Aspen Technology, Inc. (NASDAQ:AZPN) Q3 2023 Earnings Call Transcript
Aspen Technology, Inc. (NASDAQ:AZPN) Q3 2023 Earnings Call Transcript April 26, 2023
Aspen Technology, Inc. misses on earnings expectations. Reported EPS is $1.06 EPS, expectations were $1.74.
Operator: Thank you for standing by, and welcome to the Third Quarter 2023 Aspen Technology Earnings Conference Call. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Brian Denyeau, ICR. Please go ahead, sir.
Brian Denyeau : Thank you. Good afternoon, everyone, and thank you for joining us to discuss our financial results for the third quarter of fiscal 2023 ending March 31, 2023. With me on the call today are Antonio Pietri, AspenTech's President and CEO; and Chantelle Breithaupt, AspenTech's CFO. Before we begin, I will make the safe harbor statement that during the course of this call, we may make projections or 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 as well as those contained in our periodic reports with the SEC, including our most recently filed Form 10-K with the SEC.
Although please note the following information relates to our current business conditions and our outlook as of today, April 26, 2023. Consistent with our prior practice, we expressly disclaim any obligation to update this information. Please note that we have posted our financial update presentation on the Investor Relations portion of our website. The structure of today's call will be as follows: Antonio will discuss business results of highlights from the third quarter. Chantelle will review our quarterly financials and guidance for the remainder of fiscal year 2023. With that, let me turn the call over to Antonio. Antonio?
Antonio Pietri: Thanks, Brian, and thanks to all of you for joining us today. AspenTech's third quarter performance was solid despite an uncertain macro environment, with strong demand in many of our end markets and a return to double-digit ACV growth. While we did see the macro environment have a more pronounced impact on sales during the quarter. Primarily in chemicals, we're glad to be reporting double-digit growth for the last 12 months and are on track to deliver against our initial guidance range for the full year. As we noted last quarter, chemical customers have been reporting weakness in the demand environment starting in their September calendar quarter with the drop in demand being significant in the December quarter as reported in the related earnings announcements.
As a result of these dynamics, we believe the calendar year 2023 budgets reflect tighter OpEx budgets which resulted in a material pullback on software spending in the quarter for AspenTech led by bulk chemical producers. We will remain cautious about the software spending outlook from this industry for the remainder of the calendar year. Overall, we're pleased with the progress on many of our key strategic priorities through the third quarter. A key focus for us this year has been the transformation of the OSI and SSE businesses and successfully integrating them with Heritage AspenTech to compare a much larger diversified and faster growing industrial software leader. Now looking at our financial results for the third quarter. Annual contract value, or ACV, was $854.6 million up 11.2% year-over-year.
Revenue was $229.9 million. GAAP loss per share was $0.89 and non-GAAP EPS was $1.06. And free cash flow was $129.3 million. Please note there were some short-term timing dynamics this quarter that Chantelle will discuss later. Looking at the quarter in more detail. We continue to see a strong demand environment in most of our end markets. Commodity prices and CapEx and OpEx budgets remain constructive, and we're seeing continued growth in our sales pipeline across all 3 businesses. AspenTech is in an enviable market position where our solutions directly address the overlapping need for increased production of energy, chemicals and electricity in a sustainable manner. We're encouraged to see that customers' investment in sustainability and their interest to invest in AspenTech solutions to meet the dual challenge remains robust.
Despite the uncertain macro environment. We believe our diversified portfolio across traditional energy sources, chemicals, power transmission and distribution and emerging sustainability areas like carbon cap transferation and hydrogen give AspenTech numerous ways to benefit from these trends for the foreseeable future. I would now like to spend a moment providing details on what we're seeing in the market and our performance by vertical. Refining remains a source of strength in our business as it has been historically. While macro uncertainty exists a strong global demand for refined products is expected to keep refining margins healthy through calendar 2023. Additionally, we're seeing many refiners continue to increase investments to meet the stringent emission standards put in place by many countries globally.
