Aspen Technology, Inc. (NASDAQ:AZPN) Q2 2023 Earnings Call Transcript January 25, 2023
Operator: Good day, and thank you for standing by. Welcome to the Q2 2023 Aspen Technology Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your first speaker today to Brian Denyeau, ICR. Please go ahead.
Brian Denyeau: Thank you. Good afternoon, everyone. Thank you for joining us to discuss our financial results for the second quarter of fiscal 2023 ending December 31, 2022. With me on the call today are Antonio Pietri, AspenTech’s President and CEO; 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 Form 10-Q, most recently filed with the SEC.
Also please note that the following information relates to our current business conditions and our outlook as of today January 25, 2023. Consistent with our prior practice, we expressly disclaim any obligation to update this information. Please note that we have posted a 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 highlights from the second quarter, and Chantelle will review our financial results and discuss our guidance for 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 delivered solid second quarter results as we continue to benefit from a positive demand environment in many of our core end markets. We’re also seeing clear benefits from the combination of heritage AspenTech with the OSI and SSE businesses that were part of the Emerson Transaction in go-to-market activities, innovation and customer access. As I mentioned last quarter, our primary focus in the first half of the year was executing on the integration, transformation and change management plans to create unified consistent operating principles and a single business model across the entire organization. We have made substantial progress and believe our initial integration plans are largely complete.
And the transformation phase of the OSI and SSE businesses is well underway. Our primary focus is in the second quarter was instituting and standardizing on best practices across our go-to-market organization, including transaction terms and conditions and the change management required to support these best practices. While we have already onboarded the OSI and SSE sales teams in the first quarter and implemented a standardized sales methodology, we’re now focused on driving the execution required to deliver high-quality and long-term duration license agreements that support the financial predictability that investors are accustomed to from heritage AspenTech. This was a key area of reinforcement at our recent company-wide sales meeting in Boston from which I came away very pleased with the progress we have made towards establishing a common set of transaction best practices across all businesses and the enthusiasm and buying demonstrated by the OSI and SSE sales teams.
There is still more work to do in this area, but I’m encouraged by the progress to date. In terms of synergies, we are confident on our ability to meet or exceed the synergies expected in fiscal year 2023 based on the increasing pipeline across the different growth synergy categories. The actual cost synergies achieved today, the alignment and execution between the Emerson and AspenTech teams and the completion of the key transformation requirements that capture growth in ACV in the OSI business. Overall, I’m pleased with our performance in the first half of the year and confident in our ability to execute to achieve our full year financial targets. The success we expect this year in integrating and transforming the business sets up — and transforming the business sets up the new AspenTech well to deliver significant top and bottom line growth in the coming years.
I’m highly optimistic about the opportunity ahead for AspenTech and our ability to generate significant value for our shareholders. Now looking at our financial results for the second quarter. Annual contract value or ACV was $833.7 million, up 8.7% year-over-year. Revenue was $242.8 million. GAAP loss per share was $1.02 and non-GAAP EPS was $0.35, and free cash flow was $53.1 million. I wish to provide further commentary on the quarter performance from OSI and SSE. The OSI business closed significant transactions in the quarter, in line with our expectations but because of the bundled nature of the commercial arrangements in the quarter, they did not contribute to ACV growth. In our last earnings call, we talked about the importance of achieving separability for the OSI services business as a key transformation milestone to the new agreements signed are able to be included in our ACV metric.
We’re excited to announce that, as expected, we recently achieved this key milestone which will allow us to begin including from OSI agreements, the DGM product term license component and the SMS component of perpetual license agreements in our ACV metric beginning this quarter. This aligns OSI with how ACV is calculated for heritage AspenTech. Chantelle will go into more detail in her prepared remarks. We also continue to be very encouraged by the prospects of the SSE business and its contribution to ACV growth as demonstrated through its contribution of the two largest ACV growth transactions in the quarter. We equally expect that as our execution in the OSI and SSE sales organizations evolves to be in line with heritage AspenTech, we will experience greater and more predictable ACV growth.
