ANSYS Inc (ANSS) 2007 Q3 法說會逐字稿

Good morning and welcome to the ANSYS third quarter 2007 earnings conference call. All participants will be in a listen-only mode until the question-and-answer session. Today's conference is being recorded at the request of ANSYS Incorporated. If anyone has any objections you may disconnect at this time.

I would like to introduce your speaker for this mornings call, Mr. Jim Cashman, President and Chief Executive Officer. Please go ahead, sir.

Thanks a lot. Good morning, everybody, and welcome to the ANSYS call for Q3 2007. I'm joined today, as usual, by Maria Shields, our CFO. We're going to plan on sticking pretty close to the regular kind of flow that we have in our agenda today. I'm going to start off by outlining the highlights of the quarter and the year-to-date, in an overall high-level summary and then we'll dig deeper into the operational results.

The basic theme of this call is continued growth and momentum and it's driven by organic growth. Essentially we've made good progress ongoing with our customer engagements, technology advancements, and all the other things that often listeners to this call might remember. We've also continued to build the business infrastructure as commensurate with our increasing scale. And as always will be case, we have a lot of opportunity ahead of us. There's also a lot of work required along the way. Maria will then update you on line item expense performance, balance sheet cash flows and provide an update on our current outlook on earnings.

So it should be noted that the strong operational results were even as we've started investing substantially in our business infrastructure including back office integration of Fluent and also our global networking plus the usual compliance cost that come along. So after discussing these topics, we'll be happy to respond to any questions you may have.

Maria, we need to start with our Safe Harbor Statement, please.

Sure. Thanks, Jim. Good morning, everyone. Again, thank you for joining us to review the highlights of our third quarter results. Before we begin, I'd like to remind everyone that during the course of this conference call, some matters that will be discussed as 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. Additionally the Company's reported results should not be considered an indication of future performance as there are potential risks and uncertainties that could impact our business in the future. These are discussed at length in our public filings including the forms 10-Q, 10-K, 8-K and our 2006 annual report to stockholders, all of which are available via our web site.

Any forward-looking statement are based on the Company's best judgment as of today and ANSYS undertakes no obligation to update any such information unless we do so in a public forum. During the course of this call, we'll be making reference to non-GAAP financial measures in an effort to provide supplemental information to our GAAP disclosures. A discussion and full reconciliation of GAAP financial measures to comparable non-GAAP measures is including in this morning's earnings release and related form 8-K.

One final housekeeping item, before we get started, all the EPS and share data that will be discussed has been adjusted to get us back to the most recent two-for-one stock split that took place in June of this year. Now with that covered, I'll turn it back over to Jim.

Okay. Thank you, Maria. Q3 business performance and represented results above our non-GAAP revenue and earnings guidance. We did this while continuing our usual investment on a broad front, and also some highlights in technical innovation and some customer engagement things and we'll get to that in a little bit more detail. For the numbers I give, I'll be using non-GAAP numbers in the same fashion as we've been using historically, is to maintain consistency with our calls of past years and quarters. We feel, and I think we can actually demonstrate that it provides a more accurate representation of the business.

So from that high-level perspective, this really was a strong quarter. For the quarter we reported solid financial performance with non-GAAP revenue at 94 million. This is a 22% increase from last year's Q3 of 77.4 million. I should note that this quarter represents organic growth, and it was also in excess of our guidance and the analysts consensus. The non-GAAP diluted earnings per share, adjusted for the recent two-for one stock split, that is, increased 35% with non-GAAP EPS of $0.31 up from last year's Q3 comparable of $0.23 This was also above our guidance in the annual consensus, and it really represents continued verification of what happens in our model when we over perform on the top line. Our non-GAAP revenue EPS performance for the quarter primarily at direct consequence of strong comp line performance stirred by an uptick in customer adoption and with some positive currency affects. We'll discuss each of those in more detail coming up.

Secondly, all major aspects of the business performed well and with balanced performance. Balance probably being the key word by both product line and geography. We saw continued strong growth and operating margins, strong cash flows, good DSO. Business model was stable. Essentially every metric was positive. We also finally saw continued building of customer engagements both from new adopters and the long-standing relationships alike. They continued to transcend geography, industry, any kind of classification. By any measure, but particularly by Q3 standards, the volume and the size of the orders was fairly impressive, at least to us. The continuing story from customers was that this was a result of two major factors. First of all, they are facing a lot of increasing market pressures, and also, I think, a secondary one was ANSYS execution as a long-term business and technology partner for them.

Now, for the purpose -- actually I should say for the purpose of this call, this is the first quarter of a pure apples-to-apples comparison of the business since the Fluent acquisition about a year and a half ago. And as such, all comparisons for the quarter will be core organic. This quarter the purchasing accounting discrepancies and revenue are now gone. So GAAP and non-GAAP revenues are basically the same and they will be compared to the 2006 non-GAAP revenues that we discussed a year ago. So for years now we think the business has been the most useful look into the business metrics and we'll just keep on that for consistency.

So as previously mentioned our non-GAAP revenue for the quarter was 94 million, again, 22% over the 77.4 million of Q3 in 2006. Currency adjusted, this was still around 18.5%. Non-GAAP diluted earnings for the quarter grew 35% to $0.31 up from $0.23 per share in Q3 2006. This exceeds the analyst's consensus, which marks the, basically, the 40th consecutive quarter -- actually the first decade that non-GAAP EPS has met or exceeded the analysts' consensus. Overall non-GAAP operating margins for the quarter were 44%, indicative of the solid top line results. Again, a lot of that filtering the excess filtering through. This compared to a 37% in Q3 of 2006.

