Accelrys Management Discusses Q4 2012 Results - Earnings Call Transcript

Feb.26.13 | About: Accelrys, Inc. (ACCL)

Accelrys (NASDAQ:ACCL)

Q4 2012 Earnings Call

February 26, 2013 5:00 pm ET

Executives

Todd Kehrli - Co-founder and Executive Vice President

Scipio Carnecchia - Chief Executive Officer, President and Director

Michael A. Piraino - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Scott R. Berg - Northland Capital Markets, Research Division

Sung Ji Nam - Cantor Fitzgerald & Co., Research Division

Matthew J. Kempler - Sidoti & Company, LLC

Greg McDowell - JMP Securities LLC, Research Division

Kevin Liu - B. Riley & Co., LLC, Research Division

Operator

Good afternoon. My name is George and I will be your conference operator today. At this time, I would like to welcome, everyone, to the Accelrys Q4 and Full Year 2012 Earnings Conference Call. [Operator Instructions] Mr. Todd Kerhli of the MKR Group, you may now begin your conference.

Todd Kehrli

Thank you, operator. Good afternoon and welcome to Accelrys' 2012 Fourth Quarter and Full Year Financial Results Conference Call. A press release was issued this afternoon detailing these results and may be accessed on the company's website at accelrys.com under the Investor Relations section.

Speaking today will be Max Carnecchia, Accelrys' President and Chief Executive Officer; and Michael Piraino, Accelrys' Chief Financial Officer. Before they begin, I'd like to remind you that the following discussion, including the company's responses to questions at the end of the formal remarks, will contain forward-looking statements relating to the company's or management's intentions, hopes, beliefs, expectations or predictions of the future. Such statements will include but may not be limited to statements relating to the company's expected GAAP or non-GAAP revenue, earnings, EBITDA, cash flow, depreciation, capital expenditures, share count, order intake and other projections for the year ending December 31, 2013, or any quarter therein, as well as statements relating to the company's long-term prospects or the impact of its acquisitions and its strategic plans. Such forward-looking statements are subject to a number of risks and uncertainties, including, but not limited to, risk that the company will not achieve its expected financial projections and/or that the company will not successfully execute its strategic plans, in each case due to among other possibilities, an inability to withstand negative conditions in the global economy or in the markets the company serves, a lack of demand for or market acceptance of the company's products, or failure to successfully execute upon its operating plans. Additional risks and uncertainties faced by the company are contained in the company's filings with the U.S. Securities and Exchange Commission, including the company's report on Form 10-K for the year ended December 31, 2011, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as the company's Annual Report on Form 10-K for the year ended December 31, 2012, which the company expects to file next week. Collectively, these risks and uncertainties could cause the company's actual results to differ materially from those projected in its forward-looking statements, and the company disclaims any intention or obligation to revise any forward-looking statements, whether as a result of new information, future events or otherwise. I'll now hand the call over to Max.

Scipio Carnecchia

Thank you. Let me start by providing a snapshot of the highlights of the fourth quarter and fiscal year end 2012. 2012 was an important year for Accelrys, one in which we completed our initial 3-year plan following our merger with Symyx. As we've discussed in prior calls, 2010 was a year focused on integrating our 2 companies, 2011 established a new operational baseline for the business and in 2012, the company turned its focus towards growth. I am pleased to report that we successfully executed on this plan, delivering year-over-year increases in orders, revenue and operating income with double digit increases in revenue of 16% for the fourth quarter and 12% for the fiscal year 2012.

2012 was a particularly strong year for our services organization. This growth is strategically important, as services are a leading indicator of future software sales with many starting as proof of concepts that drive larger seat rollouts over time. To that end, we had substantial license transactions in the fourth quarter that began as service orders in the prior quarters.

In addition to our strong financial performance, we continue to execute on our strategy to optimize the lab-to-market value chain, delivering major releases in each of our core product families and making significant progress on our integrated road map. Since January of 2012, we've completed 3 acquisitions that bring important domain expertise and add key applications and technologies to further strengthen our portfolio. The additions of Aegis, a leading provider of process management informatics software; and Vialis, a leading systems integrator of paperless laboratory solutions, expand our footprint in downstream operations for science-driven companies.

We also added HEOS, a cloud-based information management workspace that is uniquely able to address the needs of organizations operating in an externalized research model. We are well down the path integrating our operations, developing integrated roadmaps and are in progress of executing 2013 go-to-market plans for these newly added businesses.

The reception of our strategy has been extremely positive with momentum in the market continuing to build as the business mandates of our customers are motivating them to embrace solutions that heighten collaboration between silos and across partners that leverage and protect IP more effectively and then improve regulatory compliance while enabling competitive differentiation through more productive and faster innovation cycles.

