Erica Abrams - Investor Relations Brian Donahoo - President and Chief Executive Officer Ida Kane - Chief Financial Officer.

Brian Essex - Morgan Stanley Michael Nemeroff - Credit Suisse Bhavan Suri - William Blair Brendan Barnicle - Pacific Crest Securities.

Good day, ladies and gentlemen, and welcome to the AppFolio first quarter 2016 financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Erica Abrams. Ma’am, you may begin..

Thank you, Crystal. Good afternoon, ladies and gentlemen. Thank you for joining us today as we report AppFolio’s first quarter 2016 financial results. I’m joined today by Brian Donahoo, CEO, and Ida Kane, CFO of AppFolio, to discuss our results for the quarter.

This call is being simultaneously webcast on the Investor Relations section of our Web site at www.AppFolioInc.com. Before we get started, I would like to call everyone’s attention to our Safe Harbor policies. Please note that certain statements made on this call will be forward-looking and are subject to considerable risks and uncertainties.

These forward-looking statements may relate to our future expectations and future financial conditions. It may vary based on results of operations, business forecast and plans, strategic plans and objectives and product development plans.

Forward-looking statements represent management’s beliefs and assumptions based on information currently available. Forward-looking statements involve numerous risks and uncertainties that may cause actual results or performance to be materially different from any results or performance expressed or implied by the forward-looking statements.

We discuss these risks and uncertainties in greater detail in the Risk Factors section of our filings with the SEC. We assume no obligation to update any forward-looking statements after today even if new information becomes available in the future. And now, I would like to turn the call over to Brian Donahoo, CEO. Brian, please go ahead..

‘We used to pay listing services hundreds of dollars per month per property to drive Web traffic to our vacant units. Many of the leads weren't qualified, so it was a waste of time and money. By switching to AppFolio’s Premium Leads, we were able to save money and increase lead quality.’ We’re very pleased with the early progress in this offering.

And further on the topic of innovation, we’re evolving our entire property management solution to mobile formats, moving well beyond simplified mobile apps to provide the same deep level of functionality on both mobile and desktop environments.

We learn that our customers want to accomplish more and more complex activities on their mobile devices, ranging from accounting to reporting to marketing. It's exciting to see how quickly customers are adopting this more sophisticated mobile functionality.

In the first quarter alone, we’ve seen logins via mobile device increase 140% over the prior quarter and we think that’s only the beginning of what would be a major shift in the digitization of property management. AppFolio is leading the way in mobile and focused on becoming the most mobile friendly solution in property management.

And now turning to the legal vertical, MyCase customers increased 61% to 6,834 firms in the first quarter as we leverage our sophisticated marketing and sales engines to win new customers.

We released several new innovative features throughout the quarter with a focus on enabling deep collaborations between law firms, their customers and other partners. We’re enhancing our Value+ payments offering in this vertical in 2016, further extending our land and expand strategy.

And today, we commemorate Law Day and the 50th anniversary of Miranda rights in partnership with the American Bar Association at NASDAQ’s MarketSite. This year, the President of the ABA is our featured speaker for a evening of networking, fun and topics of interest for MyCase customers and prospects throughout the New York Metro area.

This event underscores our commitment to the legal industry, continuing our investment in educating small practitioners on how to run a more successful and efficient business. Customer satisfaction remains high in the quarter.

We were active in both verticals, conducting meet-ups and other customer networking and educational events to facilitate our customer feedback loop and ensure customer satisfaction. Maintaining a strong commitment to customer service is a core part of our business.

It’s critical to our customer success and plays an important role in our consistently high customer retention. In summary, our momentum continued in the first quarter and we’re off to a strong start to physical 2016.

As we look to the remainder of the year, we remain committed to our strategy of keeping customers happy, acquiring new customers and expanding units under management, broadening our product offerings, and driving the adoption of Value+ services.

Our success to-date is the direct result of the hard work and dedication of our employees, the commitment from our customers and our continued support from Board members and investors. Thanks to all of you for your contributions. And with that, I’ll turn the call over to Ida for a more detailed financial review of the quarter..

