Aspen Technology Inc (AZPN) 2018 Q2 法說會逐字稿

Good afternoon. My name is Rose, and I will be your conference operator for today. At this time, I would like to welcome everyone to the second quarter fiscal 2018 earnings call. (Operator Instructions) Mr. Karl Johnsen, you may begin your conference.

Thank you. Good afternoon, everyone, and thank you for joining us to review our second quarter fiscal 2018 results for the period ending December 31, 2017. I'm Karl Johnsen, CFO of AspenTech. And with me on the call today is Antonio Pietri, President and CEO.

Before we begin, I will make the usual safe harbor statement that during the course of this call we may make projections or other forward-looking statements about the financial performance of the company that involve risks and uncertainties. The company's actual results may differ materially from such projections or statements. Factors that may cause such differences include, but are not limited to, those discussed in today's call and in our Form 10-Q for the second quarter fiscal year 2018, 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, January 24, 2018. Consistent with our prior practice, we expressly disclaim any obligation to update this information.

The structure of today's call will be as follows: Antonio will discuss business highlights from the second quarter, and then I'll review our financial results and our guidance for the third quarter and fiscal year 2018 before we open up the call for Q&A.

With that, let me turn the call over to Antonio. Antonio?

Thanks, Karl, and thanks to everyone for joining us today. AspenTech delivered solid financial results in our second quarter fiscal 2018 that continued to demonstrate good customer demand and execution across the company.

Looking at our financial highlights for the quarter. Annual spend was $469 million, up 4.2% year-over-year. Total revenue was $124.9 million, above the high end of our guidance range of $120 million to $122 million. GAAP operating income was $54.5 million; and non-GAAP operating income was $62.2 million, which represents a non-GAAP operating margin of 49.8%. GAAP EPS was $0.52, and non-GAAP EPS was $0.59, both of which outperform our guidance. Free cash flow was $42.2 million, and we returned $50 million to shareholders by repurchasing 756,000 shares.

We're pleased with our performance in the second quarter and through the first half of fiscal 2018. We believe we are positioned to achieve our annual spend growth guidance of 5% to 7% for the fiscal year, supported by solid performance in all 3 product suites.

We experienced another strong quarter from owner-operator customers and feel good about our performance and prospects going forward with this segment. These customers continue to operate in a favorable demand environment for their products while they remain focused on improving operations and driving cost efficiencies.

From a regional standpoint, Europe, Russia and North America delivered notable performances. We also continue to see a strengthening demand in the SMB group from Tier 3 engineering consulting customers.

The business environment for our E&C customers remains flat with signs of nascent increase in activity in most parts of the world, except for North America and Southeast Asia where the business remains challenged. As a reminder, the business environment in the quarter was still driven by the calendar year 2017 outlook informed during the difficult oil price environment of late 2016. A noticeable trend with our Tier 1 E&C customers is a focus on creating new sources of revenue around services offerings for their customers, whether that is through operations and maintenance services or implementation and monitoring services for their customers' operations. A great example of this was a key deal signed in the quarter with our APM suite that I will discuss in more detail later in the call. We believe this trend among major E&Cs is a good opportunity to position AspenTech's 3 product suites, especially the APM suite as new customer revenue initiatives to strengthen our strategic value with these customers.

The recent increase in oil prices, back above $60 per barrel, has the potential to be a positive for spending going forward. However, there are a few things to keep in mind. First, we have said in the past that oil prices are a proxy for energy companies' CapEx investment, which is the ultimate driver of work activity for E&C and upstream operators, and hence, spending with AspenTech. But we also note that it will be the long-term oil supply-demand balance that will signal to energy companies the opportunities to sustain higher levels of CapEx investment in new sources of oil production.

Second, in a change from recent years, most energy companies have yet to announce their CapEx budgets for calendar 2018. We expect to learn more in the near future as these companies announce their fiscal year plans, but we currently expect only modest overall growth from 2017 budgets that are still 40% to 50% below the peak levels seen several years ago. We believe the overall increasing CapEx budgets from international oil companies and shale-oil-focused companies will be in the mid- to high single digits. Other companies, like national oil companies, are not discussing CapEx budget increases as their [countries] focus on strengthening their fiscal budgets.

Finally, cost containment remains a top priority for these customers, which will likely make improved spending patterns a gradual phenomenon. We're not anticipating a material improvement in the macroeconomic environment for the E&C and upstream market segments in fiscal 2018.

