Appfolio Inc

NASDAQ:APPF

Earnings Call Transcript 2023-Q2

[Operator]

Good afternoon. Thank you for standing by, and welcome to AppFolio, Inc. Second Quarter 2023 Financial Results Conference Call. Please be advised today's conference is being recorded, and a replay will be available on AppFolio's Investor Relations website.

I would now like to hand the conference over to Lori Barker, Investor Relations.

[Lori Barker, IR]

Thank you. Good afternoon, everyone. I'm Lori Barker, Investor Relations for AppFolio, and I'd like to thank you for joining us today as we report AppFolio's second quarter 2023 financial results.

With me on the call today are Shane Trigg, AppFolio's President and CEO; and Fay Sien Goon, AppFolio's Chief Financial Officer. This call is simultaneously being webcast on the Investor Relations section of our website at appfolioinc.com.

Before I get started, we would like to remind everyone of AppFolio's safe harbor policy. Comments made during this conference call and webcast contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections, future market conditions or future product enhancements or development is a forward-looking statement.

AppFolio's actual future results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in our SEC filings. AppFolio assumes no obligation to update any such forward-looking statements, except as required by law. For greater detail about risks and uncertainties, please see our SEC filings, including our Form 10-K for the fiscal year ended December 31, 2022, which was filed with the SEC on February 9, 2023.

In addition, this call includes non-GAAP financial measures. Reconciliations of these non-GAAP financial measures with the most directly comparable GAAP measures are included in our second quarter earnings release posted on the Investor Relations section of our website.

With that, I will turn the call over to Shane Trigg. Shane, please go ahead.

[Shane Trigg, President and CEO]

Thanks, Lori, and welcome to our second quarter 2023 earnings call. This quarter, we continued to execute our strategy while continuing to make progress toward increasingly profitable growth. Revenue saw a healthy 25% year-over-year increase, ending at $147.1 million. Units on platform grew to approximately $7.7 million and at quarter end, we had 19,145 customers.

Our non-GAAP operating margin continued to move further into positive territory, growing from 1% this time last year to 6.4% in Q2 this year. Free cash flow also improved to approximately 4.2%, up from negative 1.2% in the same quarter last year. Our results this quarter primarily stemmed from two interrelated drivers. First is our pace of innovation. We believe business is undergoing a new wave of digital transformation, thanks to the rapid advancement in generative AI ushered in by large language models.

The promise this holds for property management companies is clear. In a recent AppFolio survey of more than 2,000 property managers, we heard that employees are spending more than one-third of their time on repetitive tasks they consider busy work. By automating those tasks with generative AI solutions, AppFolio is able to give customers time back to deliver a better resident experience and improve overall job satisfaction.

We're in our fifth year of making meaningful R&D investments in AI through products like Smart Maintenance, our AI leasing assistant, Lisa, Bank Feed, Smart Bill Entry, Folio Guard Smart Insure and more. And now we have AppFolio Realm, which unites all of our AI-powered capabilities and better positions us to deliver on our product vision to create a world we're choosing, living in, investing in, owning and managing communities feels magical and effortless freeing people to thrive.

As a part of that Folio Realm, we're piloting a new conversational interface powered by large language models that allows customers to ask, tell and teach the software to complete tasks, draft and send communications, initiate actions and automate processes on their behalf, all without having to navigate a traditional graphical user interface.

Last month, we had the opportunity to showcase our AI capabilities, including AppFolio Realm, to more than 500 customers and prospects at NAA Apartmentalize, the largest multifamily industry event. In the words of Simon Wang, CEO of Hogan Invest and AppFolio Property Manager PLUS customer, since 2019 with more than 1,800 units on platform, and I quote, "the innovation in AppFolio Realm is going to propel our productivity. These AI capabilities won't just fuel our competitive edge, they are helping us become an industry leader."

The second driver behind this quarter's results is our continued commitment to increasing operational efficiency. We sharpened our focus on the closest to home initiatives that drive efficient growth and deliver extraordinary customer value. We've taken steps to optimize headcount, prioritizing critical hires who fuel innovation for our customers. We've also begun driving meaningful improvement in infrastructure spend and our support, sales and G&A functions. These improvements allow us to reinvest in our platform and accelerate our industry-leading innovation.

The relentless execution of our strategy continues to propel the success of our business. The first pillar of that strategy is building engaged and lasting customer relationships by delivering differentiated customer experiences. The ability to quickly understand changes in business performance is a critical need of our customers, one we've recently addressed with a series of improvements to our reporting infrastructure, allowing customers to filter and surface actionable insights nearly twice as fast.

