Appian Corporation (APPN) Q3 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the Appian Third Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Staci Mortenson with Investor Relations. Please go ahead.

Thank you. Good afternoon, and thank you for joining us today to review Appian's third quarter 2017 financial results. With me on the call today are Matt Calkins, Chairman and Chief Executive Officer, and Mark Lynch, Chief Financial Officer. After prepared remarks, we will open up the call to a question-and-answer session. During this call, we may make statements related to our business that are forward-looking statements under federal securities laws and are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, including statements related to our financial results, trends, and guidance for the fourth quarter and full year 2017, the benefits of our platform, industry, and market trends, our go-to-market and growth strategy, our market opportunity and ability to expand leadership position, our ability to maintain and up-sell existing customers, and our ability to acquire new customers. The words anticipate, continue, estimate, expect, intend, will, and similar expressions are intended to identify forward-looking statements or similar indications of future expectations. These statements reflect our views only as of today and should not be reflected upon as representing our views as of any subsequent date. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations. For a discussion of the material risks and other important factors that could affect our actual results, please refer to those contained in the final prospectus related to our initial public offering and our other periodic filings with the SEC. These documents are available in the investor relations section of our website at www.appian.com. Additionally, non-GAAP financial measures will be discussed on this conference call. Please refer to the tables in our earnings release and the investor relations portion of our website for a reconciliation of these measures to their most directly comparable GAAP financial measure. With that, I'd like to turn the call over to our CEO, Matt Calkins. Matt?

Thank you, Staci. Thank you all for joining us today. In the third quarter of 2017, Appian grew subscription revenue 35% year-over-year to $20.7 million. Our non-GAAP loss from operations was $4.9 million, an improvement from a loss of $6.2 million in the prior year quarter. Our subscription revenue retention was 122% in Q3 increasing again as it has each quarter this year. All three of these figures are ahead of our guidance. Our professional services revenue was $22 million, that sequential growth of 4% and our non-GAAP professional services gross margin was 36%. Appian as a horizontal platform sold in an increasingly vertical fashion. In recent years, our primary verticals have been financial services, pharmaceuticals and federal government. Consequently we invested in sales and marketing to enhance our expertise in these sectors resulting in increased revenue and more customers. Lately, we are making investments in other industries. Through the third quarter, healthcare subscription revenue nearly tripled versus the prior year period. Year-to-date we’ve closed about as much new named healthcare business as we did new name financial services business in all of 2016. Additionally, the average deal size for new healthcare payers, rivals, new financial services and pharma deal sizes putting it in line with Appian’s strongest sectors. In Q3, we accelerated our growth in healthcare by signing top five healthcare payer. This organization produced a multimillion dollar five year agreement to replace their pre-authorization management solution, which allows doctors to get pre-approval for medical procedures on behalf of patients. As we discussed in our IPO filing, another healthcare payer, HCSC reports $10 million of annual savings with a similar Appian application. Deciding factors in our recent win included implementation speed, integration capabilities and of course demonstrated ROI. With this new customer, three of the top five healthcare payers now use Appian to perform core business functions, such as approving life saving medical procedures, introducing new products to the market and automating clinical operations and end-to-end care management for their more than 70 million combined members. After we signed new customers, our industry expertise helped them gain value for our platform leading to follow on purchases. In the third quarter, a coupled expansion deals demonstrates the strength of our land and expense strategy. Over the past three years, the major bank in the Western United States used Appian to build more than a dozen mission critical applications across their commercial retail and wealth divisions. They increased efficiency in these areas by 42% by removing obsolete tasks and reducing thousands of hours of unnecessary work each year. In Q3, the bank made an additional multimillion dollar five year investment to expand Appian across their middle market division. These expanded licenses will support the know-your-customer application which allows the bank to verify the identity of customers before they open accounts. Secondly, one of the world’s top biotechnology firms extended their initial purchase with a $1.2 million add-on. They adopted Appian only last March to automate their external stakeholder engagement process which brings together data from many legacy systems to ensure their compliance with regulatory requirements. Their new licenses purchased only six months after their initial buy will allow them to roll out this application more broadly. Appian’s partner Ecosystem including technology partners influenced about half of our new customer deals globally in Q3. This has been true for five quarters running. Additionally, in the first three quarters of 2017 the value of partner sourced deals grew four and one half times compared to the same period in 2016, and new logo acquisition grew two and one half times year-over-year. Our key technology partnerships with Microsoft, Blue Prism and MuleSoft all goes through fruit in Q3. This quarter, Appian announced that customers can now run our platform on the Microsoft Azure. Cloud agnosticism is important to many companies who want to run in the cloud now or in the future but wish to remain flexible and do not want to be locked into one specific cloud vendor. Two months after announcing a new robotic process automatic capability called Appian RPA with Blue Prism, we sold it for the first time to the department of health and human services. HHS’s program support center is the largest multifunction shared service provider since our government. Their existing processes take months to reconcile and to finalize procurement acquisitions. They chose Appian RPA with Blue Prism because of the combination of our platform along with Blue Prism’s technology, it allows for more powerful automation with legacy systems and faster implementation. MuleSoft, our partner MuleSoft which provides an integration platform help us close a $1 million deal with a global manufacturer of physical infrastructure equipment. This new Appian customer wanted to replace their existing BPM vendor happens to be one of our largest competitors because they desired a modern platform that could be used to quickly build critical business applications. Appian’s integration with MuleSoft allows our mutual customers to give users the information they need to be effective. Our overseas partner program was particularly successful. Partners influenced a just proportionate number of our international Q3 deals. Notably, PwC led us into a significant expansion with the top five banks in Spain, and other partners brought us million dollar deals with two new customers and Austrian banking group and an Australian Federal Agency. In conclusion, we continue to evolve our technology. We expand within our customer base and we add new marquee [Ph] customers. Appian’s steady, Q3 results give further evidence that we are disrupting and reinventing one of the biggest areas of IT spend that of customs software. With that, let me turn the call over to Mark to walk you through the financials. Mark?

