Exa's (EXA) CEO Steve Remondi on Q3 2017 Results - Earnings Call Transcript

| About: Exa Corporation (EXA)

Exa Corporation (NASDAQ:EXA)

Q3 2017 Earnings Conference Call

November 30, 2016, 05:00 PM ET

Executives

Rick Gilbody - CFO

Steve Remondi - President & CEO

Analysts

Jim Ricchiuti - Needham

Jason Velkavrh - Robert W. Baird

Operator

Good day, ladies and gentlemen, and welcome to the Exa Third Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mr. Rick Gilbody, Chief Financial Officer. Sir, you may begin.

Rick Gilbody

Thank you, operator. And good afternoon, and welcome to Exa's earnings conference call for the third quarter of fiscal 2017, which ended on October 31st. My name is Rick Gilbody, Exa's Chief Financial Officer. And with me on the call is Steve Remondi, Exa's President and Chief Executive Officer.

A more complete disclosure of our results can be found in our press release issued earlier today, as well as in our related Form 8-K filed with the SEC. To view the press release and the financial details, please see the investor relations section of our website at investor.exa.com. As a reminder, today's call is being recorded, and a replay will be available following the conclusion of the call.

During this call, we will make statements related to our business that may be considered forward looking under federal securities laws. These statements reflect our views only as of today, and should not be considered as representing our views as of any subsequent date. We disclaim any obligation to update forward looking statements or outlook.

These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations. For a further discussion of the material risks and other important factors that could affect our actual results, please refer to those contained in our Form 10-K for the year ended January 31, 2016, and our most recent Form 10-Q, which are on file with the SEC.

Also, during the course of today's call, we will refer to certain non-GAAP financial measures. There is a reconciliation schedule showing GAAP versus non-GAAP results currently available in our press release.

With that, let me turn the call over to Steve for his prepared remarks, and then I will provide details regarding our third quarter results, and our outlook for the fourth quarter and fiscal 2017.

Steve Remondi

Thanks, Rick, and thanks to those of you joining our call today. We delivered a solid third quarter with revenue at the mid point of our guidance range and adjusted EBITDA that exceeded the upper end of our guidance. Achieving revenue within our guidance range for 16 quarters in a row reflects our high renewal rates and a predictability of our license revenue. At the same time, our strong profitability reflects progress toward our target of delivering year-over-year EBITDA margin improvements.

Total revenue in the third quarter was $19.2 million and represents a growth of 13% from a year ago. License revenue was $16 million, growing a solid 14% over last year or 11% at constant currency. Project revenue was $3.2 million with growth of 6% as increased adoption of ExaCLOUD shifts our revenue mix to more recurring license revenue. Adjusted EBITDA for the quarter increased 46% from a year ago to $2.2 million, reflecting the leverage inherent in our model. We were able to achieve this better than expected profitability while still investing in growth initiatives that will benefit us in the years ahead.

With the consistent execution, we remain confident in our revenue and adjusted EBITDA outlook after adjusting for FX.

Let's look at the quarter's activity in a little bit more detail. Following multi-quarter trends, revenue for the automotive market continues to be strong and it continues to be led by a very strong growth in Asia. Our outlook for this end market continues to be healthy as new entrants and regulatory requirements continue to push the industry to bring more efficient, higher quality vehicles to an increasingly competitive market. Given how durable the passenger car market has been, it's important to point out that we are more closely tied to committed design and launch schedules for new vehicles than we are to manufacturer's end market sales.

In contrast, the heavy vehicle market remains stubbornly challenged as major industrial markets such as mining, large construction, and agriculture equipment continued to see declining revenue. That said, we posted solid growth in Europe due to heavy activity in the rail transportation segment as we continued to search for pockets of opportunity in the heavy vehicle market.

Finally, we are seeing continued traction in our effort in penetrating the aerospace market. Customers continue to use PowerFLOW to predict air acoustic noise generated by the airframe and landing gear. As part of our strategic plan, we are now engaging new customers in the jet engine segment as well. This is particularly interesting for engineers who are looking to optimize the thermal effects in noise generation of new jet engine designs. We believe that within the aerospace markets, industries applications of our technology to additional use cases, we will see further penetration into this market. We look forward to providing more color to this vertical at our Investor Day in December.

