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Edited Transcript of ANSS earnings conference call or presentation 27-Feb-20 1:30pm GMT

Q4 2019 ANSYS Inc Earnings Call

CANONSBURG Mar 24, 2020 (Thomson StreetEvents) -- Edited Transcript of ANSYS Inc earnings conference call or presentation Thursday, February 27, 2020 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ajei S. Gopal

ANSYS, Inc. - President, CEO & Director

* Annette N. Arribas

ANSYS, Inc. - Global IR & Insurance Officer

* Maria T. Shields

ANSYS, Inc. - CFO and Senior VP of Finance & Administration

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Conference Call Participants

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* Adam Charles Borg

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Andrew Lodovico DeGasperi

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Ken Wong

Guggenheim Securities, LLC, Research Division - Senior Analyst

* Jackson Edmund Ader

JP Morgan Chase & Co, Research Division - Analyst

* Jason Vincent Celino

KeyBanc Capital Markets Inc., Research Division - Associate

* Jay Vleeschhouwer

Griffin Securities, Inc., Research Division - MD of Software Research

* Joseph D. Vruwink

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate

* Mark William Schappel

The Benchmark Company, LLC, Research Division - Director of Research & Equity Research Analyst

* Matthew Charles Pfau

William Blair & Company L.L.C., Research Division - Analyst

* Matthew John Swanson

RBC Capital Markets, Research Division - Associate VP

* Richard Frank Valera

Needham & Company, LLC, Research Division - Senior Analyst

* Steven Richard Koenig

Wedbush Securities Inc., Research Division - MD

* Tyler Maverick Radke

Citigroup Inc, Research Division - Senior Associate

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Presentation

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Operator [1]

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Good morning, and welcome to the ANSYS Q4 and Fiscal Year 2019 Earnings Conference call. (Operator Instructions) Please note this event is being recorded.

I'd now like to turn the conference over to Annette Arribas. Please go ahead.

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Annette N. Arribas, ANSYS, Inc. - Global IR & Insurance Officer [2]

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Good morning, everyone. Our earnings release and the related prepared remarks document have been posted on the home page of our Investor Relations website this morning. They contain all of the key financial information and supporting data relative to our fourth quarter and our full year 2019 financial results and business update as well as our initial Q1 and fiscal year 2020 outlook and the key underlying assumptions.

I would like to remind everyone that today's presentation contains forward-looking information. 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.

During this call, and in the prepared remarks, we'll be referring to non-GAAP financial measures unless otherwise stated. A discussion of the various items that are excluded and a full reconciliation of GAAP to comparable non-GAAP financial measures is included in this morning's earnings release materials and related Form 8-K.

I would now like to turn the call over to our CEO, Ajei Gopal, for his opening remarks. Ajei?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [3]

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Thank you, Annette, and good morning, everyone. Q4 was yet another exceptional quarter for ANSYS, capping a stellar year. In the fourth quarter, we delivered record revenue, earnings per share and operating cash flow. Let me focus on annual contract value, or ACV, which we believe to be the best indicator of the underlying health of our business.

Q4 ACV at well over $0.5 billion in the quarter for the first time in our history, represented growth of 13% in constant currency, which was particularly gratifying considering the strong baseline set in Q4 of 2018. For the full year of 2019, ACV grew a robust 12% in constant currency. As we look to 2020, we are guiding to over 12% growth in ACV in constant currency at the midpoint of our range. This gives us further confidence that we will achieve our goal of $2 billion in ACV by 2022, while maintaining our industry-leading margins in the 42% to 44% range. Maria will provide more detail in just a few minutes.

Now let me provide insight into some of the growth drivers in the fourth quarter and for all of 2019. During Q4, 10 long-standing customers made 8-figure commitments, and nearly all of the deals over $1 million included offerings from at least 3 of our product lines. From a geographic perspective, we saw strength in all our major territories last year. While North America led with 26% revenue growth for the year, I'm delighted that revenue in Europe grew 29% in Q4 and 14% in 2019, both in constant currency. For the full year, Asia Pac revenue grew 15% in constant currency despite a modest 2% revenue growth in Q4, which was attributable to variations in deal timings. In Japan, we grew revenue 20% in Q4.

From an industry standpoint, high-tech continues to be our largest sector, fueled by electronics and our semiconductor solutions and supported by a multiphysics portfolio. And as you will hear shortly, we are continuing to add new capabilities to our product offerings so our customers can keep driving innovation in this key industry.

Moving to automotive, other vendors have signaled weakness in the sector, perhaps, because of their focus on legacy programs or their inability to pivot to emerging customer requirements. For ANSYS, however, automotive is an area of strength, in part because we have successfully broadened our offerings to address key growth drivers, namely solutions for autonomous and electric vehicles. We have seen repeated evidence of that success in electric vehicles: first with Volkswagen, which we have previously discussed; and now with Porsche. In Q4, we announced that Porsche Motorsport is using ANSYS to create an advanced electric powertrain for its electric racecar. After proving itself on the track, Porsche expects to use the car's electric powertrain to usher in a new era of commercial e-mobility vehicles.

Moving to other industries, although energy is going through a transition, we are seeing increased demand in that sector, including an extended collaboration with leading energy technology company, Baker Hughes. This long-time customer signed a new agreement in Q4 to use ANSYS simulation to drive down design and development costs, including additive manufacturing while sparking innovation.

We continue to see success in aerospace and defense, driven by increased customer investment in North America. In fact, the aerospace and defense industry is responsible for 4 of our top deals in Q4. The complex product challenges facing aerospace and defense organizations require a true multiphysics approach, including solutions for electromagnetics, fluids and next-generation materials.

