Edited Transcript of APX.AX earnings conference call or presentation 27-Aug-20 1:30am GMT


CHATSWOOD Aug 29, 2020 (Thomson StreetEvents) — Edited Transcript of Appen Ltd earnings conference call or presentation Thursday, August 27, 2020 at 1:30:00am GMT

* Kevin B. Levine

Citigroup Inc. Exchange Research – Research Analyst

Thanks, Amanda, and hello, everybody. Welcome to Appen’s First Half 2020 Results Conference Call. Thanks for your continued interest in and support of Appen. And I trust you’re all keeping well in the pandemic. My name is Mark Brayan. I’m the company’s Chief Executive Officer, and I’m joined today by our CFO, Kevin Levine.

We’ll skip through the presentation that was provided to the ASX this morning, and we will allow some time for questions later in the call.

So to the presentation into Slide 3. We’ll start there with a brief overview of Appen for those of you that may be new to the company. We provide training data for artificial intelligence or AI. Training data is an essential building block of AI. It’s how the AI learns to do things like humans, learn how to understand speech, how to see things such as text and signs. An autonomous vehicle, for example, can read road signs, provided it’s fed with thousands of pictures that have been identified or labeled as road signs.

Our customers are the developers of AI products for sale or to improve their business. We collect and label vast data sets of image, video, text and audio data to help them build those products.

AI in the market for training data is rapidly growing, and AI is tipped to become more important after the pandemic as companies accelerate their plans to digitize and respond to the new normals of more online shopping and contactless everything.

We are a strong performer in this market. We’ve grown consistently since our foundation in 1996, and we’re very well positioned with our million-plus multi-language crowd, our technology platform and our uninterruptible at-home business model. And we’ve had another terrific half.

To Slide 4, to look at the results highlights for the first half of 2020. We’re very pleased to announce that we’ve maintained high growth in the first half of 2020. Revenue was up 25% on the first half of last year to $306.2 million. This is comprised of $273.9 million of Relevance revenue, up a commendable 34%, and $31.9 million of Speech & Image revenue. This is down 20% on the prior period for reasons we’ll explain shortly.

Underlying EBITDA of $49.1 million was at a margin of 16.0%, which was clearly our guidance to the market of margins in the mid-teens. And that underlying EBITDA was up 6% on the first half of last year and included substantial investments into our growth initiatives, and we’ll discuss these initiatives in more detail later in the presentation.

Without these investments, underlying EBITDA would have been up 35% to $62.5 million. This highlights the increasing operating leverage of the business.

In addition to the strong financial performance this half, we delivered on a number of important strategic initiatives. We’ve successfully cross-sold our annotation platform, and this is the platform that we acquired with Figure Eight, and now have 4 out of our top 5 major customers using the platform for mix of pilot and production projects. This is extremely impactful. It means that we can serve our customers in many more ways as the platform enables us to work in multiple data types. It also means that we have greater control over the delivery of the data, which enables us to improve the quality of the delivery on the data and, of course, the margins.

Now we’ve also signed an enterprise-wide platform agreement one of our major customers that includes an USD 80 million annual commitment. And this improves the quality of our earnings and lifts our annual contracted value, or ACV, to USD 103 million at the end of the half.

Our business continues to be in robust health. We are holding the course on our growth strategy with no material change to our investments. We had $126 million in cash in the bank at the end of the half, and we’re pleased to announce a dividend of $0.045 per share. And that’s 50% franked and up 12.5% over last year.

Slide 5 and an update on Relevance. For those that may be new to us, Relevance data helps train search and social media platforms to ensure the relevance and currency of search results, online ads, product recommendations and other services that we all rely upon every day. Relevance revenue was up strongly this half by 34% to $273.9 million. Relevance EBITDA of $52.2 million was up 19%, and that’s impacted by the inclusion of the growth investments.

The Relevance result has benefited from the strength of our customers. They include the world’s largest online platforms that have become essential services during the pandemic for information, socializing and shopping. The results also benefited from the resilience of our at-home crowd delivery model.

The chart on the right of the page shows consistent high growth, now at 64% compound annual growth since we listed in 2015. This is due to the ongoing demand for data from our major customers but also due to new project wins with existing and new customers.

To Slide 6 and an update on Speech & Image. Speech & Image revenue of $31.9 million for the half was down on a very high first half result in 2019. And this is due to the cyclical nature of Speech & Image projects but also due to the pandemic, of which more later. And despite being down on the first half last year, it was our second strongest half for Speech & Image in the history of the company.

EBITDA was down due to the revenue result and because we’ve not reduced expenses more than we planned to as we have high conviction on the future of Speech & Image, and we need our expert resources to deliver that future.

