensation expense
33,650

 
26,304

Provision for deferred income taxes
19,573

 
20,679

Changes in assets and liabilities (net of businesses acquired):
 
 
 
Receivables, net
41,281

 
(31,102
)
Inventory
(3,887
)
 
(907
)
Prepaid expenses and other
(48,290
)
 
(18,322
)
Accounts payable
(19,309
)
 
30,596

Accrued income taxes
(6,404
)
 
(36,983
)
Deferred revenue
5,440

 
26,333

Other accrued liabilities
4,580

 
63,402

 
 
 
 
Net cash provided by operating activities
554,385

 
527,760

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(218,406
)
 
(129,966
)
Capitalized software development costs
(125,951
)
 
(72,506
)
Purchases of investments
(832,039
)
 
(999,697
)
Sales and maturities of investments
825,126

 
663,257

Purchase of other intangibles
(39,797
)
 
(7,212
)
Acquisition of businesses, net of cash acquired
(67,877
)
 

 
 
 
 
Net cash used in investing activities
(458,944
)
 
(546,124
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of long-term debt and capital lease obligations
(9,756
)
 
(1,772
)
Proceeds from excess tax benefits from share-based compensation
29,274

 
36,431

Proceeds from exercise of options
24,049

 
31,102

Treasury stock purchases
(170,042
)
 

Contingent consideration payments for acquisition of businesses
(800
)
 
(3,400
)
Other
4,823

 

 
 
 
 
Net cash provided by (used in) financing activities
(122,452
)

62,361

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(2,589
)
 
958

 
 
 
 
Net increase (decrease) in cash and cash equivalents
(29,600
)
 
44,955

Cash and cash equivalents at beginning of period
317,120

 
243,146

 
 
 
 
Cash and cash equivalents at end of period
$
287,520

 
$
288,101

 
 
 
 
Summary of acquisition transactions:
 
 
 
Fair value of net tangible assets acquired
$
1,512

 
$

Fair value of intangible assets acquired
25,489

 

Fair value of goodwill
60,511

 

Less: Fair value of contingent liability payable
(18,982
)
 

 
 
 
 
Cash paid for acquisitions
68,530

 

Cash acquired
(653
)
 

 
 
 
 
Net cash used
$
67,877

 
$

See notes to condensed consolidated financial statements (unaudited).

4

Table of Contents

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

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

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

Our third fiscal quarter ends on the Saturday closest to September 30. The 2013 and 2012 third quarters ended on September 28, 2013 and September 29, 2012, respectively. All references to years in these notes to condensed consolidated financial statements represent the respective three or nine months ended on such dates, unless otherwise noted.

Stock Split
On May 24, 2013, the Board of Directors of the Company approved a two-for-one split of our common stock in the form of a 100% stock dividend, which was distributed on or about June 28, 2013 to shareholders of record as of June 17, 2013. In connection with the stock split, 3.0 million treasury shares, which represented the amount held in treasury on June 28, 2013, were utilized to settle a portion of the distribution. All share and per share data have been retroactively adjusted for all periods presented to reflect the stock split including the use of treasury shares, as if the stock split had occurred at the beginning of the earliest period presented.

Under the terms of our outstanding equity awards, the stock split increased the number of shares of our common stock issuable upon exercise or vesting of such awards in proportion to the stock split ratio and caused a proportionate decrease in the exercise price of such awards to the extent they were stock options.

Recently Adopted Accounting Pronouncements
Comprehensive Income. In the first quarter of 2013, we adopted Financial Accounting Standards Board Accounting Standards Update (ASU) No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (AOCI). ASU 2013-02 requires an entity to disclose, either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of AOCI into net income and the income statement line items affected by the reclassification. If a component is not required to be reclassified to net income in its entirety, an entity would instead cross reference to the related footnote for additional information. The adoption of this standard did not impact disclosures in these condensed consolidated financial statements, as AOCI reclassification amounts are not material to the Company.


5

Table of Contents

(2) Business Acquisitions

PureWellness

On March 4, 2013, we purchased the net assets of Kaufman & Keen, LLC (doing business as PureWellness). PureWellness is a health and wellness company that develops solutions for the administration and management of wellness programs, and to enable plan member engagement strategies. Our acquisition of PureWellness will further expand what we believe to be a robust offering of solutions to manage and improve the health of populations.

