Aspen Technology Inc (AZPN) 2004 Q3 法說會逐字稿

Good afternoon. My name is April and I will be your conference facilitator. At this time I would like to welcome everyone to Aspen Technology third quarter conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star then the number one on your telephone key pad. If you would like to withdraw your question, press star then the number two on your telephone key pad. Thank you. Mr. Young, you may begin your conference.

Good afternoon. I'm Joshua Young, Director of Investor Relations for Aspen Tech, and with me today are David McQuillin, President and CEO, and Chuck Kane, our Chief Financial Officer. I would like to welcome you to this conference call to discuss our financial results for the third quarter of fiscal year 2004 ended March 31. For those of you on the webcast, we are having some technical difficulties that should be resolved momentarily.

Before we begin, I'll make the usual Safe Harbor statement that during the course of this conference call we may make projections or other forward-looking statements regarding future events or the financial performance of the company that involve risks and uncertainties. The Company's actual results may differ materially from the projections described in such statements. Factors that may cause such differences include, but are not limited to, those discussed in today's earnings release and in the risk factor section in our Form 10(K), as well as other subsequent filings made with the Securities and Exchange Commission.

Also please note that the following information is related to current business conditions and our outlook as of today, April 29, 2004. Consistent with our prior practice, we undertake no obligation to update this information prior to the release of our fourth quarter fiscal 2004 financial results which is scheduled for late July.

During the course of this call today, we will reference nonGAAP information in compliance with the SEC's Regulation G, we filed an 8(K) this afternoon that includes our rationale for and why we believe nonGAAP information is important in describing our operating performance, as well as a full reconciliation with the corresponding GAAP numbers. The company expects to file its Form 10(Q) for the third quarter some time in the second week of May.

On today's call, David McQuillin will begin with a review of the most significant developments followed by updated commentary on the environment and business outlook. Chuck Kane will then cover all of the financial details of the third quarter and update the Company's formal financial guidance. Then we will be pleased to take your questions. Now I'd like to turn the call over to David.

Thanks, Joshua. I would like to thank everybody for joining us today. I am pleased to report that for the sixth straight quarter Aspen Tech has met its operational targets. This is an important testament to the consistency in improvement of our execution over this extended time frame. The operating profit we reported for the third quarter was the highest in four years. A very significant milestone for the Company. I'm proud of the dramatic turnaround we have made to deliver these results, but we still have more work to do to realize the full potential of the Company.

In Q3 we also continued to pay down our debt and we showed improvement on several key financial metrics. I'll begin by covering some of the important accomplishments in the quarter. Total revenues and pro forma earnings per share were both within the range of guidance we provided at the beginning of the quarter. Additionally, for the second quarter in a row, we reported positive GAAP earnings without the benefit of a one-time gain. This is the first time this has occurred since the middle of fiscal year 1998.

We reported our fourth consecutive quarter of year-over-year software growth. We continue to believe that our longer-term growth will be fueled by the new products we have introduced over the past several quarters, and a continued recovery in the global economy, particularly in the vertical market segments that we serve.

In the meantime, I am pleased that we are growing our existing set of point solutions organically at a time when many IT investments are still undergoing a great deal of scrutiny from customers. This is cause for optimism as we build sales pipeline and invest new resources for our nine recently launched products.

For the first time in several quarters, the chemical market represented the largest percentage of our software license revenue. The amount of business we closed from this market more than doubled from the December quarter. This is a very positive sign, as chemical companies are beginning to see a gradual upturn in their businesses and are more willing to make long-term IT investments that deliver tangible economic benefits.

Finally, we finished the commercial release of Operations Manager Suite, Aspen PIMS Enterprise Edition which is our next generation petroleum supply chain solution, and we launched the first of our vertical market solutions, Aspen Oil and Gas. These are three of the nine new products that we are targeting for growth in fiscal 2005.

I'd like to briefly cover some of the financials before Chuck goes into more detail later in the call. Total revenues for Q3 were $80.7 million, which was at the high-end of the range of guidance we set for the quarter. License revenue of $35.9 million was at the lower end of our guidance. And services revenue of $44.8 million came in higher than planned.

From a geographic standpoint, our license revenues were as follows: First, the Asia Pacific region continue its steady performance in the quarter and we continue to see promising pipeline opportunities. The region demonstrated strong performance in fiscal year 2003 and has continued this momentum for the first nine months of this fiscal year. As we have mentioned before, the projected GDP growth in this region should benefit Aspen Tech as a demand for chemical- and petroleum-related products is expected to grow significantly over the next several years.

In the Amaya region of our business, we closed several deals that were focused on improving plant production, including two of the largest transactions in the quarter. We are currently seeing larger deal size opportunities in this region as the selling environment continues to improve.

We saw the largest investments in our supply chain software from the North and Latin American region. Much of the strength of this category came from refining companies in the region. We expect further improvements from this region during the fourth quarter, as it is likely to benefit from the recovering chemicals market.

