UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended March 31, 2010

 

 

or

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                 to                 

 

Commission File Number: 000-24786

 

ASPEN TECHNOLOGY, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

04-2739697

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

200 Wheeler Road
Burlington, Massachusetts

 

01803

(Address of principal executive offices)

 

(Zip Code)

 

(781) 221-6400

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:  Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

o

Accelerated filer

x

 

 

 

 

Non-accelerated filer

o

Smaller reporting company

o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):  Yes o No x

 

As of April 28, 2010, there were 92,166,322 shares of the registrant’s common stock (par value $0.10 per share) outstanding.

 

 

 



 

TABLE OF CONTENTS

 

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements.

3

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

20

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

36

Item 4.

Controls and Procedures.

37

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings.

38

Item 1A.

Risk Factors.

40

Item 6.

Exhibits.

49

SIGNATURES

50

 

Our registered trademarks include aspenONE, AspenTech and HYSYS.

 

2



 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

Condensed Consolidated Financial Statements (unaudited)

 

ASPEN TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited and in thousands, except per share data)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Revenue:

 

 

 

 

 

 

 

 

 

Subscription

 

$

3,959

 

$

 

$

5,198

 

$

 

Software

 

14,714

 

41,070

 

34,772

 

137,979

 

Total subscription and software

 

18,673

 

41,070

 

39,970

 

137,979

 

Services and other

 

26,945

 

30,222

 

88,130

 

102,346

 

Total revenue

 

45,618

 

71,292

 

128,100

 

240,325

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Subscription and software

 

1,437

 

3,063

 

4,887

 

8,587

 

Services and other

 

13,237

 

15,333

 

43,725

 

47,139

 

Total cost of revenue

 

14,674

 

18,396

 

48,612

 

55,726

 

Gross profit

 

30,944

 

52,896

 

79,488

 

184,599

 

Operating costs:

 

 

 

 

 

 

 

 

 

Selling and marketing

 

25,267

 

20,494

 

69,576

 

62,519

 

Research and development

 

12,719

 

11,738

 

36,128

 

34,904

 

General and administrative

 

12,648

 

14,441

 

47,290

 

42,923

 

Restructuring charges

 

(43

)

1,760

 

260

 

2,025

 

Impairment of goodwill and intangible assets

 

 

 

 

623

 

Total operating costs

 

50,591

 

48,433

 

153,254

 

142,994

 

(Loss) income from operations

 

(19,647

)

4,463

 

(73,766

)

41,605

 

Interest income

 

4,584

 

5,176

 

15,116

 

17,046

 

Interest expense

 

(1,834

)

(2,230

)

(6,725

)

(7,827

)

Other expense, net

 

(2,144

)

(3,308

)

(97

)

(3,969

)

(Loss) income before income taxes

 

(19,041

)

4,101

 

(65,472

)

46,855

 

(Provision for) benefit from income taxes

 

(2,713

)

3,995

 

(8,001

)

(4,145

)

Net (loss) income

 

$

(21,754

)

$

8,096

 

$

(73,473

)

$

42,710

 

(Loss) earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.24

)

$

0.09

 

$

(0.81

)

$

0.47

 

Diluted

 

$

(0.24

)

$

0.09

 

$

(0.81

)

$

0.46

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

91,835

 

90,065

 

90,923

 

90,042

 

Diluted

 

91,835

 

91,648

 

90,923

 

92,620

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

3



 

ASPEN TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited and in thousands, except share data)

 

 

 

March 31,

 

June 30,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

119,054

 

$

122,213

 

Accounts receivable, net of allowance for doubtful accounts of $4,161 and $5,809

 

28,612

 

49,882

 

Current portion of installments receivable, net of allowance for doubtful accounts of $915 and $1,015

 

54,500

 

64,531

 

Current portion of collateralized receivables

 

28,849

 

38,695

 

Unbilled services

 

1,995

 

298

 

Prepaid expenses and other current assets

 

8,787

 

9,413

 

Prepaid income taxes

 

13,670

 

13,159

 

Deferred tax assets

 

3,850

 

3,795

 

Total current assets

 

259,317

 

301,986

 

Non-current installments receivable, net of allowance for doubtful accounts of $1,009 and $1,663

 

91,839

 

113,390

 

Non-current collateralized receivables

 

34,657

 

57,671

 

Property, equipment and leasehold improvements, net of accumulated depreciation of $29,119 and $27,438

 

8,581

 

9,604

 

Computer software development costs, net of accumulated amortization of $66,956 and $65,094

 

2,413

 

3,918

 

Goodwill

 

17,909

 

16,686

 

Non-current deferred tax assets

 

10,556

 

10,788

 

Other non-current assets

 

1,745

 

1,933

 

Total assets

 

$

427,017

 

$

515,976

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of secured borrowing

 

$

33,175

 

$

83,885

 

Accounts payable

 

4,688

 

5,135

 

Accrued expenses

 

36,744

 

47,882

 

Income taxes payable

 

2,733

 

1,888

 

Deferred revenue

 

72,637

 

62,801

 

Current deferred tax liability

 

2,496

 

2,481

 

Total current liabilities

 

152,473

 

204,072

 

Long-term secured borrowing

 

54,211

 

28,211

 

Long-term deferred revenue

 

12,923

 

16,070

 

Non-current deferred tax liability

 

2,368

 

2,354

 

Other non-current liabilities

 

32,056

 

35,859

 

Commitments and contingencies (Note 11)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Series D redeemable convertible preferred stock, $0.10 par value—
Authorized— 3,636 shares as of March 31, 2010 and June 30, 2009
Issued and outstanding— none as of March 31, 2010 and June 30, 2009

 

 

 

Common stock, $0.10 par value— Authorized—210,000,000 shares
Issued— 92,364,108 shares as of March 31, 2010 and 90,326,513 shares at June 30, 2009
Outstanding— 92,130,644 shares at March 31, 2010 and 90,093,049 shares at June 30, 2009

 

9,236

 

9,033

 

Additional paid-in capital

 

513,496

 

497,478

 

Accumulated deficit

 

(357,066

)

(283,593

)

Accumulated other comprehensive income

 

7,833

 

7,005

 

Treasury stock, at cost—233,464 shares of common stock as of March 31, 2010 and June 30, 2009

 

(513

)

(513

)

Total stockholders’ equity

 

172,986

 

229,410

 

 

 

$

427,017

 

$

515,976

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

4



 

ASPEN TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and in thousands)

 

 

 

Nine Months Ended

 

 

 

March 31,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) income

 

$

(73,473

)

$

42,710

 

Adjustments to reconcile net (loss) income to net cash provided by operating activities

 

 

 

 

 

Depreciation and amortization

 

5,143

 

6,574

 

Net foreign currency loss

 

1,092

 

5,200

 

Stock-based compensation

 

13,352

 

3,659

 

Loss on disposal of property, equipment and leasehold improvements

 

50

 

406

 

Deferred income taxes

 

(2

)

1,351

 

Provision for bad debts

 

(284

)

885

 

Loss on impairment of goodwill and intangible assets

 

 

623

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

20,484

 

36,012

 

Unbilled services

 

(1,729

)

248

 

Prepaid expenses, other assets and prepaid income taxes

 

106

 

(11,645

)

Installments and collateralized receivables

 

64,514

 

(8,523

)

Income taxes payable

 

844

 

(3,867

)

Accounts payable, accrued expenses and other liabilities

 

(12,970

)

(21,677

)

Deferred revenue

 

6,903

 

(23,236

)

Net cash provided by operating activities

 

24,030

 

28,720

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of property, equipment and leasehold improvements

 

(2,099

)

(1,794

)

Capitalized computer software development costs

 

(436

)

(1,917

)

Net cash used in investing activities

 

(2,535

)

(3,711

)

Cash flows from financing activities:

 

 

 

 

 

Exercise of stock options

 

6,136

 

 

Proceeds from secured borrowings

 

9,501

 

5,532

 

Repayment of secured borrowings

 

(36,653

)

(35,900

)

Payment of tax withholding obligations related to restricted stock

 

(3,353

)

(288

)

Net cash used in financing activities

 

(24,369

)

(30,656

)

Effects of exchange rate changes on cash and cash equivalents

 

(285

)

(2,144

)

Decrease in cash and cash equivalents

 

(3,159

)

(7,791

)

Cash and cash equivalents, beginning of period

 

122,213

 

134,048

 

Cash and cash equivalents, end of period

 

$

119,054

 

$

126,257

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Interest paid

 

6,731

 

7,834

 

Income taxes paid

 

7,482

 

25,015

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

5



 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.  Interim Unaudited Condensed Consolidated Financial Statements

 

The accompanying interim unaudited condensed consolidated financial statements (Interim Financial Statements) of Aspen Technology, Inc. and its subsidiaries have been prepared on the same basis as our annual consolidated financial statements. We condensed or omitted certain information and footnote disclosures normally included in our annual consolidated financial statements. Such Interim Financial Statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP), as defined in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 270, for interim financial information and with the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. It is suggested that these Interim Financial Statements be read in conjunction with the audited consolidated financial statements for the year ended June 30, 2009, which are contained in our Annual Report on Form 10-K and Form 10-K/A, as previously filed with the U.S. Securities and Exchange Commission (SEC). In the opinion of management, all adjustments, consisting of normal and recurring adjustments, considered necessary for a fair presentation of the financial position, results of operations, and cash flows at the dates and for the periods presented have been included and all intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three and nine months ended March 31, 2010 are not necessarily indicative of the results to be expected for the full fiscal year.

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.

 

Unless the context requires otherwise, references to we, our and us refer to Aspen Technology, Inc. and our subsidiaries.

 

2.  Correction of Immaterial Errors

 

During the first and second quarters of fiscal 2010, we identified errors related to stock compensation expense, license and professional services revenue, and income taxes that originated in prior periods and concluded that the errors were not material to any of the previously reported periods or to the periods in which the errors were corrected. These immaterial errors were corrected in the first and second quarter 2010 Interim Financial Statements. The impact to certain captions in the unaudited condensed consolidated statement of operations for the nine months ended March 31, 2010, resulting from the out-of-period component of the correction of immaterial errors, is as follows (in thousands):

 

 

 

Nine Months Ended

 

 

 

March 31, 2010

 

 

 

Increase (Decrease)

 

Total revenue

 

$

(277

)

Income (loss) from operations

 

(1,092

)

Income (loss) before provision for income taxes

 

(1,092

)

Net income (loss)

 

(2,842

)

 

During the first quarter of fiscal 2009, we identified certain errors related to income taxes, stock compensation expense, and foreign transactions that originated in prior periods and concluded that the errors were not material to any of the previously reported periods or to the periods in which the errors were corrected. These immaterial errors were corrected in the first fiscal quarter 2009 Interim Financial Statements. The impact to certain captions in the unaudited condensed consolidated statement of operations for the nine months ended March 31, 2009, resulting from the out-of-period component of the correction of immaterial errors, is as follows (in thousands):

 

6



 

 

 

Nine Months Ended

 

 

 

March 31, 2009

 

 

 

Increase (Decrease)

 

Total revenue

 

$

 

Income from operations

 

887

 

Income before provision for income taxes

 

315

 

Net income

 

(3,618

)

 

3.   Significant Accounting Policies

 

Revenue Recognition

 

We generate revenue from the following sources: (1) licensing software products; (2) providing post contract support (referred to as SMS); and (3) providing professional services including consulting and training. We sell our software products to end users under fixed-term and perpetual licenses. As a standard business practice, we offer extended payment term options for our fixed-term license contracts, which are generally payable on an annual basis. Certain of our fixed-term license agreements include product mixing rights that allow customers the flexibility to change or alternate the use of multiple products included in the license arrangement after those products are delivered to the customer. We refer to these arrangements as token arrangements. Tokens are fixed units of measure. The amount of software usage is limited by the value of the tokens purchased by the customer.