I think it's noteworthy in demonstrating the integration progress that we made in terms of bringing the acquired business in the ANSYS business model. Adjusted gross margins continued in line with our business model, at a healthy 85%. There were strong cash flows from operations of about $26 million compared to $22 million of last Q3. If we look at the nine months or the year-to-date of 2007, we reported total non-GAAP revenue of 275.9 million or 44% increase over the 191.6 million in the first nine months of last year.

Just as a reminder, last year's comparable included only five months of the Fluent business over the nine month period. So the percentage increases should be taken accordingly. Software license business was disproportionately strong, but maintenance and service business also grew well. We'll break that down coming up also.

The year-to-date non-GAAP EPS was $0.90 a 36% increase over the $0.66 in 2006. Again, these EPS numbers are split adjusted. Non-GAAP operating and gross margins were 43 and 85% respectively for the first nine months. Cash flows from operations were over 85 million for the first nine months, which was a 42% increase over the first nine months of 2006. So, that's a high level. Now let's dig down to the numbers. We'll go over these in a variety of different viewpoints, category of business, geography, customer and product.

So let's -- we'll start with category business first. Overall, consolidated non-GAAP license revenue grew 23% for the quarter and for the first nine months of the year it was 54%. Again, remembering that the Fluent was only included for nine of the first -- five of the first nine months in 2006. Total paid up licenses grew at 48% for the quarter and 37% year-to-date. The lease business grew double digits, it was 42% of total business. For year-to-date it's remained at 40% of total revenues. So this continues to solidify our repeatable business space, it aids our overall visibility and maintains constant touch points with the customers.

Software maintenance grew in excess of 20% for the quarter. Our pure serve service business, basically the consulting part grew at about 10%. This allows for continued expansion of our high-end technology consulting and research, but it also represents a shift toward the higher margin work to leverage software sales and expand the deployments within the customer base. So this is quite in keeping with our overall business model.

We saw our continued good balance between the high end and the desktop products, the upper end products continued to perform well with the double digit growth evident in key areas. There were also impressive gains from the continuing migration of customers through the ANSYS work bench platform. We're also even starting to see the prototype work even a year and a half later of some of the Fluent activities going in there. So it's starting to gain some traction here. We'll be talking more about this, obviously, on upcoming calls as our product integration plans continue to move within the customer base.

Our Direct and Indirect businesses both performed well maintaining that 70-30 split in favor of Direct. That's been pretty much on par with what we've been talking about the past few quarters. So as a repeat from those calls, it's significant for two reasons. It shows an ability for the Indirect channel to keep pace with the ANSYS overall, but also future opportunity to selectively expand the product portfolio into that channel. I should note also from the Direct side virtually all of our Direct offices throughout the world produced growth.

Business intake was particularly strong for Q3 and grew at 19% basically allowing the total deferred revenue to rise to 115.3 million. Our already strong core repeatable business space has edged up to 71%. So even with the robust growth we've been seeing in some of the revenue and throughout the year, basically, one of the consistent strengths of our business model has been the ability to just maintain that solid base of recurring or repeatable revenues. It gives us visibility going into the quarter, it's helped reduce the variability of traditional back end loading of revenue in the quarter. Basically, we believe it's a byproduct of our commitment to reinvest a high percentage of our revenue back into R&D, which in turn, allows our customers to tackle the increasingly complex design issues that they are undergoing.

We have a solid balance sheet and strong cash flows. I mentioned $26 million for the quarter. That can easily support the amortization of the debt that we took on with last year's acquisition, and throughout 2006 and 2007, we've accelerated the paydown of that debt.

From a geographic perspective, we saw good growth across all regions. We continued to be encouraged by the combination of industry breadth, new customers, and some pretty good expansion within side of the existing customers. From a total business perspective, North America increased to 16% for the quarter. In general this was balanced across all aspects of the business including ANSYS Direct offices and channel alike, for the first nine months of the year, and that growth was 33%. But, again, that carries the non-comparable of the few months of additional Fluent sales for this year. Major orders in North America came from the same mix of both our long-standing customers that you've heard about over the years, and new customer that we've come to expect such as just -- rattle down this list, Boeing, Pratt, Whitney, Daimler Chrysler, Lockheed Martin, Shell Oil, BAE Systems, Goodrich, Sandy and National Labs, Dell Cam, Eaton, Parker Hampton, Nova [Capital], Goodrich, Sea Gate, Westinghouse, Naval Air Warfare Center, Fairchild, the U.S. Army, basically the list does go on for a while, but t is a particularly noteworthy.

Europe continued to perform well with an overall 26% growth for the quarter. Again, the balance throughout the various region was, again, in a good way monotonously uniform. So, balance was there also at the subregion. There was a positive currency impact of a little over 2 million, but the growth for the quarter was still around 20% ex-currency. The larger deals in Europe included the usual mixture of new and expanding customers, such as Ferrari, [Bausch], [Voit], Rolls-Royce, SGM, Volkswagen, Siemens, DLR, Volvo, [Alstem], [Grunfaus], NAN, [Belao], Leap Air, [Trilof] Shipbuilding, the French Petroleum Institute. Again, kind of a repeat of what we talked about in terms of breadth and depth of orders from North America.

