Howard Morof - CFO Jim Scapa - Chairman & CEO..

Matt Hedberg - RBC Capital Markets Richard Davis - Canaccord Rich Valera - Needham & Company Bhavan Suri - William Blair.

Good day, ladies and gentlemen, and welcome to the Altair Engineering Inc. Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's program is being recorded.

And now, I would like to introduce your host for today's program, Howard Morof, Chief Financial Officer of Altair..

Good afternoon. Welcome and thank you for attending Altair's earnings conference call for the second quarter of 2018. I'm Howard Morof, Chief Financial Officer of Altair. and with me on the call today is Jim Scapa, our Founder, Chairman and CEO.

After market closed today, we issued a press release with details regarding our second 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, please refer to those contained in our quarterly and annual reports filed with the SEC, as well as other documents that we 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.

Jim?.

intellectual property assets of CANDI for IoT and FluiDyna, a developer of disruptive computational fluid dynamic simulation software based on NVDIA GPU technology. While it is early, we are pleased with positive customer indications of interest, relative to the addition of FluiDyna to our CFT portfolio.

Another key element of our growth strategy is our patented units-based licensing model. We are looking forward to expanding this model with expected third quarter introduction of solidThinking units.

Similar to HyperWorks units, solidThinking units are designed to give customers access to a broad range of software applications under a single licensing system.

SolidThinking units will be less expensive than HyperWorks units and are targeted toward supporting our SMB customers and reseller channels focused on simulation-driven innovation where a subset of the full complement of software available under HyperWorks licensing is most relevant.

And yet another market first, the solidThinking unit pool will allow access to software both on the desktop and in the cloud. Our customers win here by getting frictionless access to multiple relevant software titles and our recurring revenue streams tied to their expanded usage.

In summary, we have a strong second quarter and we are optimistic about our outlook. Now, I will turn the call over to Howard for details on our financial performance during the second quarter as well as an update on our financial guidance.

Howard?.

Thanks, Jim. We had a very good second quarter with both software product revenue and total revenue above our guidance ranges. Software product revenue was $72.8 million, an increase of 22% from a year ago and total revenue reached $95.6 million representing growth of 17% from the second quarter of 2017.

Combined with the first quarter, our revenue increased 18% for the first six months of 2018 as compared to the same period in 2017. Adjusted EBITDA grew to $7.3 million for the quarter which exceeded our guidance and compares favorably to $4.1 million a year ago.

Currency impacts from the current quarter were muted, contributing only $2.5 million to revenue and $0.7 million to adjusted EBITDA. Our revenue mix shift continues favorably in the current quarter. Software product revenue grew to 76% of total revenue in Q2 2018 from 73% in the same quarter last year.

Software segment revenue which include software products and software-related services grew to 85% of total revenue in Q2 of 2018 as compared to 83% last year. Consistent with our expectations, revenue from client engineering services was $12.4 million, virtually unchanged from the prior year.

Other were innovation activities revenue increased 10% to $1.6 million driven by revenues from our toggled LED lighting solutions. We believe billings are an important indicator for our business and a valuable metric in evaluating our performance.

We calculate billings by adding our revenue to change in deferred revenue which has primarily related the software from the prior period. In the second quarter, deferred revenue increased 14% from a year ago and calculated billings were $89.5 million, an increase of 4% from a year ago.

For the first half of 2018, calculated billings were $204 million, an increase of 13% from the first half of last year, which is indicative of our strong software product momentum.

We tend to view billings over longer time periods due to the impact variations and timing of renewals, expansions and new customer arrangements can have on a quarter-to-quarter basis. 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 second quarter was 69.2 %, an increase of 2.2 percentage points a year ago due to a higher mix of software product revenue coupled with improved margins from software related-services activities.

Non-GAAP software gross margin was 83.5%, a decrease from 85.4% a year ago. However, excluding the impact of hardware revenues derived from certain inherited contractual programs from recent acquisitions, non-GAAP software gross margin would have been 85.1% basically consistent with a year ago.

CES gross margin was 19.8% compared to 20.5% a year ago, largely resulting from higher compensation cost relative to billings rates to our customers doing part to a continuing tight labor market. Innovation gross margin was 38.6% compared to 15.6% a year ago. Note that gross margins are likely to vary on a quarter-to-quarter basis.

