U.S. Markets closed

Edited Transcript of AZPN earnings conference call or presentation 2-May-17 8:30pm GMT

Thomson Reuters StreetEvents

Q3 2017 Aspen Technology Inc Earnings Call

Burlington May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of Aspen Technology Inc earnings conference call or presentation Tuesday, May 2, 2017 at 8:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Antonio J. Pietri

Aspen Technology, Inc. - CEO, President and Director

* Karl E. Johnsen

Aspen Technology, Inc. - CFO and SVP

================================================================================

Conference Call Participants

================================================================================

* David E. Hynes

Canaccord Genuity Limited, Research Division - Analyst

* Mark William Schappel

The Benchmark Company, LLC, Research Division - Equity Research Analyst

* Matthew Charles Pfau

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

* Monika Garg

Pacific Crest Securities, Inc., Research Division - Research Analyst, Vertical Software

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good afternoon. My name is Nathalie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Aspen Technology Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Thank you. Karl Johnsen, CFO, you may begin your conference.

--------------------------------------------------------------------------------

Karl E. Johnsen, Aspen Technology, Inc. - CFO and SVP [2]

--------------------------------------------------------------------------------

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 up the call for Q&A. Antonio?

--------------------------------------------------------------------------------

Antonio J. Pietri, Aspen Technology, Inc. - CEO, President and Director [3]

--------------------------------------------------------------------------------

Thanks, Karl, and thanks to everyone for joining us this afternoon. We delivered a solid third quarter financial performance with revenue and profitability that exceeded our guidance.

Looking at our financial results for the quarter. Annual spend was $452 million, up 4.9% year-over-year. Total revenue of $119.3 million was above the high end of our guidance range. GAAP operating income was $52.3 million and non-GAAP operating income was $57.4 million, which represents a non-GAAP operating margin of 48%. GAAP EPS was $0.47 and non-GAAP EPS was $0.52, both of which exceeded the high end of our guidance ranges. Free cash flow was $56.2 million, and we repurchased 1.7 million shares for $100 million.

We're pleased with our financial performance considering that the spending environment remains challenging due to the market dynamics we have experienced over the past 2 years. Engineering, construction and upstream customers are focused on being profitable in a $45 to $55 per barrel oil environment that they expect to continue for the foreseeable future. They remain closely focused on cost controls and reducing their operating expenses after rightsizing their businesses to match the engineering personnel headcount to the lower CapEx spend, which is about 40% lower than the peak in 2014, according to published reports.

In addition, the Latin America business environment with the major state-owned enterprises continues to be a net negative as the region and oil sector continue to struggle to recover from their macro environment and operational challenges. Positively, our owner-operator customers in the chemicals and downstream energy sectors continued to generate growth in the quarter. Similarly to last year, the growth from our owner-operator customers is offsetting the weakness and headwinds we're seeing from E&C and upstream customers. The continued strength of owner-operators demonstrate the significant value AspenTech delivers to customers every day as they increase their focus on operational excellence and asset reliability.

We did have a number of transactions with owner-operators that slipped out of the quarter. As we have experienced over the past couple of years, the current environment puts a premium on sales focus and execution. For example, contract negotiations are more challenging and transactions experience greater scrutiny from customers before approvals are obtained.

As we enter the fourth quarter, we currently expect to achieve annual spend growth for fiscal year 2017 towards the lower end of our 3% to 6% guidance range. The guidance assumes a projected attrition rate in line with fiscal 2016 and is supported by the amount of new growth that the company will generate. As we stated at the beginning of the fiscal year, the challenges in some of our end markets made possible a wider range of outcomes.

We are facing the most disruptive oil price environment in a generation and are still generating growth, which we believe is a testament to the mission-critical nature of our products and the strategic relationships we have with customers. While we are focused on driving higher growth, when you consider the macro environment we're operating in, we feel good about our financial performance and the discipline we have maintained in running the business while making important investments in new areas.

