ANSYS Inc

NASDAQ:ANSS

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to ANSYS's Third Quarter 2018 Earnings Conference Call. With us today are Ajei Gopal, Chief Executive Officer; Maria Shields, Senior Vice President and Chief Financial Officer; and Annette Arribas, Senior Director, Global Investor Relations. Please note the event is being recorded.

At this time, I would like to turn the call over to Ms. Arribas for some opening remarks.

[Annette N. Arribas, ANSYS, Inc.]

Good morning, everyone. Our earnings release and the related prepared remarks documents have been posted on the homepage of our new and improved Investor Relations website this morning. They contain all of the key financial information and supporting data relative to our third quarter and year-to-date financial results and business update, as well as our updated Q4 and fiscal year 2018 outlook and the key underlying assumptions.

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 business as of today and ANSYS undertakes no obligation to update any such information, unless we do so in a public forum.

During this call, and in the prepared remarks, we'll be referring to non-GAAP financial measures unless otherwise stated. Please take any reference to revenue to mean revenue under ASC 606 unless we explicitly note that we're referring to ASC 605 results. Note that all references to growth will be in terms of ASC 605 results since we have no baseline for last year under ASC 606. A discussion of the various items that are excluded in a full reconciliation of GAAP to comparable non-GAAP financial measures under both ASC 605 and ASC 606 are included in this morning's earnings release materials and related Form 8-K.

I would now like to turn the call over to our CEO, Ajei Gopal for his opening remarks. Ajei?

[Ajei S. Gopal, ANSYS, Inc.]

Thank you, Annette, and good morning, everyone. Q3 was yet another exceptional quarter. We exceeded the high end of our Q3 revenue and our earnings per share guidance by $8 million and $0.24 respectively. Our revenue growth as measured under ASC 605 was 12%, leading to record third quarter ASC 605 revenue and earnings per share. We recorded $762 million of deferred revenue and backlog as measured in the ASC 605, which represents a 14% year-over-year increase. Our ACV growth in constant currency was outstanding at over 13% for the quarter and 11% year-to-date. This reflects strong customer demand for ANSYS solutions and our ongoing success in the market.

Given our robust performance to-date in 2018 and the strength of our pipeline going into the last quarter of the year, we are increasing our revenue, our EPS, and our operating cash flow guidance for the full year. We're also raising ACV guidance at the midpoint. Maria will provide more details in a few minutes.

In Q3, we recorded numerous six figure deals across several major verticals. With the race to 5G in high gear, the high-tech vertical performed well with leading communications companies choosing ANSYS in part because of the multi-physics design capabilities enabled by our Chip-Package-System workflow. Our market-leading capabilities and enabling electrification and autonomy drove customer investments across the automotive sector. The aerospace and defense sector performed well as investment is increasing in the U.S. and Europe. The industrial equipment vertical, particularly the rotating machinery market, is also benefiting from the recovery in oil and gas.

In Q3, we also saw an increase in investment from the healthcare industry. We work with healthcare leaders such as Medtronic for many years on the use of in silico medicine to advance medical device design. At the September meeting of the Avicenna Alliance, a global alliance of healthcare industries and researchers that was set up at the request of the European Commission, Medtronic reported that modeling and simulation helped them release the product to market two years earlier, treating 10,000 patients during this period, and saving an estimated $10 million.

From a geographic perspective, ASC 605 revenues grew double-digits in the Americas and Europe, while Asia Pacific grew 9%, all in constant currency. Our three largest markets, the U.S., Japan and Germany, led our performance in the quarter each with double-digit revenue growth. Our new go-to-market strategy, which we described at Investor Day last year, is seeing success. Our approach enables us to effectively grow and close large enterprise deals, while efficiently addressing the large volume of our transactional business. We're intelligently matching our customer size, location and level of simulation sophistication with our routes to market, which include the use of strategic sales teams, territory sales, indirect channel partners and inside sales reps.

For our largest global customers, we're employing a higher touch direct sales model. In Q3, we had 30 customers with orders of over $1 million, which is a 20% increase compared to last year's Q3. About 80% of these customers licensed solutions from at least three of our product lines. Our top 100 customers year-to-date, represent over 40% of our total sales, illustrating our success and more deeply penetrating our largest accounts. One such account is Airbus Defense & Space, a global leader in its industry who extended their use of ANSYS core solutions to reduce their time to market from 15 years to 7 years, while accelerating their development cycle. Leveraging our solutions for autonomy and digital twins, Airbus Defense & Space is relying on ANSYS solutions to enable the future development of their autonomous innovations.

Our investments in incremental field engineering resources have also been instrumental in helping to expand our relationships at the enterprise and strategic account level. This is reflected not only in the overall growth in our software and maintenance revenue, but also in the over 30% growth of our services revenue for both the quarter and the first nine months of 2018. Services can help with enterprise adoption and more challenging customer solutions, and will be an ongoing area of incremental investment. However, we expect services revenue to remain a relatively small portion of our overall revenue even into the future.