For the quarter, operating expenses excluding stock-based compensation and amortization of intangible assets were $61.5 million compared to $49.6 million a year ago.

The increase was driven by investments in R&D including the impact of acquisitions, continuing investments and growing sales capacity to enhance revenue growth opportunities and incremental investments related to the accelerated time-link [ph] to address SOX 404 and the adoption of the new revenue recognition standard.

Operating income excluding stock-based compensation and amortization of intangible assets was $4.6 million compared to $5.2 million a year ago. Adjusted EBITDA for the quarter was $7.3 million as indicated earlier compared to adjusted EBITDA of $4.1 million a year ago. Adjusted EBITDA margin in the second quarter was 7.6%, compared to 5.1% a year ago.

On a year-to-date basis, we are at an adjusted EBITDA of 8% compared to 4.5% for the prior year to date. The year-over-year improvement reflects momentum in our software revenues coupled with realizing the initial benefits of scale on certain operating expenses as our business expands.

We continue focusing on realizing operating leverage as we progress towards our long term adjusted EBITDA margin targets of 20% or greater. We are pleased with our profitability performance from the first half of the year and expect that we will see healthy growth and adjusted EBITDA margins for the full year.

Non-GAAP net income was $3.9 million or $0.05 per diluted share, compared to $5.1 million or $0.08 per diluted share a year ago. On a GAAP basis, second quarter net income was $1.5 million or $0.02 per diluted share compared to a net loss of $7.2 million or $0.14 a year ago.

Turning to our balance sheet, we ended the second quarter with $199.2 million in cash and cash equivalents, up from $63.2 million at the end of the first quarter. This includes $135.6 million in net proceeds from our follow on public offering in June.

This offering provides Altair with additional capital to invest in our growth initiatives including potential M&A activities that could be larger than our historical transactions.

However, we will always be disciplined in our approach as we look to add technologies and capabilities that we believe will be important for either our current or long term growth opportunities. Total deferred revenue was $156.5 million at the end of the second quarter, an increase of 14% from a year ago reflecting our software momentum.

Quarter-to-quarter changes in deferred revenue can vary due to timing factors. Turning to our cash flow statement. Cash flow from operations in the second quarter was $10.6 million compared to $6.9 million for Q2 '17.

Free cash flow which consists of cash flow from operations less cash capital expenditures was $9.2 million for the second quarter, an improvement from $5.5 million for the second quarter of 2017. The increase in our free cash flow reflects the impact of our strong operating performance coupled with the timing of working capital benefits.

Turning to our outlook for revenue for 2018, we are raising our full-year forecast to reflect our continued positive momentum. The increased outlook is driven by software product revenue and includes a modest impact from our recent acquisitions.

We are also increasing our adjusted EBITDA outlook for the year which reflects the positive impact of our performance in the first half of 2018. For the full year 2018, we are providing updated guidance as follows. We expect software product revenue to be between $288 million and $290 million representing growth of 17% to 18% from 2017.

We expect total revenue to be between $380 million and $382 million representing growth of 14% to 15% from 2017. We anticipate GAAP net income to between $11.5 million and $13 million. We are anticipating an adjusted EBITDA of $34 million and $35.5 million representing a notable improvement and adjusted EBITDA margin over 2017.

We expect non-GAAP net income to be between $21.2 million and $22.7 million. This guidance exclude estimated stock compensation expense of approximately $1.7 million for the year and that we expect fully diluted share count to be approximately $77 million shares. We now expect free cash flow to be between $20 million and $23 million for the year.

From a profitability perspective, we balance the investments in the business with delivering steady improvements in profitability towards achievement of our long term operating targets. We continue to invest in R&D activities along with certain sales and marketing efforts.

We believe this balanced approached enables us to more quickly capitalize on the expanding number of growth opportunities we see in the market. We're confident these investments will position us for both improved growth and profitability in the future.

In addition, as we indicated on our last earnings call, our G&A spend is elevated in 2018 due to the accelerated implementation of SOX 404 and ASC 606. For the third quarter of 2018, we expect software product revenue to be between $72.5 million and $73.5 million, representing growth of 15% to 16% from the third quarter of 2017.

