Appian Corporation (APPN) Earnings Call Transcript & Summary

Good morning, everyone. I'm Sanjit Singh. I run the infrastructure software coverage on the software team at Morgan Stanley. Super thrilled to have the Appian management team, CEO, Matt Calkins; and CFO, Mark Matheos. Thank you both for joining us.

Thank you.

My pleasure.

Awesome. So let's get through these disclosures and we'll start to kick off the discussion. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

With that, Matt, why don't we just do a quick sort of status check on the state of the business. Obviously, the environment from a macro perspective has gotten tougher. How would you sort of assess the ability of Appian to execute in 2022? And what do you see as the opportunities going into 2023?

Yes, I'd say there's kind of 2 macro factors that affect us right now. There's the overall economy, and then there's just the moment of opportunity that's created by the confluence of a lot of businesses that we have gotten out ahead of. And the productivity boost that's going to happen as people discover the possibilities of automation this year. They've already seen it in AI a little bit, but this is a year where they're going to be asked to do more with less. And automation is going to be spotlighted, and we are ready for that. So we're expecting to get a lot of boost from that macro effect. And then we're also cognizant of and anticipating a recession as another macro effect. But our position on that so far is that we see almost no implications for Appian from the recession. We're growing well through it. And very few of our deals have shown any recessionary symptoms.

Yes. It's a great update. Let's talk about AI, because it certainly seems a topic of the moment and the impact of it on your world, which is workflow, low-code, co-development. As developer productivity increases in terms of the ability to generate code, how do you see this sort of impacting Appian as one of the platforms that companies went to to increase that developer productivity?

Yes. Let me start with an explanation. Appian is process automation. And by that, we mean that we're end-to-end, everything to do with the process: building it, running it, automating it, executing it, diagnosing and changing it, everything to do with the process end to end, that's our space. And part of that means that we own all the technologies that do the work, other than the people, right? You can do work with RPA. You can do it with AI. You do it with rules. All of these work-doing software features are in our product. And so here comes AI, exploding, right, and then getting everyone's attention and teaching us 2 things. One that AI is amazing, and can do extraordinary feats. And the second is that it's dangerously unprepared to do anything important or to make any decision because it makes so many mistakes and horrific faux-paus and does so many inappropriate and false things. So AI is incredible, but incomplete. And the lesson of this is that AI is going to need to be paired with human help, that it will not exist on its own, not for a long time. It won't make decisions on its own. It won't create things on its own. It will be an extraordinary accelerator, and it's valuable in proportion to how well it's paired with humans. So for the next year, the year after that, we're going to see a lot of stories, success stories about AI. And they're all going to be about how AI is great working with people. They're not going to be how AI just did job by itself. What we're seeing lately is that AI cannot do the job by itself. It badly needs the checkpoint and the collaboration with humans. In fact, I predict we're coming into a phase where there's going to be a standard one-two punch. AI generates, human reviews. We're going to get very used to that, right? That's going to happen in so many industries, so many like verticals, so many horizontal applications. We're going to see this all the time. AI will not do the job by itself. And so the spotlight is going to go back on the process automation, the process that allocates work, routes it, checks it, runs it through multiple stages. That's where we work, right? That's our role in this. We're the coordinator, and AI has shown that it is in need of coordination. So yes, I think AI is great. I love the spotlight that it's bringing. Of course, we use AI thoroughly through the product. We use it to suggest new text. Of course, you can do that, [ using ] generative AI. We can also use it to create new applications to suggest what nodes you should place in your application and how you should construct it based on past information. We also use it to diagnose security threats. If we see a pattern that looks reminiscent to a pattern that's led to a breach in the past, we can flag that for you. We -- AI permeates our platform, and we've been offering it -- and we also use it for inputting documents, in taking documents, reading tech scripts that sort of thing. So we use AI thoroughly, but that's not even really the point. The point is the great future that's coming with AI and how much it's going to have to be paired with human review.

And can you give us maybe a little glimpse on what the product road map could evolve to -- incorporate and orchestrate AI more effectively going forward?