Looking at the quarter in more detail, the demand environment remained positive and was similar to trends we have seen in recent quarters. We signed notable contracts in each of our key verticals and global markets and pipeline development continues to be robust. Our continued strong performance in the midst of uncertain and change in economic conditions is a testament to the relevance and resiliency of our customers’ businesses and the mission criticality of new AspenTech solutions. AspenTech has an essential role to play in helping our customers meet the demand for their products that support greater global prosperity while achieving their sustainability goals and ambitions. Historically, these two areas have been viewed as being intentioned with one another and delivering on both goals is the core of our dual challenge mission.
Our customers have validated its value proposition and recognize our unique position to help them meet the dual challenge. Refiners and chemical producers will need to meet the increasing demand for their products and significantly reduce their environmental impact volatilities will need to transform how electricity is generated and distributed to meet an unprecedented increase in demand. These are complicated challenges that will require elevated levels of investment for decades to come, and AspenTech is in a great position to benefit from these trends. I would now like to spend a moment providing details of what we’re seeing in the market and our performance by vertical. Refining continues to perform well around the world. Refining margins are expected to remain solid through 2023, albeit down from historical highs.
And overall, end market demand for refined products will continue to grow, especially for diesel and middle distillate products. The ongoing return of air travel, the upcoming import ban of refined products from Russia by the European Union and the increasing demand from the recent reopening in China are all expected to be ongoing catalyst for this market. We feel very good about the opportunity for AspenTech to drive consistently strong growth with refining customers. We had a very strong quarter and have great momentum in the power transmission and distribution or T&D market with the DGM solutions from our OSI business. We’re very pleased with the sales performance of DGM in the first half of the year. The secular trends in this market are incredibly favorable given the expected vast increase in electricity demand and increasing number of energy sources that will power the grid in the future.
The greater complexity from renewable power sources like wind and solar is creating more complex transmission and distribution networks, including commercial and industrial micro grids, which will require a wholesale rethinking of how to manage them. We expect this industry to have favorable investment trends for many years to come, considering the investment that will be required to transform the grid. CapEx spend in 2023 for power generation, transmission and distribution is expected to be about $1.2 trillion. One of our key growth synergy opportunities with DGM is to leverage AspenTech’s global footprint starting in Europe. We have already had some exciting early wins with DGM in that market and continue to actively build out our sales capacity in that region.
In December, we held the OSI user forum in Las Vegas. The event was highly successful, with 500 customer attendees, representing more than 150 utility companies from around the world. This was the first time since the pandemic started that OSI’s customers gather in person. We felt great enthusiasm from customers about the future plans for the OSI business under AspenTech, especially on the establishment of an ecosystem of third-party implementers for the DGM solutions. The oil and gas industry upstream and midstream had a banner year in 2022, supported by high oil prices and strong execution discipline. Forecasts indicate oil prices will remain elevated through 2023 at an average of $80 to $90 per barrel for Brent crude for the year based on various current projections.
The industry CapEx is expected to increase by 12% to $485 billion in calendar 2023, according to Energy Intelligence projections. With a significant portion of that increase coming from national oil companies. In our business, we had another strong quarter as the combination of heritage AspenTech Solutions and SSE’s products has created an unmatched technology portfolio that can deliver far greater value for customers. We signed a number of quality wins with the upstream customers in the quarter, including a significant contract with one of the largest oil producers in South America, and we’re also engaged with customers on the use of SSE capabilities for carbon capture and sequestration in various locations around the world. The E&C vertical did well in the second quarter and has been an important source of strength in the first half of the year.
Customers in this market are benefiting from two important trends. First, in the traditional business, investment in upstream oil and gas projects has increased notably in recent quarters. The combination of strong oil prices and tight supply after several years of below average CapEx investment in the oil and gas market is supportive of E&C’s backlog and headcount growth, which is positive for AspenTech. And second, E&Cs are aggressively investing in establishing engineering capabilities for sustainability investments that represent a new growth opportunity that is likely to be less cyclical than their traditional business. The CapEx investment required to meet sustainability targets in our core owner operator markets will be substantial, and we present E&Cs with sizable growth opportunities that haven’t been present for several years.
