ANSYS - Q2 2018

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by, and welcome to fans of the Second Quarter 2018 Earnings Conference call. With us today are Ajei Gopal, Chief Executive Officer Maria Shields, SVP and Chief Financial Officer, and Ahmed Reberts, Senior Director Global Investor Relations. At this time, I would like to turn the call over to Ms. Reelos for some opening remarks.

Speaker 1

Good morning, everyone. Our earnings release and the related prepared remarks documents have been posted on the homepage of our Investor Relations website this morning. They contain all of the key financial information and supporting data relative to our second quarter and our first half financial results and business updates. As well as on 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 the course call and in the prepared remarks, we'll be making reference to non GAAP financial measures, and unless otherwise stated, for purposes of comparability, will be presenting results in accordance with ASC 605. A discussion of the various items that are excluded and a full reconciliation of GAAP to comparable non GAAP financial measures, both under both ASC 605606 are included in this morning's earnings release materials and the related

Speaker 2

Ajay?

Speaker 3

Thank you, Annette, and good morning, everyone. Q2 was an excellent quarter across all key metrics, which has led to an standing first half of twenty eighteen. In Q2, we delivered constant currency revenue growth of 10% and our operating margins and EPS exceeded the high end of our guidance under both ASC 605606. Our Q2 605 revenue and EPS of both 2nd quarter record for ANSYS. Our deferred revenue and backlog increased 24 percent year over year to $816,000,000.

Annualized contract value or ACV grew 10% in constant currency for the first half of the year. Both of these metrics are leading indicators of the robust health our business. Given our strong performance to days in 2018 and the strength of our pipeline going into the second half of the year, We are increasing our EPS guidance for the full year. We're also adjusting our revenue guidance to reflect an increase in our constant currency revenue outlook, but in the context of an adverse currency impact of about $15,000,000 since we last provided guidance. Maria will provide more details in a few minutes.

Large deals helped to drive our success in the quarter, with 35 customers recording orders of over $1,000,000, an increase of 25% over the second quarter of 2017. These customers tend to buy multiple products 3 of our product lines. Our largest customer this quarter had combined orders of over $30,000,000 across 4 product lines. Our success in engineering services in the context of our momentum with enterprise and strategic accounts is another highlight of this quarter. We reported Q2 and first half constant currency services revenue growth of 40% 30%, respectively.

Albeit of a smaller denominator. This is evidence that we are succeeding in leveraging a world class engineering services talents to drive customer adoption of our portfolio. This is a direct result of the focus and incremental investments we have made in our field engineering team and in our go to market strategy around this important class of customers. Delighted with the performance of our North American business and with the ongoing recovery of our European business. Europe grew 11% 10% in constant currency in Q2 in the first half, respectively, continuing the significant turnarounds for that region.

As we had planned, Sales in Asia Pacific are back end loaded this year. And hence, APJ had a relatively slower growth for the quarter and the first half. I'm excited that our key regions of China and Japan delivered solid revenue growth for the quarter. However, the slower pace of implementation of go to market changes in South Korea impacted performance in that country and some centralized purchasing of enterprise deals muted results in India. With an expanded pipeline of larger deals, the ongoing addition of incremental enterprise sales resources in the region and the completion of our go to market changes, we are optimistic about our Asia Pacific performance in the second half of the year.

Representing about 24% of total revenue, our indirect channel is a key area of focus. During the first 2018, we added 11 new channel partners, including 8 in Europe. We also increased our elite channel partners to 20 from an initial group of 5. Our channel partners' certification levels across our product portfolio has also increased. And they continue to add sales capacity and technical resources and enhance their capabilities.

From an industry perspective, automotive and high-tech continue to perform strongly with notable wins driven by the rise in electronics and the push to autonomy and electrification. We saw a wonderful example of the power of our electrification solution recently when our partner, Volkswagen Motorsport shattered the time record at the Pike Speak International Hill Climb by nearly 16 seconds using an all electric race car. Ansys was very proud to be selected as Volkswagen Motorsports strategic technology partner of choice for simulating the mission critical aspects of the electric propulsion systems and the overall car design. I'm also excited that we continue to make advances in our startup program. Today, we have over 500 innovative young companies from around the world using the power of ANSYS solutions to build their next generation products and services.

Now last year, we described our vision of pervasive simulation, where simulation becomes critical across the entire product lifecycle. Our core business relies on driving innovation into our flagship solutions of mechanical fluids, electromagnetics, Semiconductors and systems. Ansys19.1 released during Q2 bolsters our leadership across all of our key physics. This comprehensive release features advances across our portfolio to improve reliability, performance, speed and overall user experience. These dramatic improvements are driving high value multi physics sales across the regions and the industries we serve.

