ANSYS Inc (ANSS) 2010 Q3 法說會逐字稿

Good day, and welcome to the ANSYS third quarter 2010 conference call. All participants will be in a listen-only mode. (Operator Instructions). After today's presentation there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

At this time I would like to hand the conference over to Jim Cashman. Mr. Cashman, the floor is yours, sir.

Thanks, Mike.

Good everybody, and welcome to the ANSYS call for Q3 2010. Of course, with me, as always, is our CFO, Maria Shields. Again, I'll let you know that all the Q3 and year to date revenue detail by geography and category have been made available on our IR home page, so we are just going to use this time and our commentary to focus on key operational results and what we see as the major business drivers. Maria will then update you on our income statement, balance sheet, cash flow highlights and the like. And we'll then wrap-up with an update on our current outlook for Q4 and the remainder of 2010, as well as a preliminary look at 2011. After that, we'll be happy to respond to any questions. So as always, let's get started.

Maria, could you start us with our safe harbor statement please?

Certainly. Good morning, and again thank you, everyone, for joining us to review the highlights of our third quarter results.

I would like to remind everyone that in addition to any risks and uncertainties that we highlight during the course of this call, important factors that may affect our future results are discussed at length in our public filings with the SEC, all of which are also available via our website. Additionally, the Company's reported results should not be considered an indication of future performance, as there are risks and uncertainties that could impact our business in the future. These statements are based upon our view of the world and our business as of today, and we undertake 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, a discussion of the various items that are excluded and a full reconciliation of GAAP to comparable non-GAAP financial measures are included in this morning's earnings release and related Form 8-K.

Jim?

Overall Q3 was a good quarter for ANSYS with reported results in the upper half of the range on revenue and out performing guidance on EPS. I'll mention, as always, the numbers that we are discussing are non-GAAP and this is in our historically consistent fashion. Our Q3 results reflect moderate improvements in certain geographies, tempered by traditional Q3 seasonality and a bit of continued caution in customer sentiment spending patterns. We also saw ongoing penetration into existing accounts, strengthening of new and renewal business, and growth in constant currencies across all our major geographies. In particular, our Asia-Pacific area led the way again this quarter with a growth of 20% in constant currency.

During Q3, we had six seven-figure customers with about 23% of these deals contributing to new business for the quarter, but the bulk of them toward building the deferred revenue balance to $187.5 million. Both our direct and indirect businesses continue to perform well, with a 73%/27% split for the quarter and year to date. This is a little bit more in favor toward the indirect, but it is indicative of two primary factors. First of all, the gradual certification of the channel into some of our newer products. And then also the positive contributions of the channel partners to the Asia-Pacific area of our business which, as I mentioned, had the strongest Q3 growth.

As targeted, the non-GAAP operating margin for the quarter was strong at 49%. And we'll continue to focus on our talent and infrastructure investment efforts with a target in the upper 40s for operating margin as we have been discussing for the past couple of calls here. Most major aspects of the business performed well with all of our geographies, major geographies, at least, showing growth during the quarter. Albeit at more subdued rates than we'd obviously like. I mentioned earlier the GIA, the Asia-Pacific grew at 20% in constant currency while Europe grew at 9% in constant currency, and North America grew at 2%. But there is some specific commentary I want to mention and I'll get to that in a couple of minutes.

We saw continued expansion in many of our major accounts, balanced by the addition of new customers. Equally important our recurring revenue base continued to be strong at 71% for the quarter and 70% year to date. The growth in business intake was well in excess of revenue growth at 17% which is a good leading indicator to us, and it contributed to the strong deferred balance. Additionally, we saw progress in cross selling activities, and in building the pipeline. And as we've discussed on previous calls, this is something that we will continue to cultivate over the next few years.

Now, we'll take a closer look at the business results from the usual broad perspectives that we look at , category of business, geography, customer info, product and the like. So we'll start with category of business first. And overall, our revenues in the third quarter continued to follow similar contours as the two previous quarters, and were fairly consistently spread with a 33% lease, 26% paid up licenses, 38% maintenance and 3% service. We saw another quarter of healthy increases and paid up licenses, up 19% in constant currency. Our maintenance business also continued to grow, up 11% in constant currency. While our blended maintenance renewal rates have now returned to the historical mid 90% level. A continued expansion in our major accounts provided contribution to new license revenue, as well as the deferred revenue balance. And of course, as I mentioned I think a couple of minutes ago, we had six, seven-figure customers this Q3 compared to two a year ago. That is a natural progression of our expansion in even our largest accounts. Our strong repeatable business base grew to 71% on a larger base of business, and this compares to 70% for Q2 of 2010, and to slightly higher 73% at this time last year, although that was on a much more subdued, paid up base in Q3 of 2009.

