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

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

Williams - Summit Research Partners, LLC.

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 Third Quarter 2014 Earnings Conference Call. [Operator Instructions] I would now like to turn the call 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 third quarter and our guidance for the fourth quarter and fiscal year before we open it up for Q&A. With that, let me turn the call over to Antonio.

Antonio?.

Thanks, Mark. Thanks to everyone for joining us today. We had a strong third quarter performance that exceeded our guidance on each of our key metrics. We have executed ahead of expectations year-to-date and believe we're well positioned to end fiscal 2014 with a solid performance in the fourth quarter.

The demand environment remains positive across each of our geographies and major verticals, which helped to drive greater than 13% year-over-year growth in total license contract value. From a global macro perspective, we continue to be mindful of the macroeconomic and political backdrop facing our customers.

Specifically, with regards to our key industries, we have not seen any material change in customer-buying patterns around the world. The energy industry continues to benefit from increasing demand in the growth regions of the world.

The chemicals industry is showing a modest recovery from a global perspective, and the engineering and construction industry continues to benefit from the investments around the world by our energy and chemicals customers.

The mission-critical nature of our software, combined with our diverse blue chip customer base and contracts that are typically 5 to 6 years in length, provide some level of protection against short-term changes in the macro environment.

We continue to monitor the macro environment closely and recognize that we would not be immune if there was a material worsening in the global macro outlook. During the third quarter, we saw balanced performance across geographies and key verticals with particularly strong performance from higher growth regions and the inside sales organization.

Once again, energy, chemicals and engineering and construction represented 90% or more of the company's business during the third quarter. Energy was the largest vertical contributor, followed by engineering and construction and chemicals.

Looking at our 10 largest transactions in the quarter, there was again a mix of engineering and manufacturing supply-chain-driven deals, and both suites performed well during the quarter.

There continues to be a substantial opportunity to broaden the usage of aspenONE across our sizable installed base, as most of our customers today are still only using a fraction of the functionality available to them.

An important part of our growth strategy is to continue delivering innovation and expanding the level of functionality available inside aspenONE. During the third quarter, we released version 8.5 of aspenONE software, which included a new version of Process Explorer and Process Explorer Analytics, PIMS Platinum and Petroleum Scheduler.

With the new Process Explorer, customers are able to take the data they collect in our industry-leading data historian and turn it into actionable insight.

The new Process Explorer Analytics capabilities for overall equipment effectiveness will enable customers to improve production, quality and equipment availability, which will drive improved efficiency and lower maintenance downtime.

The latest version of PIMS Platinum is a major step forward for the industry and represents the first-time customers can view their plan and schedule for a refinery side-by-side to assess discrepancies easily and more closely align planning and operations.

Customers will be able to react faster to these discrepancies and explore optionality to make more informed and profitable decisions. Lastly, our Petroleum Scheduling software now includes the pipeline scheduling and dock scheduling software functionality we acquired last year.

With new automated dock scheduling, our customers can now manage shipments, while taking into account berth availability and physical constraints with a clear view of products and storage.

This new version makes it simpler for customers to minimize losses from demurrage, reblending and product downgrades, leading to lower operational costs and higher throughput. This latest release of aspenONE reflects our product development focus on finding ways to drive additional efficiencies for our customers to enhance their profitability.

This release demonstrates our emphasis on developing industry- or vertical-specific visualization and analytic solutions that can create another layer of insight and value for our customers.

We see a significant opportunity to leverage the models, data and information that our industry-leading products generate to provide customers with additional insight into their operations, ultimately extending the value proposition of the aspenONE platform.

In the third quarter, we also acquired the Sulsim sulfur process simulation software from Sulphur Experts. Sulfur recovery is a regulatory mandate for refining and gas processing plants that have high sulfur feedstock.

Sulfur recovery is the latest process in acid gas cleaning, so improving the accuracy of modeling this process is essential to avoid bottlenecks.

By combining Sulsim with the acid gas cleaning modeling capabilities of HYSYS, we can provide customers with a single engineering platform to drive more efficient capital allocation and lower operating costs, while meeting increasingly strict environmental regulations.

This represents our fourth tuck-in acquisition in the past couple of years, which are a low cost way to expand the capabilities available on the aspenONE platform and can drive increased usage of our platform among our customers.

We believe there are opportunities to leverage our existing relationships with the world's largest energy, chemicals and engineering and construction companies through additional tuck-in acquisitions going forward.

