Aspen Technology Inc (AZPN) 2011 Q2 法說會逐字稿

Good afternoon. At this time I would like to welcome everyone to the second quarter 2011 earnings conference call. (Operator Instructions)I'd like to turn the call over to Chief Financial Officer, Mark Sullivan, to begin.

Thank you, Operator. Good afternoon, everyone. Thank you for joining us to review our second quarter fiscal 2011 results for the period ended December 31, 2010. I'm Mark Sulllivan, CFO of AspenTech, and with me on the call today is Mark Fusco, President and CEO.

Before we begin, I'll make the usual Safe Harbor statements 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 in our most recent Form 10-Q for the second quarter of fiscal 2011, which is now on file with the SEC. Also, please note that the following information is related to our current business conditions and our outlook as of today, February 8, 2011. Consistent with our prior practice, we expressly disclaim any obligation to update this information.

Structure of today's call will be as follows. I'll begin with a review of our financial results for the second quarter, and then Mark will discuss some additional business highlights before we open up the call for Q&A. I'd like to start with a review of the supplemental metrics that we provide. We believe they're the most meaningful indicators of our financial performance during our revenue model transition, where we're in the second year of a 5 to 6 year progression. We believe the metric that provides the most meaningful measure of the Company's growth is total contract value. TCV is a measure of the renewal value of the Company's multi-year term contract customer base. Total contract value is maintained by retaining customers, and it grows by adding new customers and expanding product usage, and by increasing prices across our customer base.

In the second quarter our licensed TCV grew by approximately 3.5% on a sequential basis. As a reminder, beginning in fiscal 2010, maintenance that is bundled with our subscription and term contracts is now a component of our total contract value. Including the value of bundled maintenance, TCV grew approximately 4.5% sequentially during the second quarter. At the halfway point of fiscal 2011, we've grown licensed TCV over 5% with bundled maintenance included over 7%,both compared to the end of fiscal 2010. Our total contract value was slightly more than $1.3 billion as of December 31.

Bookings are a measure of business closed during the fiscal period and represents the combination of license and maintenance fees that are included as part of our contracts. Bookings include the value of contract renewals as well as growth. Particularly focussed on the growth portion of bookings because the growth component increases TCV and drivers higher future revenue and cash flow. Bookings for the second quarter of fiscal 2011 were approximately $85.8 million, bringing year-to-date bookings to $160.2 million. This compares to our full-year guidance of $300 million to $325 million. As we've often explained, the timing of renewals and large individual transactions can influenced quarterly and even annual bookings comparisons. What is most important from our perspective is the degree to which we're growing our customer relationships, which is ultimately captured in our total contract value metric.

Turning to other business metrics, we closed 24 customer bookings that were greater than $1 million during the quarter, compared to 18 in the year ago period, and we closed 54 bookings between $250,000 and $1 million compared to 57 in a year ago period. The average deal size for customer bookings over $100,000 was approximately $653,000 compared to $778,000 in the year ago period. Future cash collections is the sum of the Company's billings backlog, accounts receivable, and the undiscounted value of installments and collateralized receivables. This metric provides a level of visibility into the cash-generating capabilities of our business.

The Company's future cash collections at the end of the second quarter was $688 million, an increase from $653 million at the end of last quarter, and $511 million at the end of the year ago period. The largest component of our future cash collections is billings backlog, which was $490 million at the end of the quarter, an increase from $436 million at the end of last quarter, and $206 million at the end of the year ago period. Keep in mind that our future cash collections does not include the value of maintenance associated with our legacy contracts, as maintenance was not contractually committed on a multi-year basis. So it is highly predictable given our mid-90% renewal rates. The value of multi-year maintenance does get included as customers migrate to the new licensing model.

Now, let me turn to our financial results on a GAAP basis. Total revenue of $49.8 million was up 17% from $42.7 million in the prior year period. Subscription revenue came in at $11.8 million, which is an increase from $9.7 million last quarter, and $1.2 million in the prior year period. Given the fact we're recognizing subscription bookings over the course of a 5-plus year average contract length, it will take time for subscription revenue to build. Now that we're in the second year of our revenue model transition, we're also starting to see growth in deferred revenue, representing the value of invoiced business that has not yet been recognized as revenue. This is as a result of our building subscription-based business.