From a product perspective, we continue to focus on improving our customer experience and further automating the digital simulation workflow. This week, we released PowerDelta 2.5, which significantly streamlines and automates the simulation model build process. This release reduces the time to first simulation thus increasing the number of designs customers can evaluate in the same timeframe. The more automated creation of PowerFLOW ready measures from native CAD input makes the geometry preparation faster than ever before. We expect that customers will be able to perform more functions within PowerDELTA rather than resorting to third party products.

Similarly, in September, we launched a new release of our post simulation analysis tool PowerINSIGHT. PowerINSIGHT 2.2 streamlines and automates simulation analysis, results generation, and reporting process enabling engineers to arrive at design decisions faster. The new release includes automated realistic render line capabilities and allows users to visualize and better understand the complex relationship between design and performance. With its more streamline process, PowerINSIGHT enables design and engineering teams to explore a wider variety of design concepts while hitting performance objectives.

On a final note, we made good progress on our strategic partnership with Denso Corporation. While it's still early, we are already seeing this partnership gain traction as we jointly engage existing customers in our market, expanding the opportunity for PowerFLOW.

In summary, to meet our objectives of delivering solid revenue growth while improving adjusted EBITDA margins, we remain focused on making our technology easier to adopt as reflected by the success of our ExaCLOUD initiative, PowerDELTA, and PowerINSIGHT. We remain committed to prudently investing based on the pipeline in front of us. We remain confident that we can further advance our strong position in the market, and in fact we are stepping up sales hiring in key geographies to meet anticipated demand as we enter into FY18.

Now let me turn the call over to Rick to provide more color on our third quarter performance as well as our guidance for the fourth quarter and FY17.

Rick Gilbody

Thanks, Steve. Revenue in the third quarter was in the middle of our guidance range at $19.2 million, and represented growth of 13% from a year ago or 10% on a constant currency basis. Recurring license revenue was $16 million, up 14% from a year ago, with particularly strong growth in the Asian auto market. Project revenue was $3.2 million, an increase of 6% over a year ago driven by stronger demand across all sectors in Europe.

From a geographic perspective, 41% of our third quarter revenue was from Europe, with 25% from the Americas and 34% from Asia, which is up from 29% a year ago. We will discuss our profitability measures on both a GAAP and non-GAAP basis, and have provided a reconciliation of GAAP to non-GAAP measures in our earnings press release, with the only reconciling items being stock based compensation expenses and amortization of acquired intangibles.

GAAP gross margin for Q3 was 74.4%, up from 69.8% a year ago. On a year-to-date basis, gross margin was 73.1%, up from 69.2% a year ago, as we continue to leverage a favorable license to project revenue mix. Total GAAP operating expenses were $18.4 million in the third quarter, an increase of 8% from a year ago. As a result, our GAAP net income in the third quarter was above the high end of our guidance range at $0.2 million or $0.01 per share as we continued to deliver a leverage in our operating model.

This represents a meaningful improvement from a loss of $0.4 million or $0.03 a share a year ago. GAAP expenses included $0.5 million in stock based compensation and $0.1 million in amortization of intangible assets. Excluding these non cash items, non-GAAP net income in the third quarter was also above guidance, at $0.6 million or $0.04 per share, compared to $0.1 million or $0.0 per share in the same period a year ago.

For the third quarter, adjusted EBITDA was $2.2 million, a significant improvement from $1.5 million in the third quarter of fiscal 2016, this was above the high end of our guidance range and represented an adjusted EBITDA margin of 11.7%, up from 9% a year ago and the first time we've reported double digit adjusted EBITDA margin in two years. For the first two quarters of the year, adjusted EBITDA margin was 7.1%, an improvement of 3.8 percentage points from the same period last year. As we continue to drive leverage in our business model, the seasonality of our margins has changed somewhat from prior periods. Some of the margin delivered in Q3 is attributable to the timing of expenses, some of it which we expect to incur in the fourth quarter.