Our general international area was probably the least balanced of any of them, but with improvement over the previous quarters that we talked about on the last couple of calls. The region grew at 23% for the quarter. Most of the high potential regions grew in excess of 30%, albeit off a lower basis while Japan grew at about 9%. So, on prior calls we mentioned we felt there was an opportunity for improvement in Japan. And we've seen some modest improvement. We used Q3 to implement some infrastructural improvement, improvements for the upcoming quarters. But there's a lot of additional attention required for us to reach the potential we envision.

I probably should note that currency impact was negligible for the GIA and Asia-Pacific region. In this area key customer engagements in the region included Petro [Bross], China Marine, Korea Science, Cummings, Honeywell, [Lueon], Electrooptics, Mitsubishi, Toshiba, [Tata], [Ishekowagima], Heavy Industries, again, we basically saw a continuing variety of orders from local-based businesses as well as from multinational expansion. And even though some of that now appear to come through repatriation at the headquarters levels to some of the European and North American multinational companies.

As a continuing theme, we're seeing industry breadth and increased penetration within basically our already strong and broad customer base. On recent calls I noticed -- I noticed there's been a lot of interest in various industries. On recent calls I noticed the emergence of a wide range of energy producers showing increased interest. I mean, this was stretching across the entire gamut of those, hydroelectric, nuclear wind, power bio, solar. These continued, of course, with several additional deals in the nuclear space and associated with the entire project we've mentioned on earlier calls. But other examples, First Solar, [Suselawn], Wind Energy, just to name a few.

But if you recall, and I'm connecting if you recall from the major deals that we're talking about across the world, there were also a number of ones that came from petroleum industries. So there were a number of significant deals in that list, but also additional orders, companies like Conoco, Total France, a Reliance India and others. So, every major geography had investment by customers in the oil industry also. So it just continues that the general energy field appears to be a broadening trend for us where efficiency and buyability of energy production is just an increasing demand that's being felt throughout.

Additionally, I thought I might note the recent success of Ferrari, which I mentioned a couple minutes ago, with the year's final Formula One race in Brazil in October, Ferrari won both the drivers and the constructors championship for 2007. And this comes on the heals of America's Cup victory by ANSYS customer Team Lingi. Sometimes sporting events, where, let's say that winning stands out over being quote unquote merely good, it basically can serve as a metaphor for industry competitiveness. We always feel good when our customers see those kind of successes. So, ultimately innovation, time and money all play a vital role with all of our customers and we'll continue to strive to provide the technology edge to support their efforts.

And we feel that, and why, in general, across all industries, the pipeline of new opportunities is increasing for us. The interest keeps growing. But I have to say, so do the challenges. Our customer base continues to grow and increase their adoption. But the usual concerns that dominate the headlines are also felt by them, a little bit evolving list from what we've talked about earlier. But the main ones we hear now, energy costs, labor, housing, credit, currency fluctuations, along with the usual geopolitical that's all or any of which can influence the timing decisions of our customers' buying patterns. Sometimes it's cautionary, sometimes it's a positive. But it's something we have to continue to monitor.

So in summary, there was strong balanced regional growth. There's always areas where we're attempting to strengthen. We still have a couple of areas that provide opportunities for improvement. But as we've mentioned in the past few quarters, these gratuitously are in regions where the integration activities are already starting to play a role. I guess I have to say that's been a constant theme for us for ten years, always working on the lower performing aspects. Some of the ones that we've mentioned recently are already showing signs of improvement while new opportunities to improve are always presenting themselves.

So there was good industry and major account activity. We saw continuing strong performance in every major geography and virtually all subregions, particularly in major accounts. But even with this, even with the balance, we basically have, I think, an ability to improve nearly everywhere also. So in light of the progress, we are continuing our multi-quarter discussion of ramping up this -- ramping up the capacities of our customer facing organization in response to the growing opportunity we see.

Now, from a product standpoint. Let's see, product revenue, we -- actually there's really no major shift from the previous trends and guidance we've given, so let's view that as a continuation. As previously mentioned, consolidated paid up software licenses grew by 48% over the comparable quarter. Lease business has grown to 42% of our total business. Basically all parts of our product spectrum did well. Good overall balance. This is true from the desktop to the name line products. And there was also a balance growth in the major areas of our structure teams and our fluid product lines and some of the other multi-physics aspects.

AFPs for the quarter, those were stable at both the high and low end. Again, multi-quarter trend. We think basically what we have seen is that the increase in customer confidence has tended to lead to more licensing of more comprehensive product sets. From a qualitative standpoint, the summary is, I think we feel we've got the broadest, deepest set of integrated simulation tools and it's continuing to get broader and deeper. So to get into any more depth of that could swallow up a lot of time. So, I'll invite any of you that might have an interest along those lines, visit us at ANSYS.com for the various details of product capabilities, the releases, as well as upcoming news.

So, from my perspective, although slightly premature, there's some exciting progress that we've been making in our integration architecture. I say premature because we still have a lot of execution and some releases to do. But we feel that our R&D expenditures, coupled with customer collaboration, can yield some exciting technological progress for years to come.

So basically, conclusion, in summary, by almost every metric, it was another very strong quarter, quantitatively and qualitatively for us. There was continued financial and market performance. We were doing this while we were continuing our integration efforts. And also foundational building efforts in terms of our business infrastructure. We remain committed to the long-term vision of taking simulation to a new level while meeting customer expectations, and the corporate commitments to our stakeholders.

So over the long-term we've demonstrated our ability to grow the top line in accordance with our guidance while maintaining solid margins and continuing to provide solid earnings growth. We'll continue to drive toward our simulation vision with our long-term optimism, technology dedication and laser focus on our customers. So even if we're going to be increasing our outlook later on in this call, we're going to continue our attention to detail, and if I can say, our air of cautious optimism going forward.