Consideration for the acquisition of PureWellness is expected to total $69.2 million consisting of up-front cash plus contingent consideration, which is payable if we achieve certain revenue milestones from PureWellness solutions and services during the period commencing on August 1, 2013 and ending April 30, 2015. We valued the contingent consideration at $19.0 million based on a probability-weighted assessment of potential contingent consideration payment scenarios.

The acquisition of PureWellness is being treated as a purchase in accordance with ASC 805, Business Combinations, which requires allocation of the purchase price to the estimated fair values of assets and liabilities acquired in the transaction. The final allocation of purchase price is summarized below:

(In thousands)
 
Allocation Amount
 
 
 
Tangible assets and liabilities
 
 
Current assets
 
$
1,443

Property and equipment
 
240

Current liabilities
 
(1,315
)
Total net tangible assets
 
368

 
 
 
Intangible assets
 
 
Customer relationships
 
10,464

Existing technologies
 
9,805

Total intangible assets
 
20,269

 
 
 
Goodwill
 
48,555

 
 
 
Total purchase price
 
$
69,192

 
The fair values of the acquired intangible assets were estimated by applying the income approach. Such estimations required the use of inputs that were unobservable in the market place (Level 3), including a discount rate that we estimated would be used by a market participant in valuing these assets, projections of revenues and cash flows, and client attrition rates, among others. See Note (3) for further information about the fair value level hierarchy.

The goodwill of $48.6 million arising from the acquisition consists largely of the synergies and economies of scale, including the value of the assembled workforce, expected from combining the operations of Cerner and PureWellness. All of the goodwill was allocated to our Domestic operating segment and is expected to be deductible for tax purposes. Identifiable intangible assets are being amortized over a weighted-average period of seven years. The operating results of PureWellness were combined with our operating results subsequent to the purchase date of March 4, 2013. Pro-forma results of operations, assuming this acquisition was made at the beginning of the earliest period presented, have not been presented because the effect of this acquisition was not material to our results.

Labotix

On March 18, 2013, we purchased 100% of the outstanding stock of Labotix Corporation (together with its wholly owned subsidiary Labotix Automation, Inc., Labotix). Labotix is a developer of laboratory automation solutions for clinical laboratories. We believe the combination of Cerner Millennium, Cerner Copath, and Labotix allows us to offer a comprehensive set of capabilities to support high volume laboratory testing.


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Table of Contents

Consideration for the acquisition of Labotix was $18.0 million, which was paid in cash. The preliminary allocation of purchase price to the estimated fair value of the identified tangible and intangible assets acquired and liabilities assumed resulted in goodwill of $11.7 million and $5.2 million in intangible assets related to the value of existing technologies. The allocation of purchase price is subject to changes as a working capital adjustment is finalized and additional information becomes available; however, we do not expect material changes. The goodwill was allocated to our Domestic operating segment and is not expected to be deductible for tax purposes. Identifiable intangible assets are being amortized over a period of five years.

The operating results of Labotix were combined with our operating results subsequent to the purchase date of March 18, 2013. Pro-forma results of operations have not been presented because the effect of this acquisition was not material to our results.

(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 September 28, 2013: 
(In thousands)
 
 
 
 
 
 

 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
66,400

 
$

 
$

Time deposits
 
Cash equivalents
 

 
9,785

 

Government and corporate bonds
 
Cash equivalents
 

 
6,210

 

Time deposits
 
Short-term investments
 

 
81,524

 

Commercial paper
 
Short-term investments
 

 
43,757

 

Government and corporate bonds
 
Short-term investments
 

 
509,027

 

Time deposits
 
Long-term investments
 

 
491

 

Government and corporate bonds
 
Long-term investments
 

 
569,840

 



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Table of Contents

The following table details our financial assets measured and recorded at fair value on a recurring basis at December 29, 2012:
(In thousands)
 
 
 
 
 
 
 
 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash equivalents
 
$
68,267

 
$

 
$

Time deposits
 
Cash equivalents
 

 
24,068

 

Time deposits
 
Short-term investments
 

 
90,550

 

Commercial paper
 
Short-term investments
 

 
86,458

 

Government and corporate bonds
 
Short-term investments
 

 
542,657

 

Time deposits
 
Long-term investments
 

 
6,197

 

Government and corporate bonds
 
Long-term investments
 

 
496,770

 

We estimate the fair value of our long-term, fixed rate debt using a Level 3 discounted cash flow analysis based on current borrowing rates for debt with similar maturities. The fair value of our long-term debt, including current maturities, at September 28, 2013 and December 29, 2012 was approximately $48.1 million and $59.0 million, respectively. The carrying amount of such fixed-rate debt at September 28, 2013 and December 29, 2012 was $45.0 million and $54.8 million, respectively.
 
