Karl E. Johnsen - Aspen Technology, Inc. Antonio J. Pietri - Aspen Technology, Inc..

Matthew Charles Pfau - William Blair & Co. LLC Monika Garg - Pacific Crest David E. Hynes - Canaccord Genuity, Inc. Mark W. Schappel - The Benchmark Co. LLC.

Good afternoon. My name is Namdi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Aspen Technology Third Quarter 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.

Karl Johnsen, CFO, you may begin your conference..

Thank you. Good afternoon, everyone. Thank you for joining us to review our third quarter fiscal 2017 for the period ending March 31, 2017. I'm Karl Johnsen, CFO of AspenTech, and with me on the call today is Antonio Pietri, President and CEO.

Before we begin, I will make the usual Safe Harbor statement that during the course of this call, we may make projections and other forward-looking statements about the financial performance of the company that involve risks and uncertainties. The company's actual results may differ materially from such projections or statements.

Factors that might cause such differences include, but are not limited to, those discussed in today's call and in our Form 10-Q for the third quarter fiscal year 2017, which is now on file with the SEC. Also, please note that the following information is related to our current business conditions and our outlook as of today, May 2, 2017.

Consistent with our prior practice, we expressly disclaim any obligation to update this information. The structure of today's call will be as follows.

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, as well as our updated outlook for fiscal year 2017 before we open the call up for Q&A.

Antonio?.

one, creating the ability to offer RAM studies to their customers proactively; two, making available to project teams, an effective means of review and scope of deliverables and ensuring competitive bids and three, maintaining client engagement through both the CapEx and OpEx investment cycles.

Third, our global chemical customer decided to expand their use of Mtell's machine learning capabilities in one of their largest U.S. site, and expects to rollout the Mtell product to all their chemical sites in the United States.

This decision was based on the long-term success of the Mtell technology coupled with AspenTech's technical and financial capacity.

Finally, a Latin American producer of chemicals that was a first customer in the region to implement our DMC3 technology in its chemical operations, is expanding the use of DMC3 based on the incremental value captured from it, and the reduction in time and resources to implement it.

While we're making investments to extend AspenTech's reach into new markets and product areas, we continue to run the business with a focus on expense discipline. We believe our ability to make incremental investments for growth while maintaining the strong levels of profitability is a core component of our business model.

As Karl will detail later, our strong year-to-date profitability performance enables us to raise our fiscal 2017 non-GAAP operating income. Our substantial free cash flow is a strategic asset for the company that we continue to deploy in ways that deliver value for shareholders.

In the third quarter, we returned another $100 million to shareholders by repurchasing 1.7 million shares. Our buyback program, which has been in place since 2011 hit a milestone during the quarter, as we have now returned more than $1 billion to shareholders since the plan's inception.

It is our intention to continue to buy back shares as long as market and business conditions are favorable. Before I turn the call over to Karl, I wanted to provide an update on our Executive Management team.

Effective July 1, we're promoting Michele Triponey, currently AspenTech's Senior Vice President of Customer Success to Executive Vice President of Field Operations. In this role, Michele will be responsible for overseeing all global sales and services.

Michele has been a valued member of the AspenTech team since 2005 and has a deep understanding of our customers, the industries we serve and the value our products deliver for customers every day.

Michele and I have worked closely together since 2010, as she took on increasing levels of responsibility within our global sales and services organization. I look forward to partnering with Michele in her new role and believe her experience will enhance the company's ability to execute on our growth initiatives in this environment.

Bill Griffin, who has served as Executive Vice President of Field Operations since January of 2016 has left the company in order to pursue other opportunities. I like to thank Bill for his efforts at AspenTech and wish him well in the future.

In summary, AspenTech continues to deliver positive growth and significant profitability in a challenging spending environment. We're focused on using our financial strength to extend our product portfolio and market leadership to better position the company for faster growth.

Customer reaction to our product innovation has been terrific and we continue to be optimistic about the long-term prospects for the company. With that, let me turn the call over to Karl..

Thanks, Antonio. I will now review our financial results for the third quarter of fiscal 2017 beginning with the annual spend.

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 $452 million at the end of the quarter, which is an increase of 4.9% on a year-over-year basis and 0.3% sequentially.

Let me now turn to our quarterly financial results beginning on a GAAP basis. Total revenue of $119.3 million was consistent with a $119.2 million in the prior year period and was above the high-end of our guidance range of a $116 million to $118 million.