For example, a leading North American gas turbine manufacturer signed an 8-figure deal in Q4 to shorten its design cycle using faster, more reliable and accurate combustion simulations. By deploying our Mosaic Meshing and enhanced workflows, this industry leader reduced preparation time from hours to minutes while getting more consistent and robust results twice as fast. By using ANSYS solutions, we expect this global leader to save millions of dollars a year in reduced labor and related costs.

Another large aerospace company is also benefiting from our comprehensive multiphysics portfolio. This company faced a complex set of operating conditions that made identifying potential failure mechanisms a challenge. It is using our best-in-class electrical, thermal and mechanical products as well as our electronics reliability simulation solution from last year's acquisition of DfR to improve designs and to mitigate possible failures. This resulted in an 8-figure deal in Q4, and it demonstrates our ability to efficiently integrate new technologies into our selling motion.

As you can see, our customers are benefiting from the formidable combination of ANSYS solutions across physics. This is a powerful endorsement of the strength of the full portfolio, and it is one that we believe other vendors cannot match. We continue to extend our product leadership across the entire portfolio with our recently launched ANSYS 2020 R1. R1 accelerates companies' digital transformation by enhancing the interfaces, functionality, workflows and scalability of our products. R1 includes multiple product and technology advances. But in the interest of time, I'll focus on areas of particular interest to the high-tech industry.

To make 5G a reality, the industry must develop new array and beam steering technologies that overcome millimeter wave impediments such as signal propagation at 28 gigahertz. To overcome those challenges, we continue to make major investments in ANSYS HFSS, our flagship product for designing and simulating high-frequency electronic products. R1 includes groundbreaking new phased array antenna technology that enables 5G designers to model complete antenna arrays, a task that was previously computationally prohibitive.

Developing modern antennas is only one challenge in realizing 5G systems. Chip designers must develop new architectures to co-locate the chip and the antenna, which introduces topology constraints and electromagnetic cross-dock challenges that did not previously exist. We recently announced a new product, ANSYS RaptorH, to solve these challenges. With its unparalleled accuracy, its unmatched capacity and speed and its smooth design flow integration for advanced nanometer integrated circuit design, we believe RaptorH is the most feature-rich electromagnetic tool in the market for system-on-chip flows. RaptorH marries the best-in-class engines from ANSYS RaptorX, which we gained in last year's Helic acquisition, and ANSYS HFSS into a single-chip package system design environment. Helic was acquired in Q1 2019, and this product shows the speed at which the ANSYS R&D teams can incorporate new technologies into our portfolio.

Our platform strategy is based on an extensible, vendor-neutral architecture that works both on-premises and in the cloud. ANSYS Minerva is based on this architecture and empowers companies to solve the seemingly intractable problem of dealing with the enormous amount of data created by multiphysics simulations of complex systems, such as 5G components and equipment. In R1, Minerva's scalable traceability, configuration management and versioning system ensures reliability and connectivity of simulation data to drive collaboration and insights across the product life cycle and across departmental silos. That traceability is critical to companies like Eaton Corporation that rely on Minerva to streamline the user experience when designing and manufacturing parts using additive manufacturing and other processes.

These innovations are empowering our customers to solve some of their most challenging product problems. Our ongoing commitment to improving our best-in-class solutions is further widening the technology gap between us and our competitors. That gap is certainly evident with ANSYS Discovery Live, where we have significantly broadened structural use cases and expanded generative design capabilities while adding a GPU-based, steady-state computational fluid dynamic solver. This breakthrough enables design engineers to predict airflow and heat removal at rates 100x faster than the previous GPU solver within Discovery Live. One customer told us that they reduced component design time from 3 months to less than 2 weeks.

Q4 marked the first large renewals for the Discovery business, and we are happy to see our early adopters expand their commitment to Discovery. On its most recent earnings call, our strategic partner, PTC, announced that it was also seeing a ramp-up of adoption in average deal size with its Creo Simulation Live product, which incorporates Discovery Live. As I mentioned previously, we expect the near-term financial impact of Discovery Live to be modest, but we see a strong long-term opportunity.

Over the course of Q4, we also expanded our relationships with industry leaders Autodesk, Microsoft and Rockwell Automation. With Autodesk, we built on our previously announced automotive workflow between our lighting simulation solution, ANSYS SPEOS and Autodesk VRED. Our new connection between ANSYS mechanical and Autodesk Fusion will drive revolutionary design and engineering agility for our customers, helping them expedite products to market.

Our partnership with Microsoft also expanded, growing beyond our initial collaboration where we empowered customers to access high-performance computing on demand via ANSYS Cloud, which runs on Microsoft Azure. In Q4, we grew our collaboration to make it easier for customers to adopt and deploy Digital Twins. Through our expanded partnership, manufacturers that model and connect assets using Azure Digital Twins can optimize asset production and operations using ANSYS Twin Builder. That enables users to slash product maintenance costs and speed high-quality products to market.

Similarly, with Rockwell Automation, we're enabling customers to benefit by creating a digital twin of their full manufacturing process to create and test virtual what-if scenarios. In doing so industrial companies can adapt to market demands with more agility and minimize risk.

We are also continuing to expand the market for simulation by reaching future users. Over 3,000 universities use our technology for research and teaching, including students at Carnegie Mellon University, who are building and testing their own simulations in the newly opened ANSYS Hall. More than 150,000 people have enrolled in Cornell University's massive online course in simulation based on ANSYS. And I'm pleased to announce that we have seen over 1 million downloads of our student products.

I'd like to take a moment now to recognize my colleagues at ANSYS. As you know, the coronavirus is a rapidly evolving situation. Our #1 priority remains, of course, the safety and the well-being of our employees and their families around the world. And I am humbled and grateful for the commitment that our colleagues in China and elsewhere are showing as they continue to drive business execution in difficult circumstances.