While large deals are important to us, remember that close to 60% of our total sales comes from customers not in the top 100. So, an equally important aspect of our go-to-market is the use of direct territory sales, inside sales and channel partners to efficiently reach a large number of smaller customers. We've seen success in that effort by bringing in numerous new commercial logos in Q3 with particular strength in the electronics, industrial equipment and automotive industries.

In addition, our Startup Program, which provides qualifying businesses with our solutions at a discount, has enrolled over 550 companies. Working with these exciting young companies ensures that ANSYS will play a key role in their product development processes as they grow and require additional simulation solutions. Our indirect channel, which currently represents 24% of our total revenue, continues to perform well and saw an increased volume of smaller deals.

We're continuing to execute on our channel expansion plans, adding eight new channel partners in Q3, including KETIV Technologies and Rand Simulation, two of the largest Autodesk resellers in North America. Globally, we're seeing great collaboration between our inside sales and territory account reps as well as increased investment by our channel partners, which enables us to rapidly expand our reach. One of our longstanding channel partners, ESSS in Brazil recently closed a large deal that strengthens our relationship with global energy leader, Petrobras. The agreement with ANSYS allows Petrobras to leverage the latest enhancements to the ANSYS simulation platform and gives Petrobras access to leading edge products for engineering simulation as well as local support from ESSS. Engineering simulation tools and HPC capabilities are essential to Petrobras' oil and gas exploration and production R&D activities.

Let me now shift to partnerships, which are a key component of our growth strategy. Through deep collaboration with our partners, we're able to provide customers with greater value in solving new classes of problems. Furthermore, we can expand our addressable opportunity by reaching new customers and potentially new markets through our partners' channels. In March this year, Synopsys released their ICC II with integrated ANSYS RedHawk power integrity and reliability signoff technology. This will enable robust design optimization for next generation, high performance computing, mobile and automotive products. While it is still early days, we are pleased by the response from their customers.

Our partnership with SAP is based on a new offering on SAP's Cloud Platform called SAP Predictive Engineering Insights enabled by ANSYS, which incorporates the ANSYS digital twin technology. The long-term opportunity here is very exciting, although we expect customer adoption to be deliberate as they go from an initial pilot to deployment at scale. Our partnership with PTC is based on a new offering from them called Creo Simulation Live that embeds the breakthrough simulation capabilities of ANSYS Discovery Live into PTC's Creo CAD solution. The development is on track and PTC will soon be starting early trials of the new offering. Finally also during Q3, semiconductor giant TSMC honored us with three Partner of the Year awards for our work with them on 3D ICs and 7-nanometer process nodes.

Switching gears, I would now like to talk about how we are continuing to drive innovation across our business. In Q3, we released ANSYS 19.2, which includes numerous advancements across our product portfolio. We improved speed, reliability, and usability, and we introduced our new patent-pending Mosaic meshing capabilities for fluids that delivers high quality results that's faster than before. In one use case, our Mosaic mesh required 34% less memory and delivered a solution 47% faster than previous solutions. In addition, we announced a new fluids task-based workflow, which guides the engineer through the simulation process providing best practices as defaults. The first release allows users to prep and mesh watertight geometries using 70% fewer clicks and 50% less hands on time than before.

In ANSYS 19.2, we added several important capabilities to our electronic solutions. We enhanced our Icepak electronics cooling solution to include faster modeling of IC packages and support for connecting heat sources from multiple analyses. Our HFSS 3D component library was expanded again to help collaboration, save time, and improve accuracy. We added the TDK RF Chip Antenna library and we just signed an agreement with Modelithics, a third-party model vendor to create a library of 3D-encrypted components targeting 5G design.

ANSYS 19.2 furthers our vision of making simulation pervasive across the product lifecycle. As we move from product design to manufacturing, with ANSYS 19.2, we have fully integrated the technology from our 3DSIM acquisition giving ANSYS the only complete design to analysis to print additive manufacturing simulation workflow. Additionally, our additive solutions now include physics-driven lattice optimization. And we're seeing customer success. A leading aerospace contractor invested in ANSYS Additive Print to help optimize their additive manufacturing processes and a major medical device manufacturer shows ANSYS Additive Suite to reduce failed bills.

As we've highlighted since its release in Q1, our Discovery family of products is also helping us make simulation pervasive by extending our reach to the early part of the product design phase. Our newest Discovery release features the first near real-time 3D parameter studies, enabling designers to analyze hundreds of design points in minutes. We're seeing strong interest with the number of initial purchases by major and strategic customers significantly increase in Q3 over Q2. Discovery is being used by customers in ways that we did not expect. A large automotive supplier was struggling to improve its bidding process for customer RFQs. The problem was that bid submission was bottlenecked waiting for skilled analysts to validate the bid through simulation. The company purchased Discovery for the design engineers, so that the required simulation could be performed by the designers without having to wait for an analyst. Based on a pilot with Discovery, the customer estimates that it can reduce RFQ response times by up to 75%, allowing them to bid on more business, leading to increased revenue.