Looking at fiscal year '17. There are 2 primary factors we've seen in the market. First, now that we're a quarter into calendar 2017, it has become clear that the 2017 budget cycle for E&C customers will reflect the rightsizing of their businesses that took place in 2016 calendar. These customers are facing a year of flat to slight increase in backlogs, materially reduced engineering headcount and significant cost pressures. Feedback we have gotten from customers indicate this environment could persist through calendar 2018. We're evaluating how to position AspenTech for improved growth in this market over time.

The second dynamic we are seeing is related to large deal activity for our MSC suite. Relative to last year, we have signed fewer larger deals, and the ones we have signed have not been as large. Overall, we continue to see good demand from owner-operators, but we're coming off of 2 very strong years of growth in MSC, and customers are absorbing the significant amount of new token capacity they've acquired in order to generate the value expected through the implementation of our technology.

As we have long said, there are limits to how much new technology our customers can absorb at any given time. We believe this is a temporary phenomenon, and we expect to see better growth from this group in fiscal year '18.

We will provide a specific guidance on our growth outlook for fiscal year '18 at our Investor Day on June 8, but I want to provide some high-level commentary on our expectations.

Overall, we would expect to see growth improve from fiscal year '17 levels due to the positive impact of the Asset Performance Management, or APM, suite. The customer response we have seen in the first few months since the launch of APM has been very exciting, and it's translated into a strong pipeline of opportunities. In fact, APM opportunities represent about 15% of our pipeline at this point.

In the rest of the business, we currently anticipate engineering will perform in line with this year and MSC will show a slight improvement due to the dynamics I just described with our owner-operator customers.

We remain optimistic about the long-term opportunity in our core markets and for AspenTech overall. We have been making significant investments across our product portfolio, and we believe we'll further and extend our market leadership and position us for improved growth when the spending environment improves. The reason for that optimism was on display last week as we held our biennial OPTIMIZE User Conference, which was attended by over 800 customers and prospects, and was more than double the size of our last OPTIMIZE. This year's conference focused on our Asset Optimization strategy and the substantial progress we have made in bringing that vision to reality since we first introduced it at OPTIMIZE 2015.

As we have discussed in the past, Asset Optimization is a holistic approach to asset management that focuses on an asset-designed operation and maintenance in order to drive the highest possible financial return over its entire life cycle. By implementing best practices and realizing efficiencies across all 3 of these areas, we believe customers will improve the reliability of their assets and maximize their long-term value. Our product vision is to bring all 3 areas together so customers can leverage the vast amounts of data they have already -- they already have to drive better, more informed decisions on how they manage their assets.

AspenTech's leadership in asset design and asset operations provides a strong foundation to expand into asset maintenance with the APM suite. APM represents a major step forward in the market, starting with reliability analysis to better understand how to improve the overall reliability of a system of assets, an asset or equipment. This leverages analytics and machine-learning capabilities proactively to improve the degradation pattern or breakdown of these assets.

We believe APM represents another significant area of opportunity for customers to generate incremental efficiencies and improve on their operational excellence programs. Ultimately, a customer does not benefit from the true value of asset optimization if they have designed and are operating a plant for peak efficiency but the physical plant itself experiences a failure that shuts down production.

Despite decades of investment in preventive maintenance, according to ARC, 82% of the failures and unplanned downtime are not addressable by this investment. We believe that addressing these vital issues for customers represent a significant expansion of the value creation AspenTech can provide to customers as well as a meaningful expansion of our TAM. We look forward to providing greater insight into this potential opportunity at our Investor Day in June.

Finally, there are 2 other aspects of APM that provide us with the confidence that it will become a greater component of our growth mix in the future and support faster growth over time. First, the APM suite is mostly targeted at our owner-operator customers in the downstream and chemicals markets, where AspenTech solutions are used daily as part of their operating expenses. By increasing the mix of our business in markets that are not exposed to the cyclicality of CapEx investments, we would expect to see more predictability in our performance.

