Mark P. Sullivan - Chief Financial Officer, Principal Accounting Officer and Executive Vice President Antonio J. Pietri - Chief Executive Officer, President and Director.

Brendan Barnicle - Pacific Crest Securities, Inc., Research Division Richard H. Davis - Canaccord Genuity, Research Division Peter L. Goldmacher - Cowen and Company, LLC, Research Division Mark W. Schappel - The Benchmark Company, LLC, Research Division David Griffin Sterling P. Auty - JP Morgan Chase & Co, Research Division.

Good afternoon. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to AspenTech's 2Q '14 Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the conference over to Mark Sullivan. Please go ahead, sir..

Antonio will discuss business highlights from the quarter, and then I'll review our financial results for the second quarter and our guidance for the third quarter and fiscal year and then we'll open up the call for Q&A. With that, let me turn the call over to Antonio.

Antonio?.

Thanks, Mark, and thanks to everyone for joining us today. We had a strong second quarter performance that exceeded our guidance on each of our key metrics. We feel good about our execution through the first half of the fiscal year and believe AspenTech is well positioned to deliver another solid year of operational and financial performance.

We continue to see positive customer usage patterns and strong customer demand. This helped drive strong growth in total license contract value, which grew approximately 13% year-over-year and 3% sequentially during the second quarter.

From a global macro perspective, the economic environment remains uncertain, but we have not seen a material change in customer buying behavior in recent months. We continue to be mindful of the macro environment and realize that we will likely not be immune if the economy were to significantly change for the worse.

However, we continue to see a strong pipeline of sales opportunities and benefit from having multiyear contracts with a large base of blue-chip customers in our target industries.

In addition, we continue to see a strong growth in our small and medium-sized customer segment, where we created a dedicated inside sales organization approximately 2 years ago to more efficiently capture a broader segment of our addressable market.

Our 3 main verticals all contributed to the strong performance in the second quarter, as did each of our major product lines. Once again, energy, chemicals and engineering and construction represented 90% or more of the company's business during the second quarter.

Energy was the largest vertical contributor, followed by engineering and construction and chemicals. Looking at the 10 largest transactions in the quarter, there was again a mix of engineering and manufacturing supply chain-driven deals, both of which performed well during the quarter.

We continue to see a significant opportunity to expand the usage of our products across our sizable installed base, as most of our customers are only using a portion of the functionality made available to them through the aspenONE platform.

We also brought more exciting new innovation to market with the release of version 8.4 of aspenONE, which included additional activation capabilities for Aspen Plus and HYSYS.

This enables instant analysis of heat exchanger designs, energy consumption and cost estimates, so that engineers can make quicker decisions to improve efficiency while driving down operating expenses.

We also introduced advancements in crude assay management, such as automating the process of important crude data from Aspen Assay Management into our HYSYS Petroleum Refining solution. This will significantly increase the efficiency of the crude assay modeling process and enable customers to optimize their crude inputs more quickly and accurately.

Lastly, version 8.4 includes an update to the solids modeling technology we acquired 2 years ago with SolidSim. We have now extended our solids modeling technology to include spray dryers and fluidized bed reactors.

This will enable both process engineers and particle scientists the ability to build designs in parallel using common data, allowing for faster and more efficient process design. It is a great example of the value we can generate via tuck-in acquisitions that expand the functionality available as part of the aspenONE platform.

The consistent introduction of new capabilities, both organic and acquired, is providing additional ways for customers to expand their usage of AspenTech's product suite, which in turn expands our addressable market opportunity, given the fact that increasing our customer usage drives revenue growth.

The substantial resources we devote to research and development and the pace of world-class innovation we deliver to market on a consistent basis are key competitive differentiators for AspenTech, and we're focused on continuing to extend our technology lead going forward.

While we continue to make the right investments in the business to drive sustained growth, we remain focused on expense discipline and increasing the organization's productivity.

The combination of our unique licensing and sales model, long-term contracts and best-in-class renewal rates provide AspenTech with a highly scalable business model that generates significant profitability and cash flow generation. We are committed to deploying our cash flow responsibly in order to generate long-term shareholder value.

We're doing this through a combination of M&A that further enhances the value we can deliver to our customers and a sustained return of capital to shareholders via share repurchases.

During the second quarter, we repurchased $30 million worth of stock and have scaled this program over the past 10 quarters from an approximately $40 million annual run rate to a $120 million annual run rate. Operationally, we have enhanced our senior management team with the hiring of Chris Dartnell, as our new Senior Vice President of Global Sales.