In terms of revenue by product line, our engineering product line represented approximately three quarters of our software revenue in the quarter, while the manufacturing supply chain product line represented approximately 25%. We see little changes in the trends for our engineering product line which continues to deliver consistent quarter-to-quarter performance. Many customers are demanding more collaborative PLM solutions to improve engineering efficiency and asset utilization across multiple business units. We expect that the continued investment in capital projects, especially in the oil and gas industry, will also help to drive demand for these tools.

Our manufacturing supply chain product line remains poised to show significant growth. Some of the rebound we saw in the chemicals market this quarter was due to an increased investment in our plant and supply chain products as chemical company's focused on driving productivity improvements. For the second straight quarter, our supply chain planning solutions performed nicely, particularly in North and Latin America. The pipeline for manufacturing supply chain remains strong and we believe we will benefit from the recent launch of our Aspen Operations Manager Suite which I will comment more on later in the call.

In terms of end-user market trends, the chemicals market represented the largest percentage of our license revenue as bulk chemical and petrochemical companies increased their IT investments. Over the past few quarters, most of the chemicals business we closed was in the specialty chemicals market which tends to be closer to the consumer. Despite the fact that crude oil and natural gas prices remain high this quarter, a number of our largest commodity chemical customers made investments due to a strong belief that the market is slowly beginning to recover.

Refiners and oil and gas companies continued to enjoy an environment of high crude and natural gas prices which are positively benefitting their margins. As it has been for several quarters, this industry is healthy and actively spending on projects that improve operational efficiency. Refining oil and gas was our second largest contributor in the quarter and combined with chemicals to represent approximately three quarters of our software revenue.

Refining, oil and gas we saw no significant changes to the trends we have seen in the engineering market. These companies continue to expand the use of our engineering software to execute capital projects for both chemical and petroleum companies. This industry remains an important market and benefits greatly from our collaborative engineering solutions.

Looking now at license revenue and transaction size, our statistics were fairly typical of our historical third quarters. Our average deal size for deals over $100,000 was approximately $425,000; compared to 450 K. last quarter. We closed 31 license transactions between $250,00 and $1 million; as compared to 26 transactions last quarter. And 25 transactions in the same period last year.

We closed five transactions of approximately $1 million or more, down from nine transactions in the same quarter last year. This is important evidence of our efforts to seed the market with more moderately sized pilot projects that we believe will lead to future follow-on business as we execute the projects successfully.

Services revenue was a bright spot in the quarter, totaling $44.8 million, which was flat with last year's third quarter. This is the first time in the past five quarters that services revenue has not seen a year-over-year decline. We still believe that we need to focus our efforts on improving both the profitability and growth of the services business. But we are encouraged that new licenses in our manufacturing supply chain software product line have led to renewed activity for services in this part of our business.

Netting down to the bottom line we reported an operating profit of $5.4 million. Our highest since June of 2000. This resulted in pro forma earnings per share of 6 cents which was at the high-end of the guidance that we set last quarter.

Now let me spend a few minutes talking in more detail about the transactions we closed this past quarter. As I mentioned earlier, there was a trend this quarter towards customers initiating more moderately sized projects versus deals that were significantly above $1 million. This is not surprising given the fact that this was the first quarter of a new calendar year and customers continue to be interested in staging projects rather than making substantial up-front investments.

First, I will start by detailing some of the transactions we closed for our engineering product line. Our largest transaction in the quarter was a multi-million dollar agreement with a European based petroleum company which is the fourth largest oil and gas company in the world. Like many of our petroleum customers, this company has been an active consolidator in the industry and has significantly expanded the number of its employees and plant assets over the past several years. As a result, it sought an agreement that would enable it to more efficiently leverage its process modeling knowledge across the organization.

This agreement provides them with broader access to our engineering tools in their exploration and production, refining and chemicals businesses. Part of our long-term engineering product strategy is to help our customers improve their engineering productivity and production efficiency by providing engineering models that can be shared between both the refining and the petrochemical plants.

Suncor Energy, Canada's fifth largest oil producer has been a strong supporter of Aspen Tech's vision for the enterprise operations management market. It signed a multi-million dollar agreement to expand access to four of our engineering product families. Suncor believes that our engineering tools will form the foundation for its enterprise-wide optimization efforts. Including it's multiple plants and their supply chain.

The company is in the process of investing billions of dollars to develop its interests in the Canadian oilsands. It is one of our first customers use our engineering solutions as part of the effort to convert oilsands into crude and crude-related products. Our engineering tools will deliver collaborative engineering and PLM solutions so that it can more efficiently complete detailed engineering work earlier in the project's life cycle.

As part of this transaction, Suncor listed Aspen Tech as one of its top five strategic software providers. Primcor, one of the largest independent refineries in the United States, purchased our simulation and optimization tools for its Lima, Ohio refinery. This refinery had not been performing up to Primcor's profitability standards and it purchased our software based on its belief that it could use our tools to save 5 cents a barrel, or more than $3 million a year. Our software will provide them with a better ability to predict the impact of their actions on the overall profitability of the refinery and ensure that they make the right decisions to optimize their performance.