Looking at revenue from a geographic perspective, revenue increased by 2% in North America in Q3, while our sales order growth tracked in the 6% range. Now, a significant element, and I said I wanted to comment on some things here, a significant element in this apparent low growth is that we, as a company, recognize revenue based on where it's actually utilized. And many of our historically based US companies have been expanding globally to support their customers, while also trying to tap into pools of new engineering grads that actually are relatively low in the US. And because of this, you'll see a lot of the things that traditionally would have been in the US migrating over to other regions where that usage is happening. But with that in mind, major orders in North America came from a mix of customers, including General Motors, UTC, Delphi, P&G, Trane, US Army, Shell Oil, Lockheed Martin, the US Department of Energy, Halliburton, Intel, Corning and Rolls Royce, to name a few, at least, of the ones that we are allowed to mention. Across these accounts we saw a strong mix of good and strong maintenance and lease renewals, as well as a respectable new business component.

Europe continued to show growth, despite some talk of economic challenges in parts of Europe, and some similarities to the cautious spending tone that we saw in North America. Now, there also were currency head winds, so the overall growth was 1%. But this translated to 9% in constant currency. Germany continued to lead the way with a 15% revenue growth in constant currency, actually followed by the UK coming back with a 13% growth in constant currency. The largest deals in Europe included new and renewal business with Alstom, Rolls Royce, Siemens, Ferrari, Skoda Auto, Arriva, Raphael, Shell, Luke Oil, Volvo, to name just a few.

Finally, our Asia-Pacific area was our strongest performing region again in Q3, growing 26% overall, but we actually had some tail winds there so that translated to 20% in constant currencies. Asia-Pacific benefited from stronger economics and an influx from the global multi-nationals that I mentioned a little bit before. But also remember that for the last few quarters we have been talking about some things we have been doing to strengthen that region and we are starting to get some traction from that also. Key customer engagements in the region there included Samsung, Petrobras, Ishikawajima, RHI, Hitachi, Mitsubishi, Toshiba, Toyota, Honda, EXA, Taka, Mitsubishi Electric, SIMS International and Canon, just to name a few. But I think one thing is, from this global list of major orders, and it's also evident in the smaller ones too, we saw continued improvements in a number of industry sectors. Now, a few stood out in particular though. In electronics, for instance, our cross selling has picked up and there's been a lot of growing interest across a number of lines. One example is the role that structural reliability and thermal management products have played in gaining traction in traditional electronics accounts for us, where traditionally signal integrity, RF and microwave effects dictate customer success. Likewise, the ANSYS mechanical and CFD technologies have increased their penetration into the electro-mechanical and mechatronics accounts which have been growing nicely for us.

One other aspect is high performance computing for broad scale optimization and efficient solution of large models continue to be strong, as we have been talking about, and the future trends are also looking quite positive. When you look at increased data rate, signal integrity, power efficiency of high speed electronics, these all continue to drive large sales within consumer electronics in the semiconductor industries. And, of course, from a global standpoint, we see that these are all trends that are continuing to surge.

Another sector, we also had several significant sales in the materials and chemical processing industries this quarter, and are adding several new customers in addition to, of course, expanding our relationships with a variety of process equipment companies, adding to their simulation capabilities for product optimization. A lot of these are focused around energy efficiency performance and product quality. I think when you see what's going on with that, you read the headlines every day, the new emphasis on safety and energy usage and pollution, there is a growing opportunity for ANSYS as the new methods for product development and mining practices are embraced. And focusing on these a little bit more, the energy and clean tech areas a sector that we have been talking about for a couple of years now, and there is continued momentum in spending in all forms of energy acquisition and optimization, a trend we have been talking about for a couple of years, even though the mix within that envelope may change between different energy types. So whether it's conventional petro, nuclear or alternative forms of energy, they are gaining traction. For example, new deep sea drilling regulations are requiring more traceability, reliability, redundancy, and it basically increases the demands on engineering design which obviously creates an up draft for the need and use of simulation. Again, we don't see any indicators that things are going to slow down in this sector any time soon either.

We continue to focus our efforts and investment on penetrating our existing and expanding customer base which is already quite broad. The pipeline in new opportunities continues to improve. As I mentioned, the business intake is even outpacing the revenue which is showing some of the positive signs we talked about earlier. Bottom line is, there is little doubt of the long-term opportunity, but again, in the short-term, even with increasing interest, the macro economy in many geographies is still recovering slowly and customers are still remaining quite diligent in their investment decisions. So w try to factor these realities into our guidance and business planning and, of course, we'll always continue to endeavor to do so going forward.

From a product perspective, the high-end sales continued to lead the way with, actually, fluids, electronics and mechanical all positively contributing. As we mentioned last quarter, we are continuing to see increased sales of parallel licenses in our high performance computing offerings, which basically does support the premise that with the ever-increasing pressures our customers are facing, they just simply can't compromise on speed, scope and, most importantly, the accuracy or the quality of their solutions. From a pricing perspective, overall, ASBs for the quarter were stable, really, both at the high and low ends.