Including the EU's mandate for a 55% reduction in greenhouse gas emissions by 2030 and net 0 by 2050. As the events of the past 12 to 18 months have shown having consistent and reliable sources of energy is a security imperative that increases the need for traditional energy products until the transition is achieved. With respect to the upstream and midstream industry, the strong short and medium-term outlook for oil and gas demand is helping to drive double-digit increases in CapEx budgets in 2023. This projection is reinforced by the International energy agencies forecast of record demand for oil in 2023, reflecting the ongoing recovery in air travel and the reopening of the Chinese market after its COVID shutdown among other factors. We're seeing excellent traction with our end-to-end set of solutions for this market.
The combination of heritage ajustment tech expertise in above surface upstream energy production with SSE's market-leading subsurface modeling solutions gives customers' ability to manage and optimized target exploration and production envelope and ultimately optimize entire oil and gas value chain using our solutions from the ground to the pump and across into chemicals. SSE in particular, has performed well beyond our expectations on an ACV basis year-to-date. And it is seeing very positive customer demand trends. The strong end market demand is being complemented by the transition of SSE's commercial agreements to align more closely with Heritage AspenTech which was one of the key transformation priorities for this business. For example, the recent introduction of the token-based SSE suite has received excellent feedback from customers and is contributing to grow in our pipeline.
We signed several notable wins in the third quarter, including being selected by one of the leading international oil companies to be the engineering model in a simulation technology that will standardize on for facility design in their nascent carbon capture and sequestration business, which they predict could generate in future revenue for the company. This customer selected us after evaluating multiple competitors of AspenTech in the market. This win is a great example of how the SSE suite, combined with our engineering suite will support customer sustainability. The growing investment in oil and gas projects also continues to positively impact the E&C industry and customers' backlogs, accelerating the growth in spend for our engineering suite with this customer set.
In recent quarters, we have seen a steady improvement in demand from these customers as they execute on their expanded backlog of projects. More importantly, it is now clear that a significant number of our E&C customers are materially benefiting from sustainability CapEx investments by way of improved backlog growth, which in turn, is supporting greater usage of our engineering products. We believe current trends in both traditional oil and gas projects as well as newer sustainability projects represent a more durable and diversified opportunity for AspenTech in this market going forward. Shifting to the power transmission and distribution or T&D industry. This industry continues to benefit from significant investment in T&D infrastructure critical to meet the sustainability goals of the future.
Making this market one of the most attractive long-term infrastructure opportunities in the world. Electrification of the global economy is driving rapid growth in demand for electricity and for our DGM solutions. Utilities recognize grids need to expand and become more reliable to handle the increased demand for electricity and additional complexity introduced by the growing mix of renewable sources of power generation. All these compounded by the rising rate of outages resulting from unpredictable storms. Additionally, hardening the security of the grid against the threat of cyber attacks is a national security issue and a top priority for these customers. We believe the only way to do this efficiently and at scale is to broader adoption of software technology.
We recently validated this thesis at the industry conference Distributec, where we witnessed firsthand a high level of interest and demand for DGM product demos from many of the world's leading utility operators. We're making good progress on the ongoing transformation of the oil business and go-to-market efforts for our DGM products. One key pillar of the transformation of OSI and its go-to-market activities has been educating utility customers on the benefits of adopting the term software license model, which is happening faster than we expected. Customers are embracing the benefits of the model, such as access to term license only software capabilities and for some customers the opportunity to leverage CapEx budgets to fund these projects.
This is a great outcome that will accelerate the long-term transformation of the OSI business. The introduction of the DGM token suite will soon make the full range of benefits from this licensing model available to customers. Which we believe will lead to broader deployment of the solutions in the DGM suite. While we're on track to achieve our growth target for term software ACV from new DGM product transactions for the year. We have also identified 2 items during the integration and transformation process that will have an impact on OSI's financial performance by reducing expectations for its ACV and revenue growth in the year. First, we identified several areas for improvement in OSI's project delivery organization impacting several contracts that were signed prior to the Emerson AspenTech transaction.