The end of the second quarter, total deferred revenue was $102.5 million. This represents an increase of 40% on a year-over-year basis and a sequential increase of approximately $1 million. The subscription component of our deferred revenue grew more meaningfully on a sequential basis. However, there were decreases in other components in our deferred revenue balance, which also includes services, software, and maintenance revenue.

Software revenue is the component of our revenue that is most impacted by the move to our new aspenONE licensing model. Software revenue includes new perpetual license contracts, term-based license tracts for point products with bundled maintenance, as well as the annual invoice value from legacy software license fees that were deferred from prior fiscal year periods. Software revenue for term arrangements is generally recognized annually as customer payments become due. While not recognized on a daily subscription basis, it's another source of recurring revenue. Software revenue doesn't include maintenance fees that are bundled as part of our term contracts for point solutions. This is carved out and reported within our services revenue line.

Software revenue was $13.5 million in the second quarter of fiscal 2011, which compares to $9 million in the year ago period. During the quarter, software revenue was higher than expected due primarily to earlier than expected collections on several contracts where we are recognizing revenue on a cash basis. We expect that software revenue will continue to be variable on a quarter-to-quarter basis. For the second quarter, $4.2 million of our total software revenue related to point products sold with bundled maintenance, $0.3 million related to perpetual license agreements, and $9 million related to software fees that were recognized under the Company's prior licensing model.

Finally, services and other revenue was $24.5 million, down from $32.5 million in the year ago period, but consistent with the run rate in our services and other revenue during the prior six months. As we've discussed previously, maintenance revenue will increasingly be reported within the subscription revenue line as more contracts are converted to the new aspenONE licensing model. As a result, we expect that the run rate in our services and other revenue line will be variable quarter-to-quarter, but trend downward as our revenue model transition completes.

Turning to profitability. Gross profit was $36.3 million with a gross margin of 73%, which compares to $26.2 million and a gross margin of 61% in the prior year period. As our revenue normalizes over the next four to five years, we expect gross margins to increase to the 77% to 80% range. Operating expenses were $45.5 million in the second quarter, compared to $55.5 million in the year ago period. Of the $10 million year-over-year decline in operating expenses, nearly $7 million was due to lower stock compensation expense related to the impact of the catch-up grant in the year ago period.

Total costs and expenses were $59.1 million in the second quarter, which is down from $72 million in the year ago period. Total costs and expenses continue to be managed well. We feel comfortable with the midpoint of our previously-discussed full-year GAAP expense guidance range of $250 million to 270 million. Operating loss was $9.3 million for the second quarter of fiscal 2011, an improvement compared to an operating loss of $29.3 million in the year ago period. Net loss of $10.3 million or $0.11 per share in the second quarter of fiscal 2011, compared to net loss of $30.7 million or $0.34 per share in the second quarter of fiscal 2010.

Our non-GAAP operating and net loss for the second quarter, which exclude the impact of a stock-based compensation expense and restructuring, were $6.9 million and $8 million, respectively. An improvement from a non-GAAP operating and net loss of $19.7 million and $21.4 million, respectively, in the year ago period. Our non-GAAP loss per share was $0.09 in the second quarter of fiscal 2011, compared to a non-GAAP loss per share of $0.24 in the second quarter of fiscal 2010. A reconciliation of GAAP to non-GAAP results is provided in tables within our press release, which is also available on our website.

Turning to the balance sheet and cash flow. The Company ended the second quarter with $131.6 million in cash, which was up $8.5 million from $123.2 million at the end of the prior quarter. From a cash flow perspective, the Company generated $14.8 million in cash from operations during the second quarter and free cash flow was $13.3 million, which was an increase from $9.9 million and $9.2 million, respectively, in the year ago period. During the quarter we used approximately $1.2 million in cash to buy back stock as part of the $40 million share repurchase program we announced at the time of our first quarter earnings call. The Company once again did not sell any installments receivable to raise cash during the second quarter of fiscal 2011, and we continue to reduce our secured borrowings balance, which was down by $4.4 million from the end of the first quarter of fiscal 2011, ending second quarter at $66.8 million.

As a reminder, our secured borrowings are fully collateralized. Collateralized receivables and receivable balance will continue to decline moving forward. The majority of future license bookings will not be recorded as installments receivable, but will instead be included in our billings backlog. Accounts receivable will continue to reflect the value of invoices that have already been billed and are yet to be collected. With that, let me turn it over to Mark Fusco. Mark?