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

Okay. Thanks, Jim. For the next few minutes, as usual, I'll just take a quick -- go through a quick summary of some of the financial highlights as they relate to Q3 and 2007 year-to-date, expenses, some of the balance sheet and operating cash flow highlights, and provide an update of our current EPS outlook for Q4 for the year 2007, and our initial outlook for 2008.

Beginning with cost of sales, excluding acquisition related amortization and the impact of stock-based comp, which combined, total of 5.4 million, cost of sales for the second quarter total 14 million. That compares to 12.2 million in the third quarter of last year. This resulted in an overall non-GAAP gross profit marriage of 85% for the 2007 third quarter. On a year-to-date basis, 2007 non-GAAP cost of sales, which excludes 16.1 million of acquisition related amortization and stock-based comp, totalled 41.1 million versus 28 million in 2006. Also resulting in a year-to-to date 85% non-GAAP gross profit margin for 2007.

The comparative increase over last year's third quarter and year-to-date cost of sales was largely related to the inclusion of Fluent operations for nine months in 2007 compared to five months in last year, as well as increases in salaries and headcount related expenses, as well as increases in third party royalty expenses. So as we look through the remainder of '07 and into '08, we're targeting non-GAAP gross profit margin in the 85% range.

For the third quarter our total SG&A expenses excluding 1.5 million of stock-based compensation expense were [25.1] million compared with 23.5 million in last year's Q3. And for the year-to-date, on a year-to-date basis, when you exclude 4.5 million of stock-based comp, SG&A expense totalled 76.1 million compared with [65.6] million in '06. The increases for both the quarter to date and year-to-date figures were largely impacted by, once again, the inclusion of Fluent's operations for nine months in '07, higher salary and headcount related costs, an increase in third party consulting and commission expense, as well as increases in our tax compliance and planning costs. These were all partially offset by a reduction in spending relative to our biannual international conference that we held last year. So looking ahead, we plan to continue our investment in building out our global sales presence and our business infrastructure to support growth in the future and improve our operational efficiencies.

In the area of R&D, total expenses for the quarter, net of about 450,000 related stock-based comp were 13.7 million and compares with 13 million in Q3 of last year. And on a year-to-date basis our total investment in R&D excluding 1.5 million in stock-based comp reached 39.4 million compared to 33.4 million in last year's comparable period. For both the quarter-to-date and year-to-date, the comparative increases were, once again, impacted by Fluent's operations for nine months in 2007, an increase in headcount related expenses. And also I'd like to point out that during the first nine months of '07, we've capitalized about $100,000 of internal development costs and that compares with $400,000 in 2006.

So, looking ahead into 2008, we plan to continue our long-term commitment to ongoing investment in R&D, to both extend the breadth and depth of our solutions, as well as to integrate them into the ANSYS work bench. Our current business model targets R&D spend as a percentage of total revenue in the mid teens range.

For the third quarter nine months of '07, we've delivered solid non-GAAP operating profit margins of 43.8 and 43.3 respectively. For those of you building your models, our current outlook translates to a low 40s target range for '08. We believe that this allows us to optimize the balance between earnings growth in the short-term but equally as important, continue to invest and build the business for the future.

The consolidated effective tax rate for the third quarter nine months of '07 was 40% and 38% respectively. And looking at '08 at this time, we're anticipating that throughout the remainder of this year we should expect an overall tax rate in the 37 to 39% range. During the third quarter the Company incurred 1.6 million in interest expense related to outstanding debt. On a year-to-date basis interest expense totalled 5.5 million. For the third quarter we reported an increase in non-GAAP EPS to $0.31 on 81.2 million diluted shares. That compares with $0.23 on 80.6 million shares in last year's third quarter. On a year-to-date basis 2007 non-GAAP EPS increased to $0.90 on 80.9 million diluted shares compared to $0.66 on 75.1 million shares in the comparable 2006 period.

So based upon the current business visibility, we're increasing our annual outlook for non-GAAP EPS to a range of $1.22 to $1.23 for full year 2007, which equates to non-GAAP EPS of $0.32 to $0.33 for the upcoming fourth quarter. This outlook assumes a share count of approximately 81 to 81.5 million shares. And our current outlook for 2008 targets non-GAAP EPS in the range of $1.39 to $1.42 or essentially an initial target growth in the 14 to 16% range, and that assumes somewhere between 82 and 83 million fully diluted shares.

If we take a quick look at the September 30th balance sheet. Our cash and short-term investments totalled almost $151 million. Consolidated net DSL was at 42 days. The outstanding balance on our debt was at 75.5 million. And the interest rate on the debt is variable and is set at an average rate of about 5.6% for the upcoming quarter. And the business generated solid cash flows from operations, about 26 million for the third quarter and over 85 million year-to-to date.

So with that I'll now turn it over to Jim for a final recap. Jim?

Thanks, Maria. Okay. So, let's have a little recap here. First, strong sustained performance of all the major parameters of the business, revenue, earnings, margin, cash flow, product mix, business base, visibility. Secondly, continued integration progress in synergy coupled with an ability to build for future levels of growth. Increasing customer interest at higher levels resulting in increased activities that I think was characterized by industry and geographic diversity and balance. Broad-based adoption and accelerating interest in our multi-physics offerings. And then finally, a rapidly expanding product portfolio augmented by long-standing partnerships and new ones, relationships in technology, distribution and customers.