These business mandates have increased the market demand for Scientific Innovation Lifecycle Management software and we believe have only strengthened market opportunity for our solutions and other players in this category. We are making changes this year toward -- to take advantage of this significant opportunity and to gain better alignment with the core end markets we serve, focusing our teams and go-to-market approach in accordance with these segments, life science research and development, life science analytical development quality and manufacturing and material science and engineering. This is a step in our ongoing evolution to deliver enterprise solutions that address the broader scientific needs of our customers while embracing -- while enabling us to bring greater industry emphasis to specific areas of our customers' innovation life cycles. Michael will discuss in greater detail how this will impact reporting on these businesses going forward.

In summary, we're encouraged by our results in Q4 and fiscal year 2012. We believe our strategy is well-aligned to take advantage of the opportunity in this space, evidenced by our successful results last year and the market momentum that we have been building over the course of the past 3 years. Our consistent execution, in combination with the strength of our scientifically aware portfolio of enterprise applications, make us uniquely qualified to address the challenges faced by our customers and reinforce our position as the leading provider of Scientific Innovation Lifecycle Management software.

With that, I'll turn the call over to Michael to update you on the financial performance on the business.

Michael A. Piraino

Thanks, Matt, and thank you, everyone, for joining us this afternoon to review our Q4 and full year 2012 results. I'll be detailing some financial highlights, operating metrics and trends and also discussing the acquisitions of Aegis and Vialis. The investor fact sheet can be found on the company's website under the Investor Relations section, along with a full reconciliation of GAAP to non-GAAP results for Q4 and the full year 2012 financial results. Finally, we will be providing our initial financial guidance for calendar 2013.

Q4 is the largest quarter of the year for orders performance, representing over 40% of orders for the year. Overall, orders for the quarter were up on both the total and on organic measurement when compared to the same period a year ago.

Orders performance by product family for the fourth quarter is as follows: Modeling and Simulation for the quarter was up approximately 10% versus the prior year; Enterprise Lab Management was up approximately 37% versus the prior year; Data Management and Informatics was down approximately 3% versus the prior year; and Workflow Automation and Analytics was up 10% when compared to the same quarter last year. This category is up approximately 8% on a year-to-date basis versus the same period of 2011. Order information for all product portfolio families above excludes amounts for professional services. Professional services orders as a category was up 56% for the quarter when compared to last year.

This is the last time that we will be providing product family details in this format. The product packaging strategy has changed and will result in ultimately shipping the Accelrys Enterprise Platform with most if not all Accelrys products. The result will be that Pipeline Pilot and the AEP may not be charged separately in the product-specific sale that will be bundled into an overall price, making it more difficult to discern its specific value. In addition, individual products may have different growth rates in one market segment versus another.

As Max indicated in his opening remarks, we have organized our go-to-market and product development activities around end market segments of life science research and development, life science analytical, development quality and manufacturing and material science and engineering. Starting in Q1 2003, we will report orders information on a comparative basis along these lines, as we feel that market segment performance will produce the best measurement of how a particular set of solutions is doing against the end markets it serves.

Trailing 12-month orders contribution breaks out this way: Modeling and sim, 26%; Enterprise Lab Management, 23%; Data Management & Informatics, approximately 25%, Workflow Automation and Analytics, approximately 24%. Trailing 12-month renewal rates for subscriptions on term life were 89%. Trailing 12-month renewal rates for maintenance averaged approximately 89% and trailing 12-month renewal rates for content were 88%. These results were all generally in line with our expectations. There were 15 customers with orders during the quarter that exceeded $1 million.

Approximate non-GAAP revenue breakout for the quarter by geography was as follows: North America, 52%; EMEA, 28%; and Asia Pac, 19%.

Non-GAAP revenue for the quarter ended December 31, 2012, was $47.5 million compared to $40.8 million in Q4 calendar 2011, representing an increase of 16%. The VelQuest and Aegis contributions to revenue for the quarter were over $5 million, resulting in an organic non-GAAP revenue increase of approximately 2% for the quarter and 3% for all of 2012. VelQuest revenue contribution exceeded our expectations for the year.

Non-GAAP revenue for the quarter on a constant currency basis was $47.9 million. Content revenue for the quarter decreased 30% as a result of our 2011 restructure from $4.3 million down to $3.0 million.

Gross margin as a percentage of non-GAAP revenue was down approximately 320 basis points. This is a result of the higher mix of professional services revenue.

Total non-GAAP operating expenses for Q4 2012 were $29.4 million versus $25.7 million a year ago or an increase of 14%. Sales and marketing expenses were up approximately $2.9 million or 20.7% versus the same period a year ago, representing increased sales incentives.

Non-GAAP operating income was 14.1% versus 14.5% for the full year 2012 and 2011, respectfully. As we indicated throughout the year, we continued to invest heavily in go-to-market and product development activities. Aegis was dilutive to non-GAAP operating income, adjusted EBITDA and non-GAAP earnings per share for the fourth quarter of 2012. On October 23, 2012, we announced the acquisition of Boulder, Colorado based Aegis Analytical Corp. for $30 million in cash. During Q4, Aegis contributed approximately $1 million in revenue, as indicated above -- and as indicated above was dilutive to non-GAAP earnings per share. As with the VelQuest acquisition, we've converted all new post transaction orders for Aegis products to subscription revenue accounting. At December 31, we have performed evaluation of the acquired intangible assets and deferred revenue and have included these in our preliminary allocation of the Aegis purchase price. The integration of the Aegis field organization, IT systems and infrastructure and product development is virtually complete.

