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Aspen Technology Inc
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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 of Fiscal 2018 Earnings Call. All lines have been placed on mute, to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions]
Thank you. 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 of 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 will 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 continue 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 represent a non-GAAP operating margin of 49.8%. GAAP EPS was $0.52 and non-GAAP EPS was $0.59 both of which outperformed our guidance. Free cash flow was $42.2 million and we returned $50 million to shareholders by repurchasing 756,000 shares.
We are 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 three 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 activities 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 Aspen Tech's three 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 Aspen Tech.
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 are 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 increase in 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, there country focus and strengthening their physical budgets.
Finally cost containing remains a top priority for this customers, which will likely make improve spending patterns a gradual phenomena. We are not anticipated in material improvement in the micro entomic environment for the E&C and upstream market segment 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 2018 performance in line with our expected trajectory.
This positive momentum supports our guidance of one to two points of annual spend growth from APM this fiscal 2018. More importantly the quarter delivered the set of proof points validating our thesis that the products available in the APM suite represent a significant opportunity in both 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 multi varied analytics try and do in the polymers and food industries.
Our APM pipeline continues to expand and we are 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 eco system to over 50 resellers, system implementers and OEM's which resale and deploy the APM suite in the GEI industries. The proof point achieved during the second quarter coupled with a growth in our APM pipeline and number of pilot committed validate our investment in the APM suite and support the return we are expecting from it.
We will continue to monitor our momentum and success as the fiscal year progress enabled with 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 and general construction and chemicals once again represents a greater than 90% of our business, energy was a largest vertical contributor followed by chemicals and E&C.
Looking at our ten largest transactions in the quarter, we had a healthy mix of engineering, manufacturing supply chain and APM transactions, in fact two of the three largest transactions in the quarter were APM deals. While there will be variability quarter-to-quarter, we would anticipate that all three products suites will be represented in our largest quarterly transactions going forward.
Following with our representative sample of transactions closed in the quarter. First, today we issue a press release announcing that [Cirus] (Ph) which owns the most complex refinery in the Mediterranean basin with a processing capacity of 300,000 barrels per day elected our Mtell for our refinery wide deployment to drive reliability and its capital and asset intensive operations.
Cirus’ selection of Aspen Mtell was based on a comparative proof of concept, vendor selection process that initially focused on critical refinery equipment such as large compressors and pumps.
They sighted Mtell’s ability to improve reliabilities that positively impacts a wide range of issues from reducing its current maintenance costs, to planning for abnormal process conditions, avoiding emergency or unplanned shutdowns and successfully managing unpredictable feed and demands.
Cirus expects to achieve savings from this initiative which is part of an important digitalization project. These customers also are user of our engineering and [indiscernible] products, licensing of the APN suite extends our relationship and further prove the value creation potential from AspenTech’s products.
Second, these global E&C firm and long time AspenTech customer renewed its agreement and licensed our APN 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 and 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 help to address the token overhang in the customers 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 severe detriment to the Company’s operations often causing total shutdowns.
The introduction of Aspen Mtell will mitigate unplanned pump failures and sharing continues operations and production volumes. The plan is to rollout 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 continues plant availability.
Fourth, this long-term European customer, a producer of polymers and agrochemicals, considers AspenTech a strategic IT supplier. The transaction of sand in the second quarter involves the upgrade an expansion of our manufacturing execution system products, expansion of our advanced process control technology to agrochemicals and expansion of our Aspen process sequencer product into two more polymer plants to manage and optimize the transition in this plant 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 user of our Aspen planning product for over 50 years. The Company decided to upgrade to our [indiscernible] 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 using to all the related applications.
Looking at profitability in the quarter, we generated a 50% non-GAAP operating margin that was above our expectations. We are making good progress in investing across our product and go-to market organizations to support our asset optimization strategy and the APN suite.
We are pleased with the quality and expertise of employees we are bringing into the Company and how they are expanding our domain knowledge in our new 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 investments we are making in the business include the release of Aspen version 10.1 and the acquisition of the architect technology assets. Enhancements available in version 10.1 include the new Aspen Operator training solution in the engineering suite which enables the 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 IT dynamics with the technology we acquired from in process technology and consulting group. We believe operators can achieve savings from operating training team relation of up to $15 million per project.