We expect total revenue to be between $95 million and $96 million representing growth of 12% to 13% from the third quarter of 2017. We anticipate an adjusted EBITDA of between $8 million and $8.5 million. We anticipate GAAP net income to be between $2 million and $2.5 million. We expect non-GAAP net income to be between $4.6 million and $5.1 million.

Note that this guidance exclude estimated stock-based compensation expense of approximately $0.6 million for the third quarter and that we expect fully diluted share count to be approximately $77 million for the quarter. Before I finish, I wanted to provide an update on a couple of other items.

While continuing to analyze the impacts of the tax cut and jobs act on our effective tax rate, we remain comfortable with a tax rate between 28% and 30%. This rate is higher than the new U.S.

statutory corporate tax rate due to foreign taxes withheld at the source for which we are not able to realize the benefit in the U.S., given our valuation allowance position on deferred tax assets.

Based on our significant share price growth since the IPO last November and the corresponding public quote on June 30, we will no longer qualify as an emerging growth company under the Jobs Act as of December 31, 2018 and we'll transition to a large accelerated filer at that time.

As we indicated at the beginning of the year, we expect to incur several million dollars of incremental G&A expense this year to meet the additional compliance requirements applicable to large accelerated filers [ph], based on current expectations their cost range remains operative.

In summary, we are pleased with our results for the second quarter and first half of 2018. We are seeing positive demand trends across our expanding product portfolio. We believe we will remain well-positioned to generate meaningful growth, operating leverage and profitability over the long term.

With that, Operator, can we now open up the call to questions?.

Certainly. [Operator Instructions] Our first question comes from the line of Matt Hedberg from RBC Capital Markets..

Sure. Thanks, guys. Hey, guys, congratulations on a strong quarter. Jim, I want to start with you, the success your seeing in the solvers [ph] market remains obviously a rapidly growing large market for you guys. On the call you talked about a few nice winds.

But generally speaking, can you talk about where you're seeing most of this expansion in your base? Is it primarily new projects or are you also seeing a fair amount of share shift replacement opportunities for competitors, solvers, solutions?.

The same answer I always give you, it's a mix of both, really. So we're seeing a lot of expansion in existing accounts where for the electromagnetics for example, we're seeing just greenfield opportunities actually in many cases and most cases, really. But we're also seeing some takeaways.

I think it's a growing market and so a lot of our opportunities are just simply because it's growing, but we always do some take away from the competition as well..

That's great. And then maybe as a follow up. You guys had a press release out not long ago, talking about and expanding or actually a new relationship with GE, that your customers can now use their flow simulator software.

Can you talk about just generally speaking, obviously partnerships are important to you guys in general, but where does this one stack in the sense of the other partnerships? Is there any early customer feedback or anything that customers are using that technology and sort of any benefits you're seeing from the combined platforms?.

Two parts to that. First of all, it's not common for us actually to do a partnership like that. It's actually relatively unusual. The technology that GE developed is really a very, very powerful piece of technology.

I really didn't know how much traction it would have, but to be very honest with you, we're seeing a great deal of traction for it and a great deal of interest internally as well. There just seems to be a lot of opportunities for this technology.

It's really positive because it's strategic for us with GE and then it continues to strengthen our relationship with them and they developed a really great product there and customers are very interested in it..

Thanks a lot, Jim..

Thank you. Our next question comes from the line of Richard Davis from Canaccord..

Jim, you and I have been around long enough and AI seems to likely to follow every other technology innovation and then we probably overestimate the impacts short-term and underestimate it long term.

But how are you setting up Altair to be at the forefront of application of AI to design? Because you know, at some point I do think it will matter and I realize it's not right away. But how do you think about that because that's your job to be big picture as well as tactical. Thanks..

First of all, I wasn't expecting you on the call. I thought you have your conference..

Well, I'm passing up beers right now, so it's a very big disappointment for me..

Well, I appreciate it. I don't know if you were told that I have surgery on my foot..

I did. I heard that, well, that's alright. It's what happens when we get less....

I was not excused..

Exactly..

I actually think it's a pretty thoughtful question and the way you characterized technology like AI where you probably won't have as big an impact near-term, but it will have a big impact long term, I agree with. So we're doing several things.

