MSC Software Corporation Q4 2008 Earnings Call Transcript

Feb.26.09 | About: MSC Software (MSCS)

MSC Software Corporation (MSCS) Q4 2008 Earnings Call Transcript February 26, 2009 4:30 PM ET

Executives

Joanne Keates – VP, IR

Bill Weyand – CEO and Chairman

Sam Auriemma – EVP and CFO

Analysts

Kevin Liu – B. Riley & Co.

Mark Schappel – Benchmark

Operator

Good afternoon. My name is Melissa and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter conference call. (Operator instructions) Thank you. I would now like to turn the conference over to Ms. Joanne Keates. Ma'am you may begin.

Joanne Keates

Thank you for joining us this afternoon to discuss MSC Software’s fourth quarter and year-end financial results. On the call today from MSC we have Bill Weyand, CEO and Chairman; Sam Auriemma, MSC’s CFO; and John Mongelluzzo, our Executive Vice President. I’d like to point out that slides for this conference call are available for download from our website at www.MSCSoftware.com/IR.

Before we begin let me make our Safe Harbor statement. This presentation contains forward-looking statements that involve risks and uncertainties. All forward-looking statements included in this web cast and slide presentation is based on information available to us at this time. These forward-looking statements involve uncertainties which may cause our actual results to differ materially from those implied by the forward-looking statements. Important factors that may cause actual results to differ from expectations are discussed in risk factors found in our recent Form 10-K and Form 10-Q filings with the SEC. We undertake no obligation to revise or update publicly any forward-looking statements for any reason or at any time.

At this point, I would like to turn the call over to Bill Weyand. Please go ahead, Bill.

Bill Weyand

Thank you, Joanne and good afternoon and thanks for dialing in to MSC’s Q4 conference call and our 2008 year-end conference call. Total revenue for Q4 was $65 million, which was on the high-end of the range announced earlier in February, but down 9% from the record Q4 of last year. Software revenue was $24.7 million, maintenance $33.4 million, and services $6.9 million.

Q4 revenue was impacted clearly by the global manufacturing slowdown. MSC’s multi-discipline and enterprise solutions represented approximately $8.2 million or 33% of our total software revenue in Q4.

Operating income for Q4 excluding restructuring and impairment charges totaled $6.8 million. For fiscal 08, revenue grew at 3% to $254 million; software revenue totaled $89 million, which declined 6% from the previous year. Maintenance grew at 9% to $137 million, and services grew 6% to $28 million.

For the year, our multi-discipline and SimEnterprise solutions represented approximately $28.7 million or 32% of total software revenue. We ended the year with $153 million in cash after retiring $6.5 million in debt in Q4.

Looking at our geographical business, we continue to be equal geographically with EMEA continuing to lead at 38% of our ’08 revenue, the Americas 32%, and Asia-Pacific at 30%.

Looking at transactions, again we have been tracking and reporting to you all transactions over $100,000, which grew year-over-year from 108 to 132, and in fact in each quarter throughout 2008, we exceeded the previous year in number of larger transactions.

Few comments on the economic environment. Obviously, the global economies negatively impacted our Q4 results, particularly in Europe. We emerged 2008 as a high-quality software company whose traditional engineering applications are the standard in the industries we serve, as well as the maturity of moving from release 3.2 to release 4 this year for our MD Solutions and SimEnterprise solution are gaining acceptance as the backbone for all CAE.

In looking at the industries we serve, our traditional marketplaces of aerospace, automotive, defense, and heavy manufacturing, we continue to invest heavily in terms of product development to assist our customers from moving from the pilots and proof of concepts to begin phase deployments.

In light of the economic environment, we have also looked at what industries is less impacted or more favorable going forward, and we have implemented the industry focus and marketing programs as well as strategies, for the wind energy, medical products, consumer products, as well as oil and gas.

In terms of our product strategy again, as we enter 2009 with the release 4, meaning 4 years into major releases for our multi-discipline and SimEnterprise solutions that we are now extending the integration of CAE in the collaboration for all of our customers worldwide. Today, the solutions have robust functionality for global deployment and our customers are beginning to move from pilots and proof of concepts to enabling phased deployments.

In regard of the outlook for the PLM space, and particularly the simulation market place, and (inaudible) a page from a recent study by Simdata talking about not only the weak global economy, but what are they doing to drive innovation. And manufacturing companies in a recession tend to invest more in product innovation to drive better products at higher quality and faster to market. MSC SimEnterprise MD Solutions clearly enable today reduction in IT infrastructure and IT cost.