 

Historically, we executed software license arrangements that included contractual provisions that resulted in the “upfront” recognition of license revenue upon delivery of the software products, provided all other revenue recognition requirements were met. We refer to these traditional licensing arrangements as our upfront revenue model.

 

In the first quarter of fiscal 2010, we began offering a new term licensing model for our software. This new licensing model includes contractual provisions that provide customers with greater flexibility, in that customers receive SMS for the term of the arrangement and the right to unspecified future software products that may be introduced during the term of the arrangement for no additional fee. We refer to this licensing model as the new aspenONE licensing model. Under this licensing model, we recognize revenue over the term of the agreement on a subscription basis beginning when the first payment is due, typically 30 days after signing the agreement, provided all other revenue recognition requirements are met.

 

Additionally, in the first quarter of fiscal 2010, we also began licensing fixed-term point product arrangements in which customers receive SMS for the term of the arrangement. With the inclusion of SMS for the full term of the license, revenue can no longer be recognized under the upfront revenue model as the aggregate fees are not considered fixed or determinable.  Revenue for these arrangements will be recognized as payments become due over the term of the contract, provided all other revenue recognition requirements are met.  The related SMS is recognized over the term of the SMS agreement beginning with the due date of the annual payment and reported in services and other on the consolidated statements of operations. Occasionally, we expect certain customers to elect upfront payment terms. For these arrangements with upfront payment, all of the license revenue will be recognized upfront by applying the residual method of accounting when the four revenue recognition requirements below have been met.

 

Over the next several years, we expect to transition substantially all of our customers to our new aspenONE licensing model or to point product arrangements with SMS bundled for the contract term. However, during this transition period we expect to execute some license contracts under the upfront revenue model, including perpetual licenses, which will continue to be recognized on an upfront basis.

 

Four basic criteria must be satisfied before software license revenue can be recognized: persuasive evidence of an arrangement between us and an end user; delivery of our product has occurred; the fee for the product is fixed or determinable; and collection of the fee is probable.

 

Persuasive evidence of an arrangement—We use a contract signed by the customer as evidence of an arrangement for software licenses and SMS. For professional services we use a signed contract and a statement of work to evidence an arrangement.  In cases where both a signed contract and a purchase order are required by the customer, we consider both

 

7



 

taken together as evidence of the arrangement.

 

Delivery of our product—Software and the corresponding access keys are generally delivered to customers via disk media with standard shipping terms of Free Carrier, Aspen Technology’s warehouse (i.e., FCA, named place). Our software license agreements do not contain conditions for acceptance.

 

Fee is fixed or determinable—We assess whether a fee is fixed or determinable at the outset of the arrangement. Significant judgment is involved in making this assessment.

 

Under our upfront revenue model, we are able to demonstrate that the fees are fixed or determinable for all arrangements, including those for our term licenses that contain extended payment terms. We have an established history of collecting under the terms of these contracts without providing concessions to customers. In addition, we also assess whether contract modifications to an existing term arrangement constitute a concession. In making this assessment, significant analysis is performed to ensure that no concessions are given. Our software license agreements do not include right of return or exchange. For license arrangements executed under the upfront revenue model, we recognize license revenue upon delivery of the software products, provided all other revenue recognition requirements are met.

 

With the introduction of the new aspenONE licensing model, and the changes to the licensing terms of our historical point product agreements sold on a fixed-term basis, we cannot assert that the fees in these arrangements are fixed or determinable because the rights provided to customers and the economics of the arrangements are not comparable to our historical transactions with other customers under the upfront revenue model. As a result, the amount of revenue recognized for these new arrangements will be limited by the amount of customer payments currently due, which generally results in the fees being recognized over the term of the license contracts.

 

Collection of fee is probable—We assess the probability of collecting from each customer at the outset of the arrangement based on a number of factors, including the customer’s payment history, its current creditworthiness, economic conditions in the customer’s industry and geographic location, and general economic conditions. If in our judgment collection of a fee is not probable, revenue is recognized as cash is collected, provided all other conditions for revenue recognition have been met.

 

We have established vendor-specific objective evidence (VSOE) of fair value for SMS and professional services, but not for our software products. Our VSOE determination is based upon the price charged to similarly situated customers when the elements are sold separately. We allocate the arrangement consideration among the elements included in our multi-element arrangements using the residual method. Under the residual method, the VSOE of the undelivered elements is deferred, and the remaining portion of the arrangement fee for perpetual and term licenses is recognized as revenue upon delivery of the software, assuming all other revenue recognition criteria are met. If VSOE does not exist for an undelivered element in an arrangement, revenue is deferred until such evidence does exist for the undelivered elements, or until all elements are delivered, whichever is earlier.

 

Under the upfront revenue model, the residual license fee is recognized upfront upon delivery of the software provided all other revenue recognition criteria were met.  For arrangements entered into since July 2009, the arrangement fees are generally recognized over the term of the license agreement since these arrangements include contractual provisions such as rights to future unspecified software products for no additional fee or because we cannot assert that the fees are fixed or determinable.

 

Subscription Revenue

 

When our fixed-term customers elect to license our products under the new aspenONE licensing model, SMS is included for the entire term of the arrangement and the customer receives the right to unspecified future software products that may be introduced during the term of the arrangement for no additional fee. These agreements combine the right to use all software products within a given product suite with SMS for the term of the arrangement. Due to our obligation to provide unspecified future software products, we are required to recognize the revenue ratably (i.e., on a subscription basis) over the term of the license, once the four revenue recognition criteria noted above are met. License and SMS revenue for arrangements sold under the new aspenONE licensing model are combined and presented together as subscription revenue in the consolidated statement of operations.

 

Software Revenue

 

Software revenue consists of all license transactions that do not contain rights to future unspecified software products for no additional fee. Specifically, it includes license revenue recognized under the upfront revenue model upon the

 

8



 

delivery of the license products (i.e., both perpetual and term license contracts); license revenue recognized over the term of the license agreements for fixed-term contracts including point product licenses with SMS bundled for the entire license term; and other license revenue derived from transactions that are being recognized over time as the result of not previously meeting one or more of the requirements for recognition under the upfront revenue model.

 

The license fees derived from the sale of fixed-term point product arrangements with SMS included for the contract term are recognized under the residual method, as payments come due. The related SMS is recognized over the term of the SMS agreement beginning with the due date of the annual payment and is reported in services and other on the consolidated statement of operations. Occasionally, we expect certain customers to elect upfront payment terms. For these arrangements with upfront payment, all of the license revenue will be recognized upfront by applying the residual method of accounting when the above four revenue recognition requirements have been met.

 

Perpetual license arrangements do not include the same rights as those provided to customers under the new aspenONE licensing model. Accordingly, the license fees for perpetual license agreements will continue to be recognized upon delivery of the software products using the residual method provided all other revenue recognition requirements are met. The revenue attributable to perpetual software licenses is recognized in software revenue in the consolidated statement of operations.

 

Services and Other

 

SMS Revenue

 

Under the upfront revenue model, SMS is typically included with the license for the initial year of the license term. Under these arrangements, the fair value of SMS is deferred and subsequently amortized into services and other in the consolidated statement of operations over the contractual term of the SMS arrangement. SMS renewals are at the option of the customer.

 

For arrangements executed under the new aspenONE licensing model or where point product licenses are sold with SMS for the contract term, the customer commits to SMS for the entire term of the license arrangement. The revenue related to the SMS component of the new aspenONE licensing model is reported in subscription revenue in the consolidated statements of operations. The revenue related to the SMS component of point product licenses, for which we have VSOE, is reported in services and other in the consolidated statement of operations.

 

Professional Services

 

Professional services are provided to customers on a time-and-materials (T&M) or fixed-price basis and are generally recognized as the services are performed, assuming all other revenue recognition criteria have been met. We recognize professional services fees for our T&M contracts based upon hours worked and contractually agreed-upon hourly rates. Revenue from fixed-price engagements is recognized using the proportional performance method based on the ratio of costs incurred, substantially all of which are labor-related, to the total estimated project costs. All revenue amounts are recognized within services and other in the statement of operations. Project costs are based on standard rates, which vary by the consultant’s professional level, plus all direct expenses incurred to complete the engagement that are not reimbursed by the client. All project costs are expensed as incurred. The use of the proportional performance method is dependent upon our ability to reliably estimate the direct costs to complete a project. We use historical experience as a basis for future estimates to complete current projects. Additionally, management believes that costs are the best available measure of performance. Reimbursables received from customers for out-of-pocket expenses are recorded as revenue. If the costs to complete a project are not estimable or the completion is uncertain, the revenue is recognized upon completion of the services. Revenue from committed professional services arrangements that are sold within close proximity or in contemplation of a new aspenONE license transaction is deferred and recognized on a ratable basis over the term of the related software arrangement.

 

Occasionally, we provide professional services considered essential to the functionality of the software. We recognize the combined revenue from the sale of the software and related services using the percentage-of-completion method. However, when these professional services are combined with, and essential to, the functionality of a new aspenONE license transaction, the amount of combined revenue recognized will be the lesser of the amount determined by either the subscription method or the percentage-of-completion method.

 

In the past, we have occasionally been required to commit unanticipated additional resources to complete projects, which have resulted in lower than anticipated income or losses on those contracts. We may experience similar situations in the future. Provisions for estimated losses on contracts are made during the period in which such losses become probable

 

9



 

and can be reasonably estimated. To date, such losses have not been significant.

 

Installments Receivable

 

Installments receivable resulting from product sales under the upfront revenue model are discounted to present value at prevailing market rates. Finance fees are recognized using the effective interest method over the relevant license term and are classified as interest income. The amount of the installments receivable is split between current and non-current in the consolidated balance sheets.

 

Under the new aspenONE licensing model and for point product arrangements sold with SMS bundled for the entire license term, receivables are recorded when the payments become due and payable. Payment amounts under extended payment term arrangements are not presented in the consolidated balance sheets as the related arrangement fees are not fixed or determinable. As a result, all contractual payments will be recorded as revenue on a gross basis in the consolidated statements of operations either as subscription or software revenue.

 

Deferred Revenue

 

Under the upfront revenue model and point product arrangements, a portion of the arrangement fee is generally recorded as deferred revenue due to the inclusion of an undelivered element, typically SMS. The amount of revenue allocated to undelivered elements is based on the VSOE of fair value for those elements using the residual method and is earned and recognized as revenue as each element is delivered. Deferred revenue related to these transactions generally consists of SMS and represents payments received in advance of services rendered as of the balance sheet dates.

 

Under the new aspenONE licensing model, customers receive SMS for the full contract term, and receive rights to unspecified future products for no additional fee.  As VSOE does not exist for both of these undelivered elements, we are required to recognize the revenue ratably (i.e., on a subscription basis) over the term of the license. Therefore, deferred revenue is recorded as each payment comes due and revenue is recognized ratably over the associated license period.

 

Other Licensing Matters

 

Our standard licensing agreements include a product warranty provision. Such warranties are accounted for in accordance with ASC 460, “Guarantees” (ASC 460). The likelihood that we will be required to make refunds to customers under such provisions is considered remote. Historically, any such payments have been de minimis.

 

Under the terms of substantially all of our license agreements, we have agreed to indemnify customers for costs and damages arising from claims against such customers based on, among other things, allegations that our software products infringe the intellectual property rights of a third party. In most cases, in the event of an infringement claim, we retain the right to (i) procure for the customer the right to continue using the software product; (ii) replace or modify the software product to eliminate the infringement while providing substantially equivalent functionality; or (iii) if neither (i) nor (ii) can be reasonably achieved, we may terminate the license agreement and provide a refund to the customer up to the license fees paid by the customer. Such indemnification provisions are accounted for in accordance with ASC 460. The likelihood that we will be required to make refunds to customers under such provisions is considered remote. In most cases and where legally enforceable, the indemnification is limited to the amount paid by the customer.