Thanks, Matt. This was another strong quarter for Appian. I will review the financial highlights of the quarter and then provide details on our Q4 and full year 2017 guidance. Subscription revenue was $20.7 million for the third quarter ahead of our guidance and representing growth of 35% year-over-year. We believe our subscription revenue growth is the most relevant revenue metric on our P&L when evaluating the momentum of our business and market share gains. Our total subscription software and support revenue for the quarter was $22.7 million. Professional services revenue in the third quarter was $22 million up 4% compared to Q2, 2017. The significant growth in services year-over-year is due to the abnormally low compare in Q3, 2016. Total revenue in the third quarter was $44.6 million, up 45% year-over-year. Our subscription revenue retention rate was at 122% for the third quarter, which was above the 110% to 120% range that we target on a quarterly basis. It was also up from 120% for the second quarter of 2017 and 117% in Q1 2017. This metric demonstrates the fact that overall our customers expand their use of our platform as they realize the value from our software. Now I’ll turn to our profitability metrics. Our non-GAAP gross margin was 63% compared to 64% in the same period last year. If we look at the two different components of our gross margin, you will see that they are both elite. Subscription software in support of non-GAAP gross margin was 90% for the third quarter compared to 89% in the third quarter of 2016. Our non-GAAP professional services gross margin for the third quarter remained higher than typical at 36%. Total non-GAAP operating expenses were $33.2 million, an increase of 29% from $25.7 million in the year-ago period. Sales and marketing was 43% of revenue in the third quarter compared with 47% of revenue in the prior year period and was slightly lower than our expectations primarily due to the timing of some marketing programs. We continue to have good success hiring sales people in support of our future growth with our powerful customer economics and strong subscription revenue retention, you should expect to see continued investments in our sales and marketing functions. R&D was 19% of revenue in the third quarter down from 22% of revenue in the year ago period. We are highly focussed on maintaining and extending our innovation leadership continually increasing the power and speed of our platform. G&A as a percentage of revenue declined to 12% in the third quarter from 15% in the prior year period, but you should expect cost to be quick to increase on a dollar basis as we continue to invest in our infrastructure as a public company. Non-GAAP loss from operations was $4.9 million, well ahead of our guidance of a loss of $9.6 million to $9.1 million and compared to a non-GAAP loss from operations of $6.2 million in the year ago period. As you know foreign exchange gains and losses can fluctuate. During the quarter, we had $0.3 million of foreign exchange gains compared to less than $0.1 million of foreign exchange gains in Q3 of 2016. Our guidance does not consider any additional potential impact of financial and other income and expense associated with foreign exchange gains or losses as we do not estimate movements in foreign currency exchange rates. Non-GAAP net loss was $4.7 million for the third quarter of 2017 were a loss of $0.08 per basic and diluted share compared to non-GAAP net loss of $4.7 million or a loss of $0.09 per basic and diluted share for the third quarter of 2016. This is based on $60.2 million and $52.4 million basic and diluted shares outstanding for the third quarter of 2017 and the third quarter of 2016 respectively. Turning to our balance sheet, as of September 30, we had cash and cash equivalents of $72.3 million compared with $77.7 million as of June 30, 2017. Total deferred revenue was $71.8 million up 32% year-over-year with respect to our billing terms the majority of our customers are invoiced on an annual upfront basis, however, we also have some large customers that are billed quarterly and others that are billed monthly. As such, we shared last quarter and we’ll continue to remind investors that changes in our deferred revenue are not always indicative of the momentum in the business. During the first nine months of 2017, we used $10.1 million in cash flow from operations as compared with $7.8 million used in the prior year period. Now turning to guidance, we are raising our full year guidance for 2017. For the full year 2017 subscription revenue is now expected to be in a range of $81.5 million and $81.7 million representing year-over-year growth of 36%. Total revenue is now expected to be in the range of $167.6 million and $168.1 million. Non-GAAP loss from operations is now expected to be in a range of $23.6 million and $23.1 million with a non-GAAP net loss per share of $0.39 and $0.38. This assumes 57.1 million basic and diluted common shares outstanding. For the fourth quarter of 2017, subscription revenue is expected to be in the range of $22.2 million and $22.4 million representing year-over-year growth of 34% to 35%. Total revenue is expected to be in the range of $41.4 million and $41.9 million, non-GAAP loss from operations is expected to be in the range of $9.7 million and $9.2 million with a non-GAAP net loss per share of $0.16 and $0.15. This assumes $60.5million basic and diluted common shares outstanding. In summary, this was a strong quarter for Appian and we are gaining traction in the market place. We’ll now open up the line to your questions.