And to quote the Simdata report, what are the planned expansions of spending going forward in the PLM space, simulation analysis ranked second in terms of highest priority. In terms of one of our early adopters for our multi-disciplined Actran [ph] technology, there was a recent paper published by BMW, on BMW, MSC and IBM. Simulating more, this was a record breakthrough model using our MD technology, and to quote friends at BMW, this global initiative has developed realistic car models almost entirely in the computer with the benefit of reducing both development costs, and time to market.

We are very pleased to announce earlier this month being selected by EADS in their Phoenix project to correct their IT infrastructure, and they have selected MSC as the major partner for building their multidisciplinary simulation backbone strategy. And in quoting a couple of excerpts from not only the press release, but from our friends at EADS this is the harmonization project to correct their IT infrastructure globally, and they will be deploying our enterprise solutions through all divisions and all operations in the supply chain worldwide, as their simulation backbone. In quoting Jean Botti, their CTO, EADS will benefit tremendously from this new strategic partnership and from the creation of standardized virtual product development environment for simulation, which will lead to more innovation, reduced time to market, and improved product quality as well as cost savings.

If you look at the previous announcements through ‘08, and this one with Boeing, Alenia, and now EA DS we are beginning to gain acceptance from the customers moving from pilots to global deployment in selecting MSC as their backbone in their IT infrastructure for simulation, content, and process management globally.

Earlier today, we were very pleased to announce being selected by Jaguar Land Rover and choosing SimEnterprise solutions to optimize their simulation processes. Jaguar recently was divested from Ford, now part of Tata Industries, and they have entered into an agreement to deploy our multi-discipline and SimManager applications across their entire operations to greatly accelerate their simulation capability, and optimize their new product development goals.

Looking into new industries, we are focused on, as also a recent press release by Frontier Air [ph] selecting our SimEnterprise solutions for global innovation. We are now beginning to partner with all the major players in wind generation and wind energy across the world, and this is a new and exciting market for MSC.

Summary comments, before we turn it over to Sam to cover the financials. We believe that our new SimEnterprise solutions are a transformative technology, the robustness of R4, which was released mid-year this year will drive many hundreds of customers who have implemented pilots and proof of concepts to beginning phase deployments as evidenced by Boeing, Alenia, EADS, and now Jaguar Land Rover.

We are mindful and are watching the macroeconomic environment as it affects our marketplace and the industries we serve, as well as the new industries we are entering. We continue to be laser focused to improve our cost structure as we began in 2008, and will continue throughout 2009.

We have ended 2008 with a very strong balance sheet and a conservative business model, are well positioned to weather the manufacturing business environment.

With that, Sam.

Sam Auriemma

Well, thank you Bill. And good afternoon to all of you on the fourth-quarter and year-end call. Total revenue for the fourth quarter again was $65 million and that’s down 9% from the $71.1 million in Q4 2007. Foreign currency exchange had a net minimal impact on total revenue in Q4 when compared to the results from last year. It is clear, however, that the global economic downturn impacted our revenue in the fourth-quarter, particularly in Europe, and we believe it will continue to impact our results in the foreseeable future.

For fiscal 2008, total revenue grew 3% or $7.7 million to $254 million. Total revenue in 2008 had a favorable FX impact of approximately $15.7 million. For your information, we are including a table detailing the impact of FX for each revenue component for the fourth quarter and for the year.

Let’s talk about the individual categories of our revenue. Software revenue for the fourth quarter was $24.7 million, and that is down $4.1million compared to last year. This number has a slight favorable FX impact of 300,000. We believe that this decrease is primarily the result of the downturn in the global economic business environment. We experienced during the quarter deals being delayed or deferred due to spending freezes, budgetary restrictions, and generally longer approval processes, and that is particularly in Europe.

For fiscal year 2008, software revenue totaled $89.3 million and that is down 6% when compared to fiscal year 2007. As many of you that follow MSC know, we continue to be in a product transition period, and we continue to experience lower sales of our engineering tools products, and that is partially offset by increased sales of our SimManager and MD Solutions. This transition combined with the aforementioned fourth-quarter economic downturn impacted our results.

The next slide breaks down software revenue for the four quarters of 2008 by our SimEnterprise, MD, and engineering application products. Enterprise solutions together with MD product revenue represented 33% or $8.2 million of total software revenue in the fourth quarter. For the year, MD, and SimEnterprise, and (inaudible) represented about 32% of total revenues or $28.7 million and that is up 21% of total revenues of $20.3 million in FY 2007.