Lubrizol, the $2 billion specialty chemicals company, licensed our entire Aspen Engineering Suite based on its desire to improve its product introduction process. By using our tools collaboratively to better connect its product development and manufacturing departments, Lubrizol can reduce its time to market significantly, which could result in tens of millions of dollars in savings.

As many of you may recall, Statoil, the national oil company of Norway, was one of our first Plantelligence customers and has long been one of the most innovative users of our manufacturing supply chain software. Historically, it is not been an active user of our engineering solutions. It has agreed to dramatically expand its use of our engineering suite. Additionally, we are well-positioned to close another near-term agreement with Statoil for our new Aspen Oil and Gas offering that we just announced last quarter.

On the last few calls, we've spoken at length about the strategic importance of Asia and the Middle East to our future growth prospects. We continue to make solid progress in both of these regions. In Asia, we closed three large transactions, one with SK Corporation, the largest refining company in Korea, the second with Chiota [ph], a large engineering and construction company, and finally, a transaction with Mitsui Chemicals.

Also in the Middle East, Saudi Aramco followed up on the large transaction it closed with us in the December quarter with another agreement this quarter for our economic evaluation product family. It believes that the software will help it to estimate project costs above $2 billion to within 5%.

Now let me talk about some of the larger transactions we closed in our manufacturing supply chain or MSE product line. Eni Refining signed an agreement with us to roll out our advanced process control solutions to five additional refineries. For many of you who have attended Aspen World or reviewed our customer case studies, Eni is a perfect example of demonstrable value our solutions provide to the industry. Eni saved $30 million on a previous Aspen Tech implementation by rolling out our advanced control solution at one refinery alone. This latest multi-million dollar agreement seeks to build off of that success and improve the profitability of several other large refineries in their enterprise.

Valero, the largest independent U.S. refining company, purchased our supply chain planning, information management and yield accounting solutions for a refinery it recently acquired. The key driver for this transaction was that Valero wanted all of its refineries to be on a standard technology platform so that it could facilitate consistent best in class business processes for each of its refineries.

Valero has been a long-term user of Aspen Tech technologies and has already made significant investments to deploy this IT infrastructure in 13 of their other refineries. It expects to be in a position to have real time financial and operational information for regional and corporate reporting and tracking. This defines what the enterprise operations benefit market is all about; closing the gap between business and plant systems to take a more holistic approach to our customer's enterprise operational performance.

Our European Specialty Chemical Company licensed our manufacturing execution software in order to optimize plant productivity and more efficiently manage its production of more than 600 products. This company has been facing increased competition from low cost competitors and has selected our tools to reduce its fixed and variable costs in the plant so that it could maintain its margins while aggressively pricing its products against competitors.

BASF, one of our most integrated customers which produces chemicals, plastics, performance products, agricultural products and fine chemicals in addition to crude oil and natural gas, has been a long-term engineering customer that has just begun to expand its use of our MSC products. BASF purchased our information management solutions to be the global corporate standard for its core manufacturing execution systems. BASF recognized a number of benefits of standardizing on this solution, including lowering its overall cost of IT ownership and creating corporate standards allowing more transparent and integrated information flow and decision making.

Similar to our agreement with Eni Refining, this transaction is another proof point that customers are beginning to acknowledge the emergence of the enterprise operations management market. Much the same way that the ERP market evolved we are seeing customers beginning to immediate from best of breed applications to a more standardized IT approach for their operation software, in order to more efficiently run their operations on both a regional and corporate level. ERP vendors will not be able to bridge this gap because they lack the deep domain expertise that is required to provide customers with the analytical information they need to run their businesses more efficiently.

L'Oreal, a brand new customer for Aspen Tech, licensed our manufacturing execution software to manage and optimize its plant operations. The solution will help L'Oreal to achieve regulatory compliance, as well as define production recipes and manage work orders and procedures. Close integration with 66 business systems will be achieved through connection to the company's SAP system, using the integration infrastructure module of Aspen operations manager. This transaction was a competitive win against SAP and our process manufacturing knowledge enabled us to solve difficult problems inside the plant that SAP could not address.

Our Operations Manager Suite had a significant impact on our ability to close several large MSC transactions this quarter, it was a major factor in our wins at Eni Refining, BASF, L'Oreal and several other customer sites we cannot yet reference by name. The suite was released commercially this quarter and includes four integrated components, performance score carding, roll based visualization, event management and integration infrastructure. Previously we had been primarily selling the integration infrastructure module which has already been licensed by 27 customers and has shown early traction in the market.

In addition to being a new licensable product for Aspen Tech, Operations Manager is making all of our existing point solutions more competitive by providing them with new enterprise-enabled capabilities capabilities. This is helping to competitively differentiate Aspen Tech, its customers who have already made investments in our technology can now add new value and capabilities by simply adding components of Operations Manager.

