Altair Engineering Inc.
Q3 2018 Earnings Call Transcript

Published: 9 Nov 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Altair Third Quarter 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Howard Morof, Chief Financial Officer. Sir, you may begin.

[Howard Morof:]

Thank you. Good afternoon, welcome, and thank you for attending Altair's earnings conference call for the third quarter 2018. I'm Howard Morof, Chief Financial Officer of Altair, and with me on the call is Jim Scapa, our Founder, Chairman and CEO. After market close today, we issued a press release with details regarding our third quarter performance, which can be accessed on the Investor Relations section of our website at investor.altair.com. This call is being recorded, and a replay will be available on our IR website following the conclusion of the call. During today's call, we will make statements related to our business that may be considered forward-looking under federal securities laws. These statements reflect our views only as of today and should not be considered representative of our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from our expectations. These risks are summarized in the press release that we issued today. For a further discussion of the material risks and other important factors that could affect our actual results, including risks associated with our pending acquisition of Datawatch, please refer to those contained in our quarterly and annual reports filed with the SEC as well as other documents that we have filed or may file from time to time. During the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our press release. Finally, at times in our prepared comments or responses to your questions, we may offer metrics that are incremental to our usual presentation to provide greater insight into the dynamics of our business or our quarterly results. Please be advised that we may or may not continue to provide this additional detail in the future. With that, let me turn the call over to Jim for his prepared remarks.

[James Scapa:]

Thank you, Howard, and thank you all for joining our call today. We will talk about our quarterly results, our recent acquisitions of SIMSOLID and Datawatch, some customer stories and our outlook for the remainder of the year. Our third quarter profitability exceeded expectations and we continue to move forward with excellent year-on-year growth. We had total revenue of $93.9 million, an increase of 11% from a year ago. We produced adjusted EBITDA of $9.5 million, which was nicely above the upper end of our guidance range. Our quarterly revenue was impacted by exchange rate fluctuations and revenue recognition timing, which Howard will discuss later on the call. Our software momentum continues to be strong with 17% year-to-date growth and our constant currency calculated billings grew 16% in Q3 and 13% on a year-to-date basis. On October 17, we announced the acquisition of SIMSOLID, which we believe is truly game-changing technology, targeting designers and design engineers. Unlike traditional simulation software, SIMSOLID provides extremely fast, accurate and robust structural analysis without requiring geometry simplification, cleanup or meshing. Large and complex assemblies can be solved rapidly, even on laptop computers. The SIMSOLID computational engine is a commercial implementation of novel and unpublished mathematics based on extensions to the theory of external approximations. We believe SIMSOLID is a revolutionary technological breakthrough, which will have a profound impact on product design. We also expect this technology can be extended to other physics regimes. Since SIMSOLID's acquisitions just a few weeks ago, we've developed new training and marketing material, added HyperWorks units licensing and CAD readers and we are aggressively making the software ready for commercial release on January 1, 2019. Since the announcement 3 weeks ago at our conference in Paris, the excitement around this technology is palpable. We've had almost 900,000 views of our introductory video and more than 1.5 million social media impressions. Registration exceeded 2,000 for yesterday's introductory webinar and there have been almost 2,000 downloads of the free trial version. These are big numbers. We believe SIMSOLID will deliver meaningful new revenue for Altair over the next 3 years and is likely to disrupt the current market for stimulation at the design stage. Now I would like to spend a few minutes providing some additional color regarding the announcement earlier this week of our acquisition of Datawatch, a publicly traded data preparation, data science and real-time visual analytics company with thousands of customers, including 93 of the Fortune 100 and well established best-in-class products. We are incredibly excited by the quality of Datawatch's product portfolio and how it'll accelerate our vision of Simulation-Driven Innovation. We believe the convergence of simulation and data science and our addition of Datawatch to Altair substantially increases the addressable market for CAE in general. Specifically, we see significant opportunities for increased revenue for Datawatch products in our existing customer base. Having a complete product offering that brings together Datawatch's data capabilities with Altair's simulation and design capabilities will represent a highly differentiated and value-added offering. We believe we can drive significant adoption and new revenue with many of our 6,000 existing customers, who will be interested in the value Datawatch technology offers. Our licensing model also creates a compelling reason for customers to explore our tools versus the competitors. We also believe owning this technology versus partnering is critical as it will be foundational for the future of the markets we serve. Datawatch has three product families