Our confidence is bolstered by the fact that 4 of our 5 major customers are using our annotation platform now, opening more Speech & Image opportunities amongst those customers. Also, our sales and marketing investments are yielding through some new customer wins in the half. More on these later in the presentation.

And the chart on the right-hand side shows a positive long-term growth trend and also illustrates the cyclicality of the projects.

To Page 7 and our cohort chart, which shows revenue by customer cohort by year of origination and for each successive year thereafter. And this continues to show a healthy long-term growth trend and repeat revenue. The contribution to committed revenue this half and the increase in committed revenue over time will strengthen the quality of our revenue and earnings, as will the addition of new customers through investments in sales and marketing.

We’ve made substantial progress in driving value from the acquisition of Figure Eight. If you turn to Slide 8, you’ll see the premise behind the acquisition on the left-hand side of the page. The acquisition combined Figure Eight’s market-leading platform and Appen’s 1 million-plus multi-country crowd to offer full suite solution in all data types and over 180 languages. No competitor has an offering this complete and at this scale to our knowledge. The breadth of the offering opens markets. We can now work in image, video, LIDAR, speech and text data. And that can be used to build virtually any AI product.

The platform, in enhancement since the acquisition, streamlined and increasingly automates the processes of data collection and labeling. That enables scale and margin expansion. We’re seeing productivity gains, for example, of over 100% with improved quality when we use speech recognition to pre-transcribe data prior to sending into our crowd to complete the work and to check the quality.

The platform will also enable a deeper connection with our customers. It can integrate with their systems and workflows to become a critical part of their AI infrastructure. And this connection is valuable. Our customers are committing to spend with us accordingly, and this improves the quality of our earnings.

We delivered specifically on this thesis this half. We now have 4 of our 5 major customers using the platform, which means we can work with them on more projects and more data types. It also drives committed revenue. We signed an enterprise-wide platform deal with one of our major customers that included an USD 80 million commitment to the platform and crowd services. This drove a substantial increase in our committed revenue. Our ACV, annual contracted value, was up 405% to USD 103 million at the end of the half. We’re using ACV now in place of ARR because we’re including platform and service revenue in ACV.

Revenue derived from committed contracts is up 75% and is now 12% of our total revenue. We also won a number of new customers in the period across all data modalities. None of these achievements would have been possible without platform and without the acquisition of Figure Eight. The integration of Figure Eight is now substantially complete. We have a single infrastructure and unified teams, unified branding and visual identity, a single integrated back office and a unified go-to-market offering. There’s a few outstanding tasks to fully combine our crowd, and we expect that to be completed soon.

We finalized the transaction of Figure Eight during the period with an earn-out payment of $39 million for a total investment of $286.5 million. Note that we won’t be reporting separately on Figure Eight henceforth, just as we don’t report separately on Leapforce anymore.

Slide 9 provides more details on our committed revenue. The chart on the left shows the substantial increase in annual contracted value or ACV to USD 103 million, up 405%. The increase is underpinned by the USD 80 million commitment from one of our largest customers.

The chart on the right shows the increase in committed revenue. We derived $36.3 million or 12% of our total revenue from committed contracts in the half, up from $20.8 million or 7% of total revenue last half. Note that the USD 80 million deal was done towards the end of the half, hence not fully represented in the revenue chart and also that ACV includes platform and crowd services. We’re winning more deals to bundle them together rather than platform only, hence Figure Eight [has these two] and services only for Appen.

The first half of 2020 included substantial investments in our growth initiatives. Slide 10 shows a breakdown of these investments. In sales and marketing, to add new customers and improve customer diversification; in China, to open the second biggest AI market in the world; in technology, to add capabilities for opportunities, automation and scalability; and opening the government sector. Most of these investments are specific to these areas and incremental to the money we spend on our regular investments such as additional project management and recruiters to support our growing business.

The chart on the left-hand side of the page provides a bridge from last year’s first half underlying EBITDA to this year’s. Not only can we see the size of the investments this half, but you can also see that, without these investments, EBITDA would have been up 35% on to $62.5 million at a margin of 20.4%. This illustrates our strategy of using scale and technology to improve operations, expand margins and reinvest those margins into the growth of the business. Also, the 35% growth to $62.5 million outpaces revenue growth and shows the operating leverage of the underlying business.

Strength in the underlying business and a high growth rate of our market gives us the confidence to continue to fund our own growth and press forward with our investments to build further strength into the business.