These projects will take longer than expected to complete and thus, delay achievement of project milestones for revenue recognition. The delays also present headwinds for the recognition timing of perpetual SMS ACV booked as part of the bundled deal. And second, it has also become clear that our assumptions that we could accelerate the market sales cycle to bring it closer to Heritage AspenTech was overly optimistic. So while we're pleased with the amount of demand generation activity we're seeing in this market, we also now expect that the DGM transactions will likely take 12 to 24 months on average to complete versus Heritage AspenTech traditional 9 to 12 months. It is important to note that both dynamics will be short term in nature are well understood by our team as reflected in our model going forward.
We remain incredibly optimistic about AspenTech's opportunities for growth in the E&D market. Finally, in the chemicals industry, a combination of factors, including higher energy costs and persistent supply chain challenges have led to significant destocking and declining demand for these companies resulting in a material impact on these customers' margins. This was most tolerable in the bulk chemicals market, which historically is more sensitive to macro environment than specialty chemicals. This resulted in a pullback in customers' OpEx software spending in the quarter that was more pronounced than we anticipated. For the first time this fiscal year, we saw sales cycles elongate in all regions with an increased number of deal postponements and a push out of the existing pipeline.
Note that software spending from chemical customers is a primary driver of growth for our MSC suite. Despite these near-term challenges, we continue to be positive on the long-term prospects for the chemicals market and expect it to be a meaningful contributor to our growth over time. Finally, while we continue to work through the demand environment for our APM business, I would like to highlight its performance during the third quarter. APM closed a handful of meaningful transactions globally with one existing customer signing a 7-figure transaction to expand their APM deployment across several of their businesses. I would now like to share some additional customer wins from the quarter that demonstrate our success. First, one of the largest engineering companies in the world and a long-term user of our engineering suite increased their token entitlement by more than 10%.
This customer is benefiting from sustainability CapEx investments for Carbon capture sequestration and hydrogen projects. As such, they are seeking to meet their engineers usage needs for their current backlog as well as their expectations for backlog growth in calendar year 2024. Second, a national oil company for the new entity to take control of exploration and production assets from their former international oil company partner. As part of this process, this new company signed an agreement with AspenTech to maintain and expand its access to our SSE products with expectations to significantly increase exploration drilling activities over the next 2, 3 years, this customer more than tripled its number of employees who now have access to SSE products.
Future expansion opportunities with this customer involves signing an enterprise agreement to consolidate and expand access to other AspenTech product suite across all its holdings. Third and final is our successful win of an RSV for a long-term customer of OSI, who has deployed many of our DGM products across its grid over these years. This customer issued an RFP to replace their existing real-time data historian which was end of life by one of our industrial company competitors. After evaluating our bid versus our competitors recently acquired historian product. The customer chose OSI products. In addition, this customer has already agreed to deploy our security Authenticator open app product by November 2024. But because of our control center of grade, we're now accelerating its deployment to the spring of 2024.
Furthermore, this customer is currently fulfilling a grant with the Department of Energy for a future application funded by the department to implement advanced distribution management solution capabilities, which were also quoted. This series of wins by OSI with a long-standing customer speaks to the strength of our DGM product suite significant T&D end market demand and our ability to help customers accelerate outcomes to better manage the growing complexity of the grid. Turning to our innovation investments. We were proud to release our new emissions management solution during the quarter. This new solution combines OSI technology with our traditional software expertise to consolidate customer emissions data alongside planned enterprise and battery chain OP application data into a single pain of glass view, with a holistic view of our emissions abatement targets and margins, customers can now make real decisions of the most meaningful and cost-effective ways to reduce emissions in their operations.
This is an exciting example of how AspenTech can help directly reduce our customers' carbon footprint. It is also an important example of product synergies from the Emerson transaction as we will be bringing what was originally an OSI product to our energy and chemical customers. We also announced a recent partnership between AspenTech, Emerson and Microsoft that demonstrate a successful evolution of our relationship with Amazon as well as our commitment to helping energy and industrial companies advance our sustainability goals, including reaching their net 0 targets. The 3 companies partnered to install a demo of their joint hydrogen value chain solution that helps optimize CapEx investment, life cycle operating cost of production, supply chain and storage infrastructure to expedite a speed to market.
