ANSYS Inc (ANSS) 2006 Q2 法說會逐字稿

Good morning, and welcome to the Ansys second quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] I would like introduce your speaker for this morning's call, Mr. James Cashman, President and Chief Executive Officer. Mr. Cashman, please go ahead.

Thank you. Good morning and welcome to the Ansys Q2 fiscal year 2006 call. And with me on this call, as usual, is Maria Shields, our CFO. I'll outline the highlights of the quarter and some overall summary comments and then go into greater depth on the operational results. There are basically two major themes for this Q2. The first is sustained continuation of the continuation of the excellent performance of the core Ansys business. And the second is around the closing of the Fluent acquisition and an effective start to integration that yielded accretion on a non-GAAP basis above that of our own earlier projections. Maria will then take you a through update of our line item expense performance, balance sheet, cash and an update on our current outlook on earnings. And then we'll be happy to respond to any questions you may have. So to begin with, Maria, our Safe Harbor statement please.

Thanks again, everybody and good morning. Before we begin, I'd like to remind everyone that Ansys' second quarter financial results include two months of Fluent revenue and operations following the successful close of the acquisition on May 1, 2006. The second quarter results also include a one-time $28.1 million in-process R&D charge directly related to the Fluent transaction and $1 million or approximately $0.03 diluted EPS related to the Company's adoption of FAS 123-R, accounting for stock-based compensation, in the first quarter of 2006. Also during the course of this conference call, some matters that will be discussed as either part of the prepared remarks or in response to questions may constitute forward-looking statements that involve risks and uncertainties, which could cause actual results to differ materially from those projected.

The Company's reported results should not be considered an indication of future performance and so are potential risks and uncertainties that could impact our business in the future. These are discussed at length in our public filings, including our Forms 10-Q, 10-K, 8-K and our 2005 annual report to stockholders. Any forward-looking statements are based upon the Company's best judgment as of today and we undertake no obligation to you update any such information. Additionally, I'd like to point out that during the course of this call we'll be making reference to non-GAAP revenue, non-GAAP first profit margin non-GAAP operating profit margin, non-GAAP diluted EPS and non-GAAP tax; which are non-GAAP measures within the context of the SEC's Reg G.

To clear up any confusion, I'd like to bring everyone's attention to the fact that as a change from our last quarter disclosure, the non-GAAP results and the non-GAAP outlook that we're going to discuss today do include charges for stock-based compensation. We believe that these non-GAAP financial metrics supplement our GAAP disclosures and are important indicators in measuring the underlying business performance and trends. Non-GAAP results are used by management in our assessment of actual business performance and to plan and forecast future periods. Non-GAAP financial measures be considered in addition to results prepared in accordance with GAAP but should not be considered a substitute for or superior to GAAP results.

A discussion and reconciliation of GAAP financial measures to comparable non-GAAP measures is included in this morning's earnings release and in the Form 8-K. In adherence with Reg FD, Ansys will provide forward-looking quarterly in its financial results press release and in publicly announced financial results conference calls. We will not provide any further guidance or updates on our performance or outlook during the quarter unless we do so in a public forum. Okay. Now with all that, Jim, let's get into the heart of what really happened.

Thank you. Okay. Q2, simply put, was a very solid quarter on a comparative basis for Ansys. Basically geographies, product segments and classifications of business performed very well for the quarter and for the first half. I'll attempt to highlight these on a quantitative basis to the best degree possible, while also highlighting the strong positive impact of the Fluent transaction of which two months are reflected in this quarter's results. Also included in this quarter as is one-time charge of 28.1 million for in-process R&D directly related to the Fluent acquisition.

For the numbers I give, I'll be using non-GAAP numbers in the same fashion as we've been using, geez, the entirety of the current millennium. And we feel that this gives the clearest indication of the business and provides and apples-to-apples comparison with past years and quarters. Some of the differences relate to the purchasing accounting treatment of deferred revenue associated with the Fluent acquisition, which somehow magically vanishes post acquisition even though the customers and the cash both remain. I'd also like to call everyone's attention to the fact that beginning this quarter, as Maria just said, we have included the impact of stock-based compensation in our non-GAAP results.

So with that. From a high-level perspective for the quarter, we reported solid financial performance with non-GAAP revenue at 68.2 million, that's an 81% growth from last year's Q2 of 37.7 million. Non-GAAP diluted earnings-per-share of an increase of 29% with non-GAAP EPS $0.40, up from Q2's comparable of $0.31. And actually, it's not comparable because the $0.40 in the current quarter includes a charge of approximately $0.03 stock-based compensation. So, the growth was actually higher on a non-GAAP basis. Our non-GAAP revenue and EPS performance both exceeded the analysts' range for the quarter based on above projected core performance and encouraging early integration Fluent, which helped to yield accretion above our earlier projections.

Secondly, we had continuation of strong growth in operating margins, cash flows and a continuation of our stable business model even on the blended Company basis. We had acceleration on the customer front that's underscored by new adoptors and expansion of longstanding relationships. And then finally, there were a number of activities that went on during the quarter that we think build a strong foundation for the future. It was also headlined by the Ansys International User Conference, which saw basically saw a 50% increase on all different metrics, most of all attendance. And the largest yet, Fluent CFD Summit Users Meeting. So we'll focus now on the operational highlights. And as previously mentioned, our non-GAAP revenue for the quarter was 68.2 million. This was adjusted to accurately represent the true nature of the ongoing business and as I mentioned is more than an 80% increase over the comparable 37.7 million of Q2 in 2005.

Obviously, the two components of this are two months of Fluent revenue but it also includes an 18% growth in the core Ansys business. Non-GAAP diluted earnings for the quarter grew 29%, up basically up to $0.40, up from $0.31 per share EPS in Q2 2005. And this exceeded the analysts' consensus, which basically marks the 35th consecutive quarter that non-GAAP EPS has met or exceeded consensus. Again, this was due to strong core growth, integration based accretion that was slightly ahead of plan. And again, I want to reiterate that just in this crossover period that the $0.40 actually includes over $1 million in stock-based compensation.