Let’s look at each of these in turn, starting with China on Slide 11. We’re very pleased with our progress in China. We are making genuine inroads into the market. The chart on the left shows monthly revenue to July in Australian dollars. You can see that it’s growing at quite a clip. Revenue in July, for example, was 6x revenue in January. The growth is coming mainly from the tech sector and the Chinese tech giants, in particular. Unsurprisingly, we’re building a strong position providing international data. We’re also very pleased to be winning projects in domestic data against local players. We’re working in all modes of data: text, speech, image and video and also on a number of Relevance projects.

And we maintain strict separation between our global and China operations and technology to ensure the integrity of our IP and data. We’re also in the middle of an internal audit to check that our systems and controls are working as planned. Overall, we’re very pleased with our team in China and made terrific progress.

Slide 12 provides an update on our technology. Diagram on the left is from our Tech Day in May and lays out our technology strategy. Our platform, inclusive of crowd management, client work space and annotation tool functionality, accelerates scalability through product breadth and crowd and internal productivity. These lead to 3 important commercial outcomes: including revenue growth and quality; more platform capabilities enable our participation in a broader set of projects, which increases revenue and diversifies our customer base; it also leads to productivity gains due to the scale and margin expansion that we get from the automation capabilities; and finally, it builds a strong competitive mode.

Some recent updates on technology include our LiDAR functionality that enables us to work in 3 dimensions. This is critical for applications, including robotics, manufacturing and, of course, autonomous vehicles. We’ve also released pixel-level image annotation for highly accurate data for computer vision applications.

We’re making great progress using AI to accelerate our crowd and internal operations. We now have a purpose-built speech recognizer that’s improved our transcription productivity by over 100%, including unlisted quality. This means we can produce more for our customers off the same cost base and improve our scalability and margins in the process.

We’ve also used AI to automated parts of our crowd worker onboarding process. We’ve reduced the process that used to be hours per worker to a matter of minutes. Finally and very importantly, we’ve implemented fair pay functionality into our system to ensure that all of our crowd worker is being paid fairly for the work they’re doing for us.

To Slide 13 in sales and marketing. It’s early days with our significantly enhanced sales and marketing capability, and we’re seeing some very pleasing results. We now have a truly global sales team with multiple teams in our biggest U.S. market, and they’re organized by a mix of market sector and company size. We also have a growing team of technical experts that support the team and bring the best of our [team] to every customer and opportunity.

We won quite a few new customers in the half across a mix of Speech & Image data. Some of them are represented on the left-hand side of the page, and they span Europe and the U.S. as well as some in Asia Pacific. At least one of them has come out of the pandemic. The one on the top right-hand side, for example, is the contactless ordering and delivery for a global fast food chain.

All of our new customer wins are underpinned by the annotation platform. We wouldn’t have had them without it, going once again to the importance of the platform and the Figure Eight acquisition. These customers are new and small, but given the ongoing data requirements of AI, we expect them all to grow over time.

Our final growth initiative is the government market on Slide 14. We’re pleased to report that we’re now fully set up for this market and can participate as a prime or subcontractor. Our setup includes an experienced team and a fully air-gapped technology and operational setup. It is early days for us in this market, but we believe there is substantial potential given the focus on AI by governments around the world.

I’ll now hand it over to Kevin, our CFO, to take you through the numbers in more detail.

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Kevin B. Levine, Appen Limited – CFO [2]

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Thank you, Mark, and hi, everyone. Group revenue is up 25% on the prior corresponding period driven by continued strong growth in Relevance, which is up 34%. This growth was driven by increasing demand for annotated data mainly for the existing projects within existing customers, requiring ongoing need for data refresh as well as new projects in existing and new customers. The major customers have been a source of strength and robustness for the last 3 months.

Speech & Image revenue is down 20%. Speech & Image process are cyclical in nature, heavily dependent on customer timing, investment and product life cycles and require less ongoing data refresh than Relevance projects. As a result, this can significantly consume performance on a half-on-half year-on-year basis, as evidenced in this half, as a very large transcription project with significant volumes in the prior corresponding period completed.

In addition, new business sales and data collection projects have been delayed, impacted by COVID-19. While the project nature of these activities will continue to be a key characteristic for this division, the long-term growth trend for Speech & Image volumes is positive.

Underlying EBITDA of $49.1 million represents a 6.0% increase over the prior corresponding period. As Mark mentioned, this result was impacted by the planned investment in sales and marketing, engineering and the Chinese and government verticals in order to drive long-term sustainable growth potential and performance. This investment resulted in an underlying EBITDA margin of 16.0%, down from 18.9% in the prior corresponding period.