Switching to our commitment to environmental, social and governance initiatives for just a moment, I'm proud that Newsweek recently named us to its 2020 list of America's Most Responsible Companies. And I'm delighted that 2020 Women on Board recognized ANSYS as a winning "W" Company for 2019 with at least 20% women on our Board of Directors.

To summarize, building on double-digit ACV growth in 2018, 2019 was a record-breaking year for ANSYS. These results, combined with our 2020 forecast of double-digit ACV growth and our continued investment in our market-leading products, give us further confidence that we will achieve our goal of $2 billion in ACV by 2022. So you can understand why I'm excited for 2020 and beyond. As I have told you before, the future for ANSYS is brighter than ever.

And with that, I'd like to turn the call over to Maria. Maria?

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [4]

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Thank you, Ajei. Good morning, everyone. Let me start off by saying that, financially, 2019 was our strongest year ever, and we are very encouraged about 2020, given the momentum in our business. For the full year of 2019, we delivered either above the midpoint or well above the high end of the range on our initial financial guidance, and we raised full year guidance 3x throughout the course of the year. Even more exciting is that we closed the year with a very strong fourth quarter, which included record Q4 results across all of our key financial metrics. This is quite a testament to both our resilient business model and our team's ability to execute, particularly when you consider the very strong comparables for both Q4 and the full year 2018.

Now I'd like to take a few minutes to provide some additional color on our financial performance, and then I will close with an update on our outlook and key assumptions for Q1 and 2020. And consistent with our standard practice, my comments will be in terms of non-GAAP unless I state otherwise.

For the fourth quarter, we delivered constant currency revenue growth of 18% and ACV growth of 13%, coupled with operating margin and EPS results that will grow above the high end of our Q4 guidance ranges. These record results were driven by strong market demand for our industry-leading multiphysics portfolio and by continued positive customer and business momentum.

Now let's turn to some of the key financial metrics that I'd like to highlight for the quarter and the year, beginning with total revenue. We delivered $492.5 million in Q4, and for the full year we recognized a record $1.5 billion in total revenue, growing 19% in constant currency. Q4 ACV totaled $541 million with 78% of ACV in the quarter coming from recurring sources. Notably, this is our first quarter ever reporting over $0.5 billion in ACV. For 2019, our ACV totaled $1.46 billion, representing constant currency growth of 12% with recurring sources making up 77% of the total. We remind investors that we believe that our annual ACV is a key metric for gauging our operating performance over time.

In the quarter, an increase in software lease license sales, combined with strong maintenance renewals, bolstered our deferred revenue and backlog total to $871 million, a 32% increase over last year's comparable balance.

Moving on to profitability, in Q4, we continued to build on our solid performance throughout every quarter of 2019 with strong top line results that helped to drive a fourth quarter gross margin of 92% and an operating margin of 48%.

For 2019, we finished the year with a gross margin of 91% and an operating margin of 45%. These results are evidence that, first and foremost, we are committed to managing our business with discipline and, secondly, that we are successful in integrating tuck-in acquisitions into our business model while still delivering best-in-class margins. These strong margins helped to drive record fourth quarter and full year EPS of $2.24 and $6.58, both well above our guidance ranges.

With respect to taxes, our effective tax rate in Q4 was 17% as compared to the 20% to 21% range that we had expected. The Q4 rate was favorably impacted by a $6.7 million benefit related to a December tax law change in a foreign jurisdiction. Please keep in mind that this nonrecurring benefit will impact year-over-year comparisons in 2020.

Our cash flow from operations totaled $139 million for the fourth quarter and $500 million for 2019, and we closed the year with a total of $872 million in cash and short-term investments. Let me add that the acquisitions of LSTC and Dynardo had a relatively insignificant impact on the results for the quarter, contributing $9 million of revenue and $7 million of ACV.

Now let me turn to the topic of guidance. Before I get into the specific numbers, I would like to briefly comment on China, which accounted for just above 4% of our overall revenue in 2019. First, although the trade negotiations between the U.S. and China have somewhat improved with the completion of the Phase I deal, our full year guidance assumes that the U.S. sanctions on the China-restricted entities announced in 2019 will not be lifted. We estimate that the sanctions resulted in approximately $20 million of both ACV and revenue primarily booked in the first half of 2019 that we have assumed will not be repeated in 2020. Second, the recent outbreak of the coronavirus is bringing new challenges to China and to other countries in the region. The outbreak could potentially delay some deals originally planned in the first half of 2020 to the second half of the year. This has an insignificant impact on our annual outlook and is factored into our Q1 guidance.

Before moving to our outlook for 2020, as I have consistently communicated over the past several years, our focus will be on progress against our annual targets as opposed to short-term quarterly results. You should expect, as we do, variability in quarterly financial results because ASC 606 revenue recognition rules could affect both revenue and related growth numbers based on the number, timing, size and duration of multiyear leases.

As I described in detail in our last call, in any given quarter or year, there can be a disconnect between the revenue and ACV metrics. In some quarters and years, one metric can be ahead of the other. But eventually and often in the subsequent comparable quarter or year, the other metric must be ahead because the 2 metrics sum to the same number in the long term. In 2019, constant currency revenue growth of 19% disproportionately outpaced ACV growth of 12%, driven by large multiyear lease deals. In 2020, however, we expect constant currency ACV growth of 11% to 14% to outpace annual revenue growth of 8% to 12%. Note also that in both 2018 and in 2019, the second half of the year was stronger than the first, and Q4 was by far our largest quarter. We expect that this trend will continue in 2020.

Going one level down, there are 3 reasons for why the second half will be stronger than the first. First is seasonality. The second half of the year, most notably the fourth quarter, continues to get seasonally stronger with a number of large multiyear lease deals in the pipeline. This is aligned with the timing of many of our customers' annual budgeting and spending cycles. Second is timing of specific deals. Q1 2019 saw a small number of large multiyear lease contracts that contributed significant revenue in that quarter. Naturally, these contracts will not renew this year and, thus, will not contribute significant revenue in this quarter.