Now, last week, we announced ANSYS 13, the upcoming release of our engineering simulation technology suite. The software reflects basically, basically I have to say, an ongoing, our 40 year commitment to help optimize customers' product development processes, focusing on reducing time and costs needed to foster the product innovation that our customers need. It is slated for first customer availability later this year. If you allow me to drop back into being an engineer for a second, the advanced technology behind ANSYS 13 includes just hundreds of new features that make it easier, faster, less expensive for users to bring new products to market. And with a high degree of confidence -- this is the key part -- a high degree of confidence in the ultimate performance that those products are going to achieve. I would probably lump these into three major area. First, and you've heard me talk about accuracy for awhile, the greater accuracy infuse all of our methods. It is so key because, as engineering requirements and design complexities are increasing, simulation software must produce increasingly accurate results that reflect the changing operating conditions over time. ANSYS 13, it features advanced electromagnetic transient solvers, large EDI simulation capability for fluids, and allowing structural 3-D rezoning, all of which helped produce higher fidelity results in very dynamic and changing simulation environments. These are just a few of the new features, among others, that address that.

Second of all, the higher productivity. We've talked about being able to help facilitate people's migration into a broader use of simulation technology. And this higher technology is really predicated on the adaptive architecture we built. So, again, ANSYS 13 software contains dozens of features that minimize time and effort for product development teams when they are investing in simulation. Just as an example. The product designs grow in size and complexity, and consideration of a single physics like the historical norm of decades ago, is no longer enough. ANSYS 13 basically makes it easier for users with different engineering specialties to work collaboratively and exchange data, and do real world simulations of complete products across all the things that used to be individual disciplines, and that is something that is really gaining traction also. Finally, performance innovation via software and computational power, ANSYS 13 can provide speed up ratios that are just dramatically greater. We're not talking percentage points of increase but multiples of speed up ratios that are dramatically greater than the previous software releases. What this means is these complex simulations can be accomplished more quickly and efficiently, speeding up product development and market launch initiatives across our customer base.

So in short, overall, ANSYS 13 contains so many more things that we could talk about from a technology standpoint than we can cover on any one call, particularly one of this nature. So I basically would encourage all of you that are interested in some of the details on this to visit our website to learn more.

So, with that high level, I'll now actually hand it back to Maria Shields, our CFO, to provide you with some additional color on the quarter and various aspects related to

Thanks, Jim. Overall I would summarize Q3 as one of continued business execution, supported by improving market conditions in certain geographies on one side of the equation, countered by our traditional Q3 seasonality, ongoing volatility in foreign currencies, uncertainty of deal closing time frames, and a general sentiment of customer caution on the other side. Despite all these moving pieces we continue to deliver performance on both the revenue and expense side of the equation. Top line growth drove strong growth and operating margins of 88% and 49% for the third quarter and year to date. The third quarter results were adversely impacted by about $1.3 million in negative currency at the revenue line, and $700,000 at the operating income line. And on a year to date basis the currency impact was a net positive $1.2 million to revenue and $250,000 to operating income.

In general, despite the currency volatility that we have been seeing throughout the course of the past year, our natural hedge, that is the partial offsetting of global revenues and expenses, has continued to provide us somewhat reasonable bottom line protection from a currency risk perspective. Looking ahead into Q4 and the full year 2010, we continued to project a non-GAAP gross profit margin in the 88% range, and operating margins in the 49% to 50% range. Our Q3 effective tax rate was 30% on a non-GAAP basis which was below our original outlook for the quarter. A number of factors influenced the lower rate, including adjustments for some completed tax audits in the quarter and for the filed tax returns. As we mentioned on our last earnings call, we were able to finalize work on an international business planning initiative, which was the restructuring of our Japan operations. The merger of our Japan subsidiaries resulted in significant cash flow benefits during the quarter of about $11 million and will continue to have a very meaningful impact on cash flow and income tax expense over the next several years. The overall positive impact on cash flow over a five year period is estimated to be approximately $45 million to $50 million. However, there will be a significant adverse impact on Q4's cash flow in 2010 of approximately $60 million.

Income tax expense will be reduced by approximately $2 million in the fourth quarter, and by $7 million to $8 million in 2011. And the estimated impact of the merger on cash flow and income tax expense for each year through 2015 is detailed in today's earnings release. For those of you who are interested in a more detailed explanation around the merger, I'll point you to the Form 10-Q, which we will file later today, and if you still have follow-up questions, reach out to our IR folks and we can try to clarify. But simply put, this was a good thing.

For the fourth quarter, we are forecasting a non-GAAP effective tax rate of about 30% to 32%. Our estimates for 2011 reflect an effective tax rate of approximately 30%. Both forecasts include the impact of the Japan restructuring benefits. Consistent with what we have been saying all year, we are not assuming that the R&E credit will be retroactively reinstated. To the extent it does happen, we estimate it will have a positive impact of less than 1% on the tax rate for 2010.

Taking a look quickly at cash flow and balance sheet highlights, simply put, we had another very good quarter. Cash flows from operations increased to a new quarterly record high of $72 million, a 112% increase over last year's third quarter of $34 million and year to date operating cash flows are at $192 million. This positively contributed to our total cash and short-term investments balance rising to about $495 million, of which about half is currently held domestically. Our collection efforts continue to remain strong as evidenced by consolidated net DSO at 38 days. In the quarter we paid down about $5 million of principal obligations on the debt. This leaves us with a balance of $165 million and the interest rate for Q4 is at 1%. We had CapEx of $5 million in the quarter and $9 million year to date. And based on everything that we have in our current outlook, we are planning to finish out the year with total CapEx in the range of $13 million to $17 million. Overall, cash flows from operations continue to be strong and the balance sheet is in a good position to continue to support the business for the long-term.