Secondly, we believe APM is more broadly applicable and can provide value in any industry where equipment reliability and uptime are critical business issues. We continue to see interest from new customers in these industries as our existing customers further roll out the machine-learning capabilities from Mtell, and our existing OEM partners takes Mtell's products to market in these industries. In addition, reliability is a top priority in any of these industries. And the opportunity to improve it through analytics technology, be it machine learning, multivariate analysis or root cause analysis, will be a growth driver.

Now turning back to our third quarter performance. Energy, engineering and construction and chemicals once again represented greater than 90% of our business. Energy was the largest vertical contributor, followed by chemicals and engineering and construction.

I will now provide some color on a few notable transactions signed during the quarter. First, a global oil company continued their rollout of our Adaptive Process Control technology, DMC3, by upgrading existing controllers to the latest version of our technology. This customer will continue to expand the value created from multivariable control applications through this deployment.

Second, a global E&C company that has been performing RAM studies, those are reliability, availability, maintainability studies, on a reactive ad-hoc basis, decided to adopt our Fidelis Reliability product in one of their Canadian offices as a new source of revenue, by one, creating the ability to offer RAM studies to their customers proactively; two, making available to project teams an effective means of reviewing a scope of deliverables and ensuring competitive bids; and three, maintaining plan engagements for both the CapEx and OpEx investment cycles.

Third, a global chemical customer decided to expand their use of Mtell's machine-learning capabilities in one of their largest U.S. sites and expects to roll out 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 the 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'll continue to run the business with a focus on expense discipline. We believe our ability to make incremental investments for growth while maintaining 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 are 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'd 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 are 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 had 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.

--------------------------------------------------------------------------------

Karl E. Johnsen, Aspen Technology, Inc. - CFO and SVP [4]

--------------------------------------------------------------------------------

Thanks, Antonio. I will now review our financial results for the third quarter of fiscal 2017, beginning with 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 $119.2 million in the prior year period and was above the high end of our guidance range of $116 million to $118 million. As a reminder, in the third quarter of 2016, we recognized $3.9 million of nonrecurring subscription and software revenue.

Breaking this down further, subscription and software revenue was $111.7 million for the third quarter, which is consistent with $111.7 million in the prior year period and compares to $112.9 million last quarter.

When looking at sequential comparisons, remember that we recognize subscription revenue on a daily basis, and the third quarter has 2 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 $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%. This 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 acquisitions, acquisition-related expenses and noncapitalized 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 3 quarters of fiscal 2017, we have returned 6 million shares worth $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 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 to $0.40 per share.

Turning to the full year. We are 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 and software to comprise greater than 90% of revenue with our services and other revenue representing the remainder.

From an expense perspective, we are 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 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 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 to $1.95 per share, which is an increase from our previous guidance of $1.79 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 $165 million to $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 are making significant progress on the strategic priorities 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.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Your first question comes from the line of Matt Pfau.

--------------------------------------------------------------------------------

Matthew Charles Pfau, William Blair & Company L.L.C., Research Division - Analyst [2]

--------------------------------------------------------------------------------

Just wanted to start out with digging in a little bit to the preview you gave for fiscal '18 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 '17, 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 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've seen with the -- with some of these MSC deals.

--------------------------------------------------------------------------------

Antonio J. Pietri, Aspen Technology, Inc. - CEO, President and Director [3]

--------------------------------------------------------------------------------

Well, I mean, look, I won't get into specifics of deals. What I'll say though is, certainly, we did close a handful of APM-related deals, both with our 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 2 years, in order for us to deliver the performance that we have delivered, both financial performance and growth performance, it has required a 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.

--------------------------------------------------------------------------------

Matthew Charles Pfau, William Blair & Company L.L.C., Research Division - Analyst [4]

--------------------------------------------------------------------------------

Got it. Okay. And then I 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 2?