Turning to our APM business. We delivered a solid quarter that reflects the market traction and increased customer spend that we expected to see in the quarter. We saw a meaningful quarter-over-quarter increase in annual spend from APM transactions signed during the second quarter, which brings the first half of fiscal year '18 performance in line with our expected trajectory. This positive momentum supports our guidance of 1 to 2 points of annual spend growth from APM this fiscal 2018. More importantly, the quarter delivered a set of proof points validating our thesis that the products available in the APM suite represent a significant opportunity in both the process and global economy industries.

We signed APM transactions across industries, products and geographies, including significant transactions with refining and E&C customers for our Mtell and Fidelis products, respectively. We also signed transactions for Mtell in the oil and gas, metals and mining and building materials industries and signed transactions for our multivariate analytics ProMV product in the polymers and food industries.

Our APM pipeline continues to expand, and we're encouraged by the positive market reception for this new suite of solutions. Customers are recognizing the value that machine learning and analytics can have on improving their reliability, productivity and operating life of the physical components of their assets. In addition, we have expanded our partner ecosystem to over 50 resellers, systems implementers and OEMs, which resell and deploy the APM suite in the GEI industries. The proof points achieved during the second quarter, coupled with the growth in our APM pipeline and number of pilots committed, validate our investment in the APM suite and support the return we're expecting from it. We will continue to monitor our momentum and success as the fiscal year progresses and evaluate the opportunity for greater investment in our customer-facing organizations of the APM business going forward.

Turning to our second quarter performance in more detail. Energy, engineering and construction and chemicals once again represented greater than 90% of our business. Energy was the largest vertical contributor followed by chemicals and E&C.

Looking at our 10 largest transactions in the quarter. We had a healthy mix of engineering, manufacturing supply chain and APM transactions. In fact, 2 of the 3 largest transactions in the quarter were APM deals. While there will be variability quarter-to-quarter, we would anticipate that all 3 product suites will be represented in our largest quarterly transactions going forward.

Following is a representative sample of transactions closed in the quarter. First, today, we issued a press release announcing that Saras, which owns the most complex refinery in the Mediterranean Basin, with a processing capacity of 300,000 barrels per day, selected our Mtell product for a refinery-wide deployment to drive reliability in its capital and asset-intensive operations. Saras' selection of Aspen Mtell was based on a competitive, proof-of-concept vendor selection process that initially focused on critical refinery equipment, such as large compressors and pumps. They cited Mtell's ability to improve reliability that positively impacts a wide range of issues: from reducing current maintenance costs to planning for abnormal process conditions, avoiding emergency or unplanned shutdowns and successfully managing unpredictable feed and demands. Saras expects to achieve savings from this initiative, which is part of an important digitalization project. This customer is also a user of our engineering MSC products. Licensing of the APM suite extends our relationship and further proves the value creation potential from AspenTech's products.

Second, this global E&C firm and longtime AspenTech customer renewed its agreement and licensed our APM suite to expand access to and build on experience with the Fidelis Reliability product. In the new transaction, Fidelis will be used to improve accuracy in defining scope in bidding processes, minimize risk in lump-sum turnkey projects and minimize spare parts and asset requirements on hand in clients' manufacturing processes. This transaction also helped address the token overhang in the customer's engineering suite due to the global macro environment for E&C companies, helping to mitigate a potential reduction in spend.

Third, this global metals and mining company licensed our Mtell product to address a key challenge with process pump failures in its European plant, which costs approximately $200,000 per failure. These failures are a severe detriment to the company's operations, often causing total shutdowns. The introduction of Aspen Mtell will mitigate unplanned pump failures, ensuring continuous operations and production volumes. The plan is to roll out the technology over the next 12 months to manage the unplanned stoppages by using the failure pattern technology in the context of production schedules, therefore, allowing continuous plant availability.

Fourth, this long-term European customer, a producer of polymers and agrochemicals, considers AspenTech a strategic IT supplier. The transaction signed in the second quarter involves the upgrade and expansion of our Manufacturing Execution System products, expansion of our Advanced Process Control technology into agrochemicals and expansion of our Aspen process sequencer product into 2 more polymer plants to manage and optimize the transition in these plants between different polymer-grade production runs. This is all based on the significant value generated from the use of these products.

And lastly, this Canadian energy company has been a user of our Aspen PIMS planning product for over 15 years. The company decided to upgrade to our PIMS-AO technology after an extensive evaluation and migrated all users to the technology. This transaction resulted in a significant increase in the number of tokens with plans for expanding use into other related applications.