While we continue to invest in the business and drive sustained double-digit growth, a core competency for AspenTech is our strong expense discipline. Our third quarter financial results also reflect our strong focus on execution and productivity gains across all functions of the organization.

Our ability to continue to grow the business with moderate expense growth demonstrates the scalability of the business. This combination of a strong business momentum and expense discipline has helped to drive significant improvements in our cash-generating capability.

Year-to-date, we have generated more than $142 million of free cash flow, and we ended the quarter with $275 million of cash on the balance sheet and no debt. We're continuing to deploy this cash flow to generate long-term shareholder value, including $30 million of stock buybacks in the third quarter and $89 million year-to-date.

Today, we also announced that our Board of Directors has authorized the expansion of our stock buyback program to the $200 million level, which is an effective increase of approximately $155 million based on our remaining capacity as of the end of the third quarter.

We will continue to monitor how to best use of our cash flow to enhance shareholder value through a combination of stock buybacks and M&A. I would like to give a quick organizational update.

Chris Dartnell, who we hired several months ago as Senior Vice President of Global Sales, is no longer with Aspen Technology due to unforeseen personal reasons that arose after he joined the company. We have initiated a new search process to find his replacement and expect to have the position filled in the coming months.

I, of course, continue to be actively involved with our sales organization, and we have a strong bench of seasoned sales management executives around the world. Lastly, we will be hosting our Annual Investor Day in Boston on the afternoon of May 15.

This is a great opportunity for investors to get a deeper understanding of the company's financial and operational performance, our key corporate strategies and AspenTech's business outlook. I look forward to seeing many of you there. To summarize, AspenTech delivered strong third quarter results that reflect our market and product leadership.

We are focused on building upon our business momentum 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. Thanks, Antonio. Let me begin by reviewing the supplemental metrics that we provide on a quarterly basis, starting with our term contract value, or TCV metric, which measures the renewal value of our multi-year term contracts.

Growing TCV continues to be a key focus for us, and we increase the value of this metric by adding new customers, expanding product usage and increasing prices across our customer base.

At the end of the third quarter, our license-only TCV, or TLCV, was $1.79 billion, which was up 13.6% compared to the third quarter of fiscal 2013 and up 2.7% on a sequential basis.

Including the value of bundled maintenance, our total term contract value was $2.1 billion at the end of the quarter, which was up 15.4% compared to the third quarter of fiscal 2013 and up 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 $368 million at the end of the third quarter.

This represented an increase of approximately 14.2% on a year-over-year basis and 3.3% sequentially. As we've discussed previously, the growth of our annual spend metric will normally be slightly lower than the growth in our license TCV metric, though there can be some quarter-to-quarter variability.

This is because 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 multi-year time period, whereas annual spend only takes into consideration the current year's level of spend.

However, in the third quarter, annual spend growth exceeded TLCV growth on both the sequential and year-over-year basis. This result was primarily due to the impact of booking several transactions with an average contract duration of 3 years or less, including the renewal of a large contract with a government-owned Venezuelan customer.

As a result, the impact on annual spend growth was proportionately more significant than on TLCV. You may recall that a year ago, when the large Venezuelan contracts were not renewed prior to expiration, we experienced the same type of impact, but in reverse. Now let me turn to our financial results on a GAAP basis.

Total revenue in the third quarter of fiscal 2014 was $103.6 million, up 30.5% from $79.4 million in the prior year period and exceeded the high end of our guidance range by $9.6 million.

Our third quarter revenue includes approximately $7.6 million of revenue related to a significant supply chain arrangement that had been accounted for on a completed-contract basis.

Although we indicated that there was a reasonable probability that we might receive completion sign-off on this arrangement during last quarter's call, we didn't include the associated revenue in our third quarter guidance due to the binary nature of the transaction.

The $7.6 million of recognized revenue consisted of $4.9 million of subscription and software revenue and $2.7 million of services and other revenue. We also recognized $2.3 million of previously deferred expenses related to this transaction. There's no corresponding cash flow pickup associated with this transaction.

The cash flow was received in prior periods. Looking at revenue by line item. Subscription and software revenue was $91.3 million for the third quarter, which is an increase from $70 million in the prior year period and $88.9 million last quarter.

Our growing subscription business positively impacts our deferred revenue balance, which was $249.6 million at the end of the third quarter, representing a 15.6% increase compared to the end of the year-ago period. On a sequential basis, deferred revenue increased $24.9 million.