An updated manufacturing execution system that simplifies migration from process floor to AspenONE processes floor as well as enabling users to track operating APIs in real time from any device and finally the official introduction of Aspen ProMV to the AspenONE APN suite which delivers high fidelity control and improves the quality and consistency of batch processing by managing the sources of variability introduction operation.
During the quarter, we also acquired the Cipher industrial Internet Of Things software and edge connectivity assets of Architect 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 to other plants and across the enterprise.
Specifically Cipher will capture condition and analyze data on the edge, 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 approximately with multitenant 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. Aspen Tech 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 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 Aspen Tech delivers solid second quarter results and we believe we are 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 the 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 second quarter. This represent 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, an increase of 4.1% compared to prior-year period. The over performance in the quarter is 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 a $112.9 million in the prior-year period and $115.8 million last quarter. Services and other revenue were $7.2 million compared to $7 million in the year-ago period, an $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 expense for the quarter were $58.3 million compared to $52.3 million a 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 non recurring expense of $1.5 million related to 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 and intangible associated with acquisition, litigation judgment expense, acquisition related expense and non capitalized acquire 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 from the year-ago period.
Non-GAAP net income of $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 $0.52per 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 stocks or $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 decrease $1.6 million, this is in line with our typical seasonality. As a reminder, our deferred revenue balances heavily influenced by the timing of invoices and the second quarter is typically our lowest invoice in 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 non-capitalized acquired technology. A reconciliation of GAAP to non-GAAP results is provided in tables within our press release, which is also available on our website.
Before moving on into our business outlook, I would 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 quarter, 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 are still evaluating new deductions in the legislation that could reduce this effective tax rate.
I would now like to close with our third quarter guidance and 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 million 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 a 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 to be 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 of $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 expedited cash taxes in the second quarter with the remaining 50% paid equally in the third and fourth quarter.
In Q2 our quarterly tax payment was due before the new legislation was passed and based on a previous effective tax rate of 34%. As a result, we have 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 are encouraged by the success we are 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 would 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 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 Subramaniam from Bank of America, your line is open.
Hi, thanks for taking the question and congrats on a good quarter. 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 are receiving. How much of it is upstream, how much is downstream. Can you give us some color on is it one particular industry vertical that’s going driver growth moving forward?
Let me start with where we are 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 and the first part of your question the initial set of transactions that were assigned in the quarter where in the refining sector there were a few in chemicals and there was also an oil and gas one related to 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 color on the DEI, you added lot of partners and it seems like you are putting a lot of effort there. When do you expect that momentum to pick up?
Well look in addition to signing up the foreigners we have 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 said in the past that the APM sales cycle tends to be like the MSC sales cycle, nine to 12 months so any impact from the GIs we would expect to start seeing is perhaps towards the latter part of fiscal 2019. In the meantime we are very focused on the processing industries.
Got it just one more question on that, is that a potential inflection point you see for the APM suite or is it a steady growth or fiscal 2018, 2019 many onwards.
Well I mean look, this is whole, this is a market segment, it’s not only that can take, new suite the fact is there isn’t any references in the industry for machine learning analytics, so in a way we are creating a new market, we are working on establishing the proof points and references which I believe we made good progress in that regard in Q2, but we also have to [indiscernible], we have to achieve that critical mass of customers that eventually would get across the - and the inflection point where it becomes more of a mass adoption.
We have provided guidance for the fiscal year of one to two points that should represent a material number of customers that are adopting the technology. And eventually we would expect that there is more wide spread adoption as customer can get more comfortable with the technology as the values through that and they understand what they can do for them.
Got it, and if I may, one last question. On the chemical it seems like based on what China is doing on environmental side, it seems like there might be a little bit more CapEx spend coming in 2019, 2020 timeframe, can you help add some color on how that CapEx and that is going to go for the chemical side.