For example, Eldor Corporation, a global manufacturing leader for Automotive Systems expanded their adoption of ANSYS electronics and HPC solutions to support next generation electric powertrain development, extending their adoption of a multi physics platform, based on ANSYS Structural CFD and electromagnetic products enables Eldorf to further ensure the reliability of their designs, while increasing simulation efficiency, all critical to responding to this rapidly evolving market. Multifysics was a critical topic at June's DAC, the major semiconductor industry conference. We were excited to have dozens of customers share their best practices on how they use Aansa solutions beyond the traditional sign off area, leveraging the power of multi physics simulations, big data analytics and chip packet system co analysis to tackle the challenges of 7 nanometers and 3 d IC design, just to name a few. This new functionality will help them to innovate by exceeding their power performance and area goals. A great example of our customer success was outlined in a press release yesterday with high silicon Technologies, a subsidiary of Huawei.

They're relying on ANSYS' suite of semiconductor and electronic simulation solutions for power integrity and reliability sign off to address complex multi physics challenges. These include on chip thermal effects, aging, thermal aware statistical like migration budgeting, electrostatic discharge, as well as the creation of chip power models for simulating the entire package and system. High silicon is using ANSYS Red Hawk SC, our next generation system on chip, power noise, and reliability sign off solution to enable design success Our successes with Red Hawk SC was also showcased at DAC. I'm excited that all of our 7 nanometer Red Hawk customers are using or deploying Red Hawk SC for sign off of their most complex products and design. These designs are at the heart of innovations in artificial intelligence, autonomous vehicles, 5G, mobile devices and so on.

Our successes with Red Hawk SC goes beyond the Tier 1 chip makers. We're seeing rapid adoption by a number of hardware startups focused on chip development for artificial intelligence. But to become truly pervasive, simulation must move beyond the product design phase and move upstream into ideation and downstream into operations. Anso's Discovery Live, which we introduced in Q1, provides instantaneous 3d simulation and direct geometry modeling to enable interactive design exploration and rapid product innovation. We saw early success with ANSYS Discovery Live with China Southern Power Grid which provides electricity to over 250,000,000 people.

This Fortune Global 100 company is using Discovery Live for Digital Exploration, resulting in a 3x improvement in tower design time. The company also signed a contract in Q2 to expand its ANSYS usage across physics including structures, fluids, electromagnetics, as well as high performance computing. This expansion also enables their design teams to collaborate across engineering disciplines using an integrated workflow based on the ANSYS workbench platform. Also in Q2, we announced an exciting new partnership with PTC. They're developing a differentiated solution for their customers that embeds Discovery Live's Simulation Engine into their Creo 3d CAD offering.

With the combined solution, which removes the boundaries between cad and simulation, engineers will be able to see the real time results of simulation during the modeling process. This will enable them to rapidly make trade offs and design changes in their models. With PTC's significant presence in the designer space, our partnership broadens our reach to design engineers around the world. Although there's no impact on our 2018 revenue, while the solution is in development, early customer feedback has been overwhelmingly positive. Simulation can also play a critical role downstreamed in product operations through the use of digital twins.

While digital twin adoption is still in its early stages, We're seeing significant interest from customers. Many companies have challenges in maintaining assets that are in remote or hostile locations And so it's no surprise that companies in mining, energy, as well as construction sites with heavy machinery, our early adopters of the internet of things and digital twin technology. In Q2, we released ANSYS Twin Builder, the only solution that offers a packaged approach for digital twins. Enabling engineers to quickly build, validate and deploy these digital representations of physical products. The open solution integrates with any industrial IoT platform and contains runtime deployment capabilities constant monitoring of every individual asset used during operations.

The solution empowers customers to perform diagnostics and troubleshooting, determine the ideal maintenance programs, optimize the performance of each asset and generate insightful data to improve the next generation of products. Our long Regal is a leading manufacturer of electric motors, power generation and power transmission products, serving markets worldwide. Rego leveraged ANSYS simulation to build a digital twin, enabling them to iterate on the design, optimizing both software and hardware. Their digital twin help them understand the performance impact of design changes within minutes and validate that the new design met market requirements. Likewise, regal leverage ANSYS' mechanical fluids embedded software and systems tools to reduce the design time from 6 weeks down to a few days.

I'm also delighted that in Q2, we announced an innovative partnership with Software Giant SAP. They're embedding ANSYS' technology for digital twins into their extensive digital supply chain, manufacturing and asset management portfolio, introducing a new product called SAP Predictive Engineering Insights enabled by ANSYS. This new solution, which introduces ANSYS simulation operations and asset managers ties together, engineering models, manufacturing details and operational insights including financial information. Connecting these diverse datasets enables businesses to evaluate the real time working conditions of physical objects and remotely monitor our products and assets, empowering them to quickly detect and fix issues if something goes wrong, as well as to make design improvements to future releases. This relationship is particularly exciting for ANSYS because of SAP's enterprise product portfolio in extensive customer reach.