Looking at our -- looking at profitability in the quarter. We generated a 50% non-GAAP operating margin that was above our expectations. We're making good progress in investing across our product and go-to-market organizations to support our Asset Optimization strategy and the APM suite. We're pleased with the quality and expertise of employees we're bringing into the company and how they're expanding our domain knowledge in our newer areas of focus. We believe our ability to invest for future growth while maintaining best-in-class levels of profitability is a unique differentiator for AspenTech.

Two examples of the investment we're making in the business include the release of Aspen Version 10.1 and the acquisition of the RtTech technology assets. Enhancements available in version 10.1 include the new Aspen operator training solution in the engineering suite, which enables a seamless deployment of training for operators and engineers with a dynamic simulation life cycle solution that brings operator training simulation online sooner and sustains safety throughout an asset's lifetime. This new solution combines HYSYS dynamics with the technology we acquired from Inprocess Technology and Consulting Group. We believe operators can achieve savings from operating training simulation of up to $15 million per project. An updated Manufacturing Execution System that simplifies migration from Process Explorer to aspenONE Process Explorer as well as enabling users to track operating KPIs in real-time from any device; and finally, the official introduction of Aspen ProMV to the aspenONE APM suite, which delivers high-fidelity control and improves the quality and consistency of batch processing by managing the sources of variability in production operations.

During the quarter, we also acquired the Cipher Industrial Internet of Things software and edge connectivity assets of RtTech software. Cipher extends and expands our Asset Optimization strategy by providing sophisticated cloud and edge computing technology that captures and aggregates critical data from assets throughout the plant and across the enterprise. Specifically, Cipher will capture condition and analyze data on the edge of assets from sensors and other data sources that can be used with our machine learning and analytics solutions to increase asset efficiency and uptime. Cipher is a cloud-native application with multi-tenant capabilities, leveraging a modern architecture design based on Microsoft Azure Internet of Things platform, which can also be used on-premise.

Before I wrap up, I wanted to take a moment to comment on the recently passed tax reform legislation. AspenTech is a significant beneficiary of corporate tax reform due to our practice of maintaining our intellectual property in the United States. We intend to use the additional cash flow from our lower tax rate to support our existing capital allocation priorities. Our profitability drives high levels of cash flow, which, combined with our strong balance sheet, enables us to consistently generate shareholder value through share repurchases. In the second quarter, we repurchased 756,000 shares for approximately $50 million. It is our current intention to continue our buyback at the $50 million per quarter level for the remainder of fiscal 2018.

To summarize, AspenTech delivered solid second quarter results, and we believe we're positioned to achieve our full year growth and profitability target. We continue to execute well against our Asset Optimization strategy and remain confident in our ability to benefit from our large and growing market opportunity. We believe these efforts will lead to improved growth and a strong profitability in the years ahead that can deliver value to our shareholders.

With that, let me turn the call over to Karl. Karl?

Thanks, Antonio. I will now review our financial results for the second quarter fiscal year 2018, beginning with annual spend and then finish with our third quarter guidance and updated outlook for fiscal 2018. Annual spend, which is a proxy for the annualized value of our recurring term license and maintenance business at the end of each period, was approximately $469 million at the end of the second quarter. This represented an increase of approximately 4.2% on a year-over-year basis and 1.7% sequentially.

Total revenue was $124.9 million for the second quarter, above the high end of our guidance range and an increase of 4.1% compared to the prior year period. The overperformance in the quarter was largely driven by the recognition of cash basis revenue.

Looking at revenue by line item. Subscription software revenue was $117.7 million for the second quarter, an increase of $112.9 million in the prior year period and $115.8 million last quarter. Services and other revenue was $7.2 million compared to $7 million in the year ago period and $7 million last quarter.

Turning to profitability, beginning on a GAAP basis. Gross profit was $112.8 million in the quarter, with a gross margin of 90.3%, which compares to $108.4 million and a gross margin of 90.3% in the prior year period. Operating expenses for the quarter were $58.3 million compared to $52.3 million in the year ago period. Total expenses, including cost of revenue, were $70.4 million, which was up from $63.9 million in the year ago period and from $69.5 million last quarter. The increase in operating expenses primarily reflects the investments we are making in the APM suite as well as a nonrecurring expense of $1.5 million related to a litigation judgment. Operating income was $54.5 million for the second quarter of fiscal 2018 compared to $56.1 million in the year ago period. Net income for the quarter was $38.1 million or $0.52 per share compared to net income of $37 million or $0.48 per share in the second quarter of fiscal 2017.