[Howard Morof:]

Thanks, Jim. Our third quarter results demonstrated strong operating leverage and cash flow generation and continued solid constant currency software revenue growth. Software product revenue was $71.3 million, an increase of 13% from a year ago, and total revenue reached $93.9 million, representing growth of 11% from the third quarter of 2017. Combined with the first two quarters, our revenue increased 15% for the first nine months of 2018 as compared to the same period in 2017. Our third quarter revenue was impacted by two items. First, foreign exchange rates during the quarter moved against us. On a constant currency basis, software and total revenue would have been approximately $900,000 higher than reported. On a constant currency basis, software and total revenue grew 14% and 12%, respectively. We believe this is a clear reflection of the underlying momentum and strong performance we are seeing in the business. Second, on top of the currency impact, we were unable to recognize approximately $1.8 million of software revenue in the period due to revenue recognition requirements. We have certain contracts that are bundled with multiple elements for which we cannot begin recognizing software revenue until the associated services have commenced. This is a matter of timing, and this revenue will begin being recognized ratably in future periods. We also had strong profitability in the quarter as adjusted EBITDA grew by 35% to $9.5 million for the quarter, which exceeded our guidance and compares favorably to $7 million a year ago. We are pleased with the increased leverage in our business, which reflects our growing software mix and attractive returns on the investments we are making in the business. Our revenue mix shift continues positively in the current quarter. Software product revenue grew to 76% of total revenue in Q3 2018 from 74.4% in the same quarter last year. On a year-to-date basis, software momentum continues to exhibit very strong growth, equaling 17% compared to the prior year period. As we have mentioned previously, we believe that our software momentum is best viewed over the longer time periods as quarter-to-quarter variations can occur. I would also note that the FX impact on our business predominantly impacts our software revenue and associated deferred revenue. Changes in certain currencies can have an impact on both the revenues and expenses, especially when those changes occur over relatively shorter time periods or when currency changes are more pronounced over time. As such, we think it is meaningful to measure aspects of our performance on a constant currency basis. For the first nine months of 2018, calculated billings were $288.1 million, an increase of 12% from the first nine months of last year. Our calculated billings on a constant currency basis equaled 13% growth for the 9-month period. As previously mentioned, our deferred revenue primarily relates to software products. In the third quarter, calculated billings were $84.1 million, an increase of 10% from a year ago, adjusted for the impact of a prior deferred revenue from the Runtime transaction at the end of Q3 '17. Calculated billings growth reflects the negative FX impact on revenue discussed above, coupled with a further $1.6 million impact from changes in foreign exchange rate on our deferred revenue [indiscernible]. On a constant currency basis, calculated billings grew 16% from a year ago, demonstrating our continued strong software product momentum in the quarter. We tend to view calculated billings over longer time periods due to the impact of variations and timing of renewals, expansions and new customer arrangements can have quarter-to-quarter. I would like to turn to the balance of the P&L. I will be discussing income statement metrics, some of which are on a non-GAAP basis. A reconciliation of GAAP to non-GAAP measures has been provided in the earnings release we issued earlier today. Non-GAAP gross margin in the third quarter was 71%, an increase of 2 percentage points from a year ago, due to a higher mix of software product revenue, coupled with improved margins from software-related services activities. For the quarter, non-GAAP operating expenses, which excludes stock-based compensation, amortization of intangible assets and other operating income were $60.3 million compared to $54.2 million a year ago. This increase includes onetime expenses related to the accelerated adoption of SOX 404 coupled with continuing investments on R&D and sales & marketing activities, we believe, beneficial to supporting our growth objectives. Adjusted EBITDA for the quarter was $9.5 million compared to adjusted EBITDA of $7 million a year ago. Adjusted EBITDA margin in the third quarter was 10.1% compared to 8.3% a year ago. On a year-to-date basis, we had an adjusted EBITDA margin of 8.7% compared to 5.8% for the prior year-to-date. The year-over-year improvement reflects continuing strong momentum in our software revenues driving our increase in gross margins, coupled with realizing the emerging benefits of scale and certain operating expenses as our business grows. We are very pleased with our performance in the first nine months of the year and expect that we will see healthy growth in adjusted EBITDA margins for the full year. We continue our focus on achieving our long-term adjusted EBITDA margin targets of 20% or greater. On a GAAP basis, third quarter net income was $7.3 million or $0.10 per diluted share compared to a net loss of $29.6 million or $0.59 per share a year ago. As a reminder, the current quarter reflects a $4.4 million gain on the sale of a building and the year ago net loss reflects a one-time stock-based compensation expense, primarily due to the increased value of our shares of common stock. Turning to our balance sheet. We ended the third quarter with $197.4 million in cash and cash equivalents, generally in line with our position at the end of the second quarter. Subsequent to the end of the quarter, we expanded our revolving credit facility by $50 million to a $150 million commitment. We expect to fund the Datawatch transaction with the cash currently on our balance sheet, along with drawing down no more than $50 million on our credit facility, as most of our cash and cash equivalents resides in the U.S. Turning to our cash flow statement. Cash flow from operations in the third quarter was very strong at $3.1 million compared to an outflow of $8.7 million for Q3 '17. Free cash flow, which consist of cash flow from operations less cash capital expenditures, was approximately $900,000 for the third quarter, a significant improvement from a decrease of $10.7 million in the third quarter of 2017. The increase in our free cash flow clearly reflects the impact of our positive momentum. Turning to our outlook for the balance of 2018. Note that our guidance does not include any impact from the proposed acquisition of Datawatch. We are modestly adjusting our software product revenue outlook to reflect approximately $2 million of additional foreign exchange headwinds since our August earnings call. On a constant currency basis, we are increasing our outlook for software product revenue by $1 million for 2018. We are also increasing our adjusted EBITDA outlook for the year, which reflects the positive impact of our performance in the first nine months of 2018 and our expectation for further improvements in the first - in the fourth quarter. For the full year 2018, we are providing updated guidance based upon our current expectations as follows

