Aspen Technology, Inc.

Standing by and welcome to the third quarter 2023 Aspen Technology Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1-1 on your telephone. To remove yourself from the queue, simply press star 1-1 again. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Brian Denuke. Please go ahead, Sarah.

Thank you. Good afternoon, everyone, and thank you for joining us to discuss our financial results for the third quarter of fiscal 2023, ending March 31, 2023. With me on the call today are Antonio Pietri, Aspen Tech's President and CEO, and Chantelle Brightup, Aspen Tech's CFO. Before we begin, I want to make the State Harbor Statement that during the course of We may make projections or other forward-looking statements about the financial performance of the company that involve risks and uncertainties. The company's actual results may differ materially from such projections or statements. Factors that might cause such differences include, but are not limited to, those discussed in today's call, as well as those contained in our periodic reports with the SEC, including our most recently filed form 10-KT with the SEC. Although, please note that the following information relates to our current business conditions and our outlook as of today, April 26, 2023. Consistent with our prior practice, we expressly disclaim any obligation to update this information. Please note that we have posted 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 results and highlights from the third quarter, followed by Chantelle, who will review our quarterly financials and guidance for the remainder of fiscal year 2023. With that, let me turn the call over to Antonio. Antonio?

Thanks, Brian, and thanks to all of you for joining us today. Aspen Tech's third quarter performance was solid despite an uncertain microenvironment. with a strong demand in many of our end markets and a return to double-digit ACV growth. While we did see the macro environment have a more pronounced impact on sales during the quarter, primarily in chemicals, we're glad to be reporting double-digit growth for the last 12 months and are on track to deliver against our initial guidance range for the full year. As we know, the last quarter, chemical customers had been reporting weakness in the demand environment starting in their September calendar quarter, with the drop in demand being significant in their December quarter as reported in their related earnings announcements. As a result of these dynamics, We believe their calendar year 2023 budgets reflect tighter OPEX budgets, which resulted in a material pullback on software spending in the quarter for Aspen Tech, led by bulk chemical producers. We will remain cautious about the software spending outlook from this industry for the remainder of the calendar year. Overall, we're pleased with the progress of many of our key strategic priorities through the third quarter. A key focus for us this year has been the transformation of the OSI and SSE businesses and successfully integrating them with Heritage Aspen Tech to create a much larger, diversified, and faster-growing industrial software leader. Now, looking at our financial results for the third quarter, annual contract value, or ACV, was $854.6 million up 11.2% year-over-year. Revenue was $229.9 million. GAAP loss per share was 89 cents, and non-GAAP EPS was $1.06, and free cash flow was $129.3 million. Please note there were some short-term timing dynamics this quarter that Chantel will discuss later. Looking at the quarter in more detail, we continue to see a strong demand environment in most of our end markets. Commodity prices and CapEx and OpEx budgets remain constructive, and we're seeing continued growth in our sales pipeline across all three businesses. Aspen Tech is in an enviable market position, where our solutions directly address the overlapping need for increased production of energy, chemicals, and electricity in a sustainable manner. We're encouraged to see that customers' investment in sustainability and their interest to invest in Aspen Tech solutions to meet the dual challenge remains robust, despite the uncertain microenvironment. We believe our diversified portfolio across traditional energy sources, chemicals, power transmission and distribution, and emerging sustainability areas like carbon capture and sequestration and hydrogen give Aspen Tech numerous ways to benefit from these trends for the foreseeable future. would now like to spend a moment providing details on what we're seeing in the market and our performance by vertical refining remain a source of strength in our business as it has been historically while macro uncertainty exists a strong global demand for refined products is expected to keep refining margins healthy through calendar 2023 additionally We're seeing many refiners continue to increase investments to meet the stringent emission standards put in place by many countries globally, including the EU's mandate for a 55% reduction in greenhouse gas emissions by 2030 and net zero by 2050. As the events of the past 12 to 18 months have shown, having consistent and reliable sources of energy is a security imperative that increases the need for traditional energy products until the transition is achieved. With respect to the upstream and midstream industry, the strong short and medium-term outlook for oil and gas demand is helping to drive double-digit increases in CAPEX budgets in 2023. This projection is reinforced by the International Energy Agency's forecast of record demand for oil in 2023, reflecting the ongoing recovery in air travel and the reopening of the Chinese market after its COVID shutdown, among other factors. We're seeing excellent traction with our end-to-end set of solutions for this market. The combination of Heritage Aspen Tech's expertise in above-surface upstream energy production With SSEs, market-leading subsurface modeling solutions gives customers the ability to manage and optimize the entire exploration and production envelope and ultimately optimize the entire oil and gas value chain using our solutions, from the ground to the pump and across into chemicals. SSE, in particular, has performed well beyond our expectations on an ACV basis year-to-date. and it is seeing very positive customer demand trends. The strong end market demand is being complemented by the transition of SSE's commercial agreements to align more closely with Heritage as Pentec, which was one of the key transformation priorities for this business. For example, the recent introduction of the token-based SSE suite has received excellent feedback from customers and is contributing to growth in our pipeline. we signed several notable wins in the third quarter, including being selected by one of the leading international oil