Originally published May 1, rebuilt here due to site issues.

Engineering simulation software provider Ansys (ANSS) reported revenue of $109.5 million in the first quarter of 2008 and non-GAAP earnings per share of $0.40. This compared with a consensus estimate of $105 million and $0.33.

Ansys also issued new guidance for the full year. It now expects:

* GAAP revenue in the range of $448 - $452 million
* GAAP diluted earnings per share of $1.19 - $1.25
* Non-GAAP diluted earnings per share of $1. 54 - $1.57

The prior consensus estimate called for $453 million in revenue and $1.42 in earnings per share.

One of the reasons I own Ansys is that beating and raising is something of a habit for the company.

Disclosure: At time of publication, William Trent owns shares of Ansys (ANSS).

This morning Ansys (ANSS) announced it would buy Ansoft (ANST - Annual Report) for $16.25 per share in cash and 0.431882 shares of Ansys. A conference call discussing the deal will be webcast at 11:30 EST.

Ansoft is a leading developer of high-performance EDA software. The software is based on more than 25 years of research and development by world-renowned experts in electromagnetics, circuit and system simulation. Engineers use Ansoft products to simulate high-performance electronics designs found in mobile communication and Internet devices, broadband networking components and systems, integrated circuits, printed circuit boards and electromechanical systems. The company’s products are used by blue chip companies as well as small- and medium-sized enterprises around the world.

The acquisition of Ansoft is ANSYS’ first foray into the broader EDA software industry and will enhance the breadth, functionality, usability and interoperability of the combined ANSYS portfolio of engineering simulation solutions.

The “first foray” signals that Ansys won’t be getting much, if any, synergies from the deal. Nor did the press release predict any. The fact that both companies are headquartered in Pittsburgh will minimize costs related to the combination, but that is about it.

Investors signaled their distaste for the deal by sending Ansys shares down more than 7%. In fact, the two companies now have a combined market cap that is $100 million lower than it was before the deal was announced. This could represent investor’s view of the value being destroyed by the deal, or the costs associated with combining the two companies. This is a big contrast to the positive reaction given to the acquisition of Fluent in 2006.

As an Ansys shareholder, I am disappointed that the shares are lower. However, I still think Ansys works in an attractive market segment and am willing to give some benefit of doubt to a management team that has quadrupled shareholder wealth over the last four years.

Disclosure: William Trent owns shares of Ansys (ANSS)

I have long been a fan of engineering simulation software developer Ansys (ANSS), and in January I bought shares for my personal account. Today I was rewarded for that position when ANSYS reported earnings.  In addition to beating the consensus estimate for 2007, the company raised guidance for the coming quarter and full year.

The Company currently expects the following for the quarter ending March 31, 2008: GAAP revenue in the range of $103 - $106 million
GAAP diluted earnings per share of $0.24 - $0.26
Non-GAAP diluted earnings per share of $0.33 - $0.34

Fiscal Year 2008 Guidance

The Company currently expects the following for the fiscal year ending December 31, 2008:

GAAP revenue in the range of $442 - $447 million
GAAP diluted earnings per share of $1.12 - $1.19
Non-GAAP diluted earnings per share of $1.48 - $1.51

These are better than the prior consensus estimates of $435 million in sales and $1.37 in earnings per share for the full year, and also above my own estimate of $1.06 in GAAP EPS. (I always maintain that if GAAP stands for Generally Accepted Accounting Principles, then non-GAAP must stand for unacceptable accounting.)

My prior analysis had indicated a fair value of $46 per share. With no other changes than the updates to existing estimates for 2008, the value rises to $48. Given the decline in interest rates since then, a much higher value could be justified. Since the $48 is still well above the current valuation, I see no need to make such justifications for continuing to hold.

Disclosure: Long Ansys (ANSS)

This article is a reprint of my February 8, 2008 RealMoney column

One of my favorite investment themes is engineering and infrastructure software, which I think combines the high margins and cash flow stability of a software investment with the positive long-term trends in global infrastructure development. I think investors can profit handsomely from a potential 64% rise in Autodesk, the leading player in this market.