In addition, customers using AppFolio Property Manager Plus will soon have more flexible data access via our reporting API. We also continue to find ways to deliver service excellence that makes it easy for customers to get the help they need when and how they need it. We recently released a new self-service capability that allows customers to engage with help and support resources at the point of need. Here, the results have been outstanding. The number of customer issues we resolved within the first 24 hours has increased by 17%. We've also increased the number of cases customers can solve immediately on their own through self-help resources.

Case resolution not requiring human assistance now accounts for just under one-third of our total case volume. Customer satisfaction has improved, and our support team is better able to focus on high-value interactions with our customers.

Another pillar of AppFolio's strategy is unlocking residential unit growth by acquiring new customers upmarket. We continue to expand our addressable market through innovation like affordable housing management introduced last month to all AppFolio Property Management Plus customers. Managing affordable housing comes with a unique set of challenges for property managers. In fact, in a recent survey, 75% of affordable housing operators ranked operational efficiency as their number one challenge.

Qualifying and recertifying residents of affordable housing requires a vast amount of reporting, often on disjointed systems. Affordable operators also have to meet much higher compliance standards than their counterparts in conventional housing. AppFolio's product allows property managers to manage their affordable housing and market rate units all on one platform, managing compliance, streamlining processes and consolidating accounting operations.

Over the last year, we collaborated with a group of Charter customers to build a product that embodies our customer-centric innovation, our ease of use and critical compliance capabilities. One of those customers, Dan McCoy, Executive Vice President of Operations of GSF properties serving the Fresno, California area through a mixed portfolio of more than 10,000 affordable and multifamily units on AppFolio had this to say, and I quote, "when AppFolio started pursuing affordable housing capabilities, we were fortunate to be able to have our compliance team work with them. It's good to know how we do business is reflected in the way that the platform was built."

Customers upmarket require a broad range of point solutions to complement their property management software and power their mix portfolios. In the second quarter alone, we announced seven new partnerships on AppFolio Stack, our B2B marketplace, bringing our total to 33 partners.

Since launching last year, we've seen tremendous adoption of Stack within our customer base. In fact, we closed the quarter with 1.2 million connected units. By growing our partner ecosystem, we've been able to expand our footprint without having to build native capabilities, accelerating the value we deliver to our growing customer base while improving our focus.

Let me give you an example. One of our new integration partners is Latch. They provide a terrific solution for smart lock technology in Class A and new developments. The integration allows AppFolio customers to automatically sync resident information and provision access through Latch manager's ecosystem of devices, software and services, saving teams time and increasing their efficiency.

The third pillar of our strategy is to expand customer adoption of AppFolio Property Manager Plus and our value-added services. Payments continues to be the fastest growing of our value-added services, and we're rapidly expanding our payments platform to help businesses create superior resident and vendor experiences in a safe and secure environment.

We previously talked about Apple Pay, which is now available in the AppFolio online portal for all residents. Since then, we've made additional exciting enhancements. One example is our flexible rent partnership with financial platform, Best Egg, which were available to all customers later this year, will give renters the flexibility to divide their payments into smaller, more manageable amounts that better align with their lifestyle and income schedule.

Another example is the enhancements we've made to AppFolio's accounts payable solution designed to reduce the manual burden on property managers to pay their vendors. Soon, vendors will be able to securely submit payment information through the vendor portal and choose their payment preference, resulting in more transparency and flexibility for vendors with significantly fewer steps in the payment process for property managers.

As a part of this new experience, AppFolio will also be adding instant payments, new functionality powered by Ingo Money that eliminates bank processing time and allows vendors to receive payments instantly post-payment approval. Vendors who choose to use this service will pay a percentage of the total transaction amounts.

Adoption of our payments platform continues to grow as we deliver increasing value on our platform over time. As this happens, aligning the value we provide with the value we receive is critical to delivering a safe and sustainable payments platform that our customers can trust.

Accordingly, we're implementing a change to our resident eCheck payments. Beginning July 31, we're no longer waiving the resident eCheck transaction fee. This change also applies to property management customers using our community association product.

We recognize this is a change for our customers and are working closely to support them during this transition. Updates like this help us continue to meet our responsibility to provide a secure, reliable and compliant platform while reinvesting to innovate at a rapid pace.

Wrapping up, we're quickly becoming the technology partner of choice for leading real estate businesses, from AI-powered innovation, including AppFolio Realm to our entry into the affordable housing segment, the addition of new AppFolio Stack partners and the expansion of our payments platform. We're focused on executing our strategy and delivering increasingly more value to our customers and their communities. We look forward to sharing more innovation at our annual customer conference in September and to hosting a virtual and in-person investor meeting later this year.

I'll now hand it over to Fay Sien.

[Fay Sien Goon, CFO]

Thank you, Shane.