This was not included in last year's comparable, so on an apples-to-apples basis, the EPS would have been around $0.43 or a 39% growth. Our overall non-GAAP operating margins, excluding acquisition related amortization, were 36%. Indicative of solid top line results. Adjusted gross margins continued in line with our business model at a healthy 86% and these are very strong, even considering the blending with Fluent. And finally, we have strong cash flows from operations, which increased over 25 million, which only highlights one of the reasons we focus on non-GAAP results.

For the six months of 2006, we reported total non-GAAP revenue of 114.2 million or a 52% increase over the first half of last year, again with the addition of Fluent driving that. But even without that, there was a 20% core growth for the first half of the year. The software license business was disproportionally strong but the service business also grew well. So, the year-to-date non-GAAP EPS was 80%, also at 29% over the increase of 62. And again, we've got that short-term iteration of the stock-based effects starting in Q2 affecting that. Non-GAAP operating and gross margins were basically 38% for operating margins, 86% gross margins for the first half. And cash flow from operations of over 38 million for the first six months.

I'll now take you through some numbers and go through the normal perspectives we look at; category, business, geography, customer and products. So by category business, overall non-GAAP software license revenue increased 21% core and 106% overall for the quarter. And for the first half, core software license grew 26%. The core lease business grew double digits for both the quarter and the first half and it remains at a strong 21% of our core Q2 revenues. Now, actually including Fluent the lease business grew 35% of our non-GAAP revenue and that only serves to increase our repeatable business base, which we'll talk about in a little bit here. Paid up licenses grew at a core rate of 28% and 46% total for the quarter. For the first half, the paid up revenue grew at a core rate of 35%. Service growth was 15% core for the quarter and 54% total.

In general, there's a balance between both the high-end and desktop products of our work base -- workbench base suite and there were basically noticeable gains from the continuing migration of customers to the Ansys workbench platform. Our indirect and direct businesses both performed. Maintaining a fairly consistent balance in our core business of basically 58% direct and 42% indirect. Now, including Fluent, basically about 70% of our overall business was direct. Business intake has stayed strong, which when combined with the Fluent acquisition, has allowed deferred revenue to rise to an all-time high of over $95 million. Our already strong core repeatable business base was at 63%, while now our total repeatable business base actually rose to 68%.

And as we've repeatedly pointed out, one of the strengths of our business model is the ability to maintain this solid base of recurring or repeatable revenue. We believe that this is a byproduct of our commitment to reinvest a high percentage of our revenue back in R&D. And our additional 20% is still in the high teens on the blended basis. We have a strong balance sheet, strong cash flows that can easily support the amortization of a debt that we took on with the Fluent acquisition. So, pretty solid from that standpoint. Now on geographic perspective, we saw double digit core growth across all major geographies. And of course, it was much higher when the two months of Fluent were included for the quarter.

There continued a progression of a more balanced performance across geographies that we've seen prior quarters. And a very encouraging combination of industry breadth, new customers, existing customer expansion. Now on the geography, for the purpose of the clarity, I'm going to focus on the core growth. Since all the other areas really don't have a comparable but they'll obviously be much higher. But I just want to focus on that because in general, the same trends we talked about earlier are going to prevail even throughout the geography. So on a core basis, North America grew at 22% for the quarter and 34% year-to-date. So again, core growth has continued the positive progress over the past few years, particularly strong with the performance of our major account oriented direct offices. Each of these offices have grown. And in aggregate, the offices have grown well in excess of the Ansys growth rate for both of the quarter and the year-to-date.

Major orders came from longstanding customers such as Delphi, Hewlett Packard, General Atomics, Honeywell, Lockheed Martin, Boeing, [Dresser,] General Motors, Tyco, Caterpillar, Bechtel and the list goes on. Europe continues to perform also, with a 17% core growth for the quarter and 14% for the first half. Now, there was some negative currency impact for the first half, very little in Q2. So in constant currencies, we saw basically 17% for the quarter and the year-to-date both respectively.

All major sectors performed well here with double digit growth. Germany and France continued to perform particularly well in excess of 20% core growth. The largest six figure deals in Europe included names you've heard us talk about in past calls; ALSTOM, Siemens, Phillips, Schneider, Rolls Royce, Saab, VA Hydro. Additionally, we also had some significant orders from fewer expanding relationships such as Vallejo, Airbus, which was a major expansion order of Fluent, which augments other Ansys business, PSA Peugeot, CEO. And we also expanded a major activity with the ITER project, which is a multinational advanced reactor program that Ansys was selected for. Our general international area grew at a core rate of 15% for the quarter, with a minor negative currency impact.

But taking it down a level, our GIA story, frankly, was a two part one. Japan grew at a core rate in the mid-single digits. But the rest of GIA grew at 30%, led particularly by India, China and generally strong activity across other subregions. So, I think we've made good progress in coordinating our distribution. And we particularly look forward to the combined benefits of our Japan distribution business with the established Fluent Japan organization. Key customer engagements were there. They included Mitsubishi, Cummins, Toshiba, Hitachi, NEC, Tata, repeated expansion with the Shanghai Supercomputer Center, [Chengdu] Locomotive, China shipbuilding.

One other interesting example was in Argentina with the EMSA International Organization, which focuses on clean renewable energy production, in particular hydro and wind energy. So this is obviously enhanced and aided by our multiphysics simulation capability, where basically a single percentage point of efficiency translates to millions of dollars in cycle savings. So that's -- obviously the energy industry is something quite on the radar screen these days. With our Fluent business, we saw a series of orders with longtime Ansys customers who are starting to see synergy there, Hitachi, Canon, Toshiba, which I think also illustrates some of the opportunities in Japan as well as in other parts of the region.