(4) Investments

Available-for-sale investments at September 28, 2013 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
66,400

 
$

 
$

 
$
66,400

Time deposits
 
9,785

 

 

 
9,785

Government and corporate bonds
 
6,210

 

 

 
6,210

Total cash equivalents
 
82,395

 

 

 
82,395

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
81,515

 
12

 
(3
)
 
81,524

Commercial paper
 
43,750

 
7

 

 
43,757

Government and corporate bonds
 
508,623

 
432

 
(28
)
 
509,027

Total short-term investments
 
633,888

 
451

 
(31
)
 
634,308

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
490

 
1

 

 
491

Government and corporate bonds
 
570,028

 
208

 
(396
)
 
569,840

Total long-term investments
 
570,518

 
209

 
(396
)
 
570,331

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
1,286,801

 
$
660

 
$
(427
)
 
$
1,287,034



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Table of Contents

Available-for-sale investments at December 29, 2012 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
68,267

 
$

 
$

 
$
68,267

Time deposits
 
24,068

 

 

 
24,068

Total cash equivalents
 
92,335

 

 

 
92,335

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
90,535

 
17

 
(2
)
 
90,550

Commercial paper
 
86,500

 
15

 
(57
)
 
86,458

Government and corporate bonds
 
542,236

 
497

 
(76
)
 
542,657

Total short-term investments
 
719,271

 
529

 
(135
)
 
719,665

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
6,190

 
10

 
(3
)
 
6,197

Government and corporate bonds
 
496,845

 
324

 
(399
)
 
496,770

Total long-term investments
 
503,035

 
334

 
(402
)
 
502,967

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
1,314,641

 
$
863

 
$
(537
)
 
$
1,314,967


Investments reported under the cost method of accounting as of September 28, 2013 and December 29, 2012 were $7.2 million and $6.5 million, respectively.

We sold available-for-sale investments for proceeds of $109.9 million and $8.5 million during the nine months ended September 28, 2013 and September 29, 2012, respectively, resulting in insignificant gains in each period.

(5) Receivables

A summary of net receivables is as follows:
(In thousands)
September 28, 2013
 
December 29, 2012
 
 
 
 
Gross accounts receivable
$
532,857

 
$
581,386

Less: Allowance for doubtful accounts
38,142

 
33,230

 
 
 
 
Accounts receivable, net of allowance
494,715

 
548,156

 
 
 
 
Current portion of lease receivables
34,588

 
29,692

 
 
 
 
Total receivables, net
$
529,303

 
$
577,848


During the second quarter of 2008, Fujitsu Services Limited’s (Fujitsu) contract as the prime contractor in the National Health Service (NHS) initiative to automate clinical processes and digitize medical records in the Southern region of England was terminated by the NHS. This had the effect of automatically terminating our subcontract for the project. We are in dispute with Fujitsu regarding Fujitsu’s obligation to pay the amounts comprised of accounts receivable and contracts receivable related to that subcontract, and we are working with Fujitsu to resolve these issues based on processes provided for in the contract. Part of that process requires resolution of disputes between Fujitsu and the NHS regarding the contract termination. As of September 28, 2013, 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 September 28, 2013 and December 29, 2012. While the ultimate collectability of the receivables pursuant to this process is uncertain, we believe that we have valid and equitable grounds for recovery of such amounts and that collection of recorded amounts is probable.


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During the first nine months of 2013 and 2012, we received total client cash collections of $2.3 billion and $2.0 billion, respectively, of which $44.9 million and $56.2 million were received from third party arrangements with non-recourse payment assignments.
 
(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 32.6% and 32.0% for the first nine months of 2013 and 2012, respectively. This increase was primarily due to a decrease in net favorable discrete items recorded in 2013 relative to 2012, partially offset by reinstatement of the research and development credit in 2013.