To wrap-up, I would just like to briefly comment on our 2011 assumptions around fully diluted outstanding shares. Currently we are looking at 95 million. And on currency, our outlook for the remainder of 2010 and 2011 assumes average rates in the range of $1.39 to $1.42 for the Euro, $1.60 to $1.63 for the British pound, and $0.79 to $0.82 for the Japanese yen.

Jim, I'll turn the call back over to you.

Thanks, Maria. As we have been consistently saying for many years, the long-term outlook remains bullish. And to summarize, this means that, first, the long-term premise remains intact and the opportunity is there as the adoption of simulation continues to evolve and broaden. And we actually believe and are committed to maintaining best technology to meet those demands. We continue to have a solid business, as Maria just mentioned, with a good foundation of recurring revenue streams, longstanding and expanding basically marquee top level customer relationships. These all combine to continue to generate good net income and solid cash flows.

As I said earlier, but I want to reemphasize, we will be focusing on maintaining strong operating margins in the upper 40s, which reflects continuing to invest in our business. We are going to be building the annuity base of recurring revenues and then expanding at the maximum rate allowed by the macro market conditions. So what do these factor equate to in terms of numbers? Based on our current visibility around sales pipeline, economic trends and markets, and our own internal spending plans for Q4, 2010, we are projecting revenue in the range of $157 million to $163 million, which equates to an earnings range of $0.57 to $0.60 per share. This represents both a tightening of the range and an increase of the mid-point of both revenue and earnings. This outlook does factor in some year end spending but not near the levels we saw in Q4, 2009.

Now, for those of you who may be new to the ANSYS story, it is worth noting that we had an incredibly strong Q4, 2009 as a result of a combination of pent-up demand and year end budget flush, which drove the upside in the quarter. And in fact $8.6 million over the high-end of our Q4 guidance, so we are not seeing that necessarily replicating itself at this Q4. In this climate, there has been much greater variability in the end game of our customers's year end spending patterns. So combining this with our year to date performance, we are refining our outlook for 2010 revenues to be $570.7 million to $576.7 million range. Consequently our earnings projection for 2010 is being raised to $2.05, to $2.08 range.

For fiscal 2011, our preliminary estimates for revenue is in the $635 million to $660 million range, or basically 11% to 15% growth. Non-GAAP EPS increases to the $2.25 to $2.34 range, which also averages out to double digit growth. This basically continues our progression into the mid-teens range, but it comes with a couple of very obvious caveats. First, the expectation for the year is, while it's qualitatively accurate for 2011, quantitatively it can swing as year-end purchases ebb and flow across the year end boundaries of this year, which isn't even over yet, as well as next year. And then secondly it will be influenced by any macro economic swings as the general tempo we see out there is erratic. There is simultaneous banter we get from our customer base of slow recovery, but also with pockets of renewed fear out there. So there could be some obvious changes there as we have seen ups and downs over the last couple of years.

The preliminary guidance with this in mind is cognizant of a number of unknowns out there. Our repeatable business base, our diversified geographic and customer base, deferred revenues have perennially allowed us to weather a wide range of economic situations over many years. And as I mentioned, we will continue, are continuing to ramp up key elements of our business in a judicious manner, particularly in the R&D and sales support realms to prepare us for the longer term opportunity. We plan to continue to do what we have been doings, basically focusing our investments and efforts on growing revenues and strengthening our customer and partner relationships which ultimately generate those strong margins, cash flows and earnings.

With that, we are prepared to respond to any questions that you might have.

(Operator Instructions). The first question we have comes from Steve Ashley of Robert W. Baird. Please go ahead.

Hi guys. My first question is just to follow-up on the North American. Jim, you called out the fact that you saw this situation where US companies were buying your product and maybe, I'm assuming, using that in China to do development, and that ended up just moving dollars from one bucket to another for accounting purposes. So a couple of questions around on that. Number one, is that something that's newer or is it just happening to a larger degree now? And number two, if you had to guess and normalize what the US might have grown, if you just were to have accounted for that as US business, what kind of growth we might have seen there?

First of all, to answer your question, it is not a totally new phenomenon, but it's been a little bit more pronounced over the last few quarters. Again a lot of it is, again, driven by those two factors, one of which is, in many cases with partnerships, sometimes with other companies over there, they've actually grown into that standpoint. So basically growing on that line. And then also being able to get, when they are hiring engineering grads that are going to be using that standpoint, the graduation rates outside of the US are just markedly higher than they are here. So when you are finding talent in that limited pool base, you many times have to go where that is.

I'd say one thing, and this is more anecdotal, but there are some places where even their ability to efficiently use trapped cash offshore is being put into engineering talent, too. So kind of a third factor there. This is very finger-in-the-the-wind, but just anecdotally, I would probably say that North America would have probably been somewhere near the Company norms, in that, if we took on all that in constant currencies, at least, because there also were some shifts based on the currency swings.