On January 11, 2013, we acquired our long-time partner, Vialis AG, a leading systems integrator based in Liestal, Switzerland. Under the terms of the deal, we purchased all of Vialis' outstanding stock for approximately $5 million in cash. The acquisition includes potential for additional incentive consideration of up to approximately $5 million in cash, contingent upon meeting specified growth objectives over the next 3 years. The integration process is underway and should be complete by mid year.

Adjusted EBITDA for Q4 was $8 million or 16.8% of non-GAAP revenue, compared to $8.4 million or 20.6% for Q4 of calendar 2011. Non-GAAP earnings per diluted share was $0.08 for both Q4 2012 and 2011.

Now turning to the balance sheet. We had total cash and investments of $116 million as of December 31, 2012, as compared to $144 million a year ago. In addition to cash and investments, we also carry approximately $35 million in secured notes receivable. The larger of the 2 notes, roughly $26 million, has now been classified in current assets in the consolidated balance sheet as it is due within the next 12 months.

As indicated in a recent 8-K filing, the company has executed a new 10-year lease for its corporate headquarters in San Diego. This lease commits the company to $27 million in future lease costs through the year 2023, if it doesn't exercise this option to terminate in 5 years.

From January 1, 2012, through today, we have repurchased $14 million of our common stock. Our current board authorization for 2013 is $15 million. The current share repurchase program will bring our cumulative purchases and authorized purchase to approximately $36 million by December 31, 2013.

Depreciation expense was $0.9 million for the current quarter and last year. Capital expenditures for the quarter amounted to approximately $3 million compared to $0.9 million for the same period a year ago. The increase in Q4 was primarily due to our implementation of Oracle R12 and the build out of a new facility in Massachusetts.

Finally, we would like to provide our initial guidance and following forward-looking statement reflecting the company's expectations for calendar year 2013. For the year ending December 31, 2013, we expect non-GAAP revenue to be between $185 million and $190 million. We expect non-GAAP diluted earnings per share to be between $0.36 and $0.39 on a fully diluted weighted average shares outstanding of 56.6 million and using an effective pro forma tax rate of 40%.

Additional comments with regard to our initial 2013 guidance are as follows: Aegis is expected to be dilutive for the first half of the year but accretive to non-GAAP earnings per share for the entire year. Vialis is expected to be minimally dilutive to non-GAAP earnings per share for the entire year. Aegis and Vialis are expected to contribute in the aggregate approximately $10 million in revenue for 2013. The guidance presumes that adjusted EBITDA to be in the range of $36 million to $40 million for the year. And capital expenditures are expected to be approximately $14 million for the year. The build out of the new corporate headquarters location is the main contributor to this increase.

With that, I will turn the call back to Max.

Scipio Carnecchia

Thank you, Michael. As we stated at the top of the call, 2012 successfully brought to close the initial 3-year plan following the merger with Symyx. The financial and operational results, combined with a well executed acquisition program, created strong momentum for the company and reinforced the alignment of the corporate strategy to the sizable market opportunity in this space.

We are hearing from our customers directly, as well as from the technology analyst community, that organizations that depend on science to innovate and compete in the marketplace are adopting new models that require a modern technology infrastructure to be successful. Accordingly, they are prioritizing their 3- to 5-year investments on solutions that improve their ability to manage and optimize their scientific innovation lifecycles. This is reinforced by industry analysts, such as Gartner and IDC, that have 2013 research agendas focused on helping their customers identify solutions to these challenges.

Over the past year, we've released products in each of our major product families that concentrate on addressing this market need.

In spring of last year, we released the market-leading Accelrys Enterprise Platform, the industry's first scientifically aware platform with an open services oriented architecture that enables organizations to integrate and deploy broad scientific solutions.

In the fall, we announced the new process management and compliance suite offering a unified approach to product development and process execution. This suite brings together the solutions acquired from VelQuest in combination with the Accelrys ELN and the Accelrys Enterprise Platform to change the traditional paradigm, offering a holistic suite that drives up to 25% productivity improvement, 50% decrease in cycle times and reduced compliance risk. In addition, significant enhancements were made to the Accelrys ELN, improving formulations capabilities and overall usability and adding new biology capabilities that address the needs of screening through preclinical development.

