Q3 2010 Earnings Call
October 28, 2010 4:30 pm ET
Jeffrey Townsend - Chief of Staff and Executive Vice President
Marc Naughton - Chief Financial Officer, Executive Vice President and Treasurer
Michael Valentine - Chief Operating Officer and Executive Vice President
Neal Patterson - Co-Founder, Chairman, Chief Executive Officer and President
Michael Cherny - Deutsche Bank AG
Atif Rahim - JP Morgan Chase & Co
Bret Jones - Brean Murray, Carret & Co., LLC
Steven Halper - Stifel, Nicolaus & Co., Inc.
Greg Bolan - Wachovia Capital
Eric Coldwell - Robert W. Baird & Co. Incorporated
Jamie Stockton - Morgan Keegan & Company, Inc.
Richard Close - Jefferies & Company, Inc.
Sean Wieland - Piper Jaffray Companies
Welcome to Cerner Corp.'s Third Quarter 2010 Conference Call. [Operator Instructions] The company has asked me to remind you that various remarks made here today by Cerner's management about future expectations, plans, perspectives and prospects 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 would like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corp.
Thank you, Regina. Good afternoon, everyone, and welcome to call. I will lead off today with the review of the numbers. Mike Valentine, Executive Vice President and Chief Operating Officer will follow me with sales and operational highlights and marketplace trends. 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 join us for Q&A.
Now I will turn to the results. All key measures in Q3 were at or above our expected levels. Bookings were strong and exceeded the high-end of our guidance range. Our income statement performance was very good with revenue slightly above the mid-point of our guidance range and continued strong margin expansion and earnings growth. We again had great cash flow performance, with record levels of free cash flow reflective of high earnings quality.
Moving to the details. Our total bookings revenue in Q3 was $496 million, which is 17% higher than Q3 '09 bookings and above the top end of our guidance range. Bookings margin was $398 million, or 80% of total bookings. Even though we had a strong year-over-year and sequential growth in software bookings, the bookings margin percent is down sequentially and year-over-year due to lower margins on technology resale. Given the strength in software, the lower margin percent does not concern us.
Our total backlog increased 21% year-over-year to $4.66 billion. Contract revenue backlog of $4.02 billion is 24% higher than a year ago. Software revenue backlog totaled $642 million, up 6% year-over-year.
Our revenue in the quarter was $462.7 million, which is up 13% year-over-year. The revenue composition for Q3 was $133 million in System Sales, $130 million in Support and Maintenance, $191 million in Services and $8 million in Reimbursed Travel. System Sales revenue reflects growth of 13% compared to Q3 '09, with strong growth across software, sub-licensed software and hardware revenue. Services revenue was up 18% compared to Q3 '09, with strong growth in both managed services and professional services. Support and Maintenance revenue increased 7% over Q3 '09.
Looking at revenue by geographic segment. Our domestic revenue increased 16% to $394 million. Global revenue was down $2 million or 3% to $69 million. While the weak global economy is still impacting our global business, global revenue is still up 6% year-to-date, and expect improved growth in Q4 and in 2011.
Moving to gross margin. Our gross margin for Q3 was 82.9%, which is down 10 basis points year-over-year and up 10 basis points sequentially. System Sales margin decreased 250 basis points year-over-year due to lower margins on technology resale, which were driven by a combination of lower margins on hardware and device resale and lower margins of sublicensed software. Similar to our bookings margin, the lower system sales margin is not a concern given the strong levels of software bookings and revenue. Further, as I'll discuss in a moment, we are still driving stronger operating margin expansion even with lower system sales margins.
Looking at operating spending, our second quarter operating expenses were $283 million before share-based compensation expense of $6.6 million. Total operating expense is up 7% compared to the year ago quarter. Sales in client service expenses were up 10% compared to Q3 '09, driven primarily by growth in managed services. Our investment in Software Development was flat compared to Q3 '09, reflecting continued leverage of our R&D spend, and G&A expense increased 5% year-over-year.
Moving to operating margins. Our operating margin in Q3 was 21.7% before share-based compensation expense. This is up 330 basis points compared to last year and keeps us on track to exceed our full year 2010 target of 20% operating margins. The margin expansion was driven by a combination of increased profitability in our professional services, managed services and support business models, along with ongoing leverage of investments in R&D and SG&A expense.
Moving to earnings and EPS. Our GAAP net earnings in Q3 were $60.9 million, or $0.71 per diluted share. GAAP net earnings include share-based compensation expense, which had a net impact on earnings of $4.1 million or $0.05 per share. Adjusted net earnings were $65 million and adjusted EPS was $0.76, which is up 25% compared to Q3 '09. Our tax rate was 35.4%, which is in line with the level we expected.