They can gain this value by simply plugging in one product or by increasing the amount of value they can capture by plugging in multiple products. This is creating pull-through revenue for some of our other point solutions and will gradually help to increase our average deal size over time. Additionally, they can solve even more complex problems by integrating multiple plants or business units.

Competitors are unable to match the breadth of our solution or the tight integration of the suite. I think a good example of this is the Conoco Phillips Ferndale Refinery where Operations Manager is now being used by over 200 users in the refinery and the customer has sited it as the second most commonly used application next to Microsoft Office. They purchased Operations Manager as a roll-based visualization layer over their existing Aspen IP 21 information management system.

With regards to the FTC proceeding, I don't have new news to tell you. We are continuing to prepare for litigation. As I've said in the past, the first stage of the process where we argue our case before an administrative law judge is currently scheduled for May 26. I want to reiterate our assumptions regarding the time line for the process which we shared with you last quarter. Judges typically take up to three months to render their decision, which means that the results of the hearing before the administrative law judge are likely to be announced in late September or early October.

After a decision is rendered, a lengthy appeals process could take place, which could take as many as two or more years to complete barring any settlement. Now and throughout this process there is always the potential for settlement on mutually acceptable terms. I would like to reiterate also that we believe our acquisition of Hyprotech has been beneficial to our customers and the marketplace overall. We have provided new functionality, new products and improved service to our customers that would not have happened but for the merger. The best evidence of this is our new Aspen Oil and Gas solution which would not have been possible without merging and integrating the technology of Hyprotech and Aspen Tech.

Some of you have asked about the recent decision regarding KBC. The arbitration was initiated prior to Aspen Techs purchase of Hyprotech, well over two years ago. The award applies to the Hyprotech legal entity and not Aspen Technology Inc. Aspen Tech is the owner of the RefSYS product and can continue to develop and sell RefSYS. KBCs right to HYSYS dot refinery is limited to use with their consulting services business. Aspen Tech believes that our subsidiaries compliance with any award will not impact the development, sales and marketing of the product Aspen RefSYS, which currently is generating an immaterial amount to our total revenues.

Plans for growth. Despite our success over the past six quarters of improving Aspen Techs operational and financial performance, we realize that our next challenge as a company is to drive significant revenue growth and expand our operating margins from where they are today. This is going to require that we are successful in generating license sales for our newer products. Over the past six quarters we have delivered 27 cents in pro forma earnings per share and generated approximately $60 million in cash flow from operations.

This was an important step for the Company. But top cortile companies are consistently seeking ways to rise to the next level. In order to deliver our longer term revenue and earnings targets we recognize that we need to be more effective at marketing and building sales pipeline for new products. To accomplish this, we need to bring a heightened focus on initiatives for our growth products and scale back our investments in lower growth products. This does not mean that we will increase our quarterly expense run rate. Rather we will redeploy more of our dollars into newer products while scaling back organizational resources directed towards products we do not believe will show significant growth in fiscal year 2005.

Finally, an outlook. Before I turn the call over to Chuck, I wanted to spend a few minutes providing you with some qualitative color on the current environment. With the improvement of the economy and the healthy fundamentals of our customers, the environment is significantly improved from one-year ago.

There are a number of large deals in the pipeline that have the ability to close by June which is historically our strongest quarter. These transactions continue to receive a great deal of scrutiny and analysis from customers that are demanding internally a strong business case to justify the investment. As always, it is difficult to predict the timing of these agreements, especially as Sarbanes-Oxley adds additional steps to the approval process.

We are encouraged that for the first time in the past four quarters we saw increase in spending from our chemical customers as their production and capacity utilitization have shown improvement since the beginning of this calendar year. We hope that this quarter was the beginning of an improving and sustained trend of investment from the chemicals market. While we remain cautious due to the fact that feedstock and natural gas prices do remain high.

Certainly this morning's positive earnings announcement from Dow Chemical is a positive sign. Should we see strength in chemicals beyond this quarter, it would augment our business as a refining, oil and gas and engineering construction market and put us in a solid position for the rest of this calendar year.

With that, let me now turn the call over to Chuck.

Thanks, David. I will begin by giving additional explanations's on each of the principal line items on the P&L and balance sheet and then I will conclude my discussion with our guidance and future outlook.

Total revenue for the quarter were $80.7 million with software license revenue of $35.9 million and services revenue of $44.8 million, both within the range of expectations we set forth quarter. Software license revenues grew 3% year-over-year in Q3 and are up 7% through the first three quarters of this fiscal year. As David mentioned earlier, our services business was flat year-over-year and is showing signs of turning around, but we will still show a decline for the year as compared to the prior year in our services numbers.

Expenses totaled $75.3 million for the quarter, down from $79.8 million in the third quarter of last year, which included a restructure amount of $2.1 million. Excluding the legal accrual made last quarter, quarterly expenses increased on a sequential basis by approximately $750,000. This was due to sales and marketing initiatives on new product releases, as well as increases to cost of services resulting from higher services revenues experienced in the quarter.