There is an expectation that there is going to be second wave of CapEx spending chemicals starting in 2019, 2020. There is being questions about whether that second wave could be sustained that was about a year ago but and now in the context of the macro environment the global economic growth environment in that, now you are seeing consistent growth across most developed economies. I think the premium has shifted to one where the second wave of CapEx spending chemical will probably materialize in the U.S. as well as the places because the demand will be there to sustain it in the long-term.
Got it. Thank you so much guys.
Your next question is coming from the line of Monika Garg from KeyBanc. Your line is open.
Hi Antonio thanks for taking my question. Antonio first, you have talked about annual spend this year is back, a key to growth is 4.2% lower than yearly growth target of 5% to 7%. May be could you talk about the confidence level you have that annual spend growth fix up in back half.
We restated or reaffirmed our guidance for the year five to seven. We have good visibility into our pipeline of our business, both and in engineering and MSC side but also with APM suite and our conformation of the guidance I think demonstrates that we would expect faster growth to materializing Q3 and Q4.
And then you know oil markets, you also talk about have defiantly improve recently. Have you seen increased interest from your customers to buy more software or any commentary from the customer you can share.
Look I think, so we continue to see good demand for our software from owner operators, I mean refiners and chemical producer are actually enjoying a very good macroeconomic environment and expectation is that the U.S. refiners are going to have a very strong year, this year chemical producers as well in general. So I think the demand from this customers is positive.
At the same time I do think that there are extreme businesses of these customers are still been managed in a very disciplined and cautious manner, oil supply is still exceeding demand, although its more imbalanced in the last six months, so I would expect a spend environment in the upstream sector and E&Cs that is still very cautious and measured. So we are 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. So thanks. Karl, then you know on the FQ3 revenue guidance, your revenue guidance for FQ3 is low than both for FQ2, FQ1. I guess trying to understand why would that be the case, are just conservatism on…
Yes so now I mean, when you look at Q3 you have to remember we are losing two days as compared to Q2. So when you look at Q3, you are going to lose little over a million and a quarter per day. So you are going to lose just over $2.5 million. You also had in Q2, you had that $1.5 a kind of accelerated revenue from second half of the year.
So you take those and you kind of roll from Q2, it make sense with the annual spend, and easier way to look at it, it’s just take the ending annual spend at the end of Q2, divided by 365 times the 90 days in Q3 and that gives me a good deal, 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 revenue in the quarter and the rest is just some variability around professional services.
Got it, thanks. And then your comment regarding the tax say for fiscal 2019. 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 is when the effective rate, cash tax rate as you get some timing differences related to primary and temporary differences, good example will be deferred revenue can cause a difference between the two. So by and large overtime they should aligned 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 for modeling.
Got it, okay. just a last one here, for Q3 and Q4, did you say the tax it is around 28% or 29% and I guess if I heard it correctly than why would that be higher than like 21%?
Yes so, I will start with the back end first. So, the tax rate changed on December 29, 30, whenever it was signed into law. So, you get the first half of fiscal year, is that 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, Q3 and Q4 to get to that average. So you want to have those to 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 are come up to 21% so got a little bit of a adjustment for that that drove the effective tax rate 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%.
Okay. Antonio just one on the APM, you gave good details on APM, you said two of the three largest transactions were APM in the quarter signed 50 resellers agreement but you recreated you know 1% to 2% growth on APM. When can we see higher growth in that three, thank you so much.
Well Monika we will take it one fiscal year at a time, you know we were comfortable with the guidance of one to two, you know let's get to the end of fiscal year 2018 and then we will talk about '19 but we have a pipeline that is growing, the number of pilot we are getting commitment on from customers is also increasing and we are also hearing good things from customers about our competitiveness vis-à-vis the other companies out there.
So I think overall we are confident we have a business that can deliver value for customers, deliver value for AspenTech and is a total wide space addressable market and that should provide a platform to better and faster growth in the future. But we will take it one fiscal year at a time here.
Thank you so much.
Thank you, Monika.
[Operator Instructions] Your next question comes from the line of Matt Pfau from William Blair, your line is open.
Hey guys thanks for taking my question. 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 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 those numbers they are back half hiring or some other investments that we should be thinking about that sort of driving the back half margin lower than the first half of the fiscal year.
