Altair Engineering Inc. (NASDAQ:ALTR) Q2 2023 Earnings Call Transcript

Altair Engineering Inc. (NASDAQ:ALTR) Q2 2023 Earnings Call Transcript August 4, 2023

Operator: Good day, and thank you for standing by. Welcome to Altair’s Second Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] Please be advised that today’s conference is being recorded. I’d now like to hand the conference over to your speaker today, Dave Simon, Senior Vice President for Investor Relations. Please go ahead.

Dave Simon: Good afternoon. Welcome, and thank you for attending Altair’s earnings call for the second quarter of 2023 ended June 30, 2023. I’m Dave Simon, Altair’s SVP for Investor Relations. And with me on the call are Jim Scapa, Founder Chairman and CEO; and Matt Brown, Chief Financial Officer. After market closed today, we issued a press release with details regarding our second quarter 2023 performance and guidance for the third quarter and full year 2023, which can be accessed in the Investor Relations section of our website at investor.altair.com. This call is being recorded, and a replay will be available on the IR section of our website following the conclusion of this 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 earlier 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 have filed or may file from time to time. During the course of today’s call, we will refer to certain non-GAAP financial measures.

A reconciliation of GAAP to non-GAAP measures is included in our press release. Finally, at times in our prepared comments or responses to your questions, we may offer metrics that are incremental to our usual presentation to provide greater insight into the dynamics of our business or our quarterly results. Please be advised that we may or may not continue to provide this additional detail in the future. With that, let me turn the call over to Jim for his prepared remarks. Jim?

Jim Scapa: Thank you, Dave, and welcome to everyone on the call. Altair had a solid second quarter of 2023 with software product revenue, total revenue and adjusted EBITDA, all above the high end of our guidance. Our Q2 performance aligns well with our guidance for the full year and demonstrates our continued success and strength as a company. Adjusted EBITDA for Q2 2023 grew year-over-year to $17.1 million. Software product revenue as a percentage of total revenue for the second quarter continued a strong positive trend at 88.8% compared to 88.1% in the second quarter of 2022. Software product revenue as a percentage of total revenue for the first half of 2023 increased to 89.5% as compared to 88.2% in the first half of 2022.

The recurring software license rate for the first half of 2023 was 94%, an increase from 93% in the first half of 2022. Total billings for Q2 2023 was $147.8 million, a year-over-year increase of 17.8% in reported currency and 19.6% in constant currency. Software product revenue on a constant currency basis grew by 9.4% in the second quarter versus a year ago and 9.7% for the first six months of 2023 compared to 2022. We saw strength in the quarter in our renewal base with customers choosing to renew and expand their usage of Altair units. This growth was across many products and especially in the aerospace, defense, technology and automotive verticals. We believe our second quarter performance positions the company well for the rest of 2023 and for next year.

Altair’s portfolio for software for engineering simulation continues to demonstrate leadership and innovation. Many new and significant products are in the last stages of development and planned for release at the beginning of Q4 2023, and we are excited about their potential impact in the market. We continue to integrate AI within our simulation products, especially within our solvers. Last week, Altair acquired an exciting MBSE requirements management solution called OmniV developed by two former General Motors executives. The advantage of OmniV is it is easy to learn and use and naturally connects requirements to simulation and test validation solutions to achieve program goals. OmniV is more accessible for product engineers, designers and developers to use, whereas other MBSE solutions are more abstract and geared for system engineers.

OmniV covers both process development and requirements connectivity in one vendor-agnostic solution. It connects to PLM solutions, including Teamcenter, Enovia and Windchill and to other MBSE tools, including Cameo, IBM DOORS NG and Jama Software, making OmniV easy to integrate into any engineering enterprise environment. This technology enhances our ability to support the fast-growing use of digital twin solutions, simulation and test data management and AI with an open architecture that provides a traceable ecosystem to track performance, cost and mass of a product. We believe the addition of OmniV to our already powerful offering helps to position Altair as having the most comprehensive digital twin solution in the market. OmniV will be available via Altair units, integrated into Altair’s digital twin solution set and accessible via Altair One Alters Cloud Innovation Gateway.