Headcount at the end of Q3 was 1,713, roughly flat with our headcount of 1,710 last quarter and down from 1,800 employees in last year's Q3. Gross margins on licenses were 89.3%, up modestly from Q2, but down year-over-year due primarily to the mix of products that carry additional third-party royalty payments. Services gross margins totalled 43.4%, flat sequentially, but up year-over-year from 42.6% in the third quarter of last year. Utilization rates have improved as we have made reductions to our services personnel. As we begin to execute more services projects in the coming quarters, we intend to get services gross margins closer to our goal of 45 to 46%.

Sales and marketing expenses in the third quarter were $23.8 million, down 2.6% from a year ago and up sequentially by just over $200,000. The year-over-year decrease is primarily due to a more streamlined sales organization and better utilization of third-party channels and partners. This represents 29.5% of total revenue for fiscal Q3 2004. We expect that sales and marketing will represent a slightly higher percentage of our revenues over the next few quarters as we launch additional new product initiatives.

Third quarter R&D spending was $14.2 million, which is approximately $1.5 million below last year's third quarter. On a sequential basis, R&D spending is flat. R&D costs represented 17.6% of revenues for the fiscal third quarter as compared to 19.7% last year. Our goal is to have R&D spending in the range of 15 to 16% of revenues in our fiscal 2005 time frame.

G&A costs were at $8.1 million or 10% of revenues in the quarter. This was $800,000 lower than last year and down slightly from the prior quarter. You will note that we have footnoted our G&A line on the P&L to break out the amortized, amortization of intangibles which is a material non-cash charge. This quarter amortization of intangibles was $1.9 million, or 23.4% of our G&A costs. Excluding this charge, our G&A costs would represent approximately 7.7% of revenues.

Income from operations nets to $5.4 million up from $2 million in last year's Q3, adding interest and other income yields a pretax profit of $6.3 million. Our effective tax rate for the quarter was 21.5%, and continues to be lower due to utilization of NOLs that total more than $43 million. Factoring in the tax provision yields, net income of $4.9 million, or 6 cents per diluted share on a pro forma basis. This compares favorably with pro forma net income of $2.4 million, or 6 cents per share in last year's third quarter.

As a reminder, these pro forma earnings numbers are based on a fully diluted share count of 88.2 million shares which includes the impact of the Series D preferred stock. GAAP diluted earnings per share are based on a fully diluted share count of 51.9 million shares. For GAAP purposes the fully diluted effect of the Series D preferred stock only takes effect when net income is approximately $8 million or higher. The $36.3 million difference in the share count represents the underlying Series D shares that are outstanding.

On a GAAP basis, net income applicable to common shareholders totaled $1.5 million with diluted earnings per share of 3 cents; compared to a GAAP loss of $1.9 million or 5 cents loss per share in last year's third quarter. The current quarter's GAAP results include $3.4 million of preferred stock dividend and discount accretion for the Series D preferred stock.

Now turning to the balance sheet. We ended fiscal Q3 with $114.4 million in cash and equivalents, that's down $10.5 million from $124.9 million in Q2. This decrease is primarily attributable to our repurchase of approximately 12 million of the company's 5.25 coupon convertible debt which stands at a balance of approximately $62 million at the end of this quarter.

The Company has repurchased approximately 24 million of convertible debt during this fiscal year, all at a discount to par, resulting in total savings of approximately $2.3 million. Our receivables collections efforts continue to be excellent. DSOs were billed, receivables declined for the fourth straight quarter, our DSOs for the third quarter were down 21 days to 67 days compared to 88 days in Q3 of last year, and 72 days last quarter. If you include the unbilled receivables, DSOs were 88 days, down from 109 days in last year's Q3.

We sold approximately $7 million of installment receivables in the quarter, which was down from the $17 million of receivables we sold last quarter. Although we will continue to try and sell down our installment receivables balance going forward, our near-term goal is to only sell installments to offset repurchases of convertible debt at a discount to par. We were not able to repurchase a more significant amount of convertible debt during the quarter, which is why installment sales are lower.

Net installment receivables on the balance sheet totaled $89.4 million. This quarter these installments carry an interest rate on average of approximately 7.5% and continue to be a significant source of interest income.

Turning our attention to the cash flow statement, we generated approximately $2.6 million in cash flow from operations, down due to lower sales of installment receivables. Depreciation and amortization for the quarter totaled $6.5 million, and capital expenditures in the quarter were approximately $1.1 million.

Now turning to guidance going forward, the fact that chemicals bounced back as nicely as it did this quarter makes us encouraged, but it is difficult to determine if this will be a trend that continues into the next quarter. We were also encouraged by the continued strength we are seeing from refining and oil and gas customers and the consistency of our execution.

Although our pipeline is full of many larger deals as compared to the previous few quarters which is typical of our fourth quarter, it is difficult to determine the timing of these transactions and our inclination is to remain conservative with our near-term financial targets. We believe that we will not see any material impact from new products sales until the September quarter and that our most attractive growth and operating margin performance will come in the fiscal 2005 time frame.

