Aspen Technology, Inc.

Good day and thank you for standing by. Welcome to the Q3 2021 Aspen Technology earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to Chantal Brightup, CFO. Please go ahead.

Thank you. Good afternoon, everyone, and thank you for joining us to discuss our financial results for the third quarter of fiscal 2021, ending March 31, 2021. I'm Chantal Brightup, CFO of Aspen Tech, and with me on the call is Antonio Pietri, President and CEO. 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 and contained in our most recently filed Form 10-Q. Also, please note that the following information relates to our current business conditions and our outlook as of today, April 28, 2021. Consistent with 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 third quarter, and then I will review our financial results and discuss our updated guidance for fiscal year 2021. With that, let me turn the call over to Antonio. Antonio?

Thanks, Chantel, and thanks to all of you for joining us today. I want to start by welcoming Chantelle to Aspen Tech. Chantelle adds significant experience to the senior management team, and I've been impressed by her financial and operational acumen and energy she's brought to the company in the weeks since she joined us. Let's start by looking quickly at our financial results for the quarter. Revenue was $162.7 million. GAAP EPS was $0.91, and non-GAAP EPS was $1.05. Annual spend was $609.9 million, up 1% in the quarter and 6% year over year. And free cash flow was $100 million. Overall, our third quarter performance was below our expectations. While we continue to have a meaningful pipeline of business, it remains a challenging environment to complete transactions. We had expected purchasing dynamics with customers to improve modestly in the third quarter. However, it was broadly consistent with what we experienced in the second quarter. Our assessment of growth in Q3 was predicated on the quality of conversations with customers and their commitment to a sequence of events that have historically indicated a high likelihood of closing these transactions. As the quarter closed, many of these transactions did not receive final approval at the highest level of our customers' organizations, an approval step that is new or has been historically a predictable final step. We believe there were several factors that played a role in the quarter. The unexpected polar vortex weather event in February in the United States, and specifically in Texas and many of the key energy-producing states, forced the shutdown of approximately one-third of U.S. refining capacity, as well as approximately 75 percent of ethylene capacity and 80 to 85 percent of polypropylene capacity, equally impacting other chemicals' production capacity. This emergency shifted customer attention towards shutdowns, repairs, and restarts of these assets, with the last few plants finally returning to operations only in the past few weeks. This weather event cost the refining and chemicals industry billions of dollars in revenue and incremental expenses, as being reported by these companies. One refining company reported taking an accounting charge in the quarter of between $520 and $535 million due to higher electricity and natural gas costs alone. We believe the economic impact from these storms placed additional pressure on budget and made it very difficult for customers to commit to new spending at this time. Continued COVID-related lockdowns around the world, particularly in Europe and India, are delaying the economic recovery in these regions and creating a significant stress for the local refining industry as higher oil prices and tepid fuel demand have depressed refining margins. This was also the case until recently in the United States, but as economic activity has accelerated here, margins have improved in the last few weeks. And third, These dynamics, combined with calendar 2021 budgets that are reflective of the uncertain macro environment and mid $40 oil price at the time, when they were set late in calendar 2020, created a difficult spending environment. In light of our recent performance and the current market outlook, we're now taking a more cautious outlook on growth in fiscal 2021. It is important to know that Although we did not experience any significant losses in the third quarter, our updated outlook is based mostly in the decision-making pattern by some customers. Although we continue to have significant customer engagements and demand generation activity at the top of our sales funnel that support a pipeline of business that is broadly consistent with pre-pandemic levels, we believe it is prudent to assume that the elevated level of late no decisions by customers in recent quarters could persist until at least the end of this fiscal year. As a result, we're adjusting the range for annual spend growth to 4 to 5.5 percent. Our initial guidance for the year laid out a wider than normal range of potential outcomes, and our updated outlook reflects, first, lower gross growth driven by curtailed spending in refining and chemicals, which has impacted our MSC business, and lower growth contribution from APM consistent with the pattern experienced in the fiscal year, and second, attrition that will come in at approximately 6%. I would like to spend a few minutes providing more color on what we're seeing in the market. As we discussed in depth at our investor day earlier this year, Digitalization and sustainability are two of