This year, we are focusing on more enterprise selling and engaging at higher levels with our most important customers to build long-term relationships and increased scope and scale in these accounts for the future. The aerospace vertical had some notable wins for Altair in the quarter. The space exploration company increased its software licensing commitment by more than 50%, resulting in a seven-figure annual licensing agreement. Applications range across several physics disciplines, while driving tremendous value from Altair units, which gives broad access to our deepest simulation technologies as well as our entire software portfolio, including data analytics and AI solutions. In addition, we are engaged with the same company in a variety of leading-edge consulting projects to push forward new product development opportunities with simulation-driven design.

In another aerospace win, a major aircraft component supplier has committed to a 44% increase over a seven-figure multiyear software licensing deal. This account is especially meaningful as it is at the forefront of using simulation in Lewis [ph] of physical testing for certification, which is both a major challenge and opportunity in commercial aircraft development. In the area of data analytics and AI for business applications, a new BFSI customer signed on to a six-figure annual software license related to loan servicing within two months of its exposure to the Altair suite of tools. A major European city has committed to Altair SLC as its solution for analyzing demographic data with a goal of improving social services and a large U.S. manufacturer of building products signed a multiyear six-figure annual software license for its accounting and finance teams to expand usage from data preparation to wide applications available in the Altair RapidMiner platform under Altair units.

We see great momentum in the convergence of simulation with AI, a major automotive manufacturer in APAC has licensed additional Altair units, specifically for using data science to design antennas. Altair has, for many years, been a leader in simulation software for antenna development, and we have significant domain expertise in correlating test data with simulation results for more robust design guidance. Using Altair RapidMiner, we helped this manufacturer reduce a test data analysis process from two weeks down to just a few minutes and use data science to drive rapid design exploration and optimization. We continue to encourage diversity and inclusion to support the next generation of engineers and scientists. Last quarter, we announced a STEM education scholarship program with Columbia University.

We are pleased to have recently added the University of Michigan Dearborn to our Altair #OnlyForward Scholarship program. These scholarships focus on supporting underrepresented minorities and women, which is especially meaningful as we seek to play a role in developing outstanding and diverse talent. These scholarships will support students with a demonstrated interest in increasing diversity in STEM fields. Each recipient must be a full-time student pursuing a four-year degree in engineering or computer science and a member of one of the following organizations; National Society of Black Engineers, Society of Hispanic Professional Engineers or Society of Women Engineers. Scholarship recipients will be chosen by a committee of faculty and leadership in the college of engineering and computer science this fall with nine recipients, each receiving $25,000.

Altair was named for the third consecutive year to Newsweek’s Most Loved Workplaces list as one of the top 100 companies measured by employee happiness and satisfaction at work. Credit for the string of awards goes to our global management teams who are outstanding stewards of Altair’s foundational values. We have worked hard since our founding in 1985 to create and maintain a workplace where employees can thrive in a supportive inclusive environment. Our ability to maintain these values over 38 years of major shifts in technologies, geopolitics and how we work is key to Altair’s success. Altair was also named as one of the 2023 Fortune Best Workplaces for Millennials. This award acknowledges companies that excel at providing younger employees with a sense of purpose in the workplace.

These workplace awards, combined with our STEM education commitments and strong global internship program are great indicators of our focus on talent development and sustainable work-life balance. Additionally, Altair was named the overall leader in the manufacturing data analytics sector in the latest report by global technology intelligence firm, ABI Research for advanced data collection, normalization and analytics capabilities. The report evaluated 10 data analytics vendors that enable industrial and manufacturing firms to proactively monitor their equipment and optimize their operations with the use of data analytics. ABI Research determined rankings by evaluating capabilities for data collection, streaming analytics, data normalization, core analytics, user experience, commercial success and time to value.