Finally, I would like to introduce the newest member of the ANSYS executive team, Dr. Prith Banerjee, who recently joined us as our Chief Technology Officer. A brilliant technologist, Prith, brings an exceptional blend of experiences to ANSYS. He's had very successful careers both in academia and in industry, and has earned multiple honors. Prith was a chair professor and a dean of engineering. He led one of the most iconic industry research labs and he served as CTO at two of the top global industrial companies. He also founded two startups in the electronics space. This unique mix of experiences makes him the perfect person to help guide our technology innovation and long-term product strategy.

Before I turn the call over to Maria to discuss our financial results, I would like to acknowledge the most recent milestone in her stellar career at ANSYS. This is Maria's 20th year as CFO of ANSYS, and today is her 80th earnings call. Congratulations, Maria and over to you.

[Maria T. Shields, ANSYS, Inc.]

Thank you so much, Ajei. Good morning, everyone. As you heard from Ajei, we delivered another quarter of outstanding results. This is quite an accomplishment for our team when you consider the comparable of Q3 2017 in which we reported both, double-digit top line and EPS growth. I'll take a few minutes to add some additional commentary around our third quarter financial performance and we'll close with an update on our outlook and key assumptions for Q4 and 2018.

Just as a reminder, during this first year of adoption of revenue recognition under ASC 606, we have been and will continue to provide financial results and outlook under both ASC 605 and ASC 606 through the end of this year. Beginning in 2019, we will transition to only reporting our financial results under ASC 606. In addition, any comments that I make relative to growth rates, we'll be comparing 2018 to 2017 results under ASC 605 and in constant currency. I'll provide key financial metrics under both ASC 605 and ASC 606, and consistent with our standard practice, my comments will be in terms of non-GAAP unless I state otherwise.

Our Q3 results reflect continued strong momentum and execution across the business. We reported total revenue under ASC 605 of $308 million or constant currency revenue growth of 12%. Operating margins and EPS were above the high-end of our guidance under both ASC 605 and ASC 606. Our ongoing record of execution in the quarter and the first nine months gives us confidence that we are on a path to continue to make progress against our strategic priorities and to deliver another record year of financial results in 2018.

Key financial metrics for the quarter begin with constant currency ACV growth of over 13%. Third quarter revenue under ASC 605 and ASC 606, totaled $308 million and $293 million respectively, both results include a negative currency impact of approximately $2 million as compared to the prior-year quarter. The increase in software license sales combined with strong maintenance renewals contributed to our deferred revenue and backlog under ASC 605 of $762 million, representing a record Q3 high and a 14% increase over last year's comparable balance. Deferred revenue and backlog under ASC 606 totaled $545 million.

Total recurring revenue for the quarter under ASC 605, grew 15% in constant currency to a total of $238 million or 77% of total revenue. Lease and maintenance revenue each grew 15%, indicative of strong renewals and expansions within our global customer base, as well as the value that our customers place on the ongoing investments in innovation and the high quality of our support services. This increase in our recurring revenue streams was fairly balanced across each of the three major geographies, each of which delivered double-digit constant currency growth in both lease and maintenance. Under ASC 606, recurring revenue totaled $218 million or 74% of total revenue. Under either accounting methods, our large base of recurring revenue gives us good predictability around our future performance.

The strong top line helped to drive a third quarter gross margin of 90% under both ASC 605 and ASC 606 and an operating margin of 46.7% under ASC 605 and 44% under ASC 606. The Q3 operating margins were above the high-end of the guidance ranges that we previously provided and were positively impacted by a combination of strong revenue results and the slower pace of hiring than we had planned for the quarter. These hiring delays were attributable to the summer season and a relatively more challenging hiring environment for certain positions and geographies. It is our intention to continue to aggressively recruit and hire according to our plans to ensure that we have a solid foundation for continued success as we enter 2019. We reported record third quarter EPS of $1.46 under ASC 605 and a $1.31 under ASC 606.

With respect to taxes, our effective tax rate in Q3 was 14%, which was below the lower end of the range that we had guided coming into the quarter. As we had previously communicated, the Q3 rate was positively impacted by a non-recurring net tax benefit related to certain subsidiary activities including entity structuring that were finalized in the third quarter. The total net benefit recorded in Q3 was $7 million or $0.08. The Q3 tax rate also benefited from an income mix in the quarter, which was much more domestically weighted and additional R&E credits that were above what we had forecasted. Looking ahead, we have updated our estimates and expect our effective tax rate to be in a range of 21.5% to 22.5% for Q4, which would translate to a range of 19% to 20% for the full-year.

Our cash flow from operations totaled $110 million for the third quarter and $354 million for the first nine months. We closed the quarter with a total of $729 million in cash and short-term investments of which 77% is held domestically. In line with our previously communicated capital allocation priorities, we repurchased approximately 400,000 shares during the quarter and 1.2 million during the first nine months at a total cost of $75 million and $193 million respectively. Currently, we have 4.3 million shares available for repurchase.

