Amdocs Limited (DOX) Q3 2012 Earnings Call Transcript

Good day, everyone, and welcome to the Amdocs Third Quarter 2012 Earnings Release Conference. Today's call is being recorded and webcasted. At this time, I’d like to turn the call over to Liz Grausam, Vice President of Investor Relations for Amdocs. Please go ahead.

Thank you, Anthony. Before we begin, I’d like to point out that during this call, we will discuss certain financial information that is not prepared in accordance with GAAP. The company’s management uses this financial information in its internal analysis in order to exclude the effects of acquisitions and other significant items that may have a disproportionate effect in a particular period. Accordingly, management believes that isolating the effects of such events enables management and investors to consistently analyze the critical components and results of operations of the company’s business and to have a meaningful comparison to prior periods. For more information regarding our use of non-GAAP financial measures, including reconciliations of these measures, we refer you to today’s earnings release, which will also be furnished with the SEC on a Form 6-K. Also, this call includes information that constitutes forward-looking statements. Although we believe the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that our expectations will be obtained or that any deviations will not be material. Such statements involve risks and uncertainties that may cause future results to differ from those anticipated. These risks include, but are not limited to, the effects of general economic conditions and such other risks as discussed in our earnings release today and at greater length in the company’s filings with the Securities and Exchange Commission, including in our Annual Report on Form 20-F for the fiscal year ended September 30, 2011, filed on December 8, 2011and our Form 6-Ks furnished for the first quarter of fiscal 2012 on February 14, 2012 and for the second quarter fiscal 2012 on May 15, 2012. Amdocs may elect to update these forward-looking statements at some point in the future. However, the company specifically disclaims any obligation to do so. Participating on the call today are Eli Gelman, President and Chief Executive Officer of Amdocs Management Ltd; and Tamar Rapaport Dagim, Chief Financial Officer. Following our prepared comments, we’ll open the call to Q&A. Now I’ll turn the call over to Eli.

Thank you, Liz and good afternoon to anyone joining us on the call today. Our third quarter results were consistent with our expectations across revenue, margins and earnings. And we have continued to focus on delivering total return to our shareholders for the multiple levels that our business model and market position provide. These levels include, strong send execution, ongoing operation improvement and the benefits of our share repurchase program. The combination of these three factors have allowed us to generate consistent earnings upside this year. Moreover, we are delivering these upside even in the face of more challenging 2012, revenue conditions especially at AT&T compared to our expectations at the beginning of the fiscal year. As a result we are once again excited to increase our fiscal 2012 non-GAAP EPS growth guidance to the range of 14 to 16% from 12 to 14% previously. As we are getting closer to the end of fiscal year 2012, we believe we have a lot to be proud of here at Amdocs. Into the third quarter, we continue to observe seven similar global conditions as we have throughout the year. Let me elaborate on that. The emerging markets remain strong for Amdocs. We see some more proof points that our strong relationship model, finisher penetration, strong execution and then follow-on expansion and extension, is working well also in the emerging markets. As an example to this, this quarter we signed our first managed services contract in Latin America with TIM Brasil. We are excited by this achievement that it also marks our first managed services contract to include OSS. TIM Brasil has been long-term customer across wireless and wireline. More recently, we have seen acceleration of activity with TIM Brasil associated with their launch of their (inaudible). And now additionally, with the managed services, the TIM Brasil deal coupled with the managed services deal announced last quarter in the Philippines with Globe demonstrate our unique combination of product, professional services, and managed services, is becoming well accepted in the emerging markets. In Europe, Amdocs has performed quite well against tough macro trends in 2012. We continue to project nice growth from Europe this fiscal year. Although, we closely monitor this potential implications of the bleak economic outlook on our customers, we believe the [market picture] opens both opportunities and challenges for us. As an example of it, an opportunity this quarter we signed an important new managed services deal with large wireless service provider in Europe. Providing the value proposition of managed services in less certain economic conditions. On the other hand, we expect decision cycle to be longer in Europe as budgets remains are the intense scrutiny. In North America, our outlook at AT&T stabilize in the third quarter. We have begun to win new business with AT&T albeit at a moderate pace. And the overall market level, we believe that the AT&T mobile bill cancellation is broadly affecting the mood of the wireless industry in North America. Wireless companies are in a stalemate with the regulators and everybody is waiting to see what will happen next around next data monetization, spectrum allocation and potential M&A. We expect this dynamics to continue to affect our business in North America wireless industry and feel some of the uncertainties begin to result. Currently, the prepaid segment is one of the better areas of activity in North American wireless market. In essence, peers in this market segment are trying to deliver a high quality experience similar to postpaid but on a real-time processing platform. This trend plays right into Amdocs’ sweet spot. In the North American cable and satellite industry, we see some more stabilized market conditions. Following the extension of our agreement with Comcast that we announced the quarter ago, so there we announced a five expansion and extension of our business with DIRECTV. We are building this ability into our relationship with key customers in this sector as the trends in the pay TV are exciting. We continue to believe this transformation will gradually happen in the pay TV market and we want to ensure that we will be a leading participate in the industry organization. To summarize our performance, the operation and sales execution at Amdocs has been quite strong in the past few quarters. In Q3 in particular, we signed some highly strategic long-term deals that will serve the company well into the future. Simultaneously, however, telecom industry conditions have been challenging, especially in North America, which is the source of more than two-third of our business. Additionally, we are keeping a watchful eye on Europe given the macroeconomic climate. Knowing that only so much is under our control in an uncertain telecom and general economic environment we’ve taken significant actions in the past 18 to 24 month to deliver on our commitment to driving long-term shareholder value. Under this plan, we’ve successfully executed on three main components. First, our internal investment in our people, our product and quality of delivery has resulted in greater efficiencies across Amdocs. Second, our growth strategies in the emerging markets and managed services have delivered very solid returns. Managed services in particular have increased our revenue and cash flow visibility across the business. And last, our capital structure initiative have provided further benefits including the share repurchase program and our initiation of dividend program which was approved by our shareholders this week. These actions have allowed us to deliver consistent earnings upside this year even in a more challenging revenue environment. I believe our commitment to generating attractive total return to shareholders has never been more clear. With that I'll turn the call over to Tamar.

