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ANSYS, Inc. (NASDAQ:ANSS)

UBS Global Technology and Services Conference Call

November 16, 2011 10:00 ET

Executives

James Cashman – Chief Executive Officer

Unidentified Analyst

Great, thanks for coming. Our next presenter is ANSYS. This is the one company that I regret not following formally for the last four, five years covering number of the other names in the space, but we don’t have formal coverage, but we are really excited to have with us James Cashman, CEO. He has been the CEO since February of 2000 and present since April of 1999. Jim is going to provide a brief introduction and then we will have plenty of time for your questions and we really appreciate you being here.

James Cashman – Chief Executive Officer

Well, thank you and thanks to UBS for this invitation. I am wondering if this is – first I will start with the obligatory Miranda Rights and basically forward-looking statements, basically, one thing is we are extremely enthused, I’d say not only about the last 5 to 10 years have been quite good, but we are probably even more excited about the upcoming 10 and foreseeable ones, and because of that we will come across as being pretty enthusiastic about this by engineering standards, but again, there are a lot of factors that of course in this world affected and we got a very comprehensive list of things that are in our 10-K, 10-Q, our recent filings and all of those are available on our Investor website and I would like you to take a look at that at some time.

But the key and what’s been at the heart of something for not only the last 5 to 10 years, but actually for 40 years is basically what is ANSYS do and we focus exclusively on a field of engineering and it’s related to engineering simulation. And over the course of this, we have actually achieved a position as the leading software provider of this with most of our customer base, which is now close to 40,000 logoed companies trusting us to do stimulation now. In particular, what this says is some of you might be familiar with related fields such CAD/CAM and computer-aided design and PLM.

Really, what we focus on is actually being able to make a model of customer’s product, complete product subsystem or whatever and actually put that in the computer doing it early on in the design cycle, where we actually can allow people to put it to its virtual paces, actually seeing how we’ll predict in the real world, how we’ll perform, go through a number of different things, what if the loading environment is 10 times worse than we thought. We actually see on the screen, a nuclear power facility and in that particular case one that recently happened in Japan actually it was subjected to an earthquake, I think roughly a 100 times greater than the design that was characterized toward. But really by being able to subject complicated deigns early on it allows us, if you will to get all the failures out of the way and do it in the virtual world.

Really the key is again focusing on that were going to allow customers probably a couple of key things is this technology the equations are been around for 100s of years, in some cases the software is been around for 40 years, although its gone through its many generations as you might expect, very similar to the computers have gone through many generations, but the software has also gone through generation. The key thing is for this technology to work it had to be able to predict with confidence, so in another words the quality of solution was really the key aspect. And as the increases in computing power allowed us to continue to drive the quality of the software, we were able to get to a very predictive aspect.

Many years ago this was good for indicating where potential problems might be, now it’s started to evolving to being able to predict what would happen in the real world. So, that’s really the key, and the driving aspect of this is now being able to allow companies to do predictive studies that allow them to innovate new products not just refine something that they have already been aware of in the real world. And what that does is that opens up new avenues, it opens software automotive companies we’re comfortable with internal combustion design when they need to work toward new generations of cars that hit CAFE standards of 45 miles per gallon.

When it gets to hyper drive type of vehicles, when it’s using composite materials instead of or even nano or biological materials, when it’s utilizing things where it doesn’t have a lot of experience we can utilize the computer to allow them to predict. And in reality being able to change with one parameter what might be the impact of using a different kind of material where in the real world, you might have to spend many weeks or months building an actual prototype that would test, so, going through those cycles is key. The key aspects of this and I’d like to go into what our strategy is, what the pressures are to create that market for the next few years and then go through some of the financial performance.

You get a little bit of peek at us and I’ll go through this in fairly whirlwind fashion because there’s a lot of detail here. But I think the key thing is first of all focus. This is one thing that we’ve been focused on for every year of our plus 40 years of existence. Why is that key well, because of the number of breakthroughs that we’ve had to do make this technology really be utilized on a broad base across all industries basis. To be able to push through and to create the innovation we needed in our own software. You can’t do that on a part-time basis, I would contend. What that has allowed us to do is get the broadest range of physics and I will talk about why that’s important in a second, but it’s also most importantly allowed us to amass what I obviously feel is the strongest team and I think many people would concur with that.