 

Legal fees and contingencies

 

We accrue estimated future legal fees associated with claims, assessments or litigation for which management has determined that it is probable that a loss contingency exists.  Liabilities for loss contingencies arising from claims, assessments, litigation and other sources are recorded when it is probable that a liability has been incurred and the amount of the claim, assessment or damages can be reasonably estimated.  We believe that we have sufficient accruals to cover any obligations resulting from claims, assessments or litigation that have met this criteria.

 

Reclassifications

 

Certain line items in the prior period financial statements have been reclassified to conform to currently reported presentations.

 

For further information with regard to our “Significant Accounting Policies,” please refer to Note 2 of our Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009.

 

10



 

4.  Goodwill

 

We test goodwill for impairment annually, or upon indication that there may be a triggering event that could cause impairment, at the reporting unit level using a fair value approach in accordance with the provisions of ASC 350, “Intangibles — Goodwill and Other.”  We conduct our annual impairment test as of December 31 of each year. The initial step requires us to determine the fair value of each reporting unit and compare it to the carrying value, including goodwill, of such reporting unit. If the fair value exceeds the carrying value, no impairment loss is to be recognized. However, if the carrying value of the reporting unit exceeds its fair value, the goodwill of this unit may be impaired. The amount of impairment, if any, is then measured based upon the estimated fair value of goodwill at the valuation date. As of December 31, 2009, we performed our annual goodwill impairment test for each reporting unit and determined that the estimated fair values substantially exceeded the carrying values.  As such, no impairment losses were recognized as a result of the analysis.

 

In late calendar 2008, certain negative macroeconomic factors began to impact the global credit markets and we noted significant unfavorable trends in business conditions in the second quarter of fiscal 2009. In connection with preparing the annual impairment assessment, we identified significant deterioration in the expected future financial performance of our professional services segment compared to the expected future financial performance of this segment at the end of fiscal 2008. As a result, we recognized goodwill and intangible assets impairments of $0.5 million and $0.1 million, respectively, in the professional services segment during the second fiscal quarter of 2009, which ended December 31, 2008, to write off all of the goodwill and intangible assets of this reporting unit.

 

5.   Income Taxes

 

The provision for income taxes in the three months ended March 31, 2010 changed $6.7 million, from a benefit to an expense compared to the corresponding period of the prior year. This increase was primarily related to reversals of reserves in the third quarter of fiscal 2009 for uncertain tax positions of $4.4 million due to an expiration of the statute of limitations in a foreign jurisdiction.  Additionally, income taxes increased as a result of higher profit before tax in our foreign subsidiaries for the three months ended March 31, 2010, as compared to the same period of the prior fiscal year.

 

The provision for income taxes in the nine months ended March 31, 2010 increased by $3.9 million, or 93.0%, compared to the corresponding period in the prior year.  The period-over-period increase was primarily a result of reversals of reserves for uncertain tax positions in a foreign jurisdiction and higher profit before tax in our foreign subsidiaries.

 

We are projecting a consolidated loss before tax in fiscal 2010 as a result of the change to the new aspenONE licensing model.  While we are expecting profitable results for certain of our foreign subsidiaries, the loss is primarily related to U.S. results and, therefore, cannot be used to offset foreign income or reduce foreign taxes.  Our foreign subsidiaries are required to remit income tax payments to their respective taxing authorities and will provide for such taxes on a quarterly basis.

 

We expect to reverse $5.7 million of our reserve for uncertain tax positions in the fourth quarter of fiscal 2010 resulting from the expiration of the statute of limitations related to several uncertain tax positions, primarily related to Canada.

 

6.   Fair Value

 

Effective July 1, 2008, we adopted the provisions of ASC 820, “Fair Value Measurements and Disclosures” (ASC 820), for financial assets and financial liabilities. Effective July 1, 2009, we adopted the provisions of ASC 820 for non-financial assets and non-financial liabilities. ASC 820 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements.

 

ASC 820 defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants. ASC 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

·                  Level 1 Inputs—Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

·                  Level 2 Inputs—Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted

 

11



 

prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

·                  Level 3 Inputs—Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

Cash Equivalents.    Cash equivalents are reported at fair value utilizing Level 1 Inputs. We obtain quoted market prices in identical markets to estimate the fair value of our cash equivalents.

 

Financial instruments not measured or recorded at fair value in the accompanying financial statements consist of accounts receivable, installments receivable, collateralized receivables, accounts payable and secured borrowings. The estimated fair value of accounts receivable, installments receivable, collateralized receivables and accounts payable approximates the carrying value. The estimated fair value of secured borrowings exceeds the carrying value by $4.9 million as of March 31, 2010. The fair value of secured borrowings was calculated using the market approach, utilizing interest rates that were indirectly observable in markets for similar liabilities.

 

The following table summarizes financial assets and financial liabilities measured and recorded at fair value on a recurring basis in the accompanying financial statements as of March 31, 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):

 

 

 

Fair Value Measurement at

 

 

 

Reporting Date Using

 

 

 

Quoted Prices

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

Identical

 

Observable

 

Unobservable

 

 

 

Assets

 

Inputs

 

Inputs

 

Description

 

(Level 1)

 

(Level 2)

 

Level (3)

 

March 31, 2010

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

Cash equivalents

 

$

96,000

 

 

 

 

 

 

 

 

 

 

 

June 30, 2009

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

Cash equivalents

 

$

87,918

 

 

 

 

Certain non-financial assets and liabilities are measured at fair value on a recurring basis.  These include reporting units measured at fair value using market and income approaches in the first step of a goodwill impairment test. Certain non-financial assets, including goodwill, intangible assets and other non-financial long-lived assets, are measured at fair value using market and income approaches on a non-recurring basis when there is an indication that there may be a triggering event which could result in impairment.  The adoption of ASC 820 for non-financial assets and non-financial liabilities had no material impact on the financial statements as of and for the three and nine months ended March 31, 2010.

 

7.  Supplementary Balance Sheet Information

 

Accrued expenses in the accompanying unaudited condensed consolidated balance sheets consist of the following (in thousands):

 

12



 

 

 

March 31,

 

June 30,

 

 

 

2010

 

2009

 

Royalties and outside commissions

 

$

4,414

 

$

8,627

 

Payroll and payroll-related

 

16,224

 

13,793

 

Restructuring accruals

 

4,100

 

4,974

 

Amounts due to receivable sale facilities for collections

 

654

 

2,724

 

Other

 

11,352

 

17,764

 

Total accrued expenses

 

$

36,744

 

$

47,882

 

 

Other non-current liabilities in the accompanying unaudited condensed consolidated balance sheets consist of the following (in thousands):

 

 

 

March 31,

 

June 30,

 

 

 

2010

 

2009

 

Restructuring accruals

 

$

4,597

 

$

7,244

 

Deferred rent

 

2,221

 

2,333

 

Royalties and outside commissions

 

4,244

 

5,852

 

Other

 

20,994

 

20,430

 

Total other non-current liabilities

 

$

32,056

 

$

35,859

 

 

8.  Stock-Based Compensation

 

General Award Terms

 

We issue stock options and restricted stock units (RSUs) to our employees and outside directors, pursuant to stockholder approved stock option plans.  Option awards are generally granted with an exercise price equal to the market price of our stock at the date of grant; those options generally vest over four years and have 7 or 10-year contractual terms.  Restricted stock units generally vest over four years.  Historically, our practice has been to settle stock option exercises and restricted stock vesting through newly-issued shares.

 

At our Annual Meeting of Stockholders held on April 15, 2010, our stockholders approved the Aspen Technology, Inc. 2010 Equity Incentive Plan.  A total of 7,000,000 shares of common stock have been reserved for issuance under this Plan.

 

Stock-Based Compensation Accounting

 

During the period from mid-September 2007 until November 9, 2009, we did not maintain our status as a timely filer with the SEC and we were unable to issue stock-based compensation to our directors and employees.  On October 29, 2009 the Board of Directors approved the grant as of November 9, 2009 of 2,727,033 RSUs and 264,640 stock options under the 2005 Stock Incentive Plan and the 2001 Stock Option Plan, respectively.  Since we were not able to grant awards during the period described above, a portion of the awards were vested immediately upon grant.  The RSUs were valued at the stock price on the date of grant.  We utilized the Black-Scholes valuation model for estimating the fair value of the stock-based compensation.  The stock-based compensation expense and its classification (in thousands) in the statement of operations for the three and nine months ended March 31, 2010 and 2009 were as follows:

 

13



 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Recorded as expense:

 

 

 

 

 

 

 

 

 

Cost of service and other

 

$

181

 

$

132

 

$

1,138

 

$

298

 

Selling and marketing

 

701

 

315

 

5,030

 

612

 

Research and development

 

246

 

125

 

1,637

 

314

 

General and administrative

 

691

 

707

 

5,546

 

2,409

 

 

 

1,819

 

1,279

 

13,351

 

3,633

 

Capitalized computer software development costs

 

1

 

1

 

1

 

26

 

Total stock-based compensation

 

$

1,820

 

$

1,280

 

$

13,352

 

$

3,659

 

 

The weighted-average fair values of the options granted under the 2001 Stock Option Plan during the nine months ended March 31, 2010 were as follows:

 

Weighted-average fair value of options granted

 

$

3.96

 

Average risk-free interest rate

 

1.4

%

Expected dividend yield

 

0.0

%

Expected life

 

3.4

 

Expected volatility

 

57.3

%

 

The dividend yield of zero is based on the fact that we have never paid cash dividends on common stock and have no present intention to pay cash dividends.  Expected volatility is based on the historical volatility of our common stock over the period commensurate with the expected life of the options.  The risk-free interest rate is the U.S. Treasury zero-coupon bond with a maturity commensurate with the expected life of the options on the date of grant.  In fiscal 2010, we calculated the estimated life considering historical exercise behavior, as well as anticipated future events that may affect volatility.

 

A summary of stock option and RSU activity under all stock option plans in the first nine months of fiscal 2010 is as follows:

 

14



 

 

 

Stock Options

 

Restricted Stock Units

 

 

 

Shares

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual
Term

 

Aggregate
Intrinsic
Value
(in 000’s)

 

Shares

 

Weighted
Average
Grant Date
Fair Value

 

Outstanding at June 30, 2009

 

7,569,215

 

$

7.61

 

4.3

 

 

 

150,613

 

$

10.42

 

Granted

 

 

 

 

 

 

 

 

 

Vested (RSUs)

 

 

 

 

 

 

 

(29,887

)

10.42

 

Exercised

 

 

 

 

 

 

 

 

 

Cancelled / Forfeited

 

(2,940

)

9.48

 

 

 

 

 

(2,126

)

10.42

 

Outstanding at September 30, 2009

 

7,566,275

 

7.76

 

 

 

 

 

118,600

 

10.42

 

Granted

 

264,640

 

9.55

 

 

 

 

 

2,727,033

 

9.55

 

Vested (RSUs)

 

 

 

 

 

 

 

(919,119

)

9.58

 

Exercised

 

(747,514

)

4.89

 

 

 

 

 

 

 

Cancelled / Forfeited

 

(33,865

)

23.40

 

 

 

 

 

(6,786

)

$

9.83

 

Outstanding at December 31, 2009

 

7,049,536

 

$

7.90

 

4.7

 

 

 

1,919,728

 

$

9.59

 

Granted

 

 

 

 

 

 

 

17,250

 

9.78

 

Vested (RSUs)

 

 

 

 

 

 

 

 

(192,904

)

9.68

 

Exercised

 

(494,487

)

5.02

 

 

 

 

 

 

 

Cancelled / Forfeited

 

(944,188

)

13.34

 

 

 

 

 

(37,720

)

9.59

 

Outstanding at March 31, 2010

 

5,610,861

 

$

7.23

 

4.9

 

 

 

1,706,354

 

$

9.85

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercisable at March 31, 2010

 

5,410,262

 

$

7.12

 

4.8

 

$

20,733

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest at March 31, 2010

 

6,022,206

 

$

7.11

 

4.9

 

$

22,793

 

1,603,915

 

$

9.85

 

 

In fiscal 2010, the total fair value of shares vested from RSU grants was $11.0 million.  At March 31, 2010, the total unrecognized compensation cost related to all unvested stock options and RSUs not yet recognized was $1.2 million and $15.9 million, respectively, and is expected to be recorded over the next four years as the awards vest.