Thank you, Eli. Third quarter revenue of $809 million was within our guidance range of 805 to 825 million, with foreign currency fluctuations negatively impacting revenue by approximately 5 million relative to the second fiscal quarter of 2012. Excluding the effect of currency, we ended the quarter just about the mid-point of our range. Our third fiscal quarter non-GAAP operating margin was 16.6% flat from Q2 and within our expected range of 16 to 17%. Below the operating line, net interest and other expense was negative $2.7 million in Q3. For forward-looking purposes we continue to expect that net interest and other expense maybe negative in the range of a few million dollars quarterly primarily due to foreign currency fluctuations. Non-GAAP EPS was $0.70 in Q3 compared to our guidance range of $0.64 to $0.70. A lower tax rate positively impacted non-GAAP EPS in Q3 which was attributable to the net decrease in our provision for uncertain tax position. This decrease was mainly due to the lack of the statutory limitations in certain jurisdictions. Free cash flow was $108 million in Q3. This was comprised of cash flow from operations of approximately 138 million less 30 million in net capital expenditures and other. DSO of 76 days increased quarter-over-quarter by seven days above our normal range. The increase in DSO this quarter resulted primarily from our strong North American customer base, given the combination of a few days lag of collection over the quarter end weekend and meeting large investing milestones in the last month of the quarter. Our total deferred revenue was short and long-term was up 8 million sequentially while total unbilled receivables were up 11 million as compared to the second quarter of 2012. Our cash balance at the end of the third quarter was approximately 894 million. Our 12 months backlog which includes anticipated revenue related to contracts, estimated revenue for managed services contract, letters of intent, maintenance and estimated ongoing support activities was 2.76 billion at the end of the third quarter up $35 million sequentially and up 5.3% year-over-year. During the third quarter, we purchased $122 million of our ordinary shares pursuant to our authorized share buyback program. As of June 30, we had $309 million of remaining repurchase authority under our current $1 billion authorization which extends through February 2013. Looking forward, we expect revenue to be within a range of $815 million to 835 million for the fourth fiscal quarter of 2012. This range includes minimum anticipated sequential impact from foreign currency fluctuations as compared to Q3. Translating the fourth quarter guidance into a full fiscal year, we expect other revenue growth for the year to be in the range of 3 to 3.5% on a constant currency basis. This is within our previous expected range, but toward the lower half, largely to the expected progress against project milestone which can fluctuate. On a reported basis, we now expect foreign exchange replace 1% drag on the full-year results, so we expect reported full-year revenue growth of 2 to 2.5%. This compares to 0.5% drag, we expected last quarter as rate fluctuations were unfavorable over the third quarter. We anticipate our non-GAAP operating margin in the fourth quarter to continue to be within the range of 16 to 17%. We also anticipate that our non-GAAP tax rate will be in the range of 13 to 15% and we expect Q4 non-GAAP EPS to be in a range of $0.66 to $0.72. Incorporated into this view is an expected average diluted share count of roughly 166 million shares in Q4, and the likelihood of a negative impact since foreign exchange fluctuations in net interest and other expense. We excluded the impact of incremental future share buyback activity during the fourth quarter as the level of activity will depend on market conditions. For full-year we now expect 14 to 16% non-GAAP EPS growth as compared to prior guidance of 12 to 14%. The new range reflects the benefit of our tax rate in the third quarter and all share repurchases activity to-date. As with the fourth quarter this guidance excludes any future share repurchase activity. With that we can turn it back to the operator to begin our question-and-answer session.