Turning to non-GAAP results. Excluding the impact of stock-based compensation expense, restructuring charges, amortization of intangibles associated with acquisition, litigation judgment expenses, acquisition-related expenses and noncapitalized acquired technology, we reported non-GAAP operating income for the second quarter of $62.2 million, representing a 49.8% non-GAAP operating margin compared to non-GAAP operating income and margin of $60.9 million and 50.8%, respectively, in the year ago period. Non-GAAP net income was $43 million or $0.59 per share in the second quarter of fiscal 2018 based on 73 million shares outstanding and was above the high end of our guidance range of $0.50. This compares to non-GAAP net income of $40.2 million or $0.52 per share in the second quarter of fiscal 2017 based on 77.3 million shares outstanding.

Turning to the balance sheet and cash flow. The company ended the quarter with $48.7 million in cash and marketable securities compared to $59 million at the end of last quarter. During the second quarter, we repurchased approximately 756,000 shares of our stock for $50 million. We remain on track to repurchase $200 million of stock in fiscal 2018.

Looking at our deferred revenue balance. It was $258.7 million at the end of the second quarter, representing a 7.2% increase compared to the end of the year ago period. On a sequential basis, deferred revenue decreased $1.6 million. This is in line with our typical seasonality. As a reminder, our deferred revenue balance is heavily influenced by the timing of invoices, and the second quarter is typically our lowest invoicing quarter.

From a cash flow perspective, we generated $42.4 million of cash from operations during the second quarter and $42.2 million of free cash flow after taking into consideration the net impact of capital expenditures, capitalized software and noncapitalized acquired technology.

A reconciliation of GAAP to non-GAAP results is provided in the tables within our press release, which is also available on our website.

Before moving on to our business outlook, I'd like to take a moment to discuss the recent tax reform and what it means for AspenTech. As Antonio mentioned, we will significantly benefit from the new tax legislation. We continue to evaluate the legislation and the impact it will have on our corporate tax rate. As it relates to fiscal 2018, we expect a 27% to 28% effective tax rate in the third and fourth quarters, which will lead to an effective tax rate of 28% to 29% for the full fiscal year 2018. We currently expect an effective tax rate of 21% beginning in fiscal 2019 and for fiscal periods thereafter. But as I mentioned, we're still evaluating new deductions in the legislation that could reduce this effective tax rate.

I'd now like to close with our third quarter guidance and an updated outlook for the full year fiscal 2018. For the third quarter, we expect revenue in the range of $120 million to $122 million, non-GAAP operating income of $52 million to $54 million and non-GAAP EPS of $0.48 to $0.50 per share. On a GAAP basis, we expect operating income of $46 million to $48 million and income per share of $0.42 to $0.44 per share.

Turning to the full year. We are raising our revenue guidance in the range of $490 million to $495 million and continue to expect subscription and software to comprise greater than 90% of revenue, with our services and other revenue representing the remainder.

From an expense perspective, we are adjusting our assumption for total GAAP expenses to $284 million to $287 million, which compares to our previous guidance of approximately $282 million to $287 million. Taken together, we are updating our GAAP operating income guidance to a range of $204 million to $209 million for fiscal 2018, with GAAP net income of approximately $140 million to $143 million. We now expect GAAP net income per share to be in the range of $1.90 to $1.95 compared to our previous guidance of $1.71 to $1.76. From a non-GAAP perspective, we are increasing our non-GAAP operating income guidance to $231 million to $236 million and now expect non-GAAP income per share in the range of $2.16 to $2.21, which compares to our previous guidance of $1.92 to $1.97. With respect to annual spend growth in fiscal 2018, we are maintaining our guidance of 5% to 7% annual spend growth.

From a free cash flow perspective, we are increasing our fiscal year guidance to $190 million to $195 million versus our previous guidance of $180 million to $185 million. Our fiscal 2018 cash flow guidance -- free cash flow guidance assumes cash tax payments of approximately $55 million to $60 million.

From a timing perspective, we are required to pay 50% of our anticipated cash taxes in the second quarter, with the remaining 50% paid equally in the third and fourth quarters. In Q2, our quarterly tax payment was due before the new legislation was passed and based on our previous effective tax rate of 34%. As a result, we've already paid more than 50% of our anticipated full year cash taxes.

In summary, AspenTech delivered solid results across the board, and we are pleased with the company's performance in the first half of fiscal 2018. We're encouraged by the success we're having executing against our strategy and believe we are well positioned to deliver long-term growth and shareholder value.