Thanks, Mark, and thanks to everyone for joining us today. We're pleased with the Company's performance in the second quarter, in particular the progress made against two most important metrics that we guide to, growth and total license contract value and free cash flow. From a growth perspective, another solid performance in the quarter enabled AspenTech to finish the first half of the year with license TCV growth of over 5%, compared to the end of fiscal 2010. We believe this positions us well to deliver against our full year fiscal 2011 guidance of upper-single-digit to double-digit growth in this key metric.By comparison, we're slightly ahead of last year's pace of over 4% licensed TCV growth at the halfway point of the year, when we ultimately delivered 10% growth for the full fiscal year 2010.

From a cash flow perspective, we finished the first half of fiscal 2011 with cash from operations of $21 million and free cash flow of $19 million, which is up significantly from $4.7 million and $2.8 million, respectively, compared to the last half of the last fiscal year. Also, considering the fact that the first half of the year is typically seasonally weaker from a cash flow perspective, we believe we are well-positioned to meet our objective of free cash flow in the mid-$50-million range for the full fiscal year 2011.

Drilling down further into the Company's performance for the second quarter, it was a very well-balanced effort. From a vertical perspective, our three largest sectors, energy, chemicals, and engineering and construction continue to represent approximately 90% of the Company's bookings, with energy again representing the largest single contributor to our results. We are also pleased with the performance of our indirect channels driving business in verticals such as power, and metals and mining. From a geographic performance, we were pleased with the execution in each of our major geographies, North America, Europe and Asia-Pacific. We also continue to gain traction in emerging markets, including closing a direct deal with the largest chemicals manufacturer in Russia during the quarter.

Finally, from a product perspective, demand for both our engineering and manufacturing and supply chain solutions remain solid, with engineering having a particularly strong performance in the second quarter. We believe there are attractive growth opportunities in the key markets we serve. ARC-Insight sized our target market at approximately $2.4 billion in 2008, and expected the market to grow to $4 billion by 2013.

Engineering is expected to grow to $650 million by 2013, and it is the area where AspenTech has the largest lead in market share. Engineering is our most heavily-adopted suite of solutions, but most of our customers still only use a limited amount of our comprehensive capabilities. Customers like having access to our full suite of solutions via our subscription-based aspenONE licensing model, enabling them to easily try new applications and realize value before making substantial up-front investments. Our goal is to get all of our software in customers' hands and scale with them as their usage grows.

We also believe there is a significant opportunity for AspenTech to grow its manufacturing and supply chain business. It is estimated that the manufacturing and supply chain market for process manufacturers is approximately four times the size of our engineering market, yet historically it has represented approximately a third of our business. Many of our engineering customers have not optimized their manufacturing and supply chain processes, and many of those who did have done so with generic solutions that were not optimized for process manufacturing. We believe AspenTech is well-positioned to gain market share based on our strong relationships with many of the largest energy chemical and pharmaceutical companies in the world.

On the topic of growth, I wanted to finish by reminding investors that during the transition phase of our revenue model, we continue to believe that the licensed portion of our total contract value represents the most relevant metric for understanding the underlying growth of our business. Once our revenue model transition has completed, the growth of our total licensed contract value will approximate the growth of our subscription license revenue. It is equally important to understand that our bookings metric is not a meaningful metric for estimating growth, which is heavily influenced by the timing of renewals. We assume renewals are going to happen, whether they happen after three, four or five years, because of our long history of having best-in-class renewal rates.

There is no better illustration of this concept than the fact that our bookings guidance of $300 million to $325 million for fiscal 2011 would represent a decline of approximately 10% to 15% compared to the $360 million in fiscal 2010 bookings, due to the timing of renewals. However, we are targeting to grow the licensed portion of our total contract value by approximately 10% for the year, and this is the best approximation for what our licensed growth would be if our revenue model transition was already complete. That is why we started providing the quarterly growth of our total license contract value at the beginning of this fiscal year. The relevancy of our bookings metric has gone down significantly as we have transitioned our licensing model.

We also continue to evolve our go-to-market strategies in order to increase our focus on growth versus renewing business. From a sales compensation perspective, we increased the weighting of new business entering this fiscal year, and that is something that we will continue to increase in future years. Growing our contract value is important because that drives growth and cash flow and profitability. We expect both of these to grow in excess of our licensed TCV over the next three to five years. From a profitability perspective, we are targeting a normalized operating margin, assuming transition already completed, in the low 20% range in the fiscal 2011. We believe we can increase that to the mid-20% to 30% range by the end of fiscal 2015. We also continue to target free cash flow in the mid-$90 million range for fiscal 2013, which would be a significant increase from the mid-$30 million range last year, and the mid-$50 million range in fiscal 2011.