companies to be the engineering modeling and simulation technology that we'll standardize on for facility design in their nascent carbon capture and sequestration business, which they predict could generate billions in future revenue for their company. These customers selected us after evaluating multiple competitors of Aspen Tech in the market, This win is a great example of how the SSE suite combined with our engineering suite will support customer sustainability efforts. The growing investment in oil and gas projects also continues to positively impact the ENC industry and customers' backlogs, accelerating the growth in spend for our engineering suite with this customer sector. In recent quarters, We have seen a steady improvement in demand from these customers as they execute on their expanded backlog of projects. More importantly, it is now clear that a significant number of our ENC customers are materially benefiting from sustainability CapEx investments by way of improved backlog growth, which in turn is supporting greater usage of our engineering products. We believe current trends in both traditional oil and gas projects as well as newer sustainability projects represent a more durable and diversified opportunity for Aspen Tech in this market going forward. Shifting to the power transmission and distribution, or T&D, industry. This industry continues to benefit from significant investment in T&D infrastructure critical to meet the sustainability goals of the future. making this market one of the most attractive long-term infrastructure opportunities in the world. Electrification of the global economy is driving rapid growth in demand for electricity and for our DGM solutions. Utilities recognized grids need to expand and become more reliable to handle the increased demand for electricity and additional complexity introduced by the growing mix of renewable sources of power generation. all these compounded by the rising rate of outages resulting from unpredictable storms. Additionally, hardening the security of the grid against the threat of cyber attacks is a national security issue and a top priority for these customers. We believe the only way to do this efficiently and at scale is through broader adoption of software technology. We recently validated this thesis at the industry conference Distributech, where we witnessed firsthand the high level of interest and demand for DGM product demos from many of the world's leading utility operators. We're making good progress on the ongoing transformation of the OSI business and go-to-market efforts for our DGM products. One key pillar of the transformation of OSI and its go-to-market activities has been educating utility customers on the benefits of adopting the term software license model, which is happening faster than we expected. Customers are embracing the benefits of the model, such as access to term license-only software capabilities and, for some customers, the opportunity to leverage CapEx budgets to fund these projects. This is a great outcome that will accelerate the long-term transformation of the OSI business. The introduction of the DGM Token Suite will soon make the full range of benefits from this licensing model available to customers, which we believe will lead to broader deployment of the solutions in the DGM Suite. While we're on track to achieve our growth target for term software ACV from new DGM product transactions for the year, We have also identified two items during the integration and transformation process that will have an impact on OSI's financial performance by reducing expectations for its ACV and revenue growth in the year. First, we identified several areas for improvement in OSI's project delivery organization, impacting several contracts that were signed prior to the Emerson Aspen Tech transaction. These projects will take longer than expected to complete and thus delay achievement of project milestones for revenue recognition. These delays also present headwinds for the recognition timing of perpetual SMS ACVs booked as part of these bundled deals. It has also become clear that our assumption that we could accelerate the T&D market sales cycle to bring it closer to Heritage Aspen Tech was overly optimistic. So, while we're pleased with the amount of demand generation activity we're seeing in this market, we also now expect that DGM transactions will likely take 12 to 24 months on average to complete versus Heritage Aspen Tech's traditional 9 to 12 months. It is important to note that both dynamics will be short-term in nature, are well understood by our team, and reflected in our model going forward. We remain incredibly optimistic about Aspen Tech's opportunities for growth in the D&D market. Finally, in the chemicals industry, a combination of factors including higher energy costs and persistent supply chain challenges have led to significant destocking and declining demand for these companies. resulting in a material impact on these customers' margins. This was most notable in the bulk chemicals market, which historically is more sensitive to macroenvironment than specialty chemicals. This resulted in a pullback in customers' OPEX software spending in the quarter that was more pronounced than we anticipated. For the first time this fiscal year, we saw sales cycles elongate in all regions with an increased number of deal postponements and a push-out of the existing pipeline. Note that software spending from chemical customers is a primary driver of growth for our MSC suite. Despite these near-term challenges, we continue to be positive on the long-term prospects for the chemicals market and expect it to be a meaningful contributor to our growth over time. Finally, while we continue to work through the demand environment for our APM business, I would like to highlight its performance during the third quarter. APM closed a handful of meaningful transactions globally, with one existing customer signing a seven-figure transaction to expand their APM deployment across several of their businesses. I would now like to share some additional customer wins from the quarter that demonstrate our success. First, one of the largest engineering companies in the world and a long-term user of our engineering suite increased their token entitlement by more than 10%. This customer is benefiting from sustainability CapEx investments for carbon capture and sequestration and hydrogen projects. As such, they are seeking to meet their engineers' usage needs for their current backlog as well as their expectations for backlog growth in calendar year 2024. Second, a national oil company formed a new entity to take control of exploration and production assets from their former international oil company partner. As part of this process, this new company signed