 

The total intrinsic value of options exercised during the first nine months of fiscal 2010 was $5.8 million.  During the first nine months of fiscal 2010, we received $6.1 million in cash proceeds from option exercises and paid $3.4 million for withholding taxes on vested RSUs.

 

9.  Net (Loss) Income per Common Share

 

Basic (loss) income per share was determined by dividing net (loss) income by the weighted average common shares outstanding during the period. Diluted earnings per share was determined by dividing net (loss) income by diluted weighted average shares outstanding during the period. Diluted weighted average shares reflects the dilutive effect, if any, of potential common shares. To the extent their effect is dilutive, potential common shares include employee equity awards and warrants, based on the treasury stock method, and other commitments to be settled in common stock. For the three and nine months ended March 31, 2010, all potential common shares were anti-dilutive due to the net loss. The calculations of basic and diluted net (loss) income per share and basic and diluted weighted average shares outstanding are as follows (in thousands, except per share data):

 

15



 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

Per Share

 

 

 

 

 

Per Share

 

 

 

 

 

Per Share

 

 

 

 

 

Per Share

 

 

 

Loss

 

Shares

 

Amount

 

Income

 

Shares

 

Amount

 

Loss

 

Shares

 

Amount

 

Income

 

Shares

 

Amount

 

Basic (loss) income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(21,754

)

91,835

 

$

(0.24

)

$

8,096

 

90,065

 

$

0.09

 

$

(73,473

)

90,923

 

$

(0.81

)

$

42,710

 

90,042

 

$

0.47

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Employee equity awards

 

 

 

 

 

 

 

 

1,273

 

 

 

 

 

 

 

 

 

 

2,177

 

 

 

Warrants

 

 

 

 

 

 

 

 

310

 

 

 

 

 

 

 

 

 

 

401

 

 

 

Net (loss) income giving effect to dilutive adjustments

 

$

(21,754

)

91,835

 

$

(0.24

)

$

8,096

 

91,648

 

$

0.09

 

$

(73,473

)

90,923

 

$

(0.81

)

$

42,710

 

92,620

 

$

0.46

 

 

The following potential common shares were excluded from the calculation of diluted weighted average shares outstanding because the exercise price of the employee equity awards and warrants exceeded the average market price for our common stock and/or their effect would be anti-dilutive at the balance sheet date (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Employee equity awards and warrants

 

8,453

 

3,155

 

8,641

 

2,259

 

 

10.  Comprehensive (Loss) Income

 

Comprehensive (loss) income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The components of comprehensive (loss) income for the three and nine months ended March 31, 2010 and 2009 were as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net (loss) income

 

$

(21,754

)

$

8,096

 

$

(73,473

)

$

42,710

 

Foreign currency translation adjustments

 

(648

)

134

 

828

 

(1,850

)

Total comprehensive (loss) income

 

$

(22,402

)

$

8,230

 

$

(72,645

)

$

40,860

 

 

11.  Commitments and Contingencies

 

(a) FTC and Honeywell Settlement

 

In December 2004, we entered into a consent decree with the Federal Trade Commission (FTC) with respect to a civil administrative complaint filed by the FTC in August 2003 alleging that our acquisition of Hyprotech Ltd. and related subsidiaries of AEA Technology plc (Hyprotech) in May 2002 was anticompetitive in violation of Section 5 of the Federal Trade Commission Act and Section 7 of the Clayton Act. In connection with the consent decree, we entered into an agreement with Honeywell International, Inc. (Honeywell) on October 6, 2004, pursuant to which we transferred our operator training business and certain rights to the intellectual property of various legacy Hyprotech products.

 

We are subject to ongoing compliance obligations under the FTC consent decree. On July 6, 2009, we announced that the FTC closed an investigation relating to the alleged violations of the decree, and issued an order modifying the consent decree. The modified order became final on August 20, 2009. The modification to the 2004 consent decree requires that we continue to provide the ability for users to save input variable case data for Aspen HYSYS and Aspen HYSYS Dynamics software in a standard “portable” format, which will make it easier for users to transfer case data from later versions of the products to earlier versions. We will also provide documentation to Honeywell of the Aspen HYSYS and Aspen HYSYS Dynamics input variables, as well as documentation of the covered heat exchange products. These requirements will apply

 

16



 

to all existing and future versions of the covered products through up to 2014. In addition, in connection with the settlement of the related litigation with Honeywell, we have provided to Honeywell a license to modify and distribute (in object code form) certain versions of our flare system analyzer software.

 

(b) Class action and opt-out claims

 

In March 2006, we settled class action litigation, including related derivative claims, arising out of our originally filed consolidated financial statements for fiscal 2000 through 2004, the accounting for which we restated in March 2005. Certain members of the class representing 1,457,969 shares of common stock (or less than 1% of the shares putatively purchased during the class action period) opted out of the settlement and had the right to bring their own state or federal law claims against us, referred to as “opt-out” claims.

 

Opt-out claims were filed on behalf of the holders of approximately 1.1 million of such shares. One of these actions was settled and two were dismissed. The claims in the remaining action (described below) include claims against us and one or more of our former officers alleging securities and common law fraud, breach of contract, deceptive practices and/or rescissory damages liability, based on the restated results of one or more fiscal periods included in our restated consolidated financial statements referenced in the class action.

 

· Herbert G. and Eunice E. Blecker v. Aspen Technology, Inc., et al., filed on June 5, 2006 in the Business Litigation Session of the Massachusetts Superior Court for Suffolk County and docketed as Civ. A. No. 06-2357-BLS1 in that court, was an opt-out claim asserted by persons who received 248,411 shares of our common stock in an acquisition. Fact discovery in this action closed on July 18, 2008, and a non-jury trial began on November 3, 2009 and concluded on November 24, 2009. On January 19, 2010 the court issued its order granting judgment in our favor and dismissing the case. On February 17, 2010, the plaintiffs filed a notice of appeal of the judgment. On October 17, 2008, the plaintiffs filed a new complaint in the Superior Court of the Commonwealth of Massachusetts, captioned Herbert G. and Eunice E. Blecker v. Aspen Technology, Inc. et al., Civ. A. No. 08-4625-BLS1 (Blecker II). The sole claim in Blecker II was based on the Massachusetts Uniform Securities Act. We served a motion to dismiss on December 3, 2008 which was granted on December 11, 2009. On January 5, 2010, the plaintiffs filed a notice of appeal with respect to that dismissal.  On February 23, 2010, that appeal was dismissed with prejudice by stipulation of the parties.

 

· 380544 Canada, Inc. et al. v. Aspen Technology, Inc., filed on February 15, 2007 in the federal district court for the Southern District of New York and docketed as Civ. A. No. 1:07-cv-01204-JFK in that court, is a claim asserted by persons who purchased 566,665 shares of our common stock in a private placement. Certain motions to dismiss filed by other defendants were resolved on May 5, 2009, and discovery is in process.

 

The claims in the 380544 Canada action referenced above are for damages totaling at least $4.0 million, not including claims for attorneys’ fees. We plan to defend the 308544 Canada action vigorously. We can provide no assurance as to the outcome of this case or the likelihood of the filing of additional opt-out claims, and these claims may result in judgments against us for significant damages. Regardless of the outcome, such litigation has resulted in the past, and may continue to result in the future, in significant legal expenses and may require significant attention and resources of management, all of which could result in losses and damages that have a material adverse effect on our business.

 

(c) ATME Arbitration

 

Prior to October 6, 2009, we had an exclusive reseller relationship covering certain countries in the Middle East with a reseller known as AspenTech Middle East W.L.L., a Kuwaiti corporation (ATME or the reseller). Effective October 6, 2009, we terminated the reseller relationship for material breach by the reseller based on certain actions of the reseller.

 

On November 2, 2009, ATME commenced an action in the Queen’s Bench Division (Commercial Court) of the High Court of Justice (England & Wales) captioned In The Matter Of An Intended Arbitration Between AspenTech Middle East W.L.L. And Aspen Technology, Inc., 2009 Folio 1436, seeking preliminary injunctive relief restraining us from taking any steps to impede ATME from serving as our exclusive reseller in the countries included in our agreement with ATME. We filed evidence in opposition to that request for relief on November 12, 2009. At a hearing on November 13, 2009, the court dismissed ATME’s application for preliminary injunctive relief. The court sealed an Order to this effect on November 23, 2009, and further ordered that ATME pay our costs of claim.

 

Relatedly, on November 11, 2009, we commenced an arbitration against ATME in the International Court of Arbitration of the International Chamber of Commerce, captioned Aspen Technology, Inc. v. AspenTech Middle East W.L.L., Case No. 16732/VRO, by filing a request for arbitration in that court. Our request for arbitration asserted claims

 

17



 

against ATME seeking a declaration that ATME committed a material breach of our agreement and that our termination of our agreement was lawful, and seeking damages for ATME’s willful misconduct in connection with the reseller relationship. On November 18, 2009, ATME filed its answer to that request for arbitration and asserted counterclaims against us seeking a declaratory judgment that we unlawfully terminated our agreement with ATME, and seeking damages for breach of contract by reason of our purported unlawful termination of our agreement. Our reply to those counterclaims was filed on or about December 18, 2009.

 

On March 11, 2010, a Kuwaiti entity affiliated with ATME filed a lawsuit in a Kuwaiti court naming as defendants ATME, us and a reseller newly appointed by us in Kuwait.  While we believe that the claims of the affiliated entity and the counterclaims of ATME are without merit and that we were entitled to terminate the reseller relationship, we can provide no assurance as to the outcome of the dispute. Regardless of the outcome, such claims may result in significant legal expenses and may require significant attention and resources of management, all of which could result in losses and damages that have a material adverse effect on our business. The reseller agreement document relating to the terminated relationship contained a provision whereby we could be liable for a termination fee if the agreement were terminated other than for material breach. This fee would be calculated based on a formula contained in the reseller agreement that we believe was originally developed based on certain assumptions about the future financial performance of the reseller, as well as the reseller’s actual financial performance. Based on the formula and the financial information provided to us by the reseller, which we have not had the opportunity to verify independently, a recent calculation associated with termination other than for material breach based on the formula would result in a termination fee of between $60 million and $77 million. Under the terminated reseller agreement document, no termination fee is owed on termination for material breach.

 

(d) Other

 

We are currently defending a customer claim of approximately $5 million that certain of our software products and implementation services failed to meet customer expectations. Although we are defending the claim vigorously, the results of litigation and claims cannot be predicted with certainty, and unfavorable resolutions are possible and could materially affect our results of operations, cash flows or financial position. In addition, regardless of the outcome, litigation could have an adverse impact on us because of defense costs, diversion of management resources and other factors.

 

12.  Segment Information

 

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision-maker is our Chief Executive Officer.

 

We have three operating segments: a) license; b) maintenance, training and other; and c) professional services. The chief operating decision-maker assesses financial performance and allocates resources based upon these three lines of business.