In summary, we believe we have an attractive growth opportunity and business model. As our revenue and cash flow models complete their transition, we continue to believe AspenTech is well-positioned to emerge with one of the strongest profiles in the software industry, over $1 billion in total term contract value, a growth opportunity in the double-digit range, subscription model that provides a high level of visibility into future revenue and cash flows, and best-in-class profitability margins. With that, I'll turn it back to Mark for some more comments.

I'd like to close with some thoughts regarding our guidance, starting with the P&L. Given where we stand at the halfway point of the year, we feel comfortable with the higher end of our $180 million to $190 million revenue guidance. We continue to expect our subscription revenue to grow on a sequential basis. However, keep in mind there will be quarter-to-quarter variability in the software line, because software revenue recognition is impacted by the timing of when invoices become due, as well as when cash collections are received for contracts that are recognized on a cash basis.

The second quarter software results were somewhat stronger than we had previously anticipated, because some collections of cash basis deals were received in the second quarter that weren't expected until the third quarter. From an expense perspective, I commented earlier that we're comfortable with the midpoint of our total GAAP expense range of $250 million to $270 million for the full year. There are some expense we expect to increase in the second half of the year, such as payroll taxes and sales commissions, to name a couple.We'll further refine our expense guidance after the third quarter.

Taken together, we feel comfortable with the low end of our full fiscal year operating loss guidance of $70 million to $80 million. Notwithstanding refinements to our P&L guidance, I'd like to reiterate that our P&L was still not a meaningful indicator of our business performance, and it won't be until our revenue model transition is complete. We're also reiterating our full fiscal year guidance for total contract value growth, bookings, and cash flow, as we're tracking well against each of those measures at the halfway point of the year. First half license contract value growth of 5% is in line with our full-year target of upper single-digits to double-digit growth. Bookings of $160 million compares to our full-year target of $300 million to $325 million, and our low free cash flow of $19 million is less than the half way point of our full-year target of mid-$50 million. The first half was expected to be seasonally weaker than the second half. As Mark just pointed out, we also remain comfortable with our longer-term free cash flow target of mid-$90 million for fiscal 2013.

With that, we're now happy to take your questions. Operator, lets begin the Q&A.

Richard Davis, Canaccord Adams.

Thanks very much. So, two quick questions. One, in rough numbers, what percentage of your customer base has upgraded to aspenONE?And the second question is, how does your guidance compare to the bonus plan hurdles that the firm had set? I was looking through the 14F, and I couldn't see it. Maybe I missed it, for the 2011. I saw the 2010 outlook, but how does that compare and contrast, briefly?

On the first question, we're probably just in the -- just over the 30% range, Richard. Sort of redoing the deals. You can see over the past six quarters, we've done about $500 or so million worth of bookings, that of course includes bundled maintenance, and things. We're sort of in the mid-$30 million range is my best estimate, from what I have today. We're part-way along the way, but the focus of things -- at the beginning of the transition we certainly want to make sure that we have our bookings, that we made the license model work, that we got it out in front of the customers.

Today, we're much more focussed on how we grow those relationships as we convert them.That's not to say that we're not looking to do as many as we can, because we certainly want to do that, but we want to take the opportunity to grow them appropriately. And you can see that in the results for the second quarter. The results were good from a growth perspective and it really is the focus of our sales channel now, not only to renew our deals as they come up and opportunistically if customers want to move forward, we'll do it. But we certainly want to grow them at the time of transition. And obviously, we want to continue to grow them all the way along.

As far as comp goes, we have -- at the corporate level it's very similar comp plan, if that's the question, from what it was a year ago. Which is licensed bookings and cash flow, which is the metrics that are being used by the comp committee to judge us. I don't know whether that will change in the next fiscal year, but that's the way it is at the moment.

Perfect. That's what I needed. Thank you very much.

[Sacik Palir], from JP Morgan. It's actually Sterling, how are you doing?How are you, Sterling.

Good, good. On the software, as you look at the line items, software was strong. I'm just curious what the appetite was to do deals maybe with a little bit more up-front payments, just because of year-end budget flush, versus how people are looking at the balance in terms of the move to the subscription side?