Let us take a look at our maintenance revenue for the fourth quarter. Maintenance revenue was essentially unchanged from a year ago at $33.4 million. For the year ended December 31 ’08, it increased 9% to $137 million. This part of our business continued to perform well as customers see the value in ongoing enhancements and technical support.

In fact, many customers reinstated their maintenance services during 2008.

During Q4, services revenue was $6.9 million compared to $9 million in Q4 2007, and for the year services revenues totaled $28.1 million and that’s up about 6% from the ’07 results.

Geographically for Q4 2008, the Americas revenue decreased slightly to $21 million, and maintenance grew at about 5%. Although on a net basis currency did not impact our results, we did experience some wide regional shifts. In EMEA in Q4, we saw the business contract by 24% to about $23 million. Changes in the euro decreased revenues by about $2.7 million and that contributed to the decline.

In Asia Pac in Q4, we saw revenue growth of 10% to $21 million with a favorable FX impact to revenue of $2.7 million, and those essentially offset each other.

For the year, the Americas had the strongest performance with revenue growth of 7% to $80 million, EMEA essentially flat at $96 million with changes in the euro helping them by $6.2 million. For the year, Asia Pac grew by about 3% to $78 million. Changes in the Yen favorably impacted Asia Pac revenue by $9.4 million.

We continue to have good balance of revenue across all three of our operating regions; however, with 68% of our revenue occurring outside the US, our business may be significantly impacted by changes in foreign exchange rates, as indicated in the numbers I just talked about. These FX impact revenues and operating expenses as well as other income (inaudible), difficult to forecast.

Turning to expenses, gross margin for the fourth quarter was approximately 83%, and software gross margin was 88%. Maintenance and services margins were 80%. On an annual basis, gross margin was 81% for the year 2008 and 2007. Looking forward, we expect gross margin to be relatively stable in the near term, and that is assuming relatively stable top line revenues.

As you may recall, during 2008, we initiated a cost reduction initiative to rationalize our cost and align our operations with our enterprise product transition strategy. During the fourth quarter of 2008, we enhanced this initiative to respond to the realities of the economy. When completed, charges associated with this cost reduction effort will total approximately $2.6 million, of which we recognized approximately $2 million of those costs in FY 2008, and approximately $1 million of these were recognized in the fourth quarter.

We expect to recognize the remaining cost in ‘09, and we expect these initiatives will result in lowering our annualized cost structure by approximately $12 million as salary, bonus, and benefits as and when completed and re-implemented.

Operating expenses totaled $58.4 million in the fourth quarter, $212 million in ‘08.

To give you some insight on the FX impact of our charges – of our expense numbers, we again included a table for your convenience. We have also added a number of charges associated with restructuring and other items that impacted our operating expenses that are summarized on the table on the next slide.

I will offer a brief comment on some of these. Write-downs were taken on certain trademarks as we were determined – as these were determined to be impaired during the fourth quarter, and that is largely due to recent declines in revenue and business outlook. We also recognize the aforementioned restructuring charges taken during the fourth quarter, and that is in conjunction with ongoing cost containment programs to improve future operating results.

The next two slides detail quarterly trends in our operating expenses R&D, sales and marketing, and G&A for the past five quarters are all moving in the overall favorable direction, as a direct result of our cost containment initiatives.

And this is in the face of currency increases that are the effect of raising these costs predominantly before Q4. Taking into account the aforementioned factors, we reported an operating loss of $4.5 million in the fourth quarter of 2008 and that compares to an operating loss of $1.2 million in Q4 2007.

Excluding restructuring impairment in the fourth quarter of $11.3 million, adjusted operating income of $6.8 million in the fourth quarter and that compares to $3.5 million in the same basis in Q4 of ‘07.

Lastly turning to income taxes, we had a next tax charge of $17.3 million in the fourth quarter, which resulted primarily from the salvation of valuation allowance of $22.9 million and that is offset by the tax impacts. As a result, we had a net loss in the fourth quarter of $22.5 million or $0.50 a share.

For the fiscal year 2008, adjusted EBITDA was $31.7 million and that compares to $27.2 million for 2007. And quickly some other financial metrics. Our Deferred revenue stood at $75.8 million at December 31 ‘08, and that is down from $80.6 million at the end of 2007. That is basically due to lower bookings during Q4.