Turning to our balance sheet, we ended the quarter with $25 million in cash and cash equivalents, a decrease of $8.2 million from $33.2 million at the end of the second quarter, reflecting normal cash flow seasonality. Total deferred revenue was $24.1 million, and was up a strong 52% from a year ago, reflecting strong renewal rates and order activity in the quarter.

Now turning to our outlook, we continue to be confident about fiscal 2017, and anticipate continued revenue shift that favors highly visible recurring license revenue and margin leverage. We believe our core business drivers continue to be strong; we are also monitoring market reactions to the new US administration's priorities and the recent strength in the US dollar. Taking these factors into account we are providing full year FY17 revenue guidance essentially in line with prior expectation after adjusting for material FX changes in Q4. We are increasing the mid point of our full year adjusted EBITDA guidance to reflect our strong third quarter performance and continued leverage in our business model.

During the fourth quarter, we are accelerating our hiring by targeting field resources for key geographies where we are seeing growing sustain demand. Our fourth quarter and full year guidance assumes exchange rate of $1.06 per €1 and ¥110 to the $1. With that backdrop to the fourth quarter, we anticipate revenue in the range of $19.3 million to $20.9 million. We expect adjusted EBITDA to be in the range of $1.5 million to $2.6 million, and we anticipate non-GAAP net income to range from a loss of $0.8 million, to income of $0.3 million. We estimate basic share count of 14.9 million shares, and fully diluted share count of approximately 15.3 million shares for the fourth quarter.

For the full year of fiscal 2017, we anticipate revenue in the range of $72.4 million to $74 million. This represents growth of between 11% and 13%. We anticipate adjusted EBITDA to be in the range of $5.2 million to $6.3 million, representing an increase at the mid point and an adjusted EBITDA margin of approximately 7% to 9%. And we now anticipate non-GAAP net loss to range from between $1.2 million to $0.1 million. We estimate basic share count of 14.8 million shares, and fully diluted share count of approximately 15.1 million shares for the year.

In summary, with consistent mid teen license growth and improving adjusted EBITDA, we are confident in our ability to deliver a strong performance in Q4 and for the full year FY17. We will continue to focus on balancing our key objectives of strengthening our position in the market with continued investments and scale while realizing the leverage inherent in operating model.

Operator, we are now ready to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question comes from Jim Ricchiuti with Needham and Company. Your line is now open.

Jim Ricchiuti

Hi. Thanks. Good afternoon. I wondered if you could just focus a little bit more on this step up in headcount that you are anticipating. Business has been strong in Asia, is that where some of this headcount additions going to be taking place?

Steve Remondi

Yes. Absolutely. Yes, so we are shifting to that region. We see a quite strong growth that's driven mainly well both by Japan and China.

Jim Ricchiuti

Okay. Steve, is there any way you can give a sense as to maybe what kind of headcount you have now and where you see that going and maybe the timeframe, how easy or difficult is it to bring on folks in this part of the world?

Steve Remondi

Well, so I don't think we’ve disclosed the total headcounts by actual individual countries but we have 30 or so sales executives in the world, so you are still talking not massive numbers of people here, right. So it’s still talking about single individuals in various regions and extended territories. It's never easy to find good sales executives and people in the process, so that's why we are sort of really releasing that earlier. And the process to get a head start is always a challenge but with good execution and with good searching we'll find them and get them onboard. We've always been able to find the people we need and get them onboard in a timely basis. We have people in country now I mean we have people in country in China now for last four years where we've been operating directly there. So we've a base presence everywhere, and I think that network will help us do the right recruiting.

Jim Ricchiuti

Is the growth you are seeing in Asia, is it equally strong in Japan and China or are you seeing more strength in one particular country? I heard about Korea, are you seeing any activity there?