Now, let me turn to the topic of guidance. We are updating guidance for the fourth quarter and expect non-GAAP revenue under ASC 605 in the range of $337 million to $347 million and non-GAAP EPS in the range of $1.26 to $1.32. Non-GAAP revenue under ASC 606 is in the range of $352 million to $372 million, and non-GAAP EPS in the range of $1.39 to $1.55. For the full-year, we are increasing both our revenue and EPS outlook for ASC 606. Under ASC 605, we are also increasing our EPS and maintaining our revenue outlook, while absorbing some slight currency headwinds.

These increases in our outlook reflect a strong performance in the third quarter combined with our confidence and continued positive business momentum for the remainder of the year. This translates into our updated guidance for 2018 of non-GAAP revenue under ASC 605 in the range of $1.229 billion to $1.239 billion or constant currency growth of 10% to 11%, and EPS in the range of $5.18 to $5.24. Non-GAAP revenue under ASC 606 is in the range of $1.237 billion to $1.257 billion and non-GAAP EPS in the range of $5.25 to $5.41.

With respect to the contribution from the OPTIS business, our outlook remains largely in line with what we had communicated since we closed the acquisition in early May, or a range of $25 million to $26 million of revenue for 2018. We are also updating the midpoint of our ACV outlook for 2018 to factor in both, the strong Q3 results as well as our increased confidence since we last provided guidance. Our increased outlook for ACV is a range of $1.262 billion to $1.282 billion. This represents constant currency ACV growth of 11% to 13% over the 2017 baseline. And we're also increasing our outlook for annual operating cash flows to a range of $455 million to $480 million.

For modeling purposes, we are expecting fourth quarter operating margins of 40% to 41% under ASC 605 and 43% to 45% under ASC 606. Fourth quarter operating expenses reflect disproportionately higher sales commissions and increased personnel and department structuring expenses, including an expectation for an accelerated pace of hiring as compared to Q3. For the full year, we expect operating margins of 44% to 45% under ASC 605 and 44.5% to 45.5% under ASC 606. I would like to highlight the fact that on an annual basis, we plan to finish largely in line with or slightly ahead of the operating margin target that we've committed to coming into the year. The importance of annual as opposed to quarterly margins will become a more important consideration as we transition to solely reporting under ASC 606 in 2019.

Further details around specific currency rates and other key assumptions that have been factored into our outlook for Q4 and 2018 are contained in the prepared remarks document. I'd like to remind everyone that we'll be providing our initial outlook for 2019 in February when we announce our final Q4 and 2018 results, and after we had finalized our annual planning process, which is currently underway.

In summary, we're pleased to have delivered another excellent quarter with strength across all of our key financial metrics: ACV, top line growth, operating margins, EPS, operating cash flows, and deferred revenue and backlog. Our strong third quarter performance combined with the business results from the first nine months give us confidence that our continued focus on execution and investing in the business supplemented by the large base of recurring business, strong customer relationships and a healthy sales pipeline provide a solid foundation to deliver on our 2018 goals as well as our longer-term 2020 financial targets.

Operator, we will now open the phone lines to start the Q&A. Thank you.

[Operator]

We will now begin the question-and-answer session. The first question comes from Ken Wong of Guggenheim. Please go ahead.

[Kenneth Hoi Fung Wong, Guggenheim Securities]

Hey, Ajei. So, you guys saw a nice uptick in ACV growth. Can you maybe dive in a little deeper on kind of what the key drivers are, was it attach, pricing, better utilization? And then on the flip side, maybe help us reconcile the solid ACV growth with the 13% decline in bookings for the quarter?

[Ajei S. Gopal, ANSYS, Inc.]

So, let me address – let me ask Maria to address the second part of the question first and then I'll come back to the first part.

[Maria T. Shields, ANSYS, Inc.]

Yeah, so, Ken, I think if you take a look, we've gotten away from disclosing bookings because of the volatility that ASC 606 introduces. But the short answer is, if you take a look at last year's Q3, when we announced at that time the largest deal in the company's history, that drove bookings to a 38% growth, which it should come as no surprise that because those multiyear deals are going to have a tendency to fall in different quarters, that can drive the volatility in the bookings number. And that's why we've been communicating that we think it's better for people to focus on ACV as a leading indicator of the health of the business and how we're doing against our sales performance.

[Ajei S. Gopal, ANSYS, Inc.]

And as far as the drivers for the ACV growth are concerned, I think I addressed some of them in my comments in the script. Essentially, we saw strong performance across all of the geographies and we saw really good performance in the verticals, in the industries pretty much across all of them and I called out a few of them. And I think that's reflective of two things. One is there is tremendous market demand for the kinds of solutions and products that we offer our customers and obviously our customers think that we have terrific capabilities to bring to market as well. So, I think you put it all together. Great demand for our offerings, great technology, great capabilities, we were able to execute against that. And then as I finally said in my comments, the go-to-market that we introduced about a year ago is successful, we're seeing results and that's also contributed to our success this quarter.

[Operator]

The next question comes from Gabriela Borges of Goldman Sachs. Please go ahead.