The report emphasizes Altair’s platform, versatility and depth and made note of our huge array of modeling techniques and wide variety of options to display and share IoT sensor data. With our deep expertise and understanding of manufacturing complexities and machine learning, we have developed solutions to easily build analytical applications with our low-code platform to support faster, more effective decision making. Earlier this week, the winners of the 2023 Altair Enlighten Award were announced, presented in association with the Center for Automotive Research, the Enlighten Award program showcases how the automotive industry’s leading minds are applying advanced technologies and responsible AI to create a better, greener industry. Congratulations to the winners of the 11th Annual Enlighten Awards.

Polestar, Nikola, ArcelorMittal, Volteras, Toyota, BASF, US Farathane, Adient, Multimatic and Marelli. 2023 is an important year of complex transitions for Altair in the midst of a lackluster macroeconomic environment hampered by inflation and uncertainty to set ourselves up for very strong growth in 2024 and 2025. We are managing expenses aggressively to achieve a 20% adjusted EBITDA margin this year and to position the company for continued adjusted EBITDA increases for the next three years to five years. Shifting our organization to focus more on selling our entire portfolio in key vertical markets and customers, completing the software development of several strategic and significant initiatives and establishing partnerships with key system integrators and hyperscalers to elevate our position and grow our share of wallet across key accounts.

As we take stock of where we are at the halfway point in the year, we are very satisfied that we have been extremely successful in every one of these endeavors. All while we continue to meet the quantitative financial objectives we established for 2023. As a result, we feel the company is going to be well positioned to take significant advantage of the strong demand we anticipate beginning in 2024. Now, I will turn the call over to Matt to provide more details on our financial performance and our guidance for the third quarter and full year of 2023. Matt?

Matt Brown: Thank you, Jim. Hello to everyone on the call, and thank you for joining us. Q2 was another solid quarter for Altair, once again exceeding the high end of the guidance range on software product revenue, total revenue and adjusted EBITDA. Our strong first half performance has been fueled by growth across a number of verticals and particularly in aerospace, defense, technology and automotive, where demand for our products is robust. As I dive into the details of our financial results, remember some of our revenues and expenses are transacted in currencies other than the U.S. dollar. And therefore, our reported results may be significantly impacted by changes in foreign exchange rates. To aid in the review of our results, throughout my remarks, I will make reference to growth rates in both reported and constant currency.

Total billings for the quarter were $147.8 million, an impressive year-over-year increase of 17.8% in reported currency and 19.6% in constant currency. In Q2 2023, we saw particular strength in our renewals base. We had meaningful expansions in some of our top-tier accounts as customers are broadening their usage of applications across several physics disciplines. In addition, we had notable new customer wins for our data analytics products as customers are realizing the power of Altair SLC and the Altair RapidMiner platform. This strength in billings led to software product revenue in Q2 2023 of $125.3 million, a year-over-year increase of 7.2% in reported currency and 9.4% in constant currency compared to Q2 2022. Total revenue in Q2 2023, which includes services and other revenue was $141.2 million, a year-over-year increase of 6.4% in reported currency and 8.4% in constant currency compared to Q2 2022.

Our recurring software license rate, which is the percentage of software product billings that are recurring, continues to be strong at approximately 94% for the first half of 2023. Non-GAAP gross margin, which excludes stock-based compensation, was 80.0% in the second quarter compared to 79.3% in the prior year, an increase of 70 basis points. Software product mix and an increase in our software product gross margin drove this increase. Our software product revenue, which carried higher gross margins was 88.8% of total revenue in Q2 2023 compared to 88.1% in the prior year. Over the long term, we continue to expect a general mix shift towards software product revenue as growth there will outpace services and other revenue. And as a result, we expect our non-GAAP gross margin to continue to increase modestly in the near term.

Non-GAAP operating expenses, which excludes stock-based compensation and amortization of intangible assets, were $96.9 million compared to $90.3 million in the year ago period. The year-over-year increase was in line with our expectations and was driven by increases in research and development and sales capacity, partially offset by decreases in general and administrative costs. Adjusted EBITDA in Q2 2023 was $17.1 million or 12.1% of total revenue compared to $16.4 million or 12.4% in Q2 2022. Turning to our balance sheet. We ended the quarter with $418.3 million in cash and cash equivalents, an increase of approximately $40.0 million from the prior quarter. The increase was driven primarily by cash from operating activities, and we continue to be pleased with our cash flow generation.