Even though we expect the total revenue contribution of our multiyear leases in 2020 to increase as compared to 2019, this timing of Q1 2019 deals, coupled with the seasonality of large deals, means that the first quarter's revenue from multiyear contracts will be lower than Q1 of 2019. Third, the combined effect of the China sanction and coronavirus, which I described earlier, delays first half revenue and further strengthens projected revenue growth in the second half of 2020.

Let's move on to the details of our outlook. We are initiating our guidance for Q1 and expect non-GAAP revenue in the range of $300 million to $320 million and non-GAAP EPS in the range of $0.75 to $0.88. For 2020, we expect non-GAAP revenue in the range of $1.64 billion to $1.7 billion or constant currency growth in the range of 8% to 12% and EPS in the range of $6.19 to $6.71. Our ACV outlook for 2020 is a range of $1.605 billion to $1.650 billion. This represents constant currency ACV growth in the range of 11% to 14%. With respect to 2020 annual operating cash flow, our initial outlook in the range of $500 million to $530 million, which considers a full year of interest expense on our term loans.

Looking ahead to Q1 we are expecting operating margins of 27.5% to 30%, which are reflective of the lower revenue contribution in Q1 combined with a lower proportion of variable cost. And for the full year 2020, we expect margins in the range of 42% to 43%. This aligns with the target range of 42% to 44% that we communicated back in September 2019 at our Investor Day event.

To close out from the topic of our outlook for 2020, let me just say that we have a strong pipeline, diversified business model and a high level of recurring revenues, all of which contribute to our confidence that 2020 will play out similar to the past 2 years. Further details around specific currency rates and other key assumptions that have been factored into our outlook for Q1 and 2020 are contained in the prepared remarks document.

In summary, we delivered another quarter and year of record financial performance with strength across our key financial metrics. Our continued track record of delivering on our financial commitment gives us confidence that we will deliver another year of record financial performance in 2020. In addition, we will continue to invest in our business while we execute against our strategic priorities in support of delivering on our longer-term 2022 ambitions.

Operator, we will now open the phone line to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ken Wong with Guggenheim.

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Ken Wong, Guggenheim Securities, LLC, Research Division - Senior Analyst [2]

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Maybe the first question for you, Ajei. You guys have historically been pretty conservative in terms of how you guys think about your business. And when we look at that ACV guide of 11% to 14% growth, help us understand maybe kind of what type of conservatism has been baked in and where you might see some opportunities for improvement as we work our way through the year. And then Maria, any way to help us with what the organic ACV growth of the business is for fiscal year '20?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [3]

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So I'll let Maria jump in as well. But a couple of assumptions that we've built in perhaps that might help for the 2020 ACV assumptions. Firstly, as you know, as I said in the comments, Q4 was an amazingly strong quarter in terms of ACV. So I'm excited about the performance. I'm excited about the pipeline. I think we have a very strong pipeline.

Built into assumptions that there are a couple of headwinds, which perhaps might be relevant. One is we've assumed that currency is approximately a point, so that's approximately $15 million of a headwind, and that might be relevant to the conversation. And the other is, of course, is we're assuming from the China sanctions that there's a headwind from a growth perspective, and Maria mentioned that on the call as well, and that's approximately $20 million. And so taking that -- taken together, that's approximately 2.3% or about 35% -- $35 million headwind coming into ACV for the year. And of course, that mitigates what we have in terms of an amazingly strong pipeline.

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [4]

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Yes. And Ken, with respect to inorganic contribution, we're expecting currently about 3% to 4% both to ACV and revenue will be the inorganic component.

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Operator [5]

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Our next question comes from Jackson Ader with JPMorgan.

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Jackson Edmund Ader, JP Morgan Chase & Co, Research Division - Analyst [6]

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Just had quick follow-up, Maria. The inorganic contribution, what about for 2019 to both ACV and revenue?

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [7]

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It was roughly about 3% to 4% as well for the full year.

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Jackson Edmund Ader, JP Morgan Chase & Co, Research Division - Analyst [8]

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Yes. Okay. That's helpful. And then the cash flow outlook. Looks like, again, you guys are looking for kind of low single-digit cash flow. And if we look at that as a percent of -- I know revenue can bounce around, but even as a percent of ACV, it's kind of coming down again. Can you just comment on maybe free cash flow conversion relative to what you would expect in kind of normalized years outside of all the 606 noise?

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [9]

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So let me talk about a couple of the primary factors that we built into our current outlook for operating cash flow. So first and foremost is, as you heard me say on the call, the slightly reduced margin in 2020 as compared to 2019. I also mentioned, this is the first year that we have interest payments on long-term debt that we entered into in connection with the LSTC acquisition. That's about $13 million impact. The stronger U.S. dollar. The expectation that we'll have increased tax payments in 2020 related to our strong profitability last year.

And one other nuance that you may or may not be aware of that relates to another accounting change, there is a new accounting standard that we adopted and that others will adopt that impacts the treatment of certain items that move from -- historically were treated as investing items that now move into operating, and so those will also have a negative impact relative to the cash flows in 2020. So the combination of all of those elements is what leads us to the $500 million to $530 million that we currently are projecting.

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Operator [10]

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Our next question comes from Jay Vleeschhouwer with Griffin Securities.

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Jay Vleeschhouwer, Griffin Securities, Inc., Research Division - MD of Software Research [11]

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Ajei, in your prepared remarks, you referred to the new features and capabilities in the 2020 release, including the incorporation of some acquired functionality. The question then for that is, could you talk about how you have evolved or may yet have to evolve your internal development processes, R&D management and the like? I've asked this question of other companies like Adobe, for example, that have large complex portfolios, that have also been acquisitive. I'd be curious to understand how you, particularly for multiphysics and the non-solver business, have perhaps made some changes, if any, to R&D.