[Gabriela Borges, Goldman Sachs & Co. LLC]

Hi. Good morning. Thank you for taking my question, either for Ajei or Maria, a question on the macro. The results in your commentary suggest that the environment out there is pretty stable, so I'll ask the forward-looking question which is, what are some of the leading indicators in your business that may or may not indicate any type of slowing? And how do you think about the sensitivity of the business if some of your customers do come under pressure into next year? Thank you.

[Ajei S. Gopal, ANSYS, Inc.]

Well, obviously, we can look at the overall pipeline that we have in our business and we have a pretty deep level of conversation with some of our customers. As I explained in the call, we have some amount of our revenue that comes from large customers and we're deeply engaged with them and we have a certain amount of the business which just drives through the more transactional channels that we have in the market.

We are currently seeing a very strong pipeline, as you know, over three quarters of our business, I think 77% of our business comes through recurring revenue, so that is very stable. And we continue to see good demand for what we're doing. So with that high recurring revenue, the strong diversity across the geographies that I mentioned, the diversity across industries, the good technology, the multiple routes to market, we feel very confident in our business. We're not seeing any slowdown in the pace of customer interest, we're not seeing any slowdown in the sense of customer urgency. And in fact it's quite the contrary if you start to look at some of these broader conversations that we're having with customers, it's about how their business is going to get transformed.

We're having conversations with automotive companies about helping them with ADAS and self-driving vehicles. And the market demands for those are so high, customers are investing in those areas. We're having conversations with customers about electrification and we're having success in that space, 5G, all of these are areas where customers continue to make investments. And with the breadth and the depth of our technology, we're addressing some of the most pressing problems in product design today. And so, we are very excited about our future.

[Operator]

The next question comes from Matt Pfau of William Blair. Please go ahead.

[Matthew Charles Pfau, William Blair & Co. LLC]

Hey, guys. Thanks for taking my question. Wanted to follow-up on the margin commentary, and so you expect operating margins to come at the high end, or perhaps, better than where you originally expected coming into the year. So, just perhaps some commentary on what's driving that? Is it just a factor of delayed hiring or there are other factors involved in margins coming in better than expected? Thanks.

[Maria T. Shields, ANSYS, Inc.]

Yeah. So, I would say for the quarter, as I said in my prepared remarks, it was really two things. One, the reality is the summer season and a third of our business comes out of EMEA, which tends to have a – even extended time off period, which caused delays in primarily hiring, which is about 70% of our spend today. So, the combination of the summer season as well as the unique talent that we're looking for, whether it's in R&D or field engineering in particular, which are two areas that we are disproportionately targeting to hire into, it is a bit more challenging than say three or four years ago. So, we will continue to aggressively hire so that we can position ourselves well as we head into 2019 given all the opportunities that we see ahead of us.

[Operator]

The next question comes from Jay Vleeschhouwer of Griffin Securities. Please go ahead.

[Jay Vleeschhouwer, Griffin Securities, Inc.]

Thank you. Good morning. Ajei, when you look into Q4 and perhaps into 2019, could you comment on how you're thinking about growth by end markets in the – most recent trailing 12-month period, you certainly had quite good bookings growth for Aero and A&D. But the comps for auto are going to get increasingly difficult for the next few quarters anyway. So when you look at your other verticals, could you comment perhaps on how you think industrial materials, that's electronics and so forth, might perform, in terms of your assumptions for the next period.

Also on the hiring front, you're not alone in looking particularly for AEs. All of your engineering peers Cadence, Synopsys, PTC and others are looking to do the same thing. So there is clearly a race on for that kind of personnel capacity measuring now across the industry at least in the hundreds. So could you comment on the availability and perhaps how you're targeting your AE hiring by BU?

[Ajei S. Gopal, ANSYS, Inc.]

So to the second question about recruiting, obviously, we are looking for highly skilled individuals across a number of physics – a number of our areas of physics and we are investing across the board. And so, yes, it is competitive and obviously we feel like we have a great value proposition for our employees and it's driven by a number of things. One is we think we have really exciting products and we serve really exciting customers and I think that that's a factor that causes people to want to come here. We've also continued to build out academic relationships from the purposes of recruiting. We're a quality place to work. We're building the right level of relationships that we need. So, while we're continuing to be as Maria said a little bit behind the curve in terms of recruiting, we have been recruiting and we're excited about our opportunities to continue to be able to recruit in the future. And we're cranking up the engine as we go into next year.

So that's the first piece of the question – the second part of the question. The first part of your question was around the verticals. And I think as I said in the comments, we see activity across all of the different verticals, I mentioned high-tech, you mentioned automotive in your question, we also mentioned – I mentioned high-tech in the comments. We've also had aerospace and defense, a fair amount of activity this quarter and we see that in our pipeline as well. So, I'm actually seeing a relatively broad industry split. And I don't see any particular area that we would look at and say hey, this is an area of concern.

[Operator]

The next question comes from Ken Talanian of Evercore ISI. Please go ahead.

[Kenneth Talanian, Evercore ISI]

Hi, thanks for taking the question. To follow-up on some of the subject matter earlier, I realize it's early but I was wondering if you could rank some of the factors that might positively impact ACV growth in 2019, and then contrast that with some factors that might represent a headwind?

