Appen Limited (APX) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Appen Limited FY '19 Full Year Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Mark Brayan, CEO and Managing Director. Please go ahead.

Thank you, and hello, everybody. Welcome to our full year results conference call for 2019. Thanks for taking the time to join us today, and thanks for your interest and support of Appen. My name is Mark Brayan. I'm the company's CEO, and I'm joined today by our CFO, Kevin Levine. We'll step through the presentation that was provided to the ASX this morning, and then we'll allow some time for questions later in the call. So if you could please turn to Page 3. So we're very pleased to report another high-performance result for shareholders. Our total revenue of $536.0 million is up 47% on last year. This is comprised of $67.7 million of Speech & Image revenue, which is up 32%; $430.0 million of Relevance revenue, which is 37% higher than last year; and year-end Figure Eight ARR of $33.7 million. And this returns Figure Eight to high growth and lifts its 56% CAGR over the last -- lifts it, sorry, to 56% CAGR over the last 4 years. Our underlying EBITDA for the year was $101.0 million, an increase of 42% on last year. And underlying EBITDA margins of 18.8% compared favorably to last year's 19.6%, and that's considering investments made in 2019, most notably in Figure Eight, but also in technology, in general. Our EBITDA margins were consistent with our commitment to keep margins in the mid to high teens, concurrent with investments for scale and strength. Stripping out Figure Eight reveals very strong organic growth, highlighted on the right-hand side of the page. Organic revenue, that is revenue excluding Figure Eight, of $497.6 million was up 37% on last year. Organic underlying EBITDA of $107.3 million was up 51%, outpacing the growth in organic revenue. And organic underlying EBITDA margins of 21.5% are well up on last year's margins of 19.6%. The organic results show the operating leverage of the business derived from our investments in technology and economies of scale. Turning to Page 4, where we could see that each of our core divisions contributed to the result. Speech & Image, formerly Language Resources, includes the collection and annotation of audio speech recordings, text-based natural language data as well as image and video data. Revenue growth of 32% to $67.7 million is a standout result, considering a historic revenue CAGR of 17.9% since the company listed in 2015. The result came mainly from multiple projects across our major customers. Margins were impacted by a few large projects peaking in the first half and trade-offs in gross margin for sales expansion. To the right-hand side of the page, Relevance continues to be the company's growth engine. Revenue of $430.0 million was up 37%. And its EBITDA are up 66% to $110.5 million, delivering very pleasing year-on-year margin expansion from 21.3% to 25.7%. It's also noteworthy that one of our largest customers recently updated their agreement with us to include a clause to hold prices for 5 years, mitigating margin pressure. Please turn to Page 5. We're very pleased to report that Figure Eight has rebounded to high growth. Our year-end ARR, that is annual recurring revenue, of USD 24.95 million or AUD 33.7 million lifts the business to 56% revenue CAGR from 2015 to 2019 -- sorry, that should be ARR CAGR from 2015 to 2019. The result benefited from a strong second half that included new customer wins, new expansion deals and improved churn management. We also saw an increase in larger customer wins, and this is important because large customers are less likely to churn than smaller ones. The path to profitability for Figure Eight is ahead of plan due to prudent cost management of nonessential spend that has no impact on sales or growth. We estimate an earnout payment of $36.8 million, bringing the total price of the acquisition to $287.6 million or 5.8x revenue. And this compares very favorably to similar acquisitions that are valued at double-digit revenue multiples. To Page 6 now. And we have commenced the integration of Figure Eight in earnest now that the earnout period is complete. We are moving to a simpler unified product set, updated messaging and a fresh visual identity. We're going to market with a single sales and marketing team, consolidating our crowds and shifting work to Appen's crowd and facilities. We're also combining teams, culture and back-office functions. Synergies discussed at the time of the acquisition are on track, and we expect the major components of the integration to be completed by the end of this year. Our customer cohort chart, on Page 7, benefits from the addition of Figure Eight's customers and continues to show the strength in our customer relationships year-on-year. For those unfamiliar with the chart, it shows revenue by cohort in year of origination and each successive year thereafter. We're also making good progress in our new growth markets. Please turn to Page 8. We're investing in 2 growth market sectors, government and China, to add customers and strength to our business. Governments worldwide are investing in AI through their defense, intelligence and civilian agencies for a variety of applications. We added a new government customer in 2019 that's using AI to assist disaster relief, for example. We've participated in the government market for some years now. The deeper involvement requires us to be set up with appropriate clearances and capabilities. We're midway through this process and have leased an office in Washington, D.C. We expect the process to be completed soon, and it will give us a significant differentiated capability. To Page 9 now. And our work in China is progressing at speed with 53 people in our corporate office and 154 data labelers in our facility in Wuxi. Our pipeline is growing, predominantly with business with technology companies, and we're delivering growing revenue, albeit off a small base. Thus far, we see negligible impact on our business from the coronavirus outbreak. All of our staff are safe and accounted for, and we've implemented a work-from-home policy that will remain in place until conditions improve. We've also suspended all travel in and out of China. Our projects with customers in China are currently ongoing, and we don't foresee a letup in that work. But we are monitoring that situation carefully. Our 2020 domestic targets for China are modest, and hence, any impact will have a negligible impact on group revenue and earnings. Of our major U.S. customers, combined, they rely on China for less than 10% of their revenue. So we don't expect their business with us to be materially impacted by any loss of their revenue from China. Some of our U.S. customers rely on China for their hardware supply chain and have signaled supply challenges. We're not seeing any impact of this on our business nor do we expect temporary hardware shortfalls to reduce their need to invest in AI. It's fairly early in the situation, and we're monitoring it closely. But overall, we maintain a view that the coronavirus will have a negligible impact on our 2020 group revenue and earnings based on currently available information. Please turn to Page 10. We continue to invest in technology to improve the interface with our customers, manage and communicate more effectively with our crowd workers and improve worker productivity through better annotation tools. We've released a number of new features during the year, including a secure workspace solution that improves security for at-home workers; our automated checking of crowd applicants that reduces the time taken to validate a worker from up to 20 hours to a few minutes; and machine learning-assisted tools for transcription, data collection and other applications that are showing productivity improvements in pilot projects. On Page 11, we're also pleased to announce a significant enhancement to our capabilities in the autonomous vehicle market with the launch of our LIDAR annotation tool. LIDAR is similar to radar but far more accurate. It generates 3D models that are critical for AI applications that move in space such as autonomous vehicles. Autonomous vehicles and other AI applications using LIDAR form a rapidly growing market that relies on vast data sets. Working with and labeling data in 3D is complex and requires sophisticated tooling and a trained workforce. We have a number of pilots ongoing in this space and are investing in business development to win more. Page 12 now and an update on our ESG work. As a people-based business, we have a low environmental footprint. Our work-from-home model enhances this. That said, we aim to improve and are buying carbon credits to offset our 2019 travel and will continue to do so in the future. We've made solid strides in our commitment to the ethical treatment of our crowd and social impact through our Crowd Code of Ethics, membership of the Global Impact Sourcing Coalition and our work with Translators without Borders. The latter is a not-for-profit organization that assists people in need at borders with interpretation and translation support. We've also implemented an internal development program to improve gender balance at the senior levels of the company. On governance, we are adding a U.S.-based independent nonexecutive director to our Board to improve Board independence and further our knowledge of U.S. markets. I'd now like to hand it over to Kevin to take you through our financial results commencing on Page 13.