There really was no significant uptick in any kind of up-front payments, we specifically talked about the fact that perpetual represented a very low percentage of revenue, I'd guess $300,000 or so. And total up front payments, including perpetual, are running somewhere around 5% or less of our total bookings. So, that really wasn't the driver.

Okay. And then a follow-up. In terms of the expenses, and I apologize, we have a number of earnings tonight, but looks like on the total expense side you came in really well. Was there anything that -- additional moves that you made from the expense side? How should we think about the expense run rate as you finish out the fiscal year?

Well, full-year guidance that -- we gave a range at the beginning of the year of $ 250 million to $270 million. We're comfortable at sort of the midpoint at this point in the year, looking ahead for the full year. So, that would imply a little bit higher expense in the second half. I referenced a couple of areas where we do expect expenses to be a bit higher. We get the turn back on FICA and some things like that. But we think we're going to continue to leverage the expense structure like we have been, and keep expenses under control.

And last question, when you talk about the industry side, can you give us a little bit of update on the pharmaceutical penetration?

Pharma had a pretty good quarter this quarter. I highlighted it on the call last quarter, because it really was the first time that they had, I would say, a material increase. They had a good quarter this quarter as well. We're not going to highlight all the different verticals.

We highlighted the -- what we considered to be our non-core verticals, where we're selling through the reseller channel. We started that a few years ago. This quarter we actually had a pretty good quarter in our reseller channel, and I think that that will be a good driver for us going forward. It's not huge aggregate dollars, but it is all new business for us, so this is important as we move forward. But overall it was a really good performance across all of the different groups in the company, and we're pretty pleased with how it came out.

Great. Thank you.

Philip Rueppel, Wells Fargo securities.

Thank you very much. Now that we're in the second year of the business model transition, can you give us some general perspective on the renewals? Is there any change in renewal rates, is the -- you talked about growth, is that sort of widespread, or it is just a handful of the bigger deals? Are they taking on increased tokens, or is there any increase or less pushback moving from the old model to the new model?

There has been no change, Phil. Renewal rates, they comment at various times. And as you know, we have massive renewals that come in various quarters. It is really, the focus of the company has changed over the past few years as we start to think about how we want to run the business to drive growth in the install base going forward. There has really been no change in what we're trying to do with renewals, other than we take them as they come. We're not trying to convert all of the deals at no growth just to prove out the model maybe, or other things as we're starting to scale up in the change in the business model. So there has really been no material change.

We're focussed on our growth. We're just over 5% licensed growth and our contract value, which is what we set out to do, double-digits this year. Hopefully we'll have a strong second half of the year and finish the year at the upper end of the range that we gave guidance on. So, there's really been no change. Renewal rates are the same. We're doing well in all parts of the business. It's really a focus issue for the company on growing those engagements and making sure we're monetizing things appropriately.

Okay. And then second of all, as you both mentioned, the cash flow was strong this quarter. Anything unusual from a collections perspective, or -- and are you still moving away from allowing customers to pay for multi-year deals up front?

No, they just referenced up-front payments again, including both perpetual and people prepaying their term agreements, represents a very small percentage now. 5% or less of total bookings. It is a low-level part of our business, that's mostly done either as a convenience or parts of the world but we're not really excited about extending credit. But nothing unusual. We've had for a period of time good collections. We continue to have good collections in this quarter, but I wouldn't say that that was an unusual occurrence.

It is just that the first half of the year is seasonally weaker based on how -- the history of contracts were written here and the timing of customer collections. It kind of builds as we go through the year. The first quarter is the weakest and gets better as we go. So, it's pretty much what we expected for the quarter, and as I said, we're still on track for the full-year targets.

Great. My final question, any update on the Middle East, your own -- since you've taken over the distribution there, your sales reps up to speed and any kind of qualitative perspective on how that region is doing?

I think it is going well. We're fully engaged. We have a full team there now,and have for a while. Obviously, in transition it takes a little time to build relationships. But I think we'll do well in the Middle East and we've started to see some things move in our direction.

As far as the reseller goes, we have some comments in our queue, which you can see, the arbitration is active. There was an arbitration event at the end of January, which we were involved in. We're still tracking our way through that, but we don't have any update on how that will come out.

Great. Thank you very much.

-- put in the Q.

Tom Ernst, Deutsche Bank.