the most important investment priorities in the process and capital intensive industries. Customers recognize that Aspen Tech solutions are critically important to successfully executing in these areas and meeting their goal of running assets safer, greener, longer, faster, and more profitably. Our overall pipeline of opportunities has continued to grow each quarter since the pandemic began. And in particular, we're seeing growing engagement with customers for sustainability-related activities. We're excited by the conversations we're having with customers, and they give us confidence in our long-term, double-digit annual spend growth prospects, despite the short-term challenge we're facing. The macro environment has remained less predictable than originally anticipated, proving difficult for customers to commit to new spending in the near term. We believe there are ways for our sales organization to adapt to this new environment, but this will likely only have a modest impact until macro conditions improve and normalize. The end market most impacted by macro conditions relative to our expectations is refining. Although customer engagement remains high, refining utilization rates and margins remain below historical trends, even as they have shown improvement from last year's lows in the United States. Fuel demand continues to be well below pre-pandemic levels, and during the quarter, lockdowns persisted in certain key regions, most notably Europe and India. The cumulative impact of the past year has weighed on operating budgets and refiners' ability to make incremental investments in their operations. We believe this is a temporary dynamic that will reverse itself as macro conditions improve across the world, However, in the near term, we would characterize business conditions with refiners as amongst the most challenging in the last 10 to 15 years and a notable difference from the last market cycle five years ago. Conversely, as we've discussed on recent calls, chemical customers have shown good resiliency, but spending softened in the quarter, which could be a transitory issue reflecting the factors mentioned earlier in my remarks. These customers are focused on the longer-term needs of their businesses and recognize the critical value AspenTech provides by enabling assets to operate in a more efficient and environmentally sustainable manner. Turning to the ENC market, our performance was largely as expected. The ENC industry continues to adjust to current capex spending, which is leading to higher attrition levels and lower new spend activities. As a reminder, these customers continue to use and deploy Aspen Tech solutions extensively across their operations and changes in their spending levels are a result of having fewer projects in backlog. We continue to have very close and active engagements with our ENC customers and understand the near-term challenges as well as the exciting long-term opportunities in this market. In APM, We continue to see significant interest from customers as pilot activity remains at record levels. The combination of reduced operating rates in these assets and lower spending on maintenance has had a pronounced impact on close rates in APM, and we saw a continuation of the trend towards no decisions in many of our sales cycles. The increase in customer interest and successful pilot deployments have created a significant pipeline of vetted transactions that are available to be signed once market conditions improve. We have made important progress in improving out the value proposition for APM for many customers in our core industries and GEIs, which gives us confidence that APM can grow significantly faster over the long term. We did close a number of transactions for APM in the mining and pulp and paper industries, including some minor transactions in our core industries and most notably expanded the use of Aspen Entel for an integrated oil company in Europe to one of their biofuel refineries. Finally, we have made good progress in building out our dedicated pharma unit, including the go-to-market teams. We believe the pharma market represents a significant growth opportunity for Aspen Tech, and it's an area in which we plan to continue to invest. following our highlights of a couple of transactions we closed in the quarter. First, a global chemical company headquartered in Europe and long-term user of our engineering and MSC suites was offered by an Aspen Tech competitor the opportunity to replace our engineering suite by granting a free, no-cost license to their technology for three years. After a careful evaluation by the customer of the capabilities of both solutions, The customer proceeded to renew the agreement for our engineering suite as well as gross spend by expanding use to sites in Asia and other recently acquired locations. Second, a longer-term European customer of Aspen Tech selected Aspen GDOT to expand use of the multi-unit optimization technology to a second refinery. Aspen GDOT was selected after the customer concluded a competitive tender process originally kicked off in April 2020 and postponed multiple times due to the pandemic. The customer is looking to increase profitability at this second refinery by improving operational performance. Third and final, a new customer to Aspen Tech and mid-tier mining company in Australia signed a transaction to deploy Aspen Emtel at two mining sites in Australia after conducting a pilot for the technology. The pilot was kicked off during the