However, excluding the impact of these investments of $13.4 million on the first half results, the resulting underlying EBITDA of $62.5 million, is up 35% on the prior year results. In other words, if there is no incremental increase in spend going forward and everything else stays the same, then underlying EBITDA would be $13.4 million higher.

Underlying NPAT of $28.9 million represents a 3.0% decrease from the prior corresponding period. This result was impacted by the planned investments as discussed. And excluding the after-tax impact of these investments of $10.3 million, the result in underlying NPAT is up 32.4% from the prior year results.

The effective tax rate for the period has reduced to 23.3% from 28.2%. The effective tax rate is subject to fluctuation from the tax effect of weakness from expensing and vesting of employee performance shares. Excluding these performance share-related movements, the normalized tax rate is circa 28%.

On to the next slide, 16, let’s talk about the balance sheet. Through strong operating performance and effective working capital management, the balance sheet continues to strengthen. This is always important and now more so than ever. Our balance sheet continues to display strength during these challenging times with an increased cash balance of $126 million.

Receivables have decreased as a result of positive impacts from timing of receipts. I’ll go into this in further detail when I talk about cash flow in the next slide.

Noncurrent assets comprised mainly of goodwill and identifiable intangible assets, mostly arising through the acquisition. With a high level of half year incentive review and following from a detailed full year review, we report significant headroom in the current value of these intangibles.

Borrowings comprise debt drawn to fund the Figure Eight earnout payments. Given the strength and confidence in the business, this debt was repaid in August. The debt facility remains available for [the future].

And speaking of confidence, the interim dividend payment has increased to $0.045, up 12.5% from the prior corresponding dividend and is flat to 50%.

Moving on to the next slide on cash flow. The cash balance has increased by $55 million from June ’19 and by $51 million from December ’19. The cash balance and cash conversion percentage has been positively impacted by timing of customer receipts. You will recall at year-end that we talked about some receipts expected in December ’19 that we received in January ’20. In addition to that, some receipts that we expected to receive in July ’20 were actually received in June ’20.

Cash flow from operations is strong and has benefited from working capital management and has increased by 75% (sic) [77%]. Cash has been effectively deployed for payments relating to tax, dividends, CapEx, operating expenses and growth investments. Cash conversion remains very strong at 154%.

On to the next slide. We do have a currency impact when we report, and that is because almost all revenue and earnings are generated offshore and mainly in U.S. dollars. As a result, we always show the constant currency impacts. For this half year, the currency impact is meaningful. However, it is based on the impact on the prior corresponding period. The revenue impact in this period is $21.8 million or 8.9%. And the underlying EBITDA impact is $3.6 million or 7.8% for the prior corresponding period as compared to revenue impact of $19.7 million or 12.9% and an underlying EBITDA impact of $4.7 million or 18.4% on a relative basis for the prior corresponding period.

On to the next slide. Appen continues to generate and accumulate cash. For now, we are very comfortable with our current level of cash reserves. However, we have provided some high-level guidelines as to how we’re thinking about capital management into the future. We will continue to reap the benefits of scale and automation into organic growth areas to support our growth strategy and maintain our competitive position. We will continue to pursue acquisitions, including minority investments that fit our criteria, and we look to fund these with a combination of appropriate level of equity, debt and cash. Our approach to debt funding will be to utilize the balance sheet effectively but, at the same time, work with an established conservative leverage guidelines of up to 2x combined EBITDA.

Dividend payout range to be 20% to 40% of underlying NPAT subject to Board discretion.

I’ll now hand you back to Mark. Thank you.

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [3]

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Thanks, Kevin. So on to Slide 20, some highlights from our important ESG initiatives. As a professional services business, we have a small carbon footprint, but we do buy carbon credits to offset the impact of our travel. Although travel is much reduced at the present for us as it is for all of you.

We do have a bigger role to play on social issues. So our work continues with the Global Impact Sourcing Coalition. This is a coalition of like-minded firms that provide job opportunities to disadvantaged communities around the world. We have a large cohort of hearing-disabled workers in the Philippines, for example. The work that we do with them is large and visual, and many job opportunities in the Philippines are in call centers, and they are unable to participate in that. So we’re very pleased that we’re able to provide them with opportunities.

We recently joined the World Economic Forum’s Global AI Council and to contribute to their setting of standards for fair AI. And this includes standards for data diversity, so that AI responds to the real world and also for the fair treatment of crowd workers. It’s highly aligned with our own Crowd Code of Ethics and an initiative that we’re very pleased to have a chance to contribute to.

We continue to work with Translators Without Borders on a project that the tech drives that ensures their speech and natural language products are enabled for pandemic terms and words in at-risk communities around the world.