As we spoke about for the last couple of calls, we're continuing to industry breadth and increased penetration within our existing customer base and the pipeline of new opportunities is strong. Every day there seems to be something going on in the world that causes jitters but we're seeing continually growing interest. Now, in spite of everyday worries like energy costs, higher labor, healthcare expenditures, currency fluctuations; all of which can influence the timing of customer buying decisions. We are encouraged that our existing and new customer attainment has continued to grow nicely through the first half. And the customer reception to the acquisition has been quite strong. So, on a geographic basis, in summary, double digit core growth in all major geographies. In both reported and constant currency terms. Good industry and major activity. Continuing strong performance in Europe, in particular, Germany and France. Continued momentum in North America and solid GIA virtually with some ability to improve in Japan.

We're encouraged by the addition of the Fluent Business, which is already starting to show some synergy with the core business. And it basically helps us augment some of the areas if you have a desire to grow. So, we'll continue to examine our sales strategies in each of the key geographies, just as we've been talking about for the past couple quarters and years. We plan to continue to align our sales and distributions investments in response to the strength and the sustainability of those improvements or changes in the environment. But above all with attention to -- will be the ongoing integration of our combined field teams to meet the increasing customer interests that we've already started to see.

Now, looking at the product standpoint. From a product revenue, we saw really no significant changes in either the trends or guidance that we've talked about on past calls here. So as mentioned earlier, the core software licenses grew by 21% for -- quarter-to-quarter and that's again for software licenses. Both high ends, high and low, of our spectrums grew in double digits. Ansys workbench, as we saw some of the customer announcements, that I mentioned earlier continued to gain traction and we're already starting to expand its capacity through utilization of some of the new Fluent capabilities. ASP for the quarter stayed stable and actually increased for some products base on more comprehensive portfolio sales.

We actually saw a roughly an increase of somewhere around 50% in terms of the number of larger order. And the average order size of those were somewhere in the 80% increase size. So basically, driven by customer preference. And this was actually driven by customer preference in the core business and it really hasn't yet to see the effect of including Fluent portfolio sales. So, the customers are voting in that way also.

At this point I'd like normally go into a fair amount of detail on our technology progression and product news. However, we're in a new and I'd have to call it a very exciting phase, where very much of our activity is involved in the integration of multiple great and I might mention already existing technologies between the core technologies of the Ansys family and those Fluent. And as this is actively in progress after only a few weeks, I'll allow those plans to further go along and cover them on upcoming calls. But I think it's real fair to say that the progress of the technology teams getting together has certainly exceeded my expectations. So, kudos to what they've been doing here.

Combining this with ongoing new R&D, already has started to create a buzz wherein, as I mentioned before, we had our largest and most successful International User Conference, which was about 50% on every metric, particularly attendance. And probably underscored by the fact that it really could only be accommodated this year by the Pittsburgh Convention Center. So, that was quite a big step up to for us. And roughly in the same time frame, I had the privilege of attending the Fluent CFD Summit in Monteray, which also had very impressive attendance and a very easer user base. So, in addition to some of the aforementioned customer collaborations of a strategic, there was a wide range of additional activities announced in the quarter including partnerships with MatWeb, Granta Design Limited. Basically, companies that allow access and interoperability with material databases and information management. So, we continue to build that portfolio of partnerships to expand our reach.

So basically, in summary, it was a strong quarter, continued financial and market performance on a standalone core basis. And with an immediate positive impact from the Fluent acquisition. And as we've articulated for several years now, we feel that our progress on all fronts is direct result of our continued focus and execution against this long-term strategic direction and business model, which has allowed us to provide sustainable revenue and earnings growth. But also responds to market economic opportunities. And by meeting our commitments for 35 straight quarters, we've been able to be continually reinvest in both technology and the customer facing capacities that have basically allowed us to extends our positions in each. And basically, hopefully, expand the global reach of engineering simulation across a growing base of customers, partners and industry applications.

And I've got to highlight, this has only been accentuated by Fluent and the other partners that we discussed. Over the long-term, we've demonstrated our ability to grow the top line at or above our guidance, while maintaining solid margins and continuing to provide solid earnings growth. Something that we demonstrated this quarter also. So with this in mind and with a larger scale, we'll continue to drive toward that strategic long-term vision. And while, there are a lot of unknowns out there, our longer term optimism remains intact with ever increasing confidence.

So with that, I'll now turn it over to Maria Shields, our CFO, to provide you a more detailed look at our financials including expense structure, balance sheet highlights, as well as other key factors of this quarter's business and outlook. Maria?

Okay. Thanks, Jim. Very quickly, I'm going to touch upon, recap of Q2 and 2006 year-to-date expense results. I'll go through some of the highlights of the purchase accounting issues, specifically related to the Fluent acquisition that impacted Q2's results. Go through some balance sheet and cash flow highlights and then provide some overall guidance regarding our outlook, at this time, for Q3 and full year 2006 as it relates to non-GAAP and GAAP EPS. So to kick it off. Beginning with cost of sales, excluding acquisition-related amortization of 3.6 million, cost of sales for the second quarter were 9.8 million and that's compared to 5.1 million in the second quarter of 2005.

This resulted in overall non-GAAP gross profit margin of 86% for the second quarter. And for the first half of 2006, non-GAAP cost of sales, which exclude 4.4 million of acquisition related amortization, totaled 15.9 versus 10.3 million in 2005. also resulting in an 86% non gross profit margin for the first half. The comparative increases over last year's second quarter and 2005 year-to-date cost of sales totals, is largely related to the inclusion of Fluent operations for two months, as well as increased salaries and related headcount costs. On the SG&A front for the second quarter, total expenses were 22 million, compared with 10.6 million in last year's Q2. And on a year-to-date basis SG&A expenses were 33.9 million, compared with 21.1 million in the first half of last year.