Now while we're not expecting any revenue for ANSYS in 2018, while our engineering teams are working on the new product, initial customer feedback from customers has been very positive. And finally, on the product side, We're seeing strong interest and increased opportunities from our recent acquisition of Optus. As you may remember, Optus is the leading provider of physics based simulation software for light, human vision and visualization. This best in class technology helps to extend our industry leadership and drive full portfolio sales, particularly in the automotive vertical. The $30,000,000 Q2 deal I mentioned earlier was with 1 of the world's leading automotive companies.

And like many of our automotive customers, this company is facing mounting pressures to bring new autonomous and electric vehicle technology to market as quickly as possible. This industry leader who is also a customer of Optus, realized that further investment in ANSYS's flagship solutions, including electromagnetics and functional safety, will increase their simulation efficiency, which is crucial to rapid innovation. Now before I close, I want to give you an update on our Board of Directors. First, I would like to thank 2 of our long standing Board members, Brad Morley and Pat Zovitis, who retired earlier this year, for their many years of dedicated service. And I'd like to welcome to our board 2 accomplished executives with extensive experience at leading technology companies.

Nicole Anasenas and Glenda Dorschak. Along with Doctor. Alan Gallimore, who joined the board in December, they bring a wealth of thought leadership and experience our outstanding Board of Directors, and we are very much looking forward to the value they will bring to our growing enterprise. I will now turn the call over to Maria to discuss our financial results, in more detail. Maria?

Speaker 4

Thank you, Ajay. Good morning, everyone. Ajay shared a few key highlights from our results And now, I will close my prepared remarks with an update on our outlook and key assumptions for Before I begin, I would like to We have been and will continue to provide financial results and outlook under both ASC 605606. Additionally, any comments that I make relative to growth rates will be comparing Q2 2018 to Q2 2017 results under ASC 605 and in constant currency. I will provide key financial metrics under both 605606 And consistent with our standard practice, my comments will be in terms of non GAAP, unless I state otherwise.

Our record Q2 results reflect continued strong momentum and execution across the business. Despite a stronger US dollar, that adversely affected our revenue by approximately $2,000,000 as compared we posted revenue growth of 13% or 10% in constant currency. Operating margins and EPS were above the high end of our guidance under both 605606. Our strong second quarter and first half performance give us confidence that we are on a path to continue to make progress Our key financial metrics for the quarter begin with Q2 constant currency ACV growth of 8%, and 10% growth for the first half of the year. 2nd quarter revenue under ASC 605and606 totaled $299,000,000 $309,000,000, respectively, and include positive currency impacts of $6,800,000 and $6,300,000 as compared to last year.

The increase in software license sales combined with strong maintenance renewals contributed to our deferred revenue and backlog under 605 of 816,000,000 representing a record Q2 high and a 24% increase over last year's comparable balance. Deferred revenue and backlog under ASC 606 totaled 587,000,000. Recurring revenue for the quarter under 605 grew 11 percent in constant currency to a total of $228,000,000 or 0.76 percent of total revenue. Under 606, recurring revenue totaled $225,000,000 or 73 percent of total revenue. Under either method, our growing base of recurring revenue gives us good insight and predictability into our future performance.

The strong top line performance helped to drive a 2nd quarter gross margin of 90% under both accounting methods. And an operating margin of 45.5 percent under 605 and 47.3 percent under 606. The Q2 operating margin was above the high end of the guidance ranges that we had previously provided. Margins were positively impacted by revenue results finishing at the upper end of our revenue guidance when factoring in the strengthening of the U. S.

Dollar beyond the currency ranges provided with our previous guidance, particularly against the euro and the British pound. The 606 revenue and margins were favorably impacted by the timing of deliverables under a single contract that yielded $12,500,000 of revenue This is a good example of contracts that We also experienced a slightly slower pace of hiring than we had planned for the quarter. These delays were partially attributable to Okta's integration activities that have been taking place across the teams since the closing of the deal in early May. We reported 2nd quarter EPS of $1.24 under $6.05 and $1.35 under 60 6. With respect to taxes, our effective tax rate in Q2 was 22%, which was at the lower end of the range that we had guided coming into the quarter.

Going forward, we have updated our estimates and expect our effective tax rate to be in the range of 19% to 21% for Q3. And 21% to 22% for the full year. This includes an anticipated nonrecurring net tax benefit of approximately $5,000,000 or $0.06 that we expect to record in Q3. This net benefit relates to certain subsidiary activities including entity structuring that are currently underway. Our cash flow from operations totaled $111,000,000 for the quarter, and $244,000,000 for the first half.

We closed the quarter with a total of $696,000,000 in cash and short term investments, of which 76% is held domestically. Now let me turn to the topic of guidance. We are initiating guidance for the third quarter, and expect non GAAP revenue under ASC 605 in the range of $302,000,000 to $312,000,000, and non GAAP EPS in the range of $1.25 to $1.31. Non GAAP revenue under ASC 606 is in the range of $265,000,000 to $285,000,000 and non GAAP EPS in the range of $0.93 to $1.07. For the full year, we are increasing We are also revising our outlook to reflect the estimated negative $15,000,000 impact on revenue We are also increasing our EPS outlook combined with our confidence in continued positive business into our updated outlook for 2018 of non GAAP revenue under ASC 605 in the range of $1,223,000,000 to $1,245,000,000 or constant currency growth of 10% to 11% at the midpoint and EPS in the range of $4.97 to $5.09.