Thanks, Brian. We had a strong start to our 2016 year. Total revenue for the quarter was $23.2 million, up 46% from $15.8 million reported one year ago. As a reminder, we break out revenue into three distinct categories – core solutions, Value+ services and other services.

Core solutions revenue was $9.8 million in the first quarter, up 37% from the same quarter of last year. Growth in subscription revenue for our product was driven by an increase in new customers and increase in average size of our new customers and strong customer retention.

To this end, we closed out the first quarter of 2016 with approximately 8,800 Property Manager customers, reflecting an increase of 36% from one year ago, and 6,800 law firms, reflecting an increase of 61% year-over-year.

At the end of the quarter, our Property Manager customers were managing 2.3 million units in their portfolio, up from 1.81 million units one year ago, reflecting a 27% increase year-over-year. The increase in units drives additional core solution revenue as well as incremental Value+ revenue.

Value+ services revenue was $12.3 million in the first quarter, up 59% from one year ago. Growth in Value+ services revenue was primarily driven by increases in customer count and by the success of our land and expand strategy with increasing units under management for our Property Manager customers.

Each of our Value+ service offerings experienced revenue growth year-over-year, although the majority of the growth in absolute dollars came from increases in revenues earned through our electronic payment platform and resident screening services platform. As Brian discussed, we released AppFolio Premium Leads during the first quarter.

Revenue generated from customers using AppFolio Premium Leads through our Property Manager platform will be included as Value+ services revenue. Our legacy RentLinx revenue continues to be recorded in other services. Other services revenue was $1.2 million in the first quarter, up 18% from one year ago.

This growth was driven primarily by the incremental revenue related to the acquisition of RentLinx that closed in April of 2015. For the remainder of my prepared remarks, unless otherwise noted, I’ll discuss non-GAAP results which exclude the impact of stock-based compensation expense.

A reconciliation to the corresponding GAAP results can be found at the end of the press release issued today, linked to our investor relations site at www.AppFolioInc.com. As I review operating results today, I will discuss both year-over-year and sequential quarter results.

As we have discussed, we are focused on our long-term sustainable growth and stockholder value and will continue to invest in our business for the long-term best interest of the company. This results in expenses today which may not result in revenue until subsequent periods.

Nonetheless, we are starting to experience operating leverage and we anticipate improvements in our operating margins over time. At March 31, we had 601 AppFolians, serving customers and shareholders, up 40% from 430 one year ago and up 5% from 573 in the prior quarter.

Cost of revenue, excluding depreciation and amortization, was $10.5 million or 45% of revenue in the first quarter as compared to $9.4 million or 46% of revenue in the prior quarter. The same metric one year ago was 44% of revenue.

Sales and marketing expenses were $7.5 million or 32% of revenue in the first quarter as compared to $7.1 million or 35% of revenue in the prior quarter. The same metric one year ago was 36% of revenue. We’re pleased with the operating leverage we are gaining in our sales and marketing model.

Research and development expenses were $3 million or 13% of revenue in the first quarter as compared to $2 million, flat as a percentage of revenue in the prior quarter and year-ago period. We expect to continue to invest in R&D to expand our product offerings in the vertical markets we serve.

General and administrative expenses were $3.2 million or 14% of revenue in the first quarter as compared to $3.1 million or 15% in the prior quarter. The same metric one year ago was 21% of revenue. We, again, are pleased with the continued leverage we've gained in G&A expenses as a percent of revenue.

Stock-based compensation that went to our P&L in the quarter was $463,000. Non-GAAP adjusted EBITDA was a loss of just under $1 million in the first quarter of 2016 as compared to a loss of $1.7 million in the prior quarter. This represents a sequential quarter improvement of 42%.

As we discussed with you last quarter, we are beginning to report and look at non-GAAP adjusted EBITDA as a measure of operating performance and continue to target positive adjusted EBITDA by early 2017. Weighted average common shares outstanding, used to calculate loss per share in the first quarter, was 33.5 million.

Moving to the balance sheet, we closed the year with approximately $52 million in cash and cash equivalents and investment securities and no debt. We used approximately $740,000 in cash for operations in the quarter, $1.9 million for capital expenditures, and $2.2 million for addition to our capitalized software.