Increase in expenses, as compared to the prior year's quarter date and year-to-date figures; Was largely impacted by the inclusion of two months of Fluent. Approximately 900,000 in stock-based compensation expenses in Q2 and 1.8 million for the first half of 2006. Increased salaries and related headcount costs. The inclusion of about $600,000 of incremental costs, expanded in connection with the Ansys bi-annual international user conference that Jim briefly mentioned. An increase in third-party commissions and the inclusion of one-time costs primarily on the legal and accounting matters related to the closing of the Fluent transaction in the second quarter. In the area of research and development, our total expenses for the quarter were 11.6 million or about 17% of non-GAAP revenue. That compares with 7.5 million in last year's Q2. And for the first half, our total investment in R&D has grown in 21 million or about 18% of non-GAAP revenue, as compared to 18.8 million for the first half of last year.

The quarterly and year-to-date comparative increases were primarily related to the inclusion of Fluent, about 300,000 in stock-based compensation in the Q2 results and 600,000 in the first half of the year, and an increase in salaries and headcount related expenses. Also like to note that during the second quarter and for the first half of the year, we capitalized about 375,000 of internal development costs, that compares with about 250,000 in 2005. And as we mentioned earlier, this quarter's results do include a one-time in-process R&D charge of 28.1 million that specifically relates to the Fluent transaction.

For the second quarter and for the first half, we delivered solid non-GAAP operating profit margin of 36% and 38% respectively. If you exclude the impact of the non-tax deductible in-process R&D charge, the consolidated effective tax rate for the second quarter was about 30% and 32% for the first half. I would like to point out that the Q2 and year-to-date rates are in fact impacted by the fact that Fluent's GAAP operating results, from the date of the acquisition, reflect a net loss. And as such, the related tax benefits on this loss have reduced the Company's overall effective tax rate for the second quarter and the first half of 2006.

Fluent has historically had an effective tax rate that's been higher than Ansys traditional rate. So at this time, we're anticipating that throughout the remainder of this year, we should be able to maintain an overall rax rate of 30% to 33% and a non-GAAP tax rate of approximately 35% to 37%. For second quarter, ANSYS reported Non-GAAP EPS of $0.40 on 38.4 million diluted shares, compared to $0.31 on 33.8 million shares in the second quarter of last year. And I'll also reiterate, the non-GAAP EPS of $0.40 does include approximately a $0.03 charge relative to stock-based compensation. On a year to date basis, non-GAAP EPS totaled $0.80 on 36.3 million diluted shares, compared to $0.62 on 33.7 million shares for the first half of last year. Non-GAAP EPS of $0.80 includes approximately a $0.06 charge relative to stock-based compensation for the first half of 2006.

Based upon our current visibility, we anticipate non-GAAP EPS in the rage $1.53 to $1.55 for the full year 2006. And are targeting non-GAAP EPS of $0.35 to $0.36 for the third quarter. These non-GAAP estimates include charges for stock-based compensation of a range of $0.10 to $0.12 for the full year of 2006 and approximately $0.03 for the upcoming Q3. The Company's current GAAP earnings outlook is $0.12 to $0.15 for the upcoming third quarter and $0.17 to $0.24 for 2006. Taking a quick look at June's balance sheet, it continues to remain solid. Total cash and short-term investments are at 103 million.

I'd also like to point out that the balance sheet reflects the addition of approximately 214 million of identifiable and tangible assets and 386 million of goodwill relative to the Fluent acquisition. Our total gross deferred revenue reached 95.4 million, despite the initial purchase accounting reduction of 20.1. Of which 5.9 million negatively impacted Q2's reported GAAP revenue results. And we provided a detailed explanation purchase relative to this aspect of purchase accounting in this morning's earnings release and the Form 8-K. As we previously reported, in connection with the acquisition of Fluent, the Company did borrow approximately 198 million from its Syndicated bank. The June 30 balance sheet reflects the current remaining outstanding borrowings of approximately 175.5 million under those facilities. And the interest rate on the debt is variable and is set at about 6.5% for the third quarter. And the Company generated over 38 million in operating cash flows for the first half of 2006. So with that, I'll now turn it back over to Jim. Jim?

Thanks, Maria. So to recap. Strong financial performance on all major parameters of the business both core and combined for revenue, earnings, margins, cash flow, business base, visibility, strong initial integration and collaboration with Fluent, which positively impacted the quarter's revenue and EPS. Increased customer activity accentuated by industry and geographic breadth and increased areas of adoption. And expanding sets of partnerships and relationships in technology, distribution and customers. So with regard to the outlook for the remainder of 2006, we see signs of solid prospects, which we'll monitor with caution in light of macroeconomic events that may impact our customers' buying patterns but the long-term outlook stays bullish.

For the remainder of 2006, we are raising our year end estimates comprised of a combination of strong organic performance and positive contribution by Fluent. As a result of early integration and rapid technology sharing, some of the comparative metrics will be difficult in this thing but those are still the two major elements.

We anticipate a good Q3 performance, as Q3's go, with non-GAAP revenue, again those deferred revenues didn't really vaporize. In the $75 to $76 million range, with non-GAAP EPS up to $0.35 or $0.36. Again, including the effects of stock-based compensation, which wasn't there last comparable Q3 quarter. And for the year, we are raising our guidance to consolidated non-GAAP revenues of $270 to $275 million range. And non-GAAP EPS in the range, as Maria said, of $1.53 to $1.55. But as always and I think we've continually demonstrated this, we'll keep an eye toward ratcheting up performance if the positive signs sustain themselves or increase. So with that, we're now prepared to respond to any specific questions you may have.

[OPERATOR INSTRUCTIONS] And we'll take our first question if a Richard Davis with Needham & Co. Please go ahead.

Thanks very much. Jim, with regard to like product road map and things like that. Over the next say, two part of this, kind of next 18 months to year with regard to Fluent, how does that play out? And then do you envision -- I know you just made a big acquisition. But longer term is this a business that eventually gets more into an electronic design automation or is that something of interest to you say, two, three, four or five years down the line?