Great. And then just very high level, we look at this year, if you look at the full year revenue guided to come in about up 10% next year, the initial guidance for revenue growth is up 11% to 15%, little bit faster. Maybe you could talk about that maybe accelerated or a little bit faster growth next year and what the thinking is behind that?

One thing we said was that from one standpoint there was always that issue of time. There were two factors. One of which was the time and people not wanting to jump off when the economy was very uncertain. The secondary thing is there are a lot of factors affecting businesses that were also very uncertain. People didn't know what the baseline, the operating characteristics would be for doing that, and that could be everything from global tax rates to all sorts of other initiatives. That thing was having a dampening effect. However, there is no doubt there is a huge increase in a lot of different factors that are really driving simulation. First of all, from a product innovation standpoint, you can look at everything from the cost of energy and energy efficiency. So we are talking about renovating entire lines of propulsion systems, be they for cars or airplanes or anything else that just get increasing mileage efficiency. And these are not like little tweaks and improvements in product, but they are actually sometimes generating new families of technology.

Secondarily is, as I mentioned, sometimes it is tough with the graduation rate to find engineers. You have to increase the productivity and the level of those, and this is clearly one form of automation that does that. And then you just look at the general trends that we see out there. Of course, while everybody wants to be more energy efficient, the demand for energy is increasing. You look at the demand, even for information and data, which is driving these new generation of electronics that are much higher gigabit ranges and driving up those kinds of things, which are causing ground swells. So the bottom line is, product innovation, if you look at the companies that are doing well, they typically tend to be the ones that are more innovative. In other words, you just can't hunker down forever in this environment. And if you are trying to get these increasingly complex products out in an increasingly competitive environment, then you've got to turn up the engineering juice, and simulation is one very key aspect of being able to help do that.

Perfect, thanks.

The next question we have comes from Sterling Auty of JPMorgan.

Yes, thanks. I'm actually going to follow-up on that line of questioning in this way. If you look at the guidance you gave for the fourth quarter, the year over year revenue growth actually decelerated every quarter throughout 2010. So even though it may be 10% for the full year, it looks like it slowed down as the year progressed. Why set the initial guidance for a big step up into the teens?

First of all, our guidance for 2010 pretty much tracked what we said at the beginning of the year. It is not so much a function of growth as it is a function of the inversion of the denominator that we saw in 2009 where everything was locked up in the first half of the year, and then there was a lot of pent up things that came at the end and I talked about the flush at the end of the year. So basically our guidance for the year was pretty set and the contour for the year was pretty set and the trajectory we see is a continuation of this, and this just reflects a continuation of that. That is one of those things where you can mathematically tweak numbers and come up with numbers, but you have to look at the intent behind those. If you wind back the clock to what we said earlier, this pretty much tracks along those lines given the fact that 2009 was pretty much an aberration. 2010 had a lot of erratic nature to it. Apart from that, all the things we were guiding to along the way pretty much came to pass.

Then different topic, when you look at the areas of strength in the quarter and the areas that were not as strong, is there any sense, were there any patterns in terms of the lease versus paid up trends in each of those areas?

Good point. Because I know we mentioned that in 2009. We also saw dislocations of that. Which, by the way, also skewed the annual balance. Remember, in 2009, we had some short-term migrations to lease that reverted back, we had return patterns on our economic basis. But in general, in this particular case, I would say that the general trends that we saw before all this turmoil pretty much in place. If you look at it, the least revenue balance hit its normal stride a couple of quarters ago and basically that's continued. I would say that, in general, the companies that are tending to come out of the void a little bit quicker tend to be the more established, leading companies, and those are the ones that tend toward paid-up licenses versus lease. However the lease space for the year continued to grow. It tweaked up so we maintained the base and actually added to it. It is just that disproportionately with the customer influx, we saw the traditional patterns.

Okay. Last question is on FX, in terms of looking out to 2011, how did the FX assumptions actually impact? So how much of the growth for next year is actually influenced from the FX?

Slightly positive.

Slightly positive but generally negligible.

Thank you.

The next question we have comes from Dan Cummins of ThinkEquity.

Thank you. I'll first follow-up on Sterling's question. I'm wondering what's built into the near term assumptions regarding the recovery of perpetual in terms of purchasing preferences? And then I had a question about construction.

Okay. Two major factors predominate in at least the short-term, quicker recovery of the paid up. First of all, as I mentioned, the more innovative customers came out of the bunker. Everybody is spending more diligently. Everybody is really careful and judicious. However, the ones that are driving innovation are coming out, and they are ones that have been longstanding customers that just, they predominate in that paid up license. The second part, quite frankly, as I mentioned, is the Asia-Pacific being the faster growing sector, and the traditional buying patterns in Asia-Pacific is to, when they have the money they spend a paid up license. They don't always count on a continuity of funds across multiple years. Therefore they want to actually have ownership of it. Those particular two factors are the key ones in the short term. And, by the way, those would be very predictable patterns for us. And then you said something about you put a bookmark on a construction question?