 

The license line of business is engaged in the development and licensing of software. The maintenance, training and other line of business provides customers with a wide range of support services that include on-site support, telephone support, software updates and various forms of training on how to use our products.  The professional services line of business offers implementation, advanced process control, real-time optimization and other professional services in order to provide customers with complete solutions.

 

The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. We do not track assets or capital expenditures by operating segments. Consequently, it is not practical to show assets, capital expenditures, depreciation or amortization by operating segments.

 

The following table presents a summary of operating segments for the three and nine months ended March 31, 2010 and 2009 (in thousands):

 

18



 

 

 

 

Maintenance,

 

 

 

 

 

 

 

 

 

Training,

 

Professional

 

 

 

 

 

License

 

and Other

 

Services

 

Total

 

Three Months Ended March 31, 2010—

 

 

 

 

 

 

 

 

 

Segment revenue

 

$

18,673

 

$

18,126

 

$

8,819

 

$

45,618

 

Segment expenses

 

18,588

 

3,722

 

7,561

 

29,871

 

Segment operating profit (1)

 

$

85

 

$

14,404

 

$

1,258

 

$

15,747

 

Three Months Ended March 31, 2009—

 

 

 

 

 

 

 

 

 

Segment revenue

 

$

41,070

 

$

20,145

 

$

10,077

 

$

71,292

 

Segment expenses

 

14,756

 

3,933

 

9,227

 

27,916

 

Segment operating profit (1)

 

$

26,314

 

$

16,212

 

$

850

 

$

43,376

 

Nine Months Ended March 31, 2010—

 

 

 

 

 

 

 

 

 

Segment revenue

 

$

39,970

 

$

56,780

 

$

31,350

 

$

128,100

 

Segment expenses

 

49,165

 

11,480

 

25,746

 

86,391

 

Segment operating (loss) profit (1)

 

$

(9,195

)

$

45,300

 

$

5,604

 

$

41,709

 

Nine Months Ended March 31, 2009—

 

 

 

 

 

 

 

 

 

Segment revenue

 

$

137,979

 

$

63,965

 

$

38,381

 

$

240,325

 

Segment expenses

 

45,839

 

11,143

 

29,504

 

86,486

 

Segment operating profit (1)

 

$

92,140

 

$

52,822

 

$

8,877

 

$

153,839

 

 


(1)                                  The segment operating profits reported reflect only the expenses of the operating segment and do not contain an allocation for selling and marketing, general and administrative, research and development, restructuring and other corporate expenses incurred in support of the segments.

 

Reconciliation to (Loss) Income Before Income Taxes

 

The following table presents a reconciliation of total segment operating profit to (loss) income before income taxes for the three and nine months ended March 31, 2010 and 2009 (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Total segment operating profit for reportable segments

 

$

15,747

 

$

43,376

 

$

41,709

 

$

153,839

 

Cost of license

 

(1,437

)

(3,063

)

(4,887

)

(8,587

)

Selling and marketing

 

(3,997

)

(3,508

)

(9,653

)

(10,259

)

Research and development

 

(10,591

)

(9,664

)

(29,097

)

(28,238

)

General and administrative and overhead

 

(17,592

)

(19,638

)

(58,226

)

(58,843

)

Stock-based compensation

 

(1,820

)

(1,280

)

(13,352

)

(3,659

)

Restructuring reversal (charges)

 

43

 

(1,760

)

(260

)

(2,025

)

Impairment of goodwill and intangible assets

 

 

 

 

(623

)

Other expense

 

(2,144

)

(3,308

)

(97

)

(3,969

)

Interest income (net)

 

2,750

 

2,946

 

8,391

 

9,219

 

(Loss) income before income taxes

 

$

(19,041

)

$

4,101

 

$

(65,472

)

$

46,855

 

 

13.  Subsequent Events

 

We evaluated events occurring between the end of our fiscal quarter and the date the financial statements were issued.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations with an overview of our key operating business segments and significant trends. This overview is followed by a summary of our critical accounting policies and estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then provide a more detailed analysis of our financial condition and results of operations.

 

In addition to historical information, this Quarterly Report contains forward-looking statements that involve risks and uncertainties that could cause our actual results to differ materially. When used in this Quarterly Report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this Quarterly Report. You should carefully review the risk factors described in “Item 1A. Risk Factors” of Part II below. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document.

 

Our fiscal year ends on June 30, and references in this Quarterly Report to a specific fiscal year are the twelve months ended June 30 of such year (for example, “fiscal 2010” refers to the year ending June 30, 2010).

 

Business Overview

 

We are a leading supplier of integrated software and services to the process industries, for which the principal markets consist of energy, chemicals, pharmaceuticals, and engineering and construction. Additionally, we also serve other industries such as power and utilities, consumer products, metals and mining, pulp and paper and biofuels, which manufacture and produce products from a chemical process. We provide a comprehensive, integrated suite of software applications that utilize proprietary empirical models of chemical manufacturing processes to improve plant and process design, economic evaluation, production, production planning and scheduling, supply chain optimization, and operational performance, and an array of services designed to optimize the utilization of these products by our customers. We are organized into three operating segments: software licenses; maintenance, training and other; and professional services. Each of these operating segments has unique characteristics and faces different opportunities and challenges. Although we report our actual results in U.S. dollars, we conduct a significant number of transactions in currencies other than U.S. dollars.

 

Adverse changes in the economy and global economic and political uncertainty have previously caused delays and reductions in information technology (IT) spending by our customers and a consequent deterioration of the markets for our products and services, particularly our manufacturing/supply chain product suites. As a result of the decline in economic conditions which began in fiscal 2009 and continued into early fiscal 2010, we experienced some reductions, delays and postponements of customer purchases that negatively impacted our bookings, revenue and operating results.  While we have seen some recent signs of economic recovery, such as positive financial results and earnings for some of our customers, we have no way of knowing whether this trend will be sustained.

 

New Licensing Model

 

In July 2009, we announced that for the fiscal year commencing July 1, 2009, we would offer a new term licensing model for our software. The new aspenONE licensing model provides customers with access to all engineering or manufacturing/supply chain software products within the aspenONE software suite. As part of the new offering, customers receive SMS for the term of the license and the right to unspecified future software products that may be introduced during the term of the arrangement for no additional fee. The new aspenONE licensing model provides customers the ability to utilize any product within the aspenONE suite through the use of tokens (exchangeable units of measurement) which they license in quantities sufficient for their business needs. We expect that the increased flexibility of this licensing model, which facilitates ease of access to the products in the aspenONE suite, will lead to increased usage over time, and should contribute to increased revenue.

 

Prior to fiscal 2010, we offered term licenses to our customers with extended payment terms for specifically defined sets of products (referred to as “point products”) within the aspenONE solution suites based upon the customer’s particular needs. We typically recognized revenue for these term license agreements upon shipment of the software, at the net present value of the aggregate license fees, provided all other revenue recognition criteria were met. We refer to this revenue recognition approach as the “upfront revenue model.” We also sold perpetual licenses, which were also recognized on an upfront basis. Increasingly, the majority of our software licenses has been term-based. Licenses that did not qualify for

 

20



 

upfront recognition were either deferred until such time as all revenue recognition criteria had been met, or recognized over the license term.

 

Under the upfront revenue model we offered annually renewable post contract support (referred to as SMS) as a component of our arrangements. Generally, SMS was provided for the first year of the license agreement and renewed annually at the customer’s discretion. Revenue from SMS was recognized ratably over the term of the SMS agreement. For the majority of our existing software arrangements under the upfront licensing model, customers renew their support contracts when eligible to do so.

 

Under the new aspenONE licensing model, the license, SMS, and the right to future unspecified products are included in the arrangement fee. These arrangements do not qualify for upfront revenue recognition because customers have the right to future unspecified products. Revenue under this new licensing model will be recognized over the term of the agreement on a subscription basis beginning when the first payment is due, typically 30 days after signing the agreement.

 

In addition to our new aspenONE licensing model, we continue to offer term licenses for specifically defined sets of point products. Beginning in the first quarter of fiscal 2010, we began licensing point products with SMS included for the full license term. Revenue for these arrangements will be recognized over the term of the contract as payments become due. The related SMS is recognized over the term of the SMS agreement beginning with the due date of the annual payment and reported in services and other on the consolidated statements of operations. Occasionally, we expect certain customers to elect upfront payment terms. For these arrangements with upfront payment, all of the license revenue will be recognized upfront by applying the residual method of accounting.

 

As a result of the changes to our business model, the majority of our license revenue will no longer be recognized on an upfront basis, but will instead be recognized over the contract term, either on a subscription basis or as payments become due. Since we previously recognized much of the revenue associated with the term license agreements executed prior to fiscal 2010, we will report significantly lower revenue for several years. Until such time as existing contracts expire and are renewed under the new aspenONE licensing model, we will not realize a significant increase in our subscription revenue. Additionally, if a professional service arrangement is contracted in close proximity to a related license agreement which qualifies for recognition under the new aspenONE licensing model, the professional services revenue will be recognized over the contract term. There will not be a corresponding reduction in operating expenses; therefore, we anticipate reporting significant operating and net losses for at least several years.

 

It is not our intention to enter into new or renewal term contracts that will qualify for revenue recognition under the upfront revenue model. However, we may elect to do so on a limited basis. The incremental revenue associated with amendments to existing term contracts that were recognized under the upfront revenue model will continue to be accounted for on an upfront basis provided all other revenue recognition requirements have been met. Additionally, we will continue to offer perpetual license arrangements. We do not anticipate that either of these types of arrangements will represent a significant portion of our future license revenue.

 

The predominant method of customer billing and cash collections is consistent between the new aspenONE and upfront licensing models: we will continue to invoice the customer over the contract term (generally on an annual basis), provided the customer does not elect to make payment in full at the outset of the arrangement. Consequently, we do not expect any material change to net cash provided by operating activities as a result of the changes to the way we license our products, assuming the introduction of the new aspenONE licensing model does not negatively impact customer retention.

 

Under the upfront revenue model, we record the net present value of the un-invoiced payments remaining on our license contracts as installments receivable. Under the new aspenONE licensing model, the arrangement fees are not deemed to be fixed or determinable. Therefore, the un-invoiced payments remaining on our license contracts will not be recorded on the balance sheet. We expect that the conversion to the new licensing model will cause the installments receivable balance to decline over time. Additionally, we expect deferred revenue will increase over time since the annual installments for license transactions executed under the new aspenONE licensing model will be deferred and recognized on a subscription basis.  Although we expect to see growth in deferred revenue during the balance of fiscal 2010, until such time as a significant portion of existing term contracts which were recognized under the upfront revenue model expire and are renewed under the new aspenONE licensing model, we will not realize a significant increase in our deferred revenue.

 

Historically, to assess our financial results and condition, we used a number of quantitative and qualitative performance indicators. These indicators included: software license bookings; the value of our installed customer base; revenue and expense trends; gross margins; operating and net income; cash and cash equivalents; cash flow; and liquidity metrics. As a result of the movement to the new aspenONE licensing model and the anticipated reduction in reported revenue and income, a number of these indicators will not be meaningful for the next several years. Accordingly, we will

 

21



 

focus on: the change in the value of our installed customer base; software license bookings; expense trends; cash and cash equivalents; cash flow; and collateralized receivables and secured borrowings balances.

 

An overview of our three operating segments is described below.

 

Software Licenses

 

Our solutions are focused on three primary business areas of our customers: engineering, manufacturing, and supply chain management, and are delivered both as stand-alone solutions and as part of the integrated aspenONE product suite. The aspenONE framework enables our products to be integrated in modular fashion so that data can be shared among such products, and additional modules can be added as the customer’s requirements evolve. The result is enterprise-wide access to real-time, model-based information designed to enable manufacturers to forecast or simulate the economic impact of potential actions and make better, faster and more profitable operating decisions. The first version of the aspenONE suite was delivered in 2004. Since that time, each major software release was designed to increase the level of integration and functionality across our product portfolio.