(Operator Instructions) We will take our first question from Tom Roderick from Stifel Nicolaus.

This is Chris Koh for Tom. So, just a quick question regarding the commentary around the quarter seems like it’s been pretty good in terms of all the initiatives you are undertaking, emerging markets, managed services, AT&T seems to be stabilizing, yet you are still kind of in the mid-point of the range if you back out the FX impact on the revenue and then the guidance seems to imply low end of the range where you were hoping previously. So, what would it take to see a little bit of more near-term revenue acceleration or do you expect that the kind of deal activity will filter through within next few quarters in terms of growth acceleration?

What it would take to accelerate the growth? We tried to give some of the color in the script here, but just to maybe give a different angle on to the same mode of data. In North America, the only real activity that we see today on the wireless side is prepaid, some people call it no contract but basically it’s not exactly prepaid in old fashion, it’s a highly sophisticated full customer experience with no contract, no string attached, so to speak. We hope and we believe that would actually be good for Amdocs as a trend, but other than that all that initiatives are really in a holding mode. If the family plans of Verizon and AT&T and if other things would start moving and the regulatory will allow more M&A, of the big guys or the small guys, we will see more dynamics in the wireless industry and I think it will help us. While the wireline, we know about the wireline we can apply some of our managed services ideas but that’s always have not been the growth engine of North America. In Europe, we see lot of activities, but again we read the same newspaper and talk to the same people. We have a watchful eye as we put it here on the European market. In the emerging markets we actually see great activity both in CALA and in Southeast Asia, but we have to put it in proportion, more than two-third of our revenue come from North America, the other one-third cannot pull the company specifically forward, you can do the math. For any percent we earn to the overall company when it's like 3 or 4% on the emerging markets than other business to compensate for that. So, I’d say, North America including the cable and satellite might be one thing. In general, better data monetization practices around the world could be an accelerator of business, M&A in general and more corporate activities across the board. The bottom line changes and we like changes.

And so, just to kind of going back to the regulatory issues, so just to make sure I interpret it correctly? It sounds like EMEA emerging markets, the macro in EMEA side; those are major performing at the high end of what you guys are hoping. North America seems to be a bit of a laggard. So, in terms of the regulatory environment, how that's causing people to kind of (inaudible) their spending. And AT&T mentioned on their call that they do plan on picking up CapEx a little bit in the second half. How do you see that kind of fog lifting or do you see it ramping or lifting anytime soon or do you think that kind of this prepaid-centric environment in North America is going persists for the foreseeable future?