We’re very optimistic on the outlook in this market in fiscal year 2023 and beyond. Finally, the chemicals industry had a good quarter, but does face some challenges globally and regionally in Europe. The ongoing situation in Europe and its impact on local energy supplies and consumer demand continue to weigh on chemical customers in the region. Globally, chemical customers are also experiencing a slowing demand and margin pressure as the global economy has slowed its growth. In conversations through the last quarter, many of our customers have told us they believe the current situation will recover in the second half of the calendar 2023 as economic activity picks up. We remain optimistic on the opportunity in the chemicals market, but would flag it as one of the area of our business that we are cautious on in the near term.
I would now like to share some customer wins from the quarter demonstrate our success. First, an existing SSE in heritage AspenTech customer and one of the largest oil producers in South America is looking to shorten by 65%, the time it takes to get a new oilfield discovery to production. As part of this initiative, the customer evaluated multiple vendors on their knowledge automation and AI capabilities and elected to increase the spend of SSE products due to the combination of capabilities in the SSE suite. SSE has been and remains the largest incumbent in the exploration and production portfolio of software capabilities used by the customer. Second, an international utility company headquartered in the UK owns and maintains the high voltage electricity transmission network in England and Whale.
This customer is investing heavily in its network of thousands of kilometers of overhead lines and underground cables and more than 300 substations to connect more and more low carbon electricity sources since that is a crucial factor to meeting net zero carbon emissions in the region. After a careful study to upgrade transmission management system and an extensive evaluation of multiple competitors, the customer selected the OSI solution because of its more mature, modern architecture and out of the box capabilities. This win opens up the opportunity to expand the use of OSI products into other operating areas and across other companies in the customers’ group. And third and final, Emerson and AspenTech are having success in the market. Emerson recently announced its selection as the main automation contractor for the Ras Laffan Petrochemical Complex or RLP, a joint venture between QatarEnergy and Chevron Phillips Chemical.
RLP will be the largest S&M plant in the region and one of the largest in the world. The scope of work covers automation, software and analytics capabilities, including various products from AspenTech’s engineering and MSC suites. Emersons see at the table in the very early phases of the competitive process for this major construction project accelerated AspenTech’s visibility into this opportunity. While AspenTech’s products and solutions contributed to Emersons overall bid quality to the customer. We expect this win will open many more opportunities for both companies in the future. This win is also a good demonstration that the commercial relationship between Emerson and AspenTech is already benefiting both companies and the alignment between both commercial organizations will undoubtedly continue to grow the pipeline of business.
We expect the focus on targeted growth initiatives will result in increased long-term growth and profitability for both companies through a strengthened go-to-market presence and offering. Now turning to our innovation investments. In November, we launched our new software release as aspenONE version 14, which provides augmented intelligence, guiding users to improve decision-making abilities and increased operational excellence. Introducing over 100 sustainability models, this release will help customers accelerate progress in the areas of emission management, hydrogen economy, carbon capture, material, circularity, bio-based feedstocks and renewable energy. V14 is a great example of how AspenTech will leverage our historical strength in modeling and simulation with new technologies like artificial intelligence to deliver greater value to customers through better profitability and improve sustainability.
A great example of collaborative innovation in product development is our recently announced strategic partnership and licensing agreement with Saudi Aramco. As part of this agreement, we partnered with Aramco to provide to the market a unique integrated modeling and optimization solution for the sourcing and utilization of CO2. Through this solution, we expect to provide customers the ability to rapidly evaluate sources of CO2 generation and potential opportunities for use or sequestration of the CO2 and hence, design new innovative solutions that can reduce their carbon footprint while ensuring profitability. M&A is another important part of our innovative strategy, and we continue to maintain a positive posture in this area. We got off to a strong start with Emerson, which has received fantastic early feedback from customers.
It greatly accelerates our AIoT industrial data and connectivity product road map and will enable greater visibility and understanding of an asset operating environment. We’re also proceeding on our integration planning with MicroMine (ph) as we work towards the completion of the transaction. We expect this acquisition to close as soon as we obtain the last remaining regulatory approval, which we are actively working to secure. We have become even more impressed with the MicroMine team and products as we have gotten to know them better as this process has played out and look forward to welcoming them to AspenTech. Let me finish by providing our latest thoughts on fiscal year 2023 guidance and the second half of fiscal 2023. We remain confident in our ability to deliver on the full year ACV growth target and are maintaining the guidance range of 10.5% to 13.5%, while also maintaining our free cash flow guidance of $347 million to $362 million.