As a reminder, in the third quarter of 2016, we recognized $3.9 million of non-recurring subscription and software revenue. Breaking this down further, subscription and software revenue was a $111.7 million for the third quarter, which is consistent with a $111.7 million in the prior year period and compares to a $112.9 million last quarter.

When looking at sequential comparisons, remember that we recognized subscription revenue on a daily basis and the third quarter has two fewer days than the second quarter, which equates to approximately a $2.5 million sequential decline.

Services and other revenue was $7.6 million compared to $7.5 million in the year ago period and $7 million last quarter. The timing of services revenue can fluctuate between periods based on customer demand. Turning to profitability.

Gross profit was $107 million in the quarter, with a gross margin of 90%, which compares to a $107.2 million and gross margin of 90% in the year ago period. Operating expenses for the quarter were $54.7 million compared to $56.5 million in the prior year period.

Total GAAP expenses, including cost of revenue were $67 million, down from $68.5 million in the year ago period and up from $63.9 million last quarter. As a reminder, in the third quarter of fiscal 2016, we had approximately $4.2 million of acquisition-related expenses.

Operating income was $52.3 million for the third quarter fiscal 2017, representing an operating margin of 44%, which is an increase compared to $50.7 million or 43% operating margin in the prior year period.

Net income for the quarter was $35.8 million or $0.47 per share compared to net income of $33.2 million or $0.40 per share in the third quarter fiscal 2016. Turning to our non-GAAP results.

Excluding the impact of stock-based compensation expense, amortization of intangibles associated with acquisition, acquisition-related expenses and non-capitalized acquired technology, we reported non-GAAP operating income for the third quarter of $57.4 million, representing a 48% non-GAAP operating margin compared to a non-GAAP operating income and margin of $59.3 million and 50% respectively in the year-ago period.

Non-GAAP net income was $39.4 million or $0.52 of non-GAAP EPS in the third quarter of fiscal 2017 based on 76.2 million shares outstanding compared to non-GAAP net income of $40.9 million or $0.49 of non-GAAP EPS in the third quarter of fiscal 2016 based on 83.4 million shares outstanding. Turning to the balance sheet and cash flow.

We ended the third quarter with $101.7 million in cash and marketable securities, a decrease of $38.3 million from the end of last quarter. During the third quarter we repurchased 1.7 million shares for $100 million under our stock-repurchase program.

Through the first three quarters of fiscal 2017, we have returned 6 million shares or $300 million to shareholders, demonstrating our commitment to enhancing shareholder value through our capital allocation strategy.

Our deferred revenue balance was $268.5 million at the end of the third quarter, representing a 1% increase compared to the end of the year ago period and 11% increase on a sequential basis.

As a reminder, our deferred revenue balance is heavily influenced by the timing of invoices and over the course of the year, we expect deferred revenue growth to generally be in line with the underlying growth in the business. However, there can be some quarter-to-quarter variability.

From a cash flow perspective, we generated $55.6 million of cash from operations during the third quarter and $56.2 million of free cash flow after taking into consideration the net impact of capital expenditures, capitalized software and excess tax benefits from stock-based compensation and acquisition-related expenses.

A reconciliation of GAAP to non-GAAP results is provided in the tables within our press release, which is also available on our website. I'd now like to close with thoughts regarding our updated financial outlook for fiscal 2017 as well as guidance for the fourth quarter.

For the fourth quarter, we expect revenue in the range of $118 million to $120 million. Non-GAAP operating income of $51 million to $53 million and non-GAAP EPS of $0.42 per share to $0.44 per share. On a GAAP basis, we expect fourth quarter operating income of $46 million to $48 million and EPS of $0.38 per share to $0.40 per share.

Turning to the full year, we're raising our revenue guidance and now expect revenue to be in the range of $477 million to $479 million, which compares to our previous guidance of $473 million to $477 million.

From a mix perspective, we continue to expect subscription software to comprise greater than 90% of revenue, with our services and other revenue representing the remainder.

From an expense perspective, we're adjusting our assumption for total GAAP costs and expenses to $268 million to $270 million, which compares to our previous guidance of approximately $270 million to $273 million.

We expect GAAP operating income in the range of $209 million to $211 million, net income in the range of $137 million to $138 million and GAAP EPS of $1.76 per share to $1.78 per share.

This compares to our previous guidance of GAAP operating income of $201 million to $206 million, net income of $127 million to $131 million and GAAP EPS of $1.63 per share to $1.67 per share.

From a non-GAAP perspective, we now expect non-GAAP operating income in the range of $230 million to $232 million, which is up from our previous guidance of $218 million to $224 million for the full year fiscal 2017.