Non GAAP revenue under ASC 606 is in the range of $1,210,000,000 to $1,250,100,000 and non GAAP in the range of $4.87 to $5.14. With respect to the contribution from the Optus business, our outlook remains largely in line with what we had communicated last quarter, or a range of $25,000,000 to $26,000,000 in revenue for 2018. We are also updating our ACV outlook for 2018 to factor in the negative impact from changes in currency rates since we last provided guidance. Our revised outlook for ACV is a range of 1,252,000,000 to $1,282,000,000. This represents constant currency ACV growth of 9% to 12% over the 2017 baseline, or approximately 10% to 11% at the midpoint.

We are also maintaining our outlook for capital operating cash flows, other than a slight currency adjustment and narrowing of the range to $435,000,000 to $470,000,000. I would like to remind everyone that our outlook of approximately $12,000,000 to $15,000,000 related to the acceleration of income tax payments that is associated with deferred revenue and backlog credited to retained earnings that will never be recognized as revenue in the company's financial statements. For modeling purposes, we are expecting 3rd quarter operating margins of 44% to 45% under 605 and 37% to 40% under 606. And for the full year, we expect operating margins of 44% to 45% under 605 and 43% to 45% under 606. Further details around specific currency rates and other key assumptions that have been factored into our outlook for Q3 2018 are contained in the prepared remarks document.

In summary, we delivered another solid quarter with strength across our key financial metrics, ACV top line growth, operating margins, EPS, operating cash flows and deferred revenue and backlog. The strong second quarter and first half performance give us confidence that our continued focus on execution and investing in the business combined with the ongoing growth in our recurring business our strong customer relationships and healthy sales pipeline provide a solid foundation to continue to Operator,

Speaker 0

We will now begin

Speaker 3

questions.

Speaker 0

You. Our first question is from Monica Garg of KeyBanc.

Speaker 2

Is, your total revenue yearly guidance is unchanged in spite of currency impact of 15,000,000. But then you are reducing ACV guidance by $15,000,000 due to FX. This I'm trying to understand if it's not impacting any why it is impacting ACV?

Speaker 4

So, Monica, relative to to the outlook for the full year on revenue guidance, it is slightly modified up after factoring in the the currency impact of $15,000,000. And from an ACV perspective, the same thing. It really the only changes to ACV at this point are factoring in, the negative impacts from currency in the second half of the year because of what's transpired in rate changes since we gave guidance in May. There is no other changes to ACVs than other than for currency.

Speaker 2

I mean, what I'm trying to understand is the upside you are seeing in the business in the revenue side, won't you also see in the ACV?

Speaker 4

Yeah. The the ACV range, we've, Monica, we've given a wide enough range that we believe that some of the puts and takes that may happen, particularly in Q4, where some of those larger deals are heavily weighted towards Sometimes the reality is timing may move those into another quarter. So We're trying to balance all the variables, and factor in timing around large deals and the reality that as you get to the end of the year, sometimes with holidays and things, you just run out of runway.

Speaker 0

Thank you very much. The next question is from Gabriela Perez of Goldman Sachs. Please go ahead.

Speaker 5

Good morning. Congrats on the quarter. I wanted to follow-up on 2 of the go to market initiatives mentioned in the prepared remarks, specifically the build out of the channel partners and the hiring of technical salespeople, maybe for Ajay, at a higher level, where are you in the cadence of these investments? And how long is it typically between when you add a technical sales a new channel partner and when you expect to see a contribution to the pipeline and bookings. If I could ask you also to comment on the in progress changes in APAC that I mentioned in the prepared remarks Thank you.

Speaker 3

Sure. So when you think about the changes that we're making and will be announced last year, we said we were going to go through a change in our go to market strategy, and that would include a greater focus on channel partners and would also include a clear understanding and segmentation of the market with an incremental focus on enterprise accounts, And then with our direct sales organization, also taking strategic accounts and sort of territory accounts and then working with the channel to make sure that we have a clear segmentation. As part of that process, we clearly recruited a number of new channel partners who have come on board, and that work is ongoing. Obviously, the rate at which channel partners come up to speed depends on their level of background. And the amount of work that they've done in our space in the past, we are very diligent in how we choose channel partners and it can take, it can take some time to screen them to come on board.

And obviously, they have to come up to speed on our products and so forth. But again, the speed at which they come they are able to sell depends on the their experience in our space. As far as the technical resources are concerned, we continue to recruit and we've been able to add to our technical, salespeople or our ACE organization The pace is not exactly what we would have wanted because obviously we're looking for very, very high skilled people. And so we're a little bit behind on that, but we've still continued to be add to our ranks. I think those were the questions.

