Earnings Labs

Appian Corporation (APPN)

Q3 2022 Earnings Call· Thu, Nov 3, 2022

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Transcript

Operator

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Appian Third Quarter 2022 Earnings Conference Call. I would now like to turn the call over to Sri Anantha, Senior Director of Finance and Investor Relations. Please go ahead.

Sri Anantha

Management

Thank you, operator. Good afternoon and thank you for joining us to review Appian’s third quarter 2022 financial results. With me today are Matt Calkins, Chairman and Chief Executive Officer; and Mark Matheos, Chief Financial Officer. After prepared remarks, we will open the call for questions. Today, you will want to follow along with our earnings presentation. You can download it from the main page of our investor site at investors.appian.com. During this call, we may make statements related to our business that are forward-looking under federal securities laws and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These include comments related to our financial results; trends and guidance for the fourth quarter and full year 2022 and 2023; the impact of macroeconomic changes; the benefits of our platform, industry and market trends; our go-to-market and growth strategy; our market opportunity and ability to expand our leadership position; our ability to maintain and upsell 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. They do not represent our views as of any subsequent date. They are subject to a variety of risks and uncertainties that 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, refer to our 2021 10-K and other periodic filings with the SEC. These documents are available on our Investors section of our website. Additionally, non-GAAP financial results will be discussed on this conference call. Refer to the tables in our earnings release and the Investors section of our website for a reconciliation of these measures to their most directly comparable GAAP financial results. With that, I would like to turn the call to our CEO, Matt Calkins. Matt?

Matt Calkins

Chairman

Thanks, Sri and thanks to everyone joining us today. In the third quarter of 2022, Appian’s cloud subscription revenue grew 30% year-over-year to $60.6 million. Subscriptions revenue grew by 29% to $86.5 million. Total revenue grew 28% year-over-year to $117.9 million. Our cloud subscription revenue retention rate was 115% as of September 30 and our adjusted EBITDA was a loss of $22.9 million. That last figure is outside of our guidance and we will need a careful explanation. I am going to spend much of my time today on that and a new set of charts that I want to share. Before we dig into those deep topics, I have a few quick points of news. Number one, Appian recently closed a $150 million debt facility with a 5-year term. The purpose of this facility is to remain strong in cash throughout the anticipated economic contraction. Number two, Appian opened our new dev center in Chennai, India ahead of schedule with a full complement of employees and a new office location. This will help us with efficiency and access to talent. With those news items out of the way, let’s get to the quarterly numbers. Revenue growth in every category is healthy. Revenue, in fact, has been setting records with the last four quarters, our strongest four growth quarters since the IPO and that is despite the FX headwind. Foreign exchange rate fluctuation cost us several percentage points as you will learn in the financial presentation, but it didn’t stop our revenue momentum. Still, the adjusted EBITDA number is outside of expectations and that is due to higher expenses. Those expenses were driven by hiring surge and a sharp drop in attrition. Let’s discuss how we got there. Appian came to this quarter in an unusual situation. We expected a…

Mark Matheos

Chief Financial Officer

Thanks, Matt. I will review the financial highlights for the quarter and then we will provide guidance for Q4 and the full year 2022. We delivered another strong quarter driven by subscriptions revenue growth of 29% year-over-year. We also saw strong growth in key industry verticals and each of our geographical regions. Let’s go into the details. Cloud subscription revenue was $60.6 million, an increase of 30% year-over-year and absorbed another 1% of incremental FX headwinds since we gave guidance on August 4. Normalizing for FX headwinds, cloud subscription revenue was in line with our guidance. On a constant currency basis, cloud subscription revenue grew 33% year-over-year. Total subscriptions revenue was $86.5 million, an increase of 29% year-over-year. Professional services revenue was $31.4 million, an increase of 25% year-over-year. FX changes negatively impacted professional services revenue by about $1 million. The year-over-year growth in professional services revenue was driven by the public sector, North America and APAC. As previously noted, Appian’s professional services are complementary to partner offerings, and in certain cases, support large programs that are run by our partners. Long-term, we continue to believe partners will drive most of our growth. As a result, we expect professional services revenue to continue to decline as a percentage of total revenue. Subscriptions revenue was 73% of total revenue consistent with a year ago period and 70% on the prior quarter. Total revenue was $117.9 million, an increase of 28% year-over-year and above our guidance range. On a constant currency basis, total revenue grew 30% year-over-year. Our cloud subscription revenue retention rate as of September 30 was 115% as compared to 116% last quarter. As a reminder, we continue to target a cloud subscription revenue retention rate of 110% to 120% on a quarterly basis. Our international operations contributed 31% of…

Operator

Operator

[Operator Instructions] Your first question comes from the line of Steve Enders from Citi. Your line is open.