an agreement with Aspetec to maintain and expand its access to our SSE products. With expectations to significantly increase exploration drilling activities over the next two, three years, this customer more than tripled its number of employees who now have access to SSE products. Future expansion opportunities with this customer involve signing an enterprise agreement to consolidate and expand access to other Aspen Tech product suites across all its holdings. Third and final is our successful win of an RFP for a long-term customer of OSI who has deployed many of our DGM products across its grid over the years. This customer issued an RFP to replace their existing real-time data historian, which was end-of-life by one of our industrial company competitors. After evaluating our bid versus that of our competitors' recently acquired historian product, The customer chose OSI's Cronus product. In addition, this customer had already agreed to deploy our security authenticator open app product by November 2024, but because of a control center upgrade, we're now accelerating its deployment to the spring of 2024. Furthermore, this customer is currently fulfilling a grant with the Department of Energy for a future application funded by the department to implement advanced distribution management solution capabilities, which were also quoted. This series of wins by OSI with a long-standing customer speaks to the strength of our DGM product suite, significant T&D and market demand, and our ability to help customers accelerate outcomes to better manage the growing complexity of the grid. Turning to our innovation investments, we were proud to release our new emissions management solution during the quarter. This new solution combines OSI technology with our traditional software expertise to consolidate customers' emissions data alongside plant, enterprise, and value chain OT application data into a single pane of glass view. With a holistic view of their emissions, abatement targets, and margins, customers can now make real decisions of the most meaningful and cost-effective ways to reduce emissions in their operations. This is an exciting example of how Aspen Tech can help directly reduce our customers' carbon footprint. It is also an important example of product synergies from the Emerson transaction, as we will be bringing what was originally an OSI product to our energy and chemical customers. We also announced a recent partnership between Aspen Tech, Emerson, and Microsoft, that demonstrate a successful evolution of our relationship with Emerson, as well as our commitment to helping energy and industrial companies advance their sustainability goals, including reaching their net zero targets. The three companies partnered to install a demo of their joint hydrogen value chain solution that helps optimize capex investment, lifecycle operating cost of production, supply chain, and storage infrastructure to expedite a speed to market. in a new exhibit at the Microsoft Energy Transition Center of Excellence in Houston, which was launched at a grand opening on March 7th. During the exhibit, customers were excited to see a real, palpable demonstration of a solution that will help to accelerate their sustainability journeys. I would like to briefly mention our ongoing efforts to leverage generative AI capabilities in our products. It is early days, but we have identified many use cases where this capability can help improve the workflow and time to value for our customers. We will provide more details on this exciting area in future calls. I would now like to provide our latest thoughts on our outlook for fiscal 2023. We're tightening our ACV growth range to 11 to 12 percent comprised of approximately four points of growth contributed by DGM and SSE and the remaining seven to eight points from Heritage Aspen Tech. This compares to our prior guidance of 10.5 to 13.5 percent. Our updated outlook reflects the following. We expect the demand environment and business dynamics that our customers experience in the third quarter of fiscal 2023 to continue in the fourth quarter. Second, the change in the high end of our updated range is predominantly attributable to the pullback in chemical customer software spending as well as other geopolitical considerations now impacting growth. We do not anticipate any improvement in these two areas in the fourth quarter. DGM and SSE are still tracking to deliver approximately four points of growth for the year. However, the relative contribution will be different than we anticipated. SSE has meaningfully outperformed our expectations this year and is now expected to deliver the majority of the ACV growth for these two businesses. Extended implementation timelines for certain projects and longer sales cycles in DGM will reduce its near-term contribution to ACV growth in fiscal 2023 relative to our initial expectations. To be clear, we expect this to be only a short-term issue and is primarily a function of timing. We're very optimistic on OSI's market opportunity and expect it to be a significant growth driver over time. As we have discussed throughout fiscal 2023, we intentionally constructed our guidance with a wider range to account for the number of variables facing the business this year, including our efforts on the integration and transformation of OSI and SSE, the potential volatility in the economy and uncertainty around some of our end markets, COVID, and other geopolitical factors. We believe the new guidance represents a solid outcome for the year and is in line with our initial expectations in a year when we have been executing on a significant integration and transformation effort in the context of high economic and geopolitical uncertainty. Finally, we're making some changes to realign our senior leadership team to bring greater focus to our execution and especially our transformation activities. Effective today, our current head of global sales, Felipe Suarez Pinto, will now report directly to me. Felipe is a 20-year veteran of Aspen Tech and has been running our global sales organization for the last two years. Our current CRO, Manish Ola, will be transitioning to a new role focused on all aspects of customer success, including professional services, customer support, and partners. We believe these changes will better position Aspen Tech to meet our future goals and objectives. Let me finish by saying that we continue to be incredibly bullish on the opportunity ahead for Aspen Tech. We have successfully brought Heritage Aspen Tech, OSI, and SSE together and laid the foundation for long-term, durable, highly profitable growth. We're aligned with several highly attractive market trends that provide numerous opportunities for success. I would now like to turn the call over to Chantel. Chantel?