This would lead to non-GAAP earnings per share in the range of $1.93 per share to $1.95 per share, which is an increase from our previous guidance of $1.79 per share to $1.83 per share for the fiscal year. With respect to annual spend, as Antonio mentioned, we expect to deliver full year growth towards the lower end of our 3% to 6% guidance range.

In terms of free cash flow, we are reiterating our free cash flow guidance of a $165 million to a $170 million for the year. In summary, AspenTech's third quarter performance demonstrates our ability to deliver positive growth, and strong earnings and cash flow in a difficult environment.

At the same time, we're making significant progress on a strategic priority that we believe will deliver long-term growth and additional shareholder value. With that, we are now happy to take your questions. Operator, let's begin the Q&A..

Your first question comes from the line of Matt Pfau..

Hey guys, thanks for taking my questions. Antonio....

Hi, Matt.

Hey, just wanted to start out with digging in a little bit to the preview you gave for fiscal 2018, and with respect to the APM suite potentially helping accelerate revenue growth.

So it sounds like in terms of the pressure you've seen in 2017, some of it has been on the E&C side, but then also a bit on the MSC suite as well in terms of not as many large deals or maybe more work in terms of getting some of those deals pushed across.

But maybe you can parse out the difference of getting these APM deals across versus maybe some of the issues that you have seen with some of these MSC deals?.

Well, I mean look, I won't get into specifics of deals, what I will say though is certainly we did close a handful of APM-related deals, both with reliability analysis software and machine learning and we're happy about that. We're also very excited about the reaction that we got at OPTIMIZE last week from our customers.

With regards to our engineering and MSC business, in general, what I'll tell you is look I think over the last two years in order for us to deliver the performance that we have delivered both financial performance and growth performance, it has required tremendous focus on our details, both on how we manage the business and how we execute in our sales organization.

And in Q3, we hit a bump in the road with respect to our sales execution, but I don't expect that that will be the case going forward so..

Got it, okay. And then wanted to touch on the guidance a little bit Karl.

I'm trying to parse out the difference between revenue guidance going up for the year and then being more towards the lower end of the annual spend guidance, what's sort of the difference there between the two?.

So, it's really just the timing of how the annual spend comes in during the year. And for this, our revenue for the year is already baked because of the annual spend that we close in Q4 won't have an impact to revenue until Q1.

So, it's a little bit of seeing that, also we've talked in couple other calls, we've accelerated a little bit of the cash basis revenue, and we've seen that come in and it's been a little bit of a benefit for that..

Okay, got it.

And then in terms of the reduction in the expense guidance, any changes there in terms of spending plans or hiring plans that is impacting that guidance?.

I mean a little bit of it is, just in Q3, we're a little bit behind the expenses due to hiring which you can't make that up, because some people got hired later in the quarter and some got pushed to Q4. So, it's a little bit of that.

It's not a change in the investment strategy of how we're deploying it, it's just a little bit of timing and then it's also how we see the people coming in and those investments being made in Q4 being pushed a little bit. So, not a change in the strategy of how we're investing, but maybe a little bit more in kind of the timing piece of it..

Got it. Okay. I'll pass it along. Thanks for taking my questions guys..

Thank you..

Your next question comes from the line of Monika Garg..

Hi, Monika..

Hi, Antonio. Thanks for your time. Thanks for taking the questions. First is, we have seen some improvement in oil prices end markets right, but not really improvement in the annual spend and especially the way you're guiding for the year would be modestly lower annual spend growth year-over-year.

Maybe could you talk about what we need to see to pick up in the annual spend from here and maybe touch upon kind of the sales execution in Q3 what you little bit talked about?.

Okay. Well, I mean look, as probably you have seen, oil companies are reporting increased earnings in the last week or so, and that's as a result of oil being around $50 a barrel for the past few months.

Now in those same articles what you hear and I attended CERAWeek in Houston in early March and heard it directly from the CEOs of these oil companies that attended that conference, and that they are also very focused on expense management, cost controls and running their businesses very lean.

The CEO of TOTAL was very proud of having become the most profitable oil company in the last quarter, and there was a lot of bragging around that. So, there was a lot of bragging about their ability to produce oil profitably at $50 a barrel, which emphasizes the point on expense management and control, and just in general bill tightening.

But very little announcements about new projects in upstream, which is really where the CapEx investment starts being generated. I've also read an article in the Wall Street Journal, where they talked about the five largest western oil companies taking on $214 billion of debt over the last two years, three years to finance their dividends.