Before I turn the call back over to the operator for Q&A, I'd like to let you know that we will be shifting the timing of our Annual Investor Day to the second half of the calendar year. In addition, as part of our fourth quarter earnings call, we will provide an overview of the impact of Topic 606 on AspenTech's financials and our go-forward financial model.

With that, I will now hand it back over to the operator to begin Q&A.

(Operator Instructions) Your first question coming from the line of Shankar Subramanian from Bank of America.

I have a question on the APM suite adoption. You gave a lot of examples on how it's adopted across the industries, but can you help give us color on the mix of orders that you're receiving? How much of it is upstream? How much of it is downstream? Can you give us some color on -- is it one particular industry vertical you think that's going to drive that growth moving forward?

Let me start with where we're focused today. It's natural for us to be focused on our process industry customers, refining and chemicals because that's where our sales organization is going to market every day. So we would expect that the initial set of deals and transactions for APM would be out of that customer set, which I think informs, then, the first part of your question. The initial set of transactions that were signed in the quarter were in the refining sector. There were a few in chemicals, and there was also an oil and gas one related to a pipeline monitoring application for Mtell. But as we look at our pipeline of deals, we do see transactions in our pipeline that are in the upstream sector as well, where we think APM can truly make a difference for those customers.

Got it. And if you could add some more color on the GEI, you added a lot of partners, and it seems like you're putting a lot of effort there. When do you expect that momentum to pick up?

Well, look, in addition to signing up the partners, we've been working hard to enable them through training, education and so on. I would expect that certainly that'll be part of the sales cycle here. We've said in the past that the APM sales cycle tends to be like the MSC sales cycle, 9 to 12 months. So any impact from the GEIs we would expect to start seeing is perhaps toward the latter part of fiscal '19. In the meantime, we're very focused on the process industries.

Got it. Just one more question on that. Is there a potential inflection point you see for the APM suite? Or is it a steady growth for fiscal '18, '19, '20 onwards?

Well, I mean, look, this is a whole -- this is a market segment. It's not only that AspenTech has set up a new suite. The fact is that there isn't any references in the industry for machine learning analytics. So in a way, we're creating a new market. We're working on establishing the proof points and references, which I believe we'll make good progress in that regard in Q2. But we also have to cross the chasm. We have to achieve that critical mass of customers that eventually we get across the chasm, the inflection point, where it becomes more of a mass adoption. We've provided guidance for the fiscal year of 1 to 2 points. That should represent a material number of customers that are adopting the technology. And eventually, we would expect that there's more broad -- widespread adoption as customers get more comfortable with the technology, as the value's proved out and they understand what it can do for them.

Got it. And if I may slip in one last question. On the chemical, it seems like, based on what China is doing on the environmental side, it seems like there might be a little bit more CapEx spend coming in, in 2019, 2020 time frame. Can you help add some color on how that CapEx trend is going to go for the chemical side?

Yes. There is an expectation that there's going to be a second wave of CapEx spend in chemicals starting in 2019, '20. There's been questions about whether that second wave could be sustained. That was about a year ago. But now in the context of the macro environment, the global economic growth environment and that now you're seeing consistent growth across most developed economies, I think the opinion has shifted to one where that second wave of CapEx spend in chemicals will probably materialize in the U.S. as well as other places because the demand will be there to sustain it in the long term.

Your next question coming from the line of Monika Garg from KeyBanc.

Antonio, first, you had talked about annual spend growth this year is back-half weighted. Q2 growth is 4.2%, lower than your yearly growth target of 5% to 7%. Maybe could you talk about the confidence level you have that -- I know spend growth picks up in back half.

Well, I mean, look, we restated or reaffirmed our guidance on -- for the year of 5% to 7%. We have good visibility into our pipeline of business both on the engineering and MSC sides but also with the APM suite. And our confirmation of the guidance, I think it demonstrates that we would expect faster growth to materialize in Q3 and Q4.

Got it. And then oil markets, you also talked about have definitely improved recently. Have you seen increased interest from your customers to buy more software or any commentary from the customers you can share?

No. Look, I think -- so we continue to see good demand for our software from owner-operators. I mean, refiners and chemical producers are actually enjoying a very good macroeconomic environment. The expectation is that the U.S. refiners are going to have a very strong year again this year, chemical producers as well in general. So I think the demand from these customers is positive. At the same time, I do think that the upstream businesses of these customers are still being managed in a very disciplined and cautious manner. Oil supply is still exceeding demand, although it's more imbalanced in the last 6 months. So I would expect a spend environment from -- in the upstream sector and E&C that is still very cautious and measured. So we're not -- like I said in my talk, I don't think we expect a significant -- or an acceleration of that business on that side.