And then secondly, also for you, talk about if you could the interplay, as you see it, between services, including, in particular technical consulting on the one hand, and your solver and non-solver businesses. What is the connection there in terms of services as you see it as either a leading indicator or coincidental indicator to support and enable the software business?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [12]

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So if I understand the question about R&D, and I'll try to answer it as best as I can, and hopefully, this gets to the gist of your question, we -- as any sophisticated company with a broad portfolio of technologies, we rely on a combination of both organic development, where we have a road map that we execute against. And in certain occasions, we rely on acquisitions, and the acquisitions could be because there's a technology that we've decided we need, which might be better served by going out and buying a company which has already developed that as opposed to developing ourselves.

We have an amazingly engaged and capable R&D organization, and we continue to drive innovation after innovation, and I gave you an example of some of the innovations in HFSS. And if you look at the R1 release, you'll see a chapter and verse of all kinds of new features and capabilities that continue to enhance our products across a number of different dimensions.

But at the same time, we believe that acquisitions are an important aspect, that there are a number of startup companies that have interesting ideas. There are other companies that perhaps may be a little bit more established that have developed great technology like LSTC had. And we are able to bring them in and rapidly incorporate them into our R&D processes and our development processes. We have an internal mechanism to be able to share information. We have a technical conference, for example, where our R&D leaders from around the world and technical leaders can come get together and share information. There's a lot of collaboration. And you're seeing that in the results.

I gave the example of RaptorX. You've seen the results in some of our optics technology where we announced ANSYS SPEOS, which brought together some of the work that we had on solid modeling, on the SpaceClaim side together with the SPEOS capabilities and so on. You can see that in our autonomous offerings, where we have brought together core technology that we've developed over the years as well as acquisitions that came in -- as well as technology that came in from acquisitions. You see that in our platform strategy, which includes capabilities that we've developed as well as other things that we've acquired. So it's a complex equation, but I think that our team is incredibly sophisticated, and we're able to deal with that complexity very well. So I think that's the first piece of the -- that's the first piece of your question.

The second piece is with respect to services. Look, we have a -- we are not a services company, a professional services company. That is not our business model. We're a software business. And for us, while we do services, services are fundamentally in support of driving software sales. Now we do have a small services organization that supports some of our larger opportunities. And especially when it's in a broad -- in new emerging area, we can certainly see an incremental set of requests for the services capabilities that we provide. But that's not our business, and we work with service partners around the world who can add to the ecosystem. So many of our large channel partners and others can add to the ecosystem to provide service delivery to our customers. This is obviously not an area where we are focusing on trying to significantly increase our share of the business. As I said, our business model is that of a software company.

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Operator [13]

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Our next question comes from Joe Vruwink with Baird.

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Joseph D. Vruwink, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate [14]

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The dynamic around 8-figure deals continues to be very impressive. Do you think your performance within a specific industry vertical or with the existing 8-figure customers is at a point where ANSYS is maybe benefiting from a referral sale dynamic?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [15]

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If what you're saying in the question is do you believe that customers are seeing that ANSYS has technology that can help other people in the marketplace and therefore could help themselves, in other words, the customer says, look, I can see what ANSYS is doing elsewhere, and therefore, they're in a position to help me, I think customers look to work with winners. I think we're a winner in the marketplace, and customers like to work with us. We certainly see customers who appreciate the fact that we've invested ahead of the curve, for example, in areas like autonomy and electrification, IoT, where we have great capability, and we can demonstrate customer success in the conversations that we're having with customers. I hope -- does that answer your question?

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Joseph D. Vruwink, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate [16]

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Yes, yes, it does. And then going back to the strong pipeline for FY '20, can you maybe just discuss how business conditions outside of China, outside of the affected areas, have changed year-to-date maybe relative to your expectation for the ACV pipeline and close rates at the start of the year?

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [17]

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Yes. So Joe, what I would say is on a global front, we don't see -- outside of China, we don't see any huge changes from the macro environment that existed when we exited Q4. And I think for us, the -- what gives us confidence relative to our outlook for 2020 is that -- to the topic that you just spoke to Ajei about, every single one of those 8-figure deals that were closed in Q4 were in the pipeline when we came out with guidance in November. So we successfully were able to close every single one of those, and we know that we've got a strong pipeline of deals that are scheduled to close in Q4 of next year just because of the renewal cycle.

They're lighter in Q1 just because of the ones that we closed this year that will not repeat. But we are very confident that based on everything that we know today, we've got a strong pipeline. We've got customers that are investing heavily in their own digital transformation to keep pace with market expectations. And so while it may appear on the surface that Q1's light, when you look at the full year and the fact that we're putting up double-digit ACV and revenue growth at the midpoint for the full year, we're very excited about the opportunity that we see ahead.

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Operator [18]

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Our next question comes from Steve Koenig with Wedbush Securities.

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Steven Richard Koenig, Wedbush Securities Inc., Research Division - MD [19]

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Thanks for taking my question, and I'll have one follow-up as well. On the Q4 specifically, it looks like constant currency, you were just about at the midpoint of your guide. I'm wondering, could you comment -- that's for ACV. Can you comment on what factors could have gotten you to the high end of guide? And conversely, what factors could have led you more towards the low end? You came right down in the middle on the fairway, it looks like.

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [20]

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Yes. So Steve, what I'll say is there were 2 primary factors that contributed to where we ended up on ACV, and both of those, unfortunately, were outside of our control. The first being currency. And the second, if you'll recall, we closed the LSTC acquisition right before we gave guidance in November. And about 100% of that business came through their channel. We were not able to engage with the channel during due diligence, and so as a result, what we discovered once we closed that deal, that the forecasting methodologies that their channel used were not necessarily aligned with what a public company would do.