Well, I think that we are the example of how AI is going to be orchestrated correctly. It's going to need to be one of many workers, and not the only worker. It's a powerful generative engine, but should not have the final say on anything. We orchestrate many workers. We state robotic process automation to do the work that has no exceptions involved and where you just need very high throughput, right? That's pretty easy. We orchestrate work that goes to rules, where you can just apply a business rule and get rid of a lot of the tasks that would be so rote that you don't need a human to think about it. We coordinate all of these workers, and we do it very easily with a kind of a low-code interface that allows people to drag and drop intuitively to unite all the value they're getting from these various platforms. It's been our operating principle for the last 5 years that people wanted a unified platform for their processes. Instead of buying a separate RPA product, a separate process mining, a separate AI and a separate workflow, we figured this market is too important. Processes are too important. And the thing they represent to an organization change at scale is too important to trust it to several silos. Instead, they're going to have to unify it. They'll bring it together on a single platform, and we want to be that platform. We've done some acquisitions. We built out some new functionality, and we've been that unifier. And so that's our position, in terms of coordination, is to be the unifier amongst the many parts of software that will do the work alongside humans.

Yes. I was super impressed on how quickly the team was able to bring workflow, process mining, RPA together in a unified platform. Companies a lot bigger scale has been trying to do the same thing, and you guys got there pretty quickly. And so in terms of the convergence of the enterprise automation stack, on the ground with customers, are customers -- are they looking at this in a converged way? Are they consuming automation in the way that you envisioned today? Or is it most like that's nice to have on the road map and they're still in sort of a best-of-breed motions?

Yes. Customers are almost all in a best-of-breed motion, which is to say they have one or more RPA products. They have some kind of AI that's already there. And that's fine, actually. We don't come in and say, "Kick out your RPA vendor. We're here to do everything." Instead, we say, "We're here to build you a process. And the life cycle of the process, we've got that. And by the way, somewhere in that life cycle, there's going to be RPA, Okay, we got that too." And somewhere in the life cycle of that process, you need to call in some AI, we've got that. So instead of challenging the tower of RPA leadership, whoever the RPA champion is, we say, "Don't worry about it." They can keep doing their RPA silo stuff, right? We're just going to have the RPA that pertains to the processes you build. It will be a lot easier to do that entirely within one environment.

In terms of process mining, if you acquire that capability through an acquisition of -- called a lot of labs about 1.5 years ago. What's been the evolution and customer receptivity to process mining?

Yes. This could be a really exciting year for process mining for us. We have that technology. We've been working on it. It is released. We've got customers who are using it, and it's wonderful to be able to diagnose the efficiency of your processes. To us, this is a critical weigh station in the vision of being able to do everything for one process, including test whether it's efficient and make changes accordingly. The process mining is a key puzzle piece in that big vision. And this year is when it's coming -- I mean it's already out. I don't want to downplay it, but it's coming to a new kind of maturation this year because we will be demonstrating just how easily it interfaces with the rest of our suite and diagnosis process or what you can change about it. In a Boardroom style, an executive could relate to and say, "Now I know why I spent that money, and I'm glad I did." Or Here's why I'll make the new investment, to create another process, because there's so much clear value generated. It's perfect for this year. I've been aiming for this year because we've seen the recession coming for as long as it's been since we bought Lana. We've known that there was going to be a new emphasis on quantifying whether your money was well spent, and only doing it if you've got a short time to value. So this gives the year to show value with process mining. When people want that proof of the value. So we will be there with it.

Yes. You guys have been quite vocal on your concerns about the macro and positioning for that environment, we've had those discussions before. One of my favorite topics with you, Matt, over the last several years is pricing and packaging. And so to the point around the platform and the suite becoming more relevant going forward, you guys had made the decision not to charge separately for each of those individual capabilities, but getting customers to consume it as part of the broader platform. Why is that still the right monetization strategy going forward?

It's the right way to encourage our form of usage, which is unitary combined usage. By having one price, one SKU that represents the entire platform that covers every stage in the life cycle of a process. We encourage customers to think that way and to think that they're buying the entire life cycle of their process in one purchase. I want to encourage that form of use, and I wouldn't want to put any kind of a toll gate up that prevented them from thinking and using it that way. At the same time, of course, I would appreciate being able to make money if they were to really get use out of one of these components to say they did a tremendous amount of process mining or something like that. And so we do charge above a regular amount of usage. If there's an excessive amount of usage, we are going to charge again. But the initial price encourages them to view this product and this market as one in which everything to do with the process can be bought and used.

A major topic at any software company has to think through is how to effectively penetrate your TAM and how pricing is a consideration of that. Historically, you guys have priced on a per user basis. There was a moment in time where you guys are looking to move to a per-app pricing, like incentives for customers to -- and so what sort of -- how has that evolved per user to the number of apps over a certain time period? And is there a world where Appian is to more of a compute consumption-based pricing model?