Thank you. [Operator Instructions] Our first question comes from Sanjit Singh with Morgan Stanley. Please proceed with your question.

Hi. This is [Indiscernible] filling in for Sanjit Singh. A very nice quarter. A couple of questions on just sort of new customer acquisition, I think you guys mentioned any numbers, but how was new customer acquisition in the quarter versus sort of historical?

We don’t plan to report our new customer acquisitions in every quarter. But we’re comfortable with our progress. We feel that our plans are moving along as you know, and as I mentioned on the prior conference call, adding new customers is a priority for us. And we feel that the strategy is the right one and that is proceeding appropriately. And we just don’t plan on putting those numbers on every call.

Got it. Since I’m pretending to be Sanjit, a dump question for you. Can you help me understand what the differences between the RPA opportunity and versus just going to through customers saying, listen, we’re going to automate that process by enabling you to every easily creating an application for that using our low-code platform?

Okay. The RPA product does something distinct that Appian as a platform would not do. Appian integrates, but we integrate to APIs. In other words, we integrate in the way that an application was expecting to be integrated with and that could be simple through web services. It could be complicated through old APIs. We find a problematic ways to integrate. Robotic process analytics -- automation does not work that work. RPA instead integrates as if it were a human through the interface as it were, through the screen which is to say, it’s with mouse movements and entries of data, keystrokes, stimulated keystrokes. That allows you to integrate with things that aren’t setup to do a standard integration. So the Appian approach integration would be have an API-based approach. The RPA approach would have been through the screen approach and we simply do not carry that functionality alone. We do that through the partnership with Blue Prism. So there are very different approaches and they appeal to different kinds of applications. That’s why it so important to us.

Will there be much of a difference in terms of the -- is it more of a difference in sort of the backend there seems you’re trying to automate processes around versus the types of processes that you try to automate?

It does affect the types of processes that we try to automate. It does extend our reach to application generally old legacy applications, the means of reaching are more up obscure, more difficult. It widens the periphery of the Appian’s span of control in the enterprise.