We have a lot of skunk works projects happening around the company that were in the area of machine learning and AI. I've kind of brought them together under one leader. One of the PhDs in the company who drives one of our products in the area of optimization and those sorts of technologies.

So under her leadership, we bought in a number of people together. We have a lot of projects running and we're kind of experimenting with predictive analytics how to apply it in some very interesting types of simulation to really enhance what we're able to do. And we're looking at a lot of new technology also.

We're spending a lot of time looking at new companies and technologies out of the university in that space and hiring, frankly. This afternoon, we had all of our summer interns. They do a thing once a summer to present the process that they're doing and several of them are doing things in the machine learning area.

So it's bubbling up, I guess is what I would say and we're trying to figure out how it can apply in a number of different areas..

Perfect. That's really helpful. Thank you so much..

Thank you..

Thank you. Our next question comes from the line of Rich Valera from Needham and Company..

I just wanted to ask a question on the billings number. You guys have to put up some very strong billings numbers for the past couple of quarters. Obviously a bit lighter this quarter, but yet you raise the full year pretty nicely.

I don't know if you're willing to comment on how we should think about billings going forward presumably, we'd see some acceleration above that 4%, but understood that's lumpy and you kind of want to average that.

Any commentary at all on that, please?.

Sure. No, it's a fair question. We feel like we had a very strong first half and we're feeling great about the second half as well.

It is a little bit on the lumpy side, it's the way we run the business, too, in a sense that we're not chasing business, we're not out there discounting in order to close something and so it doesn't always come in exactly when you think it's going to come in. So in general, we're working on real positive about how the whole first half went.

It may be came in a little bit differently than we might have expect to a super strong first part of the year. But we're feeling very, very solid about things going forward as well. I don't know if Howard wants to add something there..

I think, Jim, that's very well-stated..

Okay..

Fair enough. And then I wanted to just get your updated thoughts on your ability to hire people. This year you went into it looking to make a fair bit of an investment, I think, particularly on sales and marketing, but I think also on R&D. And it seems like you're hitting your expense targets more or less.

Seemingly suggesting that you're hiring on pace and then your increased guidance, the top line was up by around $10 million and the bottom line by quite a bit less and that would seem to imply some incremental investment beyond what you'd contemplated earlier. So if that is the case, I'd be curious where that incremental investment might be going.

Two questions there. Thank you..

Here, I'm going to let Howard answer if he wants to, or I can always say something here if you want..

I'll chime in and you'll certainly add. We have pretty good view on revenue guidance as well. We're comfortable conservative in that regard.

On the expense side, we're being thoughtful obviously in our higher ringer [ph] investments are going into the sales in marketing area as we've indicated before, adding to our capacity, encoded carrying account executives in particular. So that area as a continual focus.

In addition to which obviously we have continued to invest in our investing in R&D activity, some of that by acquisition, some of that obviously ongoing activities with a view towards items that produce opportunities near term as well as long term.

As we said earlier this year, we think the market is very healthy and we think it warrants these areas of investment and spend..

Was I correct that it's incremental? Was I correct that there's an incremental investment implied in your new guidance relative to the old guidance?.

I would say a little bit so, but not a real significant shift in perspective..

One thing I can add actually and this is more qualitative than quantitative, frankly at this point. But there is a little more salary pressure, I think than we've seen in the past couple couple of years.

If you read the papers, there isn't that -- wages are staying the same, but I think it feels where we are where you have very, very highly in-demand people, we do notice more salary pressure than in the past.

I think we're managing it super well, we're managing our heads very well, but that's adding to it as well and I think the M&A piece of it, we do some M&A and then we digested and some of the cost cutting takes a little bit longer to do and some of the new revenue takes a little longer to come as well, so you get the cost before that revenue sometimes as well.

I think it's a mix of all those things..

Fair enough. Appreciate the color. Thank you, gentlemen..

Thank you. Our next question comes from the line of Sterling Auty from JPMorgan..

Just one question from our side.

Actually it's a follow up from Jim, what you were just mentioning about some salary, some upward pressure and salary expenses, things like CES margins and revenue have recovered nicely from kind of the trends at the end of last year? So specifically within CES, can you update us on how both hiring trends and also retention within that business is holding up?.