In January 2013, the American Taxpayer Relief Act of 2012 (Act) became law. The Act reinstates the research and development tax credit retroactively from January 1, 2012 to December 31, 2013. In the first quarter of 2013, we recognized the research and development tax credit related to 2012 as a favorable discrete item. Research and development tax credits generated in 2013 are being recognized pro-rata as a component of the overall 2013 effective tax rate.


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(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
 
2013
 
2012
 
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
$
115,344

 
342,992

 
$
0.34

 
$
98,887

 
342,502

 
$
0.29

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

 
8,457

 
 
 

 
9,237

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
115,344

 
351,449

 
$
0.33

 
$
98,887

 
351,739

 
$
0.28


For the three months ended September 28, 2013 and September 29, 2012, options to purchase 7.2 million and 5.6 million shares of common stock at per share prices ranging from $36.92 to $50.54 and $27.62 to $42.98, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.
 
Nine Months Ended
 
2013
 
2012
 
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
$
338,291

 
343,681

 
$
0.98

 
$
285,424

 
341,287

 
$
0.84

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

 
8,651

 
 
 

 
9,746

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
$
338,291

 
352,332

 
$
0.96

 
$
285,424

 
351,033

 
$
0.81


For the nine months ended September 28, 2013 and September 29, 2012, options to purchase 5.8 million and 4.3 million shares of common stock at per share prices ranging from $32.92 to $50.54 and $27.62 to $42.98, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.


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(8) Share-Based Compensation and Equity

Stock Options

Options activity for the nine months ended September 28, 2013 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
24,072

 
$
16.99

 
 
 
 
Granted
3,596

 
47.66

 
 
 
 
Exercised
(2,472
)
 
10.11

 
 
 
 
Forfeited and expired
(239
)
 
37.77

 
 
 
 
Outstanding as of September 28, 2013
24,957

 
21.89

 
$
766,741

 
6.40
 
 
 
 
 
 
 
 
Exercisable as of September 28, 2013
14,255

 
$
10.40

 
$
601,743

 
4.92

The weighted-average assumptions used to estimate the fair value of stock options granted in 2013 were as follows: 
Expected volatility (%)
 
30.4
%
Expected term (yrs)
 
9.1

Risk-free rate (%)
 
1.9
%
Fair value per option
 
$
19.46

As of September 28, 2013, there was $130.2 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 3.37 years.
Non-vested Shares

Non-vested share activity for the nine months ended September 28, 2013 was as follows:
(In thousands, except per share data)
Number of Shares
 
Weighted-Average
Grant Date Fair Value
 
 
 
 
Outstanding at beginning of year
602

 
$
28.41

Granted
238

 
46.66

Vested
(276
)
 
24.00

Forfeited
(10
)
 
22.73

 
 
 
 
Outstanding as of September 28, 2013
554

 
$
38.54

As of September 28, 2013, there was $13.6 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 1.74 years.


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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
 
Nine Months Ended
(In thousands)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Stock option and non-vested share compensation expense
$
12,527

 
$
9,721

 
$
33,650

 
$
26,304

Associate stock purchase plan expense
1,168

 
719

 
2,867

 
2,064

Amounts capitalized in software development costs, net of amortization
(237
)
 
(218
)
 
(900
)
 
(600
)
 
 
 
 
 
 
 
 
Amounts charged against earnings, before income tax benefit
$
13,458

 
$
10,222

 
$
35,617

 
$
27,768

 
 
 
 
 
 
 
 
Amount of related income tax benefit recognized in earnings
$
5,221

 
$
3,910

 
$
13,819

 
$
10,621


Treasury Stock

In December 2012, our Board of Directors authorized a stock repurchase program of up to $170.0 million, excluding transaction costs, of our common stock. The repurchases were to be effectuated in the open market, by block purchase, or possibly through other transactions managed by broker-dealers.

During the nine months ended September 28, 2013, we repurchased 3.6 million shares for total consideration of $170.0 million. These shares were recorded as treasury stock and accounted for under the cost method. Repurchased shares at the time of the stock split were utilized to settle a portion of the stock split distribution, as further described in Note 1 of these notes to condensed consolidated financial statements. As of September 28, 2013, the program is complete.

Authorized Shares

Effective May 24, 2013, we amended our Second Restated Certificate of Incorporation of Cerner Corporation to increase the number of authorized shares of our common stock from 250,000,000 to 500,000,000 shares.