Free cash flow through the first half of 2023 was $83.0 million. Let’s turn to guidance for Q3 and full year 2023. We’ve provided detailed guidance tables in our earnings press release, including reconciliations to comparable GAAP amounts. We are continuing to see an FX impact relative to 2022 as foreign exchange rates have changed throughout last year. To continue to provide more clarity on the FX impact to our expectations, we’ve provided growth rates in both reported currency and constant currency in our guidance tables. For Q3, we expect software product revenue in the range of $111 million to $113 million, a year-over-year increase of 7.0% to 8.9% in reported currency and 5.8% to 7.7% in constant currency. For full year 2023, we are maintaining our previous outlook for software product revenue in constant currency and slightly decreasing our outlook in reported currencies due to changes in foreign exchange rates to a range of $548 million to $558 million, a year-over-year increase of 8.2% to 10.2% in reported currency and 9.1% to 11.0% in constant currency.

As expected, services and other revenue has begun to stabilize in 2023 compared to the sharp declines we saw in 2022. While services and other revenue was down year-over-year in the first half of this year, we expect it to be roughly flat in the second half of the year. As a result, we expect total revenue for Q3 2023 in the range of $126 million to $128 million, a year-over-year increase of 5.6% to 7.2% in reported currency and 4.4% to 6.1% in constant currency. For full year 2023, we are maintaining our previous outlook for total revenue in constant currency and slightly decreasing our outlook in reported currency due to changes in foreign exchange rates to a range of $611 million to $621 million, a year-over-year increase of 6.8% to 8.5% in reported currency and 7.5% to 9.3% in constant currency.

Moving to adjusted EBITDA. For Q3 2023, we expect adjusted EBITDA in the range of $3 million to $5 million or 2.4% to 3.9% of total revenue compared to $6.8 million or 5.7% of total revenue in Q3 2022. For full year 2023, we are maintaining our previous outlook for adjusted EBITDA in constant currency and slightly decreasing our outlook in reported currency due to changes in foreign exchange rates to a range of $119 million to $129 million or 19.5% to 20.8% of total revenue compared to $108.6 million or 19.0% of total revenue in 2022. And finally, for the full year 2023, we are maintaining our outlook from the last quarter for free cash flow, which we expect to be in the range of $108 million to $116 million and represents a substantial increase year-over-year.

As a reminder, our cash flow expectations are sensitive to billings and collections patterns, which fluctuate seasonally. In particular, our historical pattern has shown a larger free cash inflow in the first half of the year, primarily from collections on billings from Q4 and Q1 and a smaller free cash inflow in the second half of the year. We’re expecting that pattern to continue this year. We are pleased with the outperformance we’ve seen in the first half of the year and look forward to a strong second half. With that, we’d be happy to take your questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Matt Hedberg with RBC Capital Markets. Matt your line is now open.

Matt Swanson: Yes. This is actually Matt Swanson on for Matt. This is kind of a question for Jim and Matt. But Jim, you mentioned – I think the word you used was lackluster to describe the macro environment right now. And I think that’s kind of been reflected in PMI. So I mean, could you talk a little bit about how resilient the budgets, those R&D budgets that you’re selling into are in this type of macro? And then maybe, Matt, if you could extrapolate a little bit more on how you’re thinking about the macro for guidance.

Jim Scapa: Sure. Hi Matt Swanson. Yes, lackluster, from my point of view, just means fireworks aren’t really going off. So it’s not a down market in the sense of 2009, but it’s kind of a sideways market from my point of view. And when I think about R&D budgets, I think everybody is watching costs more than they are in a more dynamic market, frankly. And I think the economy tends to ebb and flow and it’s cyclical a little bit. And I think 2023 in general is on the lower part of that cycle. It’s why I’m anticipating 2024 and 2025 to be basically that cycle. Again, it’s not – I mean you can see our numbers. We had very solid billings growth. We’re seeing a lot of potential actually in the market and actually increasing potential towards the second half of this year.