[Operator:]

[Operator Instructions]. And our first question comes from Bhavan Suri from William Blair.

[Bhavanmit Suri:]

I just had a couple of questions. I guess, first, drilling into solidThinking, I'd like to sort of get a little color on how the business is going and then, b, sort of as you've transitioned to the unit-based model for that sort of products, so what the uptick has been sort of viral-based crossover we see happening with sort of the HyperWorks business. Have you started to see that inflection yet or is it too early?

[James Scapa:]

I think, it's too early, to be honest with you. We're really just getting out to all the resellers. They have to be acclimated to the model. They seem to be very positive though. I met with founder of one of the largest resellers in the U.S. personally 1.5 months ago. And he was pretty excited actually and saw really big opportunities, particularly excited because solidThinking now includes the whole platform, the Inspire platform, which has greatly expanded with a lot of simulation capabilities for manufacturing and industrial design as well, but we also included a new solution, which we call SIMSOLID. And SIMSOLID is a higher end. It's part of our HyperWorks solution that's higher-end solution for simulation analysts actually. And what we did is, we integrated our structures, electromagnetics and fluid solution all in one environment where you can run multidisciplinary. And in the mid-market where these guys sell, there's two basic competitors, if you will. It's the CAD integrated simulation, which inspired, honestly does - is at a much higher level, but they also run into other solutions that are pure simulation solutions that in certain instances, their products can't win. So the SIMSOLID product is just extremely strong in those environments. So he was very excited.