In a new exhibit at the Microsoft Energy Transition Center of Excellence in Houston, which was launched at a grand opening on March 7. During the exhibit, customers were excited to see a real palpable demonstration of a solution that will help to accelerate their sustainability journeys. I would like to briefly mention our ongoing efforts efforts to leverage generative AI capabilities in our products. It is early days, but we have identified many use cases where this capability can help improve the workflow and time to value for our customers. We will provide more details on this exciting area in future calls. I would now like to provide our latest thoughts on our outlook for fiscal 2023, we're tightening our ACV growth range to 11% to 12% comprised of approximately 4 points of growth contributed by DGM and SSE and the remaining 7 to 8 points from Heritage AspenTech.
This compares to our prior guidance of 10.5% to 13.5%. Our updated outlook reflects the following: first, we expect the demand environment and business dynamics that our customers experienced in the third quarter of fiscal 2023 to continue in the fourth quarter. Second, the change in the high end of our up tailor range is predominantly attributable to the pullback in chemical customer software spending as well as other geopolitical considerations now impacting growth. We do not anticipate any improvement in these 2 areas in the fourth quarter. Third, DGM and SSE are still tracking to deliver approximately 4 points of growth for the year. However, the relative contribution will be different than we anticipated. SSE has meaningfully outperformed our expectations this year and is now expected to deliver the majority of the ACV growth for these 2 businesses.
Conversely, extended implementation time lines for certain projects and longer sales cycles in DGM will reduce its near-term contribution to ACV growth in fiscal 2023 relative to our initial expectations. To be clear, we expect this to be only a short-term issue and is primarily a function of timing. We are very optimistic on OSI's market opportunity and expect it to be a significant growth driver over time. As we have discussed throughout fiscal 2023, we intentionally constructed our guidance with a wider range to account for the number of variables facing the business this year, including our efforts on the integration and transformation of OSI and SSE. The potential volatility in the economy and uncertainty around some of our end markets COVID and other geopolitical factors.
We believe the new guidance represents a solid outcome for the year and is in line with our initial expectations in a year what we have been executing on a significant integration and transformation effort in the context of high economic and geopolitical uncertainty. Finally, we're making some changes to realign our senior leadership team to bring greater focus to our execution and especially our transformation activities. Effective today, our current Head of Global Sales, will now report directly to me. is a 20-year veteran of AspenTech and has been running our global sales organization for the last 2 years. Our current CRO, , will be transitioning to a new role focused on all aspects of customer success, including professional services, customer support and partners.
We believe these changes will better position AspenTech to meet our future goals and objectives. Let me finish by saying that we continue to be incredibly bullish on the opportunities ahead for AspenTech. We have successfully brought Heritage AspenTech, OSI and SSE together and lay the foundation for long-term, durable, highly profitable growth. We're aligned with several highly attractive market trends that provide numerous opportunities for success. I would now like to turn the call over to Chantelle. Chantelle?
Chantelle Breithaupt: Thank you, Antonio. I will now review our financials for the third quarter fiscal 2023. As a reminder, these results are being reported under Topic 606, which has a material impact on both the timing and method of our revenue recognition for our term license contracts. Our license revenue is heavily impacted by the timing of bookings and more specifically renewable bookings. A decrease or increase in bookings between fiscal periods resulting from a change in the amount of term license contract per renewal is not an indicator of the health or growth of our business. The timing of renewals is not linear between quarters or fiscal years and this nonlinearity will have a significant impact on the timing of our revenue.
ACV, which we define as an estimate of the annual value of our portfolio of term license and term and perpetual software maintenance and support our SMS agreements as our primary growth metric. ACV provides insight into the annual growth of retention of our recurring revenue base which is the majority of our overall revenue as well as recurring cash flow. Although because of the Emerson transaction, the subsidiary that included the OSI and SSE businesses begin as the surviving entity. As a result, the year ago comparison, as you see in our reported financial statements only includes OSI and SSE in the third quarter of fiscal 2022, and year-over-year comparisons are not meaningful. Annual contract value was $854.6 million in the third quarter of fiscal 2023, up 11.2% year-over-year.