And finally, we enhanced our modeling and simulation applications. Discovery Studio added new biotherapeutic capabilities, continuing to focus on this growing area of scientific investment. Materials Studio reinforced its market leadership position with integration to the Accelrys Enterprise Platform and Pipeline Pilot enabling computational scientists to use our solutions to share models, best practices and results across the global enterprise for the first time. These enhancements to our portfolio have been positively received by the market and our customers. Of particular note, we have added new customers in each geographic region of our business that demonstrate that the expansion of our portfolio has enabled us to grow our footprint within our existing customers, as well as bring entirely new customers into the fold, indicative of the market opportunity for this software category. Examples include Debio Recherche in Europe, ScinoPharm in Taiwan and Stepan Company, MARS and Cambridge Isotope Laboratories here in the United States.

In addition to being selected as the ELN for MARS, the Contur ELN was selected for the largest trial of academic ELNs in the U.K., over 400 scientists at 16 leading research universities, as well as being selected by the German Cancer Research Center to support over 1,000 scientists. Our position as the leading provider of the electronic laboratory notebooks was recognized by Gartner as very high or high in each scientific and functional domain in their recent report on considerations for selecting an ELN. Accelrys was the only vendor that achieved these ratings in all categories.

As we continue to pursue the opportunity in Scientific Innovation Lifecycle Management, we recognize that the next evolution of our business requires greater focus on the end markets we serve. Our move to these market segments will not only help us effectively target go-to-market efforts but will also enable us to align our product strategy to the end market need, thus driving continued organic growth. In addition, this segmentation provides a focused market lens with which to examine acquisition opportunities.

In conclusion, we are pleased with the financial and operational results we achieved in 2012. Our successful execution of our strategy has enabled the company to diversify our business, extending downstream from research through commercialization and broadening our footprint in industries beyond biopharma. The result is an expanded total market opportunity that has enabled us to address growing adjacent markets and establish our position as the leading provider of Scientific Innovation Lifecycle Management software. Our teams are energized about our performance and are heads down executing on our plans to ensure we continue our market momentum in 2013.

With that, I'd like to turn the call over for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Chad Bennett.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

I guess, a couple of questions into the guidance that you gave for 2013. I guess, how should we think about the revenue segments you officially report, meaning license maintenance, professional services and content? Professional services obviously grew significantly this year. Should we expect more moderated growth there looking into this year and then an acceleration in license? And how should we think about the content business going into this year and potential decline there? As much as you can give us color on.

Michael A. Piraino

Yes. So, Chad, this is Michael. Good question. Yes, without getting too detailed, I think directionally you can assume we've had 5, 6, 7 quarters now of substantial growth in professional services. As Max, I think, pointed out, it started to pay off nicely in terms of some license revenue that we are able to track down and book in the fourth quarter of 2012. But I would not expect on a go-forward basis for that business to be continuing to grow at 50%, 60%, 70%, 80% kind of year-on-year. We probably talked about this with you and others before that we kind of have an overall model for professional services that not get much bigger in terms of the overall pie, other than about 20% of the business. We're approaching that now. And obviously, we want to make sure that, that business also focuses on its margins -- on its gross margin. And again, we've targeted in the 20% range for that. So I think you should expect from a revenue, an orders and a revenue perspective for the growth rate in services to slow down somewhat 2013 versus 2012.

Similarly, with respect to content, it's still a portion of the business that we intend to break out as we have been doing each quarter over the last 6, 7 quarters since we restructured the business and discontinued some of those databases. It's essentially kind of been down year-on-year, about 30%. I would expect that to be more muted than that going into 2013 without giving you a specific number. We knew that this business would have a tail to it. And eventually, we kind of get to the end of the parade, so to speak and that decline would slow down. And we expect that decline to slow down in 2013.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. And then license growth accelerates from where it was in '12, I assume?

Michael A. Piraino

Well, you can imply what license and maintenance would be. I don't want to break those out specifically, but you can imply what those might be and again, in the context of us giving you color around these other 2 segments.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. And so the overall revenue growth if I take kind of the midpoint of your revenue range, it implies a deceleration in growth. And I know there's probably a little bit noise in terms of what acquisitions contributed in '12 versus maybe what they'll contribute in '13. But I guess, should -- I mean, in the organic level of the business, shouldn't we be thinking about the business accelerating from a growth perspective? Or is there more work to be done in these new solutions? And is it earlier in the process than maybe I was thinking?

Michael A. Piraino

Yes. So let me lay a little bit of the groundwork and then Max can kind of pick up at the end here. Just kind of look at what the baseline is that we reported basically 3% organic revenue growth in 2012. I think if you take the midpoint of our range and then kind of back out what we -- the Aegis and Vialis contributions for 2013 will be, it implies a 3-ish percent organic growth rate for the year for '13. I would tell you, though, that again, we don't give quarterly guidance, but the way we kind of modeled it out, the organic growth rate is higher than that exiting 2013 than it is for the year. So full stop there. That's about revenue. Again, from an orders perspective, we would expect total orders growth and in particular, organic orders growth to be greater than the 3% revenue growth.