As Bill mentioned, cash and investments at the end of the year were $152.6 million. Additionally, during the fourth quarter we paid back approximately $6.5 million of our remaining long-term debt and that will reduce our overall interest expense going forward.

CapEx continues to be low in fiscal 2008 and totaled about $3 million. That is down from $8.1 million in 2007, and we expect CapEx to be no greater than $5 million in fiscal 2009.

As we looked forward, we must take into account the global economic crisis and how this will impact our business. Accordingly, for Q1 and Q2 in 2009 our best estimate of total revenue will be a decline from 2008 results of approximately 15% plus or minus several percentage points. And that will be mostly driven by lower software revenue with less impact expected in maintenance and services revenue.

For the year, we expect revenues to decline in the range of 12%, plus or minus several percentage points. Again, we expect most of that to be in our software category. The guidance we give here assumes a relatively stable foreign currency and economic environment, and continued acceptance of our products.

Additionally, we expect seasonality to be in line with historical results with the summer months being our weakest and the fourth quarter our strongest. We will manage our cost structure closely, weighing the needs of our business as we move through these difficult times.

We believe that in the long run, our strategy of providing leading-edge enterprise simulation software will differentiate us from our competition. We will evaluate our business model as we go forward to maximize our market opportunities as Bill mentioned in these tough economic times.

We are committed to continuing to improve our cost structure and streamline our business where and when it appears necessary.

Now, I will turn the call back over to Bill.

Bill Weyand

Thanks Sam. We believe MSE is becoming the must-have IT infrastructure solution in the PLM space for simulation. MSC is also beginning to be recognized as the systems integrator and backbone for all CAE and simulation as evidenced by a number of the major corporations that are selecting us as their partner to drive product quality, innovation, efficiency and time to market.

Although the present economic downturn is impacting our customers and their IT spending trends, we believe that they and we will continue to deploy our solutions to drive product innovation and emerge a better market competitor as the market improves. And the evidence that this is beginning to take place is that many of our key customers worldwide are selecting and beginning MSC’s phased deployment from pilots to global deployment and MSC as their simulation backbone. Thank you.

Joanne Keates

Melissa, we will turn it to questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Kevin Liu.

Kevin Liu – B. Riley & Co.

Hi, good afternoon, looking at the services margins it looks like it was up nicely year-over-year and sequentially up. So, was just wondering kind of what drove that and whether or not that was impacted at all by some of the maintenance reinstatements you discussed?

Sam Auriemma

Sure. You know, we have continued to control costs in that category and every category going – in our business. So, some of it has been driven by cost containment efforts, and some of it has been driven by continued volume in that business.

Kevin Liu – B. Riley & Co.

And with regard to the professional services work there, I mean during Q4 and then maybe as you look out to Q1 now, what have you been seeing in terms of customer decisions regarding going forward on implementations that were planned, have you seen anyone either cancel or delay some of these implementations.

Bill Weyand

This is Bill. We haven't seen on the services side cancellations, particularly as (inaudible) customers are moving from pilot projects to phased deployments. In fact, our visibility with major aerospace and automotive manufacturers – it continues to be enhanced as again, as they more from a pilot to a multi-quarter, multi-year phased deployment of our solutions with our services business and services partnering with them, continues to add some brighter light in this marketplace.

Kevin Liu – B. Riley & Co.

And then just lastly on going back to guidance, you mentioned the services side of the business want be as impacted as the software, just wanted to get some details regarding the maintenance revenue, is there any reason to think that they would come down. What are you seeing in terms of renewal rates there? And then also whether – are customers asking for any sort of pricing reductions or the like?

Bill Weyand

Sure, this is Bill. I will be happy to comment on maintenance. As you well know, technology is incredibly sticky and our solutions are required in order to simulate and test products. That is number one. Number two is that we do have a number of large customers that have our technologies to the core, and whether –- they are usually fairly straightforward renew. We also have 10,000 customers. So, we have a lot of small renewals as well. We are not anticipating that this market is going to be negatively affected, although it probably won't grow at a rate that it did in 2008.

Sam Auriemma

We got a couple of moving parts in that. You know, in 2007 – in 2008 we had a number of one-time catch up renewals, and that is somewhere in the high $4 million number. You know, whether that – that is really not part of the stream. Those are sort of catch up from prior years. We also had a pretty good tailwind from currency in that business, particularly in Europe and Asia that helped our results. So, again this is the first time we have given any real look at our business, and we recognize there is plenty of volatility and risk in the numbers that we have given, but most of that number, as Bill has indicated, is going to be concentrated in the software part of our business, and services, professional services, which is somewhat tied to that as well.