In November I wrote bullishly about Dassault (DASTY) and Ansys (ANSS), which I bought in January. Since those columns were written the stocks have performed in-line with the market, which is a nicer-sounding euphemism for saying they have gone down. I was more bearish about Parametric (PMTC), which has indeed turned in the worst performance of the three.

Long term, however, I still think the space has tremendous opportunity and think the overall market downturn is providing additional opportunities – most notably that of industry leader Autodesk (ADSK). Autodesk is best known for its AutoCAD software, a customizable and extendable computer aided design (CAD) application for 2D drafting, detailing, functional design documentation and basic 3D model-based design.

A common misperception is that AutoCAD is focused on architectural markets, and that a slowdown in construction activity could be disproportionately harmful. However, the largest end market is manufacturing (product design) and the civil engineering/infrastructure market is nearly as meaningful as construction.

The shares were downgraded by an analyst at Jeffries in January, who cited “anecdotal channel evidence of slowing manufacturing demand in Europe” and a “decent chance” that spending on computer-aided design software and related technologies will slow in both North America and Europe in 2008. Yet his less-than-2% trims to his EPS estimates, which simply brought them in line with the rest of the crowd, are more than reflected in the 25% decline in the share price since the December.

At any rate, Autodesk continues to meet or exceed earnings estimates and has seen modest positive revisions to estimates over the last month. Since its products are used in the early stages of the construction process, if the potential slowdown doesn’t show up soon it likely won’t show up at all.

Furthermore, with more of its customers migrating to a subscription-based model some of the uncertainty surrounding upgrade adoption has been mitigated and revenue growth and stability are more transparent. Subscription revenues are growing at twice the rate of license sales. Deferred revenues have grown 12% in the last nine months, including an 18% increase in long-term deferred revenues. All of this lends to greater confidence in the level of sales and earnings over the next year.

Autodesk generated $640 million in free cash flow over the last 12 months, which amounts to a free cash flow yield approaching 8% of enterprise value. With a 500-basis point advantage over Treasuries and a long-term expected growth rate of 16% (which is more than justified by the company’s high return on equity) the stock looks very attractive here.

If Autodesk grows in line with estimates and narrows the spread between its cash flow yield and the Treasury yield to a still-attractive 100%, its shares could rise to $63, for a potential return of 64%. The shares offered a similar spread to Treasuries as recently as December, when the shares were trading above $51. Meanwhile, short of a considerable decline from the existing level of sales and cash flow it is hard to see significant further downside.

Disclosures: Long Ansys (ANSS)

I just printed an order for Ansys (ANSS).
Ansys has a fairly predictable January sell-off that I just took advantage of.

My investment thesis is here.

This article was originally published at RealMoney on November 19, 2007.

With shares of Ansys (ANSS) up 100% over the last two years and more than 1,200% over the last seven, it hardly qualifies as undiscovered. However, with only four analysts covering the stock – and none from bulge bracket investment firms, the stock may remain under-appreciated.

Earnings have exceeded estimates by a wide margin for several consecutive quarters (including a significant earnings beat just two weeks ago), which is further evidence that the current consensus may not fully reflect the company’s earnings power. The shares soared on that news but have since come back down to their prior levels due to the overall stock market weakness. I think this baby is wrongfully being thrown out with the market’s bath water.

Ansys (ANSS) designs engineering simulation software used in such industries as aerospace, automotive, manufacturing, electronics, biomedical and defense. Simulation software reduces the time it takes to move products from the design stage into manufacturing because it allows for much of the necessary product testing to be simulated rather than tested on prototypes. Ansys licenses its technology to businesses, educational institutions, and governmental agencies.

On May 1, 2006 Ansys acquired one of its largest competitors, Fluent. The acquisition depressed trailing earnings and elevated trailing valuation multiples, possibly keeping Ansys off the radar screen of some investors.

Despite a fairly hefty multiple of 28x next year’s earnings, the company generates a strong free cash flow yield of 3.5%, which is nearly as high as the current yield on five-year treasuries. Unlike Treasuries, Ansys also offers significant growth that should more than compensate for accepting the related risk. Based on my calculations, the stock has an intrinsic value of $46 per share based on that ability to generate excess cash.