Scipio Carnecchia

Yes. So, Chad, the only comments that I would add to that -- thank you, Michael. We're not going to try to parse the guidance. The guidance is the guidance. I think Michael and I stand on our track record over the course of the last 3 years. This is -- we've used this term -- this phrase consistently. This is an execution story, not an expectation story. And we're committed to continuing to grow the business and to accelerate that growth. And we're going to do it organically and we're going to do it through thoughtful on-strategy acquisitions.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. So, Max, just give me a sense just because I know the way we're looking at the business now is different than in the past year, give me a sense of where we are in kind of sales capabilities, I guess, you'd say in these new solutions like the process management and compliance suite and your Enterprise Platform. Is this still kind of a training period, so to speak, for the sales force to get them up to speed with all the new products and the new solution set? And more importantly, is this evangelical sale to the customer the way you're packaging it now?

Scipio Carnecchia

No, I think that if we reflect on 2012, we made a tremendous amount of progress, not just integrating some of the previous acquisitions and then bringing into the fold the 3 that we've done since the beginning of 2012, HEOS, Aegis and Vialis. But I think the thing that we probably haven't talked a lot about is the progress that we've made in our field organization. And I say that broadly, not just the selling team but the presales team and the services...

Michael A. Piraino

All customer facing...

Scipio Carnecchia

Yes, all the customer-facing elements of this. And what Michael was alluding to is, going into 2013, we've brought focus to that coverage model. The way that we're actually organized and structured in our field, maps to those 3 submarkets, the life science research and development, which is really from early research in life science on through to preclinical. And then that 80 QM analytical development quality and manufacturing, which kind of picks up from preclinical and takes you all the way through to manufacturing. And then the third market segment, which is the materials science and engineering, which is really an expansion on some of the things we have been doing historically in early materials science in companies that are consumer packaged goods, food and beverage, oil and gas energy, chemical companies.

So the folks that we've got -- the folks that we've inherited, which have been a fantastic injection of domain expertise in our field organization, I think we're pretty far along there. There's always more progress to be made and every time we add an acquisition, there's the integration of the people and getting them all in the same team and aligned against a common purpose, but I feel really good about the progress we made in 2012.

Michael A. Piraino

Yes. You might remember, too, I think we talked a year ago about the additional solutions training and things that were taking place at kickoff. And we just completed kind of Round 2, right, or Phase 2 of that training. So that's an ongoing process for sure.

Operator

Your next question comes from the line of Scott Berg.

Scott R. Berg - Northland Capital Markets, Research Division

First of all, Max, your first set of pre-scripted comments talking about the products you had shipped, [indiscernible] with all the products going forward, maybe that was Michael's comments and I want to have to break up a few different areas. Can you talk about something of the solution or maybe the individual models? Is pricing going to change much? Customers buying this on a more consolidated basis?

Scipio Carnecchia

It's kind of a little tough to pick you up there, but I'll try to address that. What we're doing is -- we established the product to you that we've been reporting on 3 years ago in an effort -- in an endeavor to bring some transparency to performance of the business in a more granular level down to the products. What you watched us do over the course of the last 18 months with the introduction of the Accelrys Enterprise Platform is use that as, as the name implies, as a platform. Scientifically, we're a platform to connect not just all of our applications organically and the things that we acquire, but also then, partner solutions and homegrown solutions that customers would have. What we've done is we've evolved that and rolled that out. We had started to ship a platform with every one of our solutions, every one of our applications. And so as we try to report on things like workflow, automation and analytics, it's become very challenging for us to have confidence in kind of the direction of performance of those pillars, the historic product pillars because now, the value customers are getting isn't just in the application. They're getting the value from the platform itself. And so, we thought as we've gotten into more of a market segment orientation on our fields group, we thought that, that would be a superior way for us to, going forward, provide insight into the performance of the business.

So the second part of your question, Scott, was is pricing going to change. And our pricing is evolving because we want to capture the value that we're getting for the platform while, at the same time, not disrupting what our now 1,500 customers that are used to a certain model. So we've been evolving that in a very thoughtful way. We started -- gosh, it was over a year ago and I don't think there's anything really there for us to report that, that would be considered a breakthrough or some sort of major significant change other than directionally, we're going to have to -- we're acquiring companies, we try to get folks on to a single model and that takes time.

Michael A. Piraino

This is Michael. I will add one thing though and we've probably spoken about this in Q&A before. But we have a very, very active pricing committee. And we meet every month. There are hot topics each month. It's a cross-functional team across the executive membership. And my point in bringing that up is there's a lot of market intelligence and a lot of thought given every single month to how products are positioned and priced in the marketplace. And we take action, some major, some minor, but every month.

Scott R. Berg - Northland Capital Markets, Research Division

Okay, great. And then just question on, I guess, demand on a higher macro level. You guys clearly have, I think, from the business right now, revolving around a couple of things. Can you maybe talk about that demand from your 3 different kind of global reporting segments? So there's South America, the EMEA region or Asia Pac relative to where it was at this point, a year ago?