In terms of the development team has actually focused on the engineering physics and simulation. What we are up to now is about almost 2,200 people, 60 locations, and 40 countries. But I think the one key aspect is if you think of what the computer, what the personal computer looked like in the 70s, what it looked like in the 80s, what it looked like in the 90s and what it looks like now with mobile computing, think metaphorically of how this, how our technology has also progressed through those numerous stages. And I think one of the key things is, if you went back to the literature you find that to every year of our 40 year existence, we were driving force a leader and always considered in the top one or two at every point through that things. So, we were able to maintain viability, not just at one point of time over sustained basis and it’s because of that team.

As a result, I mentioned almost 40,000 logoed customers, but I think one of the key thing is that virtually if you can think of anybody that makes a physical product, we’re probably that quiet company in the background that maybe played some role in helping them do that and in that degree there are 96 of the top Fortune 100 industrial companies that actually rely on ANSYS to drive their next generation of product simulations. Through that obviously we build up those relationships over decades. It’s one of the reasons why we have a model that has a recurring revenue base typically around 70% level. Why our fastest growing customers are the customers who have utilized this the longest, so actually continuing to accelerate that usage.

But also the fact they trusted because of a commitment to quality, so not only leading in technology, but we were the first company, in our space, to achieve ISO 9000 certification many years ago, first to achieve an even more stringent nuclear qualification. So the key is if customers are going to utilize this on a virtual environment, they had to be able to do it with the same kind of pace that they traditionally had put in being able to test a physical product.

I think one thing if you look at a number of aspects, it was basically recognized and this is in literature such as FORTUNE, Businessweek, and a number of things, basically recognized for some of the things that we’ve done to bring innovation. And I think the other that’s been very key to us is being able to be a vibrant strong independent company as bullish as we are in the technology. We probably are on the conservative side when it comes to the way we run the business. But that’s actually served us through a number of up and down economy.

So basically understanding that long-term financial stability is key for us to continue the reinvestment that we do in R&D and we typically over the years have reinvested 15% to 20% of every dollar that we take in back in R&D because we need that to push the next hurdles through there.

Not surprisingly that this also creates them the opportunity for a very diverse business. The diversity helped us in a number of ways. First of all when the economy goes in a number of different ways, sometimes it cycles through, sometimes it gets the hole below, but more often than not maybe you see pockets currently have concern in Europe, but basically if you look at it basically one-third of our business is in the Americas, one-third in Europe and one-third in Asia-Pacific and as I achieve that balance for more than 10 years we’ve been more than 50% offshore.

Perhaps more importantly is that diversity also plays itself out into industry because of the generic nature of our software can be applied any product, any industry, and we’ve got the broadest range of integrated solutions we’re basically in virtually every industry but no one industry accounts for more than 20% of our business. So, it tends to help us buffer through there. And as we’ve gone through over the last few years, every one of these sectors well there may be current hot sectors at any given year everyone of these has continued to grow.

So, it continues a huge base and then the other thing we found is sometimes that the industries that didn’t even exist years ago like the nano or even some of the energy type of systems actually when companies are ready for moving into that, our software is really all ready to take care of that. And so not surprisingly I would probably suggest that almost any company that you can think of naming would be on the list of ANSYS customers.

So, why did we get to this particular standpoint, that as well a business strategy basically this is in some ways its matured, its evolved a lot, but this is really the core essence of the strategy that we embarked upon over 10 years ago and one of the key aspect of this is that at that time people are saying that the market was saturated with a no growth market everybody who could use it is already using it, well that was true based on assumptions of that day, the computers were too anemic, which meant that it was, it took a high degree of expertise to actually run it, but think in terms of how many people took home PCs and portable computing for granted years ago versus what we do now.

And that’s same thing followed through to us. And what we were thinking was it was only starting to get interesting. So, if you look at it, we really started in this lower left hand bubble, which was advanced technology. The geekiest of engineering equations that only really the proverbial rocket scientist could actually use, but what we realized was that we felt that the need for people to be able to predict performances for early on, get that design right, get the market quicker and I’ll talk about the market pressures that existed then and I would contend exist even in greater term right now.

But if you look at it, traditionally this market was very fragmented. We wanted to bring together all of the top quality physics and this is type of things that typically a product can go through and structural mechanics basically how long will it last would break. With fluid dynamics, they could be everything from internal combustion efficiency in an engine to aero efficiency in an aircraft engine or a car and every one of these have things that you will see in everyday standpoint.

But if we could bring all of those together and then actually allow for the first time with the increases in computing capability people to look at complete systems, actually not just put arcane kind of mathematical loads on a mathematical model, but take a complete system actually simulate the environment that was going through, actually simulate, putting it through an environment a 100 times harsher than its designed, though just to see where those potential failure points might be and combine all the cumulative effects that hit a real product in the real world and do that in computer. How could that transform the way engineering was done at a time where engineering content and innovation was even more the issue?