In summary, we had a strong start to the year and are encouraged with the operating leverage we have gained. As we look to the remainder of the year, we are maintaining our outlook for revenue in the range of $100 million to $104 million, which represents year-over-year growth of 36%, at the midpoint of the range.

We are committed to continued improvement in our operating model and expect to reach positive adjusted EBITDA by early 2017. With that, I would like to turn the call over to the operator for questions.

Crystal?.

Thank you. [Operator Instructions] And our first question comes from Brian Essex from Morgan Stanley. Your line is now open..

Hi. Good afternoon and thank you for taking the questions. I was wondering if we could start by maybe digging into the Value+ services just a little bit and the impact that RentLinx may have had on the quarter.

And, specifically, I am interested in not just the revenue contribution, but also on the margin as I believe that Value+ tends to carry with a lower gross margin.

So how should we think about the addition of RentLinx on to the platform going forward?.

Sure, Brian. Good question. So for the quarter that we just finished, RentLinx was a very small part of our revenue. Think of it as significantly less than $100,000. We’re just launching the product.

So from a go-forward perspective, we’re really excited about the opportunity it brings us, expanding into a new area of Property Manager spend, being the advertising spend. From a margin perspective, it does come to us at approximately a 50% after-direct-cost-of-revenue-associated-with-it margin.

But it adds in a very nice way to our operating leverage over time. There aren't a lot of incremental costs that we will incur in supporting it over the long-term. So think of it as adding potentially significant operating margin dollars to the business..

Got it. And maybe on operating leverage, nice leverage in the quarter. G&A costs below where they were last year from what I can see.

Where are you primarily getting that leverage from? And what can we expect – I understand you’re going to plough back into R&D in that, but what can we expect in terms of areas where you’re going to gain the most leverage and how do you think about that drop in G&A versus where we were last year?.

Yeah. So I think G&A last year in the first quarter was about $3.3 million, and that’s including stock-based comp; this year, $3.5 million including stock-based comp. Remember, last year, we weren’t a public company. So I’d say that maybe accounts for a little bit of the difference in the stock-based comp expense that you're seeing there.

But, otherwise, I think the last couple of quarters, we've been relatively stable in G&A. .

Got it.

So is that where would you see the most leverage going forward?.

We’ve certainly seen some leverage there over the last couple of quarters and we’ll continue to invest as we need to to support the growing organization, but, obviously, the costs directly correlate to an increase in revenue..

Maybe just to kind of put a finer point on it, in terms of upside to the quarter that you may have realized, how would you kind of prioritize the spend for that upside and what you might kind of let fall through to the bottom line?.

So in the past, we’ve talked about the understanding that we have some directly correlated cost in cost of revenue, right? So as revenue grows, we’ll have some third-party costs that will continue to grow directionally to the growth in revenue.

And as we’ve seen, again, we continue to invest in R&D, obviously, which is strategic to us, short-term and long-term, both addressing the needs of our customers as well as expanding into different revenue opportunities.

So I think what you’ve seen come through in the business model the last couple of quarters, which is on the selling and marketing side as well as the G&A side, are additional opportunities for increased leverage in the future..

Got it. Okay, thank you very much..

Thanks, Brian..

Thank you. Our next question comes from Michael Nemeroff from Credit Suisse. Your line is now open..

Hi, guys.

Can you hear me okay?.

Yes..

Yes, we can..

All right. Thanks for taking my questions. And nice job in the quarter. Just a couple of questions. Last quarter – I know it’s early days, but can you just give us a sense on the progress as you last – you talked about heading up-market a little bit into the mid-market.

Maybe, Brian, if you could tell us some of the preparation that you’ve been doing and some of the progress that you’ve made there..

Sure. Yeah. Michael, you know that we focus on the SMB segment of the property management market and these are customers that have unit portfolios or real estate portfolios between 20 and 3,000 units. Just as a reminder, we’re not focusing on the enterprise space, which we would say is probably 10,000 units and higher.

We’ve become the de facto standard for the first time buyer in the property management market and the small property manager. And we’ve really figured out how to scale that side of the business. And over the last quarter, we’ve really aligned and focused our resources on prioritizing prospects with higher unit counts.