Yes. Customers want predictability, so it's hard to go to a consumption base. I would love it because I'd love to find a closer proxy for value delivered. That's always my guideline when creating a new price. I want to find a proxy for how much value we're really offering the client, be sure that there's some consumer surplus, but not too much. So I would love to do that, but I think that I can't because the clients want too much predictability. So instead, we charge by the user or by the application. If it's by the user, of course, just count of users. If it's by the application, it's either by the length -- the number of users of the application or the length of time it takes to make the application. We can quantify that in either direction. But we want to be as simple as possible. We understand there's a complicated field. We want to take variables off the table. And so having something straightforward that customers can wrap their minds around is our priority on pricing.

Yes. I want to bring Matt into the equation.

Mark.

Mark, sorry. I apologize. Long week. Mark, on the investment profile. So the company has been investing for growth, and quite successfully sustaining 30% subscription revenue growth for a number of years. Can you talk about the decision to continue to invest through the downturn? You're not necessarily targeting profitability right away. Can you walk us through what are your expectations in terms of measuring your return on sales and marketing investment to sustain that growth?

Yes, sure. So it's true that we do believe Appian is a worthy investment. We have no real concerns with -- if you look at historical investment levels and how we've evolved over time, our overall kind of level of losses aren't concerning to us. I think they're justified by our top line growth, which you mentioned, but also just the customer unit economics that we have, which are quite elite. If you take, for example, our gross renewal rate, it stands at 99%, which -- you hear software companies in the 90s, 95%, but 99% is just extraordinary. And that leads to a really impressive kind of [ comically ] large, if you will, LTV to CAC. So these customers stick around forever. That speaks to the mission criticality of our applications that we're building. It speaks to the product being a really capable quality product. And so there's an argument to land as many beachheads as we can, right? And kind of get those ARR streams in our P&L, building over time and focusing on that. Now we've been a lot more prudent than that. We're not a growth at all cost company, but we do obviously want to grow. And we want to kind of look at that TAM and look at that opportunity as one that, again, is worthy of investment. In 2022, we did a lot of hiring. We had -- historically, we've always tried to get top talent, and we've never lowered the bar. And it's been tough to kind of reach hiring targets over time. But 2022 is -- folks are aware, it was a little bit of an opening up of the tech market, a little bit of a softening, if you will, and we were able to kind of hire ahead and get a lot of the heads we needed. So we're very happy to have hired sales folks and engineers that we've been trying to get for a while. And again, this was -- we continue to see strong demand for the product. And we said, "Well, let's get these folks to help us grow." And I think, in 2023, it makes sense to kind of just take a little bit of foot off the accelerator on hiring, kind of digest what we've hired. There's a lot. But that's not to say we're going to enter a new phase where we're not investing anymore or anything like that. We still see a long-term potential that's worthy of investment. All those unit economics are holding strong and the growth prospects are still there. So we do -- because of that kind of digestion of the hiring that we have, we'll see an improvement in EBITDA losses in 2023. And we pointed to those actually kind of cutting in half by the second half of 2023 versus 2022. So I think we're moving the margins better, but again, focused on growth and sustainable growth.

And Mark, is there any way to think about the timeline to get to breakeven profitability? And if you think about the longer-term targets, what should investors' expectations on achieving those milestones over time?

Yes. So we talk about this internally a lot. And if we can execute on our plan here, you'll, again, see us dramatically improve EBITDA in actually pretty quick order here. And the question will be, like, do we want to do that again? But I think we're going to be very careful with that. Again, we don't really want to sacrifice the opportunity in front of us just to get to kind of an arbitrary number, at least at this point. So we're kind of carefully debating the pros and cons of planning for a profit number versus planning for just further growth in a disciplined fashion. So we'll continue to debate that at this point. And if we have any news to share, we'll share it with you.

Great. One of the things I point out with investors is that Appian gets about 70% of its revenue from financial services, insurance, life sciences and government, which I think the takeaway there is not necessarily brand new startups or tech companies, right? It has probably served you guys well in this environment. In these specific verticals, financial services, insurance, life science, the government, what was your assessment of customers in these verticals in terms of their ability to invest in 2023? And does that sort of prevent a more material slowdown in growth that maybe some of the other software companies are seeing?

Yes. I mean I think those areas, if you had to pick industries that were resilient and kind of looking at our customer base and our product inherent capabilities around efficiency, those are the ones you'd probably pick in a year where you had some soft macro. And we're very happy we don't have exposure to tech, for example. I mean this can only go so far, of course, if the recession is deep enough, it will start impacting every industry. But we think those larger enterprises, we found them to actually -- as they increase in size at Appian, they actually end up buying more and more software because they've seen the ROI, they've seen the benefits of the platform. And when you're a multibillion-dollar company, it's actually not that expensive to build more apps and gain that efficiency. Our process finding functionality, as Matt mentioned earlier, actually quantifies that for the executive leadership at that company. And they can actually measure in the units that make sense to them, labor hours, dollars, whatever they want to see, how much they're saving and how much Appian is helping out their business. So they love it, and they'll buy more.