--------------------------------------------------------------------------------

Karl E. Johnsen, Aspen Technology, Inc. - CFO and SVP [5]

--------------------------------------------------------------------------------

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 the annual spend that we closed 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 a couple other calls, we've accelerated a little bit the cash basis revenue, and we've seen that come in and there's been a little bit of a benefit from that.

--------------------------------------------------------------------------------

Matthew Charles Pfau, William Blair & Company L.L.C., Research Division - Analyst [6]

--------------------------------------------------------------------------------

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, if that is impacting that guidance?

--------------------------------------------------------------------------------

Karl E. Johnsen, Aspen Technology, Inc. - CFO and SVP [7]

--------------------------------------------------------------------------------

No. I mean, a little bit of it is, is in Q3, we're a little bit behind expenses due to hiring, which you can't make that up as some people got hired later in the quarter and then 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.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

Your next question comes from the line of Monika Garg.

--------------------------------------------------------------------------------

Monika Garg, Pacific Crest Securities, Inc., Research Division - Research Analyst, Vertical Software [9]

--------------------------------------------------------------------------------

First is, we have seen some improvement in oil prices and 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 a pickup in the annual spend from here? And maybe touch upon kind of the sales execution in Q3, what you little bit talked about.

--------------------------------------------------------------------------------

Antonio J. Pietri, Aspen Technology, Inc. - CEO, President and Director [10]

--------------------------------------------------------------------------------

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 also a lot of bragging about their ability to produce oil profitably at $50 a barrel, which emphasizes their point on expense management and control and just, in general, belt-tightening. So -- and -- but very little announcements about new projects in upstream, which is really where the CapEx investment starts being generated. I've also read some -- an article in the Wall Street Journal where they talked about the 5 largest Western oil companies taking on $214 billion of debt over the last 2, 3 years to finance their dividend. So I think some of this profitability ends up going to address or delever those companies and, just in general, build their cash portfolios. Now what do I think it's 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're 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 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 these bigger projects. When that will happen, if I had that answer for you, I'd probably make a lot of money.

--------------------------------------------------------------------------------

Monika Garg, Pacific Crest Securities, Inc., Research Division - Research Analyst, Vertical Software [11]

--------------------------------------------------------------------------------

Then you talked about 15% of the 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 kind of to gauge quantitatively the 15% of pipeline in the APM?

--------------------------------------------------------------------------------

Antonio J. Pietri, Aspen Technology, Inc. - CEO, President and Director [12]

--------------------------------------------------------------------------------

Yes. I won't talk about the specifics, but we do look at our 5 quarter pipeline as a metric that we've always tracked here even before I became CEO that as the Head of Field Operations has a metric that I used to track. And that metric is the pipeline is in line with the metric. Our historical performance has bounced up and down a little bit over the last 6 to 18 months, but it's also the velocity of conversion of that pipeline. And that's sometimes what you -- what we experienced in Q3 in that not only our largest transaction for the quarter moved out of the quarter, but also a number of other deals. And I think that'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 that's -- we'll correct that going forward and get back on a more healthy growth path.

--------------------------------------------------------------------------------

Monika Garg, Pacific Crest Securities, Inc., Research Division - Research Analyst, Vertical Software [13]

--------------------------------------------------------------------------------

Got it. And then, Karl, you announced an acquisition of rights to OTS software in April. So is there any revenue you are baking in for the F Q4 guidance from this deal?

--------------------------------------------------------------------------------

Karl E. Johnsen, Aspen Technology, Inc. - CFO and SVP [14]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Monika Garg, Pacific Crest Securities, Inc., Research Division - Research Analyst, Vertical Software [15]

--------------------------------------------------------------------------------

Got it. 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?