 

·                  Engineering  Process manufacturers must be able to address a variety of challenging questions relating to strategic planning, collaborative engineering, debottlenecking and process improvement—from where they should locate their facilities, to how they can make their products at the lowest cost, to what is the best way to operate for maximum efficiency. To address these issues, they must improve asset optimization to enable faster, better execution of complex projects. Our engineering solutions help companies maximize their return on plant assets and enable collaboration with engineers on common models and projects.

 

Our engineering solutions are used on the process engineer’s desktop to design and improve plants and processes. Customers use our engineering software and services during both the design and ongoing operation of their facilities to model and improve the way they develop and deploy manufacturing assets. Our products enable our customers to improve their return on capital, improve physical plant operating performance and bring new products to market more quickly.

 

Our engineering tools are based on an open environment and are implemented on Microsoft Corporation’s operating systems. Implementation of our engineering products does not typically require substantial professional services, although services may be provided for customized model designs, process synthesis and energy management analyses.

 

·                  Manufacturing  Our manufacturing products focus on optimizing customers’ day-to-day process industry activities, enabling them to make better, more profitable decisions and improve plant performance. The typical production cycle offers many opportunities for optimizing profits. Process manufacturers must be able to address a wide range of issues driving execution efficiency and cost: from selecting the right feedstock and raw materials; to optimizing energy consumption; to production scheduling; to identifying the right balance among customer satisfaction, costs and inventory. Our manufacturing products support the execution of the optimal operating plan in real time. These solutions include desktop and server applications and IT infrastructure that enable companies to model, manage and control their plants more efficiently, helping them to make better-informed, more profitable decisions. These solutions help companies make decisions that can reduce fixed and variable costs in the plant, improve product yields, procure the right raw materials and evaluate opportunities for cost savings and efficiencies in their operations.

 

·                  Supply chain management  Our supply chain management products enable companies to reduce inventory and increase asset efficiency by giving them the tools to optimize their supply chain decisions, from choosing the right raw materials to delivering finished product in the most cost-effective manner. The ever-changing nature of the process industries means new profit opportunities can appear at any time. To identify and seize these opportunities, process manufacturers must be able to increase their access to data and information across the value chain, optimize planning and collaborate across the value chain, and detect and exploit supply chain opportunities. Our supply chain management solutions include desktop and server applications and IT infrastructure that enable manufacturers to operate their plants and supply chains more efficiently, from customer demand through manufacturing to delivery of the finished product. These solutions help companies to reduce inventory carrying costs, respond more quickly to changes in market conditions and improve customer service.

 

Because fees for our software products can be substantial and the decision to purchase our products often involves members of our customers’ senior management, the sales process for our solutions is frequently lengthy and can exceed one

 

22



 

year. Accordingly, the timing of our license bookings and revenue is difficult to predict. Additionally, we derive a majority of our total revenue from companies in or serving the energy, chemicals, pharmaceutical, and engineering and construction industries. Accordingly, our future success depends upon the continued demand for manufacturing optimization software and services by companies in these process manufacturing industries. The energy, chemicals, pharmaceutical, and engineering and construction industries are highly cyclical and highly reactive to the price of oil, as well as general economic conditions.

 

Our software license business represented 36.5% of our total revenue on a trailing four-quarter basis.

 

Maintenance, Training and Other

 

Our maintenance business consists primarily of providing customer technical support and access to software fixes and upgrades, when and if they become available. Our customer technical support services are provided throughout the world by our three global call centers as well as via email and through our support website. Our training business consists of a variety of training solutions ranging from standardized training, which can be delivered in a public forum or on-site at a customer’s location, to customized training sessions which can be tailored to fit customer needs.

 

Revenue generated by our maintenance, training and other business represented 40.8% of our total revenue on a trailing four-quarter basis and is closely correlated to changes in our installed base of software licenses. This percentage has increased, not as a result of higher SMS revenue, but as a result of the implementation of the new aspenONE licensing model which recognizes subscription revenue over time, as opposed to our historical practice of generally recognizing revenue upfront upon shipment. For the majority of our existing software arrangements under the upfront model, customers renew their support contracts when eligible to do so.  The majority of new software license contracts sold include maintenance for the entire term of the arrangement.

 

We expect SMS revenue to decrease as we transition our business to a predominantly subscription-based model, because the revenue associated with SMS will be reported as subscription revenue within the consolidated statements of operations.  Further, we anticipate reduced SMS revenue due to the continued trend of customers electing to replace perpetual agreements with new term contracts.  Moving customers to term-based contracts generally results in larger combined software license and SMS revenue for the business; however, it results in a reduction in SMS revenue.  Eventually, we expect the majority of our customers to be under the aspenONE licensing model, and accordingly, the majority of SMS revenue will be accounted for in the subscription revenue line.

 

Professional Services

 

We offer professional services that include designing, analyzing, debottlenecking and improving plant performance through continuous process improvements, coupled with activities aimed at operating the plant safely and reliably while minimizing energy costs and improving yields and throughput. Our implementation and configuration services are primarily associated with assisting customers in their deployment of our manufacturing and supply chain management solutions.

 

Customers who obtain professional services from us typically engage us to provide such services over periods of up to 24 months. We generally charge customers for professional services, ranging from supply chain to on-site advanced process control and optimization assistance services, on a fixed-price basis or time-and-materials basis. Professional services represented 22.7% of our total revenue on a trailing four-quarter basis, and has experienced lower margins than our other business segments.

 

Critical Accounting Estimates and Judgments

 

Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

 

·                  revenue recognition for both software licenses and fixed-fee professional services;

 

·                  impairment of long-lived assets, goodwill and intangible assets;

 

23



 

·                  accounting for contingencies; and

 

·                  accounting for income taxes.

 

Revenue Recognition

 

We generate revenue from the following sources: (1) licensing software products; (2) providing SMS; and (3) providing professional services including consulting and training. We sell our software products to end-users under fixed-term and perpetual licenses. As a standard business practice, we offer extended payment term options for our fixed-term license contracts, which are generally payable on an annual basis. Certain of our fixed-term license agreements include product mixing rights that allow customers the flexibility to change or alternate the use of multiple products included in the license arrangement after those products are delivered to the customer. We refer to these arrangements as token arrangements. Tokens are fixed units of measure. The amount of software usage is limited by the value of the tokens purchased by the customer.

 

Historically, we executed software license arrangements that included contractual provisions that resulted in the “upfront” recognition of license revenue upon delivery of the software products provided all other revenue recognition requirements were met. We refer to these traditional licensing arrangements as our upfront revenue model.

 

In the first quarter of fiscal 2010, we began offering a new term licensing model for our software. This new licensing model includes contractual provisions that provide customers with greater flexibility, in that customers receive SMS for the term of the arrangement and the right to unspecified future software products that may be introduced during the term of the arrangement for no additional fee. We refer to this licensing model as the new aspenONE licensing model. Under this licensing model, we recognize revenue over the term of the agreement on a subscription basis beginning when the first payment is due, typically 30 days after signing the agreement, provided all other revenue recognition requirements are met.

 

Additionally, in the first quarter of fiscal 2010, we also began licensing fixed-term point product arrangements in which customers receive SMS for the term of the arrangement. With the inclusion of SMS for the full term of the license, revenue can no longer be recognized under the upfront revenue model as the aggregate fees are not considered fixed or determinable. Revenue for these arrangements will be recognized as payments become due over the term of the contract, provided all other revenue recognition requirements are met. The related SMS is recognized over the term of the SMS agreement beginning with the due date of the annual payment and reported in services and other on the consolidated statements of operations. Occasionally, we expect certain customers to elect upfront payment terms. For these arrangements with upfront payment, all of the license revenue will be recognized upfront by applying the residual method of accounting when the four revenue recognition requirements below have been met.

 

Over the next several years, we expect to transition substantially all of our customers to our new aspenONE licensing model or to point product arrangements with SMS bundled for the contract term. However, during this transition period we expect to execute some license contracts under the upfront revenue model, including perpetual licenses, which will continue to be recognized on an upfront basis.

 

Four basic criteria must be satisfied before software license revenue can be recognized: persuasive evidence of an arrangement between us and an end user; delivery of our product has occurred; the fee for the product is fixed or determinable; and collection of the fee is probable.

 

Persuasive evidence of an arrangement—We use a contract signed by the customer as evidence of an arrangement for software licenses and SMS. For professional services we use a signed contract and a statement of work to evidence an arrangement. In cases where both a signed contract and a purchase order are required by the customer, we consider both taken together as evidence of the arrangement.

 

Delivery of our product—Software and the corresponding access keys are generally delivered to customers via disk media with standard shipping terms of Free Carrier, our warehouse. Our software license agreements do not contain conditions for acceptance.

 

Fee is fixed or determinable—We assess whether a fee is fixed or determinable at the outset of the arrangement. Significant judgment is involved in making this assessment.

 

Under our upfront revenue model, we are able to demonstrate that the fees are fixed or determinable for all arrangements, including those for our term licenses that contain extended payment terms. We have an established history of

 

24



 

collecting under the terms of these contracts without providing concessions to customers. In addition, we also assess whether contract modifications to an existing term arrangement constitute a concession. In making this assessment, significant analysis is performed to ensure that no concessions are given. Our software license agreements do not include right of return or exchange. For license arrangements executed under the upfront revenue model, we recognize license revenue upon delivery of the software products, provided all other revenue recognition requirements are met.

 

With the introduction of the new aspenONE licensing model, and the changes to the licensing terms of our historical point product agreements sold on a fixed-term basis, we cannot assert that the fees in these arrangements are fixed or determinable because the rights provided to customers and the economics of the arrangements are not comparable to our historical transactions with other customers under the upfront revenue model. As a result, the amount of revenue recognized for these new arrangements will be limited by the amount of customer payments currently due, which generally results in the fees being recognized over the term of the contracts.

 

Collection of fee is probable—We assess the probability of collecting from each customer at the outset of the arrangement based on a number of factors, including the customer’s payment history, its current creditworthiness, economic conditions in the customer’s industry and geographic location, and general economic conditions. If in our judgment collection of a fee is not probable, revenue is recognized as cash is collected, provided all other conditions for revenue recognition have been met.

 

Our management uses its judgment concerning the satisfaction of these four basic criteria, particularly the criteria relating to the determination of whether the arrangement fees are fixed or determinable and the criteria relating to the collectability of the arrangement fees, during evaluation of each revenue transaction. Additionally, judgment is required concerning the satisfaction of these criteria for reseller transactions. We typically recognize the fees related to reseller transactions on a net basis using the sell-through method of accounting. To date, revenue related to our reseller arrangements has not been material.

 

We have established vendor-specific objective evidence (VSOE) of fair value for SMS and professional services, but not for our software products. Our VSOE determination is based upon the price charged to similarly situated customers when the elements are sold separately. We allocate the arrangement consideration among the elements included in our multi-element arrangements using the residual method. Under the residual method, the VSOE of the undelivered elements is deferred, and the remaining portion of the arrangement fee for perpetual and term licenses is recognized as revenue upon delivery of the software, assuming all other revenue recognition criteria are met. If VSOE does not exist for an undelivered element in an arrangement, revenue is deferred until such evidence does exist for the undelivered elements, or until all elements are delivered, whichever is earlier.

 

Under the upfront revenue model, the residual license fee is recognized upfront upon delivery of the software provided all other revenue recognition criteria were met. For arrangements entered into since July 2009, the arrangement fees are generally recognized over the term of the license agreement since these arrangements include contractual provisions such as rights to future unspecified software products for no additional fee or because we cannot assert that the fees are fixed or determinable.