Well, I think the key thing -- I'm going to answer those in reverse order. First of all, as the world is electronic, anything that -- if we are looking at simulating entire products in their entire duty cycle, lifecycle, even at the concept stage obviously that is a one element we have to comprehend. So, we already have a number of electromagnetics and thermal capabilities. With Fluent, we've gained some of their cooling and their ice pack and air pack capabilities. So that clearly -- since that's part of the real world that's part of the real world that we want to simulate. So flat out, that's something we've talked about for years that we continue to grow on. In fact, you can tell from the customer list that I mentioned that, in fact, many of them are companies you view as being providers of electronic equipment.

Now the former issue you mentioned, which is regarding the product road map, actually that is a part of the standpoint where I didn't want to let you get ahead of the already solid work development teams are doing. But I've got to say, I've been involved over a couple of companies with tricky integration issues of this nature and all the pride and passion that goes into creating two great product lines. But I've got to say, I've been overwhelmed this time, and I've said that many times internally here, about just how well and how openly the teams have embraced that technology.

So really the ability to take things that aren't even on the drawing board, we've got a lot of stuff on the drawing board but taking things that are already there and making them work together as a concerted capability, a portfolio. And also the fact that there's already work going on underway to share fundamental parts of technology to link things under the workbench methodology. To utilize the inherent Ansys and ICEM CFD meshing capabilities. To combine the different kind of physics that both Fluent and CFX, even on the Fluent side alone those complementary physics. Those things are already being attacked with a vengeance. So, I would probably expect earnings calls without pre-announcing products, that you'd start things coming out very quickly along those lines. It may be, even though the financial results are good for the long term, this may be one of the biggest keys and signs of potential opportunities is the progress they've made on it.

Thank you. The Fluent guys, I've known for them a few years. And I think you're right, I think they have really smart developer guys.

No doubt about that. So, I think that was good.

And then the other one and this is more kind of a macro thing. But this is -- investors are kind of -- are trying in my opinion to kind of convince themselves that the U.S. or the world is in recession or going into recession. Now, I don't agree with that but on the assumption I'm wrong; talk to us kind of how your business has performed in markets where it's been slow. Because as I recall post 9-11 you made your numbers, et cetera. But talk about how the market affects you guys and how you guys work through those things if that happens.

I think the key thing is, first of all, and the heart of all of it is basically solid technology. Backed up by that, I think is a business model -- and as you've mentioned and I have to agree with this, we've gone through times when in the late, in the mid-90's, late's 90's, there was that Asian flu thing that supposedly brought a lot of companies down. And then there was the dot com boom. And then there was the 9-11 bust. And then there was recession. The bottom line is, there's always some place where something is going on funny in the world and those are things that we just have to kind of do for.

The one part that I think is key, and this is where our constant investment in R&D over a sustained long period has basically helped us is, during the growth periods obviously that kind of raises all boats. But again, we've done I think reasonably well in those periods. But also in times where people might be pointing to recessions, you very often see a standpoint where the leaders in that market are saying, "well, we know we're going to come out of this. We know we've got longer term development cycles. And therefore, we're going to utilize this time to prepare for the next bump." So during the 9-11, during the late 90's, early 2000 when the signs of recession started to come in, we had companies that were actually upping their investment, while they were looking at other expenditures being held down.

They were viewing this as being -- I think that's difference between having tools that do simulation and a capability for the multiphysics full simulation route. So, I think we've seen that. On a microcosm basis, I think you only have to look at the situation. I've heard a lot of companies, not necessarily in our space but across the board say that, "Germany has been a tough place to do business." We've been highlighting that as being one of our growth areas for quite a few quarters. And it gets down to; Do have the technology and do you have the customer team to go after that? And that's something that we've focused on. I mentioned for instance, the North America group grew pretty well for us but our major account oriented direct offices grew well in excess of the Ansys growth rate. And again, that was aimed toward meeting or going toward a long-term.

Now, when I say that, yes, as companies tighten their belt they're always going to be more financial introspection. And people start looking at all aspects, sometimes that stretches out the buying cycles a little bit. But we still think that there are ways to succeed and handle a healthy business through a wide range of capabilities. I hit maybe about five different facets. I hope that answers your question.

That's helpful. I appreciate it. Thanks very much.

We'll now go to Barbara Coffey with Kaufman Brothers.

Yes, Fluent was sold a bit differently, didn't have quite the same mix of direct versus indirect. And they also had a fair amount of revenue that comes in on an annual basis versus perpetual. What are kind of your thoughts on going forward of -- are your going to have the same resellers selling everything or is it going to sort of that piece of it?

Well, it's the same thing -- it's basically the same model that we have used throughout. At end of the day, the customer is the major focus point for us. So, as you've noticed our core standpoint, while we have been growing license revenues and things like that, our lease base just continues to chug along in the low 20 percents of our business. And we make it so the customer decision. If they want to -- it's totally based on the realities in that situation.

Fluent does, in fact, have a larger lease base and we don't see any prevailing reason to change that one way or the other. It's a good balance of overall business. and if that's what the customer is deciding we're totally happy to accommodate them. As you can see, regardless of that base of business, we were able to grow even existing customers. And that's just by trying to provide them the technologies they need and the most convenient manner to it.

Now, on the question -- I think you also had a question in there on direct and indirect. We've always said that we want a portfolio of situations. We don't artificially maneuver it. As some of our direct bills started to grow, we started to look at OEM relationships, such as what we did with AutoDesk and even some of the other DLM providers. So in general, we want to keep a balance of that mix. It increases our reach, while allowing us to focus our scarce resource on some of the higher things that have the ability to have other functions taken care of.

But at end of the day, I've got to focus back on the customer. We're going to maintain that strong relationship. And, in fact, it's not a universal on Fluent capabilities. It's -- that's a work in progress because it's not automatic that any of our indirect channel gets to do that. Some of them have picked up the CFX product line. Some of them have point picked up ICEM CFD products and the like. But they have to go through a pretty rigorous certification process. They have to show that they're able to support the customer. And basically, they have to demonstrate a desire to invest and grow the business along with us. And basically, share our passion for taking this simulation to a much higher level than it's been over the past few decades.