(9) Hedging Activities

The following table represents the fair value of our net investment hedge included within the condensed consolidated balance sheets:
(In thousands)
 
Fair Value
Derivatives Designated
Balance Sheet Classification
September 28, 2013
 
December 29, 2012
 
 
 
 
 
Net investment hedge
 Short-term liabilities
$
14,986

 
$
15,015

Net investment hedge
 Long-term liabilities
29,973

 
30,030

 
 
 
 
 
Total net investment hedge
 
$
44,959

 
$
45,045


The following table represents the related unrealized gain or loss, net of related income tax effects, on the net investment hedge recognized in comprehensive income:
(In thousands)
 
Net Unrealized Gain (Loss)
For the Three Months Ended
 
Net Unrealized Gain (Loss)
For the Nine Months Ended
Derivatives Designated
Balance Sheet Classification
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
 
Net investment hedge
 Short-term liabilities
$
(523
)
 
$
(262
)
 
$
2

 
$
(362
)
Net investment hedge
 Long-term liabilities
(1,058
)
 
(786
)
 
2

 
(1,085
)
 
 
 
 
 
 
 
 
 
Total net investment hedge
 
$
(1,581
)
 
$
(1,048
)
 
$
4

 
$
(1,447
)


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(10) Contingencies    

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

(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, communications expenses and unreimbursed travel expenses. “Other” includes expenses that have not been allocated to the operating segments, such as software development, marketing, general and administrative, share-based compensation expense and depreciation. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such. Items such as interest, income taxes, capital expenditures and total assets are managed at the consolidated level and thus are not included in our operating segment disclosures. Accounting policies for each of the reportable segments are the same as those used on a consolidated basis.

The following table presents a summary of our operating segments and other expense for the three and nine months ended September 28, 2013 and September 29, 2012: 
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2013
 
 
 
 
 
 
 
Revenues
$
641,541

 
$
86,289

 
$

 
$
727,830

 
 
 
 
 
 
 
 
Cost of revenues
107,560

 
12,017

 

 
119,577

Operating expenses
148,478

 
34,078

 
256,459

 
439,015

Total costs and expenses
256,038

 
46,095


256,459

 
558,592

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
385,503

 
$
40,194

 
$
(256,459
)
 
$
169,238

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Three Months Ended 2012
 
 
 
 
 
 
 
Revenues
$
591,327

 
$
85,155

 
$

 
$
676,482

 
 
 
 
 
 
 
 
Cost of revenues
131,663

 
17,915

 

 
149,578

Operating expenses
131,787

 
32,794

 
214,627

 
379,208

Total costs and expenses
263,450

 
50,709

 
214,627

 
528,786

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
327,877

 
$
34,446

 
$
(214,627
)
 
$
147,696

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Nine Months Ended 2013
 
 
 
 
 
 
 
Revenues
$
1,837,171

 
$
278,249

 
$

 
$
2,115,420

 
 
 
 
 
 
 
 
Cost of revenues
327,356

 
45,250

 

 
372,606

Operating expenses
439,345

 
84,685

 
726,521

 
1,250,551

Total costs and expenses
766,701

 
129,935

 
726,521

 
1,623,157

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
1,070,470

 
$
148,314

 
$
(726,521
)
 
$
492,263


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(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
 
 
 
 
 
 
 
 
Nine Months Ended 2012
 
 
 
 
 
 
 
Revenues
$
1,707,259

 
$
247,793

 
$

 
$
1,955,052

 
 
 
 
 
 
 
 
Cost of revenues
403,618

 
51,468

 

 
455,086

Operating expenses
372,668

 
97,616

 
618,464

 
1,088,748

Total costs and expenses
776,286

 
149,084

 
618,464

 
1,543,834

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
930,973

 
$
98,709

 
$
(618,464
)
 
$
411,218


(12) Related Party Transactions

On July 30, 2013, our wholly owned subsidiary, Cerner Property Development, Inc., entered into a Real Estate Purchase Agreement (the "Agreement") with Trails Properties II, Inc., a Missouri corporation ("Trails"), to purchase approximately 237 acres of land located in Kansas City, Missouri. Trails is an entity controlled by Neal Patterson, Chairman of the Board of Directors and Chief Executive Officer of Cerner Corporation, and Clifford Illig, Vice Chairman of the Board of Directors of Cerner Corporation. The total purchase price of the property is $45.5 million, subject to adjustment under the Agreement. The transaction is expected to close, on or about December 27, 2013, subject to certain conditions defined in the Agreement. The property is being acquired as a site for future office space development to accommodate our anticipated growth.