 

Subscription Revenue

 

When our fixed-term customers elect to license our products under the new aspenONE licensing model, SMS is included for the entire term of the arrangement and the customer receives the right to unspecified future software products that may be introduced during the term of the arrangement for no additional fee. These agreements combine the right to use all software products within a given product suite with SMS for the term of the arrangement. Due to our obligation to provide unspecified future software products, we are required to recognize the revenue ratably (i.e., on a subscription basis) over the term of the license, once the four revenue recognition criteria noted above are met.  License and SMS revenue for arrangements sold under the new aspenONE licensing model are combined and presented together as subscription revenue in the consolidated statements of operations.

 

Software Revenue

 

Software revenue consists of all license transactions that do not contain rights to future unspecified software products for no additional fee. Specifically, it includes license revenue recognized under the upfront revenue model upon the delivery of the license products (i.e., both perpetual and term license contracts); license revenue recognized over the term of the license agreements for fixed-term contracts including point product licenses with SMS bundled for the entire license term; and other license revenue derived from transactions that are being recognized over time as the result of not previously

 

25



 

meeting one or more of the requirements for recognition under the upfront revenue model.

 

The license fees derived from the sale of fixed-term point product arrangements with SMS included for the contract term are recognized under the residual method, as payments come due. The related SMS is recognized over the term of the SMS agreement beginning with the due date of the annual payment and is reported in services and other on the consolidated statement of operations. Occasionally, we expect certain customers to elect upfront payment terms. For these arrangements with upfront revenue, all of the license revenue will be recognized upfront by applying the residual method of accounting when the above four revenue recognition requirements have been met.

 

Perpetual license arrangements do not include the same rights as those provided to customers under the new aspenONE licensing model. Accordingly, the license fees for perpetual license agreements will continue to be recognized upon delivery of the software products using the residual method provided all other revenue recognition requirements are met. The revenue attributable to perpetual software licenses is recognized in software revenue in the consolidated statements of operations.

 

Services and Other

 

SMS Revenue

 

Under the upfront revenue model, SMS is typically bundled with the license for the initial year of the license term. Under these arrangements, the fair value of SMS is deferred and subsequently amortized into service and other in the consolidated statements of operations over the contractual term of the SMS arrangement. SMS renewals are at the option of the customer.

 

For arrangements executed under the new aspenONE licensing model or where point product licenses are sold with SMS for the contract term, the customer commits to SMS for the entire term of the license arrangement. The revenue related to the SMS component of the new aspenONE licensing model is reported in subscription revenue in the consolidated statements of operations. The revenue related to the SMS component of point product licenses, for which we have VSOE, is reported in services and other in the consolidated statements of operations.

 

Professional Services

 

Professional services are provided to customers on a time-and-materials (T&M) or fixed-price basis and are generally recognized as the services are performed, assuming all other revenue recognition criteria have been met. Revenue from committed professional services arrangements that are sold within close proximity or in contemplation of a new aspenONE license transaction is deferred and recognized on a ratable basis over the term of the related software arrangement.  We recognize professional services fees for our T&M contracts based upon hours worked and contractually agreed-upon hourly rates. Revenue from fixed-price engagements is recognized using the proportional performance method based on the ratio of costs incurred, substantially all of which are labor-related, to the total estimated project costs. All revenue amounts are recognized within services and other in the statements of operations. Project costs are based on standard rates, which vary by the consultant’s professional level, plus all direct expenses incurred to complete the engagement that are not reimbursed by the client. All project costs are expensed as incurred. The use of the proportional performance method is dependent upon our ability to reliably estimate the direct costs to complete a project. We use historical experience as a basis for future estimates to complete current projects. Additionally, management believes that costs are the best available measure of performance. Reimbursables received from customers for out-of-pocket expenses are recorded as revenue. If the costs to complete a project are not estimable or the completion is uncertain, the revenue is recognized upon completion of the services.

 

Occasionally, we provide professional services considered essential to the functionality of the software. We recognize the combined revenue from the sale of the software and related services using the percentage-of-completion method. However, when these professional services are combined with, and essential to, the functionality of a new aspenONE license transaction, the amount of combined revenue recognized will be the lesser of the amount determined by either the subscription method or the percentage-of-completion method.

 

In the past, we have occasionally been required to commit unanticipated additional resources to complete projects, which have resulted in lower than anticipated income or losses on those contracts. We may experience similar situations in the future. Provisions for estimated losses on contracts are made during the period in which such losses become probable and can be reasonably estimated. To date, such losses have not been significant.

 

26



 

Installments Receivable

 

Installments receivable resulting from product sales under the upfront revenue model are discounted to present value at prevailing market rates. Finance fees are recognized using the effective interest method over the relevant license term and are classified as interest income. The amount of the installments receivable is split between current and non-current in the consolidated balance sheets.

 

Under the new aspenONE licensing model and for point product arrangements sold with SMS bundled for the entire license term, receivables are recorded when the payments become due and payable. Payment amounts under extended payment term arrangements are not presented in the consolidated balance sheets as the related arrangement fees are not fixed or determinable. As a result, all contractual payments will be recorded as revenue on a gross basis in the consolidated statements of operations either as subscription or software revenue.

 

Deferred Revenue

 

Under the upfront revenue model and point product arrangements, a portion of the arrangement fee is generally recorded as deferred revenue due to the inclusion of an undelivered element, typically SMS. The amount of revenue allocated to undelivered elements is based on the VSOE of fair value for those elements using the residual method and is earned and recognized as revenue as each element is delivered. Deferred revenue related to these transactions generally consists of SMS and represents payments received in advance of services rendered as of the balance sheet dates.

 

Under the new aspenONE licensing model, customers receive SMS for the full contract term, and receive rights to unspecified future products for no additional fee. As VSOE does not exist for both of these undelivered elements, we are required to recognize the revenue ratably (i.e., on a subscription basis) over the term of the license. Therefore, deferred revenue is recorded as each payment comes due and revenue is recognized ratably over the associated license period.

 

Other Licensing Matters

 

Our standard licensing agreements include a product warranty provision for all products. Such warranties are accounted for in accordance with ASC 460, “Guarantees” (ASC 460). The likelihood that we will be required to make refunds to customers under such provisions is considered remote. Historically, any such payments have been de minimis.

 

Under the terms of substantially all of our license agreements, we have agreed to indemnify customers for costs and damages arising from claims against such customers based on, among other things, allegations that our software products infringe the intellectual property rights of a third party. In most cases, in the event of an infringement claim, we retain the right to (i) procure for the customer the right to continue using the software product; (ii) replace or modify the software product to eliminate the infringement while providing substantially equivalent functionality; or (iii) if neither (i) nor (ii) can be reasonably achieved, we may terminate the license agreement and provide a refund to the customer up to the license fees paid by the customer. Such indemnification provisions are accounted for in accordance with ASC 460. The likelihood that we will be required to make refunds to customers under such provisions is considered remote. In most cases and where legally enforceable, the indemnification is limited to the amount paid by the customer.

 

Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended June 30, 2009 for a discussion of our critical accounting policies and estimates related to impairment of long-lived assets, goodwill, and intangible assets and accounting for income taxes.

 

Results of Operations

 

Comparison of the Three and Nine Months Ended March 31, 2010 and 2009

 

The following table sets forth our condensed consolidated statements of operations for the three and nine months ended March 31, 2010 and 2009 (dollars in thousands):

 

27



 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

 

 

2009

 

 

 

2010

 

 

 

2009

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription

 

$

3,959

 

8.7

%

$

 

0.0

%

$

5,198

 

4.1

%

$

 

0.0

%

Software

 

14,714

 

32.3

 

41,070

 

57.6

 

34,772

 

27.1

 

137,979

 

57.4

 

Total subscription and software

 

18,673

 

40.9

 

41,070

 

57.6

 

39,970

 

31.2

 

137,979

 

57.4

 

Services and other

 

26,945

 

59.1

 

30,222

 

42.4

 

88,130

 

68.8

 

102,346

 

42.6

 

Total revenue

 

45,618

 

100.0

 

71,292

 

100.0

 

128,100

 

100.0

 

240,325

 

100.0

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and software

 

1,437

 

3.2

 

3,063

 

4.3

 

4,887

 

3.8

 

8,587

 

3.6

 

Services and other

 

13,237

 

29.0

 

15,333

 

21.5

 

43,725

 

34.1

 

47,139

 

19.6

 

Total cost of revenue

 

14,674

 

32.2

 

18,396

 

25.8

 

48,612

 

37.9

 

55,726

 

23.2

 

Gross profit

 

30,944

 

67.8

 

52,896

 

74.2

 

79,488

 

62.1

 

184,599

 

76.8

 

Operating costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and marketing

 

25,267

 

55.4

 

20,494

 

28.7

 

69,576

 

54.3

 

62,519

 

26.0

 

Research and development

 

12,719

 

27.9

 

11,738

 

16.5

 

36,128

 

28.2

 

34,904

 

14.5

 

General and administrative

 

12,648

 

27.7

 

14,441

 

20.3

 

47,290

 

36.9

 

42,923

 

17.9

 

Restructuring charges

 

(43

)

(0.1

)

1,760

 

2.5

 

260

 

0.2

 

2,025

 

0.8

 

Impairment of goodwill and intangible asset

 

 

0.0

 

 

0.0

 

 

0.0

 

623

 

0.3

 

Total operating costs

 

50,591

 

 

 

48,433

 

 

 

153,254

 

 

 

142,994

 

 

 

(Loss) income from operations

 

(19,647

)

(43.1

)

4,463

 

6.3

 

(73,766

)

(57.6

)

41,605

 

17.3

 

Interest income

 

4,584

 

10.0

 

5,176

 

7.3

 

15,116

 

11.8

 

17,046

 

7.1

 

Interest expense

 

(1,834

)

(4.0

)

(2,230

)

(3.1

)

(6,725

)

(5.2

)

(7,827

)

(3.3

)

Other expense, net

 

(2,144

)

(4.7

)

(3,308

)

(4.6

)

(97

)

(0.1

)

(3,969

)

(1.7

)

(Loss) income before income taxes

 

(19,041

)

(41.7

)

4,101

 

5.8

 

(65,472

)

(51.1

)

46,855

 

19.5

 

(Provision for) benefit from income taxes

 

(2,713

)

 

 

3,995

 

 

 

(8,001

)

 

 

(4,145

)

 

 

Net (loss) income

 

$

(21,754

)

(47.7

)%

$

8,096

 

11.4

%

$

(73,473

)

(57.4

)%

$

42,710

 

17.8

%

 

Revenue

 

Total revenue for the third quarter of fiscal 2010 decreased by $25.7 million, or 36.0%, compared to the corresponding period of the prior year. This decrease was primarily attributable to our transition to the to the new aspenONE licensing model. The components of the decrease consisted of a $26.4 million reduction in software revenue and a $3.3 million reduction in services and other, offset by $4.0 million of subscription revenue.

 

Total revenue for the first nine months of fiscal 2010 decreased by $112.2 million, or 46.7%, compared to the corresponding period of the prior year. This decrease was primarily attributable to our transition to the new aspenONE licensing model.  The components of the decrease consisted of a $103.2 million reduction in software revenue and a $14.2 million reduction in services and other, offset by $5.2 million of subscription revenue.

 

Subscription Revenue

 

Subscription revenue relates to the licensing of our products under the new aspenONE licensing model, where SMS is included for the entire term of the arrangement and the customer receives the right to unspecified future software products that may be introduced during the term of the arrangement for no additional fee.  License and SMS revenue for arrangements sold under the new aspenONE licensing model are combined and presented together as subscription revenue in the consolidated statements of operations.

 

During the third quarter and nine months of fiscal 2010 we recognized $4.0 million and $5.2 million of revenue, respectively, from subscription agreements. Subscription agreements were not offered prior to fiscal 2010. The relatively small amount of subscription revenue recognized in the current year is a reflection of the short time span that the new aspenONE licensing model has been available.  We expect that subscription revenue will grow in the future as our new aspenONE licensing model gains greater market acceptance.