And so as a result, that ended up -- the contributions from the acquisitions were a little bit less than we anticipated. So if you take the combination of the forecasting negative, which we have now fixed and has been resolved as we head into 2020, and the impact of currency, the 2 of those essentially would have brought us closer to the midpoint.

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Steven Richard Koenig, Wedbush Securities Inc., Research Division - MD [21]

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Got it. That's helpful, Maria. And then for my follow-up, you explained in some pretty good detail why second half looks -- should be somewhat stronger than the first half. I'm wondering specifically relative to the coronavirus assumptions and the statement that the full year shouldn't be impacted, I'm wondering what inputs are you considering there in terms of the second half bounce-back in making that forecast. What kind of -- are you looking at the news? Or does it come from your channel in China? Or what's giving you confidence in that assumption, specifically around the outbreak?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [22]

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So let me take a crack, and then I'll have Maria jump in as well. We are in -- obviously, as you can imagine, we are in very close contact with our team in China, and we're working closely with them as well as we're in contact with our channel partners in China. We're a software business. And as you can imagine, a lot of the activity that needs to be done in order to communicate with customers and work with customers can actually be done over the network, it can be done over telephone calls and so forth. And we are seeing that our team in China, and I alluded to this in my comments, our team in China is able to -- despite the fact that some of our offices are closed, our team in China is able to go in -- to be able to work from home and to reach our customers, who are also working from home and are able to get access to their systems and so forth.

And so based upon that and what we're seeing in terms of our ability to move our business forward, we've taken a -- we're somewhat conservative. We're moving -- we believe that there will be obviously some impact in the sense that there will be some business that will be delayed from the first half to the second half. But we believe that the underlying dynamics of the market continue to be strong. The demand for our products continues to be high. We're continuing to be able to make progress against opportunities, and so we've modeled this as essentially a delay of activity that might have otherwise been scheduled for the first half, delaying into the second half. Maria?

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [23]

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Yes. And I'll just say, Steve, relative to that commentary, we have factored in into our Q1 outlook some prudent caution relative to the coronavirus and the impact that it will have on our Q1 business in China specifically.

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Operator [24]

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Our next question comes from Andrew DeGasperi with Berenberg.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [25]

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First, on your partnership with Rockwell. I was just wondering when do you think you expect to see some progress there. Should it be consistent with the Digital Twin opportunity you highlighted at your Investor Day? Or would it potentially materialize sooner than that?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [26]

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So our partnership with Rockwell is very much about the opportunity to help with the manufacturing process, and it's the use of digital twins in the manufacturing process to be able to optimize that. So yes, it is related to the deployment of digital twin technology. But at the same time, this is not an esoteric long-term multiyear activity. We are working actively with customers today. And customers, I think -- working together with customers, I think we can demonstrate the benefit of the use of digital twins and being able to optimize their manufacturing processes. And I'm not sure if we could talk about specific customers today by name, but there's one particular large CPG customer, for example, that we're actively engaged with that I'm very excited about.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [27]

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Great. And just the last one on -- in terms of the energy sector, you mentioned it was a low growth cycle last year, and -- but it picked up in the second half. Can you mention what's changed?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [28]

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Yes. I think when you look at energy, what's happening is that the industry is transitioning some of its investments from where they've historically been, so looking at things like digital transformation, they're looking at predictive analytics, material intelligence, additive manufacturing, robotics, autonomous systems. So it's not only what they've traditionally looked at, but they're starting to broaden. And of course, these are areas where we can now -- we've historically had a lot of investments, and then we can continue to broaden our conversations with these service providers in the energy sector to include all of these new capabilities where they're seeking to broaden their own solutions. And that's continued to drive -- that continues to drive opportunities.

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Operator [29]

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Our next question comes from Rich Valera with Needham & Company.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [30]

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Ajei, I appreciate your comments on Discovery Live. Just wondering -- you mentioned you didn't expect it to be sort of material near term, but if you could give us any sense of when you think that might be able to be a material contributor.

And then what other opportunities might you have beyond the PTC arrangement now, either to sort of broaden that agreement as they've broadened out their product line or potentially to partner with other players in the CAD industry?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [31]

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Well, as far as our relationship with PTC is concerned, look, I'm excited about the relationship with PTC. I think that they're a great partner. And obviously, they have recently gone through the acquisition of Onshape, which is the great technology they brought onboard, and we continue to have conversations with them about how our relationship can evolve and grow. So that's an ongoing dialogue we continue to have with our partners at PTC.

As far as the first question in terms of the Discovery business in the aggregate, I mean I think that the technology is incredible, and we're going after a market opportunity that continues to evolve and develop, and that's one of the reasons why we've been incredibly cautious about how we imagine the financial impact of this business is going to be. And I think we've been very consistent in saying that this is going to be a relatively modest piece of our business for a long time, and that's in part driven by the fact that the audience that we're going after is a relatively conservative audience. And adoption of these kinds of technologies, unlike the consumer technology, adoption takes time.

We continue to drive the new innovation and the innovations that we -- I described some of the innovations before, I don't want to go through them again, but we continue to drive new innovations and new capabilities and that continues to broaden and strengthen our capability in the market. So I'm excited about where we are. I believe we've made great progress. We have seen progress with customers who have come through the enterprise renewal process. So it wasn't like they were just buying it to evaluate it. They're buying it and they're rebuying it. So that's a really positive sign, and we continue to see that as a tailwind for the business as we go forward.

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Operator [32]

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Our next question comes from Matt Pfau with William Blair.