Matt, maybe...

Can I say something about a recession and why we would choose to invest during a recession? A recession is like a confidence test for the economy. For every little bond of exchange and commerce that exists in the web of an economy, a recession is a confidence test. And some of those bonds are going to break and some of them are not going to break. Appian has got a 99% gross renewal rate, which means that our bond with our customers is exceptionally strong. And so I believe that we are better positioned to weather a recession than other firms. And therefore, we have less of an imperative to reduce our spend dramatically in order to weather a storm. We're actually very well prepared for that storm. Secondly, the revenue that we're investing and gathering is exceptionally high quality. Not only does it have that 99% gross renewal rate, it's also got a 90% margin -- gross margin on it. So this is marvelous revenue that we're going after. [indiscernible] a long time, terrific margin. And then finally, we understand that this situation, the recession, is in some ways, a trigger for our renaissance. The recession is more than a confidence test. It's a productivity check during years in which money is cheap and growth is everywhere. You don't worry about productivity. Buyers don't -- I mean, companies are not focused on productivity in a typical year, in a boom year. They're not thinking about it. They think about it when a hard year dawns, and they have to make cuts. And they still have to service everything. When they're told they have to do more with less, that's when they check their productivity. And so productivity as a statistic tends to proceed in fits and starts. Last year was very poor. The worst productivity growth since 1974. U.S. non-farm was negative 1.3%. So we're in a productivity trough right now. But the recession is going to trigger a reconsideration of productivity, which is to say people are going to look at technology and ask themselves, can I get more from the money I'm spending? Can I get more? And the funny thing is, at this moment, the answer is a resounding yes. If you look at AI, where AI is right now, if you look at the progress in robotic process automation, the extraordinary benefits that people are getting. Like software is more than just helping us do the work now. Software is ready to step up and do the work. And that is -- that's the other side of the productivity universe, right? Software is ready to do the work almost, right? It needs a little bit of help, but it's incredible now just how much potential there is. And so when businesses face a recession, and then they go to the productivity well, they're going to find it rim full. The productivity well is ready to transform the economy and we're at the forefront of that. So we want to invest in order to be there when this trigger hits and everybody starts thinking how do I get productivity, right? So the recession, yes, macro, it could be bad, but at the same time, we're exactly what they're going to be looking for in a time like this. And so this is why I insist that it makes sense for us to be investing because we're moving into this productivity revolution. And we're ready to be a prime player.

Yes. It's a great thought. And I'm certainly going to see how it plays out for Appian terms of growth over the next couple of years. Going back to that point around customer and exposure to industries. Matt, can you talk a little bit about taking Appian outside of those core verticals? And what sort of the initiatives you have? And who would you sort of -- which industry do you think is sort of ripe for that, looking for productivity enhancements with that being take the platform to?

As you just mentioned, most of our revenue comes from a core 5 industries, 70%, right, is finance, government, insurance pharmaceutical, health care, I think that's it for -- but, however, a lot of the other industries, we're represented by just a couple of the world's biggest. So we have some of the world's biggest airports. We have some of the world's biggest energy companies, some of the world's biggest retailers, just a few, a scattering and they happen to be platinum names. And so we're very applicable to these other industries, very applicable. We -- they've got processes. They've got change. They need to change at scale and we're the topic for a large firm wants to do that. So we're ready. The way we should do this, the way I want to do it, is with partners and solutions. I think we should stay with our institutional focus on our core, but draft partners and go to market with them with intellectual property developed in tandem built on top of our platform so that they've got a stake in going to that market. We have a differentiator, and we're not seen as a substitute for other technologies they could have used. We want to go with a partner with a solution after specific other markets. So for example, we're going after state and local in a way that we have never gone after state and local, and we're doing it with Deloitte in this case. We have -- we've got a great solution. We've got a solid partnership, and that could be a sixth great industry.

That makes a lot of sense. I wanted to come back to the lawsuit, which you guys won versus Pega last year for misappropriation of trade secrets. Can you give us a status update on where we are in the legal process? Were the many steps before final resolution? And how should we think about the timeline for a final resolution?