Was there anything that I missed?

Speaker 5

Just in progress changes in APAC, and then I have a follow-up on Discovery if I may?

Speaker 3

Yes, in APAC. So essentially, the point about APAC was, as I mentioned in the script, We have a year that's more, a little bit back end loaded. And that obviously, the timing of deals obviously then has an overall impact up on quarter performance versus year performance. That's number 1. Point number 2, I would say when we were a little bit slower in implementing some of the go to market changes that I talked about in South Korea and that had an impact, I would say on our performance in that country.

And then the other point I mentioned was around, the centralization of some large enterprise deals. Essentially, what happens is we serve customers obviously who are global in nature, they have workforces around the world. And we had a few deals where, even with workforces in India, the customers chose to purchase at a different country and centralized the purchasing. So, so that's the, that's the situation over there. It's obviously a multi physics solution that these customers are going after as opposed to a historical kind of single physics view.

So that's really the changes that I highlighted in the script.

Speaker 5

A follow-up is on Discovery Live. What can you share at this point about unit economics? I think we've talked about a 2000, 4000, 6000 price point before. With the PTC agreement, any color you can tell us on the gross margin line and the contribution that have. And one of the questions that we have is when you look at the price points of CAD solutions historically, they've also been in that same sort of range 2004,005,000 range.

When you've gotten customer feedback, has there been any concerns or pushback around while the price of adding on Discovery Live is almost equal on perhaps more than the price of the base cat solution. And sometimes when you're upselling at that kind of price point meaning double, that can be a little bit of an uphill battle. So I would love to hear if any of the feedback from customers has touched on that at all and maybe being positive in spite of that. Thanks.

Speaker 3

So firstly, this was our 1st full quarter of discovery in the marketplace. And, we've seen trials increase. We've conducted or we've sold Discovery Live in every single geo. We've sold Discovery through multiple channels. And the feedback has been very positive.

We're seeing customer traction. I gave you an example in the script of China Southern Power grid. So there is clearly market demand for the product. There's validation that the product hits the sweet spot and this validation that we have it right. So I'm excited about that.

With respect to PTC, that's a royalty arrangement with PTC. So to your point about margins, it's a royalty arrangement. As far as the revenue impact from the PTC relationship, it's at this point of time, we don't have product in market and we don't expect to see any impact in 2018, we're expecting this to have an impact on the following year. As far as customers' interests are concerned, they don't view this as a this is not sort of a small add on to a cab solution. Discovery Live the simulation aspects of Discovery Live are extremely powerful, and this is brand new industry leading capability.

So we're seeing a lot of excitement from customers, especially some of the, especially in the PTC installed base as they think about their creo users, for them to be able to get CAD, we don't see any problem in maintaining the price point, at all. So we don't see that as a problem right now. Obviously, we'll have product in market later on, and we'll have, hands on evidence later on. But right now, we don't see the price point as a problem at all. And I think I addressed

Speaker 0

all the time. Thank you. The next question is from Gal Mundala of Berenberg.

Speaker 6

Hi guys. Thanks for taking my question. I'd like to ask one in terms of the large deals. Now you guys have done 3 large deals of $30,000,000 over the last three quarters or so. Can you just give us a bit of a color about the opportunity the way you see in terms of your existing installed base, how many of those customers are starting to look at the overall folium, maybe consolidate some of the vendors that are using in simulation and what that means for the opportunity in the pipeline of your large deals just trying to get an idea?

Is that out of your customers at 'twenty? Is it 100? Just kind of if you can ballpark it for us? Thank you.

Speaker 3

So one of the important, metrics to consider as you think about our evolution for large deals is to think about the the journey that we've been on. And, if you look back at the history of ANSYS, we were historically selling single physics and our sales motions were around being able to sell an incremental solver at a time, and we were operating very much at the lower levels of the organization. We've obviously moved up over the years. And certainly with the changes that Rick in the go to market that I spoke about earlier, the changes that Rick has made, We have a very clear and thoughtful approach to being able to address the needs of our customers. We use channel partners where appropriate we use inside sales where appropriate, and certainly we have also strategic accounts and enterprise accounts.

These are accounts that we believe will be driving significant multi portfolio sales. And as I mentioned in my script, we have, something like 75% of these large $1,000,000 deals include 3 or more physics. And so you're seeing what you're seeing in these in the evolution is customers who were previously single physics customers are now expanding their footprint and moving to multi physics customers. No one shows up on day 1 as a non customer of ANSYS and then buys multiple, multiple millions of dollars of software with across multiple physics. Usually what happens, they'll come in and they'll grow.

And so many of our existing customers and many of these large deals come from customers who've had years of success with ANSYS who are now expanding their use of simulation. The reason they're expanding their of simulation is not just because we're building we're reaching them in the best possible way we are. We're trying to meet the customers where they are we're trying to adjust our go to market to addressing these of the customers. So that's one, but it's also the case that the products that they're dealing with are becoming significantly more complicated. So if you take, for example, automotive and I mentioned an automotive sale, whereas years ago, we may have had a conversation with customers about structures fluids or airflow.