For our fourth fiscal quarter ending June 30, we expect that software license revenues will come in between $37 and $39 million, with total revenues between $81 and $83 million. We expect total expenses to be in the range of $75 to $76 million, and expect operating margins to approach double digits for the quarter. Excluding the preferred stock dividend and discount accretion, we expect pro forma earnings per share to range between 6 and 7 cents for the quarter. Based on today's stock price we anticipate the weighted-average shares outstanding to be approximately 89 million shares.

As a result of the higher earnings per share in Q3, we are adjusting our earning guidance for fiscal year 2004 to be between 17 and 19 cents from our previous range of 16 to 19 cents. And we expect total revenues for fiscal 2004 to come in between $319 million and $321 million. For fiscal 2005 we continue to maintain our previous guidance that we expect to be at double-digit operating margins for the full fiscal year. Further details of fiscal 2005 will be provided on our next earnings announcement at the end of fourth quarter.

So this concludes our formal remarks and I'd like to turn the call over for Q&A. April, can you take that, please?

Yes, sir. At this time I would like to remind everyone, if you would like to ask a question, press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Richard Davis with Needham & Company.

It's actually John Miata for Richard. I think it was David had mentioned seeing sales from the channel. Is that grown over time or do you have a target percentage of revenues that you would like to see come from the channel by whether it be fiscal year '05 or whatever target you may have?

John, this is Chuck Kane. We have seen the channels grow as you recall. Two quarters ago we set up a distribution arrangement in the Middle East which is one area of growth. We continue to provide such programs elsewhere in the world, particularly at international locations and it is our expectation to better streamline our sales model and better provide margins by continuing efforts and investments in this area, particularly during next year.

Okay. Just one more question, with respect to your chemical business, is that for the most part does that reside in Asia-Pacific?

This is Dave. Our chemicals business is global as is the industry. On previous calls we've talked about the improvements and the leading indicators that historically indicated a rebound in chemicals. We believe the improvement in this part of our business in Q3 is further evidenced that a rebound may in fact be underway and as I mentioned in my formal remarks, the earlier news today of Dow's positive earnings announcement I think is another sign that we have an improving trend. That being said, given the unprecedented length of the downturn in chemicals, we're hesitant to declare a trend after just one positive quarter and that's one of the reasons we are remaining conservative with our guidance.

Okay. For the most part, chemical spending does that track GDP roughly? I imagine it would lag a bit.

We think it lags a bit.

Okay. Thank you very much. You're welcome.

Our next question comes from the line of Phil Rueppel with America's Growth Capital.

Thanks. Given I don't want to say, sudden but nice rebound in the chemical's market and strength there, a little surprising to see that software licenses at the low end of the range. Were there any issues with renewals there or did some new deals or customers slip into the fiscal fourth quarter? Can you give us some color around that number?

Sure. First of all we look at it as good news that we hit our targets without needing many large license deals. These larger deals are still in the pipeline as we mentioned and we expect several may close next quarter. It was simply a matter of timing in terms of deals closing. I'm encouraged by the fact that we did not go into the end of the quarter dependent on those large deals to close, as I mentioned. I think this reinforces the success we've had in managing the business. So I think that we are encouraged that moving into our historically strong Q4 with the improvements we are seeing in the environment, that those larger deals will come back and that we will see further improvements in our license revenue.

So it sounds like some of the large deals are still ongoing, you didn't lose them to competitors?

Correct.

Okay. And as we sort of ramp up or if the chemicals market continues to show signs of strength and improvement over time, does that change the competitive landscape? Are there different players or are they some of your traditional competitors that are stronger vis-a-vis in the chemical space versus oil and gas or is it pretty much the same cast of characters?

It is pretty much the same cast of characters with some exceptions, for example, some of the distributor control system companies have larger install base in chemicals versus refining, and that changes the competitive dynamics a bit, but it's relatively minor.

Another point I'd make about the quarter is that most of our customers are on a calendar fiscal year, and it is not unusual that in their first quarter that they will generally be a little slower about going about making IT investments. That is another reason why it's not surprising that the larger deals were not higher for the quarter.

Right. Great. Thanks very much.

Sure.

Next question comes from the line of Robin Roberts with Stephens, Incorporated.

Hi, Dave and Chuck. The last quarter you mentioned that South America and Latin America do not meet expectations and that's why you changed the sales leadership there. How are those regions doing this quarter? And what additional work do you need to do in order to improve the sales culture right there?

Robin, this is Dave. I think, yeah, the changes we talked about that were actually made in the November time frame. So those changes have now been fully made effective and I think we are seeing the benefits of those changes. As I mentioned, one area of the business that continued to improve was supply chain planning performance and that was strongest in the North American and Latin American regions. So I think we are satisfied and positive about the performance in the NALA region, North American, Latin American region.

Okay. And yesterday the Chinese premiere was talking about a cooling down of Chinese economy and looking at your customer base, especially the company's producing commodity type of chemicals, oil and gas, how does that impact their business and their outlook and especially their appetite for IT spending going forward?