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Matthew Charles Pfau, William Blair & Company L.L.C., Research Division - Analyst [33]

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I just wanted to ask on the LSTC acquisition. How is the integration of that business progressing? You mentioned that, historically, they've done majority of their sales through the channel. Are you working on transitioning that sales notion more to your internal sales force? And then I do know they have some exposure in automotive, and you mentioned that the autonomous and electric was good for ANSYS. How about LSTC and their automotive exposure?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [34]

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So firstly, the area that -- let me start with the last piece. The area where LSTC has a lot of strength in automotive is in crash testing. Crash testing, when I meant the more legacy areas, I was talking about potentially a transition from electric to the internal combustion engine. And if you start to think about that transition, customers are spending more money on electric drivetrains and thinking about that change versus internal combustion engines.

However, when you consider now the fact that you have, say, a battery inside a car, and as I've described in previous calls, the transition to an electric drivetrain and to a battery-operated car fundamentally changes the nature of the design. The chassis changes. Weight assumptions change. There's a fundamental redesign taking place across the car in the aggregate. But that means that you have to rethink what it means for collisions and response to collisions. And then of course, the battery, you have to worry about battery explosions and battery fires and things of that nature. So you have to really rethink and spend a lot of effort understanding how collisions -- because collisions might happen, you have to make sure that the collisions are not going to be catastrophic, and that means there continues to be significant demand even in the new world of electric cars for the kind of work that we're doing, and I'm very excited about the opposition there in the marketplace. So that's with respect to the actual end market in automotive for LSTC.

As far as the integration of the technology and the product is going, the integration is going really well. We are -- the technology is very consistent with what we expected. We were a long-time reseller as well of the technology, so we certainly understood it before we did the acquisition. It's consistent with what we expected, and it's a great team, and they're great people.

As far as the channel partners are concerned, we're working with those channel partners. They're integrating into the ANSYS ecosystem, and we're working with the channel partners. We're honoring those relationships and supporting those channel partners because they have some really valuable customer relationships and incredible skills and capabilities that we want to maintain within the ANSYS ecosystem. So we want those channel partners to grow and thrive within the ANSYS ecosystem. And the good news is that we have a vibrant channel relationship already, and those channel partners can grow inside it. And we are very supportive of them continuing to be able to grow their business as being part of the broader ANSYS family.

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Operator [35]

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Our next question comes from Jason Celino with KeyBanc Capital Markets.

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Jason Vincent Celino, KeyBanc Capital Markets Inc., Research Division - Associate [36]

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I understand the lower revenue dynamics driving the lower margins in Q1, but expense growth looks to be the highest in Q1. Can you maybe talk about acquisition integration costs, investments or core cost timing?

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [37]

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Yes. So what I'll say, Jason, is, please keep in mind that Q1 is the first quarter of all 5 of the acquisitions coming into play that we did last year. So the combination of the acquisitions along with our own organic hiring and a number of digital transformation activities that we've got going in our own business, just result in Q1 having a lot less variable cost than if you look across the entire year. So we're excited that we will continue to run our business with diligence, that we'll continue to deliver best-in-class margins. But we really encourage you to look at the margins over the course of the full year as opposed to just a 90-day period.

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Jason Vincent Celino, KeyBanc Capital Markets Inc., Research Division - Associate [38]

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Great. And then relative -- actually following back to the coronavirus and that pushing some ACV and revenue into the second half, I understand that it might delay some work. But can you maybe talk about second half resources that would be devoted to that?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [39]

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When you say resources that would be devoted to that, what specifically are you referring to?

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Jason Vincent Celino, KeyBanc Capital Markets Inc., Research Division - Associate [40]

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Well, if you think about what it takes to close a deal, if you have got work that was supposed to close in first half that is closed in second half, would there be a second half work that would be delayed as a result?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [41]

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I understand what you're saying. No, we don't see any significant impact. I mean when you consider the aggregate of our business, it's so large. We're talking about a relatively de minimis amount relative to the overall value of our business. So it's a tiny -- it's noise in the big scheme of things from a back-end deal closing perspective, the people who actually close the deals as far as the books are concerned.

As far as the actual work with the customers, as I said, a lot of that work is taking place right now, where we are able to work with the customer virtually. We are able to do -- continue with telephone calls. We're able to continue working over the Internet. We can do webinars. We can do webcasts. Customers have access to demo systems as they need to. All of that activity continues to take place. As I said, our colleagues in China -- and once again, I want to acknowledge our colleagues in China who've been working under difficult circumstances for a while -- our colleagues in China are able to continue to drive the business forward, and they are actively working to do that.

And so we feel like a lot of the spade work that we need is continuing to happen. We will continue to see -- we will continue to close business in Q1. And -- but we've modeled -- for the sake of being prudent, we've modeled the slippage of some business into the second half of the year. And that's, of course, already in the guidance.

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Operator [42]

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Our next question comes from Adam Borg with Stifel.

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Adam Charles Borg, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [43]

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Great, just a quick one. In the prepared remarks, it was interesting to see some increasing momentum in the health care vertical in North America. Maybe you could just talk a little bit more about what's driving the strength and what efforts you're devoting against that in 2020.

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [44]

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Yes. So let me just try to take that for a second. Look, we see simulation is becoming increasingly important for a sector of the health care market. And while it's a relatively small vertical for us today, I think we're making significant progress there, especially in Q4. In the physics -- in physics that's based on the health care sector, specifically that we're focused on, which is things like device manufacturing -- medical devices and so on, we've been working with the regulator of the FDA. We've been working with the EU. And we believe that the health care industry is heading more towards things like in silico trials and outcomes like personalized medicine, and then physics space simulation will play an even more active role.

And we've, frankly, been very active in this field for a long, long time, maybe for the last decade. And we've been engaging globally with policymakers, with academics, with consortia to try to make sure that we can explain to the industry and bring the industry and the regulations along to the use of in silico trials, and I think we've made significant progress.