Got it. Yes. So Karl then, on the FQ3 revenue guidance, your revenue guidance for FQ3 is lower than both for FQ2, FQ1. I guess, trying to understand why would that be the case or it's just conservatism on...

Yes. So no, I mean, when you look at Q3, you have to remember we're losing 2 days as compared to Q2. So when you look at Q3, you're going to lose a little over $1.25 million per day. So you're going to lose just over $2.5 million. You also had, in Q2, you had that $1.5 million of kind of accelerated revenue from the second half of the year. So you take those and you kind of roll from Q2, it makes sense with the annual spend. An easier way to look at it is just take the ending annual spend at the end of Q2, divide it by 365, times the 90 days in Q3, and then that gives you a good view of what subscription would be, plus or minus a little bit of cash basis and the timing of renewals or growth in the quarter, whether they materialize as revenue in the quarter. And then the rest is just some variability around professional services.

Got it. And then your comment regarding the tax rate for fiscal '19, so you said the tax rate could be 21% or could be lower depending upon when you look in details on the tax side. So would the 21% be both for cash and non-GAAP tax rate?

Yes. So what you end up with sometimes between the effective rate and the cash tax rate is you get some timing differences related to permanent and temporary differences. Good example would be deferred revenue can cause a difference between the 2. So by and large, over time, they should align. But in any year, any quarter, you can get a little bit of departure, but I wouldn't say it's by 200 or 300 basis points. It will be close enough modeling.

Got it. Okay. Just the last one here. For Q3 and Q4, did you say the tax rate is around 28% or 29%? And I guess, if that -- if I heard it correctly, then why would that be higher than, like, 21%?

Yes. So I'll start with the back end of it first. So the tax rate changed on December 29, 30, whenever it was signed into law. So you get the first half of our fiscal year is at the 35% rate. And then the second half is at the 21%. So you have to take an average. And then what you do is you adjust Q2, 3 and 4 to get to that average. So you want to have those be equal. Q2 would have been slightly lower, but what happened was we had to revaluate our deferred tax assets because we put them on the books at the 34%, 35% rate. And they're going to come off at 21%. So you had a little bit of an adjustment for that, that drove the effective tax rate in the quarter up. But we did say for Q3 and Q4, somewhere in that 27% to 28% range; and then for the full year, 28% to 29%.

Got it. Antonio, just one on the APM. You have -- gave good details on APM. And then you said 2 of the 3 largest transactions were APM in the quarter, signed 50 resellers agreement, but you reiterated 1% to 2% growth on APM. When can we see higher growth in that suite?

Well, Monika, we'll take it one fiscal year at a time. We're comfortable with the guidance of 1% to 2%. Let's get to the end of fiscal year '18, and then we'll talk about '19. But we have a pipeline that is growing. The number of pilots that we're getting commitments on from customers is also increasing. And we're also hearing good things from customers about our competitiveness vis-à-vis other companies out there. So I think, overall, we're confident we have a business that can deliver value for customers, deliver value for AspenTech. And it's a total whitespace addressable market and that should provide the platform to have better and faster growth in the future, but we'll take it one fiscal year at a time here.

(Operator Instructions) Your next question comes from the line of Matt Pfau from William Blair.

So I guess, what I wanted to hit on was the guidance on expenses for the back half of the year. Karl, it sort of implies a fairly decent drop-off in operating margin for the back half both sequentially from the first half and then relative to the year-over-year compares. So just sort of wondering what assumptions are in the number. Is there back half hiring or some other investments that we should be thinking about that's sort of driving the back half margin lower than the first half of the fiscal year?

Yes. So Matt, it's typical with our model. The reason being is if you look at the guidance we just gave, you can figure out the implied guidance for the Q3 spend. And really, what you're going up, $3 million, $4 million, is really our benefits is what you'll see in there. And you see that typically in our fiscal Q3 or the first calendar year. So if you look at that cap -- that expense increase in Q3 compared to Q2, it's predominantly benefits resetting. So people are resetting their benefits where they kind of max them out during the year. There's a little bit of hiring in there and some other kind of investments, but nothing that material compared to prior years with the hiring we had. And then if you kind of take that and look at the first half expenses implied Q3 and look at Q4, Q4 is pretty flat with the Q3 implied guidance that's in there. So there's nothing spectacular in there. It's actually just sort of the normal uptick you see in Q3 and then just kind of flat expenses through the year. And then from the margin point of view, you do have the decrease in revenue just because of the days.