Steve Enders

Analyst · Citi. Your line is open

Hey, great. Thanks for taking the question. I guess just to start – I just want to get a little bit better clarity on what you are seeing in the macro currently. Is there anything in the pipeline that’s been impacted or how should we kind of think about what’s necessarily in there that you are calling it out, but not necessarily seeing it in the guide always on the revenue impact for 4Q?

Matt Calkins

Chairman

Yes, I am glad you asked that, because I want to clarify this, Matt. We are not seeing anything else that I didn’t put in those numbers. So, the evidence of a economic episode is really thin on the ground right now for us. Maybe there is a little bit there in sales cycle delays or perhaps it’s just the effect of a federal dominated quarter. I mean, the effect is pretty small. We saw a couple of deals slip, including one notable deal slip out of the past quarter. But now there is no big factor that hasn’t – that didn’t come across in those charts.

Steve Enders

Analyst · Citi. Your line is open

Okay, got it. That’s helpful clarity right there. And I guess for the investments that you did make in the hiring environment, that’s particularly strong, any big areas of focus that you would call out and where it seems to be in place on the sales side? Are there certain regions, certain verticals, certain roles that you are particularly hiring for on the sales side?

Matt Calkins

Chairman

Yes, I’d be happy to speak to this. The number two area we were pressing to hire for was to get a critical mass of engineers on the ground in Chennai. So that it would appear to be a real office, with a real location, a real team that was together from day 1. That was a push. And that was our second priority. Our top priority, however, was to staff up our account executives and SDRs. And we specifically wanted to have access to more accounts. I felt for a while we were understaffed in terms of account executives and that we were missing access to some transactions, because we didn’t have the time to show up. And so, this has been my big push all year, but it wasn’t until Q3 that we really got it done.

Steve Enders

Analyst · Citi. Your line is open

Okay. I just want a quick clarification. I mean, is the hiring initiative is that done at this point like, I don’t want to call it a hiring freeze, but is this pretty much the end of those major investments there?

Matt Calkins

Chairman

That’s affirmative.

Steve Enders

Analyst · Citi. Your line is open

Okay, perfect. Appreciate the questions here.

Operator

Operator

Your next question comes from the line of Sanjit Singh from Morgan Stanley. Your line is open.

Sanjit Singh

Analyst · Sanjit Singh from Morgan Stanley. Your line is open

Thank you for taking the question. Matt, I really want to talk about how you are thinking about the demand environment over the next 12 months. On the previous question, you are pretty clear that the data – the indicators you are looking at doesn’t really signal any impending slowdown. But even if you guys admit like the attrition rather that you are seeing the organization is at an all-time low, which could be kind of a signal that is kind of an economic indicator that things are more uncertain if employees are staying at their jobs for longer. And so in the context of the investments in sales and in R&D, in Chennai, what’s the risk that you are overstaffed relative to the demand environment that could ultimately materialize? And what are sort of the contingency plans if that scenario occurs?

Matt Calkins

Chairman

Yes, okay. First of all, I think your observation about low attrition being an economic signal is perceptive. And I think that that reads as an economic signal to me as well. It speaks more to the general technology job market than the demand for our products. However, the demand for our products has maintained its strength, right. So maybe some parts of the economy are showing that weakness and you could see it in the attrition figures. But our demand seems to be more resilient than that. And so the pipeline, the sales, we see steadiness instead of decay. Let’s say that, however, that there is some decay. Let’s say that we hit a recession in the early part of next year and it lasts for two to three quarters, which I would not be at all surprised if that’s what we get. That’s what I am expecting. I still think the other side of that. Okay, during that we have a good ROI story and a good reliability story. So I think we are kind of a good all weather option during a recession. Our customers are happy. Our retention is strong. Our performance is notably better than our competitors and surveys and such. And our product is focused on determining the ROI that a customer is getting to be sure that the money they have already spent is spent well instead of spending new speculative funds. So we are well positioned during a period of turmoil. And then coming out the other side of it, I feel extremely confident that there is building demand for digital transformation and for process automation like we provide, we see that marketing opening up and we want to be ready for it.