[Bhavanmit Suri:]

Great, great. That's helpful. And then just sort of growth rate of that business. But then, I guess, as a follow-up, I'd love to know the growth rate of the solidThinking business or sort of where was it vis-à-vis expectations, but I also want to follow up with just a little more philosophical question. As you think about the investment that you make either acquisition or R&D, obviously, the Datawatch acquisition being in mind, how do you sort of split that between analytics to Datawatch's again some data prep, analytics, P&L part separated [indiscernible] so you've got carriage, you've got a bunch of other stuff there versus the solver investment where you can sort of directly cross-sell into a base that sort of is looking for more solutions, whether it's electromagnetics, computational hemodynamics, et cetera. How do you balance that sort of [indiscernible] new areas that we can do versus sort of core stuff for existing sort of engineering customer base and I'd love to sort of understand by that philosophy.

[James Scapa:]

Sure. So specifically around the Datawatch solutions, most of my business is with enterprise-level customers. The SIMSOLID product line is trying to address the mid-market more and is new for us and we're excited about what we're doing there, but it's not where the vast majority of my business is. Every customer I visit, I won't name names, okay. But every automotive company when I visit with their senior management, aerospace companies, the first question they're asking me is, what are you doing with machine learning, what are you doing with data science and how are we going to integrate this into our solutions in CAE. So I think, with my enterprise customers, the ability to really deliver knowledge first of all, who has lot of expertise coming in and integrated solutions is going to be something very attractive to them. I think, it's - you're going to see a lot of uptake actually.

[Operator:]

And our next question comes from Sterling Auty with JPMorgan.

[Sterling Auty:]

I wanted to just dive into the auto sector a little bit given the comments in the press release and a lot of investors asking given the kind of the global environment, what's happening there. Jim, what are you seeing in terms of their willingness or eagerness to take on additional solutions either more products or more products for more users in the environment that we're in currently?

[James Scapa:]

So we don't sell cars, right. We sell technology to develop cars. And actually, in this environment, first of all, the whole market is expanding because you have a ton of new companies. There is like 12 EV companies along the West Coast right now that didn't exist 3 years ago. So automotive - if I look at my different sectors, automotive is growing as fast and maybe even faster than all the other sectors, which are all growing pretty nicely. So automotive is still going very, very well, is still hot actually in many ways, and I think there is a hunger for all these guys to really be extremely competitive in this market. The cost for what we do and the cost for engineering is a very small percentage of their overall spend, and I think they're all seeing it is a very, very worthwhile spend right now.

[Sterling Auty:]

Okay. And then one follow-up, Howard. I want to make sure I understood the revenue recognition in the bundled contract. Am I to understand it was a bundled contract that you just didn't hit the services delivery milestone so that you could recognize the software component? Or just help me understand that a little bit better.

[Howard Morof:]

So, yes, Sterling, that's essentially is in a nutshell, which is under our revenue recognition criteria. Until we deliver - start to deliver all of the service elements, the revenue is deferred, including the software side. So simplistically, their software and training delivered it, we don't recognize the software portion until we start to commence on the training side. So it's all about timing, and the $1.8 million will get picked up as we look forward into Q4 and beyond.

[Operator:]

And our next question comes from Rich Valera with Needham & Company.

[Richard Valera:]

Jim, I just wanted to ask a broader version of Sterling's question. Have you seen any changes in the receptiveness of customers to purchase solutions given the current macro outlook, putting aside auto? Just have you seen any kind of hesitation or pulling back from your customers, given sort of the macro choppiness we've seen here?

[James Scapa:]

So I'm like a fairly cautious CEO, I would say. I've been around a long time and I've seen a lot of business climates. So far, things continue to be pretty strong, to be perfectly honest with you. So I also certainly worry about where my things go with all the geopolitical and macro issues, but, honestly, up until now, I haven't really detected that.

[Richard Valera:]

Got it. And then just a follow-up on your comments regarding Datawatch and specifically, Monarch, it sounded like maybe you were saying that you thought that you could sell data prep to your existing CAE customers, to your kind of core customers at some point. Is that what you're thinking? Is there a market to sell their data prep tools into the CAE base, do you think?

[James Scapa:]

So what I think about data prep is, data prep is sort of an essential element of data science. And what - if you're familiar with that market, I won't mention some of the players there. Data prep and data science are kind of coming together because it's very natural you can't do data science unless you're able to do the data prep piece very well. And so for that reason, I think, there is going to be a pretty strong need for both. Does that make sense?