Yes, but before I get to that, I would be looking for another maybe $2 million in perpetual this quarter, just given how it has trended, and what I thought you had said something earlier this year that perpetual would continue to recover in terms of purchasing preference. I understand lease also continues to tick up quarter on quarter, as well. I think, to the point that was made earlier, you are talking about an acceleration in growth rate. I just want to try to get at how much of that rests on this rise in perpetual, where you will get cash and orders up front.

It is going to continue to tick up. Also, keep in mind, in general, we are also finding, if you projected things at the beginning of the year, the dollar rates and things like that could also change things. But in general, of course, it's driven by a couple of things. I mentioned, that A, the recurring base continues very strong even on this increasing base. In fact, we have already gotten back to the consistent renewal rates, which, of course, create one base line. But the second one is that the actual license growth does tend to pick up.

Okay, thanks. I just wanted to ask also about the engineering construction vertical. We are just hearing a lot about the adoption of tools applied to building physics. I'm just curious if you are seeing this yet in your pipeline, specifically related to green mandates?

Well, yes. It definitely is. I mentioned for the last couples of years, we have started being included and named to a lot of these clean tech and green tech kind of indices. There is a growing body of experience there, but it is a fairly new one. And obviously, everything from efficient energy management to thermal management of building to radiocity and heat loss and those type of particular things are all particular aspects of that. Apart from that, in construction, infrastructure spending that you hear about might drive different projects. But what is really behind our growth in that area are the renovations of new forms of basically new generations of construction machinery that actually helps build that.

And then, finally, the third aspect is, even apart from green buildings, which also tend to be somewhat unique and nonstandard in their envelope and construction, are these increasing concerns about building safety, survivability in wind, tsunami, earthquake situations, going into areas that are simultaneously, where there is rapid expansion going on, but there is also some of the more dramatic sensitivities to those kinds of issues. And of course that tends to drive it up quite a bit. But that is also a transition from an industry that traditionally was driven largely by an adherence to a published code versus the scientific examination of the individual peculiarities of any kind of building. That is also an emerging society of usage that basically grows along with the traditional code based implementation of building approval.

The next question we have comes from Richard Davis of Canaccord.

One quick question on the numbers and then a more general question. The question on the numbers, you talked about the contribution on the Japanese transaction on the bottom line. Did you mention, I've been running between meetings and calls, but did you mention the revenue impact?

No revenue impact. It is just a tax issue. So it impacts cash flows and the effective tax rate. Nothing to do with revenue.

So it doesn't add anything to the numbers you are posting?

No.

Okay. Got it. Then the other thing is, it's always interesting to talk to these little companies, or these organizations. But have you seen any impact, because they are excited about their opportunities, but like some of these open source solvers like Code AST or Visual FEA, CAE pipe and stuff like that, has that had any impact at all on your business? Have you seen anything?

Negligible. Any time anybody comes out with anything, there's an impact, but it's been quite negligible. I think one of the things is, like most things that are standard and contribution based, they tend to lag a little bit. We are still in a phase where advancement of capabilities, and some of the new innovations are still basically required. This is not necessarily done with a series of little small plug ins that can be done by individual people in the community, but it is also driven by basically being able to create these new solver engines. But I'll tell you one thing that actually has surfaced, because these things have been around for a few years, is that our customers that are basing their product designs on this, they have some pretty stringent quality aspects. They can't afford to be wrong. So basically, some of the ISO quality procedures we have in place are actually pretty critical toward maintaining the customer confidence in the standpoint. So when you get down to it, the relative cost of the software is incredibly minute, compared to the cost of being wrong or a warranty recall or anything like that. So it just doesn't turn out to be a major driver.

Got it. Okay, that's helpful, thanks.

The next question we have comes from Steve Koenig of Longbow Research.

Hi, good morning. Just a couple of finance questions and then I want to ask a question on technology. First of all, in Q3 your intake was higher than your recognized revenue. Was that simply the slight mix shift towards leased licenses in the quarter or were there other factors behind that?

It is leases and text renewals, so orders outpaced revenue and that's what contributes to the $187 million plus deferred revenue balance. And I think Jim also spoke to, I think, the seven figure orders, roughly 23% of them were new business in nature and the rest of them were renewals of either lease or text. So, that's really the gating factor.

Okay. They were renewals of lease or maintenance

Yes.

Okay. Then the other finance oriented question, can you address, either of you, a little bit on assumptions about how we should think about seasonality next year either in revenues or expenses, either with reference to the compares or with reference to the analyst models that are out there? Do you have any commentary you can offer us on that?

I wouldn't see it departing much from the landscape that you see this year.

Kind of an undulating increase is probably how I'd categorize it as we continue to ramp up some of the investments. The revenue patterns are pretty well there, like I mentioned. However, some of the new norms of realities of trans annual migration of license revenue, year end boundaries, budget flush and that like, they still need to be manifest also. But then apart from that, I'd always say Q3 is always the more variant quarter, just because there is a lot of vacant time at some of the companies, and when they come back how much actually gets processed in essentially the September month versus falls over into the October month. Those type of things. But those patterns, in general, two of the three, we've seen year after year and the third one is just one that continues to need to flesh itself out. That third one, of course, being the how do people view their year end budget versus what the upcoming one and what are their prospects going forward. That is more totally macro driven.