Sanjit Singh

Analyst · Sanjit Singh from Morgan Stanley. Your line is open

Makes sense. And then just a question on how the demand for your products is materializing, going potentially into a more uncertain IT budget environment? As you look across workflow, process mining, and RPA. Are you seeing customers sort of be more conservative in terms of their ambitions around automation, or are you seeing that accelerate within your existing customer base?

Matt Calkins

Chairman

Yes. The way I define automation is when software helps you do the work. And a recession is like the number one time that you would want software to help you do your work. And so this isn’t a time to pull back on automation technology, it’s actually the time to rely on it. And if you can push more work to your robotic process automation, or your artificial intelligence, or your intelligent document processing, or process mining, or workflow or rules, these are all natural ways to be more efficient. That’s exactly the kind of thing that if you are comfortable with them as a tool, you would want to double down on in a recession. And we are seeing in our new – we have a new feature in process mining that allows you to introspect Appian data and render a scorecard to show how well you are optimizing your Appian processes, how efficient they are, especially relative to the past and how you can tune them up. We are seeing demand for that. We are seeing new deals come in focused on that. So, I think that we have got a product that will be in harmony with economic disruption.

Sanjit Singh

Analyst · Sanjit Singh from Morgan Stanley. Your line is open

Makes sense. Thank you, Matt. Appreciate the color.

Operator

Operator

Your next question comes from the line of Kevin Kumar from Goldman Sachs. Your line is open.

Kevin Kumar

Analyst · Kevin Kumar from Goldman Sachs. Your line is open

Thanks for taking my question. Matt, maybe going to the comment you said about lengthening deal cycles, and maybe that – some of that’s related to government. Maybe touch on kind of what you are seeing in the government sector in terms of demand, in terms of sales cycles and kind of appetite in this environment? Thanks.

Matt Calkins

Chairman

Yes. I should speak to that. The lengthening deals cycle is, it’s not even clear to me that that’s really happening because our data is a little dodgy out of the CRM system. And it’s a minor change. So, it’s well within the margin of error, to which I would attach on that chart. However, I can speak with much more precision, about the situation in the Federal Government. I can say that they had a strong quarter that it is our second largest industry. And it grew by the second most behind, of course, financial services and that growth was solid across subs and on-prem, [indiscernible] a very solid result.

Kevin Kumar

Analyst · Kevin Kumar from Goldman Sachs. Your line is open

That’s helpful. And then maybe a follow-up on the partner ecosystem, we have heard some positive comments on growth of the partner ecosystem. And just curious if you are seeing anything incremental in terms of contribution, new logo wins, kind of strength of that partner influence deal. And is that starting to become an incremental tailwind? Thank you.

Matt Calkins

Chairman

I see abnormally high level of enthusiasm amongst our partners. Maybe it’s just because I am on the road the last few weeks. I was at our Asia -Pac Conference last week in Sydney, Australia. And then yesterday, I spoke at our Public Sector Conference in Washington, D.C. And in both cases, partners are everywhere, exceptionally enthusiastic, buying up all the space, all the sponsorships, making commitments, right. But certain partner told us, they wanted to make it a billion dollar business and other partner told us they wanted to go from a team of 10 to a team of 100 within a year. I can’t say the names behind these partners. But these are serious organizations, are like top five partners for us, at least globally, though, not necessarily in the region where they were speaking. But I am seeing not just enthusiasm, but real excitement about jumping at the Appian opportunity. It makes me want to raise the price of sponsorships actually.

Kevin Kumar

Analyst · Kevin Kumar from Goldman Sachs. Your line is open

Got it. Thanks for taking my question.

Matt Calkins

Chairman

Yes.

Operator

Operator

Your next question comes from Jake Roberge from William Blair. Your line is open.

Jake Roberge

Analyst · William Blair. Your line is open

Hey. Thanks for taking my question. Just want to follow-up on that public sector commentary. 40% growth in government agencies, pretty impressive. But given Q3 is the strongest spending periods for the U.S. Government, are customers operating with a user lucid mentality, or can we actually see some of that demand spill into Q4 and into 2023?