On governance, we welcomed Vanessa Liu to our Board during the half. Vanessa is the Vice President of SAP’s venture arm and a former McKinsey consultant with many years of experience in the U.S. tech sector. She brings extensive knowledge of that market to our Board and the company, and we welcome her.

Slide 21 now for some forward-looking views. AI is a hot topic and a high-growth market with strong demand tailwinds. Training data is essential for AI, and this has served us well and will continue to provide us with growth for many years to come.

The pandemic is also a hot topic, unfortunately, and that does provide some advantage to some sectors and disadvantage to others. E-commerce, for example, saw a 10-year growth in 3 months in the U.S., measured as a percentage of total retail as consumers shifted to online shopping and other contactors retail experiences, so clearly, an advantage from everybody being at home for e-commerce. Other advantaged sectors include technology of all sorts from video conferencing to social media to payment networks; pharmaceuticals, in the rush to find vaccine and for other health-related items; logistics and delivery services; everything, including cardboard boxes and freight forwarders to ensure that all of these goods put online get to us somehow; streaming and gaming services as we seek more entertainment at home; and pretty much anything that could be done on a contactless basis.

Now the good news for us is that these sectors are also heavy users of AI. Our e-commerce relies on search and recommendation engines. Speech and natural language processing is enabling contactless customer experience, communications and logistics. Manufacturing and retail are using computer vision to automate processes, build scale, enable more with less human contact.

So to Slide 22. This is a great time to be a proven AI performer, and we believe we are very strongly positioned to win. We have a market-leading position. We’re unaware of a competitor with our capabilities, customer base and scale. We’re investing in AI-enabled technology to open markets, automate the work we do and build more scalability and margin expansion into our business. We have a peerless on-demand crowd of over 1 million workers covering 180 languages in 70,000 locations, in 130 countries. We have a highly skilled and very resilient staff. Their ability and grit to deliver to our customers through this pandemic is commendable and to be applauded.

And we have a proven, scalable and uninterruptible at-home business model. We don’t have to learn how to work from home. We already did it. We had strength through 24 years of operations. Our growth investments yielding benefits, $126 million of cash in the bank, net debt positive and cash conversion of 154%.

We are in terrific shape, but we’re not fully unaffected. No business is. Slide 23 lays out the impacts of the pandemic on the business. It’s important to note that they’re all near term and thus far, their impact has been very low. Some of our smaller customers are doing it tough. We have customers in the travel sector, for example. We’re helping them as much as we can. We’ve deferred renewals and discounts, but they are finding the pandemic hard.

Our new customer — our new business, sorry, is going well but not as fast as we planned due to the pandemic. Our customers and prospects had to adjust to working from home. Some of the projects were understandably reprioritized at the onset of the pandemic. I heard this morning that even simple things like customers that provide us with desk phone numbers that aren’t forwarded to cell phones slowed down the sales process.

Combined, these impacts amounted to low single-digit percentage points of revenue in the first half. Now those of you that follow us will know that some of our largest customers rely on online ad spend for their revenue. There has been slowed down in that spend globally, and although it is forecast to rebound strongly next year. Now we’ve recently seen an impact of this slowdown on our ad-related programs, and we expect it to have a small impact on the second half revenue based on what we know and see at the current time.

Slide 24 for a summary and our outlook statements. Company continues on its long-term growth trajectory. We’re very pleased with the half and the progress with our growth initiatives. We’re strongly positioned to win in a high-growth market, and we expect the market to accelerate post pandemic. As such, there are no material changes to our growth investments. We’re taking a long-term view, and this is the time for us to put our foot down.

As stated, we do see a small impact from the pandemic on second half revenue due to the slowdown in ad spend. Slowdown is forecast to bounce back in 2021. So the impact will be in the near term in our view. Consequently, we are maintaining our guidance based on current information.

Our loan book at August ’20 stands at $475 million. This includes year-to-date revenue and orders in hand for delivery this year. Our full year underlying EBITDA for the year ending December 31, 2020, is expected to be in the range of $125 million to $130 million, and that’s at AUD 1 to USD 0.70 for the months of August to December 2020. And this is per our practice of maintaining the rate we struck at the beginning of the year throughout the year. Finally, we expect full year underlying EBITDA margins to be in the high-teen percentages.

That concludes the presentation. Before I hand it back to the moderator for questions, I would like to recognize and thank our hardworking global team for their performance and the group have demonstrated, as always, but especially during the pandemic. This is their result. I have the privilege of presenting it to you, but I thank them for their hard work.

Thank you all once again for your interest in and support of Appen. Please take good care in the pandemic. I’ll now hand it back to the moderator to take questions. Back to you, Amanda.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Quinn Pierson from Crédit Suisse.