Thank you, Mark. We are pleased to report that we continue to translate strong revenue growth into efficient and meaningful bottom line growth. Our revenue increase of 47%, including Figure Eight, has been driven largely by continued increase in demand from current projects with existing customers. Growth has also come from adding Figure Eight and new products -- new projects with existing customers as well as sales to new customers. Underlying EBITDA, including Figure Eight losses, is up 42%, driven by delivering increased volumes and improved margins in Relevance and achieving the benefits of scale, process and technology. Excluding Figure Eight, organic performance is strong, with underlying EBITDA growth of 51% on organic revenue growth of 37%. Underlying NPAT is up 32% on the prior year, impacted by the investment in engineering and the result in higher levels of amortization. The effective tax rate for 2019 is slightly better than last year, and it's impacted by tax deductions of employee performance rights, and these can vary from year-to-year. If you can please turn over to Slide 14, and we'll talk through on the balance sheet. So the balance sheet is strong with increased activity translating to higher cash and receivables balances. Intangibles have increased significantly with the acquisition of Figure Eight. Impairment testing revealed there is significant headroom while using conservative inputs. Appen is debt-free at year-end, and the robust balance sheet contributed $35 million out of the total debt repayment of $57 million during the year. An estimated earnout liability of $30 million -- $37 million has been booked in respect of Figure Eight payable next month. Appen has declared a final dividend of $0.05, partially franked to 50%, and this is up 25% from $0.04 in the prior year. Over the page to Slide 15. Cash at year-end has increased by $35 million to $75 million. And in fact, the cash balance would have been higher if not impacted by some timing issues with receipts at year-end. These issues were resolved in January. Strong performance this year has seen cash flow from operations increase by 47% to $83 million. Cash has been effectively deployed during the year to pay debt, dividends, CapEx and transaction costs for the Figure Eight acquisition. Even with the receipt timing issues, cash conversion from EBITDA was strong at 88%. Over the page, and we call out that we have currency translation exposure given that most of our transactions are in USD and we report in AUD. In 2019, we benefited in a meaningful way from a weaker Australian dollar. This contributed to a 10% -- to 10% of the revenue growth and 11% of our underlying EBITDA growth. I'll now hand you back to Mark. Thank you.