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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.

Our third fiscal quarter ends on the Saturday closest to September 30. The 2013 and 2012 third quarters ended on September 28, 2013 and September 29, 2012, respectively. All references to years in this MD&A represent the respective three or nine months ended on such dates, unless otherwise noted.

On May 24, 2013, the Board of Directors of the Company approved a two-for-one split of our common stock in the form of a 100% stock dividend, which was distributed on or about June 28, 2013 to shareholders of record as of June 17, 2013. In connection with the stock split, 3.0 million treasury shares, which represented the amount held in treasury on June 28, 2013, were utilized to settle a portion of the distribution. All share and per share data have been retroactively adjusted for all periods presented to reflect the stock split including the use of treasury shares, as if the stock split had occurred at the beginning of the earliest period presented.
 
Except for the historical information and discussions contained herein, statements contained in this quarterly report on Form 10-Q may constitute “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements can often be identified by the use of forward-looking terminology, such as "could," "should," “will,” "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast," “plan,” “guidance” or “estimate” or the negative of these words, variations thereof or similar expressions. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including without limitation: the possibility of product-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities; our proprietary technology may be subject to claims for infringement or misappropriation of intellectual property rights of others, or may be infringed or misappropriated by others; risks associated with our non-U.S. operations; risks associated with our ability to effectively hedge exposure to fluctuations in foreign currency exchange rates; the potential for tax legislation initiatives that could adversely affect our tax position and/or challenges to our tax positions in the United States and non-U.S. countries; risks associated with our recruitment and retention of key personnel; risks related to our reliance on third party suppliers; risks inherent with business acquisitions; the potential for losses resulting from asset impairment charges; risks associated with the uncertainty in global economic conditions; managing growth in the new markets in which we offer solutions, health care devices and services; changing political, economic, regulatory and judicial influences; government regulation; significant competition and market changes; variations in our quarterly operating results; potential inconsistencies in our sales forecasts compared to actual sales; volatility in the trading price of our common stock and the timing and volume of market activity; the authority of our Board of Directors to issue preferred stock and anti-takeover provisions contained in our corporate governance documents; material adverse resolution of legal proceedings; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials incorporated herein or therein by reference. Forward looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as to the date they are made. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.

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

Our fundamental strategy centers on creating organic growth by investing in research and development (R&D) to create solutions and services for the health care industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 12% or more. This growth has also created an important strategic footprint in health care, with Cerner® solutions licensed by approximately 10,000 facilities around the world, including more than 2,700 hospitals; 4,150 physician practices; 45,000 physicians; 550 ambulatory facilities, such as laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics and surgery centers; 800 home health facilities; 45 employer sites and 1,750 retail pharmacies. Selling additional solutions back into this client base is an important element of our future revenue growth. We are also focused on driving growth through market share expansion by strategically

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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 expect to drive growth through new initiatives and services that reflect our ongoing ability to innovate and expand our reach into health care. Examples of these include our CareAware® health care device architecture and devices, employer services, Cerner ITWorksSM services, revenue cycle solutions, such as Cerner RevWorksSM 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 more than 20% over the most recent five- and ten-year periods. We expect to drive continued earnings growth through ongoing revenue growth coupled with margin expansion, which we expect to achieve through efficiencies in our implementation and operational processes and by leveraging R&D investments and controlling general and administrative expenses.

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

Results Overview
The Company delivered strong levels of bookings and earnings, and solid revenue and operating cash flow in the third quarter of 2013.

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $928.0 million in the third quarter of 2013, which is an increase of 21% compared to $769.9 million in the third quarter of 2012. Revenues for the third quarter of 2013 increased 8% to $727.8 million compared to $676.5 million in the third quarter of 2012. The year-over-year increase in revenue reflects ongoing demand for Cerner's core solutions and services driven by the HITECH Act and other regulatory requirements, and increased contributions from newer areas, such as Cerner ITWorks and Cerner revenue cycle solutions and services.

Third quarter 2013 net earnings increased 17% to $115.3 million compared to $98.9 million in the third quarter of 2012. Diluted earnings per share increased 18% to $0.33 compared to $0.28 in the third quarter of 2012. The growth in net earnings and diluted earnings per share was driven by strong growth in services and higher margin components of system sales that more than offset a decline in technology resale. Additionally, our margin expansion initiatives, which include creating efficiencies in our implementation and operational processes, have contributed to our earnings growth.