Okay, great. Thanks. So it sounds like you don't really have any major issues with the estimates that you see that are out there in terms of them seasonality departing from the current visibility?

No.

No, not really.

Okay, good. Then my last follow-up here, I'm wondering, are you seeing, if not customer demand, are you seeing opportunities for the use of the cloud and doing parallel computing and simulation? Is that a phenomena that you see opportunity in?

We see a longer-term opportunity in that. And obviously, it's something we monitor very closely. However, the one thing is that if you look at the kind of applications that are running there, they are not largely set on sending something massively large out, and then keeping each of the thousand things that are sent out, all keeping track of one another because they're all part of the same simulation. Sometimes people refer to that as the scatter gather mode. If we send out an entire automobile, for instance, for simulation, we have to keep track of the various things. It is not like populating a cell on a spreadsheet, bringing it back and resolving it all. These things all have to work in concert. And that is really not exactly where it is.

However, as I also mentioned, high performance computing has been, since we have released it almost, it's become one of the fastest growing sectors because the ability to harness that computing power in parallel. For us, the good news is, for us, we already did the heavy lifting on the things we would need for the cloud and definitely for HPC, and that's basically restructuring our algorithms, such that they're happy fragmenting, solving their individual bits and coming back together. So that would be the really tough part to tackle if we were surprised by it. So that is essentially what we are running, if you will, in some respects, like in an internal cloud inside a customer's firewall. Which basically relates to a couple of other reasons, in addition to the technological hurdle, why it's been a little slower to take hold. First of all, the burst bandwidth requirements. And secondarily, a little still concern about customer concerns about security and IP protection. And by that, what I mean is it is one thing if somebody intercepts one burst of a little cell of something, that you can't resynthesize it into the total thing. But if we utilized this, the entire product with simulation would be outside in the cloud and therefore, at least conceivably, not practically, but conceivably could be done. And those are concerns. The bandwidth and security and IP. But those are issues I think the industry will clearly solve, as will they solve the other one.

But the bottom line is we are also basically in a situation right now where our code can fragment over those many solvers. And in fact, for years, we have had an offering ourselves that allowed people to utilize it on external networks and submit their standpoint. So we've got the ability to provide that to customers even now. It is just that I think there will be some further advances. So short-term probably nothing in the next six to 12 months. However, over the next few years, I think it will be an increasingly interesting standpoint.

I had a feeling we could get some interesting commentary from you on that issue, so thanks for your thoughts.

(Operator Instructions) The next question we have comes from Ross MacMillan of Jefferies & Company.

Thanks a lot. I just had a couple of housekeeping questions first. Maria, just for clarification, the impact from the subsidiary merger on EPS or net income, are those numbers you've laid out on a non-GAAP basis, or a GAAP basis, or are they the same?

They are both.

Okay. And did you give us what the underlying tax rate assumptions are? Or did you give us what the actual tax rate assumptions are for Q4 next year?

Yes. 30% for next year and 30% to 32% for Q4.

30% to 32 for Q4. Okay great. And then, just so I understand this, you have a large negative impact to cash flow in Q4. And then, over the course of the next five years, you have a positive impact. Is that cumulative positive value above this negative for Q4?

No. It's a net cumulative $40 million to $50 million over the period. So short-term negative, long-term net positive.

Okay. Got it. Understood. So $40 million to $50 million over the five years and then this one time, $58 million to $63 million in Q4?

Right.

Okay, perfect. Then just one for Jim. I wasn't clear regarding the comments on the US, whether you think this is the start of an ongoing trend, or whether you thought this was a one time anomaly. And if it's the long-term trend, what are the implications for investment in the US, headcount growth, sales growth, et cetera? Thanks.

First of all, this is not a one time phenomena. Of course, once you keep recalibrating the denominator, obviously the math straightens itself out a little bit. But the bottom line is that right now, there is two major factors. Right now those other economies are growing currently a little bit more robustly and that doesn't mean that the US won't reverse that kind of trend. However the one trend that may take a little bit more time to sort out, if it does, are the pool of engineering talent that is utilizing the software. And that is one that I've even mentioned in the past has concerned me a little bit more. Because it takes awhile to put them through the entire curriculum and it takes time for them to get experience. And there's a huge void between the current graduation rates of new engineering talent outside this country versus inside. We are down at the bottom, Europe is secondary, and major parts of Asia-Pacific are really putting a lot of emphasis on it. And as long as those trends persist, it will be a difficult thing.

So just, again, tying that to headcount, we should expect to see moderation of growth in the US, versus an acceleration or certainly a higher growth rate overseas from a net headcount this year?

That's probably true, overall if I look at it, but the control volume is pretty much fixed on this planet. Therefore if it moves somewhere else in totality, it's at the same level. So it doesn't create much of an overall -- it basically recreates a repartitioning, a re-slicing of the pie, if you will, as opposed to dramatic changes in the size of the pie.

Okay great. Thank you very much.

The next question we have comes from Brad Reback with Oppenheimer.

Hi, guys, how are you? So following up on Ross a little bit on the hiring front, I believe Jim last quarter, you had alluded to the fact that you were having some difficulty hiring salespeople or finding qualified salespeople. Any update on that?

