Cerner (CERN)

Q2 2010 Earnings Call

July 28, 2010 4:30 pm ET

Executives

Jeffrey Townsend - Chief of Staff and Executive Vice President

Neal Patterson - Co-Founder, Chairman, Chief Executive Officer and Acting President

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

Michael Valentine - Chief Operating Officer and Executive Vice President

Analysts

Corey Tobin - William Blair & Company L.L.C.

Michael Cherny - Deutsche Bank AG

Atif Rahim - JP Morgan Chase & Co

George Hill - Leerink Swann LLC

Charles Rhyee - Oppenheimer & Co. Inc.

James Kumpel - Madison Williams and Company LLC

Jamie Stockton - Morgan Keegan & Company, Inc.

Steven Halper - Thomas Weisel Partners

Richard Close - Jefferies & Company, Inc.

Sean Wieland - Piper Jaffray Companies

Presentation

Operator

Welcome to Cerner Corp. Second Quarter 2010 Conference Call. [Operator Instructions] The company has asked me to remind you that the 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'd like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corp.

Marc Naughton

Thank you, Jeremy. Good afternoon, everyone, and welcome to the call. I’ll lead off today with a 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 and CEO, will join us for Q&A.

Now I'll turn to our results. All key measures in Q2 were at or above expected levels. Our bookings were strong and exceeded a high end of our guidance range. Our income statement performance was very good, with revenue above the high end 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 quality earnings.

Moving to the details, our total bookings revenue in Q2 was $468 million, which is 19% higher than Q2 '09 bookings. Bookings margin was $397 million or 85% of total bookings revenue, up from 84% in Q1.

As Michael will discuss, we are pleased to announce that we did sign our RevWorks client this quarter. In discussing our overall bookings, I do want to point out that due to the structure of this initial RevWorks contract, bookings will be recognized over time as the client achieves benefits. Thus the strong overall bookings performance this quarter did not include any current impact from the RevWorks contract.

Our total backlog increased 21% year-over-year to $4.48 billion. Contract growing a backlog of $3.85 billion is 24% higher than a year ago. Support revenue backlog totaled $637 million, up 7% year-over-year.

Our revenue in the quarter was $456 million, which is up 13% year-over-year. The revenue composition for Q2 was $136 million in system sales, $128 million in support and maintenance, $184 million in services, and $8 million in reimbursed travel.

System sales revenue reflects growth of 19% compared to Q2 '09, with strong software and sublicense software growth more than offsetting flat hardware revenue. Services revenue was up 16% compared to Q2 '09 with good growth in both managed services and professional services.

Support and maintenance revenue increased 4% over Q2 '09. As we indicated last quarter, we expect support and maintenance revenue growth to improve in the second half of the year based on enhanced software sales the past several quarters.

Looking at revenue by geographic segment, our domestic revenue increased by 13% to $381 million. Global revenue grew 12% to $75 million, reflecting another solid quarter following the challenging 2009.

Moving to gross margin. Our gross for Q2 was 82.8%, which is down 60 basis points year-over-year and 140 basis points sequentially. The gross margin decline was driven by lower system sales margins which were down 160 basis points year-over-year and 60 basis points sequentially. The lower system sales margins were related to lower margins on hardware, with licensed software margins remaining flat year-over-year and sequentially.

Looking at operating spending, our Q2 operating expenses were $285.6 million before share-based compensation expense of $5.8 million. This is up 7% compared to a year ago. Sales in client service expenses were up 10% compared to Q2 '09, driven primary by growth in managed services and professional services. Software development expense was up 3% compared to Q2 '09, reflecting continued control of this expense line.

G&A expense decreased 3% year-over-year. The decrease is primarily related to the year-over-year difference and the impact of foreign currency as we had an FX loss in the year-ago period compared to a small FX gain this quarter.

Moving to operating margins. Our operating margin in Q2 was 20.2% before share-based compensation expense. This is up 290 basis points compared to last year, and keeps us on track for our full year 2010 target of 20% operating margins.

Moving to earnings and EPS. Our GAAP net earnings in Q2 were $55.5 million or $0.65 per diluted share. GAAP net earnings include share-based compensation expense, which had a net impact on earnings of $3.7 million or $0.04 per share. Adjusted net earnings were $59.1 million, adjusted EPS was $0.69, which is up 29% compared to Q2 '09.

Our tax rate was 35.7% which is slightly higher than our projected level of around 35%. We expect to be closer to 35% for the rest of the year, assuming the R&D tax credit is extended.

Read the rest of this transcript for free on seekingalpha.com