Cerner (CERN)

Q3 2011 Earnings Call

October 27, 2011 4:30 pm ET


Jeffrey A. Townsend - Chief of Staff and Executive Vice President

Michael R. Nill - Chief Operating Officer

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

Zane M. Burke - Executive Vice President


Atif A Rahim - JP Morgan Chase & Co, Research Division

Richard C. Close - Avondale Partners, LLC, Research Division

Michael Cherny - Deutsche Bank AG, Research Division

Steven P. Halper - Stifel, Nicolaus & Co., Inc., Research Division

Kipp R.F. Davis - Barclays Capital, Research Division

Stephen B. Shankman - UBS Investment Bank, Research Division

George Hill - Citigroup Inc, Research Division

Jamie Stockton - Morgan Keegan & Company, Inc., Research Division

Donald Hooker - Morgan Stanley, Research Division

Sebastian Paquette - Goldman Sachs Group Inc., Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division



Welcome to Cerner Corporation's Third Quarter 2011 Conference Call. Today's date is October 27, 2011, and this call is being recorded. 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'd like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corporation. Please proceed, sir.

Marc G. Naughton

Thank you. Good afternoon, everyone, and welcome to the call. I will lead off today with a 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, is traveling today but should be able to join for Q&A.

Now I will turn to our results. All key measures in Q3 were at or above our expected levels. Bookings were very strong and exceeded the high end of our guidance range. Our income statement performance was excellent with revenue and adjusted EPS above expected levels and continued margin expansion and strong earnings growth, and we had very strong cash flow performance.

Moving to the details. Our total bookings revenue in Q3 was $650 million, which is the second best result in company history, second only to Q4 of '09. Bookings exceeded the high end of our guidance range by $50 million, and we're up 31% from Q3 of '10. Bookings margin in Q3 was $534 million or 82% of total bookings. As Zane will discuss, the strength of bookings spanned across all business models. Our bookings performance drove a 21% increase in total backlog to $5.66 billion. Contract revenue backlog of $4.96 billion is 24% higher than a year ago. Support revenue backlog totaled $691 million, up 8% year-over-year.

Revenue in the quarter was $571.6 million, which is up 24% over Q3 of '10 and about $30 million over our guidance. The revenue composition for Q3 was $189 million in system sales, $139 million in support and maintenance, $233 million in services and $11 million in reimbursed travel. The upside relative to our guidance was largely driven by higher system sales, as well as very strong services revenue.

The system sales revenue reflects 41% growth from Q3 of '10, and included greater than 20% growth in licensed software and subscriptions and over 50% growth in technology resale. The technology resale growth included record levels of device resale, reflective of rapidly increased traction in the resale of CareFusion and other devices. Even with strong software growth, the even stronger growth in technology resale led to lower system sales margins of 55%. However, when you look at the growth in system sales margin dollars, it mimics the growth in revenue at a very strong 37%.

Services revenue was up 22% compared to Q3 of '10 with strong growth in both managed services and professional services. Support and maintenance revenue increased 6% over Q3 of '10.

Looking at revenue by geographic segment. Domestic revenue increased 27% year-over-year to $499 million. Global revenue was $72 million and grew 5% compared to a year-ago period.

Moving to gross margin. Our gross margin for Q3 was 78.9%, which is down compared to 82.9% of a year ago and 81.2% in Q2. The decline in gross margin was driven by the record levels of technology resale that I discussed, as well as an increase in third-party services. While significant upside in technology resale and higher third-party costs led to gross margins slightly below our target of 80% range, we still drove very strong gross margin dollars with growth of 18%. We also drove solid operating margin expansion despite the lower gross margin.

Looking at operating spending. Our third quarter operating expenses were $323.3 million before share-based compensation expense of $7.5 million. Total operating expense was up 14% compared to Q3 '10, with the majority of the growth driven by an increase in revenue-generating associates in our services businesses. Sales and client service expenses increased 16% compared to Q3 of '10, driven primarily by growth in managed services and professional services.

Our investment in software development increased 8% compared to Q3 of '10. We expect to continue growing our R&D investments in coming years to accelerate innovation in areas Mike and Jeff will discuss. We expect to be able to do this with R&D still growing slower than revenue, so we maintain the leverage we have achieved from our R&D investments. G&A expense increased 16% year-over-year, driven by personnel and other expenses related to increased hiring and training.

Moving to operating margins. Our operating margin in Q3 was 22.4% before share-based compensation expense and was up 70 basis points compared to Q3 of '10. We still expect operating margin expansion in Q4 and for the full year to fall within the 100 to 200 basis point range we targeted at the beginning of the year.

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