Third quarter 2013 and 2012 net earnings and diluted earnings per share reflect the impact of stock-based compensation expense. The effect of these expenses reduced the third quarter 2013 net earnings and diluted earnings per share by $8.2 million and $0.02, respectively, and the third quarter 2012 net earnings and diluted earnings per share by $6.3 million and $0.02, respectively.

Our third quarter 2013 operating margin of 23% reflects an increase of 140 basis points compared to 2012, which was driven by the previously discussed margin expansion efforts and a lower mix of low-margin technology resale revenue.

We had cash collections of receivables of $766.1 million in the third quarter of 2013 compared to $661.7 million in the third quarter of 2012. Days sales outstanding was 66 days for the third quarter of 2013 compared to 68 days for the second quarter of 2013 and 73 days for the third quarter of 2012. Operating cash flows for the third quarter of 2013 were $164.2 million compared to $182.2 million in the third quarter of 2012.


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Results of Operations
Three Months Ended September 28, 2013 Compared to Three Months Ended September 29, 2012
The following table presents a summary of the operating information for the third quarters of 2013 and 2012:
(In thousands)
2013
% of
Revenue
 
2012
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
202,632

28
%
 
$
229,925

 
34
%
 
(12
)%
Support and maintenance
166,308

23
%
 
154,333

 
23
%
 
8
 %
Services
342,212

47
%
 
277,948

 
41
%
 
23
 %
Reimbursed travel
16,678

2
%
 
14,276

 
2
%
 
17
 %
 
 
 
 
 
 
 
 
 
Total revenues
727,830

100
%
 
676,482

 
100
%
 
8
 %
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
Costs of revenue
119,577

16
%
 
149,578

 
22
%
 
(20
)%
 
 
 
 
 
 
 
 
 
Total margin
608,253

84
%
 
526,904

 
78
%
 
15
 %
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Sales and client service
304,665

42
%
 
259,141

 
38
%
 
18
 %
Software development
82,998

11
%
 
78,094

 
12
%
 
6
 %
General and administrative
51,352

7
%
 
41,973

 
6
%
 
22
 %
 
 
 
 
 
 
 
 
 
Total operating expenses
439,015

60
%
 
379,208

 
56
%
 
16
 %
 
 
 
 
 
 
 
 
 
Total costs and expenses
558,592

77
%
 
528,786

 
78
%
 
6
 %
 
 
 
 
 
 
 
 
 
Operating earnings
169,238

23
%
 
147,696

 
22
%
 
15
 %
 
 
 
 
 
 
 
 
 
Other income, net
3,509

 
 
3,351

 
 
 
 
Income taxes
(57,403
)
 
 
(52,160
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
115,344

 
 
$
98,887

 
 
 
17
 %
Revenues & Backlog
Revenues increased 8% to $727.8 million in the third quarter of 2013, as compared to $676.5 million in the third quarter of 2012.
 
System sales, which include revenues from the sale of licensed software, software as a service, technology resale (hardware, devices, and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions, decreased 12% to $202.6 million in the third quarter of 2013 from $229.9 million for the same period in 2012. The decrease in system sales was driven by lower levels of technology resale, which more than offset growth in subscriptions and software as a service.
Support and maintenance revenues increased 8% to $166.3 million in the third quarter of 2013 compared to $154.3 million during the same period in 2012. This increase was attributable to continued success at selling Cerner Millennium® applications and implementing them at client sites. We expect that support and maintenance revenues will continue to grow as the base of installed Cerner Millennium systems grows.
Services revenue, which includes professional services, excluding installation, and managed services, increased 23% to $342.2 million in the third quarter of 2013 from $277.9 million for the same period in 2012. This increase was driven by growth in CernerWorksSM managed services as a result of continued demand for our hosting services and an increase in professional services due to increased implementation and consulting activities and growth in Cerner ITWorks and Cerner RevWorks services.