Thanks, Kevin. On Page 17, we highlight some important market trends: firstly, that AI continues to rely on large volumes of high-quality training data. Quite simply, the more data, the better the AI performance. The availability of quality data continues to challenge AI developers. Data supply is a large problem for those starting their AI journey and the largest problem for those in production. This mirrors our own research. It's only when developers and organizations move to production and deployment in the real world do they fully realize the need for high data volumes and data quality. The data supply challenge is exacerbated by the growth in AI and, with it, the growing demand for data. Organizations must invest in AI, lest they fall behind their competitors. So over the page. We're very well positioned to benefit from these trends and the need for large volumes of high-quality training data. We are a proven provider. This is essential because our research also shows that companies that want to deploy AI in the real world want to partner with reliable and proven data providers. And we have the 2 essential assets to deliver training data: a global and diverse crowd and enabling technology that allows the sourcing and delivery of training data at scale. Page 19 and to our outlook statements. Our work and investments in recent years have strengthened our position in the high-growth AI training data market. 2019 saw substantial investments in technology that are now paying off. 2020 will be a year of investment in sales and marketing to grow our customer base and further cement our strong position. This investment will soften our first half margins to the mid-teens. We expect margins to return to the high teens by the year-end. We reiterate that we expect a negligible impact from the coronavirus on 2020 group revenue and earnings based on currently available information. Our order book, inclusive of year-to-date revenue and orders in hand, is currently approximately $210 million. Our full year underlying EBITDA is expected to be in the range of $125 million to $130 million, and that's at USD 0.70 to the Australian dollar. The outlook is, of course, susceptible to upside or downside from factors, including timing of work from major customers and Australian dollar fluctuations. That ends the formal presentation. Thank you once again for your interest in and support of our company. I will now hand it back to the moderator to manage questions. Thank you.

[Operator Instructions] Your first question today comes from Garry Sherriff with Royal Bank of Canada.

A few questions, Mark and Kevin. Firstly, thank you for going through expectations on coronavirus for calendar year '20. I get everything you're talking about in terms of your tech customers only having about 10% of their revenue out of China. I guess I'm just trying to get a sense of that, those hidden indirect impacts. And by that, I mean, have any of your larger tech customers in the last couple of weeks been in touch? And maybe just talk around the tech budgets should consumer or business sentiment become more negative. That's the first question.

Garry, we've canvassed all of our customers, and there's been no indication on current projects currently. As you suggest, if they suffer a material shortfall in hardware supply, for example, that may prompt some cost control in general. But at this point, we're not seeing any indications of that. But we're looking at it closely.

Another way of looking at it, calendar year '20, your expectations, and I know you haven't disclosed revenue per se, but what portion of your calendar year '20 is underwritten or under contract?

So we disclosed the order book of $210 million. And you could look at order book numbers for prior periods to get a sense of what that may -- what percentage that may indicate for full year.

Okay. EBITDA margins for Speech and Relevance going forward, again, could we just -- I noticed in your guidance, you've talked about first half being a little lower. I'm just trying to segregate that out by segment, if we can just get a little bit of color on what we should be thinking for margins for each of those major segments going forward.

Yes. Garry, yes, Speech & Image, we would guide in terms of full '20 to be similar lines to '19. So I think for both of those divisions, basically similar, but obviously overlaying impact for investment in sales and marketing and a bit of engineering. So flow that through in terms of from the overall -- total overall margin guidance.

Okay. And the last 2 questions, just on F Eight, looked a really big improvement in Q3 and Q4. Two questions. One, is there any form of seasonality that we should be aware of in F Eight? And if so, what drives that? And secondly, did you have to sacrifice price or margin to land some of those larger deals?

So no, there's no -- we've looked back over the last few years, there doesn't appear to be any meaningful seasonality or consistent seasonality. Clearly, some quarters do better than others, but there doesn't seem to be any pattern to it. And no, we didn't sacrifice price to deliver the Q3 and Q4 results. It was a combination of sort of better sales leadership. Our head of sales, Jon Kondo, took a hands-on approach with the Figure Eight sales team in Q3 and Q4. And it was also due to much better management of existing customers and churn. We saw far less churn in Q3 and Q4 compared to Q2.