Our confidence is based on our pipeline of business, the momentum building from the integration and transformation activities undertaken, the 2023 CapEx spend projections and economic outlook in our core industries. Our success in achieving these outcomes will still depend in part on continuing to successfully execute on our integration and transformation initiatives across the company. As a reminder, we have always expected the second half of the year to be a stronger contributor to growth and free cash flow given the historical buying patterns of heritage AspenTech customers and the expected timing of DGM and SSE contributions, including for the anticipated synergies. We are pleased with the performance of DGM and SSE so far, and believe the operational progress we have made in the first half of the year and our growing sales pipeline puts us on track to deliver 4 points of ACV growth from those businesses.
We also continue to be mindful of the macroeconomic environment, COVID developments in China and the challenges facing the chemicals market, which we have flagged as the key variables in how we performed within our ACV growth range for the year. Before I turn it over to Chantelle, I want to reiterate how much progress we have made in the first half of the year in bringing heritage AspenTech, OSI and SSE together as one company. We have created a world-class industrial software company that is poised to accelerate growth and generate significant profitability as we execute on our long-term strategy. The new AspenTech team has done an amazing job getting us to this point, and I want to recognize their efforts and commitment to our success. So with that, let me turn the call over to Chantelle.
Chantelle Breithaupt: Thank you, Antonio. I will now review our financials for the second quarter of 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, renewal bookings. A decrease or increase in bookings between fiscal periods resulting from a change in the amount of term license contracts up for 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 non-linearity will have a significant impact on the timing of our revenue.
As a reminder, we have transitioned from annual strength ACV, annual contract value as our primary growth metric. This define ACV as estimated of the annual value of our portfolio of term license and term and perpetual software maintenance and support or SMS agreements. ACV provides insight into the annual growth and retention of our recurring revenue base which is the majority of our overall revenue as well as recurring cash flow. Annual contract value was $833.7 million in the second quarter of fiscal 2023, up 8.7% year-over-year. As Antonio mentioned, we are pleased to have recently achieved separability for DGM software, which will allow us to prospectively recognize the growth of DGM term license and SMS businesses into our ACV metric on a stand-alone basis.
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Main contributors to this go-to-market change are the enablement of implementation service partners to operate autonomously and directly with our DGM customers. The change to OSI commercial contracts whereby the customers will be contracting for software licenses and professional services separately. And the streamlining of tools and processes for implementation services to significantly reduce complexity and interdependency with our software. We will begin to see the impact of this change at DGM beginning in this third quarter which will have a meaningful benefit to ACV in the second half of this fiscal year. It’s important to note that achieving separability has multiple business benefits as well, including the general acceleration of revenue and free cash flow generation.
Annual spend for 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 $697.5 million at the end of the second quarter of fiscal 2023, which increased 9% compared to the second quarter of fiscal year 2022 and 2.2% sequentially. As a reminder, we intend to provide this annual spend disclosure for Heritage AspenTech only for fiscal 2023 to provide investors comparability with our historical disclosures. Total bookings, which we define as the total value of customer term license and perpetual SMS contracts signed in the current period, that’s the value of term license and perpetual SMS contracts signed in the current period where the initial license have not yet being delivered under Topic 606, plus term license in perpetual SMS contracts signed in the previous period for which the initial licenses are deemed delivered in the current period with $242.8 million, a 16.3% increase year-over-year.
Total revenue was $242.8 million for the second quarter. As a reminder, as a result of the Emerson transaction, the subsidiary that included OSI and SSE businesses became the surviving entity. As a result, the year ago comparisons you see in our financial statements include OSI and SSE in the second quarter of fiscal 2022, and year-over-year comparisons are not meaningful. Now turning to profitability, beginning on a GAAP basis. Operating expenses for the quarter were $209.1 million. Total expenses, including cost of revenues were $302.2 million. Operating loss was $59.4 million and net loss for the quarter was $66.2 million or $1.02 per share. Please note that the net loss in the quarter reflected approximately of a non-cash gain related to the mark-to-market adjustment for the Australian dollar foreign currency derivatives related to the pending MicroMine acquisition.