One comment, difficulty only in the fact that we were, it was a slower rate than we'd like. The one thing we said was we weren't going to take quality, we weren't going to sacrifice the quality, because this is really not a short-term finger in the dike kind of thing, this was a multi-year building standpoint. In general, your highest performing salespeople that are out in the marketplace are normally closing in on their accelerator plans and things like that. A lot of times, those are the ones that aren't looking to jump or change locations second half of the year. But we have definitely seen a pick up of that. And also, not surprisingly, we've seen some of that growth and attraction happen in Asia-Pacific where we've seen the results. But that's one that we'll see coming out.

Now, we are also increasing the long-term R&D investment. And in general, that's going moderately. It's that aspect but also we are looking for increasing the services aspect of the business, because one thing we found is that, now that people are starting to come out and invest in, or at least showing these renewed interest in investing in simulation, the one question they've got is how can they implement something with greater certain. And that drives some opportunities in the service aspect of the business. So, those are three major axes along which we are hiring and it's not going bad, but it's not also going spectacularly. Part of that just may be just because we are insisting on quality.

Great, thanks.

The next question we have comes from Greg Halter of the Great Lakes Review.

Yes, hello. I wondered if you could comment on your uses of cash going forward, given the very strong free cash flow currently, and what I would project would continue to be very strong. If you balance that out between maybe share repurchases, possibly the initiation of a dividend? I'd love to get your thoughts on that, as well as acquisitions.

I'll tell you, this may sound like the broken record part of the standpoint. But I'd say in general, because of the growth projections and things like that, and the opportunity we see in front of us, I think there is still a kind of pecking order that has always existed. I think right now, now that we have had a chance, after we do an acquisition, we always make sure we do the best job we can of bringing it onboard. And I think we've started to see 2010 with cross selling and the strength of the electronics and electronics/mechanical convergence starting to take hold. And even some of the things we have done with the entity, consolidations and things like that. It's now been a couple of years in very difficult times. Obviously, our balance sheet is in much better structure than it would have been two years ago. So, given what we want to accomplish, obviously acquisitions and mergers and partnerships are very much in our standpoint. So that's one thing we focus on.

Things we have done in the past. We have done share repurchase. But we've done that opportunistically and that is totally based on price, particularly when it gets down to ridiculous levels like it did at one point. Man, we were in on that. The other thing is we look at the debt buy down in terms of, right now the spread on interest really isn't something huge. We jumped down to the lowest tier on the rate structure and that was good enough. Keep in mind, while the cash balance is also very good right now, from the things we talked about earlier there is a $50 million, $60 million projected outflow for Q4 related to the tax restructuring. That is all a good thing but that is one definite flow of that.

And the final thing is, we've never said no to a dividend. However, when we look at that pecking order, if you will, the things that we see from an opportunistic and a Company building standpoint, and through the acquisition standpoint, we certainly would want to run a gamut of that and not hurt anything before we started doing that. I think we've demonstrated we can get much greater returns through smart acquisitions properly integrated. I think we still move along those lines. I guess I covered every aspect of it.

That is helpful. On the acquisition side, would you be looking at something that would be a tuck in or something that brings another leg to the stool that can be then integrated into what you are doing currently?

It can be any of the above. Keep in mind, the basic family of physics we basically have all in place. So as opposed to adding another trunk of a tree out there, it's more like adding branches onto the existing thing. Because once you say electronics, there is a broad scale of things that are in electronics that are push along that standpoint. Likewise, for any of the basic physics. But tuck-ins could be there. The tuck-ins probably, they're made more along the lines of a make versus buy kind of thing for our internal investment. A lot our other acquisitions are ways to quickly partner with, if you look at our history, partner with outher best-in-class providers of parallel technologies that also link with our overall simulation environment. So that would be one we would get into. There are even some that, as we start to flesh out the overall physics realms, start to branch out. I don't want to use the word transformational, because it's not a complete change, but they basically extend slightly beyond maybe what people traditionally thought of. But bottom line is, it could be any of those three major ones.

Okay. Thank you.

It appears that we have no further questions at this time. We'll go ahead and conclude our question and answer session for today. At this time I would like to hand the conference back over to Mr. Cashman and Ms. Shields for any closing remarks.

Thanks a lot. There was a good flow of questions there, so I'll just be brief here. Basically, in close, not much has changed from what we said last quarter or over recent times. The emphasis is on the continued focus on execution and our technological differentiation and advancement. Basically the customer acceptance of our existing vision, basically a unique value proposition, coupled with the ongoing investments we're making in the expansion of our business basically a systems approach to simulation. It continues to make us optimistic about the long-term opportunity. So basically it's been true for the last 40 years, we continue to be propelled by a really good combination of, I think, a strong, solid, resilient business model, loyal customers, great channel partners that we talked about earlier this call, superlative technology. Also a shoutout and thanks to all the talented and great employees we have here. So with that I'll sign off and thank you for joining us today.

We thank you, Ms. Shields and Mr. Cashman for your time. The conference is now concluded. We thank you for attending today's presentation. At this time you may disconnect your lines, thank you.