It's actually Stanislovsky, I'm sitting in for Tom.

Hi, Stan.

Thanks for taking my call. Couple of quick questions. Did you guys finish the $40 million share repurchase program already?

No, we put that in place, I forget the exact date, but it was sometime in fourth quarter. I want to say sometime in November, we announced it on the last call. It really didn't go effective until very late in the quarter. We spent $1.2 million of that $40 million in the fourth quarter. I think we purchased 96,000 shares, plus or minus. So, no, we're just getting started with that.

Okay. Got it. And the average deal size, it dropped down to $653,000. Anything unusual there?

Nope, just the -- we only had one, I would say really large deal, which we classify in the above-$5 million range for the quarter. I was just -- this is just how they come and in the June quarter we had some big ones, and in September we had some big ones. It just bounces around. There is nothing to read into it, one way or the other.

Okay. And any changes in general competitive landscape, any particular company giving you sleepless nights more so than others?

No, competitive landscape is the same. We have the same competitors in each one of our spaces. I feel good about the products that we sell, about the things that we're doing in R&D and what we bring to market coming forward, and how the gang is executing around the world. So, no change.

But I do think that we would expect that we would become a better competitor over time as we moved away from some of our distractions of the past. And as we start focusing on more growth, as opposed to renewals of deals and things, that will make us a better competitor. So I'm hopeful that we'll be a tougher competitor over time, but nothing material in the competitive landscape.

All right. Thanks for the time, guys.

Sure.

Peter Goldmacher, Cowen and Company.

Hi, guys. Fusco, you talked a little about the bigger opportunity in supply chain. Can you talk a little bit about how you're going after it and how you're allocating resources for that opportunity? And how you're thinking about the competitive landscape in that opportunity?

It is supply chain, we're number one in the world in supply chain in process manufacturing. We have the best suite of products and the deepest suite of products of anybody in the world. We've spent a lot of time and a lot of money in the past four or five years building out these solutions and integrating them and they're just now really starting to get integrated to fulfill, I guess, the vision that we had for an integrated supply chain over -- that we started a number of years ago.

As far as allocation of resources, we don't sell by horizontal. Our sales force sells all the solutions that we have. We think we're adequately staffed. But I brought it up and I brought it up in my comments because this is an opportunity, as we start to think about penetration and growth of install base, in a much more material way, compared to the old revenue model and the things that it -- I guess the unintended consequences that it had in the sales force. I think we've become a better competitor in this space, and clearly in emerging markets where there's lots of new plants being built and lots of investment. These are places that we're spending our time and allocating our resources. So, we are number one at it, we expect to stay there. We want to broaden our lead. We'll do it through good products and good execution in the sales force. And I think so far, so good, but I think we can do it even better going forward.

Okay. Thanks.

Bhavan Suri, William Blair & Company.

Hi, guys. Laura is here, too, so I'll jump in with a quick one and she'll jump in with another. Would it be fair to say that the second half of the year should be stronger in bookings?I know renewal rates bounce around. But some of the way cash flow grows, should I suspect that bookings could be stronger in the second half than the first half?

We gave overall guidance for the year of $300 million to $325 million for bookings. We're at the higher end of the range now at the half year. It really depends on what the renewals are. Again, we certainly have some renewals and do them. We're comfortable with the guidance that we gave, so I wouldn't expect it to be particularly stronger one way or the other. Our focus is on growth, and how we grow those deals and how we grow those engagements. I'm much more interested in achieving a better growth in TCV for licenses, compared to what we did last year, which wasn't bad, about 6% in the back half of the year. We want to do low double-digits for growth, and that is what we're fixated on and I'm sure we'll do our fair share of bookings in the process.

Hi, it's Laura with a question. Can you also let us know in engineering, what percentage of customers would you say are using the broader suite, and what do you think the product penetration is?

The contract's in force, I referred to it earlier, in a question for Richard Davis, they're primarily engineering contracts. Most of them, 80% of them, are probably engineering contracts, because we've only been selling term for manufacturing and supply chain for a couple of years. So, we're just part-way through the -- in the 35%, mid-30% range, in conversion. We are starting to see uptick in the amount of usage that people that have all of the software have, and we said towards the end of this fiscal year we'll start to give some data out about what the uptake of usage is. We don't have anything for you at the moment, but we're just early in it, Laura. And I think it will come along quite , but we're just early on

Another question from me. Which is progress on the Cloud offerings?