Today, the conversation is about electrification. I mentioned the example of Volkswagen Motorsport. It's about electrification, it's about electric drivetrains. The conversation is about autonomous. And these are all These are all intrinsically multi physics solutions that include our electronic solutions or embedded software, optical solutions with Optus in the case of autonomous and so forth.

And so the nature of the customer problems have changed. We're in the right place at the right time with the right portfolio. We have the right go to market. We're in a position to get to the customers as they need to, which is essentially, which is essentially driving the growth of our portfolio. The other point I made in the script is we've made investments in our engineering services organization, and we're able to monetize that investment and that also drives adoption and it drives customer success.

So we're very excited about this movement towards larger deals, towards satisfying customer needs at a higher level, and we're very optimistic.

Speaker 6

Thank you. And just as a follow-up, when I looked at your ACV growth around 8% constant currencies, deferred revenue backlog still even in constant currency, might be growing above 20%. Can you just talk a bit about that mix shift that's going on still between perpetual licenses in leases. How does that compare kind of year on year? Maria, if you can comment on that and how does that compare with your expectations that you had, do you still see more and more leases coming in and are those large contracts mostly likely to be leases in the future as well?

Speaker 4

Yes. So, Gail, what I'd say is, I commented in the script, I called out the fact that the recurring revenue streams are growing double digits in constant currency, and no doubt perpetual licenses are single digit growth this year. That being said, certain geographies, particularly in Asia, as Ajay had alluded to, that are slated for second half tend to be paid up in nature, but no doubt as the enterprise has strategic accounts become a larger part of the quarterly business flow. They are choosing leases as opposed to traditional when they were more single physics customers they tended to be paid up and now they are migrating. We will continue, to have a flexible business model that enables to choose because that's the most important element we believe as customers migrate to truly broadening the use of multi physics across the enterprise and adding new products to their portfolio of usage we need to allow them to license the software under whatever model makes sense for them.

And currently a number of those are choosing multiyear leases and we're okay with that.

Speaker 0

Thank you very much. The next question is from Ken Talanian of Evercore ISI. Please go ahead.

Speaker 7

Hi guys. Thanks for taking the question. So first for a bit of housekeeping, could you tell us the inorganic contribution to ACV in the quarter? And a rough estimate of what you now expect for the year?

Speaker 4

Yes, it's about 4 to 5 for the quarter and 2.25 to 30 for the year.

Speaker 7

Okay, great. And I guess for Ajay and sort of bigger picture question, but given the big deal activity, was wondering if you could help us understand what level of upsell you're starting to see on some of these deals as you expand the physics?

Speaker 2

What do you mean what level of upsell?

Speaker 3

Are you talking about expansion across physics or use cases? Could you clarify?

Speaker 7

Well, simply if you were revisiting a renewal with customer and say they are paying $1,000,000. On average, how much upsell are you getting above the prior run rate?

Speaker 3

It's very hard to give you a formulaic, it's very hard to give you a formulaic response because the fact remains, that each of these deals it depends on the industry that the customer happens to be in. It depends on the geos and it depends on the specific initiatives that they underway. And, so there's no standardized answer. The broad trends though that I've mentioned several times, the broad trends that we're seeing of smarter products, that's driving a lot of this conversation. And so you'd get, and I gave you the example of how we're having these broader conversations with a number vendors in the automotive customers in the automotive space, if I think about telecommunications, we're having conversations about 5G and those happen to be strategic initiatives, and so on.

I can pick the industry and we and whatever the strategic area is, that's the area that we're on to try to help them be successful using our technology. And that's what drives that's what drives the incremental use of technology And oftentimes you'll find customers, starting to take a step away from some of their core areas of competence as they start to move into some of these new physics. And in particular, customers have historically not used electronics heavily in the building of their products. Are when they come to when they recognize that you now need to build smarter products, they need more support for electronics, you know, that's that depends on the level of staffing they can get and that's that depends a little bit on the broader support they're able to get together for themselves and we're in a position to help there too. So a lot of it really depends on where the customer is, industry, geo, and so on.

Speaker 0

Thank you very much. Next question is from Rob Oliver of Robert W. Baird. Please go ahead.

Speaker 8

Hi guys. Thanks for taking my question and apologize for the bad connection here if I have one. Just given the push into indirect channels and partnerships and the success you guys are having there. I mean, how should we think about kind of the longer term mix of direct versus indirect business. I think traditionally it's been about 3 quarters direct.

And do you guys see that changing at all? And then I'll put my follow-up in now in case I get cut off again. This is the 2nd quarter in a row where you guys mentioned it's been challenging to hire and that hiring would be back end loaded. I'm just wondering, is that a Seal technical sales issue and what gives you guys the confidence that you'll be able to hire in the second half of the year? Thanks a lot.