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Quinn McComas Pierson, Crédit Suisse AG, Research Division – Co-head of the Small Cap Research [2]

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Maybe just firstly, on your guidance of $125 million to $130 million EBITDA. I guess just kind of firstly, it’s a pretty sizable second half skew compared to the first half to achieve that. I guess kind of firstly, is that — is the — is that skew or the split, 1H-2H, as budgeted back in February? Or has the skew changed at all?

And then secondly, if you could just maybe help talk us through some of the bigger bridging components to get us from the 1H to the 2H, whether it’s the new contract kicking off or it’s more of fixed cost leverage from the investment that’s occurred this half, if you could just help us bridge that a little bit, that would be helpful, please.

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [3]

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Yes. Quinn, it’s — first of all, in terms of the shape versus budgets in February, it’s not a mile away. We always anticipated a big skew towards the second half, and that’s because we were spending disproportionately in the first half compared to the second half. And so we’ll see that cost base relatively consistent through the second half and the benefits of those investments coming through to give us the revenue uplift. So yes, it’s effectively just leveraging that first half investment through in the second half.

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Quinn McComas Pierson, Crédit Suisse AG, Research Division – Co-head of the Small Cap Research [4]

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That’s helpful. And then maybe secondly, on the contract win, the $80 million contract you announced. I guess just a little bit more color on that would be of use. For instance, are we — is that kind of already kicked off at the run rate? Or is it a phased or more of a delayed start? And just any kind of background you can provide in terms of what kind of a little bit more color on what that contract is, for instance, how much of that contract is services versus a platform fee?

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [5]

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Yes. So the contract has commenced, and we see no reason that the customer won’t meet that commitment. So that’s good news. It is a mix of our platform and services, but it’s bundled. The majority of it is services, but it is a mix of both. And we’re very pleased that the customer is — we got that confidence in their need for the data and the service we provide them to make that commitment.

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Quinn McComas Pierson, Crédit Suisse AG, Research Division – Co-head of the Small Cap Research [6]

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That’s helpful. And just to kind of clarify, is the $80 million, will we say — since it’s an existing large customer, is that $80 million incremental to what you had been doing? Or is part of that $80 million previous work just now formalized in contract form?

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [7]

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It’s the latter.

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Quinn McComas Pierson, Crédit Suisse AG, Research Division – Co-head of the Small Cap Research [8]

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It’s the latter? Is that correct?

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [9]

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Yes.

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Operator [10]

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Your next question comes from Lucy Huang from Bank of America.

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Lucy Huang, BofA Merrill Lynch, Research Division – Analyst [11]

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I just have 3. So firstly, in Speech & Image, you guys mentioned that the first half was impacted by the pandemic and some cyclicality. I’m just wondering, based on your customer feedback that you’re hearing today, when do you think new customer spend will come back into this part of the business? Are we likely to see it return in the second half? Or do you think it’s likely to come back in FY ’21? And then secondly, just also on your market share. How do you think Appen’s share has tracked through the first half? And what’s your sense around competitive dynamics? Are you seeing any changes to the dynamics, particularly in the Speech & Image sector?

And then just to dig deeper — a bit deeper on that $80 million contract that you mentioned before. How much did the customer spend in the prior year? Just wondering if they’ve spent a similar amount or whether the commitment is actually an increase in terms of the customer spend. And just whether this annual commitment, how long is that locked for? Is it just for 1 year? Or is it a multiyear agreement?

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [12]

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Okay. So if I can remember these in order. First of all, on Speech & Image, we do expect spend to come back in the second half but more definitely in ’21. And the — probably the main thing that impacted it was just the massive shift in everybody working from home. It was relatively easy for a business like ours to do but quite difficult for many other businesses. And things were just interrupted and delayed.

Other than small customers directly impacted by the pandemic, such as people in the travel sector, what we’re hearing from customers is their projects and budgets are there. They’re just being deferred because they’ve got more important things to get the company rightsized from an at-home environment.

Keep in mind also that the vast majority of our customers are in the U.S. And the U.S. is not traveling as well as Australia when it comes to managing the pandemic. That was the first question.

Second question on market share and competitive dynamic. No massive change to the competitive dynamic, which is to say that we have existing — our existing major competitor is still in the market, and we see the smaller competitors from time to time in various deals. Probably a little less noise from some of those smaller competitors. Some of them are loss-making, VC-funded businesses. And one would have to think that this is not the ideal environment for them. I don’t know anything, but I — we get regular reports from our marketing team, for example, on share of voice. And we tend to be at the top end of those reports on a consistent basis currently.