Now in Q4 specifically, as I said, we had several larger deals with medical device market leaders, specifically focusing on the use of simulation and leading to products that could be deployed more rapidly and products that could get regulatory approval more rapidly. So that translates into a very specific value proposition to the customers, which is they can get new product to market faster and at lower cost and with greater probability through the regulation process. And so that's a low-hanging fruit for us, but we see all kinds of opportunity in the [hardware] space that we're working towards.

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Operator [45]

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Our next question comes from Tyler Radke with Citi.

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Tyler Maverick Radke, Citigroup Inc, Research Division - Senior Associate [46]

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Just 2 quick ones for you, Maria. So I just wanted to clarify the question on ACV performance in Q4. I thought you said that if you had the currency play out as you'd originally expected and then some of the pipeline forecasting issues with the acquisition, you would have kind of come in in the midpoint of guidance. I guess what kind of prevented you from -- sorry, go ahead.

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [47]

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Near the midpoint?

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Tyler Maverick Radke, Citigroup Inc, Research Division - Senior Associate [48]

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Yes. I guess what would have prevented you from going towards the high end? Were there any types of deals that slipped? Or what's kind of the factors there? And then just a quick follow-up. As I think about the divergence between operating cash flow, margin and operating income margin, over time would you expect those to kind of triangulate kind of in the same neighborhood? I think they're north of a 10-point delta today. But just how to think about those in the long run?

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Maria T. Shields, ANSYS, Inc. - CFO and Senior VP of Finance & Administration [49]

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So Tyler, what I'd say is like any year-end, there are customers that will apply pressure to get better discounts or better terms and conditions. And so if you decide to take those deals, then you can always end up at the high end of guidance. And if you decide to think about our business as a long-term play and not give in to the pressures of giving away software and services that are highly valuable, for discounts that make a number in Q4 look better, we just choose to run our business for the long term. And so there's always ways to make the numbers look better, but are they the right ways for the business in the long term? So as we said, we're very excited about our performance in Q4. We closed the deals that were in our forecast that mattered. We had a record quarter, and we're excited about what we see ahead for 2020.

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Operator [50]

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Our next question comes from Mark Schappel with Benchmark.

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Mark William Schappel, The Benchmark Company, LLC, Research Division - Director of Research & Equity Research Analyst [51]

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Just one question, Ajei. Could you just clarify your prepared remarks around the improvements you saw in the energy sector? Are you seeing broad-based improvements in that industry? Or did your comments just pertain to the big deal with Baker Hughes?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [52]

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No. As I said, I think I mentioned this in one of the earlier questions as well, we are seeing customers in the energy sector. And again, we have a definition of the energy sector. We have customers in the energy sector who are looking to broaden what they were previously interested in. So it wasn't just the conversations that we've been historically having. There are broader conversations about things like predictive intelligence and materials and robotics that I mentioned before.

Another area that continues to be of interest is emissions reduction, things like carbon capture. And so we saw some new opportunities that emerge from things like carbon capture with applicability for renewable energy and energy storage, battery management, battery systems and things of that nature. So all of those are outside of the traditional business that you might have perhaps associated with the energy sector, and those represent incremental opportunities for us as we think about our business going forward.

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Operator [53]

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Our next question comes from Matthew Swanson with RBC Capital Markets.

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Matthew John Swanson, RBC Capital Markets, Research Division - Associate VP [54]

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This is Matt Swanson on for Matt Hedberg. You performed really well in the automotive sector in 2019 by going after some of those new dollars around electrification and automation. So far in 2020, it seems like PMI data might be improving for areas like Germany, Brexit. It seems like there's less uncertainty from the U.K. Could you talk a little bit about the return, maybe if some of those old dollars, and what that could mean to the space?

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [55]

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Well, as I said, I think that some of the directions that we've talked about in the automotive industry -- for 100 years the automotive industry has been based on assumption that it's an internal combustion engine, and it's driven by a human being. And both of those assumptions are being challenged at the same time. So we expect -- so a significant amount of the R&D spend is going towards these next-generation technologies. It is going towards electrification. It is going towards electric systems. It is also going towards electric driving. It's also going towards autonomy. And while we may not necessarily see full autonomy in the short term, as we go on this journey to autonomy, we have improved safety systems, we have autonomy and limited circumstances and so forth. So that level of investment is an ongoing stream of investment that we see happening for multiple years, and we're excited about that.

That being said, when you look at the full portfolio, I think that we have some tremendous strength in the automotive industry outside of these new areas that we've talked about. We talked briefly about crash. That's an area that we continue to be strong. That's obviously through the acquisition. And we continue to be strong in other areas with the portfolio that we've driven. Some other interesting areas like optics have also come into our portfolio through acquisitions. So we have a very strong footprint in the automotive industry today. We have good capabilities, both for the emerging areas, where there's a lot of R&D spend, as well as the more traditional areas. And we're very excited about our position.

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Operator [56]

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This concludes our question-and-answer session. I would like to turn the conference back over to Ajei Gopal for any closing remarks.

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Ajei S. Gopal, ANSYS, Inc. - President, CEO & Director [57]

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Great. Thank you. 2019 was another outstanding year for ANSYS, and we exceeded expectations on many of our key financial metrics. We continued to improve execution across the geographies and our go-to-market strategies. We broadened our product capabilities, and we announced several new partnerships and collaborations. These are important accomplishments, and they continue to move the business in the right direction, and they give us confidence in our ability to achieve our long-term targets. We are looking forward to another exciting year in 2020.

And in closing, I would like to express my sincere gratitude to our customers and to our partners for their support. And of course, a shout out to my ANSYS colleagues. Thank you all for your efforts, and thank you for another exceptional quarter and an exceptional year. Thank you all for joining the call. Please enjoy the rest of your day.

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Operator [58]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.