From a Cloud perspective, I would -- we've made no public statements about Cloud, and what we're doing from a road map perspective, but I think it's fair to assume that Aspen would be interested in this, and it would certainly be something that we could do with all of our desktop solutions. We may target different customers at different times, or start with smaller as opposed to larger, depending upon the buying pattern, but I think you'll see something as it relates to the Cloud from Aspen in the coming little while here.

Great. Mark, one final one from me about the competition. Can you talk a bit about switching costs? I'm trying to understand what it take to, say, move from Aspen to a competing product. How do we think about the customer when they go through that process of thinking about changing vendors, and how often does that happen?

I think it depends. In the engineering space, you can certainly if you -- we have ways and certainly, I'm sure our competitors are targeting our business as well to convert some of those models and switch, but the switching costs are actually quite high. When I think about our engineering space, we want to broaden that total market through the usage of our products, which isn't necessarily a displacement strategy for our major competitor.

In the manufacturing supply chain there is a lot of white space. The growth strategy to pull out a controller from Honeywell or somebody would be much more difficult than selling into new markets where there's lots of opportunity and no installed software from a commercial competitor. So we're focussed there, and we're focussed in places that we're strong. We wouldn't expect that displacement of a competitor is going to be the main strategy for growth in any one of these spaces. We're going to grow around them.

Thanks for the questions.

Sure.

Brendan Barnicle, Pacific Crest Securities.

Great. Thanks so much, guys. Mark, I wanted to follow up, I know you had some commentary on gross margins, but is it fair to assume that we should see gross margins stay the same range that we saw in the first half of the year?

Again, we haven't given any specific guidance on gross margins because -- primarily because the P&L is still kind of a work in progress, right? We're missing a bunch of revenue, if we went through the transition had normalized P&L, our margins would be significantly higher because we would have a lot more revenue. But I think going forward, your margins are going to be in the range you've seen, and they're going to improve over time as we continue to add to that top line. We have to take more and more of the revenue.

Great. That's very helpful. You also mentioned in the second half, we should see expenses creep up a little bit. What areas, in particular, should we see those changes?Is it sales and marketing becauseyou have year-end accelerators or something? What are those areas that we should look at increasing?

Well, I mentioned we just get some of these fabulous FICA costs coming back in at the start of the year. That's worth a little bit of money. A lot of it is just really boring accounting stuff. Things like vacation accruals bouncing around. It is just really not material to the performance of the business. We probably are going to try to add a few people but again, it is going to be incremental in nature. So it's a number of little things. There is really no large impetus to why we think expenses will be up just a bit in the second half.

Is it right then to model on equally across all of the three main expense categories?

What do you mean by three main expense categories?

The marketing, R&D, and G&A?

Yes, it's fair. I would take each one up a little bit.

And just lastly, share count increased about a million or so despite the buy-back. Obviously, stocks performed well, just driving that. What should we be using for assumptions on share count for the remainder of the year?

I have to get back to you on that one. I don't have a number in my head.

And then lastly, Mark, we heard from a couple of different vendors about seeing just overall recovery in applications, application refresh cycles. How much of that are you guys seeing in that macro improvement playing into the strength of recovery you're seeing?

I've seen that there's been consistent demand in -- it hasn't been dissimilar from what we've seen in the recent past, over the past four or five years. We've been growing our business in double digits from a licensed perspective, and we're on track to do it again for this year. Clearly, emerging markets has more activity and that is consistent with what we had last year as well. And then some of the more mature markets, but we weren't as cyclical going into the downdraft in '09, and we're not as cyclical now from a buying pattern perspective.

But clearly, the economy is better. Our customers are better. Oil is in the mid-80s to 90s. The chemical companies are doing pretty well. So overall, it is a pretty good environment, but I could wouldn't say it is markedly different from what we've seen in the recent past.

Terrific. Really helpful. Thanks.

Brendan, one quick follow-up on your question to the margins, too. We kind of hammer this concept of the variability, but margins will be variable from quarter to quarter, as well. Obviously, if we get a bigger software revenue number in a particular quarter that is going to drive very high margin business into the gross margin. Numbers I was giving kind of good for average thinking, but quarter to quarter, it will bounce around a little bit.

Mark Schappel, The Benchmark Company.