So my guess is, some indirect channels, as always, will quickly probably adopt this and earn the right to it. Some of them will come a little bit later and some of them may never come along. But it's nothing artificial we're doing, other than the fact that we're trying to make that available and give people a chance to earn it. However as I mentioned, even with the blending of Fluent, which was largely a direct, we've still got a good mix of indirect business in there, and would like to keep that balance going forward. But do it through innovation not through arbitrary decisions.

And will your direct sales force be selling Fluent products and their direct sales force be --?

One of our key concepts is a single face to the customer. We've already seen some of the benefits of being able to operate, not sending in multiple sales forces to actually battle and go through that. At the end of the day, we want to take the combined assets of what we have and solve the combined problems that our customers are trying to solve right now. Now, that involves an interesting standpoint in terms of being able to provide services and be able to back up the customer and meet the different needs, as predicated by what particular solutions they might be able to use. But at the end of the day, we do expect our direct sales force to become quickly up the curve. Be able to represent the entire product portfolio and also know when to bring the considerable Fluent resources into play when the customer comes in. But basically, present the entire suite of our products.

Okay. Thank you.

We'll take the question from Mark Schappel with Hapoalim Securities .

Congratulations on the quarter, number one.

Thank you.

Jim, did I hear you right during your comments, that core license revenue growth was about 24% year-over-year on the quarter?

No, actually I think I said 21% on a core basis.

21%, thank you.

Were you talking about the for the quarter or were you talking for the year-to-date?

Just for the quarter.

Yes, for the quarter we were looking at 21% core and total software license revenues for the first half were about 26%.

And were there any $1 million plus deals in the quarter?

$1 million plus , no. Again, we tried to use the analogy, we just try to have a really good solid swing and sometimes they go over the fence. Most of the time you hit doubles and liners into the gaps but you're always making good contact. And in general, we've seen most that have growth, I talked specifically about the growth of the number of orders or customer commitments and the average size of those orders. We saw both of those jump quite a bit.

But in terms of any of them getting to the seven figure size, no. I think we're still on the standpoint where you're more likely to see continuous repetition of some of the same leading names of customers continually augmenting existing installations with six figure orders piled on. Six figure orders over a sustained multi-year basis. And if we went back and looked at that, you'd see that there were many customers that repeat on a yearly and sometimes even a couple times a year basis. And that's basically the kind of relationships we like to have, where we're continually growing with the customers. It's not a one-time event, kind of a fire and forget standpoint. And it's something we've talked about for golly, eight to 10 years now. And it's one that we're very comfortable with. The customers seem to like also.

Thanks. And Maria, you mentioned the stock-based compensation expenses expected in 2006, I believe you said $0.10 to $0.12. I'm sorry.

For the year.

Yes, for the year. I did not catch the third quarter number, could you repeat that please?

It's going to be $0.03, similar to what you saw in Q1, Q2.

But they'll be pretty balanced across the year, roughly put.

And then one more question and I'll let somebody else get on here. But in the past, your G&A and your sales and marketing line items were reported on separate line. This quarter they were combined. What's the plan going forward for the future?

We're going to do combined. The reality is, if you start looking at it on the Fluent side, the classifications differences, a lot of it's overlapped. Where do you put the customer sales reps, are they in sales, are they G&A? Rather than hiring accountants to push numbers to reclassify things, we just thought it would be better to focus on SG&A.

Okay. That's all for me. Thank you.

Thank you.

Next is Ruchir Lahoty with Thomas Weisel, please go ahead.

Congratulations on the quarter.

Thank you.

I have a couple questions. What's the nature of these R&D expenses closer to -- it's called --?

It's called the in-process write-off.

In-process write-off. What is the nature of that?

Well essentially, at the time we acquired Fluent they had some advanced R&D projects going on for advancement of their capability solver and architecture. Well again, at the end of the day, basically from an accounting treatment standpoint -- actually, I'm going to leave the accounting treatment standpoint to Maria. But all I'm saying, is that the ruling was that you have to write that off. Now, I'll tell you, we're not throwing it off. We're actually utilizing it. So as an engineer, I tend to struggle with the concept of writing off something that still has value and you're still using. But it was something that we had to do. Maria, and maybe I should let you about the --,

Basically, in the accounting rules as they relate to valuations today, and my understanding is this is being examined by the FASB, if you have R&D projects that are incomplete at the time of the acquisition that have not reached what they refer to as technological feasibility; you basically have to do a valuation of that asset and take a write-off. Not dissimilar than what you'll see in other technology transactions.

Yes. I got that. And on the integration side, what are the time lines you're looking at for total sales and operations integration?

Well, we're already seeing it in this half, however, some of the interactions and things like that. But I'd say by -- right now the current plans that I've seen, and we've left it up to an awful lot of the grassroots to go through that. And it looks like beginning of 2007, it will be coming out of the gates pretty strong and consolidated. However, the consolidation and the cooperation is already going on now and this is only a few weeks into it. It's been very, very impressive the reception by both customers and the various organizations.

Okay. Thank you, gentlemen.

Thank you.

Next is Tim Fox with Deutsche Bank. Please go ahead.

Hi, thank you, good morning. Maria, I was wondering -- if missed this, I apologize. Did you give out the breakout between software license and maintenance for the non-GAAP adjustments, the deferred write-off?

Well, the whole 5.9 million goes to software revenue, license revenue.

All license. No maintenance there.

It's a one line adjustment. It's in this morning's press announcement as well.

Okay. Perfect. And for Jim, you mentioned you had some very strong geographical results. But Japan has been a little bit weak. And this isn't just for Ansys, it's been across a number of companies in the design automation world, as you're probably there. Is there anything going on there from technology adoption or do you think it's more macro related? I don't know if you can just touch on Japan there, that would be great.