Chris, well we don't know about the timing, but we think prepaid is a factor for a while it will be. I’d say that if data monetization and more ideal how to monetize data better the first trial actually or the first attempt is what AT&T and Verizon are coming up with the family plans and so forth, but if that will accelerate that will help some of the dynamics in the market. And as I said, corporate M&A stuff like this between the different carriers in North America would help as well. And right now we call it stalemate because we think that everybody is in wait-and-see mode rather than in active mode pursuing the business. In general, our business in North America is healthy. The growth is the one thing that we want to see accelerating. And in AT&T as expected we said it two quarters ago that we expect it by now to stabilize and start growing again, and that's what we’ve seen and we’ve new business with AT&T, which is a very good indication for us.

(Operator Instructions) We will move next to Dan Cummins, ThinkEquity. Please go ahead.

Yes, I wanted to ask about AT&T and Verizon’s rollout of the family bucket plans. I think you had referenced that capability around the time you acquired Bridgewater and that's really an important capability, but presumably a first step on the way to very sophisticated to a real-time connectivity between the network and the marketing systems, etcetera. Where do you think these carriers are on that journey and what can you tell us about Amdocs role thus far in getting AT&T there, if you could?

First of all, yes, you got it right, as differently mentioned there under the context of the acquisition of Bridgewater that could be an enabler for us to offer very sophisticated real-time two way, network related and IT related services they can offer to their consumer. We have the systems actually with the latest release of our software, we have even some more sophistication been in there. We see some traction, some in North America, some in other places. As a matter of fact, we won an important deal in Asia-Pacific. And I believe that what will happen is that you will see early adopters of carrier start trying that in the context of the regulatory environment of course. So, what you see in North America is the first attempt through the family plan, that's something we have in our software for quite some time. So, we’re excited about it, but we believe only at the beginning. If that will accelerate, it would mean that we'd be able to have an opportunity to show our power if you will, like to put it this way in more than one carrier in North America and worldwide. So, I’d say where it is and its infancy. It's really, really just the beginning.

We will take our next question from Ashwin Shirvaikar from Jefferies.

It’s Ashwin from Citi. So, you had some good traction here with managed services deals, I guess two questions follow from that, one is should we expect your revenue growth to eventually start matching your recent backlog growth? And then related question on the cost side or cash side is, is that what’s affecting your DSOs recently, sort of greater milestone based or percent to completion based work that’s affecting the DSOs that caused it to go up?

Regarding the backlog as an indicator of future growth overtime of course, there is co-relation, but I wouldn’t take it as far as taking the quarterly changes in backlog to foresee the next couple of quarter’s growth, exactly how it will run through the numbers because of different dynamics in how customers are actually contracting with us. Some may secure the business for many years, some will just do it on a quarter-to-quarter basis and this is where we see the challenging, at least internally I can tell you it’s another indicator, it’s not how we ourselves forecast and we provide it to you guys, the investors as another indicator, as another (inaudible) the business is moving ahead and we are increasing our visibility into the future. So, overall we are glad about the fact we’re continuing to see signings, healthy signings. We just gave some examples in our prior comments about exciting deals we signed DIRECTV, in TIM Brasil, in Europe, those are long-term deals definitely impacting both 12 months backlog as well as the longer-term viability of the company. Going and moving into the cash question, you’re absolutely right. The fact we’re seeing more transformational projects ramping up, it means by definition and based on the fact we’re progressing in a project, recognizing revenue based on percentage of completion then you hit only later. After you perform the work and provide the deliverables, you hit some kind of an investing milestone which enables us to actually invoice and close the gap versus the revenue. So, that's what's creating an unbilled accounts receivable. This quarter specifically there was a specific combination with some North American customers of some collection lab of just two days into July 2 because of the end of quarter over a weekend. Some invoicing milestones were including as well related to projects and other activities, but in general if you look over the last year on why the unbilled accounts receivable has gone up is predominantly because of transformational projects.

And we will hear next from Jason Kupferberg from Jefferies.