Well, we have a lot of large multi-national and local companies in the Asia/Pacific region. Our view is that barring any dramatic or drastic collapse of the economy in China, we don't expect any effect on our business, most of our customers are stable cash flow businesses that are not susceptible to a significant effect and we continue to be very optimistic about growth prospects in that region for us.

Okay. In the past, the petroleum sector is strong, although you made a comment before where the profitability growth in petroleum and oil and gas has -- IT spending growth has not caught up with the profit growth. I'm wondering, are you seeing them making accelerating spending IT to keep up with their profit growth?

Well, on an absolute basis, first of all the spending in oil and gas and the downstream petroleum part of the business is large. I think that we are clearly seeing an improving trend in their budgets and their willingness to spend money that's driven by continued good performance financially, driven in that part the high cost of crude. And also a need to enhance their productivity and competitiveness and deal with environmental regulations which require more blended types of gasolines to be produced.

Okay. You mentioned that in this quarter you do not depend on end of quarter large deals to close the quarter. It sounds like deal closure rate is better than expected. So looking at your sales reps, what is the percent of sales reps that are hitting quotas so far and how does that compare with your target?

We haven't seen a dramatic change, Robin, in the achievement on quota on a per-salesman basis. I think the point that we wanted to make in the call was that, the revenue is comprised of a lot more smaller deals, so the volume has increased, but on a quota basis that, of course, doesn't impact necessarily the quota. The deals were spread out with more sales representatives throughout the Company which is also a good sign. But we didn't see any sort of dramatic shift in achievement on quota. We do see that typically in our fourth quarter which is the end of our fiscal year.

Your next question comes from the line of Richard Williams with Garbin Institutional Equity.

I wonder if you could give a little bit of color on the SAP deals last quarter. You mentioned that you beat them on one deal. I think it would be interesting just to hear what is changing, if you are noticing any change out of them. Thank you.

Sure. Well, the particular deal that I cited that I named on the call was L'Oreal. That was a deal for a manufacturing execution roll out initially, a pilot that will be expanded to tens of plants around the world. There we competed head on with SAP who was incumbent in the account. And I mentioned that we won based on the strength of our differentiated software that solves very specific and challenging problems in the plant and our domain expertise and our proven track record in doing these kinds of roll outs. So we continue to see ourselves being strong versus SAP in the plant with respect to the manufacturing software.

I had mentioned on on a previous call that we also see some very early indications that spending is starting to come back into the supply chain part of our business. It has continued to be healthy in petroleum, but there are signs it is starting to come back now in chemicals although we'll need a few more quarters to declare that a trend. And there what we see is many customers who might have purchased large SAP systems, who might have some of their supply chain software on the shelf or who have tried to roll it out, some of those customers are now coming back and saying that they need a more fit-for-purpose solution to solve some of their specific challenges and we are getting renewed opportunities in those accounts. And we hope to see that trend continue and be something we can talk about on future calls.

Also are you seeing any activity on the private companies, small companies, if they are introducing any new rivals or, by the same token, is I-2 making any progress with Shell? Thanks.

We have not seen any significant change in the competitive landscape overall including with smaller competitors, if that's your question, Richard. Do you want to rephrase that or did I -- or clarify it?

That was just it just to see if there were any private companies that were developing that could at some point become a rival to you.

It's certainly possible, but we have not seen any indication of that this past quarter or previous to that.

Okay. Thank you.

Thank you.

Your next question comes from the line of Philip Alling with Bear Stearns.

Thanks much. Certainly we have seen some better predictability in your results the past few quarters and wanted to get a sense, you make some positive comments about larger deals in your pipeline and improvements in the chemicals vertical and you are coming into a seasonally strong quarter, yet I would characterize the guidance you gave as relatively conservative and certainly below consensus expectations that are currently out there. Can you give me a sense of like are you baking in some large deals in your guidance for fiscal 4Q, should I look at that number and say, well, this assumes that no large deals close?

Well, let me first point out that our focus over the past six quarters has really been on returning to profitability, managing cars, doing it while maintaining revenue levels in a pretty challenging environment, the challenges, as you know, have included the FTC process, the significant restructuring of our balance sheet and an unprecedented sustained downturn in the chemicals market which historically has been our largest market segment.

I think our efforts culminated in this past quarter with our most profitable quarter in over four years. Clearly, we see ourselves entering the next stage for the Company which is profitable, but more importantly sustainable growth. We are not managing our business quarter-to-quarter and we are proactively taking steps to drive growth for fiscal year 2005 and we believe that growth will come through first, improving our sales and marketing efforts for these newer products which I mentioned and from continued improvement across all of our end-user markets. And we certainly hope to be able to begin to demonstrate the same consistent improvement in growth that we've demonstrated over the past six quarters on the bottom line.

Okay. So could you speak to the expectation about large deals and sort of the guidance that you give, are you baking in closure of large deals or is that something you can comment on?