Chris joins AspenTech from Honeywell, where he has spent the last 24 years in a variety of managerial roles, most recently as the Vice President and General Manager of Strategic Geographies based in Shanghai, China. He has extensive experience stemming into our 3 core industry verticals and customer base.

In addition, he has been based in 3 continents and has experience leading sales organizations in over 60 countries.

We're excited to be adding an executive of Chris' caliber and believe he will be an important member of our executive team as we continue to improve our penetration within our top 350 accounts and as we further expand our inside sales effort directed at small and medium enterprises.

To summarize, AspenTech delivered a strong second quarter results and we're optimistic about our outlook for the remainder of the fiscal year. We believe the company is well aligned from a product and organizational perspective to continue delivering solid growth and best-in-class profitability and cash flow generation.

With that, let me turn the call over to Mark.

Mark?.

Okay. Thank you, Antonio. Let me begin my section by reviewing the supplemental metrics that we provide, starting with our term contract value or TCV metric, which measures the renewal value of our multiyear term contracts.

Growing TCV is a key focus for us, and we increase the value of the metric by adding new customers, expanding product usage and increasing prices across our customer base. Our license-only TCV was $1.75 billion at the end of the quarter, which was up 13.3% compared to the second quarter of fiscal 2013 and up 3% on a sequential basis.

Including the value of bundled maintenance, total term contract value was $2.05 billion at the end of the quarter, which was up 15.2% compared to the second quarter of fiscal 2013 and up 3.3% sequentially.

Our annual spend, which is a proxy for the value of our recurring term license business at the end of each period, specifically the annualized value of our term license and maintenance revenue, was approximately $356 million at the end of the quarter. This represented an increase of approximately 11% on a year-over-year basis and 2.9% sequentially.

As a reminder, the growth of our annual spend metric should be slightly lower than the growth of our license TCV metric, though there can be some quarter-to-quarter variability.

License TCV is calculated using each contract's terminal year annual payment and therefore, takes into consideration the total price escalation over the course of a multiyear time period. Whereas, annual spend only takes into consideration the current year's level of spend. Now let me turn to our financial results on a GAAP basis.

Total revenue of $98.8 million was up 27.8% from $77.3 million in the prior-year period and exceeded the high end of our guidance range by approximately $10 million. The largest driver of the revenue upside was approximately $6 million of subscription and software revenue associated with customer contracts that are recognized on a cash basis.

Included in this amount, as we previously discussed, are a couple of large, legacy cash-basis contracts that come due at the very end of the second quarter. And we did not include the revenue from those contracts in our second quarter guidance.

The $6 million of upside to our second quarter revenue is simply a matter of timing between Q2 and Q3 as compared to changing our view from a full year perspective. Excluding this timing difference, our revenue exceeded the high end of guidance by about $4 million as a result of higher services revenue and license growth.

Moving onto revenue by line item. Subscription and software revenue was $88.9 million for the second quarter, which is an increase from $69 million in the prior year period and $78.7 million last quarter.

Our growing subscription business positively impacts our deferred revenue balance, which was $224.8 million at the end of the second quarter, representing a 17.1% increase compared to the end of the year-ago period. On a sequential basis, deferred revenue decreased $7.6 million.

As we've talked about previously, the second half of the year is a stronger period for our deferred revenue due to the same factor that drives the timing of our cash flow, which is the timing of when we bill customers.

For the full year, we expect our deferred revenue to grow at a solid rate, which is one of the components taken into consideration in our guidance for cash flow growth in fiscal 2014. On a quarter-to-quarter basis, we believe it's more meaningful to look at the growth in our annual spend in TLCV versus evaluating movements in our deferred revenue.

Services and other revenue was $9.8 million compared to $8.3 million in the year-ago period and $8.9 million last quarter. Turning to profitability. Gross profit was $86.3 million in the quarter with a gross margin of 87%, which compares to $64.9 million and a gross margin of 84% in the prior year period.

Operating expenses for the quarter were $50.2 million, up from $50 million in the year-ago period. Total GAAP expenses, including cost of revenue, were $62.7 million, which was up slightly from $62.4 million in the year-ago period.

We are committed to maintaining our history of solid expense management and it's something that we remain focused on as we move forward. Operating income was $36.1 million for the second quarter of fiscal 2014, an improvement compared to an operating income of $14.9 million in the year-ago period.

Net income for the quarter was $23.3 million or $0.25 per share compared to a net income of $9.9 million or $0.10 per share in the second quarter of fiscal 2013. Turning to non-GAAP results.

Excluding the impact of stock-based compensation expense, restructuring charges and amortization of intangibles associated with acquisitions, we reported a non-GAAP operating income for the second quarter of $39.5 million and a non-GAAP net income of $25.4 million.