So, just wanted to start with the question on AT&T. Obviously, the stabilization is encouraging here. It sounds like you started to win a little bit of incremental work. I mean, are you basically saying that you think we’ve kind of seen the trough in AT&T revenue and we should start to see some incremental improvements quarter-over-quarter going forward. I just want to make sure we have that picture accurate?

So, Jason, the short version is yes. What's the size of it, whether it's every single quarter and in same pace, we really don't know, but the short answer is yes. We think that we saw the low point behind us and with stabilizing and growing back in AT&T.

Just kind of segue to my follow-up question, I mean, as you guys start to think about fiscal ‘13, I know it's obviously premature to provide any specific guidance, but the multiyear guidance we had from last year's analyst meeting would seem to suggest some implied acceleration next year, event it's for currency aside. Is that in general a valid assumption still based on what you see in the backlog and the pipeline as well as some of the visibility on AT&T? I recognize obviously the macro environment has changed quite a bit since you gave that multiyear outlook but any general thoughts would be much appreciated?

As you said, it's quite early to talk specifically about fiscal ‘13. I will say in general if you’re looking on the kind of the thesis we’ve shared with the investors, is that this company can grow in general faster than the market by taking market share and this is exactly what we continue to do and providing the investors with double-digit returns to different, I’d say strength of the company both in the fundamentals of the business and the combination with the capital allocation to shareholders and we still believe this is overall the thesis. What it means exactly in terms of providing in all the indications of the numbers for fiscal ‘13, I think it's a bit too early.

We will take our next question from Sterling Auty with JP Morgan.

I was wondering if you could give us some color around the DIRECTV renewal in terms of, obviously with Bell Canada’s renewal you had the pricing impact and that had a little bit of revenue headwind through this fiscal year. Did you experience the same thing here with DIRECTV and maybe later on top of that the opportunity at TIM Brasil, normally when we saw the contract of that magnitude and managed services, would you expect little bit more of the lift? So, is the new guidance balanced? Was there may be a price consideration to DIRECTV offset by a good opportunity here in TIM Brasil?

DIRECTV wasn’t, now we’re securing our future in relationship with DIRECTV to this contract. We don't see totally any similarity between the Bell Canada renewal at the time and between the DIRECTV relationship and circumstances. So, we did not see a significant price pressure. We are taking and expanding additional activities within DIRECTV moving forward. So, that was part of the overall combination of the deal in terms of how we’re providing additional value to the customer and it's not just a price discussion, it’s something much broader. So, that's the typical kind of dynamics we’re seeing around managed services where we are coming and actually discussing with the customers before the renewal date is approaching, different opportunities for us to expand our footprint and bring additional value, and through that also discussing the extension and the new pricing environment. Going back to TIM Brasil, the usual dynamics within managed services deal is such that the beginning, usually the first year or two are tougher in items of profitability and then the margin profile is improving overtime. This is part of how we do business all the time. The same goes for other managed service deal that we are signing. It requires a very, very big deal in order to suddenly put an impact and change the profile. If you remember 2008 when we signed a very large deal in AT&T, managed services providing services for all of their legacy wireline customer care and ordering that was big enough for comparison to the overall company to make such a dent, but overall I don’t think you should look on TIM Brasil in the same way.

And then maybe one quick follow-up. Tax rate was the items in the quarter more one-time in nature and we should still use the range that you gave for the fourth quarter as our understanding for a longer term tax rate?

The overall tax is 13 to 15%, we may see quarters in which it will be lower, sometimes maybe specifically higher, though that’s more likely to be lower than higher but we will see in the future some kind of cases like that where we are positively seeing the fact that the accruals we’ve made against tax uncertainties are no longer needed, which was the case in this quarter, but overall I advise you to take the 13 to 15% as the proper one.

Sterling, I just wanted to add on your first question on DIRECTV. Actually I think it’s a good example of a win-win expansion and extension, which is measured on value and not on price or whatever, that’s something that we are very proud of at Amdocs that we are not into the regular price war every time. So, you have to respect the customer and that fact that you became more effective and efficient also, but that should not necessarily be the center of the discussion and I’d say that DIRECTV is win-win, it’s a good deal for both sides that’s the bottom-line.

Our next question comes from Julio Quinteros from Goldman Sachs.