An Eye on the Risks

With the possibility of a recession rising, it is worth considering a possible demand slowdown. The company’s largest end markets are aerospace and autos. Aerospace is booming but major projects like the A-380 and Boeing Dreamliner are past the design stage, so arguably demand could slow until the next major product cycle is under way. Autos face the opposite risk – slowing demand due to the overall industry’s distress.

The long sales cycle and potential for large license sales can lead to lumpy sales patterns, a risk reduced by the Fluent acquisition since Fluent sells a higher proportion of lease-based licenses rather than perpetual licenses. Ansys has been a leader for many years, and even if it were to fall behind technologically its customers would be unwilling to migrate to a new platform immediately. This lag could allow them to catch up or buy the necessary technology.

The company could fail to successfully integrate a future acquisition. However, its acquisition of Fluent, and Dassault’s (DASTY) purchase of ABAQUS, has reduced the pool of potentially large acquisition candidates significantly.

Valuation

Ansys has generated more than $103 million of free cash flow in the last 12 months. Based on its current enterprise value of $2.9 billion, Ansys is generating a free cash flow yield of 3.5%, slightly less than the yield on five-year treasury securities.

According to Zacks Investment Research, the consensus five-year earnings growth estimate is 18% per year, which compares to 11% actual historic market growth and a 13% theoretical sustainable growth rate (equal to the average ROE since there is no dividend.)

I think sales can grow 15.7% in 2008 and 15% in 2009, which should generate nearly $130 million of free cash flow in 2008 ($1.60 per share) and $160 million in 2009 ($2.00 per share). At that time, assuming a 100% required return premium to treasuries and a 4% terminal growth rate the company could be worth $3.7 billion, or approximately $46 per share. I further believe they would have $4 per share in net cash by that time for a total potential value of $50 per share and total potential cash on cash return over the 2+ years of 30%. Discounting the cash flows to the present at a required return of 8.5% generates an estimated current intrinsic value of $46.00 per share, from which the current price represents a 20% discount.

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Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

This article was originally published at RealMoney on November 6, 2007.

Parametric Technology (PMTC) develops software used for Product Lifecycle Management (PLM) and Enterprise Content Management (ECM). At a P/E of approximately 15x and a 5.3% free cash flow yield, Parametric appears cheap relative to other technical software developers. However, its earnings quality has historically been low and it faces more severe competition than some of its peers. With earnings quality improving and the valuation favorable, PMTC certainly bears watching. But for now I think Dassault Systemes (DASTY) and Ansys (ANSS) have sufficiently better prospects to justify their higher valuations.

Compared to companies like Ansys, which develops highly technical products and has relatively few competitors, Parametric has significant competition in each of its business segments.

PLM competitors include Dassault Systemes SA, Siemens (SI) subsidiary UGS, Autodesk (ADSK) and Agile Software (AGIL). They also compete with larger enterprise-solution companies such as SAP (SAP - Annual Report) that have entered the PLM market and offer solutions integrated with their other enterprise software applications.

ECM competitors include EMC (EMC - Annual Report) Documentum, IBM’s (IBM - Annual Report) FileNet, OpenText, Adobe (ADBE) Framemaker, and the Microsoft (MSFT - Annual Report) Office suite.

Parametric suffered mightily during the tech downturn, but since 2004 the company has been engineering a turnaround based on improved profitability and a return to growth. Current consensus growth estimates for the next five years are just 7%, or half the rate expected for the industry. The lower growth estimates are part of the reason for the cheaper valuation. However, they also make for a lower bar to clear, and the recent reversals of its deferred tax valuation allowance are a signal that the company is now “more likely than not” to earn sufficient income in future years to utilize tax losses from prior periods.

There are a few other issues that cause me to think Parametric’s low valuation is justified. For example, 58% of revenues are derived in North America, which faces an uncertain near-term economic outlook.

Another issue is earnings quality. Gross margins have been declining due to a higher percentage of revenue being derived from consulting and training rather than license and maintenance revenue. A bad debt charge-off in 2006 and increased customer financing activity are other signals that earnings quality may be low.