Scipio Carnecchia

Sure. So I think that it's pretty straightforward. I think we're as good or superior in the Americas and in Asia Pac, and in Europe, we're better, but it's a relative statement against the idea that I think a year ago, gosh, you remember everything that was in the news, in austerity and cutbacks. You would have thought that Europe was going to sink into the molten earth there. So I don't think that Europe is great. I just think that on a relative basis, it's better than it was a year ago.

Michael A. Piraino

Yes, I agree with Max's comments on the macro side. I would also say, and again all this detail is in the investor fact sheet, but the fact that Aegis and to some degree, VelQuest, even though it's been in the family now for 14 months, are basically North American centric, right? So you might see a little bit of math weighting the revenue, which is how we report the geo breakout more in favor of North America. And that's just really a result of the last 2 acquisitions have been North American.

Scott R. Berg - Northland Capital Markets, Research Division

Okay, great. And my last question is just general margin structure, kind of go-forward basis. Through your acquisitions last 2 years, we've seen margins either flat line or slightly compressed due to the couple of the acquisitions have been slightly dilutive to the model. You guys did a great job in 2009 to 2011 improving margins, whether it's on an operating level or EBITDA level. Absent acquisitions here in '13, should we in general see them begin to expand again maybe more in the fiscal '14? And then I'll get back in the queue.

Michael A. Piraino

Yes. This is Michael. I think the last word you said was '14. I don't know if you meant 2014, we're not going to comment on that necessarily. But I think what's implied by the guidance and the color around the guidance in 2013 is that both the gross margins and the operating and or adjusted EBITDA margins will improve meaningfully in 2013. We have that target model, that's out there. We talked a lot about that at the various functions and sessions that we give. And we still kind of maintain that target model as a model that we can not only aspire to, but achieve over the next handful of years. Obviously, in the short run, with the growth in services, it's penalized the gross margins a little bit, but there is implied operating margin improvement in the guidance that we gave for '13.

Operator

Your next question comes from the line of Sung Ji Nam.

Sung Ji Nam - Cantor Fitzgerald & Co., Research Division

So kind of going back to your guidance for 2013, especially for organic growth assumptions. Are there -- are you factoring in kind of any assumptions in your -- what you're seeing in your end markets? Are you seeing kind of more challenging environment? Are you factoring that in or -- yes, if you could talk about that.

Scipio Carnecchia

Sure. So, Sung Ji, this is Max and just to the questions that we just had, we actually see the end markets in the U.S. and Asia Pac improve compare to where we were providing guidance last year and trying to retread that ground a little, improved in Europe but again off of a much more terrible baseline, if you will, a more terrible circumstance from a year ago. So we've considered where we are without trying to make a lot of predictions around what's going to happen. And so, that's the consideration. That's kind of the thoughts that had gone into that relative to how the end markets affect our planning.

Michael A. Piraino

Yes. I mean, I think -- go ahead.

Sung Ji Nam - Cantor Fitzgerald & Co., Research Division

Well, I guess, I'm trying -- I'm not trying to simplify the factors too much. But assuming that end markets are improving and your assumptions for organic growth is kind of flattish year-over-year, so kind of curious as to -- are there other certain assets that might be underperforming, that there might be potential for divestitures in the future, that might not be critical to your core business, things like that. Kind of how should we look at the overall business? I know you obviously can't achieve overnight but just trying to figure out, get a better sense of kind of the outlook in the next couple of years.

Scipio Carnecchia

Sure. I mean, the basic sentiment there, Sung Ji, is that we grew last year. We plan on growing here in 2013 in the endeavors, the energy, the efforts that we're putting in is to accelerate that growth and accelerate it organically. And certainly to add the appropriate things, beyond strategy things that are the right things from an inorganic perspective. When I look across the portfolio, which we do very consistently, we use a product portfolio approach to managing our resources in research and development. We evaluate whether there's things in there that we should be deemphasizing or things that we should be investing more heavily in. And part of that exercise is to try to determine whether there are things in there that we would potentially divest ourselves of. You watched us, I think it was May of 2011 that we restructured our content business. We had done some of that soul searching at that same -- at that time around that topic and concluded that it didn't make sense to divest ourselves of it, and I think we've put it in a much better position today than it was the day before we made the decision to do the restructuring. But those things are things that are evaluated all the time.

Michael A. Piraino

I would add, Sung Ji, it's Michael, that when we look at acquisitions and do the diligence around those particular assets, obviously, what we're looking for are assets that are growing from an organic perspective at an accretive rate to our own base business. Now the way we go about computing that, as you know, is we don't drop them in until a year later. That serves 2 purposes. One, you get a good comparison, but you also get the benefit of taking, whether it's a VelQuest product line, an Aegis product line to some degree, Vialis, and moving them through a much larger distribution channel. So our expectation is that we accelerate the growth rate of acquisitions once they've been in the family and integrated for awhile. So to some degree, the things that we're buying we know are growing faster, that's why they got on the list in the first place. And then we would expect to kind of help that growth along with the distribution channel we have.

