Cerner (CERN)

Q2 2011 Earnings Call

July 28, 2011 4:30 pm ET

Executives

Jeffrey Townsend - Chief of Staff and Executive Vice President

Marc Naughton - Chief Financial Officer, Executive Vice President and Treasurer

Michael Nill - Chief Operating Officer

Zane Burke - Executive Vice President

Analysts

David Larsen - Leerink Swann LLC

Richard Close - Avondale Partners, LLC

Bret Jones - Oppenheimer & Co. Inc.

George Hill - Citigroup Inc

Atif Rahim - JP Morgan Chase & Co

Sebastian Paquette - Goldman Sachs Group Inc.

Donald Hooker - Morgan Stanley

Jamie Stockton - Morgan Keegan & Company, Inc.

Sean Wieland - Piper Jaffray Companies

Presentation

Operator

Welcome to Cerner Corporation's Second Quarter 2011 Conference Call. Today's date is July 28, 2011, and this call is being recorded.

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Previous Statements by CERN
» Cerner's CEO Discusses Q1 2011 Results - Earnings Call Transcript
» Cerner's CEO Discusses Q4 2010 Results - Earnings Call Transcript
» Cerner CEO Discusses Q3 2010 Results - Earnings Call Transcript

The company has asked me to remind you that various remarks made here today by Cerner's management about future expectations, plans, perspectives and prospectives constitute forward-looking statements for the purpose of the Safe Harbor provisions of the Security and Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading Risk Factors under Item 1A in Cerner's Form 10-K together with other reports that are on file with the SEC.

At this time, I'd like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corporation.

Marc Naughton

Thank you, Regina. Good afternoon, everyone, and welcome to the call. I'll lead off today with the review of the numbers. Zane Burke, Executive Vice President of our client organization, will follow me with sales highlights and marketplace trends. Mike Nill, Executive Vice President and Chief Operating Officer, will discuss operations. Mike will be followed by Jeff Townsend, Executive Vice President and Chief of Staff, who will discuss strategic initiatives. Neal Patterson, our Chairman, CEO and President, will be traveling today and not be joining us on the call.

Now turning to our results. All key measures in Q2 were at or above our expected levels. Bookings were very strong and exceeded the high-end of our guidance range by $80 million. Our income statement performance is very good, with revenue and adjusted EPS above our guidance and consensus, and continued strong margin expansion and earnings growth. We again had excellent cash flow performance with strong level of the free cash flow reflective of good earnings quality.

Moving to the details. Our total bookings revenue in Q2 was $650 million, which is the second-best result in company history, second only to Q4 of '09. Bookings exceeded the midpoint of our guidance range by about $100 million and we're up 39% from Q2 of 2010. Bookings margin in Q2 was $540 million or 83% of total bookings. I thought it'd be appropriate to provide some additional color on the strong bookings performance.

With respect to the $100 million over attainment, about half of the upside is related to 2 large contracts that were included in our original bookings guidance coming in above the risk-weighted amounts we forecasted. These contracts were HealthSouth, which we announced this morning, and our seventh ITWorks client contract that Michael will discuss later. The remaining $50 million of upside came from strength across all of business models that led to a record 23 contracts over $5 million in the quarter.

Looking at the mix of long-term contracts, the ITWorks deal and overall strong hosting bookings led to bookings from long-term contracts being around 35% of total bookings, which is the high end of historical levels which have averaged around 29%. Note that even if you adjust long-term bookings down to historical levels, our bookings still would have exceeded the high end of our guidance range and grown approximately 30% year-over-year. In short, this was an outstanding bookings quarter, no matter how you slice it.

Our bookings performance delivered 21% increase in total backlog to $5.41 billion. Contract revenue backlog of $4.74 billion is 23% higher than a year ago, the full revenue backlog totaled $679 million, up 7% year-over-year. Revenue in the quarter was $524.2 million, which is up 15% over Q2 2010. The revenue composition for Q2 was $157 million in systems sales; $138 million in support and maintenance; $217 million in services; and $12 million in reimbursed travel.

Systems sales revenue reflects 15% growth from Q2 of '10 driven by strong growth in software and subscriptions. Technology resale was basically flat. The strong growth in device resale offsetting decline in traditional technology resale. Services revenue was up 18% compared to Q2 of '10, with strong growth in both managed services and professional services. Support and maintenance revenue is 8% over Q2 '10.

Looking at revenues by geographic segment. Domestic revenue increased 18% year-over-year to $450 million. Global revenue of $74 million was down 1% year-over-year, but was up 5% sequentially, and we expect positive year-over-year growth for the remainder of the year, based on strong global bookings in the first half of the year and a strong pipeline.

Moving to gross margin. Our gross margin for Q2 was 81.2%, which is down 160 basis points year-over-year and down 40 basis points sequentially. Gross margin continues to be impacted by strength in device resale, which carries the lower margin than our traditional hardware resale and an increase in third-party services. As we have discussed previously, we expect gross margin to remain in the low 80s, but we still expect to continue expanding operating margin, which we did again this quarter despite the lower gross margin.

Looking at operating spending. Our second quarter operating expenses were $311.2 million before share-based compensation of $6.6 million. Our total operating expense was up 9% compared to Q2 of '10, but a majority of the growth driven by an increase in revenue generating associates in our services business.

Sales and client service expenses increased 11% compared to Q2 of '10, driven primarily by growth in managed services and professional services. Our investment in software development increased 2% compared to Q2 of '10, reflecting continued leverage of our R&D investments. One way we are leveraging these resources is by moving some of them to support growth initiatives, such as ITWorks.

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