To get a feel for overall earnings quality, I calculated the accrual ratio, or the change in net operating assets divided by average net operating assets. This ratio describes the percentage of earnings contributed by discretionary accounting items rather than actual cash flows. An ideal accrual ratio would fluctuate around zero. Parametric’s has been all over the map, though it has been improving for several quarters.

Sources: Zacks Research Wizard, William A. Trent

If Parametric continues to improve its earnings quality, or if it gives back some of the stock gains it enjoyed post-earnings (or preferably both!) it could become an attractive buy candidate.  In the meantime, interested investors may find an option play worthwhile.

The January 17.50 puts were trading recently at $0.50/$0.75. If you could write the option for $0.60 it would offer a 3.1% 2.5-month return on the money at risk, which annualizes to nearly 15%. You’d be forced to pay $17.50 for the shares if they drop between now and then, but the option premium would give you an effective price of just $16.90. At that price, the 6.0% free cash flow yield would probably be enticing enough to justify a buy anyway.

Disclosure: Short naked put options on Ansys (ANSS)

William Trent currently has a short position in put options related to Office Depot (ODP).

This article was originally published at RealMoney on November 5, 2007.

Dassault Systemes (DASTY) is trading down nearly 6% after the company trimmed its earnings outlook by five Eurocents last week. The company now expects to earn between €1.96 and €2.00 in 2007, compared with earlier guidance of €2.00 - €2.05. With a solid overall business and a valuation that I believe looks reasonable, I think investors will ultimately find today’s price to have been an excellent entry point.

Dassault designs engineering software used for Product Lifecycle Management (PLM) (81% of 2006 revenue) and Mainstream 3-D design (19%). It has grown through organic growth and a series of acquisitions, including Abaqus in 2005 and MatrixOne in 2006 – each of which was in the order of $500 million consideration. It is 44.5% owned and effectively controlled by France’s Groupe Industriel Marcel Dassault.

Dassault offers software under several brands, including Solidworks for Mainstream 3D design and CATIA, DELMIA, SIMULIA and ENOVIA for PLM. However, a key aspect of its growth strategy is to combine the strengths of its various programs and allow customers to customize solutions using the company’s V5 platform.

The company generates 47% of its revenue in Europe, 31% in the Americas and the remainder in Asia. Although it blamed the lowered outlook on the weak dollar, the company’s latest annual report said its greatest currency exposures are between the Euro (its reporting currency) and the Yen, Pound and Korean Won.

More than half of the company’s sales are on a recurring (software rental or maintenance contract) basis rather than through perpetual license fees. With a largely industrial customer base, revenue growth drivers include business investment and industrial production in its end markets.

Competition

Dassault lists its primary PLM competitors as Parametric (PMTC) and Unigraphics, which was recently acquired by Siemens (SI). Its main competitor in Mainstream 3D is Autodesk (ADSK). The company also competes with Ansys (ANSS), Agile (AGIL), MSC Software (a href="http://stockmarketbeat.com/blog1/category/msc-software-mscs/">MSCS - Annual Report) and to a lesser extent Oracle (ORCL - Annual Report) and SAP (SAP - Annual Report).

The combined revenue of the nearest competitors and comparables, which I believe to be Dassault, Ansys, MSC and Parametric, has been approximately 11% annually over the last decade. Dassault has used its acquisitions and the opportunities provided by the V5 platform to grow at a faster rate than its peers.

In 2006 Dassault grew 24%, much of which was contributed by the Abaqus and MatrixOne acquisitions. On an organic basis sales grew 10% (12% assuming constant currency exchange rates.)

Risks

As I see it, the greatest risk Dassault faces is loss of a major customer. Although the company cites a customer base of 100,000 just 20 of those account for 25% of sales, with the largest customer accounting for 5%.

A potentially greater, though probably less likely risk is the company’s long-standing relationship with International Business Machines (IBM - Annual Report). IBM has a non-exclusive distribution relationship with Dassault and accounted for 45% of sales in 2006, so a rift between the companies could have a serious impact. The companies renegotiated the partnership earlier this year such that Dassault is taking responsibility for mid-market customers and IBM will serve enterprise customers. However, this adds a new risk related to maintaining a larger sales force.