Actually the CES business has been surprisingly solid, I would say. I think margin, a tiny bit effect and actually again from some salary pressure. But in general, CES businesses is very, very solid for us..

All right. That's all we had. Thank you..

Thank you..

Thank you. Our next question comes from the line of Bhavan Suri from William Blair..

Hey, guys. Can you hear me okay? I apologize for the background noise. I'm sort of traveling..

We can hear you..

I guess my first question is something that have come up a lot with investors pushing it too, is as you view the macro economic issues around some of the trade work we're entering especially in automotive, I guess a, how much of the growth is coming through automotive; and then sort of diversification between acquisition solvers, high performance, computer -- you got a whole lot of stuff.

I guess how would we think about that particular rest [ph] and what could potentially be a negative outcome should that sort of fall [ph] where the automotive companies sort of start seeing a decline because of whatever tariffs might be imposed?.

First of all, right now we're not noticing an impact, to be perfectly honest with you. Once doesn't know where things go right now at the moment..

Right..

But in general, our sense is that all of these companies, a lot -- the auto market is not what it was before.

There's something like 12 electric vehicle companies across the West Coast for example that are all excellent customers for us and all of the automotive companies across the globe are just in hot pursuit of delivering next-generation products.

Even if they have some impact there and I need to reduce some of their investments, I don't think it's going to happen in the areas where we play very much. At least right now, I don't see that..

Got it. And then, sort of thinking doing well, but you sort of said will offer some units-based model there and then obviously you've also started a startup program. Sort of the move down the market seems a little more enhanced.

Just sort of the thought process there or maybe the size of the market, sort of what you think you can capture in that mid-smaller market that others haven't? That would be helpful..

We think the mid market is an enormous opportunity for us, actually. We're going after it in multiple ways. We're hiring more sales guys and pushing down, moving to the new model for solidThinking, we think is going to be a lot more interesting and attractive for the resellers and for the customers.

And similarly, when you start a program, actually, is getting a lot of traction, actually. Actually beyond what we had anticipated. It's where we see thousands of companies coming in and inquiring. It's a good thing.

I just think that a lot of company is looking to do simulation or more simulation than they were in the past and now Altair is well-positioned to be able to serve that market..

Great. That's super helpful. Thanks, guys. Congrats and I'll talk to you soon..

Thank you..

Thank you. [Operator Instructions] Our next question comes from the line of Gal Munda from Berenberg Capital.

Your question, please?.

Just two questions from me. First, what's driving the upgraded guidance? Like what has changed from the previous quarter and then maybe does acquiring smaller vendors make you more successful as a specialist simulation vendor? Thanks..

I'll let Howard take the first one if you want..

Our view on revenue along with the other things that follow is driven by what we will consider to be an obviously a very good first half of the year.

Obviously our momentum is software-driven so it's a combination of success of our existing customers, the ability to attract new customers, expansion and such with coupled with adding sales capacity which was a very key growth trigger for us and continuing to do so really all complementing each other, supporting against obviously a pretty good market on an overall basis.

It's a lot of different factors layered in that are really helping support our view on our ability to grow revenue..

We're just generally feeling optimistic about how things are going. The pipeline is extremely solid and we are not typically overly optimistic. We try and be very, very realistic about our prognostications. And as you come in towards the end of the year, you have a little greater and greater confidence in what you're predicting.

I forgot your second question. I apologize.

Could you repeat it?.

Yes.

Just around acquiring smaller vendors, does that make you more successful? Maybe a specialist simulations under?.

It all depends, actually. Because sometimes that's true. Sometimes you're filling out a gap or something and one of the products or one of the technologies that we're trying to make sure we have full coverage for their user base or something. But some of the technologies we're looking at that are small and new can have very broad-based applicability..

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Jim Scapa for any further remarks..

In general, we feel like we delivered very, very strong solid second quarter results. We see increasing opportunities to extend our leadership position in CAE in adjacent markets and we're investing to drive faster growth from the future.

We believe we're well positioned to deliver strong growth and increasing profitability in the years ahead which should generate significant value for shareholders. Look forward to speaking to all of you again soon. Thank you..

Thank you. Ladies and gentlemen thank you for your participation at today's conference. This does conclude the program. You may now disconnect. Good day..