Quarterly ACV was impacted by the medior chemicals demand the impact of certain DGM services projects that extended beyond their completion state and longer sales cycles for DGM solutions as referenced by Antonio. We are encouraged that the DGM term software and have begun to benefit from achieving favorability as we discussed last quarter. However, it will be lower than expected due to the longer sales cycles. Will show a presentation on the DGM separability today after market close to provide investors with a more detailed overview of the topic and what it means for our business going forward. This can be found on the Presentation section of our IR website. Annual spending for Heritage AspenTech, which the company defines as the annualized value of all term license and maintenance contracts at the end of the quarter for the businesses other than OSI and SSE was approximately $712 million at the end of the third quarter of fiscal 2023, which increased 8.6% year-over-year and 2.1% sequentially.
As a reminder, we intend to provide this annual spend disclosure for current adjustment tech-only fiscal 2023 to provide investors comparability with our historical disclosures. Total bookings was $231.3 million, a 15.4% decrease year-over-year. As a reminder, bookings are impacted by the timing of renewals, which were down year-over-year. Please refer to Slide 11 of our third quarter earnings presentation now available on our IR website for a complete description of hastening bookings. Total revenue was $229.9 million for the third quarter. In addition to the lower bookings in the quarter, there were 2 other items that weighed on our quarterly revenue performance. First, while we are seeing accelerated demand from customers for SSE solutions, we have not yet started to extend SSE contract duration meaningfully beyond its average historical length of 1 year due to customer uncertainty from the macro environment.
As a reminder, after Topic 606, contract duration impacts the amount of revenue recognized. Secondly, several OSI services projects that have extended beyond their completion, they are a headwind to revenue under OSI's historical percentages of completion accounting. We have taken several steps to avoid the outcome in the future, including accelerating the hiring to stock projects, enabling an ecosystem of third-party partners to implement services projects and instituting best practices to make the service business more predictable overall. These actions are all part of the OSI integration process and has helped to lay a solid foundation for the business. As such, we are confident about the ability to grow from this mutation line going forward.
While the OSI services business did face some headwinds in the quarter, we are excited to see the accelerated conversion of DGM customers through term from perpetual license transactions in the pipeline, which is more in line with our core business model and value proposition. Now turning to profitability, beginning on a GAAP basis. Operating expenses for the quarter were $214.6 million. Total expenses, including cost of revenue, were $308.4 million. operating loss was $78.5 million, and net loss for the quarter was $57.6 million or $0.89 per share. Please note that the net loss includes the impact of 2 Australian dollar foreign currency derivatives related to the pending Micromine acquisition. Namely a realizing of $10.3 million of cost at line of the revenue; and secondly, a noncash loss of approximately $25.1 million related to the mark-to-market adjustment for the new derivatives entered into our third quarter.
The total unrealized loss we have incurred related to the derivative activity has been approximately $40.5 million year-to-date. As an update on Micromine, we continue to work to secure the final remaining international regulatory approval in order to complete this acquisition. We remain committed to completing this transaction are very excited to bring this team and solution this . Turning to non-GAAP results. Excluding the impact of stock-based compensation expense, amortization of intangibles and acquisition and integration planning related fees. We reported non-GAAP operating income of $56.8 million in the third quarter, representing a 29.1% non-GAAP operating margin. As a reminder, margins will fluctuate period-to-period due to the timing of customer renewals and the resulting impact on license revenue recognition in a given quarter.
Non-GAAP net income -- non-GAAP net income was $69.1 million in the quarter or $1.06 per share based on $65.2 million shares outstanding. Turning to the balance sheet and cash flow. We ended the quarter with approximately $286.7 million of cash and cash equivalents. We also fully paid down the $264 million that was outstanding on our term loan balance in the quarter. We generated $131 million of cash from operations and $129.3 million of free cash flow in the quarter after taking into consideration the net impact of capital expenditures and capitalized software deployment payout statements. On that note, I would like to highlight 2 factors regarding free cash flow. First, we saw a meaningful impact to cash collections at the end of the quarter due to the Silicon Valley Bank crisis.