Well, sometimes some of the newer historically have been a little bit slower for adoption, more methodical but also probably more pronounced and sustained once they pickup. I think really one of the key things is we saw how a stronger presence by Ansys in a territory, even where we've got a good distributor, and Germany is one example. Our distributors there are doing a great job but they're doing it in conjunction with an Ansys operation.

And I think the same thing -- any for instance, we've heard the same thing about Germany being very, very tough to do business in, and it's been have gone for us. So, I think a similar thing, at least we have the opportunity over the next couple of years to build up some of that kind of relationship and interaction in the Japan market. But there are some differences in there.

Nevertheless, even without that, we're still getting -- we still are growing there. We still are building some of the customer relationships. It's just a situation that we'd like to improve. And we're always, no matter what's going on, we are always looking at the areas where we'd like to improve. A few years ago I remember talking about France. And for the last few years that's been an area of great performance for us. So it's just one of those things of continual redoing, continual expansion and growing. But we're growing there but we just think we'd like to have -- we'd like to bring it up a notch.

Okay. That's helpful, thanks. And just one last one if I may and then I'll turn it over. I just want to clarify, Jim, you said that your large order pipeline was improving. I think you said it was up from a deal size perspective up over, I think it was around 80%.

I said the average order of those big deals have grown up there. So, we're getting larger amounts. Again, not the seven figure orders but the continual expansion, these continual -- I wouldn't call it water torture. But it's a continual rolling expansion. It's not a number of series of steps. It's kind of like a ramp. And the number of those have probably increased by about 50% or more but the average value of those have also increased. And it just seems customers, particularly as they get more familiar with us and we build a long-term track record, there seems to -- I don't know if it's a short phenomenon or not, it's tough to say with only a couple of data points but the adoption rates seem to increase as confidence comes up. As opposed to, for instance, maybe necessarily capping down.

Very good. Congratulations on the quarter.

Thank you.

We'll now go to Irit Jakoby with Next Generation.

Hi, congratulations on the quarter. And just one question on the stock option expense in the non-GAAP. I was just curious why you are changing your policy and putting the stock opt expenses in non-GAAP?

Well, Iri, that's a very good question, and I'd be happy to answer it. Right now currently as part of the routine three-year review cycle that the SEC has implemented as a result of Sarbanes-Oxley; they're reviewing Ansys public filings, including our Form 10-K's and our 8-K's. So, based upon current feedback from the SEC staff, we've elected to make the adjustment to our presentation format, which include now adding back stock-based compensation as part of our non-GAAP reported and non-GAAP outlook. I'll just say at this time, that we're continuing our dialogue with the SEC staff on this issue. And depending on the outcome of those discussions, we may consider future modifications going forward. But, as I said, we're currently having discussions with the SEC on this matter.

Okay. Great. And one follow-up, you mentioned that in this quarter 70% of sales were direct versus 30% partner Fluent. I was just --?

That's for the combined Company. For our core business --.

So, that was for the combined Company in Q2 and I just wanted to see sort of what your outlook is for the rest of the year and going forward? How you see that trending?

I think that's going to be somewhere along that. Now obviously, the 70% also only had about a 2/3 of Fluent, so my guess is that it's going to tweak up a bit. However, we still see a strong part of the indirect business and we'll continue to find unique, interesting ways of working with them. So it's going to be more along the lines in the low 70's, I'd guess.

Has there been any uptake of under some of the partners of Fluent offerings that they're adding to their mix?

I'm sorry, could you repeat the question? I'm getting an echo here and I don't know if anybody else is getting it but I didn't quite hear --?

So, the follow-up question, and it'll be my last one. Are you getting any uptake from your partners, are they uptaking any of the Fluent offerings?

Well, not currently because Ansys has got to go through -- first of all, we're going through -- any transition will be governed more by the customers than it will by kind of channel thing. But the other thing is, it takes a while to learn a new product and get certified in it. So, nobody's currently certified but obviously there are people that are interested in being able to convey those offerings. And like I say, that's not a right but it's a privilege that needs to be earned and we'd actually like it if they did that.

At one standpoint, there was an element within Fluent that was actually trying to increase their amount of indirect business. So, it is a good way to get reach. But we'll do it only in a way that maintains our commitment to quality of service, quality of support, knowledge and ability to work with the customer. So, it's currently, that's a long winded way of saying; currently no, but long term, it will start to ramp in but not universally.

Okay, great. That's it for me, thanks.

Thank you.

We'll now go to [Sunil Daptartar] with Centennial Asset Management.

You mentioned about the solid in all geographies. Is it possible to talk about the verticals that you sell into? Did you see any verticals weak, any verticals particularly strong in different parts of the world?

Well, I basically say -- also as you can almost maybe infer, if I hadn't gone through that big long list of customers, basically every industry went quite strong. In general what we've seen, is the best performing companies across a broad range of ones, are the ones that are building upon these new capabilities versus just proliferation of old tools. I saw -- obviously, we listed a bunch of automotive customers. We mentioned a lot of aerospace companies. Electronics, healthcare, I mentioned a couple of examples in terms of energy related things, which is very strong. Keeping refineries strong during hurricanes and tsunamis. Keeping offshore platforms going. Looking at renewable forms of energy like the wind and the hydro examples.

I talked about EMSA but I also talked about companies like VA Hydro that continue to expand with water, hydroenergy. Talking about also about the ITER project, which is a new generation of capability for cleaner, more powerful nuclear kind of capabilities. So we're seeing it across every brand. I'd say in general, it's been driven more by the leaders kind of flocking to this new wave of technology.

Then in that case, due to that optimism you're seeing in all the verticals, when you look at the Q3 guidance, it appeared a little bit tempered in the sense you use the word of caution.