Sung Ji Nam - Cantor Fitzgerald & Co., Research Division

Okay, great. And then just another question on gross margins. Could you maybe help us kind of figure out how the gross margins will trend throughout the year, given kind of what's the fluctuations with professional services? Will it be kind of increasingly -- will it be improving increasingly throughout the year?

Michael A. Piraino

Yes, are you asking specifically about gross margin?

Sung Ji Nam - Cantor Fitzgerald & Co., Research Division

Yes, just about gross margin.

Michael A. Piraino

Okay. Yes, so generally you should expect them to improve quarterly throughout 2013 with kind of one exception. If you go back -- remember the business is a little bit seasonal. And so, the high-water mark for gross margins in '12 would have been the third quarter. And then it dips a little bit in the fourth quarter. So I see the same seasonality in 2013. But generally, you should think about those margins as the margins around professional services continue to improve, you should expect those generally to kind of trend up during the year.

Operator

Your next question comes from the line of Matthew Kempler.

Matthew J. Kempler - Sidoti & Company, LLC

Could you first just kind of update us on the product integration process at this point? How far away do you think we are from seamless interfaces and data integration between the acquired solutions?

Scipio Carnecchia

Matt, it's Max. So I think that's one of those questions where I don't know if you're continuing to do acquisitions, I don't know that you ever -- you're never on the other end of that, right? But as far as the things that if we go back in the way back machine 3 years ago, we've made a tremendous amount of progress, not just in getting those things integrated, but establishing a framework so that we're very clear as to what we want this to look like as we bring new things in. So for example, when we're sitting down with an acquisition target as we're getting serious, part of due diligence is to actually set the expectation around what that's going to mean after close -- after we close and become one company, what the expectation is as far as their involvement and getting their products connected to the platform and then over time, making them look and feel and operate kind of within that framework consistently.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then touching on the spike in the service revenue. So that's primarily tied to pilot engagements. I mean, the magnitude step-up that we saw in the jump in service revenue, is that relative to the magnitude of jump that you're seeing in the number of engagements you're involved in? Or is there something else that's involved in that service revenue line?

Scipio Carnecchia

Well, I think there's 2 things. One is the number of engagements, right? There is a very significant volume, but I think you also have to take a relative perspective where -- when Accelrys was Accelrys before adding things like VelQuest and Contur and even before the Symyx merger, we were a very light touch services model. A lot of the original products on the modeling and simulation side of the business did not require any services whatsoever. So in addition to having a good solid volume of these proof of concepts in pilots and kind of Phase 0 things that we've been doing in 2012, we're also, when you kind of compare it, we've got a portfolio that requires more services than we were historically 3 years ago.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then from your view with the acquisitions that we're putting -- integrating into place now, your organizational realignment we're going to based on the market segments, do you view 2013 as a partial transition year or is this one fully at this point based on execution and growth?

Scipio Carnecchia

Well, I think that 2013 is a year about execution. What we're talking about as far as organizing our field to map our coverage model to these segments is it's an evolution. That's not a hard left hand turn. That's not a big restructure. It is a very natural evolution and something that we've been working towards for the better part of 2 years.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then lastly, on the nonorganic side, maybe you can update us on your latest thoughts in '13 regarding acquisitions and if you still see a decent number of holes to fill for the business or you've narrowed down what you're looking for.

Michael A. Piraino

So, Matt, this is Michael. I would categorize the Corporate Development activities as continuing to be very robust, very active as we kind of said going into the beginning of last year would not surprise us if we get something done this year. There continues to be white space in the -- whether you're looking at it through a segment lens or a product lens or a geography lens and I think there are a lot of assets that are being evaluated. We continue to take a very strict, as you know, very strict view towards acquisition criteria, and we do a lot of work before we're at the table negotiating a transaction. But yes, I would expect that we will continue to be acquisitive and active for the balance of this year for sure.

Operator

Your next question comes from the line of Greg McDowell.

Greg McDowell - JMP Securities LLC, Research Division

I wanted to ask about the new market segment orientation of the field group and how disruptive if at all this was to sales territories and sales reps switching accounts and whether this should make us think differently about the company area of 2013.

Scipio Carnecchia

Yes, Greg, this is Max. We're just trying to get across with the last call or 2 is I think this is not a -- well, we know this is something that we have been planning for and moving towards with every incremental acquisition and as we diversify the business from what has been our historical base of life science research, pushing down that value chain downstream into development, into the quality labs and then ultimately into manufacturing as we have done over the last 2 years with Vialis, with Aegis, with VelQuest, with Contur and Symyx and then being able to take that same technology and that same science and bring it to other industries that value science and new science in their innovation, like consumer packaged goods, food and beverage, oil and gas, chemical companies, that has been on the drawing board for us and the rate limiting function has been having the capabilities and then having the domain expertise that come with the people, that come with these acquisitions. So I think you want to look at this market segmentation transition as very much an evolution, and it's been something that we've been working towards for quite some time. I don't -- I think there's limited disruption in the field, but I don't think it's significant at all and we had it all rolled out since January, anyway.