Your next question comes from the line of David Hynes from Canaccord.

So nice to hear the APM traction in your comments. One of the things that jumped out to me was you were talking about E&Cs as prospective customers on that front. I was thinking about this more as a play on kind of leveraging historic operating data. So do E&Cs have this? Are there different use cases in how the refiners use it? Just maybe talk about selling APM into the in-season, exactly how that works.

Okay. But let me look at -- let me first say, engineering and construction companies, in addition to designing and building these plants, they also provide consulting and do studies for these owner-operators. In the context of the comments that I made about the top-tier E&Cs looking for new sources of revenue generation, they see the APM suite as a potential set of products and tools that they can then help deploy for these customers or help monitor once they're implemented. So in a way, they are used either -- they think of the APM suite as a way to provide consulting or implementation services for those products and eventually monitoring of the assets that are under the Mtell supervision.

Okay. Yes, that makes sense. I'll sneak one more just to keep up with my counterparts. So we're 3.5 years kind of removed from the major 2014 reset in the energy market. We know you signed 5- to 6-year deals. So there's still, in theory, this period of kind of challenging renewals as you work through the base. I'm going to ask you to get your crystal ball out. If we fast-forward past these renewal headwinds, right, maybe 2 to 3 years, when everyone's kind of now buying against reset expectations, does it feel like Aspen can get back to a 10% annual spend grower at some point?

Well, look, what I would say is that our attrition as a result of the downturn in oil prices and therefore less CapEx, our attrition jumped from 2% to 3% to 5% to 6%. That's 3 points of growth that we have to overcome every year, every quarter. And if you -- as you say, if you play it forward and you do -- you get through a full cycle where you've reset every contract, you could see our growth rate getting into that high single-digit, double-digit growth. I've told investors in the past that if you look at the gross growth of the company before attrition, the company is still generating 10%, 11% gross growth. If you were to take back -- take attrition back to a normal level of 3%, then you're in that sort of 8% range. And we're banking with APM as creating a new source of growth and delivering that extra 2%, 3% that gets us to double digit.

Your next question comes from the line of Rob Oliver from Baird Company.

So on -- Antonio, last couple of quarters, you've given a number around the pipeline and -- that was represented by APM. And I think it might have come in Q&A, so I'll give you a chance to touch on it if you want to. But I think you said it was 19% a couple of quarters ago, 21% this quarter. It seems like obviously you're much more broad-based in the demand with Fidelis now kind of kicking in a little bit, maybe that number becomes less relevant, but just wondered if you wanted to touch on that quickly.

Yes. No, look, it moved up again as a percentage of our total pipeline. Our total pipeline also improved, and it's in that 24% to 25% of our total pipeline. We -- certainly, we monitor that pipeline. But I think, more importantly, an indicator of our ability to turn that pipeline into transactions is the number of pilots that we are performing or that we perform with our customers to prove out the efficacy of the technology. And the number of pilots that we're performing and that we're -- that are committed to be performed continues to increase, so that gives us confidence that the pipeline is also of good quality.

And I would assume these deals are competitive. And just wondering, how much your -- the software DNA that you guys have and the installed base that you have plays a role. I know you went out of your way to mention in the prepared comments that on the E&C deal that DJ just asked about, that it was -- also helped address the token overhang. If these are competitive situations -- and we just saw PTC come out and say that their IoT business was better. We think the software DNA there is helping them a lot. How much of a competitive advantage is that for you guys right now as you build that pipeline?

Yes. Well, look, certainly, at the moment, we're 100% focused on standing up the APM suite and the products in the suite. Now over time, you can see the synergies between the APM suite, the MSC suite and the engineering suite. I think, certainly, that deal with that E&C company is perhaps an early indicator of that. But from an operational standpoint, we already have use cases where we see the synergy and the value creation from combining some of the APM technologies with MSC technologies. So that -- we'll have to do some work in the products to achieve those synergies. But over time, I know that we would see the benefit from that.

Your next question comes from the line of Gal Munda from Berenberg.

I'd just like to ask a bit more about the APM pipeline, just to understand how much of that pipeline today is still the new pilots that you're guiding and how much is it expansion opportunities from the ones that you've been doing over the last year.