We are pleased with our revenue growth rate and increasing profitability in the second quarter. As you heard from Shane, we delivered revenue growth of 25% year-over-year to $147.1 million and grew our free cash flow to 4.2% of revenue. Core Solutions revenue was $38.5 million in Q2, a 19% year-over-year increase driven by new customers, additional total units on platform and continued adoption of AppFolio Property Management Plus or APM Plus, particularly as we move up market.

At the end of the second quarter, we managed approximately 7.7 million property management units from 19,145 property management customers compared to 6.8 million property management units from 17,878 property management customers a year earlier. This represents a 7% increase in customers and a 13% increase in our ending property management units.

Value-added services revenue in Q2 grew 30% year-over-year to $106.1 million. While still attractive, the payments business growth rate was more moderate than in the previous few quarters. As we indicated in the last quarter's call, our 2023 guidance seems that the high adoption rate of cards for payments over the past few years will normalize in 2023.

Also, we saw increased adoption and utilization of our risk mitigation product called Folio Guard and screening services as well as a continued benefit from the rise in property management units under management.

Turning to spending. Headcount decreased 3% year-over-year to 1,723 at the end of this quarter due to normal attrition and a slower hiring rate as we strategically replace and enhance key positions with an eye to its operational efficiency and our pace of innovation.

In Q2 of 2023, the non-GAAP cost of revenue, exclusive of depreciation and amortization, was 39% of revenue compared to 40% in the second quarter of 2022. Our product mix has continued to shift due to an increasing mix of value-added services revenue. However, additional headcount efficiencies offset the related expenses for third-party service providers.

Now turning to non-GAAP operating expenses. Our year-over-year dollar increase in operating expenses for Q2 is primarily due to employee costs associated with retaining talent, particularly in specialized areas such as R&D. These costs will partially offset by a modest decline in ending headcount on both a year-over-year basis and on a sequential quarterly basis. As Shane indicated, we have taken steps to optimize headcount while maintaining or increasing our pace of innovation.

On a percent of revenue basis, combined sales and marketing, R&D and G&A fell to 51% in the second quarter of 2023 from 54% in the second quarter of 2022. As a percent of revenue, sales and marketing expenses decreased from 21% in the prior year to 18% in the current year. R&D expenses as a percent of revenue increased from 19% in Q2 last year to 22% this year.

As Shane said, we continue to invest in expanding our product offerings, including innovation in AI with AppFolio Realm and capabilities that will help us move up market, such as affordable housing and further expansion of the SPAC marketplace. Our G&A expenses as a percentage of revenue decreased from 13% in the prior year to 11% in the second quarter of 2023.

On stock-based compensation expenses, as a percentage of revenue, were lower than usual at 7.3% in the second quarter of 2023 compared to 8.5% in the prior year due to four features associated with changes in our leadership team. Overall, I am pleased that our non-GAAP operating margin in the second quarter of this year improved to 6.4% compared to 1% in the second quarter of last year. Free cash flow this quarter was approximately 4.2% compared to negative 1.2% in the same quarter last year.

Turning to the balance sheet. We ended the second quarter with $164 million in cash, cash equivalents and investment securities. As you heard from Shane, on July 31, we no longer raised the eCheck transaction fees, and this update will enable us to continue to invest in a platform that our customers can continue to trust. As a result, we are increasing our projected full year 2023 revenue guidance range to $592 million to $598 million. The midpoint of this range represents a full year growth rate of 26%.

Our change in guidance is primarily due to the new pricing on eCheck transaction, and as I said earlier, assumes that high growth in the use of cards for payments will moderate gradually in 2023.

Regarding the seasonality in our value-added services consistent with prior years, our property managers experienced an expansion of new tenants in the third quarter. This typically results in higher demand for our risk mitigation and screening services in the third quarter. Then in the fourth quarter, these value-added services are seasonally slower. We expect such seasonality to continue in 2023.

We expect 2023 cost of revenue, exclusive of depreciation and amortization relative to Q2 2023, will decrease slightly as a percentage of revenue due to changing product mix with value-added services revenue.

As a result of our increase in revenue guidance and operating efficiencies from moderation hiring, we are pleased to increase our full year non-GAAP operating margin guidance to 5.5% to 6.5% of revenue, and free cash flow is projected to grow from 6% to 7% of revenue.

Basic weighted average share of spending are expected to be approximately $36 million for the full year. Our guidance and second quarter results show that our growth strategy is working and we are improving profitability for a sustainable business. This is an exciting time to be at AppFolio, working with our customers and employees on building an industry-leading real estate platform while being at the forefront of new technology like AI.

Thank you for joining us on this journey and for participating in our call today. Operator, this concludes the call today.

[Operator]

Thank you. Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.