Yes. All right. So the verdict came out almost a year ago. You may be familiar with the story, I won't put labor it too much, but it's pretty extraordinary. Nine years of industrial espionage, and the verdict finally put a cap to that. They tried to stop the final judgment, but the final judgment was entered in the fall. And the judge said, "No. This is good." He entered it. And that's where it stood. We had dueling websites for a while, right? They had their statement up on a website. We had our statement up on a website. And now that stalemate has broken because they had to file the appeal. Their official appeal has been filed, and we are filing this month, our response to that official appeal. That has changed the dynamic a little bit because we realized in their appeal that they are actually not challenging the finding of violation of the Virginia Computer Crimes Act. So it was a shock to us that they did not challenge that, but they just let it go. They are challenging the bulk of the money. They're challenging, yes, the size of the award for sure. They're going to try to change that. But the admission, well, not the admission, but the lack of objection to the VCCA finding was very interesting. And now we know which arguments they're going to take, and we're going to respond to that. We feel good about it. We've always felt good. I want to remind the audience that these are not punitive damage. Punitive damages are highly volatile. You don't know whether they're going to be collected or not because juries run wild and then someone has to rein them back in, that's punitive. If somebody finds a syringe in their can of Pepsi, the jury might punish Pepsi a lot more than the damage actually done just by saying, hey, don't put syringes in drinks. This is not like there. There is no dollars of punitive in this finding. It is purely undue enrichment. And undue enrichment is a lot harder to overturn. I'm not saying it's impossible, but it's a lot harder. So we've got an uphill battle, and we have a good legal team. And the jury found the evidence overwhelming and so did the judge. So we expect to fight on this for -- well, there's the appeal. The appeal will be late this year. We'll be in court. And if they lose that appeal, again, if they lose that. They will almost certainly appeal to the Virginia Supreme Court, which would take another year, right? And then they might even try to appeal to the U.S. Supreme Court. I feel comfortable in predicting that the U.S. Supreme Court has no interest in taking the case.

That's fair enough.

I think they would have to stop.

In terms of the impact of the final judgment, not only on Appian, but also in the broader marketplace, particularly with respect to like competitive deals. What's been the -- what have you seen with respect to that in terms of perspective deals?

Pegasystems has been very vocal. They go around bringing this up. And for a while, we were shy about it and just thought the legal process should take its course. But eventually, we had to post our perspective on our web page. And I encourage you if you're interested in hearing our perspective, just go to the web page and see what we say about it. Say Appian/Pega. I believe that Pega's recent decision to withdraw from trying to seek new logos speaks for itself. They are not attempting any new deals. They're focusing on a core of 250 customers, I believe they said. And that's very advantageous for us because not only can we win the new deals that they're not contesting, but I think we have a good shot at the 250. I think many of them have refused to do a new deal with Pega. In some cases, long-standing allies of theirs have made big announcements that they're making an investment in Appian. Accenture just said they were going to triple the size of their Appian practice. Some Pega stalwarts have refused to take a bid from Pega for their next business, and we are benefiting from that. So yes. I mean, Appian versus Pega is a classic rivalry in the space. We're the 2 firms is at the high end of process automation. So their weakness is our strength and vice versa.

Let's see if we had any questions for the team. If you can just raise your hand, I'll get a microphone to you. No questions, we're hitting all the topics. Quickly on just, you mentioned Pega as a competitor. But when you think about Microsoft Power Platform, ServiceNow, UiPath, parts of Salesforce. I guess the basic question is, is this a winner-take-all or most market? Or do you see an ecosystem of players then the market is big enough to support Appian's growth objectives?

There's going to be an ecosystem. I like to say inside of Appian, you can find only 2 choices in this market, you can be the biggest or you can be the best. Appian cannot be the biggest, not against Microsoft ServiceNow, Salesforce. We're not going to be the biggest. So all of our guns are focused on being the best, having the highest customer satisfaction, having the most advanced product, being ahead on the consolidation of the market. We are absolutely focused on being the best. I believe there is a long-term lane in this market for the best. For a best-of-breed pure play, I think there's a long-term lane. And right now, that's contested pretty much just by Appian and Pega. We have all these other rivals definitely, but they're mostly contesting the low end of the space. And so we have the high-end. And I don't believe we're likely to catch too much competition there. Economically, it doesn't make as much sense for a vendor who can scoop up the low end at very low cost to instead turn to the high end and invest a great deal to try to contest it.

Well, with that, we're out of time. Mark and Matt, thank you for giving us the update on Appian. Really appreciate it.

Thanks a lot.

Thank you.