No. It's mostly new. Hopefully, we can get into that expansion of transactions that we've already done now. But it's mostly new opportunities that are being identified in the marketplace. So that's what it is.

Okay. That makes sense. And in terms of the deals when you do go in and sign a deal, like with Saras, how does that compare to the overall deal sizes to your core business? Is it a comparable deal size? Or is that kind of bigger or smaller?

Well, look, like we said, 2 of the top 3 deals in the quarter were APM deals. We are -- we had an initial premise for the size of deals that we could do with these customers. Some of these deals are competitive. And of course, you have that price pressure. But even in that context, we're satisfied with the annual spend that we got for those deals. So early indications are good, but -- the value creation for us, but I'd like to have a few more quarters under my belt before I can speak with total confidence about what's going to be possible.

Your next question comes from the line of Sterling Auty from JPMorgan.

This is actually Ugam Kamat on for Sterling. So your tax rate is going to go down significantly in FY '19. It will be like 21% versus, what, 28% to 29% that you estimate for this fiscal year. Just wondering how would you prioritize investments versus capital return to shareholders? And in investments, particularly, would you be driving it towards the APM suite?

Well, I mean, look, it's like -- I think it's what we said to investors when we meet with them and also in previous calls. Our capital allocation priorities are very straightforward. Certainly, organic investments internally in the company, whether it's R&D or go-to-market functions, then M&A and then share repurchases. I said in my remarks that depending on the outlook that we see for the APM business in Q3, Q4, we could decide to take advantage of that opportunity and put some more investment in the APM business as a priority. Then there's M&A and, if not, share repurchases. And regardless, we're committed to our share repurchase program. And assuming there's excess cash, that's where it will go.

All right. And just one more, if I could sneak in. It's just going to be quick. You mentioned there was a cash collection-based revenue in the quarter. How much amount was it? And how much of a tailwind did it have on the revenue?

Yes. So the impact on the revenue was about $1.5 million in the quarter.

Your next question comes from the line of Steve Koenig from Wedbush Securities.

I wanted to ask you guys, on the quarter relative to annual spend, did manufacturing drive, would you say, the majority of that if you could say? Or just more qualitatively, is that still back on track after the pause that you saw in Q3 fiscal '17? And then just to put it out there, the back half of my question is about the engineering suite. Did you -- is the hurricane helping that? Did you see it help that at all? Or could it help somewhat in the second half? And are you anticipating that at all?

Let me answer the second part of your question on the hurricane. No, we saw no benefit from that. The fact is that very few of those plants were impacted, so -- and there's no benefit expected in the future. So look, as you can expect, based on what you know about AspenTech, our engineering business certainly has strong headwinds. And we're able to overcome those headwinds to deliver positive growth that are out of the engineering suite, but that growth is mitigated by those headwinds. Our APM business is a new business, so it's in its early stages of growth. And the MSC, at the moment, is a workhorse that we're riding here to deliver the lion's share of the growth. And look, our MSC business is performing well, and we would expect -- I would expect it to perform in line with the historical performance of the past 6, 7 years, sort of that area of double-digit growth.

(Operator Instructions) Your next question comes from the line of Mark Schappel from Benchmark Company.

Just one question here. Antonio, regarding your APM suite, competitively, there's not much in the way of meaningful competition yet, mainly because it's still early days for the category. But for the few competitors that you do see out there or at least the vendors out there that are trying to put an offering in the marketplace, they're obviously much different than your traditional competitors for your MSC and your engineering products. Just wondering if you could just discuss a couple of the people that you do see or you do at least hear about that are trying to put a predictive maintenance product in the marketplace.

Yes, yes. Well, and I think the keyword is predictive maintenance -- or keywords. So the 2 most common competitors that we're seeing in the marketplace at the moment are GE, but the fact is that GE's solution is not predictive maintenance. It's condition-based monitoring, and we tend to do very well against them. Schneider is also the second company that we see out there often. Their solution seems to be a combination of condition-based monitoring with some predictive capabilities. And then once in a while, we're seeing a couple of other companies. S-A-S, SAS, and a company called C3 IoT as well. So we -- now that we've signed some deals, we are getting feedback from customers about how they -- how our technology compared to that of others, the advantages that they see. And look, we're satisfied with what we're hearing. It's early days in the market, but I think the combination of these products within the expertise around the process industry and data certainly makes us a strong contender.

(Operator Instructions) There are no questions at this time. Presenters, you may continue.

Well, I want to thank all of you for joining the call today. I look forward to seeing you in the future. Thank you all. Thank you, Rose.

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