So, I think, some of this profitability ends up going to address or delever those companies, and just in general builder cash portfolios.

What do I think is going to take for CapEx spend and eventually annual spend to grow in the engineering business, I think it's for the oil supply and demand balance to get more skewed towards higher demand and supply or the supply shrinking to a level where it signals to oil companies that if they're going to invest in new projects, there's going to be a market for that oil.

Of course the dynamic right now at $50 is shale producers getting back into the game, because they are the most profitable operators and they are driving oil production, and therefore mitigating the rise in the oil price and that's why you see oil prices bouncing between $45 a barrel and $55 a barrel.

And there's also an opinion that, that will continue for longer, but I think it's about the supply and demand balance coming much more into balance, and a signal to oil producers that they can go ahead and invest in this bigger projects. When that will happen, if I had that answer for you, I'd probably make a lot of money..

Thanks.

Then you talked about 15% of pipeline is in APM, how to think about pipeline translation to revenue? What I'm trying to understand is, is your pipeline like 12 months of revenue or a year of annual spend, so kind of to gauge quantitatively the 15% of pipeline in the APM?.

Well, I won't talk about the specific, but we do look at our 5-quarter pipeline as a metric that we've always tracked here, even before I became CEO, as a Head of Field Operations is a metric that I used to track.

And that metric is – the pipeline is in line with the metric, our historical performance is bounced up and down a little bit over the 6 months to 18 months.

But it's also the velocity of conversion of that pipeline, and that sometimes what we experience in Q3 and not only our largest transaction for the quarter moved out of the quarter, but also a number of other deals.

And I think there's a combination of factors, but certainly I don't like to make excuses and we're here to deliver outcomes and sales execution is what we focus on. So we'll correct that going forward and get back on a more healthy growth path..

Got it.

Then Karl, you announced an acquisition of rights to OTS software in April, so is there any revenue you are baking in for the FQ4 guidance from this deal?.

No, so the deal was really to just acquiring rights to technology, so it didn't come with customers or contracts or anything else, just literally buying the technology..

All right.

And just the last one, deferred revenue growth year-over-year was just kind of modestly up 1.5%, maybe could you walk through that or is it kind of just a factor of annual spend growth?.

No, it's a factor of two different things.

The first is when you look at the deferred revenue, we give the whole amount, but you really need to focus on just the current, the long-term is a kind of a hangover for some single-pays and some OPS deals that were linked to licenses that are just kind of amortizing down, so if you look at the long-term deferred revenue, you see that kind of coming down ratably over time.

So when you look at just the current piece, it had an increase of about – I think it was around 3%, Q3 over Q3, which is more in line with what you'd expect.

But the second piece that influenced it was, we had a couple of large renewals at the end of quarter that closed in Q3, but because of the payment didn't do until the next quarter, because they get 30 days, what ends up happening is it comes out of what normally would have been in deferred revenue and it doesn't go back in until Q4.

And if you kind of factor those and you'd be more at that 5% or 6%, 6.5% year-over-year growth in deferred..

Got it. Thank you, so much..

Yeah..

Your next question come from the line of David Hynes..

Thanks guys. So, maybe we could start with annual spend attrition.

And I know it's a metric that you share only annually, but can you give us an update on how that's tracking at least relative to what we saw last year? I think last year you said it was 6%, I mean is it going to be more or less in line or we're going to see an uptick in attrition, what should we expect when Q4 comes around?.

Well, I think that's what we've mentioned. We haven't been able to make inroads into that attrition rate that is basically mostly driven by the E&C business. We've put in place initiatives in fiscal 2017 at the beginning of the year to see if we could mitigate that attrition rate of 6% last year.

And what we're finding is, as I mentioned in my notes or in my script that the dynamic is one where these customers have right sized their businesses to a number of engineering personnel head count. There is a certain amount of entitlement that they need for our software to match that head count, and that's what the discussions end up being.

Certainly there has been some cases where we've been successful expanding usage of the products, but what we're finding like with the oil companies, there is a strong focus on cost control and expense management and that's what's coming through..

Yeah, okay. And then moving on I guess to the sales head transition, maybe some color, kind of when did this happened how extensive of a search did you guys go through? I mean you're putting somebody with largely a services background at the head of your sales team when you guys are embarking on a pretty major new effort with APM.

So curious, the thought process behind that and any additional color you could share on – Michele and how you're thinking about that team?.

Yeah, certainly. Look, I won't talk about the specifics of when Bill departed the company or the reasons for it, but as an Executive Officer of the company, we have certain requirements to report and that probably will give you the answer.