Valuation

Dassault current market cap is approximately $7.3 billion, and with net cash on hand of nearly half a billion its enterprise value is about $6.8 billion. Given that it is on track to exceed its 2006 free cash flow generation of $300 million, the free cash flow yield of 4.4% compares favorably to the yield on five-year treasuries, and the 10% growth rate of recent years looks like a nice inducement for taking on the added risk.

By some common measures (5x book value and a P/E in the mid-20’s) the stock doesn’t exactly look like a bargain. But these measures overlook the cash flow generating power available to software companies. With essentially fixed costs and high margins, each dollar of sales contributes mightily to cash.

Although a recession or slowdown in Dassault’s key end markets or further dollar weakening could delay investor rewards, Dassault’s current valuation and long-term prospects appear to justify the wait.

Disclosure: Short naked put options on Ansys (ANSS)

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I am taking a look at a couple of the engineering software stocks, and a review of recent conference call transcripts can frequently be a good place to start.

Ansys (ANSS) provides software that simulates physical forces such as turbulence, heat and pressure. Seldom was heard a discouraging word on that call, and for good reason. The closest I could come to was:

So even as we increase our outlook this will also be tempered of course by our short term engineers’ paranoia which I have to say has also served us well.”

(Excerpt from full ANSS conference call transcript)

Dassault Systemes (DASTY) has simulation and 3D design, plus software to help companies manage the product life cycle. It, too, has been on a tear for the past few years, and is showing no signs of stopping.

One of our most visible initiatives is the successful transformation of our PLM channel. Looking at the quarter, we had good progress in the PLM value channel and with IBM in large accounts. Our results today demonstrate that we are well in line with our plans, driving growth for CATIA and ENOVIA.

CATIA performed well with both large accounts and mid-market. We continue to invest in strengthening and broadening the CATIA product line. In mid-June, we completed the acquisition of ICEM, expanding our presence at the front-end of design. ENOVIA’s strong results demonstrate that our products form a powerful combination and are clearly complementary.

In total, we have had a dynamic product release schedule during the 2007 first half. We continue to advance our technology and strategic roadmap. During the second quarter, we launched our newest brand, 3DVIA, whose goal is to enable 3D to become a universal media for online product experiences.

(Excerpt from full DASTY conference call transcript)

Parametric (PMTC) has much in common with Dassault. Except for the being on a tear and showing no signs of stopping, that is.

We are disappointed with our performance in other areas. Most of the revenue shortfall was in license revenue. Our Desktop Solutions revenue declined year-over-year, which is counter to our recent trend of strong growth in this line of business.

The performance was spread across Pro/ENGINEER new seats, modules, and upgrades, with the most significant change from recent quarters in upgrade and module sales. By geography the revenue weakness was concentrated in North America and Japan.

(Excerpt from full PMTC conference call transcript)

The next question, of course, is to determine whether the successes at Ansys and Dassault are priced in, or whether Parametric has taken enough of a beating to be worth taking the risk.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.

Autodesk, Inc. (ADSK) reported record quarterly revenues of $509 million, an increase of 17 percent over the first quarter of fiscal 2007. The company, which makes engineering and architectural design software, is like all too many tech companies in that a probe into stock option practices means they don’t know how much they actually earned.

What is known about the results, however, looks pretty good, as analysts were only expecting $500 million in sales. Autodesk also raised estimates for the next two quarters and the full year to levels above the wall street consensus.

Growth indicators look solid:

• Total backlog increased $23 million compared to January 31, 2007.
• Total deferred revenue increased $21 million sequentially. Deferred maintenance revenues from subscription increased $34 million sequentially.
• Unshipped product orders increased by $2 million sequentially to $19 million at April 30, 2007.
• Channel inventory as of April 30, 2007 was below the normal range of three to four weeks.
• DSO decreased to 47 days.

Although I think Ansys (ANSS) has more potential, Autodesk also appears reasonably valued. Its $9.7 billion enterprise value is backed by nearly $400 million in free cash flow, an amount that is nearly double the level of two years ago. After they complete their options review, this one could be a stock to watch.