Got it. Got it. And then one for Mark. You noted the very high growth rate in professional services that was largely due to easy comp from the year ago period, but if look like over the last two quarters it seems like over 50% growth over the past two quarters kind of elevated levels of professional services versus what we had taken originally been thinking about at the time of the IPO. Is this is a durable impact on going forward basis? Is this just more professional services work that you guys need to be doing? Or it just an indicative of a period of very strong sort of new projects ramping up?

I think in the last quarter we talked about a huge, like we had a significant amount of new customers that we acquired. And as you know the first, those – the applications that we do for our new customers we want to be in there. We want to make sure that those applications are successful, so then we can go basically land-and-expand throughout the enterprise. And so you’re seeing some of that in Q2, our professional services surge in Q3. You also saw – Q4 is a – there’s a seasonality built in, so you have Thanksgiving, Christmas, all that stuff, but also you should see some tapering out. So I think it’s a phenomenon of the new logo add than anything else. And I think Matt wants to chime in a couple of points as well.

I love your answer, of course it's perfect, but I will say a little bit more. There’s going to be volatility in the services. As you can see, because that compares versus last year is exceptionally favorable, and Q4 is expected to be down, but the services are contributing – they’re caused by new logos and there’s a nice indication that that's working well. They’re caused by new logos and they lead to more follow-on, so a very healthy link in the chain for us. They mean good things in all directions. On a median basis for customers who use Appian professional services, we earn $0.79 of software revenue for every dollar of PS revenue in the first year of that customer. But that grows in the second year of that customer $1 professional services means $3.79 of software. And by the third year a dollar in services is $8.37 of software. So there’s very virtuous cycle in both directions. So, I see it as a strength, I don't like expectations up on services. Its volatile thing, but like I see it as it is a strength about our software business when we do our own services.

And you mentioned a good ramp in terms of the oversee partnerships since sort of partners overall contributing better to the business or sort of increasing contribution from the partners bringing new deal. Does that – are they able to take any increasing portion of those services? Or is it just not – doesn’t make sense for you to do that given you get such good follow-on when you get in there and you get these initial implementations and get that follow-on for subscription in multiple years?

It’s is absolutely necessary that our partners take more of the services business. And we -- I was just over in Europe last week and I’m meeting with partners and there’s excitement there. There's is a determination to staff Appian opportunities that I've never seen before. I feel very good about our apartment stepping up and we need them to step up because Appian's services staff is not designed to be capable to handle the increase in our logo acquisition nor our software revenue.

Excellent. Thank you, guys. Very nice quarter.

Thank you.

Thanks, Sanjit.

[Operator Instructions]. Our next question comes from Richard Davis with Canaccord Genuity. Please proceed with your question.

Thanks very much. Two quick questions. One, you kind of touch on this segment on the prepared remarks, but I noticed you guys were sponsors of, I think it was InsurTech or something. And it just seems to me that that's a space that an industry that's right for kind of low-code, so I guess these analogy from the World Series that just finished, kind of what inning do you see we are that see us in the upgrade cycle there? And then the second question for you guys is, one the things you have to do as CEO is kind of keep the firm focused, but you also have to say no to things. And so kind of what are some other things that you’ve had to defer this year and how do you think about that? Thanks.

With regards to insurance as to low-code in our industry in general, I say we’re in the first inning, which isn't to indicate a lack of maturity in our outreach, but to compare the past to the future potential, I think it's so much weighted toward the future. With regards to insurance specifically and where we are on the growth curve. We are -- the insurance is one of our five initial industries that received vertical focus from sales and marketing but not as much as we put into financial services, pharmaceuticals and government. Lately, insurance is becoming more verticalized, and we’re making higher in the sales force specifically for insurance, gathering experts and going to shows like the one that you referenced, so that that investment continues apace. It's true that we can't invest in everything. We’ve got terrific start in places like education and energy, and transportation and retail and none of those are receiving the kind of verticalized attention that insurance is receiving today. But I can't wait to get them. We just have to – we have to be sure that the things we focused on we put enough energy behind to get them past the escape velocity.

Great. Thank you very much.

Our next question comes from Jesse Hulsing with Goldman Sachs. Please proceed with your question.