Steve Remondi

Yes. So Korea remains very healthy but it's a smaller market opportunity in and of itself, especially in ground transportation dominated by a very strong business relation with Hyundai and KIA, but in particular we have been -- I'd say the Japanese OEMs have been may be not as deeply deployed as some of our other customers. So there is some stronger opportunity to catch them up as they continue to deploy, so they are sort of in the phase. We kind of go through phases on a roll, it is interesting how sort of deployment sort of ebbs and flows in various regions. So that's one big driver for us in Japan and then in China the team just continues to execute strongly and there is a bit of shift in marketplace. There is a lot more engineering work going on in local market in China, just to give a number. I mean the Chinese end market sales for cars is around 25 million units a year compared to like 16-17 million here in North America. So very strong market, lot of local designs going on now that's been a big expansion in the last few years. So just manufacturing they are really doing and scaling up much of the engineering work. We are seeing lots of people we know from our Japan and Europe and US customer base, former employees actually now at work in China. So there is more bringing that knowledge into the market. So we are just seeing a stronger demand in the market that's very much ready to really step up to world class engineering.

Jim Ricchiuti

Okay. One last question and I'll jump back in the queue. Normally you see a sequential bump up seasonally in project revenue. How much of an impact does the growth in what are you seeing in the cloud impact the normal patterns that we've seen in years past?

Steve Remondi

Yes. So we are shifting somewhat. I think the part of that is we are certainly shifting also resource allocations to focus more on the license deployment side. We are trying to win customers off our projects sooner and on to the cloud sooner. And we are also not expanding the cost of goods line as much to support our strong growth or much higher growth in project revenue. So all of that consistently is part of what we are trying to achieve is we try to now demonstrate improving margins in the business. Do you want to add anything to that Rick or --

Operator

Thank you. [Operator Instructions] And our next question comes from Steve Ashley with Robert W. Baird. Your line is now open.

Jason Velkavrh

Hi. This is actually Jason Velkavrh on for Steve. Thanks for taking my questions. The first one I have is just on the full year guidance I think you mentioned that it was -- the reduction was just almost entirely due to FX, I just want to confirm is that right?

Rick Gilbody

Yes. The majority of it is FX.

Jason Velkavrh

Got it. Okay, that's helpful. And then I just wanted to dive into the Denso partnership a little more and you mentioned in the prepared remarks but just curious if you can give a little more color, are they starting to demonstrate cost savings to any of their OEM clients and just kind of any more color on that partnership would be really helpful.

Steve Remondi

Yes. Sure. I think and actually I think we'll actually cover quite a bit more of this in our Investor Day. So I think that's going to be a nice segway but certainly we are doing joint activity, joint selling, joint engagement with customers to start them engaging in the process of how that design process should be as they design in, as the OEMs design in or attempt to design in Denso sub systems. So that’s just raising awareness to different people, different parts of the organization that we are already in, but it's -- these are very big organization and so there is always new people, new organization, new parts of the organization to meet, we need to be aware of what the potential is. We'll definitely talk a lot more and it's actually -- there will be some comments via video tape from our core champion, our executive champion at Denso that will be relayed to at Investor Day.

Jason Velkavrh

Okay. Great. I looking forward to the Investor Day. And just one last one for me. Just in terms of percentage of customers or percentage of your installed base hitting their CPU usage selling, just anything would you call there trend over the past few years, has that been -- is that sort of the same as it was this time last year.

Steve Remondi

Yes. We see similar patterns I like. It's always a few -- I mean everybody tries to plan right so that's what they just saying every year. They try to make their best estimate and plans of what they need for capacity. They prefer to buy once and then execute upon that plan. So each year it tends to be somebody different. It tends to rotate around. So, yes, again this year we have customers who have run out of capacity, had to actually top up orders or pull their renewal earlier than they have in the past to keep capacity ability going.

Operator

Thank you. I am showing no further questions at this time. I'd like to turn the conference back over to Steve Remondi, Chief Executive Officer for closing remarks.

Steve Remondi

Okay. Well, thanks everyone for joining us on our call today. With consistent revenue growth and upside to adjusted EBITDA during Q3, we remain confident in our outlook for FY17. Our business momentum can be largely attributed to our strategic investments and expanding our reach, enhancing our technology and making our solutions easier to adopt. We believe these factors will help us drive continued, consistent revenue growth and improving profitability while further expanding our leadership position in the marketplace. We look forward to speaking with you at our Investor Day on December 14 here in Burlington, Mass. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. And you may now disconnect. Everyone have a great day.

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