--------------------------------------------------------------------------------

Karl E. Johnsen, Aspen Technology, Inc. - CFO and SVP [16]

--------------------------------------------------------------------------------

No, it's a factor of 2 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 hangover for some single pays and some OTS 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 large renewals at the end of the quarter that closed in Q3, but because the payment isn't due 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 in, you'd be more at that 5% or 6%, 6.5% year-over-year growth in deferred.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

(Operator Instructions) Your next question comes from the line of David Hynes.

--------------------------------------------------------------------------------

David E. Hynes, Canaccord Genuity Limited, Research Division - Analyst [18]

--------------------------------------------------------------------------------

So maybe we could start with annual spend attrition. 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 are we going to see an uptick in attrition? What should we expect when Q4 comes around?

--------------------------------------------------------------------------------

Antonio J. Pietri, Aspen Technology, Inc. - CEO, President and Director [19]

--------------------------------------------------------------------------------

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 put in place initiatives in fiscal '17 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 my script, that the dynamic is one where these customers have rightsized their businesses to a number of engineering personnel headcount. There's a certain amount of entitlement that they need for our software to match that headcount. And that's what the discussions end up being. Certainly, there's 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.

--------------------------------------------------------------------------------

David E. Hynes, Canaccord Genuity Limited, Research Division - Analyst [20]

--------------------------------------------------------------------------------

Yes. Okay. And then moving on, I guess, to the sales head transition. Maybe just color. Kind of when did this happen? 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.

--------------------------------------------------------------------------------

Antonio J. Pietri, Aspen Technology, Inc. - CEO, President and Director [21]

--------------------------------------------------------------------------------

Yes. I mean, yes, 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's 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 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 in that it is an environment that requires a strong focus on execution, and that really means a strong focus on details, strong knowledge of our products, strong institutional knowledge, understanding of our customers, how 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, capabilities, 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's worked for me for about 7 years. I know her very well. She's 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 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 were taken around our APM business that will ensure that that's a business that's well launched and taken care of. So I hope that answers the question, DJ.

--------------------------------------------------------------------------------

David E. Hynes, Canaccord Genuity Limited, Research Division - Analyst [22]

--------------------------------------------------------------------------------

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 at my model, which goes back to like '08, '09, 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, 7 or 8 years?

--------------------------------------------------------------------------------

Karl E. Johnsen, Aspen Technology, Inc. - CFO and SVP [23]

--------------------------------------------------------------------------------

Yes. 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 at the beginning of each calendar year. And this year, the IRS was about 4 to 6 weeks behind in schedule in 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 that will impact the year-to-date or the year -- full year.

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

Your next question comes from the line of Mark Schappel.

--------------------------------------------------------------------------------

Mark William Schappel, The Benchmark Company, LLC, Research Division - Equity Research Analyst [25]

--------------------------------------------------------------------------------

Just one question here. Want to come back to Karl. Karl, I'd like you to go back to an earlier question regarding the annual spend. Could you just go through one more time the divergence between the lower-than-expected annual spend and the higher revenue guide?

--------------------------------------------------------------------------------

Karl E. Johnsen, Aspen Technology, Inc. - CFO and SVP [26]

--------------------------------------------------------------------------------

Sure. So the easy way to look at it is if you look in our year-to-date results and then you can walk forward from there for the Q4 revenue to get to the kind of the full year guide. And what you do is you're going to -- we're going 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 gets you -- 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 a 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've got a little bit of a benefit from a cash basis, customers and we 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 3 legs of the stool.

--------------------------------------------------------------------------------

Operator [27]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Antonio J. Pietri, Aspen Technology, Inc. - CEO, President and Director [28]

--------------------------------------------------------------------------------

Thank you, Nathalie, and thank you, everyone, for joining the call today. Look forward to seeing most of you and others since we're going to be attending a few conferences -- investor conferences these next 2 months. So thank you, and we'll see you around.

--------------------------------------------------------------------------------

Operator [29]

--------------------------------------------------------------------------------

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