Long-term outlook stays bullish for the remainder of 2007. We're raising our estimates from the last call based on the newest data. We anticipate a good Q4 performance, even when compared to a very strong Q4 in 2006. We expect the non-GAAP revenue in the 99 to $101 billion range, with the non-GAAP earnings in the $0.32 to $0.33 range, as Maria just went over. For 2007 fiscal year, our guidance for non-GAAP revenue increases to the range of 375 to 377 billion with non-GAAP EPS increasing to the $1.22 to $1.23 range. For 2008 we're envisioning a growth in the mid-teens, 14 to 15% range of 425 to around 432 million with earnings in the range of $1.39 to $1.42, or about a 16% increase. As I mentioned, we're accelerating the build up of our customer facing teams and our business infrastructure, but we're going to continue to monitor the marketing -- market factors out there as we've demonstrated for the past few years.

So, that's basically the recap, and with that, we're now prepared to respond to any specific questions you may have.

(OPERATOR INSTRUCTIONS) Our first question comes from Richard Davis, Needham & Company.

Hey, thanks. Jim, I'm just trying to think about kind of where the market is in terms of how corporations, how companies are buying the technology. Is it still a technology sale or do you see -- there's some firms that are really pushing kind of a PLM style interface where they interlink all their applications, or is it just each buyer is a little bit different? In other words, kind of where is the market in terms of adoption and that thought process?

Well, each -- if we used a football kind of metaphor, I'd say we're probably on about the 35 yard line of market, not even to midfield on the market potential. To answer your question -- I mean, every buyer is a little bit different. However, we do see it they are kind of like major clumps. There's still a group that's still from a legacy standpoint or even a current using standpoint. It's a technology sale. And with our base of technology, we normally do okay with that. There are some that are doing -- that look at an overall more of holistic approach to it. And of that, some of those stem around PLMs, some draw distinctions between what happens prior to the life cycle going forward. And as such, they have kind of different adopting patterns. We do see that there are higher levels inside the -- in the Company there's a convergence between the IT infrastructures that have been increasing over the years.

I think some trend that we've been talking about over the last few years is, these don't tend to be as much the big lump sum commit for the next 20 years kind of implementations. But once you've built trust up in the customer, you'll notice there's a fair number of these names that probably two or three times a year for the past few years we've mentioned them. And they are just continuing to roll that up in almost a continuous fashion as opposed to a fairly lumpier granular fashion, which is, I think, one reason why we've been able to maintain trajectory. There are some different clumps. One thing we have seen, though, I think is probably the most appreciant, is that an awful lot of some of the major companies are instituting initiatives for, specifically, the role of simulation, and what it does in terms of verifying designs early on. That's probably one of the more encouraging things we've seen as people have started to get on board with that over the last couple of years in particular.

Got it. And then the follow up would be, different from the first question, but a lot of companies particularly in the cad business really struggle in Asia with software piracy.

Yes.

How do you guys handle that? Is that an issue for you? Just kind of some thoughts on that.

I think it's an issue for everybody. It does happen. We occasionally see it show up. When we see it show up, we'll mention whatever web site it's on. We'll work with the basic authorities. We do take our intellectual property very seriously. What we found in increasing amounts is that in these major markets, when you consider how much we put in R&D, we are coming up with fairly significant releases every few months, every year. And as such, by the time some of these things are cracked and put on the market, they may already be a release or two behind. In general, most viable concerns, or let's say, most people that have the money had the money in the first place to spend on it, they are interested in making this part of the fabric of their company going forward.

So there's probably a whole layer of it that's invisible to us. There's probably another layer that we do see. When we see that, we take action. In general, we are seeing pretty across-the-board sweep in terms of when major companies go mainstream, they definitely want to utilize us. In general, they have got a lot of highly trained engineers utilizing this, continuity becomes an issue for them also.

Got it. That's helpful. Okay. I'll turn it over to the next caller thanks.

We'll go next, Dan Cummins, Banc of America.

Hello?

Yes, hello.

Yes, okay. Yes.

Sorry, yes, this is Dan Cummins. Jim, I wanted to just ask a little bit about end markets with respect to, for example, some manufacturing end markets that might be under some stress next year. At least one of your logo customers has been in the news with a caution -- cautious outlook. Can you go through the phasing associated with changes in their product cycles with respect to demand for your products? And then just in general, mixed terms, I heard you loud and clear on energy. But maybe, can you give us some idea, some other verticals that are going to be meaningful above or below where they are now in terms of current growth rates?

In general some of the things we've seen in electronics and in medical, if I just rattle a couple of others off where we've seen emerging trends. You think about in medical. Medical is one of those things where you've got to be like aircraft engines. You've got to be like 99.999% right. 80% of the right answer is just going to be a recipe for disaster. So those are the ones that we tend to do fairly well with.

With regard to, I think your first question was related to around how other customers are facing pressures. In general this one is a mixed bag. I'd lump them into two camps. There are some that just tighten the buckle and they do, in fact -- they don't hunker down but they do really start to watch every expenditure more closely. It does happen, it's happened every year that I've been here. However, I would say that, in most companies, unless they are planning on turning out the lights in five years, they have an ongoing stream of innovation going forward. And they are working at new breakthroughs that can allow them to drive the top line and be viable for the next few years. That's, quite frankly, really in our sweet spot.