I would really characterize this as an alignment of our existing resources, of our marketing and our sales and sales support resources more than anything else. And early progress is good. We’ve seen average unit size in the quarter for new customers increase significantly. We’re happy with that and we expect to see that trend continue.

We’ll have some variability, but we’ll see it continue. We are committed to the small and medium-sized business space and I think we’re doing a smarter job of aligning resources on higher value targets..

That’s great. Maybe, Ida, if you would, just maybe – I know you don't like to give out some of the quantitative details. So maybe if you could qualitatively just discuss ARPU and the trends that you saw in the quarter and whether you were pleased or displeased with the different sides of the business, both in the legal and the APM verticals..

Yeah, sure. So I guess what I would say there is we’re very pleased with the results that we had in the quarter. If you look at revenue on a sequential quarter basis, we had talked about Q4 being lower Value+ revenue, specifically in the screening market.

And we had anticipated, as we have seen in the past, that that comes back to us in Q1 and it did again this quarter.

So we feel like we’re making steady improvements or increases in ARPU as our customers continue using the Value+ services that they are using and then expand into additional Value+ services that we've offered, the latest one being Premium Leads on the property management side, which we’re excited about as well.

So we’re pleased with the progress in ARPU. On the legal side, it’s been pretty steady as well with the Value+ service that we have there. And so, we continue to work on expanding both the number of customers we bring in as well as the revenue per customer..

Great. And then, just lastly, Ida, you had mentioned adjusted EBITDA positive by early 2017, would you expect that all of 2017 will be full-year adjusted EBITDA profitable or just to get to that level by early 2017? Thanks. .

Sure, thanks. So, I guess, what I’d say there is that we continue to, obviously, make decisions to grow the long-term – to create a long-term sustainable growth engine for our shareholders. And from time, we’re going to make investments that could impact the short-term, be it a quarter or two.

But we are seeing leverage in our model and we continue to focus on expanding that leverage in the form of adjusted EBITDA positive by early 2017. So we’re excited about where we are..

Okay. Thanks for taking my questions. Thank you..

Thank you..

Thank you. And our next question comes from Bhavan Suri from William Blair. Your line is now open..

Hey, guys. Thanks for taking my question. And nice job there. Just wanted to touch first on, when you look at the Value+ services, you commented sort of that some of it come back. Growth had tapered down there a little bit sort of even from the year-ago period, the last quarter.

Sort of when you look at that, just some color on what you’re seeing in terms of strengths and weaknesses of some of the particular Value+ services, the Web site, the payments, background check, et cetera.

Just a little more on each one of those and sort of how those have been performing vis-à-vis expectations? Probably some did well, but it sounded like growth slowed there a little bit..

I’d say we’re really pleased with the results across the board and feel good about the growth and expansion that we’ve had in Value+ services across the board. So, yeah, I’m not sure that – I think there’s certain visibility that you have, but under the covers there is positive growth across the board there..

Okay, okay. And then when you look at the pattern – and you guys have talked about historically sort of what gets adopted together, what gets adopted first.

Any color in terms of – has that changed at all or are those still pretty consistent in terms of what new customers will start adopting from Value+ service and sort of how those expand?.

Sure. Brian, I’ll take that one. We haven’t seen any change to that. We have a large number of Value+ services, most of them really mission critical to our customers’ business. Most of our customers adopt our payment platforms, which was really a number of revenue sources, as well as our background screening services kind out of the bat.

And then a large number also adopt our Web site services. But we haven’t seen any change to those adoption rates. And I think the other thing that’s important to understand on that is, adopting is one thing, but also we need our customers to use those services, and our customers are using those – continue to use those services at record rates.

I’ll also remind you there is some seasonality to the screening business, which is a large part of Value+ services in Q4 as residents are less likely to move during that period of time. And so, those rates do go down a little and then they bounce back in Q1 and they certainly did bounce back in Q1 this year.

Did that help you with the question?.

Yes, it does. No, that’s helpful. And then one quick one on sales and marketing, I think there have been a couple questions on leverage. You did a nice job there. When you look at the sales and marketing model, you’ve, obviously, sort of shifted some of the acquisition costs towards targeting some of these, let’s say, slightly larger customers.