Yes. Thank you. And hi, guys. I want to follow-up on Richard’s question. I guess, Matt, if you look at the verticals that you're focused on and where you built these practices. Where are you seeing the most incremental growth and looking forward which financial services and government are been big for you? But I'm wondering what do you think number three is going to be out of the five or so verticals that you're focused on?

Okay. Thanks Jesse. I already know what number three is going to be. Its pharmaceuticals. Pharmaceuticals has done – really it’s been quite close to government, so there's almost a tie for second there. Financial services is our clear number one. Government pharmaceuticals and I'm alluding in the prepared remarks here that healthcare maybe becoming number four. That healthcare may be stepping up, and now instead of the big three, it would might have a big four. We see some good momentum there. So, that will be my prediction for the next one. I feel there’s so much potential everywhere. The real emphasis I want to leave you with is, every one of these verticals is exceptionally fertile. These organizations, every medium to large organization in the world needs to be a software company, needs to customize some of their processes and procedures and behaviors with software and they just looking for a way to make it easy to build that and to change it. So I feel like we've got a winning position in every one of these verticals. The ones who are investing in and the ones we haven't yet. But if I had to pick one that will be the next breakout, it will be healthcare.

Yes. That makes sense. I have two kind of related questions about demand in the funnel. One, do you feel like inbound are increasing as low-code is a category kind of gets more attention. I think Forrester had a report out, talking about it. And also you guys did some stuff this last quarter around publishing your pricing and free trials and that sort of things. Is the funnel building if you were to look at the top of the funnel and what metrics you guys track? Is that moving in a direction that excites you?

Okay. First of all, I’d say a number of things have been good for us in top of the funnel success. I believe the IPO. It’s actually good for us. So I think the greater degree of publicity that we receive for being a public firm has helped. I think that our partner activity has helped, because they refer more. The IPO leads to partners, the partners leads to more exposures. I think the verticalization is helping. I say all this and I want to at the same time qualify it by saying that we -- the top of the funnel is not an exceptionally quantifiable thing even if you were to do, a say, counts of the touches or the connections we collect, you can't make assumptions about the equivalence of those over time particularly when you're doing outreach in new forms. And so, I don't want to say quantitatively or scientifically the top of the funnel is better than it used to be. I can't make a statement like that. But I see energy and I think the energy has come from another -- number of steps that we’ve recently taken.

Thank you.

Our next question comes from Raimo Lenschow with Barclays. Please proceed with your question.

Hey, guys. This is Mohit on for Raimo. Thanks for taking my question. Matt, just following up on that vertical focus and vertical strategy that has been discussed, I’m just wondering as you look outside the Top 3 or maybe the Top 4, 5 verticals and you think about penetrating outside those verticals? Is there any sort of changes that do you think that need to happen to the sales motion or go to market as you will not only build the reference – referencable customer base [ph], but also try and play that land-and-expand playbook in those non-core verticals, I want to say that?

That’s right. It’s a good question. There is undoubtedly a slightly different motion depending on the vertical. So, for example, I could imagine going after an education vertical with more of an educational license for the students and then you have to charge if the institution uses it, right. I can imagine approaching different organizations in different ways and that might be correlated within verticals. However, I think our purpose -- the way that Appian does go after – I’d say there's set of end thing that we want to go after. We go after them serially, one at a time. And so the most advanced project is like probe and that probe features us. But we pull lessons from that and that affects the end plus first and the end plus second, and as you add more experiment, you’re learning more faster and that relays -- our learnings from those relay back on to the experiments we have yet to begin. So, the reason we don’t approach all numbers of a set simultaneously for first of all, financial limitations. But secondly, you learn more if you do it in an order and you’re very attuned to being perceptive about each one of those as a teaching moment. So that's the way we’re trying to do it. And by the way you see the same thing when we move geographically, right. We had one office at a time and we draw on lessons that we’ve received from previous offices. And there's this lot of territory that we haven't touched yet. We have no office in very important areas and then that's because that's just not the member of the set we got into yet. This is a distinctively apt in approach. We mean to stay with it whenever were approaching a set of possibilities.

Thank you.

Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to management for closing remarks.

We appreciate very much you time this evening. It’s a pleasure to share with you our results from the third quarter of 2017. And I have nothing else to add. Thank you. Good night.

This concludes tonight’s conference. You may disconnect your lines at this time. Thank you for your participation.