So we found it happened -- basically it happened in the 2000, 2001 kind of that tough economy back then. We'd have some that would kind of slow down a little bit. We actually had some that even as they were starting to reduce inventories and reduce factory turns or having temporary furloughs, they were actually investing in more software at that exact same time. It's tough to say how any one company will go. But in general, most companies are continuing to try to keep that research going on, even if they may be controlling the flow of inventories in manufacturing progress. And again, depending upon the internals of the companies or the velocities of the companies, some may actually really put the reins tight on spending, and some, I wouldn't say they opened the flood gate but they kind of keep more of a status quo out there. But that's probably from a holistic standpoint, what we see. Does that cover you or not?

That's perfect. I wanted to just ask generally about the electronics exposure. I've got that at something like high teens. Can you just give us a sense whether the exposure there is to process equipment and fabrication or more towards the end markets associated with electronics?

Well, unfortunately it's that great universal answer, it's both. But at the end of the day, a lot of it is driven, I mean, a lot of it ultimately gets driven by the end user demand. I mean, you look at what's happening with any kind of electronics, they are shoving more functionality with it. It's going to smaller cases. There's more regulatory scrutiny being put on things. So you put all of those things together, and it tends to drive a pretty high demand. And it is for both industrial usage and user consumer markets.

And I guess the other thing is, that you look at, in addition to what I just said, these things are -- they hit the market and they are almost obsolete in three or four months after you hit the market. You just can't spend the same amount of time getting them to market as you once did. You also, definitely, can't be wrong or have an oops at the prototype stage. That's really is the -- that's really the basic thesis.

Thank you.

We'll go next to Philip Alling, Bear Stearns.

Thanks very much. Jim, initially just wanted a clarification with respect to the deferred revenue balance. Did you say that was 115.3 million or 113.2?

Well, again, general, I think specifically what I said, if I did, I misspoke, I said total deferred revenue. On the balance sheet I think there might be a slightly lower amount. What you have to realize, it probably is around 113 million. However, some of the orders we came up with probably -- well, the 2 million you might see as the differential, really represent longer term liabilities, because they represent business intake that was taken for business out beyond the '08, '09 kind of time frames. And as such, it just gets classified different. However, it is still a customer commitment with purchase order behind it and things like that. It's just the way that it shows up. For instance, I guess by one year it can't fall into current liability. It becomes a long-term liability when you combine the two of them the math will work. Is that right, Maria?

That's correct.

Okay. I'm basically still a recovering engineer, so I'll check with my financially astute side kick.

All right. Thanks for the additional commentary there. With respect to my first question, as far as the relative strength of the paid-up licenses in the quarter versus the lease deals, is that what you would have expected? And then sort of just as a follow on to that, what are your expectations with respect to lease and maintenance bookings? Would you expect to see normal seasonality there in Q4 and Q1? Which, have been the past--

I'd expect normal seasonality first and foremost. I think in essence if you tried to net out everything, what we saw was the lease business came in about as we expected. The paid up revenue is where we saw above what we expected, which also is what comprehends why we saw more revenue in total, why we had the overachievement on the revenue side of things. In general that's not too surprising, because when we do have those upticks it's driven by increased customer demand. Most of the time these are people that have already started to invest for the long-term and they are just accelerating their ability to acquire the value from it. So I would expect that most of the time you see the over-performance. That balance is going to be in the pay up line.

Would you be able to provide any color for investors as far as what expectations should be, as far as the relative mix between paid up license going forward and lease deals?

No, I think what we've been guiding to the last few quarters and what we talked about the year-to-date is and things like that, I think you're going to see around the 40%. It's going to dither between the high 30s low 40s, but it's going to be right in that level. Even then, we didn't see huge swings. But even a small swing in increase in the lease space can have behind it quite a few licenses because of the financial differences in the lease payments.

Okay. Well, I'll circle back into the queue but thanks very much for now.

We'll go next to Mark Schappel, Benchmark.

Hi. Good morning.

Good morning.

Nice job on the quarter. Jim, first question for you, looks like a neat little partnership you announced recently here with a company called Network Analysis. I was wondering if you could just give us a few more details on that partnership and specifically what it brings or what additional capabilities they bring to ANSYS?

They're basically just a network, there's a network of partners that we're always doing. This was a smaller technology one. It definitely brings in a different kind of different kind of solution capabilities. We're always looking for partners to work with. It works within our work bench infrastructure. Like many of these, it's not material in and of itself, but when you look at the number of technology partners that can plug into the work bench, as well as its ability to fit into a broad range of IT infrastructures, that's the case. In general we talk about simulation. It's not any one base of technology, it's a broad range of capabilities that can predict the performance out here. That's just one aspect. That's just the final aspect of it. Not financially material, but it does allow for solution of a much broader -- of a somewhat broader range of issues for us.

Okay, great. You also mentioned in your prepared remarks, the term you used was infrastructure improvements in Japan in the quarter. I was wondering if you would elaborate a little bit?

Yes. Thank you if they sounded prepared. Probably they weren't. I would say that, in general, with this infrastructure -- with this integration, it's not just a Japan thing, by the way. First of all, we had to do some significant work to bring two different reporting and financial systems in the back office together, and we've made incredible progress on that. If there wasn't we'd have a lot of trouble with our reporting results. We wanted to bring the two customer bases together. That means bringing together customer relationship management systems together. In Japan, we have -- in Japan and other parts of the world, specifically now we have a larger employee base. We got past that -- past that critical mass. So we had, in terms of how we deal with the clients, how we deal with finance, how we deal with legal and contracts, how we deal with a much broader employee population. We needed to build up those capacities to allow the customer facing organizations to function on what they do best. So we've got other places in the world that we had to do that.