Well, that's primarily just related to the fact that a lot of places kind of slow, historically, seasonally Q3 has been probably the least dominant quarter in the year. And that's; many parts of Europe go on vacation and holiday for long periods of time, it's a slower period in North America. It's just a recognition of a seasonality trend that's been around the business as long as I have and that's getting to be a long time. So it's not related to any really economic thing. It's not related to any sector thing. It's just really to the fact -- but even then we did increase the Q3 outlook. It's just that we also treat Q3 for what it is. And sometimes people don't start getting back in the groove until September. And so if something slips a week or a couple weeks or something like, that the business is still there. But Q3 is just one of those quarters. But apart from that ,I don't want to lose the point that we actually have increased our outlook for Q3 on top of it. We just recognize Q3 as being Q3.

Okay. And in that case you're looking for a very strong Q4.

Well, strong both actually, by our standards. But yes, Q4 continuing to be strong. So, it's a continued ramp-up, that's why we increased, basically, the guidance for the year also.

Okay. One last question on the share count, what is the share count you're assuming for Q3 and Q4? Do you have any numbers for the EPS range, you must be having assuming a higher share count in the third quarter and the fourth quarter?

I'm looking to see if I've got that. I don't have that at my hands. If you give Lisa a call back, she can provide you with that data.

Okay, great, thanks.

Thank you.

We have one last question and that comes from Alan Brochstein with Piedra Capital. Please go ahead.

Hi, sounds like it was a great quarter across the board. But I was wondering if you could address; of the upside, how much would you attribute to the core business compared to the merger going a little bit better than expected?

Oh, boy. Parsing it down that level gets really difficult. Obviously, with the core growth in the very high teens for the first year, and the first half, 20%. We were a notch above our guidance. I think in the past, we talked about guidance in probably in that more of mid-teens kind of range and we clearly, went through that. And then I'd say that there was a little bit -- it's harder to say what the pure accretion aspect was. But it was ahead of our projections slightly. And we did talk about a guidance thereof immediately out of the gates of $0.01 or $0.02 and we obviously went through that too. Maria, do you have a different perspective on that?

Mostly, I'd say it kind of follows along of what we've seen in the past. When we over produced on the top line, it disproportionately flows to the bottom line. And I'd say that coming out gate, the we were perhaps a little skittish customers would slow down their decisions. And the reality is, we didn't see that on either sides of the business.

That's good point. Normally, people come out with real, real -- we came out with accretive prospects out of the gate. But very often when that first thing comes out, even on this call we've had questions about "the road map," the products road map. Now, that sometimes gives a wide range of customers the desire to sit back and say, "I need a little bit of time to make sure I pick the right path." And by interacting with them and by our technology teams having such a strong start, we just did not see that kind of tick down. But there's obviously, the unforeseens that come in but we weathered through those.

So, at this point, do you think that the slight acceleration in the contribution in any way changes the long-term outlook, are you more bullish for the overall contribution?

I think bullish for the long-term but I think ultimately I never -- we didn't have too many doubts about being able to get there in a good time frame. And eventually, I think we'll get there sooner. And once you get there, then the thing is; What are the opportunities for to you expand even beyond what you thought? I don't want to get into that kind of standpoint there. But with some of the interaction I've seen right now, we've talked about the ability of these two technologies to coming to and basically accentuate and be able to drive the value performance curve in terms of what we provide to our customers. And clearly, if we're doing that quickly and not doing redundant things and stuff like that; that certainly provides us capacity to try to get to the next stage quicker. But trying to quantify that right now would be very difficult.

Okay. And just one last question. You guys are obviously charting uncharted waters at this point. What are the barriers to adoption of your technology and where do you think you guys are in terms of --?

I just want to make sure understand. When you say charting, we go through unchartered waters all the time. So, are you talking specifically about our technology?

Yes, your technology.

Okay.

It's new and where are you guys and what is the adoption?

I've always said that we're primarily on the -- we're kind on the 30 yard line and not crossed mid-field yet. It's -- probably the biggest situation we have is, by selling to engineers, they tend to look at things, actually I should say we because I are one of us. We tend to really dig through -- if you look at the history of almost all the technology, whether it was CAD, whether it was the first wave of simulation. Even after the technology was proven to deliver results, it still took a number of years for companies to start to ramp-up. And I think there's an issue of A) a certain skepticism. So, it takes time to get familiar with the new technology, than to be convinced that it's there. But the probably even more importantly, for broad scale adoption across major customers, it takes them time to change their processes to be able to adapt that. And they don't do that at the drop of the hat nor should they. because at end of the day, they still have to get their products out.

So basically what we see, I actually talked earlier on this call about the; not that any one sector was strong but the leaders across numerous sectors were taking up on this. And that's normally what we see happen. If the leaders come out and they gain a competitive advantage, then a lot of the industry will tend to follow them. But that obviously, builds in anywhere from a two to five year kind of lag. So it's a -- there's a lot of growth potential in here. We have to execute on technology basis. We have to execute on interacting with the customers.

Fantastic thanks a lot.

Thank you.

At this time I'd like to turn the call back over to Jim Cashman for any additional or closing remarks.

Well, thank you. In close, still long term enthusiasm with many encouraging signs. But we'll always keep -- we'll keep the degree of vigilance that we've had on there for some of the very reasons of the questions that you folks asked on this call. We continue to be bolstered by a strong combination of the solid business model that I've been talking about for a long time, loyal customers, dedicated channel partners and basically talented committed employees. These ingredients, they just continue. They've afforded us the opportunity to provide consistent performance for revenue and expense with an expanding customer base, expanding base of technology to support our long-term initiatives. And basically, all of these have become stronger as a result of the Fluent acquisition.

And, in fact, as we close, we'd like to congratulate both the Ansys and Fluent teams on a strong combined first quarter of operations. If any of you listened to this now or on playback, your efforts have given us a great initial start to our ongoing success. So, we thank you for that. And thank all of you for your attendance on this call and look forward to talking to you same time next quarter. Thank you.

And thank you very much. And that does conclude our conference for today.