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Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 26% in the third quarter of 2013 when compared to the same period in 2012. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services and Cerner ITWorks and Cerner RevWorks services bookings that typically have longer contract terms. A summary of our total backlog follows:
(In thousands)
September 28, 2013
 
September 29, 2012
 
 
 
 
Contract backlog
$
7,627,181

 
$
6,061,500

Support and maintenance backlog
769,847

 
723,687

 
 
 
 
Total backlog
$
8,397,028

 
$
6,785,187

Costs of Revenue
Cost of revenues as a percentage of total revenues was 16% in the third quarter of 2013, compared to 22% in the same period of 2012. The lower cost of revenues as a percent of revenue was driven by a lower mix of technology resale, which carries a higher cost of revenue.
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 16% to $439.0 million in the third quarter of 2013, compared with $379.2 million in the third quarter of 2012.
 
Sales and client service expenses as a percent of total revenues were 42% in the third quarter of 2013, compared to 38% in the same period of 2012. These expenses increased 18% to $304.7 million in the third quarter of 2013, from $259.1 million in the same period of 2012. Sales and client service expenses include salaries of sales and client service personnel, depreciation and other expenses associated with our CernerWorks managed service business, communications expenses, unreimbursed travel expenses, expense for share-based payments, sales and marketing salaries and trade show and advertising costs. The increase as a percent of revenue reflects a higher mix of services during the quarter that was driven by strong services revenue growth and the decline in technology resale revenue.
Software development expenses as a percent of revenue were 11% in the third quarter of 2013, compared to 12% in the same period of 2012. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium platform, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. A summary of our total software development expense in the third quarters of 2013 and 2012 is as follows:
 
Three Months Ended
(In thousands)
2013
 
2012
 
 
 
 
Software development costs
$
106,986

 
$
82,873

Capitalized software costs
(47,492
)
 
(25,126
)
Capitalized costs related to share-based payments
(552
)
 
(533
)
Amortization of capitalized software costs
24,056

 
20,880

 
 
 
 
Total software development expense
$
82,998

 
$
78,094

 
General and administrative expenses as a percent of total revenues were 7% in the third quarter of 2013, compared to 6% in the same period of 2012. These expenses increased 22% to $51.4 million in 2013, from $42.0 million for the same period in 2012. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency and expense for share-based payments. The increase in general

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and administrative expenses was primarily driven by an increase in corporate personnel costs, as we have continued to increase such personnel to support our overall revenue growth, and an increase in amortization expense due to acquired intangibles.

Non-Operating Items
 
Other income was $3.5 million in the third quarter of 2013 and $3.4 million in the same period of 2012.

Our effective tax rate was 33.2% for the third quarter of 2013 and 34.5% for the third quarter of 2012. This decrease was primarily due to reinstatement of the research and development credit in 2013. Refer to Note (6) of the notes to condensed consolidated financial statements.

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, Brazil, Canada, Cayman Islands, Chile, Egypt, England, France, Germany, Guam, India, Ireland, Israel, Malaysia, Mexico, Qatar, Saudi Arabia, Singapore, Spain, Switzerland and the United Arab Emirates.

The following table presents a summary of the operating information for the third quarters of 2013 and 2012:  
(In thousands)
2013
 
% of Revenue
 
2012
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
641,541

 
100%
 
$
591,327

 
100%
 
8%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
107,560

 
17%
 
131,663

 
22%
 
(18)%
Operating expenses
148,478

 
23%
 
131,787

 
22%
 
13%
Total costs and expenses
256,038

 
40%
 
263,450

 
45%
 
(3)%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
385,503

 
60%

327,877

 
55%
 
18%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
86,289

 
100%
 
85,155

 
100%
 
1%
 
 
 
 
 
 
 
 
 
 
Costs of revenue
12,017

 
14%
 
17,915

 
21%
 
(33)%
Operating expenses
34,078

 
39%
 
32,794

 
39%
 
4%
Total costs and expenses
46,095

 
53%
 
50,709

 
60%
 
(9)%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
40,194

 
47%
 
34,446

 
40%
 
17%
 
 
 
 
 
 
 
 
 
 
Other, net
(256,459
)
 
 
 
(214,627
)
 
 
 
19%
 
 
 
 
 
 
 
 
 
 
Consolidated operating earnings
$
169,238

 
 
 
$
147,696

 
 
 
15%
Domestic Segment
Revenues increased 8% to $641.5 million in the third quarter of 2013 from $591.3 million in the same period of 2012. This increase was driven by strong growth across most of our business, offset by lower levels of technology resale.
Cost of revenues was 17% of revenues in the