first quarter of our fiscal year 21. The value of Aspen Emtel's predictive capability was proven during the second quarter, and the transaction was signed this past quarter. Aspen Emtel was selected for being a commercially available software application, industrial equipment agnostic, fast to deploy, and for providing a clear value proposition to reduce operational downtime. This success will lead to further rollout of Aspen Emtel to other mining sites in the future and create opportunity for other Aspen Tech products with this company. As we look forward, we're focused on managing and executing against the things that are in our control to ensure we're best positioned to benefit from an improved macro environment as quickly as possible. In particular, we continue to make excellent progress in building out and expanding our market-leading product portfolio. The market is responding to our vision of the self-optimizing plant and how we can leverage artificial intelligence across our solutions. Feedback on both Aspen 1v12 and the AIoT Hub has been very positive. For example, a U.S. chemical manufacturer has been drawn to our V12 offering as a way to democratize AI access and utilization in their business. They have noted that our AI power model building workflow is a very user-friendly way to build artificial intelligence models without having existing resources trained in advanced computer science. For them, it would put AI functionality directly into the hands of the manufacturing technical personnel where it is needed most. We believe our recently introduced innovations combined with our existing technology and 40 years of domain expertise reflect a compelling product market fit that meets our customers' strategic priorities of improved efficiency and reduced environmental impact. We have introduced a tremendous amount of innovation over the past year, which provides for a number of different opportunities for faster growth over time. Whether it is hybrid engineering models, Aspen GDOT, the AIoT Hub, Aspen Enterprise Insights, or any of our other recent innovations, we have more ways to deliver value for customers than at any point in our history. We will continue to make significant investments in our product portfolio and go-to-market efforts to best position the company for the long term. We have great confidence in our business and believe our ability to invest through all the stages of the economic cycle strengthens our market position and ability to deliver on our long-term objectives. We're also hosting our biannual Optimize Conference on May 18th through the 21st, where we will continue to engage customers across all the innovation we have released and our long-term historical products. This will be our first virtual conference virtual customer conference, and it is generating significant interest with thousands of customers now registered. We have a strong lineup of sessions and speakers, with the technical sessions being oversubscribed from customers' interest to present how our solutions are being leveraged to create value and improve sustainability in their operations. We look forward to your participation as well. From a capital allocation perspective, we did not repurchase any shares in the first three quarters of fiscal year 2021. And we anticipate that it is unlikely that we will meet our previous stated intent of repurchasing $200 million of stock in fiscal year 2021. The lack of share repurchase activity in recent quarters was driven in large part by practical limitations, namely a lack of available open windows to reinstitute our buyback. We have a demonstrated track record of deploying capital to drive shareholder value throughout prior business cycles. Our capital allocation framework and philosophy remain the same. Invest organically in our business, inorganically with acquisitions, and where business and market conditions allow us, return excess cash to shareholders via share repurchases. Finally, I would like to welcome the two newest members of Aspen Tech's Board of Directors. Karen Goltz, and Jill Smith. Karen is a retired Ernst & Young partner who held a number of senior positions in her 40-year career with the company, including as Global Vice Chair of E&Y Japan and its professional practice and professional ethics and independence. We're excited to add Karen's expertise and experience to Aspen Tech's board. Jill has more than 20 years of international business leadership in diverse industries, most recently serving as president and COO of Alight Minds, an IP commercialization company for technology and life sciences, and earlier in her career as CEO and president of Digital Globe, and a partner at Bain and Company. We're excited to add the diverse expertise and experience of Karen and Jill to Aspen Tech's board. Before I turn the call over to Chantel, I want to reiterate the inherent strength of our business and our continued confidence in its long-term growth opportunities. Even as many of our customers face a challenging environment, we believe we will grow our business 4% to 5.5% in fiscal 2021 and generate industry-leading margins. As the impact of the pandemic fades and economic conditions improve, we expect our business will begin to realize the customer demand that has built up over the past year, who are well-positioned to benefit from our investment priorities that we believe will sustain double-digit annual spend growth for years to come. Now, let me turn the call over to Chantel. Chantel?