These results are net of the impact of recognizing the revenue from the completed contract, which reduced deferred revenue by $7.6 million in the third quarter. Services and other revenue was $12.3 million compared to $9.4 million in the year-ago period and $9.8 million last quarter. Moving down the P&L.

Gross profit was $88.3 million in the quarter with a gross margin of 85%, which compares to $66.7 million and a gross margin of 84% in the prior year period. Operating expenses for the quarter were $56.9 million, up from $50.4 million in the year-ago period.

Total GAAP expenses, including cost of revenue, were $72.2 million, which was up from $63 million in the year-ago period. Our third quarter GAAP results include approximately $4.9 million of incremental expense related to the purchase price of the Sulsim assets we acquired, as discussed earlier by Antonio.

Since this was an asset acquisition, and it's our intention to modify and enhance the product prior to making it commercially available to our customers, the accounting rules related to capitalized software require us to expense the entire purchase price in the period.

The $4.9 million is considered an operating expense and is included in research and development in our GAAP income statement.

Since the $4.9 million is onetime in nature, and we don't believe that expensing the acquired assets is an accurate representation of the true economics of the transaction, we have excluded the impact of this accounting treatment from our non-GAAP results, consistent with our other acquisitions where the technology intangibles were capitalized.

Operating income was $31.4 million for the third quarter of fiscal 2014, an improvement compared to operating income of $16.3 million in the year-ago period. Net income for the quarter was $20.8 million or $0.22 per share compared to net income of $10.5 million or $0.11 per share in the third quarter of fiscal 2013. Turning to non-GAAP results.

Excluding the impact of stock-based compensation expense, restructuring charges, amortization of intangibles associated with acquisitions and non-capitalized acquired technology, we reported non-GAAP operating income for the third quarter of $40 million and non-GAAP net income of $26.4 million.

This represents an improvement from our non-GAAP operating and net income of $20 million and $12.9 million, respectively, in the year-ago period.

Our non-GAAP income per share was $0.28 in the third quarter of fiscal 2014 based on $93.4 million diluted shares outstanding compared to non-GAAP earnings per share of $0.14 based on $95.4 million diluted shares outstanding in the third quarter of fiscal 2013. Turning to the balance sheet and cash flow.

The company ended the third quarter with $274.9 million of cash and marketable securities, an increase of $39.2 million from the end of last quarter. From a cash flow perspective, the company generated $69.6 million of cash from operations during the third quarter.

On a non-GAAP basis, operating cash flow was $73.5 million and free cash flow was $72.5 million. Both of these figures exclude the $3.9 million cash payment related to the Sulsim asset acquisition. During the third quarter, $30 million was used to repurchase our common stock.

As a reminder, there was no cash flow associated with the deferred revenue recognized from the supply chain transaction referenced earlier, as the net cash flow from this project had been received in prior periods. 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 guidance. I'd like to close with thoughts regarding our financial outlook for fiscal 2014, as well as the fourth 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 respect to the P&L, we are raising our fiscal 2014 revenue guidance to approximately $385 million to $387 million, which is above our prior guidance of $372 million to $378 million.

From an expense perspective, we now expect total GAAP cost and expenses, $264 million to $267 million, which is within the range of our prior guidance of $262 million to $267 million.

Note that this updated GAAP expense guidance includes the $4.9 million expense related to the Sulsim asset acquisition and the $2.3 million of expense recognized due to the completed contract. We now expect GAAP operating income of approximately $119 million to $121 million, net income of $75 million to $77 million and GAAP EPS of $0.80 to $0.82.

This compares to our prior guidance of GAAP operating income 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.

From a non-GAAP perspective, we now expect non-GAAP operating income in the range of $138 million to $141 million, which is up from our prior guidance of $120 million to $126 million for fiscal 2014.

This would lead to non-GAAP earnings per share in the range of $0.94 to $0.96, which is an increase from our prior guidance of $0.80 to $0.84 for the fiscal year. With respect to total license contract value growth, we are increasing our fiscal 2014 growth target to 11% or better, up from our prior guidance for double-digit annual growth.

We have delivered strong growth through the first 3 quarters of fiscal 2014 and see a solid pipeline of opportunities for the fourth quarter as well. From a free cash flow perspective, we are increasing our fiscal 2014 guidance to a range of $170 million to $175 million.

Our previous guidance was in the range of $165 million to $170 million of free cash flow. Consistent with our treatment in our third quarter results, we have excluded the financial impact of acquiring the Sulsim assets from our non-GAAP earnings and free cash flow guidance.