[Maria T. Shields, ANSYS, Inc.]

So, I would say the same factors that are impacting ACV growth this year, we expect to continue into next year. So at the top of the funnel we will continue to see progress relative to our enterprise and strategic accounts as they continue to expand usage, adopt new users, we think Discovery Live as we continue to see broader adoption of that product in our enterprise accounts will drive ACV growth. And in the momentum and territory accounts, we're seeing good progress as well and our channel is very strong and delivering good new business growth. So I would say the same factors that we're seeing driving double digit ACV growth this year. We will expect as we enter into 2019 and we'll talk about more of that in February when we get deeper into our guidance and outlook around 2019.

[Ajei S. Gopal, ANSYS, Inc.]

And just to amplify the comments that Maria just made and I talked a little bit about this in my comments as well. We're taking a thoughtful approach to go-to-market and for the larger accounts where we see more opportunity, we're investing more with those customers and that includes with certain customers doing a little bit of incremental services. And what that's translating to is, our opportunity to deliver broader-based solutions to these customers, which means larger deals, it means multi-physics deals and it means multi-year or deeper levels of engagements. So all of that drives customer activity, it drives the size of the opportunities and obviously it drives the annualized view of what the numbers look like and that's reflected in the ACV. So that's one piece of it.

We've also made investments in our ACE organization this year and we continue to make investments in the ACE organization. And even though it is – there is a war for talent we've been successful in recruiting people. I think in the last quarter we grew our business by a net of 100 people, which is quite considerable given that we are relatively small company in terms of head count. So the engine is moving, we're able to bring people onboard and our field engineering organization is able to engage – our ACE organization is able to engage with customers at the right level and of course that helps our customers be successful but it also drives more business for us.

And so there's a number of different dimensions that we've been driving and setting ourselves up for in the last year, essentially along the lines that we talked about in the go-to-market transformation messaging that we gave you guys a year ago at Investor Day. And what you're seeing right now in the results is the success of what we said we would do and obviously we see the momentum of this continuing as we move forward.

[Operator]

The next question comes from Sterling Auty of JPMorgan. Please go ahead.

[Sterling Auty, JPMorgan Securities LLC]

Yeah, thanks. Hi guys. Wanted to follow-up on in terms of the hiring piece, but I wanted to ask from this standpoint. As you embarked on the effort to improve the overall growth of the company, you mentioned the need for the incremental hires AEs as Jay was mentioning et cetera. I just wondered where you feel we are in the progress of where you think you need to get to in terms of head count staffing to be able to drive the kind of growth that you want?

[Ajei S. Gopal, ANSYS, Inc.]

I think, we will talk about our plans for next year and go through our head count plans for next year when we talk about next year's guidance in our – when we announce Q4, and so that will be in February I believe. So I think we'll go through more details on that. What I can say is that we made a conscious decision this year to bring on board incremental ACE resources significantly more than we had in previous years and we've made good progress towards doing that.

[Operator]

The next question comes from Rich Valera of Needham & Company. Please go ahead.

[Richard Valera, Needham & Co. LLC]

Thank you. A couple of regional questions, understanding you guys just put up a strong quarter in Germany. There's been some fairly cautionary comments coming out of the German auto OEMs and likewise, the Chinese auto OEMs. Just wondering if you are seeing any hesitation from that kind of perhaps end-market weakness they are seeing. And then on South Korea last quarter, you had mentioned you thought that would pick up in the second half and wanted to know if you thought that would pick up in 4Q since it looks like it didn't pick up in 3Q? Thank you.

[Ajei S. Gopal, ANSYS, Inc.]

So, let me address the question about automotive. As we've said I think pretty consistently over the last few quarters, maybe a year, some of the areas of investment in automotive have to do with ADAS, autonomous vehicles, electrification. Those are all the big areas where the OEMs are making, I would say significant levels of investments and it's not just the OEMs, it's the entire supply chain.

If you think about the transformation this represents, it's people retooling to take advantage of different technologies, moving from an internal combustion engine to electric solution requires a significant change, starting to think about automotive, the testing that's involved, how you validate autonomous vehicles. All of those are significant changes from business as usual. And that's where the investment is taking place in the automotive industry. And frankly, all of that plays directly to our capabilities in our sweet spot. So, we feel very confident that the technologies and the solutions that we provide are in demand not only by the OEMs, but the entire automotive supply chain.

[Maria T. Shields, ANSYS, Inc.]

Yeah. And on the South Korea question, as we mentioned on the last call, we've been working relative to changes in the go-to-market and working through account assignments because we do have a hybrid model in South Korea. And so as you can imagine working through go-to-market changes don't happen in one quarter, but we are confident based on what we're seeing relative to the pipeline and the progress around those that transformation that we will continue to see positive results in Q4, and as we enter 2019 as those go-to-market and account assignments are completed.

[Operator]

The next question comes from Rob Oliver of Robert W. Baird & Co. Please go ahead.

[Matt S. Lemenager, Robert W. Baird & Co., Inc.]