As we built that then, how do we get beyond that level says well only the rocket scientist literally can utilize our software. Why shouldn’t every engineer, equations on the left, were things that any engineer in their normal back or lower end level actually took time learning to do these equations to determine how good the design would be. Well, then why shouldn’t every engineer have access to these? It was only 15, 20 years ago that if you suggested that every engineer would have a PC on their desk with word processing that you’d be laughed out because that was a waste of engineering time. And now we take it for granted. And there will be a time it’s happening now or we are taking it for granted that every engineer should have the ability to quickly have the power of these equations to help evaluate their designs. But, when you have that kind of capability think of the way that can transform the traditional way engineering was done.

So, with that we had to take into account all ways of allowing companies to do more with maybe the same amount of resource, do it in shorter time, inject more innovation in and that’s where being able to change the process, I mean the way we communicate change as a result of everything from FedEx to e-mail. So, being able to change that is only key. And then the other trend we saw was as opposed to engineering typically being done in one place, for instance automotive always being done in Detroit, being able to look at sites where companies were getting truly global, competition was going truly global.

So, how you capture then all of this engineering information and they get utilizable throughout the entire engineering universe and the overall total supply and customer chains that our customers were going through, basically making sure that relevant information was captured and that people would make better decisions more quickly.

And so this is something we continue to move along, the reason why we have the segment like this is each one, as you move to the upper right, has a different level of maturity, but you have to take into account the entire standpoint to bring this overall simulation driven product development to market and so we’ve actually over the course of this thing we’ve actually done a couple of acquisitions. We do this for couple of key reasons, one of which is that all of that innovation we need to do if we can partner with already best in class companies, we can actually acquire the technology, sometime if it exists more quickly than we could every incubate it with our own structure, even though we could do it with time why away.

Secondarily is, we are always looking for top quality proven engineers and it’s a difficult thing to actually be able to build up. If you go in our website today, you would see over 80 spots and we are still trying to hire for it and its difficult. So, most recently we brought a patchy systems into our family of products it’s a smallish company, but it particularly key because what it is, it’s one of the key lynch pens in terms of being able to – this may be a sensory overload slide, but bringing together a broad range of – in product today we increasing complexity where used to be there was a mechanical world and electronic world.

Those worlds are merging together, which only tend to exacerbate the type of problems that we are going to see in term of the complexity of products and with the increased complexity of products and reduced margin for error, there is increased potential problems that can come out, but what this represents was being able to merge the electronics in with mechanical side being able to take into account everything from mobility and high performance computing to power management, I mean we all take for granted for some degree the mobility that’s in electronics today, but also you can see if they get more powerful, not only do you worry about them over heating and functioning correctly, but battery life, power conservation is a very key aspect.

You also see embedded in this is that not only something like a complete system like an offshore oil platform, which we would stimulate, but being able to go down to the chip and even the nano level. So, the scale of simulation is also particular key, but you can see in the delivery of this – of a product just complicated all of the different factors, all of which have to work. It does not make a difference if the electronic circuitry is artfully designed, if it overheats, if it breaks the first time it’s dropped, if it doesn’t deliver the right signal at the right time. So, being able to balance all of these together, just one example of how we are continuing to round out that ability to do complete systems.

With that then, we are also, as I mentioned, since we are putting so much into R&D each time, actually in the next month, before the end of the year, we’ll actually be releasing version 14 of our software. And it’s again I probably offer you given the brevity of time here is to just visit ansys.com, the website, these are some major themes in here, they are related to – turbo machinery is related to a new generation of aircraft engine and power generation, where energy utilization and optimization 15% improvements in fuel efficiency of turbine engines, things like that are particularly key, but the advances that we see and materials going on all the time, everything from efficiency. But if you look in detail, it will be 250 to 300 major kind of functional increases in there. So, if that is something that you are interested in digging in from an engineering standpoint, there is plenty of information.

But why do we think that this is really probably we thought it was only starting to get exciting at the end of the 90s, but now we are starting to think that, it’s really only getting more – and at this point, this again the same chart that we put on there. Energy was becoming an issue. We are seeing that even back then, but time to market, how quickly products became obsolete in terms of the product lifecycle, kind of a dearth of engineer, there were lot of MBA grads and a lot of law grads and people like that coming up, but what was coming up for the typical engineers that will actually create these new generation of products that we tend to love.