As I think we start to emerge, if you will, from a little bit of a lackluster feeling. But every customer is certainly just as we are managing our costs very closely; I think our customers are doing that as well. For us, that creates opportunities; we’re seeing many very significant customers coming to us, very much more interested than they were before and maybe making a switch to our platform. And of course, that’s very, very promising. But those take a little bit longer. And I think we’re going to start seeing the results of that in 2024, more so than in 2023. So yes, I hope that was clear.

Matt Brown: Yes. And Matt, I would just add on to answer the second part of your question there. What Jim just described is embedded in the guide for the year. So where you’re seeing us coming out and guiding the midpoint in constant currency for software product revenue growth at about 10%. That’s not quite what we saw last year, right? So it’s reflected a little bit. But having said that, we’re looking all the time at the pipeline, and we feel very good about our positioning and the way that our pipeline is shaping up for the year. And in particular, I think we’re doing all the right things to make sure that we’re investing for a really fantastic future as well. So we feel very, very good about the position that we’re in and looking forward to continue to capitalize on that far into the future.

Matt Swanson: Yes. No, both parts of the answers are really helpful. And then, Jim, thank you for the additional color on some of your AI initiatives that you’re going through right now. If I could just ask about it maybe a slightly different way for some indirect benefits. One being, are you seeing any increased conversations on the HPC business and people trying to figure out the compute side? And then the second would be, if this is finally at the moment, we start to see more generative design, which might increase the pace of design cycle, more designs, what does that mean to the simulation business? Is that possibly a catalyst sometime I know we’re extrapolating a lot on AI right now in general. But…

Jim Scapa: Yes. No, it’s a great question. I actually asked that question this morning because we have a customer that went through a whole benchmark – there’s a number of little players in the space coming out with AI solutions, physics-based AI solutions and Altair launched our physics AI solution like a quarter ago or two quarters ago, and they selected us. And I – the first question I asked is, did they select us because of our units’ model or because we’re bigger or because of the technology. And he said because of the technology, we are clearly in the lead, which was a great answer. I loved hearing that answer. But then I asked, is that going to reduce the amount of simulation that make too because we dramatically are reducing the time it takes to validate designs and he said, no, absolutely not.

They’re just doing more of it, which is obviously the answer I want to hear, but I think it’s a true answer. So I mean, I just think the technology as it always has, is continuing to get better and people are going to do more and more simulation, whether they’re using AI embedded or integrated or as part of it, I think they’re going to – the use of this kind of algorithmic technology is only going to continue to grow in my view. So I think we’re in a great spot. We have a lot of really amazing stuff coming. This has been an absolute year of investing, which is what I tend to do in these, if you will, lackluster cycles and then come out swing in. So yes, we’re very excited about the product as well.

Matt Swanson: Thank you.

Jim Scapa: Sure.

Operator: Our next question comes from the line of Ken Wong with Oppenheimer.

Ken Wong: Great. Thanks for taking my question. Jim, just touching on just the macro a little bit. I think when you’re closing out your prepared remarks, you mentioned take advantage of strong demand that you anticipate in 2024. Was that just kind of general, again, expectations that you’ll start to see more fireworks? Or is there something in your pipeline, something that you guys are in, like internally that gives you the comfort in saying that strong demand in 2024.

Jim Scapa: I think it’s both. I’ve been doing this for a long time. And so I have a pretty good feel for what happens macro to Altair, if you will. But we do see a lot of really big opportunities that are building in the pipeline that are a little bit longer, take a little bit longer to gel. And we feel excited about where things are going. So it’s a combination.

Ken Wong: Okay. Perfect. And then, Matt, if I could, just as we look at the outlook, I realize that your revenue is probably a little lumpier than, let’s say, a traditional SaaS company. But I guess 3Q does look a little lighter, a little more back-end loaded into Q4. Any slippage, some timing stuff or help just help us walk through the thinking behind that 3Q, 4Q dynamic?