SVB was one of the primary excuse by our treasury operations to accept customer payments. And it took time to direct customers to other financial institutions. This is entirely a matter of timing. And as of speaking, more than half of this cash has already been collected. Second, we no longer exclude acquisition and integration planning-related payments from our free cash flow calculation. We have made this change based on discussions with the SEC. Free cash flow presentation for our results this quarter and prior comparable periods have an updated to reflect this change. For the third quarter and year-to-date, this change in methodology impacted free cash flow by approximately 0.8% and 6.9%, respectively. I would now like to close with guidance.
As a reminder, we expect the current environment from our third quarter to continue through our fiscal -- final fiscal 2023 quarter. Additionally, we are providing these updates in consideration of our progress and learning so far in transforming and integrating the OSI and SSE businesses. For ACV, we are now targeting 11% to 12% growth for the year. We maintain expectations for approximately 4 points of growth from DGM and SSE with the main impact coming from the slowdown of chemical industry software spending and other deals political considerations impacting share adjustment type. We now expect bookings to be between $1.03 billion, $1.06 billion. This includes $547 million of contracts that are up for renewal in fiscal 2023 and approximately $210 million of contracts up for renewal in the fourth quarter.
Total revenues are expected to be between $1.04 billion and $1.06 billion. This includes $670 million to $690 million of license and solutions revenue approximately $312 million of maintenance revenue and approximately $61 million in services and other revenue. Relative to our prior guidance, we estimate that 2/3 of this revenue adjustment is being driven by the integration and transformation factors we've spoken to earlier. And the final third being is our Heritage AspenTech business. As a reminder, revenue in our model can be volatile due to Topic 606. One of the drivers of that variability is the outsized impact of contract duration as revenue recognition is based on TCE total contract value. For Heritage AspenTech duration is approximately 4 to 5 years on average.
And for SSE, while duration has remained consistent at approximately 1 year, our plan assumes that it would begin to lengthen in fiscal 2023 as part of our transformation efforts. This is why FSG revenue contribution will be lower than expected in our fiscal year, even though it is tracking ahead of plan on an ACV basis, which is the key metric for how we manage and evaluate our business. Moving to expenses for fiscal 2023. We expect a total GAAP expense range of $1.19 billion to $1.224 billion and GAAP operating loss range of $179 million to $164 million. GAAP net loss is expected to be in $110 million to $97 million for GAAP net loss per share between $1.68 to $1.48. From a non-GAAP perspective, we expect operating income to be $398 million to $413 million, for non-GAAP income per share of $5.63 to $5.83.
From a free cash flow perspective, we expect to generate a minimum of $315 million in the fourth quarter being our largest free cash flow quarter of the full fiscal year. As noted previously, free cash flow guidance has been updated to reflect the change in calculation methodology. And effective January 1, 2023, we no longer exclude acquisition and integration planning-related payments from our computation in cash flow. The change in calculation methodology does not represent a change in our expectations. For context, year-to-date acquisition and integration planning-related payments represent 4.1% of the sum over fiscal 2023 free cash flow guide in these year-to-date statements. We estimate that this change in methodology is responsible to roughly 35% of the total decrease in our fiscal 2023 free cash flow forecast using the midpoint of our prior rate presented on January 25, 2023.
In addition, our free cash flow guidance for fiscal 2023 as to cash tax payments of approximately $75 million. Finally, in terms of synergies, while there are certain objectives that are taking longer than anticipated, as Antonio and I have touched on today, we have made significant progress this year in aggregate. We believe we are well positioned for the long term, from both a growth and profitability perspective. As well as our ability to realize the $110 million of adjusted EBITDA synergies by 2026. To wrap up, AspenTech continues to deliver solid growth and profitability and is more challenging economic conditions. We remain on track to deliver a year of double-digit ACV growth and significant free cash flow generation while integrating and transforming OSI and SSE with Heritage AspenTech.
We are confident that the progress made in fiscal 2023 has provided us with a strong foundation for accelerated growth and expanding profitability in the years to come. With that, operator, we would now like to begin the Q&A, please.
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