And at the same time, global competition was on the rampant increase. Everybody was getting increasingly cost constrained and worried about that, but lawsuits and warranties were in the papers all the time. Even over the last couple of years, we have seen problems with those warranties, increased government regulation, increased CAFE standards and in fuel efficiency, customer expectations, all of these things were on the dramatic increase and really I haven’t seen an abating of those over the year. But when you combine all those together, those margin for errors that engineers used to rely on were being shrunk and a wrong decision could really cause an overall major problem.

The same standpoint was increased uncertainty and increased product complexity. And really just a summary slide, while we are talking about this, it’s now become pretty much over the last 10 years in common industry, but you will see that major thing that customers are saying, these are independent to us are really along these lines and this is what they are seeing today. So, this is just a saying that this trend overall is going to be increasingly complex.

You hear this whole thing about smart products, it’s no longer a typical fan or a typical automobile, now its hybrid systems if the amount of electronics that are in the car. Systems are becoming increasingly connected, interconnected, mechanical, electronic convergence, systems that need to adapt to the environment in real-world operating conditions, adapt to different user characteristics, and the thing is many times this is being done with totally new systems, where somebody doesn’t have 30 years of engineering experience in a field, but they have to get to that same level of knowledge, so they can design that in.

Well, with the predictable simulation being able to do a lot of what if studies even come up that learning curve, very quickly. Trend that – one of the trends that’s very much in flavor right now is the major mobility trends that really drive toward the need for stimulation. So, basically everything from functionality, longer battery life, you look at what’s happening with bandwidth and streaming data this time, balancing all that together while people are expecting new capabilities and companies are trying to tout their competitive advantage create a real drive for innovation. And when you have to get these cycling out every six to nine months, you really don’t have time for the traditional kind of prototype cycles that used to be there.

So, just closing up on financial highlights, a little snapshot of what we are also what we are projecting for the short-term. If you look at it, we have a very robust business model, that’s one of the things served us over the years. We actually have a very strong indirect channel, it works symbiotically with us, but it’s roughly three-quarter – one-quarter, we found that as we start to get more embedded in major accounts, that they want to have direct relationships with us.

In terms of revenue stream, we actually for 12 years have had software as a services, it’s a very small sliver and I could go into great detail of why that is an emerging trend, but it’s a ways off, but we will provide paid-up licenses, we will pay due lease and we also have a subscription enhancement services. The reason why I point out those and the reason that it shows up here is that this is what refers to that 70% recurring revenue that I mentioned a little bit earlier, so that part is always what we’re building off of while continuing to build license growth. It allows a greater predictability of our revenue and it’s a testament to the growing customer base we have.

Highlight of the Q3 results, actually our non-GAAP revenue growth was 27%, there was a little impact from a couple of months of that Apache acquisition but the organic growth rate was 20%, non-GAAP income very strong margin structure, quite strong, basically operating – gross operating margins in that 80 – high 80s but the operating margins because of the revenue over performance actually peaked above 50%, but our cash flows are very strong, everything that you would expect on their very key.

Series of growth drivers that you see here and also the highlight of our fourth quarter outlook, which we also raised as a result of our Q3 earnings call, but all detailed and broken out there so, we try to be very transparent on the organic statement of what the currencies will be, but as you can see many, many particular growth drivers and as we see a number of published financial goals, so we’ve been able to stay with those very quickly.

So, in wrapping up the key thing was building a company that would lead in technology, continue to push through, but could perform in a broad range of economies, even in 2009 we grew revenues and earnings. So, with that…

Question-and-Answer Session

Unidentified Analyst

Just one quick question before the breakout, just in terms of the macro a number of the design simulation stories have been holding up very well, that’s a good numbers last night obviously not as – your growth has been phenomenal and the margin structure has been great, but what has really been in your opinion the offset to kind of that headwind of what’s going on in the macro and what the results that the industry has been putting up?

James Cashman

Well, the key thing is that in general everybody is looking for innovation. Companies are looking for ways to excel and gain market share. It used to be maybe that people would think as long as I am one of top four I’ll be in good shape. Now, there may only be room for three or four survivors, so some people are not saying how do – I stay in that top comp, but how do I actually survive. And even though you can get a certain point by doing cost cutting and streamlining businesses, long-term if you don’t have a stream of products that are capturing that it’s very difficult to survive in this world particularly with all the changes that are being enforced on people.

So, the fact is they is still, even while GDP is may be down, even sometimes IT spending may be down, companies usually are very slow to stop the spending of R&D, which is really going to be representative of those in next generation of products that help cement our market performance.

Unidentified Analyst

Great, thank you Jim. And, we all will move to the breakout.

James Cashman – Chief Executive Officer

Thank you.

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