Speaker 3

So in first, as far as your question about, the amount, the volume of business to the channel partners, We're not seeing we don't fundamentally expect the numbers to change dramatically in the short term, and it's been, as you rightly say, about a quarter, 3 quarters and that's what we certainly see in the short term going forward. As far you provided a question about hiring people, we this year, as you know, we increased our hiring aperture and we were looking for significantly more people than historically have been in a position to hire And it takes a certain amount of time to rev up the recruiting engines, and that obviously adds latency to the process. And it's also the case that we're looking for very skilled individuals. And some of these individuals are harder, a little bit harder to find. So we're building our recruiting pipeline, which is, of course, both our internal pipeline as well as some recruiting partners, and we have a key focus on making sure we can address bring more people on board.

Maria, anything to add?

Speaker 4

Yes, Rob, I just wanted to add one thing. As with any time that we acquire businesses, It just has a natural slowdown as as we think through the integration, as we think through what talent do they bring to the table that that may be able to fulfill roles that we had additionally that we had originally thought in the plan that we were going to go to market Phil. So that combined with no doubt a more challenging hiring environment has slowed things down, but that being said, We continue to have an aggressive recruiting engine. In fact, we just recently hired a couple more additional people on that team. To help us as we head into

Speaker 3

Thank

Speaker 0

you very much. The next question is from Rich Valera of Needham And Co. Please go ahead.

Speaker 9

Thank you. Ajay, auto featured very prominently in your prepared remarks. And I know that historically been a large customers of your products. And just wondering is there something going on specifically in the auto industry that's leading to kind of more activity, bigger deals that's somewhat unique to auto or is that something you expect to sort of see pervasively amongst your other verticals that you

Speaker 3

Well, the the reason one of the reasons, I've mentioned auto is really there. They epitomize this change that's taking place towards smart connected products. The big the big trends in automotive which are, you know, autonomous, vehicles, electrification, and sort of connected, if you will. All of those trends, we have great technologies that support our customers through that transition. So we have For example, with the Optus acquisition that we just recently concluded, we have now an end to end simulation allows our customers to be able to simulate driven miles.

And so one of the big challenges with autonomous you can't, it's very difficult to test autonomous vehicles, and we can now with this integration across the portfolio and the traditional assets portfolio, we now have an integrated view of virtual mouse driven as well as an integrated view of of the sensors, including camera, lidar, and radar, as well as, of course, ultrasound for short distance, and we can kind of close the loop on the simulation So that's a very exciting solution. It's completely relevant to what the car companies are dealing with right now, and not just on road, but also off road similarly for electrification. And I give a couple of examples and similarly for connected and we're talking about 5G and antenna design and so forth. So that's clearly making a difference for the end customer. And then of course, those changes reverberate through the supply chain.

And so we're having conversations and we're working with customers, for example, around, around the integration safety technology into a semiconductor, into semiconductors. And so in fact, in Q2, a major automotive chip provider, they expanded their use of simulation if this is a chip provider, they expanded the use of simulation to include ANSYS Medina, which is our safety solution to get ISO 262 2 functional safe for ISO262 functional safety analysis, which is appropriate for the auto industry. So there's an enormous amount of reverberation through the supply chain from the automotive sector that you're seeing. So I think that's one area. What these broad trends think are applicable across industries.

As I said, industries are at different levels of maturity, and we expect see these trends repeating themselves across other industries as well.

Speaker 9

And then just a quick follow-up for Maria. Can you reiterate you said on taxes for 2018, what it was in Redpoint too? Thanks.

Speaker 4

Yeah. So what I said was for Q3, we're looking at a range of 19% to 21 percent because we will have a nonrecurring benefit of about, $5,000,000 or $0.06 And then for the full year, we are looking at, a rate of 21% to 22%.

Speaker 0

Thank you very much. The next question is from Jay Fleisharn of Griffin Securities.

Speaker 10

Thank you. Good morning. For Ajay first, with respect to making the simulation more pervasive via partnerships in particular, if in the case of the PTC relationship, you penetrate, let's say, the majority of the active creo base, that would add about 100,000 licenses to the ANTA space, perhaps more. When you consider your other partner opportunities, particularly in operations, such as with SAP or ARRIS, are you thinking in terms of potentially tens of 1000 or 100 of 1000 of additional licenses added to your base, albeit at possibly substantially lower than usual ARPUs for the solvers. And then relatedly, I'll ask your question.

I asked PTC, which is how are you managing, or implementing the partnerships more deeply into the ANSYS organization not just at the highest levels of the company. And then just to, throw my follow-up in for Maria. Your 605 non GAAP operating margin guidance, about a 200 basis point decline at the midpoint from 2017 is the margin anti matter for the year, mostly due to higher R and D. Including the Optus acquisition, or is it mostly SG And A as you add sales and AEs, plus variable comp on the bookings growth?