And then finally, throughout the world, you look at the size of our development organization and how it's spread out, it's actually quite powerful. But to bring that power into full harness, we have to build up the communication and networking infrastructure and the bandwidth that allowed those people to work. Because we're now supporting and developing 24 by 7 even on the same projects. So that's all the foundational activity that went on corporate wise. But then in remote geographies where all of a sudden we had much larger employee bases, building up that people meets technology meets customer infrastructure was something we had to build to break some of the log jams. And we made a lot of progress in that Q3, but we still think we have to harvest a lot more results in terms of business results.

Okay. Thank you. I'll let somebody else get on.

We'll go next to Greg Halter, Great Lakes Review.

Hello. Wondered if you could comment on something I read in, I think, one of your magazines. The engineering and knowledge manager programmer offering, what you envision the Company to be able to obtain out of that offering?

The primary thing is, there's a lot of companies out there dealing with data management, they're keeping track of a lot of snapshots, almost like keeping a family album of data. In general, we were in behind as not to create another one of those, but actually to be able to manage the trajectory of data and the generation and synthesis of knowledge as you go through there. Because, as we're running all these simulation one, yes, and keep in mind, a lot of these simulations are parametrically based. Not just parametric on geometry but parametric on all the environmental assumption that is go into them. While being able to infer that and be able to allow people to leverage and utilize that data has been -- that's been one of the predictable shortcomings is more and more people have been using tons of simulation. It's creates a lot of data. That data, after it gets looked at the first time, we want to make sure it's a highly leveraged asset as opposed to just piles of clutter.

And that's really what the entire drive of that is. So being able to facilitate knowledge, capture and transmission, as well as use it as a bedrock for process, basically process evolution within our customers. Because, in essence, now that they are using tools in ways they weren't using them ten years ago. It might be that some of the processes that they used ten years ago also need to evolve. This is something to help facilitate that.

Okay. Thank you. And secondly, looking at where your cash is, if you have any outside of the country. I don't know if you do or don't. But if you do, are you having any trouble getting that out of the other countries in order to pay down debt or whatever the case may be?

First of all, I think we're using the cash flow pretty efficiently to pull down debt. Secondly, to answer your question, yes, we do have cash by history and by necessity in other foreign jurisdictions. In many cases we need to keep some of that expatriated to support operations and meet obligations there. The other thing is, if you talk about difficulty, the only thing I can say is that the cost of trying to repatriate some of that capital just isn't anywhere near worth the benefit of having it here. So the balance of having that all there and even in some cases the inherent hedging that can -- dealing with currency that can happen there, given our global distribution is a very prudent thing. I'd say it's something we're managing but it's not an issue we're trying to recover from.

Okay. Great.

Maria may have some additional insights on that though.

No. Excellent answer, Jim.

Okay. Thank you.

You get paid to say that. (laughter)

We'll go next to Barbara Coffey, Kaufman.

Hi there. Could you just give me a bit of a profile, because, historically you've had a bit more perpetual licenses and now with Fluent you have more lease clients. Is there really a profile of user that prefers to have a lease software with you rather than a perpetual or is there -- a bit more profile on who's doing what and why?

I'd say the main profile, actually this kind of links to one of the earlier callers questions. First of all, from our standpoint, there isn't a predetermined outcome we want. For years we've been talking about we make it sales force neutral, customer nut -- they can base it on the financial realities. [Fuller] traditionally had more of a lease based. Historically and sustained at an earlier time of it's standpoint. We still support it. But I think it's more emblematic of technology buys versus more strategic buys. So why there's not been any attempt or any real visible outcome of sweeping changes in that, we have seen that as some of the major customers look and say, okay, we view that ANSYS as a viable entity, we know this is a long-term direction we want to take, as they go through that process, many customers will look at it and say, oh, this makes more sense to own versus lease. If you're going to hang onto your car for 20 years, it may make sense to buy it versus leasing it, for instance. It's more of that kind of thought process. By profile, does that give you --

I didn't know, for instance, in the fluid world if the design cycles were more episodic, and therefore required a more lease arrangement rather than long-term?

I don't think that's the issue so much. If there's any endemic quality to a difference in the fluids businesses, because of the complexity of it, maybe in terms of a technological maturity it maybe lags the other parts of our business a little bit, just as the mechanical business probably lags the electronics circuit design kind of stand point. And as such, there's a lot less, let's say permanency or stability. When I say stability, it's not like it's plateauing out. People expect it's going to continue on. And sometimes that supports more of a lease arrangement.

Thank you.

We'll go next to Tim Fox, Deutsche Bank.

Good morning still.

Good morning.

First question was on a comment you made, Jim, earlier about possible expanding products into the channel. I was just wondering if that was just a general comment about the capacity there or if you have some specific product categories that you are contemplating entering more aggressively into the channel?

We have, basically, philosophically, we would like all of our channels to be able to sell all of our products. However, what that means is they have to provide value and growth in addition to ANSYS. They also have to maintain our pretty astringent ISO 9001 standards, in terms of a certification process. Do they know it. Can they provide quality support to our customers and the like. Obviously it takes a little bit of time to learn new technologies and to go through the certification process. Also we have some channel partners that are a little smaller. We've got some that are very large. Some of our largest ones are already running with the ball. Some of the other ones aren't moving along that lines as quickly or don't have that expertise. So all I'm saying is, if this is a multi-year kind of trajectory, where it provides capacity for us to grow with channel that we already have good business and personal relationships with. So as such, it only provides additional upside capacity for us. However, we'll only do that in a way that maintains the quality of the technology and the business relationships that we have going forward.