So it’s hard to put a figure on market share, but I think we’re traveling pretty well. And I don’t see any huge change in the competitive dynamic.

To the large committed order. Yes, it’s an annual — it’s a 1-year arrangement, but there are ways that, that contract came in and growing year-on-year. A lot of that’s contingent on the quality of the job we do for the client and the amount of data. And we’re confident we meet that.

It is — as we said, to Quinn’s question, it is within the spend that we expect from that customer. We don’t go into individual customers and how much they spend. So I can’t answer the second part of your question, but it is within the spend from that customer. I hope that covered all questions.

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Operator [13]

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Your next question comes from Siraj Ahmed from Citi.

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Siraj Ahmed, Citigroup Inc. Exchange Research – Research Analyst [14]

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It’s Siraj, by the way. Mark and Kevin, just have a few questions. Can I start with the guidance? Just on the revenue side, typically, you’re working on at this stage would be 70% of your revenue, I think full year last year. This year, given you’re slight calling out a bit of weakness in ad revenue and Speech & Image. I think, Mark, you said Speech & Image won’t come back in the second half. Just keen to understand how you’re thinking about the second half revenue if that’s all right.

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [15]

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Yes. So it’s a little hard to hear you, Siraj. Sorry, that — look, the mathematics, I suppose, around these numbers move about year-on-year, right? So I think it’s a good starting point to use the ratio from the same time last year to see where we’ll end up for the full year. And if you do that math, you come up with a revenue number. And from there, we derive our earnings number. So other than to recommend that you do that mathematics, that’s the extent of the sort of forward-looking guidance we’re giving on revenue.

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Siraj Ahmed, Citigroup Inc. Exchange Research – Research Analyst [16]

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Sure. So Mark, just clarifying, I mean, there is no reason why the math shouldn’t work out this year, I guess, is the question. Because it sounds like some of the existing work is coming off, but you potentially have new work that could add on to it. Is that the way to think about it?

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [17]

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So the — and again, it is a little hard to hear. Your voice is quite muffled, Siraj, I’m sorry. The second half will be stronger than the first half. I think we made that clear earlier on. And you can draw some conclusions as to where the revenue will end up based on that order book number. However, we caution that the ratio of that order book number at different times in the year — so the full year does move around from year-to-year. So it’s not a fixed amount, can give you some guidance.

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Siraj Ahmed, Citigroup Inc. Exchange Research – Research Analyst [18]

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Sure. Just moving on to the cost comment. Just clarifying that you’re saying you’re not reducing costs, which then implies that, to meet your guidance, gross margins have to improve. Is that — can you give some color on that?

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Kevin B. Levine, Appen Limited – CFO [19]

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Yes. Siraj, so the way we think about that is we start to enter a lot of that investment. And so if you think about that cost investment is that’s essentially happening uniformly through the year. But then to layer in the expected revenue in H2 revenue, uplift of H1 essentially gives us a compounding positive impact then to EBITDA.

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Siraj Ahmed, Citigroup Inc. Exchange Research – Research Analyst [20]

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Sorry, Kevin. So you’re saying that cost investment, that will go away? Or that — because the cost base, if you could just clarify that, please?

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Kevin B. Levine, Appen Limited – CFO [21]

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Yes. And I’m not sure if I heard the question clearly, but I think answering in terms of what I think you said in terms of — if the cost as I said is uniform, yes. As I said, we start to enter a lot of that investment. And so that spend throughout the year into H2, right, would be not that much different from H1, right, that it will always be we’ve got — we’re expecting uplift in revenue. So more revenue and uniform cost base gets us to high EBITDA levels.

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Operator [22]

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Your next question comes from John — Josh Kannourakis from UBS.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division – Research Analyst [23]

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Just following on from that prior question just because — sorry, it wasn’t that clear just on the line. So when we’re talking about the level of investment in the first half, do you expect that level of investment to be replicated? And apologies if I missed that earlier. And just interested in your views on how we should be looking at that sort of step-change investment medium term in terms of what the sort of steady state of that investment level would be?