As we've noted in prior years, our quarterly cash flow has a significant degree of variability due to the timing of cash collections. And once again, we will have significant amount of customer payments that come due at the very end of our fiscal year, which increases the variability for the fourth quarter.

Looking at the fourth quarter, we expect revenue in the range of $94 million to $97 million, non-GAAP operating income of $30 million to $32 million and non-GAAP EPS of $0.19 to $0.21. On a GAAP basis, we expect fourth quarter operating income of $27 million to $29 million and EPS of $0.18 to $0.19.

It's important to note, on a sequential basis, the $7.6 million of deferred revenue recognized in the third quarter was onetime in nature and will not flow through into the fourth quarter.

In summary, we're pleased to report solid third quarter results that underscore the positive business momentum we are seeing in the market and the continued improvements in the company's profitability and cash flow generation capabilities.

We believe we are well positioned to continue this solid performance in the fourth quarter and meet our increased targets for TLCV growth, profitability and free cash flow guidance for FY '14. 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 Peter Goldmacher with Cowen..

Can you help us understand a little bit better where the upside came from? You have a lot of initiatives going on at the company now that are newish. You have the internal selling efforts. You've got these new products -- the new acquired products. You're making a bigger effort to go-to-market in some of the supply chain areas.

Where did the upside come from?.

Peter. This is Antonio. Probably, look, I don't think you can point to anything specifically as far as upside. We had a strong performance across all regions in the world. Certainly, we have our so-called high-growth regions that I've mentioned before that performed very well. Our inside sales organization performed very well.

We're starting to see the impact from some of the innovation that we've released in the last couple of years. And in general, it's just very balanced performance. The share of engineering and manufacturing and supply chain products was consistent to past quarters.

And so overall, it was a very balanced quarter, and there wasn't anything obvious that you can pinpoint as an upside..

Your next question comes from Sterling Auty with JPMorgan..

I apologize. I hopped on a little bit late, but I wanted to make sure that I understood.

So the $7.6 million deferred revenue release, that was related to that retail contract, correct?.

Yes. It's the contract we mentioned on the call last quarter that was a combination of a perpetual license and some services that were deferred until completion, so yes..

And remind us, you didn't include that in your guidance, correct?.

No. We didn't include it because, again, it was sort of a binary decision. It was either all going to get recognized or not. It was dependent on completing -- getting a sign-off on the project. It wasn't 100% certain, but we felt reasonably confident. But we did exclude it from our guidance..

Okay. So if I look at -- relative to expectations, you had $103.6 million. If you back out the $7.6 million, that kind of puts you around $96 million, so still nice upside.

Kind of echoing on the last question, looking at -- I think you had, what, just over 14% growth in your annual spend, can you talk to either geographically or vertical where you saw maybe the pickup?.

Well, as I mentioned to Peter, look, it was very balanced performance. We do see faster growth out of places like Russia, the Middle East, Latin America, but that's from a smaller base. But our sort of mature regions, North America, Europe, Asia, they all performed well and balanced. So you cannot pinpoint to anything specific.

As Mark mentioned in his remarks, we did close a contract in Venezuela that provided some acceleration of the annual spend because of the duration of that contract. But otherwise, it was very balanced performance across the world..

Okay. And since you brought up Russia, can you kind of go through any insights? Are you seeing any impact on that business? I believe that's still a relatively small area for you in the grand scheme.

But can you maybe give us some context there?.

Yes. I mean, Russia is not material in the context of our global business, but we do have a nicely growing business there. We haven't seen any impact from the ongoing issues around Ukraine. And hopefully, it will continue to be that way, no impact there, whatsoever..

Okay. And then last question on the expense side.

As it relates to headcount, any change to the headcount plan here for the full year relative to what you were originally thinking?.

No, not really, not through the end of FY '14. Of course, now we are into the planning process for FY '15, and we're looking at where we need to make investments. And as I've said in the past, certainly, our inside sales organization is an area of focus for us as far as investments, but also some of these faster growing regions where we see upside.

But otherwise, as I noted in my remarks, we're always looking for ways to drive productivity gains out of the business..

And maybe just slip one last one in there. Just over the last several years, usually, you would give us the next year guidance either on this call or at the Analyst Day.

Where -- what should we be thinking on that front?.

Yes. We'll get into that at Analyst Day, which is in just a couple weeks on May 15..