Matt Calkins

Chairman

Great. At the end of the Federal fiscal year, there is often a little bit of a use it or lose it mentality. And that leads to the occasional large bluebird. Some years are characterized by a bluebird or two, which is to say a big deal that comes in unexpectedly because the agency had money burning a hole in their proverbial pocket. This year we did not have that kind of a quarter. Government performed solidly, but not randomly. So, that is not the explanation for the strength we saw this time. And as for whether deals can come in and other quarters, yes, they can. Public sectors, not all Q3, that’s just the best quarter, but thereby all year round.

Jake Roberge

Analyst · William Blair. Your line is open

Great. Thanks. That’s helpful. And then could you give us an update on the lawsuit with Pega. On their earnings call, it seemed like Pega may have been talking down the severity of verdict. But given the size of the ruling, I would love to get some more color from you on how that process is going.

Matt Calkins

Chairman

Yes. I heard that. And the statement that they said it’s just a lawsuit, nobody gets sued all the time. So, I don’t want to say too much about this, because we have been so discreet. We have been very good about it. But I will at least mention a couple of facts. First of all, it’s not just a lawsuit, it’s a verdict. It’s a final judgment at this point, because the judge entered it this past quarter. Pega violated the Computer Crimes Act, right, full stop. They willfully and maliciously, the judge says “willfully and maliciously” misappropriated Appian’s trade secrets. So, I don’t know what this means for their customers prospects, their partners, even their employees, everybody has got to decide for themselves. But it’s definitely not just another lawsuit.

Jake Roberge

Analyst · William Blair. Your line is open

That’s helpful. Thanks for taking my question.

Operator

Operator

Your next question comes from the line of Joe Meares from Truist. Your line is open.

Joe Meares

Analyst · Joe Meares from Truist. Your line is open

Great. Thanks for taking the questions. I am just curious on the 10% loss target for the end of next year. Is that a function of revenue growth, or do you plan to make any reductions anywhere? Is there any wiggle room to gross margin? And then do you plan on kind of staying at that level after you get there, or to try to drive that further down into 2024? Thank you.

Matt Calkins

Chairman

Yes. First of all, it’s the second half, okay. We are going to do that in the second half. And we are not going to do it by shrinking, I want to be clear. We are simply going to constrain how much we need to spend, in order to achieve the growth we know we can achieve. We have put in place the team that can win in 2023. We have got the team now. We have got them faster than I expected. And that will give us a little bit of a dividend, and that we will be more prepared to go into the New Year. We are not going to shrink. We are not – I expect great growth. We are going to obviously see what happens to the recession at all. But we are in a good position to keep winning in this market. And we are not intending to freeze or to go backwards, quite the contrary. We believe that with this latest batch of personnel, we are in a situation where it is possible for us to both limit additional expenses and maintain strong growth.

Joe Meares

Analyst · Joe Meares from Truist. Your line is open

Got it. Thank you. I am just curious on the additions to sales and marketing. Could you just remind us how long typically it takes to get those types of personnel ramped and then you will start to see the benefits of those hires? And then just curious how demand has trended thus far in Q4 compared to Q3? Thank you so much.

Matt Calkins

Chairman

Yes. First of all, with regards to your question about sales and marketing personnel, and how long they take to get ramped, I want to first note that we did not hire for marketing hardly at all in the third quarter. We were targeting sales. We feel that we had inadequate marketing staff and therefore that was not our area of focus. We added – so we hired more than 104. I think we hired more than 100 people into the sales department last quarter because it was our number one area of focus and the place we most felt we needed to expand in order to deliver the 2023 results that we want. The reason why we are doing that is because we feel that there is an up ramp of opportunity. And we mean to capitalize on that by showing up to those deals. And we needed a larger account executive team to do it. So, that is exactly to the second part of your question. That is exactly what motivated the sales up around to the first part of your question.

Operator

Operator

Your next question comes from the line of Derrick Wood from Cowen. Your line is open.

Andrew Sherman

Analyst · Derrick Wood from Cowen. Your line is open

Great. Thanks guys. It’s Andrew on for Derrick. Mark, maybe on the Q4 cloud sub guide, I may have missed this, but what’s the FX impact to that? And maybe just walk us through your assumptions you have made there as far as macro sales cycles, pipeline conversion, anything there would be helpful?