Speaker 3

So Jay, let me try to address that multipart question. I'm not sure I have all of these. Let me look at Maria's notes here. So the first was around the number of users. So look, it's much too soon for us to give you a revenue projection of where we'll be with, some of those partnerships.

It's obviously the case that we will be expanding the number of users to others, which is traditionally not been using ANSYS solutions. That's certainly the case as you start to think about going downstream into operations, And of course, as you start to think about the design of community, and we believe that there's an opportunity to monetize that relationship going forward, Obviously, it'll depend on the kind of user and the industry they're in. You're also absolutely right to suggest that the cost that we would charge or our pricing for, you know, run time licenses for digital twins will be different from our thing for our traditional solvers, and that's obviously going to be that's obviously going to be the case because the use case is a different and the nature of usage across those two use those two cases will drive a different level of complex the and, and solver need. As far as investing in the relationship is concerned, I think that the relationship has multiple touch points. We have project management in place.

We have multiple touch points up and down both from an R and D perspective, as well as from a go to market perspective, from an R and D perspective, obviously, the teams are working together to make sure that we can, sync up on deliverables and we get everything in place for product release by PTC. But our teams are working closely together. And from a go to market perspective, obviously, there's some planning involved, to make sure that we are understand what we're doing together. So I think that that's well underway, and obviously, this is a working partnership people rolling up the sleeves and getting the job done. So I'm excited about that relationship and I'm excited about, frankly, the mobilization on both sides of both companies, both PTC, and us to move things forward.

Maria was there, there was another question, right?

Speaker 4

Yes, around margins. I'll take take that one. Jay, if you look at our guidance for full year, under 605, we're saying 44% to 45%, which was pretty much in line with what we had communicated as we came into the year relative to our perspective for the full year. We are building in the impact of Optus, which is slightly negative as we had communicated last quarter. And no doubt, we are continuing, to add investments across the business, particularly on the people front.

R and D, field engineering, as Ajay mentioned, on the partnerships We have added, incremental people whose full time job now is to focus on the success of those partnerships. So we're investing across all the functions of the business to prepare ourselves to be able to continue, take advantage of the tremendous market opportunity

Speaker 3

Chris, Chris, do we have another question? Operator

Speaker 0

Our next question is from Ross MacMillan of RBC Capital Markets. Please go ahead.

Speaker 11

Thanks so much. Ajay, I know it's early on Discovery Live, but the example of China Southern Power Grids suggests that It may be a way to engage with customers and then actually drive adoption of the broader portfolio into those accounts. I was just curious, is that a secondary effect, a trend that you think is going to be more pervasive? And then my follow-up for Maria, on the ACV growth you've given us for both Q2 and first half in constant currency. I wondered if you had the comparable growth rates for ACB in 2Q 2017 and 1H17?

Thanks.

Speaker 3

To answer your question, there are actually, I would say, a couple of, important, use cases for Discovery Live. And, one as we've discussed is, of course, the, is the use of Discovery Live by by individuals who have not necessarily been used using simulation and those individuals could be at companies who historically have not bot Answer solutions. And so that's clearly a use case. But there's a really exciting use case, which the Discovery Live, Southern China experience, does bring to bring to focus. And that is that Many of our customers who are historical users of ANSYS recognize the opportunity to be able to broaden the deployment of simulation through their engineering base by making discovery live available to their designers.

And so we'll go from flagships into the designers. But equally, we can go in from the designers into the flagships because we have now the ability to provide this end to end coverage across the organization for people of different levels of skills and capabilities and understanding of simulation with the ability to be able to move and migrate work across the different product lines. And so that's a a dynamic that we're very excited about, and we see this pattern continuing with customers and that's something that we're encouraging And certainly, our enterprise sales force is excited about that because that gives them an opportunity to engage with some of these large customers and they're seeing large opportunities for Discovery Live, but then they're seeing that driving further flagship sales. So that's the symbiotic effect that we're very excited about.

Speaker 4

And Ross, to your question on ACV growth. ACV is a new metric that we just started reporting in 2017 So we have not gone back, to, to recreate ACV under historical data. So I don't have the comparisons for last year

Speaker 0

to maintain the conference back to Andre Gopal for any closing remarks.

Speaker 3

Thanks, Chris. I'm delighted by the excellent quarter and the progress that we've made. Our pervasive simulation strategy is clearly resonating with customers. And as I think about the rest of the year, our focus remains on execution. We will continue to strengthen our flagship products with ANSYS 19.2 that's coming out soon, and we will continue to expand our ecosystem through additional partnerships.

And of course, we will continue to support and grow our customer base. In closing, I would like to express my sincere gratitude to our customers and to our partners. And a shout out to my Ansys colleague, Thank you for all your efforts, and thank you for another great quarter. Thank you all for joining me on the call today, and I look forward to our next discussion. Enjoy the rest of your day.

Speaker 0

Thank you very much, ladies and gentlemen. That concludes this conference call and you may now disconnect your lines.