But is the efficiency cost still driven by the leverage on the Inside Sales model or is this sort of a broader strategic thinking about lower sales and marketing costs vis-à-vis getting the – how should we think sort of how you guys have approached that?.

We really just aligned resources to focus more intently with our Inside Sales model. That is really what we’re doing. We’re doing – we’re focusing kind of our resources on those larger opportunity customers, but, really, we’re doing it with the same set of tools that we've been using.

I wouldn't say that that's an area that we are intently focusing on in terms of cost reduction or efficiency as we get to profitability. We’re looking at all parts of the business for that. But, really, in that area, we’re doing more with what we have and we’re aligning resources to the higher opportunity targets..

Got it, got it. That’s really, really helpful. And then a quick update on the competitive environment, largely in legal, sort of how are win rates looking? And sort of that tends to be – the property management space, you’re sort of becoming, as you said, de facto.

How is the legal sort of competitive landscape looking? Any change there? And maybe some color on win rates, that would be really helpful. Thank you..

Yeah. I’ll take that one as well. We added around 689 new firms during the quarter. It was a record for firm growth for us. So I would say there's still a big greenfield opportunity there. The small and medium-size solo practitioners are really overlooked in terms of the technology world today.

So we haven't seen any significant change to the competition in that area. Much like property management, we’re not usually selling against an incumbent, we’re selling paper and pencil and a lot of other solutions and we’re usually the first system of record that small and solo practitioners are buying..

Great. Great, guys. Thanks for taking my questions, Brian and Ida. That was helpful. Thanks again..

Thank you..

Thank you..

Thank you. And our next question comes from Brendan Barnicle from Pacific Crest Securities. Your line is now open..

Thanks so much.

Ida, following up on Brian's question on gross margins, given the impact from RentLinx, can we assume that gross margins have bottomed in Q1?.

So, Brendan, I guess, what I’d say there is we talked before about how the revenue mix impacts our gross margin. And so to the extent – on an individual product basis, there are some third-party costs associated with them.

So to the extent that the amount of revenue coming from one of those Value+ services fluctuates or gains significant traction vis-à-vis other ones in a particular quarter, there could still be fluctuation.

I think we have seen, in the past, in Q4, an increase in our cost of revenue as a percentage of revenue based on the decline in screening revenue, for example. My expectation would be that that continue in the future, as it has in the past.

Now, what I will say is, we continue to gain leverage in some aspects of our – and look at other aspects of our cost of revenue cost in total to gain additional leverage over time. And so, we’re working on kind of offsetting some of those costs as well. But I wouldn’t say it’s forever going to improve from here on out. There’ll be fluctuation..

Great. That's helpful. And, Brian, you mentioned the increase in the number of units at new customers. And we calculated that as well. Now, we’ve seen, as a result, not surprisingly, sort of a deceleration in your new customer additions.

Where do you think that bounces out? When do you think you’ve kind of hit that sweet spot of – you’re at that optimal size that you’re going to go after and then we can start to see maybe that customer count number start to accelerate growth again..

Yeah. We had a great quarter there. We’re happy with the balance that we've seen between the number of customers and their average portfolio size, as you noted. That is going up. And again, that is really a result of our aligning resources, sales and marketing and other resources, against the highest value prospects.

I think you’ll continue to see that trend over the year. I don't know how to tell you where it’s going to balance out. I think you should expect to see continued progress towards that throughout the year. I think we’re relatively early in making those adjustments and seeing the results of those adjustments..

Great.

And then lastly, when you think will be the point where you might start to break out the contribution from legal?.

Yeah. So what we’ve talked about before is to the extent that the revenue becomes kind of 20-plus-percent of the business that we would break that out, so we’re still south of 10%. So I’d expect to still be a ways out here..

Great. Thanks, guys..

Thank you. And I’m showing no further questions at this time. Ladies and gentlemen, this conference will be available for replay after 8:00 PM Eastern Standard Time today, May 9, 2016 through May 13, 2016 at 11:59 PM Eastern Standard Time. You may access the remote replay at any time by dialing 1-855-859-2056 and entering the access code 93220882.

That does conclude our conference for today. Thank you for your participation in today's conference. You may now disconnect at this time..