Your next question comes from Quinn Pierson with Crédit Suisse.

I guess just firstly, on the sales and marketing investment, you flagged that will pull down the first half margins. Could you maybe just talk us through the timing of that investment deployment? Is the way to think about it that there's a step-up occurring basically now, which will pull down the first half margins, but then the return on that investment can drive sales in the second half, which was -- which will, I guess, kind of bring the margins back up? Is that the timing to think about?

Yes, pretty much, Quinn. We're staggering the hiring throughout the year, but there's a lag obviously between hiring and return that plays out, as you suggest. And by staggering the hiring, that does give us the opportunity to throttle the hiring if the returns are coming. But in general, what you suggest is correct. We hire early in the year, and that delivers sales and a return on those hires in the second half of the year.

Yes. And then secondly, on Figure Eight, could you just talk us through how much of the revenue growth is coming from existing customers versus new customers? And what the pipeline of new customers looks like for Figure Eight? And in particular, I'm just trying to understand how well Figure Eight is being used as a deployment to, I guess, sell the existing crowd to a new set of customers?

So to the first question, it was pretty well balanced in terms of new customer wins and expansion deals in the second half, expansion being upsell of existing customers. So there was good flow of new customers and then good balance with upsells to existing customers. In terms of the platform as a platform for further sales growth, it opens up our addressable market quite considerably. Our largest customers have their own data labeling platforms, and we work on those platforms. The majority of companies worldwide do not have a data labeling platform, and they need one. And this is what we have now with the acquisition of Figure Eight. So we have a much greater addressable market, and so what you suggest is entirely correct. We'll now be able to access more customers, sell the platform, and that will have pull-through to our crowd resources.

Is that thesis already playing out? Or is it kind of the sales and marketing staff being hired now that can kind of take that to the next level?

So it's playing out, but it's early days. So we've had some joint customer wins, sale of the platform and sale of Appen crowd. But going forward, that's the focus of our sales and development efforts.

That's helpful. And then just lastly for me, just what you're seeing in terms of the competitive environment. We've seen a fair amount of, I guess, investment in various kind of data labeling solutions, especially kind of more on the platform or kind of tech-heavy side of things. I guess, are you seeing some of these competitors as direct competitors to you? Or do you see them, I guess, playing in, I guess, different segments of the market? Just any views on how you're seeing the competitive landscape would be helpful, please.

So we see them variably in our sales campaigns, but we don't see them in the very largest accounts. We don't see them in our global customers. And we're told by our global customers that they rely on our size, our strength, our scale and our reliability to service them. But yes, we do see various competitors from time to time but not in our biggest customers.

Your next question comes from Siraj Ahmed with Citigroup.

It's Siraj. Just a few questions. Just first thing on sales and marketing investment. I mean, Kevin, if you could just talk to the quantum of the investment. And maybe, Mark, where are you targeting this as well? Is it the sales and marketing investment? Is it Figure Eight? Is it LIDAR?

So we're not disclosing the quantum of the investment other to say that it will have an impact in margins, which we've illustrated in the pack. In terms of where we're deploying that investment, we currently have good focus on our large customers. And so we want to strengthen that focus more broadly across the technology market in the U.S. We also want to tackle other market verticals in the U.S., autonomous vehicles being one, financial services being another, health and pharmaceutical being another. And then we're also able to target midsized companies very effectively with the Figure Eight platform. So we're setting up sales teams to go after each of those broad segments. We're also investing in sales in the U.K. and Europe and furthermore investing into sales presence in Asia Pacific outside of China. So it's fairly broad brush, Siraj, and we balance the resource with where we believe the opportunities are in terms of market size and market stage and maturity.

Got it. And just maybe just thinking to the margin. As you said, the first half margins at mid-teens, full year margins at high teens. I mean, is the expectation that margins will be up year-on-year at the full year level? And two, just thinking should the second half margins be the base going forward? Because that sort of implies 22%, 23% margins in the second half. Should that be the base going forward?

How can you get margins in the 20s when we say high teens?

No. I'm saying for the second half.

Sorry. No, we maintain the practice, Siraj, of keeping margins in the mid to high teens whilst also investing in growth. So we're just calling out specifically that early in the year, in the first half, we'll have some sales resource that's going to cost money, that will take a few months to deliver revenue. So there will be a softening in the first half. But for the full year, we'll return to those mid to high teens.

And Mark, I'm just confirming, did it -- or just clarifying, do you expect margins to be up year-on-year for the full year? Or is it too early to say?

Too early to say.