This is Paul Thomas for Julio. You have been buying back a lot of stock and with the first dividend payment coming up here in the fall, how should we think about the capital allocation between dividends and buybacks going forward?

What we’ve discussed last quarter and we continue to hold that division of course, is that we should think of a framework in which approximately half of our free cash flow is used for reinvestment into the business and about half is going into returns of shareholders in the form of dividend and completing that with buyback. This half is not a constant number. It's something that we will change from time to time according to the opportunities we see in front of us in terms of the M&A pipeline and the other considerations like that, but overall, that’s a framework you should be thinking of.

We will take our next question from Daniel Meron from RBC Capital Markets.

So, first thing, Eli you guys mentioned the first managed services operating support system deal was TIM Brasil here. Should we think about it as a potential for reference account for additional OSS, would that start marking a more significant impact on other carrier decision making for this segment?

So Daniel, I’d tell you that we both want to think about it as a reference to come. In general, there is no reason that (inaudible). It is a fast growing country, sophisticated system. They have the same KPIs or harder than others because of the growth and all the World Cup and Olympics everything coming their way, they cannot afford to do any mistake. So, yes, we hope that this will turn into showcase to other places and other carriers in the region and outside of the region.

And then just looking at [direct-to-video] just as a segue into the operation in the cable segment, can you provide with an update there on the trends there and what they're thinking versus carriers in general are they back to trying to update their systems or are they still kind of slow?

Look, for us they are still kind of slow. They think that they do more. So, we still see gradual transformation. So, I'm not talking about this early DIRECTV right now, but in general you would see companies upgrading their CRM front-end system. You will see a collection system being replaced. You would see an invoicing because their legacy system can provide only that many cycles of bids and it's a really pain in the neck. So they need the new invoicing system. They would need to have some new enterprise product catalog because they are having more and more offerings and they cannot get away with it. So, that we see already and the nice thing about it that we see that they are using components of our (inaudible), the full BSS OSS deck into their let's call it legacy environment. What we don't see yet is like full transformation like TIM Brasil would transform the whole organization or Vodafone Netherlands or U.S. Cellular or other, this type of transformation we don't see yet. As I’ve said, we believe that eventually it will come. They will eventually have higher competition among themselves and with the telcos, the telcos is actually progressing in this pay TV space as well. So the world is not stagnant. Not to mention what will happen as soon as Apple or Google or one of this disruptive guys will get into the market. So altogether, I think the dynamics outlook is higher, in other words, more changes rather than lower and that seems to be the fact. So, we see right now component. The good sign is that they are using our CS components. That's a very good indication for us. The same model of delivery or managed services or whatever, everything that we see under telecom side, but you ask me the bottom line, that is low.

Our next question will come from David Kaplan with Barclays.

I really do have a question on the FX side. When you think about or can you give us a little bit of color on the impact of FX on quarters. I mean, you mentioned in the press release that the impact was on the revenue side, but is there a positive impact or potential chance of impact on FX, given the shekel weakness on the cost side for you guys or is the mix of costs not that heavily weighted in this direction?

I’d say in general, our hedging program is designed to hedge the net exposure. So, on the one hand, we have currencies on the revenue side that are not U.S. dollar and on the other side on the cost, we have currencies such as the Indian rupee or Israeli shekel that are dominant in the cost side. So, it's all designed to protect on the net exposure and in that sense, for example, to your question about the Israeli shekel, we are heavily hedging the Israeli shekel. So, we are less impacted in the near-term by changes for the positive or negative in the exchange rate. In the longer term, of course, by definition, the company is monitoring very carefully difference in exchange rates as we do labor, cost and other (inaudible) factors that may impact our cost structure. And that’s been very effective because of the results you’re seeing is that while the currency volatility continues to be very strong we are able to protect our operating margins in an effective way.

That does conclude our question-and-answer session. I'd like to turn the conference back over to Liz Grausam for any additional or closing remarks.

Thank you very much for joining the call this evening and we do appreciate your continued interest in Amdocs. We hope you all have a wonderful evening. Thank you.

That does conclude today’s conference. Thank you for your participation.