Greg McDowell - JMP Securities LLC, Research Division

Yes, that's helpful. And then I was wondering as we think about the 3 different market segments, if you could just touch on as you look back in 2012, which market segments performed fast, in your opinion, and maybe as you look at your pipeline for 2013, which of the 3 segments have maybe the most growth potential.

Scipio Carnecchia

Sure. Well, let me start by saying that we believe that each one of these segments, each one of these market segments on its own is a grower. And the strategies and the efforts that we put into with the teams that are leading these segment groups are all about how do we accelerate, optimize and take advantage of those opportunities.

So if you think about the 3 segments, life science research is really the historical legacy and heritage market of Accelrys. And the customers in that segment and the areas of their businesses are going through some pretty profound and far reaching changes in their business models. So if you think about big pharma, early research, the outsourcing, the working with joint venture partners, the kind of things you do with contract research organizations. So there's a lot going on there, and that's the opportunity for us to be able to deliver that next generation platform to those customers.

Analytical development quality management is really taking what has been paper-based processes, manual systems and automating them. And that is a -- I would consider that almost a greenfield in some regards. And then the material science and engineering, just as an example, something as core as the notebook. In that particular segment, less than 10% of scientists and engineers in those labs are using notebooks, less than 10%. So there's a pretty significant opportunity there. So I don't want to necessarily stack rank them but the things that we've moved into distributed -- diversified into, obviously, we believe are growing very quickly. And we're taking advantage of that with 80 QM and MS.

Operator

[Operator Instructions] Your next question comes from the line of Kevin Liu.

Kevin Liu - B. Riley & Co., LLC, Research Division

Looking at some of Max's comments earlier, I think you guys talked about your end customers, discussing plans 3 to 5 years out. I was kind of curious as to what sort of products are higher on the priority list early on and then whether -- how you feel about whether those projects are actually funded kind of for this year and next?

Scipio Carnecchia

Well, so what I was alluding to in the prepared remarks is information and insight that we've been able to derive from some of the traditional technology industry analysts. So the partners and the IDCs. So as we have expanded our portfolio and our capabilities, Kevin, since you've been following us for a while, 3 years ago, Gartner didn't know who Accelrys was. They didn't -- IDC, we weren't on their radar. Now we're being invited to take regular meetings with those organizations to provide our insights and our input and our point of view as to where many of the critical issues are around the changes that are unfolding for customers in these markets. And so coming directly back to your question, not only is it flattering, but I think it's very much validating because they're getting those questions, the Gartners and the IDCs are getting those questions from their end-point customers, their end-market customers. And they've identified that we've got some very unique things. So when you talk about that notebook, the electronic laboratory notebook with Contur outside of life science, those material science and engineering customers, I think that is a here and now. That is a very fast-growing space. And we've got a very unique offering in that regard. For the life science customers, the analytical development and quality manufacturing area, for them to be -- for those organizations, for those businesses to be able to retool themselves over the course of the next 3 years, to be able to do what's required of them, they're going to have to make investments in technology. And we think we're pretty uniquely qualified to do that, both with the things we've had organically with the platform and then the things that we've now attached to the platform through the acquisition of VelQuest and now Aegis and the notebook, the validated notebook from Symyx.

Kevin Liu - B. Riley & Co., LLC, Research Division

Got it. And it certainly didn't seem like macro uncertainty didn't impact you guys at all on the booking side in Q4. As we've made our way through Q1 here, how are you feeling about kind of the pace of renewals, as well as fields with new customers who might have them moving too close?

Scipio Carnecchia

Yes, I think from an economic -- when you talk about macro economics, we kind of picked up on that question a couple of different ways and there were points in 2012 that we were nervous, not because of anything we were seeing in the business but because of things we were reading in the paper, right? We talked about Europe earlier. Now we're sitting around here worried about sequestration. And those are real things, right? Budget fights, tax fights, all that. But we have not seen that show up at the point of contact with our customer when it comes to getting a contract either renewed or a new contract stood up because 2012 was a year of significant new business for us as well. So we were able to demonstrate that -- this versification is helping us, not just radiate and do bigger deals with our existing customers but do new business as well.

Kevin Liu - B. Riley & Co., LLC, Research Division

Okay. And just a couple of questions on the sales and marketing side. Obviously that was up considerably on a sequential basis over the last year. Was that mostly just kind of incentive comp tied to seasonality or were there any sort of meaningful investments made in terms of headcount or other marketing programs?

Michael A. Piraino

Yes. So, Kevin, it's Michael. Most of it has to do with Aegis for the quarter that wasn't in the prior year. And they had a component of a sales force that we've added there, but most of it really had to do with higher commissions, both direct and indirect. And obviously, that's reflective of a successful quarter from an orders perspective.

Operator

There are no further questions. I'll turn the call over to Max Carnecchia.

Scipio Carnecchia

Fantastic. Well, that now concludes our earnings call for today. Thank you, everybody, for your participation.

Michael A. Piraino

Thank you. Good night.

Operator

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

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