Since the inception of this foreign currency derivatives, the total net unrealized loss would we have incurred has been approximately $15.3 million. There will continue to be fluctuations until the closing of the Micromine transaction. Turning to non-GAAP results. Excluding the impact of stock-based compensation expense, the amortization of intangibles associated with acquisitions and acquisition and integration planning related fees. And excluding the impact of the unrealized gain on the foreign currency derivatives. We reported non-GAAP operating income for the second quarter of $86.6 million, representing a 35.7% non-GAAP operating margin. As a reminder, margins will fluctuate period to period due to the timing of customer renewals and for license revenue recognized during the quarter.
Non-GAAP net income was $22.8 million or $0.35 per share based on 64.6 million shares outstanding. Turning to the balance sheet and cash flow. We ended the quarter with approximately $446.1 million of cash and cash equivalents and $264 million outstanding under our term loan agreement. On December 23, 2022, we entered into a credit agreement with Emerson for an aggregate term loan commitment of $630 million. We intend to use the proceeds from borrowings under the agreement to pay in part the cash consideration for funding the pending MicroMine acquisition. Also in January, we fully paid off our existing term loan balance. In the second quarter, we generated $49.5 million of cash from operations and $53.1 million of free cash flow after taking into consideration the net impact of capital expenditures, capitalized software and excluding acquisition and integration planning related payments.
We had a solid cash generation quarter that was in line with our expectations. Our free cash flow cadence will be more back end loaded than prior years due in part to business mix, upfront integration expenses and the timing of the expected impact of our synergy initiatives. In terms of synergies, we’ve made additional progress in each of our four synergy buckets, growth, business transformation, cost and the commercial agreement with Emerson. The most notable milestone was the DGM separability that we discussed earlier. We believe we are well positioned for the long term from both a growth and profitability perspective and on our ability to realize the $110 million of adjusted EBITDA synergies by 2026. I would now like to close with guidance.
We have performed well in the first half of 2023 and have delivered on the business integration and transformation initiatives needed to position the business for faster ACV growth in the second half of the year. We are encouraged by the overall demand trends across the business while also being mindful of an uncertain economic outlook. To account for this uncertainty, we continue to believe maintaining a wider guidance range is prudent. With respect to ACV, we are maintaining our target of 10.5% to 13.5% growth for the year, including 4 points of growth contribution from the DGM and SSE product portfolios. We are encouraged by the transformation and integration outcomes with DGM and SSE and the trends in heritage AspenTech. We are maintaining our bookings guidance in the range of $1.07 billion to $1.17 billion, which includes $547 million of contracts that are up for renewal in fiscal 2023.
This includes approximately $133 million of contracts up for renewal in the third quarter. We continue to expect revenue in the range of $1.14 billion to $1.2 billion. We expect license and solutions revenue in the range of $765 million to $826 million and maintenance revenue and service and other revenue of approximately $312 million and $64 million, respectively. From an expense perspective, we expect total GAAP expenses of $1.207 billion to $1.217 billion. Taken together, we expect GAAP operating income in a range of loss of $67 million to a loss of $15 million for fiscal 2023, with GAAP net income in the range of negative $7.5 million to a positive $32.5 million. We expect GAAP net loss per share to be in the range of a loss of $0.11 to positive $0.49.
A non-GAAP perspective, we expect operating income of $503 million to $555 million and non-GAAP income per share in the range of $6.83 to $7. From a free cash flow perspective, we continue to expect free cash flow of $347 million to $352 million. Our fiscal 2023 free cash flow guidance assumes cash tax payments in the range of $94 million to $101 million, which is unchanged. We would expect the third quarter to be the largest free cash flow quarter of the year, driven parts of the timing and cash collections for SSE’s renewal portfolio. To wrap up, AspenTech is performing at a high level. We generated solid growth and profitability in the first half of the year and we believe we are well positioned to deliver on our full year financial targets.
We are targeting a large and expanding market opportunity that we believe can support significant levels of growth and profitability over time. With that, operator, we would now like to begin the Q&A.
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