Mark Matheos

Chief Financial Officer

Yes. So, on the Q4 side, we are factoring in an absorption of 2%, since our last earnings call. So, that’s the deterioration that we have seen, that happened in some of the currencies flowing through and that’s the 2% impact. In terms of the actual conservatism on the side, it’s basically not reflecting anything massively different than then what we have seen in Q3. It’s just ongoing, kind of same recipe for how we build up our guidance, which is to say we look at all the opportunities that we have out there, and of course, the backlog and just kind of assume the same level of traction in the macro environment that we have had and no real further deterioration.

Andrew Sherman

Analyst · Derrick Wood from Cowen. Your line is open

Great. And Matt, I think Appian Unlimited has been out for over a year, can you talk about others is trending versus your expectations. And if you have had any renewals from those customers, so far, if you see this driven some strong up-sell activity?

Matt Calkins

Chairman

I love it as a way of aligning incentives. I continue to see interest in Appian Unlimited. It continues to be a minority purchase, which is to say, an unusual method of sales, because most of our customers like the normal ways, if I see into that sort of thing. So, I am a price model enthusiast. I think you could say, I love construing pricing models that set everybody’s expectations and incentives the right way, doesn’t mean that all of our customers do. It’s definitely still in the mix. I don’t see it growing as a share of the mix. It’s the minority of our demand. We may try to give another push forward next year, but it looks like it may stay in the distinct minority. And actually maybe it makes more sense for customers, I have always felt this for customers who understand the value of our platform. And two things that will make them understand the value properly are the maturation of our sector, and familiarity with us. And so the more we can raise the profile of our market and ourselves, the more we are likely to get adoption of a novel pricing mechanism like that. But I don’t have any news on growth in there. It remains a substantial, but not majority way to purchase Appian software.

Andrew Sherman

Analyst · Derrick Wood from Cowen. Your line is open

Okay. Thanks guys.

Operator

Operator

Your next question comes from the line of Fred Havemeyer from Macquarie. Your line is open.

Fred Havemeyer

Analyst · Fred Havemeyer from Macquarie. Your line is open

Hi. Thank you. I think the first question was a head on is in regards to hiring and just how you are thinking about managing towards your profitability guidance? When in the quarter was apparent that hiring was coming in much stronger and that your profitability was going to be looking like we are at risk of missing your guide?

Matt Calkins

Chairman

That’s on me. I did not notice until the quarter had concluded that we had hired above our guide.

Fred Havemeyer

Analyst · Fred Havemeyer from Macquarie. Your line is open

Thank you. And then just one question to clarify on the lawsuit as well, Matt, does Pega have to pay anything at the moment? And typically how long would you say these tips – these types of lawsuits tend to go on for?

Matt Calkins

Chairman

Yes. Pega is not obliged to pay anything right now. They are at liberty instead to contest the verdict. Now, the verdict has been entered and the final judgment has been entered. And their arguments were heard and rejected by the judge. And interest is now accruing at the rate of about $122 million per year. So, they are at liberty to draw this out if they wish, and it appears they do wish. But there is a consequence to that.

Operator

Operator

Your final question comes from Vinod Srinivasaraghavan from Barclays. Your line is open.

Vinod Srinivasaraghavan

Analyst · Barclays. Your line is open

Hi. Thanks for taking my question. I just want to talk about Appian Community edition. I think that’s been out for a year plus now. Is some of the sales hiring maybe related to some of the positive signals you are seeing from this kind of pool, or is it more just related to kind of the existing opportunity within larger customers?

Matt Calkins

Chairman

I am sorry. I couldn’t hear all that. Will you say again?

Vinod Srinivasaraghavan

Analyst · Barclays. Your line is open

Sorry. The significant sales hiring you are making related to signals that you are seeing from the pool of Appian Community users, or is it more related to just the opportunity within your existing clients to kind of just go deeper?

Matt Calkins

Chairman

Right. Well, that actually has to do with opportunities that I see happening in the market that we are incapable of addressing, because we don’t have the sales staff to participate, right. And so knowing how much we get out of the customers who are capable of touching and knowing that the customers that we are not touching are not so terribly different from the ones that we are. We understand there to be a much larger opportunity and merely need the staff to participate in it. So, that’s the rationale. Thanks for the question.

Vinod Srinivasaraghavan

Analyst · Barclays. Your line is open

Okay. Thank you. End of Q&A:

Operator

Operator

Thank you. Ladies and gentlemen, this does conclude today’s conference call. We thank you all for your participation and ask that you please disconnect your lines.