 

Although we expect to see growth in subscription revenue during the balance of fiscal 2010, until such time as a significant portion of existing term contracts which were recognized under the upfront revenue model expire and are renewed under the new aspenONE licensing model, subscription revenue will not represent a large portion of our total revenue.

 

Software Revenue

 

Software revenue consists of all license transactions that do not contain rights to future unspecified software products for no additional fee. Specifically, it includes license revenue recognized under the upfront revenue model upon the

 

28



 

delivery of the license products (i.e., both perpetual and term license contracts); license revenue recognized over the term of the license agreements with SMS bundled for the entire license term; and other license revenue derived from transactions that are being recognized over time as the result of not previously meeting one or more of the requirements for recognition under the upfront revenue model.

 

Software revenue in the third quarter of fiscal 2010 was $14.7 million as compared to $41.1 million in the corresponding period of the prior fiscal year, a decrease of $26.4 million, or 64.2%.  The decrease was primarily attributable to the changes to our business model described above.  Prior to July 2009, the majority of our license revenue was recognized on an upfront basis. Going forward, we expect that most of our software revenue will be recognized over the contract term, either on a subscription basis or as payments become due.  Of the $14.7 million of software revenue in the quarter, approximately $2.7 million was recognized from current quarter bookings, which included approximately $2.0 million from point product term license arrangements and $0.7 million from perpetual license arrangements.  The remaining $12.0 million of software revenue represented amounts that had been deferred in prior periods.

 

Software revenue in the first nine months of fiscal 2010 was $34.8 million as compared to $138.0 million in the corresponding period of the prior fiscal year, a decrease of $103.2 million, or 74.8 %.  The decrease was primarily attributable to the changes to our business model described above.  Prior to July 2009, the majority of our license revenue was recognized on an upfront basis. Going forward, we expect that most of our software revenue will be recognized over the contract term, either on a subscription basis or as payments become due.  Of the $34.8 million of software revenue in the first nine months of fiscal 2010, approximately $8.0 million was recognized in the same quarter in which it was booked and included $6.0 million from point product term license arrangements and $2.0 million from perpetual license arrangements.  The remaining $26.8 million of software revenue represented amounts that had been deferred in prior periods.

 

Looking ahead for the balance of fiscal 2010, we expect the majority of software revenue recognized to consist of amounts related to contracts booked and deferred in prior periods, and to a lesser degree, revenue from new perpetual and point product license arrangements.

 

Services and Other Revenue

 

Services and other primarily consists of professional services, SMS on software fees (excluding SMS bundled in the new aspenONE license offering), and training and are dependent upon a number of factors:

 

·                  the number, value and rate per hour of service transactions booked during the current and preceding periods;

·                  the number and availability of service resources actively engaged on billable projects;

·                  the timing of milestone acceptance for engagements contractually requiring customer sign-off;

·                  the timing of negotiating and signing maintenance renewals;

·                  the timing of collection of cash payments when collectability is uncertain; and

·                  the size of the installed base of license contracts.

 

Services and other in the three and nine months ended March 31, 2010 decreased by $3.3 million, or 10.8%, and $14.2 million, or 13.9%, respectively, compared to the corresponding periods of the prior fiscal year.

 

Professional Services

 

Professional services revenue decreased by $1.2 million during the third quarter of fiscal 2010 as compared to the corresponding period of the prior fiscal year.  The decrease was primarily due to a reduction in customer discretionary spending initiatives resulting from the decline in the global economic environment.  We began to experience the impact of this reduction in consulting projects during the second quarter of fiscal 2009.

 

Professional services revenue decreased by $7.0 million during the first nine months of fiscal 2010 as compared to the corresponding period of the prior fiscal year. The most significant portion of the decrease was due to the decline in the global economic environment, which impacted our customers’ ability to commit to more discretionary spending initiatives. We began to experience the impact of this reduction in consulting projects during the second quarter of fiscal 2009.  We expect our professional services revenue to remain relatively consistent in the near term.

 

SMS and Training

 

Revenue from SMS decreased $2.0 million in the third quarter of fiscal 2010 compared to the corresponding period of the prior fiscal year. The decrease was due to the continued trend of customers electing to replace perpetual license agreements with new term contracts and customers transitioning to the new aspenONE licensing model, partially offset by

 

29



 

improved customer renewal rates in the current quarter.  Moving customers to term-based contracts generally results in larger combined software license and SMS revenue for the business; however, it results in a reduction in SMS revenue.  Looking ahead, we expect SMS revenue to decrease as we transition our business to a predominantly subscription-based model, because the revenue associated with SMS will be reported as subscription revenue within the consolidated statements of operations.

 

Revenue from SMS decreased $5.3 million in the first nine months of fiscal 2010 compared to the corresponding period of the prior fiscal year. The decrease was due to the continued trend of customers electing to replace perpetual agreements with new term contracts and customers transitioning to the new aspenONE licensing model.  Moving customers to term-based contracts generally results in larger combined software license and SMS revenue for the business; however, it results in a reduction in SMS revenue.  Another contributing factor to the decrease in SMS revenue was slightly lower customer renewal rates. Looking ahead, we expect SMS revenue to decrease as we transition our business to a predominantly subscription-based model, because the revenue associated with SMS will be reported as subscription revenue within the consolidated statements of operations.

 

Training and other revenue decreased $0.1 million in the third quarter of fiscal 2010 as compared to the corresponding period of the prior fiscal year due to the overall decline in the global economic environment.

 

Training and other revenue decreased $1.9 million in the first nine months of fiscal 2010 as compared to the corresponding period of the prior fiscal year due to the overall decline in the global economic environment.

 

Cost Overview

 

 

 

Three months ended

 

Nine months ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Total cost of revenue

 

$

14,674

 

$

18,396

 

$

48,612

 

$

55,726

 

Total operating costs

 

50,591

 

48,433

 

153,254

 

142,994

 

Total costs

 

65,265

 

66,829

 

201,866

 

198,720

 

Less stock-based compensation

 

1,819

 

1,279

 

13,351

 

3,633

 

Total costs, excluding stock-based compensation

 

$

63,446

 

$

65,550

 

$

188,515

 

$

195,087

 

 

Total costs, which include the cost of revenue and total operating costs, decreased $1.6 million and increased $3.1 million for the third quarter and first nine months of fiscal 2010, respectively, as compared to the corresponding periods of the prior fiscal year.  Excluding stock-based compensation, comparative adjusted total costs decreased $2.1 million and $6.6 million in the third quarter and first nine months of fiscal 2010, respectively.

 

During the period from mid-September 2007 until November 9, 2009, we did not maintain our status as a timely filer with the SEC and we were unable to issue stock-based compensation to our directors and employees.  On November 9, 2009, we became a timely filer and we issued 2.7 million restricted stock units (RSUs) and 0.3 million stock options to our directors and employees.  A portion of these awards were vested upon issuance to reflect the fact that we were unable to issue equity grants for the past two years.  The stock-based compensation cost recognized during the second quarter of fiscal 2010 associated with the November grants represented $9.2 million of the total $13.4 million of expense recorded for the first nine months of fiscal 2010.  These expenses are included in the cost of revenue and each of the respective operating expense lines of our consolidated statements of operations and materially impact the comparative analysis of the year-to-date amounts.

 

Cost of Subscription and Software

 

Cost of subscription and software consists of: royalties; amortization of capitalized software costs; the costs of providing SMS related to our new aspenONE license offering; and costs related to delivery of software.

 

Cost of subscription and software in the third quarter and nine months of fiscal, 2010 decreased $1.6 million, or 53.1%, and $3.7 million, or 43.1%, respectively, compared to the corresponding periods of the prior fiscal year.  These period-over-period reductions were primarily due to decreases in royalty costs recorded during the period related to our license products, and to a lesser extent, lower capitalized software amortization charges.  In connection with the adoption of

 

30



 

the new licensing model during the first quarter of fiscal 2010, we renegotiated the majority of our royalty arrangements to a flat-fee basis.  Previously our royalty expense was correlated to the mix of products sold and was recognized in the period in which revenue for those products was recorded.  As a result of the change to flat-fee arrangements, these costs are expected to be incurred evenly over the fiscal year.

 

Cost of Services and Other

 

Cost of services and other consists primarily of personnel-related and external consultant costs associated with providing professional services, SMS on arrangements not licensed on a subscription basis, and training to customers.  The costs of providing SMS for the new aspenONE license offering are included in cost of subscription and software.

 

Cost of services and other for the third quarter of fiscal 2010 was $13.2 million compared to $15.3 million in the corresponding period of the prior fiscal year, a decrease of $2.1 million, or 13.7%.  Our gross profit margin improved slightly to 50.9% in the third quarter of fiscal 2010 as compared to 49.3% in the corresponding quarter of the prior fiscal year.

 

Cost of services and other for the first nine months of fiscal 2010 was $43.7 million compared to $47.1 million in the corresponding period of the prior fiscal year, a decrease of $3.4 million, or 7.2%. Our gross profit margin deteriorated slightly to 50.4% in the first nine months of fiscal 2010 as compared to 53.9% in the corresponding period of the prior fiscal year.  Since SMS has a high gross profit margin relative to the other streams included in services and other, the reported gross profit margin of services and other will likely decline over the next several years even though the underlying economics of the business are unchanged.

 

Professional Services

 

The largest component of the reduction in cost of services and other in the third quarter of fiscal 2010 pertained to our professional services business, which accounted for $1.8 million of the decrease.  We reduced our staffing levels over the course of fiscal 2009 to better align our cost structure with the decreased demand for professional services.

 

The largest component of the reduction in cost of services and other in the first nine months of fiscal 2010 pertained to our professional services business, which accounted for $3.6 million of the year-over-year decrease.  We reduced our staffing levels over the course of fiscal 2009 to better align our cost structure with the decreased demand for professional services, which led to a period-over-period reduction in our costs of approximately $2.9 million.  We also experienced a decrease in project-related reimbursable costs as a result of lower professional services project activity, partially offset by an increase in stock-based compensation.

 

SMS and Training

 

Cost associated with SMS and training decreased $0.3 million in the third quarter of fiscal 2010 as compared to the corresponding period of the prior fiscal year.  This decrease was primarily due to the allocation of a portion of SMS costs to costs of subscription and software revenue for the support provided to aspenONE subscription customers.

 

Costs associated with SMS and training increased $0.2 million in the first nine months of fiscal 2010 as compared to the corresponding period of the prior fiscal year.  Gross profit margin on SMS and training remained strong despite a modest year-over-year decline resulting from decreased SMS revenue as described above.

 

As the subscription business grows, we expect SMS revenue will migrate from services and other to subscription revenue because it will be included in a single bundled fee paid by the customer.  Currently, it is not possible to predict the rate at which this migration will occur because it is a function of the rate of adoption of the new aspenONE licensing model.  We do not have sufficient experience with the rate of adoption to provide a meaningful forecast of this change.  Eventually, we expect the majority of our SMS revenue to be included as part of our term license contracts, and accordingly, the majority of maintenance revenue will be accounted for in the subscription revenue line.

 

Selling and Marketing

 

Selling costs are primarily the personnel and travel expenses related to the effort expended to license our products and services to current and potential customers, as well as for overall management of customer relationships. Marketing costs include expenses needed to promote our company and our products and to acquire market research and measure customer opinions to help us better understand our customers and their business needs.

 

Selling and marketing expenses in the third quarter of fiscal 2010 increased by $4.8 million, or 23.3%, compared to the corresponding period of the prior fiscal year. The increase was predominantly due to higher commissions, payroll and related and stock-based compensation expenses.  Commission expenses