Appian (APPN 2.56%) has been a volatile but profitable small-cap stock play in recent years. As of this writing, shares are up over 250% over the last three years. However, the low-code software development platform is facing a new challenge: COVID-19.  

While many businesses have been struggling to adapt under shelter-in-place mandates and work-from-home orders, companies in the digital world have been more resilient -- often seeing higher demand for their services because of the pandemic. It's a situation that would seem to bode well for Appian, too. But if management's guidance for the second quarter and its axing of full-year expectations are any indications, the company is finding the coronavirus crisis anything but smooth sailing.

A couple of aspects of our response to coronavirus have been particular drags on this cloud software and service provider, but the team at Appian is looking to use the immediate-term uncertainty to its advantage. 

Someone holding a tablet with a brain made of electrical connections hovering above the screen.

Image source: Getty Images.

Unpredictable business gets even more unpredictable

After a strong showing in 2019 (34% growth in full-year subscription revenue, 17% growth in total revenue), 2020 got off on the right foot. Revenue growth came in far higher than expected, and losses continued to narrow as Appian expanded.

Metric

Q1 2020

Q1 2019

Change

Subscription revenue

$50.4 million

$34.6 million

46%

Total revenue

$78.9 million

$60.3 million

31%

Total gross profit margin

69.4%

60.1%

9.3 pp

Adjusted EBITDA

($3.62 million)

($7.30 million)

N/A

Free cash flow, including cash paid for acquisitions

($10.2 million)

($20.7 million)

N/A

pp = percentage points. EBITDA = earnings before interest, tax, depreciation, and amortization. Data source: Appian.  

Thanks to the big advance in its high-profit-margin subscription revenue segment, gross profit on services rendered soared in Q1. Losses also narrowed, and free cash flow (revenue less cash operating and capital expenses) would have been a few million shy of break-even if not for Appian's purchase of a robotic process automation company in the quarter for a price listed as $6.14 million in the quarterly update.   

But though Appian's subscription low-code development segment accounted for nearly two-thirds of total revenue, its low-profit margin and unpredictable "professional services" segment still account for a sizable portion of the pie -- enough that it's going to cause some trouble in the headline numbers later this year. Even though its cloud-specific subscription revenue is expected to grow another 25% to 26% year-over-year in Q2, management said overall revenue will fall by 7% to 8%. Coronavirus-induced headwinds to professional services spending are largely to blame, and Appian warned this could persist through the rest of 2020.  

In addition, some revenue that was expected to be realized in Q2 got pulled forward into Q1, which explains that period's much-0higher-than-anticipated financial results. To be fair, CFO Mark Lynch said it is difficult to say just how seriously COVID-19 will ultimately affect Appian's customers, and the company does have a habit of under-promising and over-delivering. Nevertheless, investors should expect ongoing strength in subscriptions to be offset by weakness in the company's variable professional service segment as those customers moderate their spending in response to the pandemic and the recession it is causing.  

Low-code and automation are the way of the future

The picture isn't great at the moment, but it should be a temporary situation for Appian. As work-from-home orders are digested and organizations implement continuity plans to avoid further disruption, I believe top managers' attention will shift back to the digital tools that can help organizations update their operations. Appian CEO Matt Calkins agrees. The cloud-based digital transformation that enables remote work is more important than ever, and Appian's easy-to-implement low-code platform is an agent for that change.  

The robotic process automation (RPA) purchase it made in early Q1 should serve it well also. RPA creates software-based bots that can be deployed to interact with other software, liberating people from having to perform tedious time-intensive tasks. For example, Calkins said one customer, a labor union, is using its RPA to more quickly onboard and verify contractors. Another customer, an insurance broker, is using Appian's RPA for filling out annual loan and insurance documents.  

The coronavirus pandemic has caused a slowdown in new deployments of Appian's tech, but Calkins and company are preparing for what should be a big uptick in activity when the headwinds diminish. Adjusted EBITDA losses are expected to widen to between $14 million and $16 million in Q2, in part as it hires new talent and otherwise invests for growth.  

While it may not be a comfortable situation for all investors, I for one think advancing the subscription business will be well worth the money. At the end of March, Appian had $149 million in cash and equivalents and zero debt, so it certainly can afford to spend and grow its platform to a more profitable scale. In today's environment -- as has so often been the case in the past -- cash is king, and those companies willing to deploy it during times of rapid change more often than not come out stronger. COVID-19 is disrupting Appian's growth trajectory for now, but I don't think it will keep doing so for long.