With respect to Michele, look Michele has been a member of not only my executive team as CEO, but my predecessor's executive team as well. She is also the executive sponsor for some of our large accounts in the company and she engages with customers on a regular basis.

In her role as a SVP of Customer Success, she has to understand and drive her organization to engage with customers in order to make sure our products are being implemented, the adoption of those products implemented is sustained and in general provide support, in addition to just being exposed on a daily basis to our sales organization.

So I have no concerns whatsoever with Michele's capabilities and experience to step up into that role.

Especially in the context of the environment that we're dealing with and that it is an environment that requires a strong focus on execution and that really means a strong focus on details, a strong knowledge of our products, a strong institutional knowledge, understanding of our customers, our customers deploy our products and how they get value from those products.

So if you look at the current environment and you look at Michele's experience, capability, skills and qualifications, I think Michele is actually a perfect fit for this environment. We did not conduct a search. I was happy to select Michele to step into the role. She has worked for me for about seven years. I know her very well.

She is a grinder and I know she'll come in and play that role. In addition, I will partner with her to make sure that not only she is successful, but the company is successful going forward. So....

Yeah..

...I'm very happy for Michele. She deserves a promotion. She was the best qualified person for that job considering what the company is going through.

And with respect to APM, Michele has been involved in our APM strategy helping put words to the strategy, involved with some of the acquisitions and in the overall process, including setting up a professional services team, customer support and so on. So she will have no problem.

There's also other decisions and actions that we're taking around our APM business that we'll ensure that's a business that will launch and taken care of so. Hope that answers your question DJ..

No, that does. And look forward to engaging with her at the Analyst Day here coming up. Maybe one last question for Karl, free cash flow. Typically there's some pretty big seasonality, right.

I mean, I look back to my model, which goes back to like 2008, 2009 and Q3 has always been kind of the highest free cash flow quarter of the year, sometimes quite noticeably. And to get to the midpoint of your reiterated guidance implies that Q4 cash flow is actually going to be better than Q3.

So is there something unusual going on this year, why is it different than the previous, whatever it is seven or eight years?.

Yeah. So, we feel comfortable about the guidance and we're on track for hitting it. What really happened in Q3, DJ, was for our international customers we need to get a certificate from the IRS beginning of each calendar year, and this year the IRS was about four weeks to six weeks behind in schedule and getting those out.

And so, by the time we got them to our customers, it delayed them paying us. So we pushed off – probably about $8 million to $10 million got pushed off out of the quarter into Q4. I think we've gotten almost all of it by this third week of April. So, we're back on track. It was really just the IRS slow, because they had a hiring freeze in the service.

So, they just got backlogged in getting us certificates, but not that it will impact the year-to-date or the full year..

Okay. That makes sense. Okay, great. Thanks for all the color guys..

Thank you..

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

Hi, Mark..

Hey, hi. Good evening. Thanks for taking my question. Just one question here, I want to come back to Karl. And Karl, I'd like you to go back to an earlier question regarding the annual spend.

And could you just go through one more time the divergence between the lower than expected annual spend and the higher revenue guide?.

Sure. So, the easy way to look at it, if you look at our year-to-date results and then you can walk forward from that for the Q4 revenue to get to the kind of the full year guide.

And what you do is we're going to have to pick up a day of revenue in the fourth quarter, which is probably about $1.2 million, $1.3 million and then you get the annual spend from Q3 that comes in. So, that's the easy way to do the math to get there and then you kind of get a little bit of fluctuation around the services revenue.

But the overarching view is that, it's how the annual spend comes in during the year. So, if annual spend comes in closer to the front of the year, you get more of that revenue throughout the year. If it's spread towards the back-end, you get less of it.

So, it's a little bit of the timing of where we were at the beginning – our initial viewpoint at the beginning of the year when we were looking at forecasting revenue, annual spend has come in a little differently.

And then the last piece is really, we got a little bit of a benefit from cash basis, customers may have a little bit of good viewpoint into those in the fourth quarter that kind of rounds out the answer to that. So, it's really those three legs to the stool..

Thank you. That's helpful..

There are no further audio questions at this time. I'll now turn the call back over to Antonio..

Thank you, Natalie (sic) [Namdi] (47:15). And thank you everyone for joining the call today. Look forward to seeing most of you and the others, since we're going to be attending a few investor conferences this next two months. So, thank you and we will see you around..

That does conclude today's conference call, you may now disconnect..