Siraj, if you look at the guidance and you look at our numbers, I think you get the answer there. And then, obviously, I think it's consistent with our theming, certainly, where we basically strive to get efficiency in our margins and then redeploy it back into the business. So in 2019, we did that with engineering. We continue to do that in 2020 but to a lesser degree because we've established that base. 2020 now is reestablishing our base in sales and marketing, and we're doing that. And obviously, going to the future, we'll identify other areas of growth where needed and obviously look to redeploy where appropriate.

Sure, very clear. And just lastly, on the renegotiated deal, I mean, pretty positive, keeping pricing flat for 5 years. But could you just talk to any commitments in volumes? I mean, have you consolidated the providers? As you said, for the large customers, Appen is seen as a preferred supplier. So are there any commitment on volumes in that level -- in that deal, please?

No, there's no commitment to volumes. The only commitment is to keep prices flat over the next 5 years. And as you say, that is positive because it mitigates some margin pressure. But there's no commitment to volumes.

Your next question comes from Josh Kannourakis from UBS.

First question, just a follow-up on that 5-year deal. Are you able to say whether that is your largest single customer deal or just a large customer?

No, we can't. We've made the statement, and that's it.

Yes. Got it. And then just to clarify, so is that holding prices from FY '19 levels moving forward?

Yes.

Right. Perfect. And then just following on from the margin commentary before. So just to be 100% clear, I think it was pretty clear in the outlook statement. But the high teens margin is for the full year '20 result, not necessarily just the second half.

Yes.

Got it. And then just in terms of, I guess, moving forward, do you expect sort of that cadence in investment in sales and marketing to continue into '21, et cetera? Or is this a sort of more one-off in nature?

Probably more one-off. I mean we'll continue to invest in sales for growth. But like last year, we made a big investment in technology. This year, we're making a big investment in sales and marketing to build that base. If there will be ongoing investments, that will be more incremental in nature going forward.

Perfect. And then just government contracts, historically, you have talked to that being a pretty significant opportunity. And I think you mentioned some help around disaster relief there. How are you going in the progress of getting a sort of prime contractor licensing? And do you think you'll have any progress on other departments like defense, for example, within this calendar year?

So we're close to getting things all set up and complete. We expect that to be finalized in Q2, and that'll provide us with the opportunity to bid on business as a prime contractor. And we have a solid pipeline of opportunity, and we're optimistic that, that will play out and deliver meaningful revenue this year. But of course, we've got to win the business.

Yes. Of course. And is there many other prime contractors providing annotation services that you know about in the market at the moment?

Not specialists like us. We're working with a prime, or we're a sub to somebody at the moment. So you could argue that they're providing labeling services, but we're actually doing it. But we're unaware of any other specialists.

Okay. Perfect. And just one really big final one for Kevin, just around the AASB 16 impacts. Kevin, I think in the second half, for the right-of-use depreciation and interest, it implies about sort of $3 million for the second half. Is that -- and $5 million was the full year. Is that sort of a run rate we should expect into the future? Or can you guide us to any changes that you expect from that?

Yes. So just to kind of link it through, when we released our 2018 report, we talked about an expected EBITDA impact of $1.5 million for '19. And so what happened, we were pretty close to that, but we actually brought on some new premises in '19. And so that impact we've factored into our guidance. In addition to that, we had additional EBIT -- I guess, additional rental, which obviously didn't flow into EBITDA, and that was for new premises. Obviously, it was new. It wasn't factored into the guidance. And obviously, it wasn't factored into the numbers. But essentially, your numbers are in a ballpark and, yes, would be a good proxy of going forward.

Yes. So just to confirm, the second half run rate is a reasonable proxy for going forward?

Yes.

Your next question comes from Stella Wang, a private investor.

Just a couple of them. Firstly, following on the contract towards a big customer, are you looking to do similar agreements with your other top 5 customers? And has that pricing, now set flat, has it been going up or down in the last 2 or 3 years?

Stella, we have regular conversations with customers to try and get assurance, future assurance on a variety of levels. So we constantly try that. In this instance, what we're able to achieve is an agreement that held prices flat. The prices -- we had, you may recall, I think 2017 or 2016, we had a lot of pricing pressure. Since then, prices across our customers have been more or less at a constant level. We always are concerned about price pressure. So we were quite happy to strike this deal because as volumes go up, people are demanding of better prices. But in general, prices have been around this level, and this mitigates any future pricing pressure.

Second question, during the lockdown in China recently, did any of your global scale and technology advantage placed you in a better operational form compared to your Chinese competitors? I'm asking this because I want to see if any of your competitive advantage shines through that might benefit you going forward to get a stronger traction coming out of the virus lockdown.