Yes. So Matt, it’s typical of that our model, the reason being if you look at the guidance we just gave you can figure out the implied guidance for the Q3 spend. And really what is going up $3 million, $4 million is really a benefit what you will see in there, you see that typically in our fiscal Q3 the first calendar year. So if you look at that cap that down expense increase in Q3 compared to Q2 it predominantly benefits resetting so people are resetting the benefits where they kind of max them up from the year.
There is 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 inside Q3 and look at Q4, Q4 is pretty flat with the Q3 implied guidance that's in there. So there is 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.
Alright okay thanks guys.
Your next question comes from the line of David Hynes from Canaccord. Your line is open.
Hey thanks guys how are you doing. So nice to hear the APM traction in the comments, one other things that jumped out to me was, you talking about E&C's as prospective customers on that front. I was thinking about his more as a play on kind of leveraging historic operating data. So does E&Cs have this - other different use case and how the refiners use it, just may be talk about selling APM into the end season, exactly how that works.
Let me first say, in general construction Company in addition to the signing and building this plant. They also provide consulting and do studies for this owners operators. In the context of the comments that I made about the top tier E&C looking for new sources of revenue generation, they see the APM suite as a potential set of products and tools that they can then held deploy for this customer or help monitor once they are implemented, so in a way they are used either - they think of 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 as super vision.
That make sense, I will sneak one more just to keep counter parts. So we are three and half years kind remove from the major 2014 recent R&D market, we know you sign five to six year deals, so that there is still in series as period of challenging goals as you work to the base. I'm asking your crystal ball out, if we fast forward past these renewals headwinds, right may be two to three years and everyone's got now buying against recent expectations does it feel like Aspen can get back to a 10% annual spend grower at some point.
What I would say that our accretion as a result of down turn in oil prices under [indiscernible] topics or attrition jumped from 2% to 3% to 5% to 6% that three points of growth that we have to overcome every year, every quarter. And if as you say, you play forward and you do, you get through a full cycle where you reset every contract, you could see our growth rate getting into that high single-digit, double-digit growth.
I have told investors in the past that if you look at the gross growth of the Company before attrition the Company is still generating 10% to 11% gross growth. If you were to take attrition back to a normal level of 3%, then you are in sort of 8% range we are banking with APM as 389 and new source of growth and delivering that extra 2% to 3% that gets us to double-digit.
That’s perfect, very helpful. Okay, thanks guys.
Thank you.
Your next question comes from the line of Rob Oliver from Baird Company. Your line is open.
Hi, Rob.
Hey guys, thanks for taking my question, how are you. So Antonio last couple of quarters, you have given a number around the pipeline and is that’s what represented by APM,I think that’s might come in Q&A, so I give you chance to touch on it as you ask for, but I think you said it was 19% a couple of quarters, so 21% this quarter. It seems like obviously your - you must be more broad based in demand with Fidelis kind of kicking in a little bit, maybe that number becomes less relevant, I just wondered if you wanted to touch on that quickly?
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, certainly we monitor that pipeline, but I think more importantly an indicator of our ability to turn the pipeline into transactions is a 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 are performing and we are that are committed to be perform continues to increase. So that’s that give us confidence that the pipeline is also of good quality.
And I would assume these deals are competitive and just wondering, how much the software DNA that you guys have with certainly the installed based that you have plays a role I know you and your – mentioned in the prepared comments that take it on E&C deal that these guys are best about, that it was also help address token overhang. If these are competitive situations and we just our PTC come out and say that, their IOT business was better we think the software DNA that is helping them a lot. How much of a competitive advantages that for you guys right now, as you build that pipeline? Thanks a lot.
Yes, well look certainly at the moment, we were 100% focused on standing up the APM suite and the products in the suite. Now overtime you can see the synergies between the APM suite, the MSC suite and the engineering suite, I think certainly that deal with our E&C Company is perhaps an early indicator of that, but from an operational standpoint, we have already have used cases where we see the synergy and the value creation from combining some of the APM technologies with MSC technologies, so we will have to some work in the products to achieve those synergies, but overtime I know that we would see the benefit from that. Thank you.