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [24]

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So what we’ve done is we’ve taken on a lot of resource sort of late last year and in the first half to build the sales team and so on, and what was mainly in the sales team. You can see that in the bridge on that slide. I forget which number it is. In prior years, for example, we did a lot of investment into the tech team and lease going forward. So a lot of investment in the sales team. So the ramp-up in expense was very high in the first half. And we’re going to hold that through the second half. But that sales team is going to deliver more from a revenue perspective. So revenue is going to go up, and costs are going to be relatively constant, and that’s going to result in an earnings uplift. The math’s pretty simple.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division – Research Analyst [25]

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Yes. No, got it. That was clear. Sorry. I just wanted to make sure — yes, that’s very good. I just…

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Kevin B. Levine, Appen Limited – CFO [26]

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Josh, I’ll touch on this as well. The important point is we have that — we’re just calling out the incremental spend, right? So certainly, that’s — in terms of what Mark said, that’s essentially the guidance for this year, that will be largely meaningful, and we expect to see similar levels in H2. However, then when it comes to 2021, then once you will look at the businesses by market, we’re going to be doing a repeat of sales and marketing investment to this level from an incremental point of view.

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [27]

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Yes. That’s a good point. And again, we didn’t provide this bridge last year, but had we provided a bridge like the one on — let me just find it quickly. Was it 16, I think?

17. Had we done a bridge like that last year, this time last year, you would have seen an uptick in the technology spend, right? So last year would be building technology. And clearly, there’s more work to do on the tech. And hence, we continue to spend on tech. This year is the year of building the sales force. And so going into next year, you will have that sales force build on the incremental spend, but not at this level.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division – Research Analyst [28]

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Got it. And then just on to the — another question around the guidance. So you obviously called out that first half, second half skew even pre — really pre-COVID. And so I guess since then, you’ve noted the incremental — the lower sort of ad spend. I’m just also interested if you could give, in light of that, just a bit more context on some of the Relevance projects that you’ve been winning. And it looks like there’s been a few decent awards of new projects across the first half based on some of the online activity. Interested if you could you just give a bit more context on that new projects into the second half?

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [29]

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Yes. We had won a number of projects through the year. In fact, just overnight, we’ve won another. And you’re familiar enough, Josh, of the business to know that if these things grow, they can steamroll pretty well. But there is — we’re just expressing some caution because some of the ad-related programs, which is not a massive amount, but some of those programs we’re seeing the customer tap the brakes a little bit because if their revenue from ad spend goes down, they need to spend less with us. But the opposite require — applies, right? If it goes back up, they spend more with us. But for the moment, we’re just tapping the brakes a little bit on that ad-related spend.

The good news is much of it has been tapered over by some of these new projects. But we don’t have as much of a sort of a steamroller. But we can’t see as much of a sort of a steamroller at the moment than we would normally see at this point in the year.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division – Research Analyst [30]

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Got it. And then just you mentioned a bit of context around your views around M&A and debt funding and the like around the capital management. Just interested if you could talk a little bit about where you see some capability gaps or potential adjacencies to Appen given its expanded client and customer base.

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [31]

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Yes. And you know, Josh, that the challenge for us is always finding the opportunities because we’re in a relatively dimensioned space. And many of the players in our space are loss-making, VC-funded businesses. There’s very few at scale.

From a core business perspective, we don’t see any material capability gaps. We’ve got the crowd that we need. We’ve got the technology we need, and we’re building out the sales team that we need. We’ve got tremendous recruiting and delivery capability. So the core business is pretty solid.

We do look a little bit to the left and right from occasion, so for example, other at-scale businesses that could be deployed via the crowd model. So we’re looking for opportunities to grow business and to leverage the capabilities that we’ve got.

And the point of the slide on capital management, just to give you some insight into how we think about managing the capital rather than to signal anything specific.

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Kevin B. Levine, Appen Limited – CFO [32]

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And sorry. I just want to cover something because Josh, you raised it and Quinn has raised it earlier as well. And that is just to clarify — Mark said it but just to try to clarify. So in terms of how we see the half year results relative to our internal budgets, we are very close to meeting 2% of that. So for us, it’s — we set this plan at the beginning of the year way before anyone knew what COVID was about, and we haven’t taken up sort of the payment at all. So we’ve got the view on the long term, not on the short term. We have those plans. We’re sticking to those plans. And then for us, very much H1 results is line in line with the expectation. And so therefore, that flows through to our guidance and our expectations around the second half.

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Operator [33]

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Thank you. That does conclude our question-and-answer session at this time. I will now hand back to Mr. Brayan for closing remarks.

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Mark Ronald Gerard Brayan, Appen Limited – MD, CEO & Executive Director [34]

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Yes. Thanks, Amanda. And thank you, everybody, for attending. We hope you’re all safe and well during the pandemic. And we, as always, appreciate your interest and support. And no doubt, we’ll see you — well, maybe not face-to-face, maybe over the video conference during the road show over the next week or 2. Thanks once again, and I hope you all have a pleasant day.

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Kevin B. Levine, Appen Limited – CFO [35]

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Yes. Thanks, everyone.



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