[Richard Valera:]

Yes. I guess, I'm just trying to figure out, has it been - it sounds like, in the past, it hasn't been sold into the base, but you're thinking as you kind of have this merging of data prep and data science, that there will be a market forward essentially with those customers. Is that fair?

[James Scapa:]

I think, that is true. I think, you may see some of the tools and capabilities delivered a little bit differently. For example, you may start to see more data prep capabilities integrated in the data science platform. But because of our units model, we make it easy for a customer who is doing data science with Angoss to be able to immediately use their units and use Monarch or Swarm to do their data prep.

[Richard Valera:]

Got it. And one follow-up, last one for Howard. Is it - can you quickly tell us what the adjustment was that you made to the prior year deferred revenue for the acquisition? I think, it was the Runtime acquisition.

[Howard Morof:]

The adjustment?

[Richard Valera:]

Yes.

[Howard Morof:]

For the acquired deferred revenue, yes, that was about $2.1 million.

[Operator:]

[Operator Instructions]. And our next question comes from Alex Frankiewicz with Berenberg.

[Alexander Frankiewicz:]

I just had a couple around the Datawatch acquisition. The first one is, given that Datawatch core customers are in financial services mainly and other industries outside of simulation, do you think you could see some churn in base given that you'll no longer be making investments there?

[James Scapa:]

I didn't say we're not going to make investments there. What I said is, we're not going to make, if you will, significant incremental investments there. So I think that businesses still important and we will certainly have a team that focuses on those customer accounts. And in particular, I think, we're going to focus on the more substantive accounts, trying to do what Altair tends to do, which is deliver more love and support to the more meaningful accounts that are in that market. It's sort of that 80-20 rule. And we have a little bit of a luxury to grow those accounts, make them more substantial and convert them to subscription model over time.

[Alexander Frankiewicz:]

Okay. That's helpful. And then also just given that Datawatch typically sold into different divisions than your traditional products within Datawatch's stand-alone products, how are you thinking about penetrating those accounts given that your typical sales reps will talk to the R&D and engineering departments?

[James Scapa:]

So we think there's a play on the R&D and engineering and test side, first of all, which obviously, we know those customers and we're going to explore that and we'll do an overlay team that basically calls into the existing customers and identify some of these groups in the existing customers that basically have a need for these tools and can run them under a licensing model.

[Operator:]

And our next question comes from Alex Tout with Deutsche Bank.

[Alexander Tout:]

I think, I missed the start of the call where you explained this, but, I think, in the press release you said that the shortfall relative to the guidance was due to FX and then I heard another question referring to a delayed services contract something like that, that might have been driving it. So just to be fully clear, how much of the shortfall relative to your expectations was driven by FX? And how much by that services contract and any other factors that might have been driving that?

[James Scapa:]

Thanks, Alex. Really just the two factors

[Alexander Tout:]

I'm sorry, was that just a specific 606 recognition issue? Or it was a genuine projects overrun? And are these kinds of projects significant in the overall revenue?

[Howard Morof:]

No, it's not a 606 issue because we still operate under 605. And it had to do with contracts where you have multiple elements and our revenue recognition criteria needing all elements within a customer arrangement to begin - to have started to deliver services or such an order to trigger revenue recognition.

[Alexander Tout:]

Okay, I'm sorry, and then just finally, the slight trim to full year guidance, what is that? Is that FX or the contracts? And does it kind of imply that you don't expect to fully complete that contract by the end of the year? Just the explanation there.

[Howard Morof:]

So we had FX absolutely as a contributor. And on the $1.8 million, that will be recognized essentially ratably over time under 605, so over the remaining duration of that arrangement. So you are correct.

[Operator:]

And I am not showing any further questions at this time. I would now like to turn the call back over to Mr. James Scapa, founder and CEO, for any closing remarks.

[James Scapa:]

Okay. Thank you. I just want to thank everybody for joining the call for your interest in Altair, and I look forward to answering any questions that the rest of you might have. Thank you.

[Operator:]

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