Thank you very much.
Your next question comes from the line of Gal Munda from Berenberg. Your line is open.
Hey thanks for taking my question. I just like to ask a bit more about APM pipeline, just to understand how much of that pipeline today is still the new pilot that’s you are guiding in and how much is that expansion opportunities from the ones that you have been doing over the last year.
No. It's mostly new you know, hopefully we can get into that expansion of transactions that we have 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 deals when you do go in and sign a deal like Azure, how does that compare to the overall deal sizes to your core business is it comparable deal size or is it kind of bigger or smaller.
Well, look like we said, two of the top three deals in the quarter were APM deals, we are you know 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 are satisfied the annual spend that we got for those deals. So early indications are good but the you know the value creation for us but I would like to have a few more quarters under my belt before I can speak with total confidence about what is going to be possible.
That's very helpful, thanks guys.
Your next question comes from the line Sterling Auty from JPMorgan, your line is open.
Hey hi guys, this is actually Ugam Kamat on for Sterling. So your tax rate is going to go down significantly in FY '19 it would be like 21% versus 28% to 29% that you estimate for this fiscal year. Just wondering how would you prioritize investments versus capital return to shareholders, and investments particularly would you be driving it towards 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 purchases.
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 is M&A and if not share repurchases and regardless we are committed to a share repurchase program and assuming There is excess cash that's where it will go.
Alright thank you and just one more if I could sneak in, it's 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 you have on the revenue.
So the impact on the revenue was about 1.5 million in the quarter.
Alright, perfect, thank you so much.
Your next question comes from the line of Steve Koenig from Wedbush Securities, your line is open.
Hi gentlemen, thanks for taking my question. I want to ask you guys, on the quarter relative to annual spent, did manufacturing drive extend a majority of that if you could say or just more qualitatively is that still back on-track after deposit spot in Q3, fiscal 2017. And just to put out together, that back half of my question is about the engineering, is the hurricane helping that, could you just see it helped that at all or could it help somewhat in the second half and now you are anticipating that at all.
Let me answer the second part of your question on the hurricane, no we saw no benefit from that, and the fact is there are very few of those plants were impacted, so and there is no benefit expected in the future. Look as you can expect based on what you know about AspenTech, our engineering business certainly has a strong headwinds and we are able to overcome those headwinds to deliver positive growth out of the engineering suite, but that growth is mitigated by those headwinds.
Our APM business is a new business, so it’s in early stages of growth and MSC at the moment is work horse that we are riding here to deliver the lion share of the growth. And look at our MSC business is performing well and we would expect, I would expect it to perform in line with our there historical performance of the past six, seven years out of that area of double-digit growth.
Fantastic, great. Well thank you so much.
Thank you Steve.
[Operator Instructions] Your next question comes from the line of Mark Schappel from Benchmark Company. Your line is open.
Just one question here, Antonio regarding your APM suite, competitively there is not much in a way of meaningful competition yet, mainly because it’s so early days of the category but for the few competitors that you do see out there or could be the defenders out there are trying to put an offering in the marketplace. There are obviously much different than your traditional competitors for MSC engineering products, if you just discuss a couple that the people that you do see or you do see about that our trying to put a protective maintenance product in the marketplace.
And I think the key word is predictive maintenance of key words. So the two most common competitors of that we are seen in the marketplace are GE, but the fact is that GE solution is not predicted, maintenance is condition based monitoring and we tend to do very well against them, Schneider is also the second Company that we see out there often.
There solutions seems to be a combination of condition based monitoring with some predicted capability and then once in while we are seeing couple of all the companies SAS and Company called C3 IOT as well. So we now that we signed some deals we are getting feedback from customers about how they our technology compared to that of others, the advantages that they see.
And look we were satisfied with what we are hearing, certainly there is in the market, but I think the combination of these products with the expertise around the process industry and data certainly makes us strong contender.
Great, thank you.
Yes, thank you Mark.
[Operator instructions]. There are no further 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 are welcome. This concludes today's conference call. You may now disconnect.