Yeah. Good morning. It's Matt Lemenager on behalf of Rob this morning. I had a question on the partnerships. So there's a slew of them now and the number of them has kind of ramped over the past 12, 24 months. Which of the partnerships, whether it's PTC, SAP, maybe Synopsys are expected to have the earliest impact on the P&L? And does late 2019 feel like the right timeframe to think about that for that kicking in and having an impact? Thank you.

[Ajei S. Gopal, ANSYS, Inc.]

Well, I think the way you should think about these partnerships is that in each one of these – each one of them is different. And in the first year of the partnerships, we're really building out the product. So you should really expect relatively modest contribution as the partnership starts to get into high gear.

As you well know, these kinds of relationships are multi-year relationships, and these are not quick wins that result in incremental revenue overnight, because you're talking about new products being brought to market, you're talking about training additional sales forces and so on and so forth.

So I would just urge you to be – well, the way we think about these partnerships is that these are strategically important, but these are long-term activities. And as we think about our business, they represent an adjacent avenue for growth for us in the long term.

[Operator]

The next question comes from Steve Koenig of Wedbush. Please go ahead.

[Steve R. Koenig, Wedbush Securities, Inc.]

Hi ANSYS, thanks for taking my question. Congrats to Maria here on your 80th earnings anniversary. I got a ways to catch up with you, Maria.

[Maria T. Shields, ANSYS, Inc.]

Thank you.

[Steve R. Koenig, Wedbush Securities, Inc.]

I'm – oh, yes. So, Rob, kind of got at some of – I was going to ask about kind of the sequencing of the adjacencies in terms of what's most significant. Currently I imagine OPTIS is fairly significant, the autonomous is contributing somewhat. And then what's the longer – how do they sequence longer term in terms of what looks potentially the largest down the road. But if I could just maybe add to that as well, I'm wondering what, if anything, is the opportunity to apply more IP in the area of machine learning and AI to any of these adjacencies, and also more broadly in the domain of comp sci type IP. What sorts of things would you like to see to accelerate your roadmap?

[Ajei S. Gopal, ANSYS, Inc.]

So, couple of quick questions about – so the ordering of some of these adjacencies. Obviously, we have products in the market with respect to the Discovery family of products today. Again that's early. But I gave a couple of examples of customers and obviously our relationship with PTC as I described is based upon them bringing a product to market actually relatively soon. Jim Heppelmann, who is the CEO of PTC, has described the Discovery Live technology as being jaw-dropping. And I think that they're very excited about that as they bring the technology to market.

So, I think that that's obviously something that we see happening in the shorter term. We did an acquisition of OPTIS earlier this year, and OPTIS gave us some really important technology with respect to optics, lidar, radar. And we also have now as a result of the OPTIS solution, we have a closed loop simulation environment that allows us to be successful we believe in the ADAS testing space to allow our customers to validate miles without having to physically drive miles but use testing – and use simulation as a way of being able to validate the functions of an autonomous vehicle. So that's another area where we've made investments. We talked about it last year. We've made investments and we're delivering product in the marketplace today.

So I think those are some areas in the – as you think about digital twin, those represent a little bit further out, I would say than some of these other areas because digital twin is still, I would say, a number of customers are very excited about the technology, but it represents a longer term rollout because it requires a change in the way people think about how they're maintaining their equipment, the way they're managing their businesses, and so there's a – I would say, that that's a little bit longer term as we think about some of these adjacencies. And so, that perhaps gives you some context.

To your second point about machine learning. Look, we believe that physics-based simulation and machine learning AI are very complementary. And we believe that our hybrid approach is quite viable and could be very valuable. And we've embraced and we've used machine learning methods and tools for quite some time, actually well before the current buzz around this area. And as with everything that we do, our objective is to make sure that we can advance the capabilities of the physics-based simulations that we bring to market. And so to give you a couple of examples, so our RedHawk-SC product, it's based on big data and machine learning techniques to enable rapid design iterations. And the whole idea is that using this technology, which combines machine learning and physics-based simulation, engineers can now make better design decisions than they could before.

We're also making use of machine learning techniques, for example, in specific use cases – for example, we're looking – we're figuring out and inferring the optical properties of materials, where we're using machine learning in some of the ADAS scenario generation. So to be able to do automated testing for ADAS, you want to automatically generate the road scenarios, we're using machine learning to help do that. We're using machine learning to help design smart assistants to gauge HPC resource usage and so on.

So we're very confident about where we're going. We think that AI machine learning techniques will complement what we're doing, and our traditional simulation technology, physics-based simulation and for our customers we think that means that they can just be more efficient and effective when designing their products.

[Operator]

The next question comes from Ross MacMillan of RBC Capital Markets. Please go ahead.

[Ross MacMillan, RBC Capital Markets LLC]

Thanks so much. Maria, I just wanted to ask, if we look at ASC 606 and ASC 605, obviously ASC 605 revenues are tightened but maintained for the year, ASC 606 are going up. And I think I understand the implications of a shift to lease versus perpetual and how that impacts ASC 606. But is there anything else happening on lease that is having an influence rather than just that mix shift? And I guess specifically, anything happening on average duration of these deals that would also be impacting the amount of revenue that gets booked to perpetual with that shift?