Kevin Liu – B. Riley & Co.

Okay, thanks a lot.

Operator

Your next question comes from the line of Mark Schappel.

Mark Schappel – Benchmark

Hi, good evening.

Bill Weyand

Hi, Mark.

Mark Schappel – Benchmark

Hi, Sam. I will start off with you. I just want to make sure I heard you right on the guidance, are you expecting to be down 15% from ‘08 levels for Q1 and 12% for the year. Did I catch that right?

Sam Auriemma

In the early part of Q1 and Q2 is probably down 15%, and there is plus a good size range in that margin, plus or minus several percentage points. You know, Q4 as you look at the seasonality between Q3 and Q4 in our business, normally you see Q3 down, because of the summer months and you see Q4 up for the winter. You saw just a modest increase in Q4 in our 2008 results. So, we were impacted again in Q4 already by a downturn, particularly again in Europe. If you take a look at the numbers we gave on that piece. So, early on in the year, the year-over-year comparison is about 15%, we weren’t impacted by it. By overall for the year 12% and that is plus or minus, pretty wide range Mark of percentage points for the year.

Mark Schappel – Benchmark

Okay, thank you. And Bill, I was wondering just moving on to, I was wondering if you could provide some additional commentary on the slowdown you are experiencing in Europe, especially with respect to maybe some of the various countries and industries that you play in?

Bill Weyand

Sure, I will happy to. Well, Sam covered a little bit on Q4, but obviously the currency situation has changed, and that as one impact on us. And secondly, it has to do with the timing of orders, and thirdly, the size of orders. And this is not new news to you, because it is affecting a lot of companies in our space. Having said that, the EADS announcement, and the EADS new partnership agreement was signed in December of ’08, and we should begin to see orders as a result of it throughout ‘09 and ’10, as they go to phased deployment. So that is number one and given the auto industry challenges worldwide with the announcement again about Jaguar Land Rover. That order will be ‘09 revenue as well. So, we're seeing that if we get to the right level of executives, that a decision for MSC as a strategic backbone becomes a strategic decision to help them greatly accelerate product innovation and reduce cost and time to market.

The parts of the marketplace that you would expect that we and others are probably feeling some of the slowdown is also at the low end of the market where someone buys to see the [ph] software, and that is the process, when someone puts a budget freeze on that process stops. If you again become strategic and in the European auto industry, they are actually poised to invest in a number of strategic projects that if it is funded in the end that we would benefit from those. But it is clearly uncertainty in terms of how long budgets are frozen, and what gets approved when. Our pipeline is very encouraging and our base of customers that have done pilots and proof of concepts are very wide. So, it is now moving to an IT structure for them as their backbone and they are getting funding approval as a strategic project.

Mark Schappel – Benchmark

Okay, and then finally on the automotive front, you appear to be having some good success with the foreign nameplates.

Bill Weyand

Yes.

Mark Schappel – Benchmark

Maybe you could just give us little insight as to what you are seeing with some of the domestic manufacturers, obviously, the front-page stories are not that encouraging.

Bill Weyand

Well, yes, it is off. It is very clear that Detroit has some huge problems, and it is very clear that the uncertainty of two of the three is very high. Probably, the only one that today is viewed as so far in moving through the cycle is Ford, and they have not requested any funding and stay the course. But you can assume that they are cutting every dollar of expenses they can in every category, and the good news for MSC is that we haven't relied upon Detroit automakers to be part of our automotive revenue, and have worked very closely with the European and Asia-Pacific automotive companies.

Should things turn, then I think that we're in a reasonable position to benefit from Detroit's emphasis on better vehicles faster.

Mark Schappel – Benchmark

Thank you.

Bill Weyand

You are welcome.

Operator

And at this time there are no further questions.

Bill Weyand

This is Bill. Let me just summarize. I know it has been a busy reporting day for everyone. I just want to summarize and say that MSC continues to be a very solid company with a strong marketplace position and no debt and a strong cash position. Our strategy for evolving from tools to enterprise simulation is starting to drive our customers’ movement from pilots to phased deployments. We have given guidance for the first time in two years, and it is at this time that our best estimate for what the business environment looks like for 2009. These are estimates and these estimates may change as the market unfolds, and we will continue to keep you all informed. Thank you.

Operator

Ladies and gentlemen, this does conclude today's conference call. At this time you may disconnect.

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