I think based on this past quarter and the mix of deals that we had, we want to continue to anticipate that sort of mix. So we are not baking in big deals into that number and that's the conservative stance we want to continue to take. The sales cycle for many reasons explained in our script over things such as Sarbanes-Oxley, sign off and such, is continued to be concerning as far as timing of large deals getting close. So we wanted to take a conservative stance and we managed the operational model to deliver as we expect and those are the levels that we come out at right now.

Your next question comes from the line of Justin Marchus with Graham.

So my question is also on the larger deals, I mean if you are unsure about timing, can you just talk about the size of those deals if and when they would get signed over the next several quarters?

Well, as you can see from this past quarter, we had only five deals that were over $1 million which is materially lower than what we are used to on a quarter-to-quarter basis. Another note to make is that the deals that were over $1 million were not significantly large deals in and of themselves. So as far as some of the major deals that are in our pipeline, again, we are just going to cautiously take a viewpoint that the closure of those deals may take more time than through the rest of our fiscal year. We have not lost any of those deals. There is, they are highly qualified. But the timing is what we are judging our estimate on right now.

Is the, I guess the quality and also the quality and the size of these deals potentially larger now that you've seen the chemicals doing better, oil is doing well continuously, I'm not asking about timing, but from 90 days ago or 180 days ago, how could you quantify that type of pipeline?

This is Dave. I would definitely say it is up and I think the reasons are two-fold. We've been working a very deliberate strategy over the past six quarters as we've talked about, to get customers up and running on smaller deals, in many cases pilots if you will, and with those pilots now being seeded into the market over the past many quarters those are now starting to move on to offer us tunes for larger deals.

Second factor is the overall improving trend across all of our markets, what is most noteworthy is the potential and I will reinforce potential improving trend in chemicals that we talked about on the call as evidenced by the chemicals returning to being our largest market this past quarter.

At this time I would like to remind everyone, in order to ask a question, press star then the number one on your telephone keypad. You have a follow-up question from the line of Richard Davis.

This is the other Richard Davis down in Atlanta. A question for you guys, first a simple question I guess, is it a reasonable assumption that the deals more than $1 million that the majority of those are in chemicals or is that a logical leap that we shouldn't make?

No, Richard, this is Dave. That's not a leap we should make. The distribution of those deals is pretty balanced.

Pretty balanced. Okay. And more kind of a longer term question, I always try to figure out where people are hiring, could you give us a sense as to where in terms of like geographies, geographies, departments or product lines that you are kind of making incremental new hires, typically that reflects management teams expectations about future growth, maybe not next quarter but over the next year or so, could you maybe flush that out a little bit, that would be useful?

Sure. In terms of region, clearly Asia/Pacific. As I mentioned on the call, we see continued opportunities there, very bright prospects for growth and we are certainly hiring there to build our presence and build on our momentum. In terms of functional area the Company, also as I made note of, we are adding to our sales and marketing ranks, focused in areas where those additions will drive accelerated traction for our new products and building pipeline for those products, which total now over nine that we released over the past couple of quarters. So that's an area of focus.

Great. I'm sure you had to hire someone for Sarbanes-Oxley but I won't torture you with that.

It was more than one, Richard.

[laughter] Thank you very much.

Your next question comes from the line of Robin Roberts.

What is the size of a revenue break down between engineering and MSC. And then what is the total revenue break down between the two product lines?

Well, license revenue basis the breakdown was approximately 75% engineering, 25% manufacturing supply chain, which is pretty consistent with the trend of the past couple quarters.

Then on the total sales it was roughly 50/50 which again is typical of historical trends.

Okay.

Robin, we lost you. Hello?

Robin, please press star one to complete your question.

Hello?

Please proceed.

Okay. Looking at aside from revenue breakdown last quarter you had 70% engineering and 30% supply chain and this quarter you mentioned that supply chain is very strong. I'm wondering what attributed to the slight revenue mix change?

That trend, that change, rather, was fairly slight. I think we would rate it as being pretty much immaterial. And I think we had mentioned on the previous quarter call as well that we were seeing improvements in the manufacturing supply chain business. So that's why the quarter performance and breakdown was pretty close to being the same. I think as we move forward into Q4 and beyond certainly we expect that MSC will begin to grow as a percent of total revenues. We'll start to see a slightly different trend emerge.

And one of the other characteristics of the MSC business is large deals and so the large deals as we've tagged it as pipeline and moved forward and potential closes in the future again that trend should bode well for MSC going forward.

That's all the time we have for today's call. Are there any closing remarks?

Thanks, April. First of all I would like to thank all of our investors for their support. The Company continues to show progress each quarter and we believe we are well-positioned to deliver attractive growth and earnings next fiscal. We hope to see many of you at the several investor conferences this quarter including the Prudential Securities Software conference on May 19th and Stevens IT conference on June 8. We invite you to schedule a one on one with myself or Chuck or to stop by our office in Cambridge, Mass, any time. Thank you very much for joining us this evening and that's the end of the call. This concludes today's conference call. You may now disconnect.