Your next question comes from Richard Davis with Canaccord..

How would you describe the -- your kind of mid-market inside sales effort in terms of where it is in terms of filling out and development? Are we all the way filled out and now you're just kind of growing it? Or are you still net hiring people, et cetera? So just kind of give us a sense on that..

Yes. No, look, we continue to -- we're now almost 2.5 years into this process. Certainly, it's now a stable organization in the areas that we're focusing on. But there's still opportunity to expand the scope of that organization, both across verticals and on the size of deals that they can handle.

So we'll probably continue to invest additional headcount in our small and medium customer segment..

Your next question comes from Brendan Barnicle with Pacific Crest Securities..

Antonio, you mentioned the sales change, and I was wondering if there have been any other reorganizations that you've looked at doing or changes you've been implementing now that you been at the helm there for a good 6, 9 months?.

No. Look, I think, certainly, it was an unfortunate development with Chris Dartnell. And while I'm back running the sales organization, and I'm pretty familiar with that role, we're instituting, certainly, incremental changes and enhancements in our marketing organization to drive increased focus around digital marketing.

Certainly, we want to get better at user segmentation and maybe some market analysis to understand better how we need to reach our customers in a much more efficient manner, especially through digital channels. And -- but otherwise, it is the same group of people driving the performance of the business..

And Antonio, you mentioned aspenONE and just that customers are only using a fraction of the functionality there.

Can you give us anything more specific? I mean, what percent of the installed base is now on aspenONE? And then within customers, generally, what percent of the functionality do you see them using right now?.

Yes. Look, we -- I think we've mentioned this before. Over 90% of our customers are now -- on a dollar basis, are now on the aspenONE licensing model. The penetration of customers varies by geography, by type of customer, by the size of customers.

And so it's hard to characterize the penetration in any single way, except that more than 90% of them are already in the aspenONE licensing model. And this is an area that we'll try to expand a little bit on during the Investor Day in 2 weeks..

Great. And then one last one. One of the verticals that had been newer a couple years ago was pharma, and I wondering if there's anything new on the pharma side lately..

Pfizer, AstraZeneca, Merck, Sanofi-Aventis, you name it. But it is an industry that is not necessarily focused on optimization, which is the core of what we do. It's much more focused on measurement and tracking, and we deliver that through our MES solutions. But there's a lot less opportunity to optimize in the pharmaceutical industry.

So we see it as a good industry, but it's not going to support our long-term growth goals here in the company..

Your next question comes from Mark Schappel with Benchmark Company..

Mark, I was wondering if you could just run through the accounting of the Sulsim transaction again..

one, was a cash flow impact, $3.9 million; the other was an expense impact, $4.9 million. So hopefully that makes some sense, but that was -- it was treated like internal capitalization because of the nature of the way we're going to use it..

Your next question comes from Richard Williams with Summit Research..

Could you give any kind of color geographically on conditions? How they might be changing?.

Rich, look, we don't -- of course, where we sit, we don't see anything that's coming at us in any of the regions that would dramatically change our outlook -- performance outlook in the different regions around the world. We operate in very strong industries today. The world continues to demand energy.

Chemicals are a necessity for every day life, and engineering, construction companies benefit from building all these assets for the energy and chemical companies. And certainly, we do expect stronger growth out of places like the Middle East because of all the investment that's going there, certain parts in Asia and Latin America. But the U.S.

is also enjoying a renaissance in the chemicals industry, which is driving a lot of build-out, and there are parts in Europe such as Russia where we also see good possibility. So overall, we're positive about the outlook, but we're also cognizant that situations like the one in Ukraine could change that outlook very quickly..

How about in Venezuela? Do you expect to do more business there?.

Well, look, certainly, Venezuela is a lot about 1 customer, the national oil company down there, PDVSA. They have been an AspenTech customer for, I would say, over 25, 30 years. We have a good business with them, and we've managed to now recover all the business that didn't get renewed 12 months ago.

And our expectation is that we'll continue to grow that business as time goes on, but we just closed a transaction with them, so....

Okay.

And how big is Ukraine as a percentage of revenues?.

Ukraine is -- Ukraine, as business coming out of Ukraine, is meaningless. It's very little..

There are no further questions at this time. I would like to turn it back over to Antonio Pietri for closing remarks..

Well, again, I want to thank everyone for joining us today, and we look forward to seeing you on some of the promotional activities that we have in the coming weeks. And we look forward to the next call. Thank you..

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