Mark, in the previous couple of quarters you've noted some particular strength or some particularly strong demand coming from the chemical sector, and I was just wondering if this trend continued this quarter, or did you see more of a normal distribution between your energy and chemicals and the (inaudible) customers?

It was more of a normal distribution. In fact, energy this quarter and for this first half of the year is marginally stronger than we would have seen in the past. I expect -- every other year that I've been here it moderates itself and at the end of the year it looks pretty much the same every year. So, I wouldn't expect it to be skewed one way or the other. It does bounce around quarter to quarter. But we've seen consistent demand and we're seeing demand from chemical companies, energy companies. We've seen interesting demand and token limits being hit by engineering and construction companies. So, this consistent demand everywhere, but I wouldn't expect it to be materially different by the end of the year than it has been in the past.

Okay. And then with respect to your large deals in the quarter, were there any multi-million dollar deals that were notable?

We had a bunch of multi-million dollar deals, as I mentioned a few minutes ago. We had only one in the above-$5 million category. We didn't have one that skewed it that was $20 million or something, like we've had maybe in other quarters. We had good demand. A lot of $1 million to $3 million, $1 million to $4 million deals. You can see it in the overall spread of the deals that we had, and the ASP is down just because we were missing some of the real, real big ones. But overall, we had 24 deals that were over $1 million, so it was a good spread, and it was a good quarter overall.

Okay. And then just finally for modeling purposes, your G&A expenses were lower than I anticipated. Should we use this as a new baseline going forward?

Well the G&A expenses, certainly from last year, are benefiting -- we talked a lot and fortunately, we don't have to talk about it anymore, about the high finance and audit cost that we used to have. So we're definitely seeing the benefit of that. We had some things in the G&A in the first quarter that might have sort of been up on the run rate. We had the cost of the secondary and some things like that we talked about on the last call.

I think G&A costs are going to continue to trend down. Again, you will see them go up along with the other expenses in the second half of the year, predominantly because of payroll taxes and some of the other items I talked about, there will be across the board expenses. But we do expect G&A costs to continue to trend down over time.

Thank you.

Our final question comes from Richard Williams, Cross Research.

Can you talk a little bit about the services?I noticed a bit of a drop-off 1Q to 2Q, not sure just what's going on there.

Services first to second quarter was roughly flat overall. Year-over-year, it was down in the second quarter from right around $32 million down to $24. And that's a couple things. We had a project a year ago wrap up and took some revenue in the quarter that was bundled and would have been in deferred, and then also we've got the SMS business moving from the maintenance line into the subscription line. We have been relatively flat on services for the past three quarters or so.

As Mark said in his comments, we expect the services line to continue to drop as the SMS business moves up into the subscription line, but I don't expect that the professional services business is going to fall off a cliff. I think it will be relatively stable. It does bounce around a little, depending on what -- the time of the year and what gets bundled, and other things. But services will modestly drop, I would imagine, going forward just because of the maintenance line moving up into the subscription.

And margin-wise, how is that trending and where are you expecting it to go?

For services?

Yes, for services.

Services overall, as you see last year at the half year, we were about 50% gross margin in services. This year we were around 53% or so. So overall, the margins are in line. The business is fine. We certainly would like to improve our professional services business a little bit and improve that, but overall the margins of the business are fine.

And then final the utilization rates, how are those looking? And then I'm done.

I didn't hear the last comment, sorry.

The utilization rate for your service business?

Utilization rate is okay. We try to keep up with the volumes of the business and keep people employed as much as possible. We like to target somewhere in the 75% range for billable time. It could be modestly up or modestly down, depending upon the type of service offering, or what the time of the year, or whatever. But overall, utilization rates are okay.

Okay. Thanks very much, guys.

Sure.

I'd now like to turn the call back to management for closing remarks.

Okay. Thank you very much for attending here today. I really appreciate you joining us. Second quarter was a real good quarter for us,and we're pleased with the performance in the first half of our year. We are tracking well against the guidance that we gave for the full year, and we're making very good progress. We're pleased with the growth of the business that we had on the license line, and certainly the cash flow performance on a year-over-year basis was a good one. And we're looking forward to the remainder of the year.

And then finally, from me to my employees that are listening, thank you to all of you for the continued hard work. It is much appreciated by all of us, including our shareholders. I look forward to seeing you at various investor conferences as they come up in the first calendar and second calendar quarter of the year. Thanks.

This concludes today's conference call. You may now disconnect.