Okay. That's helpful. And my follow-up would be, around Europe we've seen several of your broader peers deliver pretty good results in Europe. I was just wondering if you could comment if there's anything in particular in Europe that's going on, whether there be pent-up demand, vertical specific demand to drive that strength in Europe and do you see that continuing in the near term?

In the near term we see it continuing. Our performance has been strong in Europe, has been for a while. We continue to see that going. That's also with our without currency affects and we've been maintaining that kind of relationship. I don't see any fundamental differences. Sometimes there's a little bit more of a longer term perspective in some of that customer basis which makes a difference. And the other thing is, sometimes I see a greater tendency toward a consortium kind of spending. So it's almost like demand aggregation. So for instance we mentioned in previous calls the [Vietair] project in terms of many entities coming together and saying we're going to pool this thing. And then, when we win an engagement like that it percolate to other things. We've seen similar other standpoints, in terms of medical research and other things like that. That's not a major difference but it's kind of a maybe a -- it is a philosophical factor that does work out well for us.

Great, thank you.

We'll take our final question from Greg Halter, Great Lakes Review.

Yes, given your fine job on reducing debt, as well as integrating Fluent so far, just wondered what your outlook is for the acquisition area and/or a share buyback?

Those things, they are not programmatic, but they are always on that list of things that we're considering. Basically what it gets down to, first and foremost, anything that drives shareholder value. It is kind of a mantra but I don't mean it to just be a hollow one. So first and foremost, we continue to -- we've done this for a decade, we continue to maintain relationships with a broad range of potential partners out there. Sometimes those are technology partnerships, sometimes they are OEM relationships. Sometimes they turn into acquisitions. We're more worried about building up that network of relationships and getting to know one another things out of the way, build business trust and hopefully provide value for shareholders and customers along the way. We've continued to do that. I have to admit that over the last -- over the previous year, we were making sure we did a good job on trying to bring together the recent [Ager] acquisition we did, getting those business infrastructures into place, actually buying down the debt, which we historically did not have. So it wasn't like we were -- that we were going in full bore but we were doing all the preparatory work for a whole range of relationships that might ensue.

So that almost brings us back to the same point we would have been at three or four years ago. We're still always interested in any kind of partnership that helps us accelerate our vision faster than we can percolate and grow it internally. We're primarily looking at anything that does accelerate that vision but also makes business sense. We're continuing to progress along those things. I wouldn't be surprised if it's the same thing we've been talking about for years. I'd expect over the next couple of years and over the next five years. That answer will probably be the same one. I'm not saying that to be cryptic. It's just absolutely the way we work.

Okay. I presume there were no share buybacks in the quarter?

None.

There were none. That's something that we've continued from time to time. And again, that's driven totally by a function of the balance sheet and the possibilities of shareholder value on that case.

All right. And one last one, relative to Fluent, I know you're pretty far along on the operational integration, but where do you think you stand relative to the sales integration?

Actually the sales integration probably was the first one that we jumped in on. And the primary issue was that we were just not going to allow customers to be confused by dueling business cards out there selling solutions. In fact we mentioned that on every call since the acquisition. We had our customer facing organization put together day one. Now, so that's been from the various phases. We continued to evolve and look at the relative strengths that came from each model and take the best of each of those. To continue to evolve the relationship. But we still had one customer relationship going forward. The only minor footnote I'd put on there, was again, linking to is something that was asked by an earlier caller is that sometimes if you're looking at the indirect channel and like, there are things we have to do from a timing standpoint to get them certified, have their business cases put in place and make sure we'll maintain that quality. That's probably about the only place where sometimes we might have minor gradations. Those really are the tail end of the bell curve.

I guess, maybe, I should have said the cross-selling effort.

I'm sorry, okay. My bad. I missed that totally. Well, again, we've already seen those things. I think that's one. Probably maybe -- I could go through a bunch of anecdotal aspects, but you might notice that already we've been reporting, let's say, business levels above what either company was on a much smaller denominator standalone. I think that that, at least points toward the fact we've started to see what could be the tip of an iceberg long-term, in terms of that coming together. Anecdotally I could -- we could mention a number of customers where we have had that, those crossover sales.

That is helpful. Thank you.

Thank you.

At this time lied like to turn the conference back over to Mr. Cashman for any additional remarks.

Okay. Well, actually, I think with those questions we covered a broad range of things. Appreciate that. I guess to close, all I'm going to say is we're going to continue to focus on execution. It's been a long-standing standpoint. It is an important aspect. But I have to characterize us as being encouraged by the response that we're seeing to our product vision and offerings. I'll just say we're committed to, and we take seriously, the strong combination of our business model, the customers that have been with us for years and continue to grow with us, the channel partners that have been with us for years, and continue to grow with us, the great technology base we have, which I feel, I'm biased, but I feel it's second to none in our area, and also we've just got a ton of talented and highly committed employees. And this combination has basically allowed us to have the sustained performance we've seen over a number of different economic clients -- climates. We're very appreciative of this.

In summary, we have a lot of opportunity in front of us over the next few years. But we also have a lot of work to do to reach that full potential. I'd like to thank those customers, those employees and the overall friends that we've had that have helped us to this point. To all of you on this call, we'll see you next quarter, thanks a lot.

This concludes today's conference. Thank you for your participation. You may disconnect at this time.