This represents an improvement from a non-GAAP operating and net income of $18.6 million and $12.3 million, respectively, in the year-ago period.

Our non-GAAP income per share was $0.27 in the second quarter of fiscal 2014, based on 93.8 million diluted shares outstanding compared to a non-GAAP earnings per share of $0.13 based on 95.5 million diluted shares outstanding in the second quarter of fiscal 2013.

The earnings outperformance was driven primarily by the recognition of the high-margin, cash-basis revenue referenced earlier. A reconciliation of GAAP to non-GAAP results is provided in the tables within our press release, which is also available on our website. Turning to the balance sheet and cash flow.

The company ended the second quarter with $235.7 million in cash and marketable securities, an increase of $14.2 million from the end of last quarter. From a cash flow perspective, the company generated $46.3 million of cash from operations during the second quarter and $45.2 million of free cash flow.

This was offset by $30 million that was used to repurchase stock in the second quarter. Turning to guidance. I'd like to close with some thoughts regarding our financial outlook for fiscal 2014, as well as for the third quarter.

As a reminder, even though we are now in year 5 of our revenue model transition and are generating material profitability, our P&L is still not a completely meaningful indicator of our business performance and it won't be until our revenue model transition is complete in fiscal 2015.

With that said, we expect third quarter revenue in the range of $91 million to $94 million, non-GAAP operating income of $28 million to $30 million and non-GAAP EPS of $0.18 to $0.20. On a GAAP basis, we expect third quarter operating income of $24 million to $26 million and EPS of $0.16 to $0.17.

There are 2 factors to consider to put our third quarter revenue guidance into further perspective. First, as discussed, our second quarter benefited from approximately $6 million associated with cash-basis deals that were previously anticipated to be collected and recognized in the third quarter.

Second, there is also some upside potential to our updated guidance range. For several years, we've been working with a customer on a significant supply chain implementation. This arrangement, which included perpetual software licenses and professional services, has been accounted for on a completed contract basis.

Accordingly, all revenue and costs associated with this project has been deferred and recorded on the balance sheet pending successful completion of the project. We are reasonably confident that we'll receive completion sign-off on this project in the third quarter.

However, given the binary nature of this transaction, we made the decision to exclude the potential contribution for both our third quarter and full year 2014 guidance.

If we do receive customer acceptance, we would expect approximately an additional $7.5 million of revenue, above and beyond the $91 million to $94 million guidance range I just provided. We would also realize additional cost of approximately $2.5 million.

There is no corresponding cash flow pickup associated with this transaction, as most of the net cash flow from this project has already been received in prior periods. Now let me turn to our full year guidance.

From a revenue perspective, we are increasing our guidance to $372 million to $378 million, which is up from our prior guidance of $360 million to $368 million.

From an expense perspective, we are adjusting our assumption for total GAAP costs and expenses to $262 million to $267 million, which compares to our prior guidance of approximately $265 million to $270 million for the full year.

Taken together, we expect GAAP operating income in the range of $105 million to $111 million, net income in the range of $65 million to $69 million and GAAP EPS of $0.70 to $0.74.

This is up from our prior guidance of GAAP operating income of $90 million to $98 million, net income of approximately $56 million to $61 million and GAAP EPS of $0.59 to $0.65.

From a non-GAAP perspective, we now expect non-GAAP operating income in the range of $120 million to $126 million, which is up from our prior guidance that was up $104 million to $112 million for full year fiscal 2014.

This would lead to non-GAAP earnings per share in the range of $0.80 to $0.84, which is an increase from our prior guidance of $0.69 to $0.74 for the fiscal year.

As a reminder, none of the quarterly or full year guidance numbers on either GAAP or non-GAAP basis include the revenue or expense associated with the completed contract arrangement I just described.

With respect to total license contract value growth in fiscal 2014, we continue to target a double-digit growth rate over fiscal 2013 and remain optimistic about our outlook based on continued high customer interest levels. From a free cash flow perspective, we are increasing our fiscal 2014 guidance to a range of $165 million to $170 million.

Our previous guidance was $160 million of free cash flow. Consistent with prior years, we expect our free cash flow to be weighted to the back half of the fiscal year with the third quarter being the largest contributor to free cash flow. This is due to the timing of when we invoice customers and their payments become due.

In summary, we're pleased to report another solid quarter that demonstrates the underlying momentum in the business and the continued improvement in the company's profitability and cash flow generation capabilities. We believe we are well positioned to continue delivering the solid operational performance in the second half of fiscal 2014.