[Maria T. Shields, ANSYS, Inc.]

Relative to duration, Ross, no, there's been no change in duration. What I'd say is on the ASC 606 front, as we've been saying all year that the multi-year lease deals, particularly in the larger accounts, are heavily skewed to Q4, mostly around customers, yearend spending and budgeting and planning activities. So the disparity between ASC 605 and ASC 606 is largely driven by the difference in revenue recognition, as well as the timing of the larger deals that drives some of the volatility depending on the timing of when they close under ASC 606.

[Operator]

The next question comes from Alex Frankiewicz of Berenberg. Please go ahead.

[Alexander Frankiewicz, Berenberg Capital Markets LLC]

Hi. Thanks for taking my question. I just had a question on Discovery Live in terms of general adoption. How is that going versus the plan so far? And do you see any potential competition arising from Altair's recent acquisition of SIMSOLID?

[Ajei S. Gopal, ANSYS, Inc.]

So, we're actually very pleased with the adoption of Discovery Live. We continue to see good customer traction. I gave you an example and there are a couple of kinds of customers who are looking at Discovery Live or – one is of course the larger customers where we've historically had some technology and they are looking at the use of Discovery by their design teams, and that leads to a subsequent purchase and then larger purchases down the road.

And then the second area is we're seeing customers who have previously never used simulation before being able to use Discovery, because it's just so easy for them to use. So, I'm actually – I think we're pretty much on where we expected to be with respect to our internal milestones, both from a customer adoption perspective as well as from a product release perspective. And since the launch in February we've had two major product releases and we continued to add technology and capabilities to our products. So, I'm very excited about that.

You asked to comment about competition, it's perhaps helpful to sort of just reflect on exactly what Discovery Live is. Discovery Live is fundamentally trailblazing technology and it sets the bar for a transformative user experience for design engineers. Now, we know that others see that – they recognize the same opportunity that we see. And this is an opportunity where ANSYS can fundamentally change product design by democratizing simulation.

And while we see competitors incrementally improving existing tools and technologies either by organic activities or through acquisitions, we have yet to see frankly anything as transformative as Discovery Live. We believe Discovery Live is in a class of its own. And I referenced some of the comments from PTC for example earlier on this. You've got to realize that Discovery Live builds on a whole new solver architecture that's based on GPUs.

It's essentially orders of magnitude faster than traditional 3D method. And it supports multiple physics and multi-physics simulation, and that gives design engineers the intuitive insight that they're expecting. I mean, it essentially makes simulation as easy as a video game for a designer. So we don't – we are excited by the technology, we don't see – we think the bar is very high and we're not seeing anything else in the marketplace that's like it right now.

Now I am really excited about the portfolio that we have. With Discovery Live, we've got speed; we've got interactivity with our flagship solvers. There's an enormous breadth and depth and accuracy. Taken together, our portfolio frankly is simply unrivaled in the industry today.

[Operator]

The next question comes from Saket Kalia of Barclays Capital. Please go ahead.

[Saket Kalia, Barclays Capital, Inc.]

Hey, guys, thanks for squeezing me in here. Maybe just one because most of my questions have been answered. Ajei, maybe for you, you talked about adding on other resellers, notably a couple that were some large Autodesk resellers. Can you just maybe give us some broad brushes on the strategy there and perhaps how Discovery Live could maybe work with other CAD tools in addition to PTC?

[Ajei S. Gopal, ANSYS, Inc.]

I think the comment that you made about working with resellers, we have a pretty broad strategy for our reseller community around the world. And we're essentially looking to in key areas – and for key coverage areas, we're looking to bring resellers on board who are familiar with simulation, who understand what we do and are in a position to broaden our go-to-market. And the two – and the examples that I gave in my prepared remarks were examples of companies that have been able to satisfy those metrics and are able to help us, and of course we can help them with great product and great capabilities.

As far as Discovery Live is concerned, we believe that it's a simulation, it's a simulation solution. Discovery Live is not a CAD offering. It's CAD agnostic. We're not a CAD offering. The guys that do CAD do a number of things that Discovery Live has no intention whatsoever of doing. Discovery Live is a simulation solution and it works with CAD. It adds to CAD a completely different dimension. And that's why customers are excited about it.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Ajei Gopal, Chief Executive Officer, for any closing remarks.

[Ajei S. Gopal, ANSYS, Inc.]

Thanks so much, Andrew. So I continue to be extremely pleased with our performance – our outstanding performance through the year and the progress that we're making towards those strategic initiatives. Our pervasive simulation strategy is resonating with customers and our broad go-to-market changes are yielding results. We continue to strengthen our core products and we are making the right investments in next generation offerings.

And in conclusion, I would like to express my sincere gratitude to our customers and to our partners and as always a shout out to my ANSYS colleagues, thank you all so much for your efforts and thank you for another exceptional quarter. Thank you all for joining the call today. I look forward to our next discussion. Please enjoy the rest of your day.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.