With that, we're now happy to take your questions. Operator, let's begin the Q&A..

[Operator Instructions] Your first question comes from the line of Brendan Barnicle with Pacific Crest Securities..

LTCV and TCV have been growing nicely in this kind of 13% to 15% range.

What would it take to see those accelerate materially or decelerate, for that matter?.

Well, that's -- this is Antonio. Our focus here is on consistent execution. And as you said, our growth rate has been between 13% and 15% every -- as we plan the year and as we plan our quarters, we look to make sure that we're consistent. What would it take to grow? Well, perhaps, a bigger investment with the certainty of the return on that.

We have invested in our business and we have an inside sales organization that has been growing in a significant way over the last couple of years. We've opened our operations in other -- in various parts of the world.

And that delivering the performance that we have, we come in every day making -- to make sure and execute, so that our growth rate doesn't decline, and that's what we do. And so we're satisfied with our level of execution..

Antonio, you mentioned in your prepared comments the SMB opportunities and what you were seeing there.

Can you just remind us of how to size that? What do you think about in terms of TAM there, in terms of penetration, what that might be able to provide in terms of growth going forward?.

I assume when you say SMB, you mean the small and medium businesses?.

That's right..

Yes. Well, like -- we've slowly been adding and increasing the scope of the group as the model has proved out over the last 2 years. I've said in the past, our top 350 accounts have the lion's share of our TLCV.

The small and medium enterprises constitute a small portion of that TLCV, but it is in that area that we're finding a material number of new customers. Of course, these are new.

We're also seeing, as we've engaged this group in a more focused manner, that we're able to grow that segment faster than it's been growing in the past and we're optimistic about the outlook for that organization..

Your next question comes from the line of Richard Davis with Canaccord..

Just a little bit more of an open-ended question.

Antonio, what are you -- at a high level or even a granular level, what do you plan to do differently than what your predecessor, Mark, did?.

Well -- I mean, look, I headed a strategy, which I was part of defining and then take into market from an execution standpoint. We've maintained our commitment to that strategy. It's paid off for us in the past.

But as we look forward, certainly we want to make sure that we continue to deliver the growth rate that we have in the past and continue to drive productivity increases out of the organization.

So we're looking at different areas, as I've talked about, our top 350 accounts and the small and medium customer market, there's also a group of mid-tier accounts that are sort of 300 to 400 accounts that, where we believe, perhaps, there's an opportunity there if we also go to market in a more focused manner.

As most of our customers are converted to the aspenONE licensing model, we're going to be focusing in a more stronger way in driving usage and product adoption, and there are some ways that we can do that through digital market and digital engagement, and I think that we have learned actually from our inside sales organization.

So we believe there's still opportunity to drive productivity and growth in different customer segments in our total population of customers..

Your next question comes from the line of Peter Goldmacher with Cowen..

Antonio, Mark, I wanted to ask you a little bit more about your customer base reaction to some of the new products you're building and some of this stuff you've bought and are rolling out.

What do you think are the 2 or 3 things you're doing with these products that are really driving that adoption? So what element of your execution have you guys gotten crisp on that's driving that adoption?.

Yes, I think there are 2 components, Peter. One is our -- the way we are focusing the innovation in our products. So one, we're extending the functionality of our products either through acquisitions or organic development in-house. That is taking cost -- that is expanding the envelope of customers that have access or that need to use our products.

And that's proven to be material. We're seeing the impact of the functionality that we have both acquired and developed in-house on the growth -- on the usage growth of some of our products.

At the same time, I think key to our -- to the product innovation strategy is we're making the functionality from other products in our mainstay products, HYSYS and Aspen Plus, a lot easier to reach, to activate.

So this is where the activation functionality comes into play is in that now, customers can access other products and generate results by clicking an icon on the HYSYS and Aspen Plus, and that's driving incremental token consumption or usage.

So that's on the products and then on the sales organization, I talked about this before, is increasing focus on our top 350 accounts. The inside sales organization for the small and medium enterprises is certainly driving incremental growth.

And I still think there's an opportunity to target in a more focused manner that mid-segment of customers that we have. So all those things are proving to deliver incremental value for our customers and AspenTech..

Your next question comes from the line of Mark Schappel with Benchmark..

Antonio, I was wondering if you could just speak a little bit about your pipeline coverage ratios and whether in your view they are similar to what they were last year at this time?.

Yes. As I've mentioned before, the pipeline coverage ratio is something that we track on a regular basis. It's part of our sales discipline and execution.

On a global basis, the ratios have remained constant as we've grown the business, which is good, but we have also seen an increase of those ratios in some of the regions where we expect faster growth, which is also good. And then if you break it down into a more granular basis by territories, countries and so on, you see different ratios.

But on a global and by our major regions, we have consistent ratios and we're positive about our outlook..

Great. And then, Antonio, over the summer, I recall that [indiscernible] was having an issue with either delayed resigning, I think it was [indiscernible] multi-year term agreements.

And with Colombia back in the news regarding currency issues, I was wondering if the contract is still safe [ph] or do you expect any problems with that particular contract?.

Yes. So we've closed a couple of pieces of that -- of those contracts in Venezuela. There's still one that remains. Our business in Venezuela is done on a U.S. dollar denominated basis, so we're not affected by the currency fluctuations or issues in that country. So -- but we're still working to close the remaining piece of that contract..

Okay, great.

And then just finally, Mark, with respect to the tax rate, what should we think about with respect to a tax rate for the rest of the year?.

Yes, we -- a couple of years ago, we talked about we had pretty high tax rate on the GAAP financials, but it's starting to kind of gravitate into the range that we would expect it to be in, which is just a little over 36%.

Most of our business is in the U.S, We're still not paying cash taxes, but from a book perspective, it's sort of getting normal, if you will, to the 36% range..

The next question comes from the line of Bhavan Suri with William Blair..

It's David Griffin in for Bhavan. Just a couple of quick ones.

First, are you charging for the integration of the assay module in HYSYS or is it more to drive the usage of HYSYS?.

It drives usage of HYSYS. We've got a very specific sort of pricing philosophies on -- with regards to our integration. We see our assay management technology as being of very high value and competitive, but we believe that there's credit value from having the usage come through HYSYS in that case..

Great. That's helpful.

And secondly, can you maybe just give us an update on how things are going in Russia and the Middle Eastern markets in terms of penetration?.

Yes. I mean, Russia is -- there's tremendous white space in Russia. A lot of existing assets with little technology. I couldn't be more pleased with our performance in Russia. And the Middle East, it's been 4 years since we stepped into that region.

We have the momentum that we expected in that region and I'm also very happy with the performance that we're getting out of those 2 regions..

Your next question comes from the line of Sterling Auty with JPMorgan..

I'm curious. Antonio, in your prepared remarks, you made the commentary about you wouldn't be immune from an economic downturn. [indiscernible] stimulus but it feels like we're getting better economic conditions in terms of the manufacturing that came out in Europe are getting better, the U.S. is better.

I'm just curious what's motivating, what was the thought [indiscernible]?.

Sterling, I don't mean to interrupt, but your voice is going away and I had a hard time hearing you.

Are you there?.

Antonio, is that better?.

Yes, much better now..

Okay. Sorry about that. I was saying, in your prepared remarks, Antonio, you mentioned the -- not being immune to an economic downturn, but it feels like the European PMI, even some of the U.K. data, even the GDP out of the U.S., it seems like things feel like they're getting stronger.

I'm just kind of curious what motivated -- why the mention about being -- not being immune to a downturn?.

Well, I mean, look, I think in general, things do feel like they're getting better. Nonetheless, we don't know what could be coming our way and we're careful about the outlook that we take. But we perform at a certain level over the last 2 or 3 years regardless of the economy and when the outlook was worse, but we're just careful.

And we're definitely seeing business slowdown in some of the specific areas. India, for example, the currency exchange rate there have been an issue, but we run a very global business here and on a global basis, we're optimistic about our second half performance..

Is there any direct impact in terms -- we see a lot of headlines in terms of what's happening in China in economic activity and oil, and the energy complex seems to be a big part of their growth and expansion.

How does that region impact your growth in demand, is it direct or indirectly, and what are you seeing?.

Well, I mean, look, China, we've been doing business in China for -- since 1983. We have a good business there. Now the macroeconomic environment in China seems to be less relevant with regards to the industries that we're focused on. China is in a build out of refiners and chemical plants.

I think there's still an important opportunity there for us and we continue, focused on execution..

The last question, with the release of 8.4, is there any additional new functionality besides some of the stuff that we talked about with SolidSim that's only available on the licensed model that could further encourage some of those older legacy, perpetual customers to come in and make that conversion?.

In 8.4, specifically, nothing that I can't recall right now. That was mostly an engineering products release, but I can confirm that later..

At this time, there are no additional questions in the queue..

Great. Well, I want to thank everyone for joining the call today and your interest and attention to AspenTech. And we look forward to talking to you in upcoming calls. Thank you, everyone, and thank you, operator..

Thank you. This concludes today's conference. You may now disconnect..