Earnings Transcript for APXYY - Q4 Fiscal Year 2021

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Appen Limited FY '21 Full Year Results Conference Call. [Operator Instructions]. I would now like to hand the conference over to Mr. Mark Brayan, Chief Executive Officer. Thank you, and over to you, sir.

Mark Brayan: Thank you very much, and hello, everybody. Welcome to the call for our full year results for 2021. I hope you're all doing well and possibly back in your offices as we get to -- used to living with COVID. I'm traveling regularly once again, and I'm pleased to be able to spend time with our customers, partners and staff in our offices all around the world, so life returning to some sort of normal. My name is Mark Brayan. I'm the Chief Executive. I'm joined today by our Chief Financial Officer, Kevin Levine; and our Head of IR, Rosalie Duff. The presentation was loaded to the ASX website this morning. I'll be referring to that throughout. The presentation will take 30 to 40 minutes, and then we'll open up for questions, and we aim to finish at 12

Kevin Levine: Yes. Thank you, Mark. So on to -- on Slide 31, our revenue and other income increased 8% to $447.3 million. This reflects a strong half-on-half performance with the second half up 28% on the first half, reversing the first half decline of 2%, and that's comparing to the prior corresponding period. There were 2 major drivers for the record second half performance. Firstly, Global Services, which delivered a significant turnaround from the first half revenue reduction of 9% with second half revenue up 19% versus the prior corresponding period and up 32% on the first half of FY '21. This record second half revenue performance was driven by continued increase in non-ads and with ad-related projects returning to growth, as forecast. This highlights the value that our Global customers place in our ability to deliver high-quality data at scale across all data modalities. The second driver was China with 422% growth coming from both increases in market share, i.e., from new customers as well as in customer share, i.e., expansion from existing customers in new and existing projects. Underlying EBITDA, excluding an FX loss of $1.2 million, increased 12% to $78.9 million. This result in the associated margin was positively impacted by strong second half drivers, namely revenue growth, gross margin expansion and moderate expense increase to support the growth. Underlying NPAT reduced 10%, impacted by increased amortization of product development investments. The effective tax rate of 20.5% is in line with the prior year. The effective tax rate is subject to fluctuations from the tax effect of movements from expensing, investing of employee performance shares and differences in overseas tax rates. Excluding these fluctuations, we have reduced the normalized tax rate to 25%. Over the page and to the balance sheet on Slide 32. Balance sheet remains strong and resilient with no debt. Trade receivables increased by $38.6 million to $89.2 million, increase in trading volumes approaching year-end. Invoices were raised on 30th December for work completed in December as the billing milestones were satisfied. This resulted in an increase in trade receivables and a corresponding decrease in contract assets. Noncurrent assets comprise mainly goodwill and identifiable intangible assets, mostly arising through acquisition. Following a detailed impairment review, we report adequate headroom in the carrying value of these intangibles. Noncurrent assets increased mainly due to $45.4 million being recognized as goodwill relating to the Quadrant acquisition. Total liabilities increased by $19.1 million to $107 million, mainly due to the earn-out liability of $18.4 million associated with the Quadrant acquisition. The final dividend of AUD 0.055 per share has been declared. This is in line with last year and is 50% franked. This takes the full year dividend to AUD 0.10 per share in line with FY '20. Over the page on to Slide 33. In 2021, we invested $30.2 million in product developments, representing 6.8% of revenue. This focus is important to drive customer growth and repeatability as well as quality improvements and margin expansion. Since FY '19, we have strategically invested in engineering resources to develop new products. 68% of our product spend was capitalized in FY '21, up from 64% in the prior year, reflecting our commitment to development of new products and tools. We will continue to invest in product development of up to 10% of annual revenue. Moving on to Slide 34 on the cash flow. The cash on hand at year-end decreased by $12.6 million. However, this was due to the upfront payment for Quadrant of $25.3 million. Cash balance and cash conversion were impacted by timing issues, primarily due to the working capital cycle impact from the higher volumes in November and December. Cash flow from operations reduced by $17.9 million due to the aforementioned working capital cycle impact. However, this was somewhat offset by lower tax payments. Cash has been effectively deployed for product development, tax, dividends, OpEx and growth investments. Notwithstanding the cash flow cycle impacts, the cash flow conversion from EBITDA was still solid at 77%. Thank you, and I'll hand you back to Mark.

Mark Brayan: Thank you very much, Kevin. So to conclude and to move now to Page 35. We're very pleased with our performance in 2021. We also refreshed our growth strategy to transform the business with a focus on revenue growth, customer diversification, automation and product expansion. Implementing this strategy is a journey, so we're taking a long-term view, and we've set ourselves 5-year targets as our North Star. Those targets are to at least double our FY '21 revenue by 2026. This demonstrates our focus on long-term revenue growth. We're off to a good start. Our revenue order book for this year, which includes year-to-date revenue, plus orders in hand, stands at USD 190 million. We also expect the FY '22 half-on-half revenue skew to be similar to prior years, excluding FY '20. The second target is to improve the mix of customers with 1/3 of revenue from our non-Global customers. That is 1/3 of revenue from customers other than the 5 U.S. tech giants. And we'll achieve this with investments for growth in new products, sales and marketing partnerships. We'll explore M&A opportunities, and we're targeting higher than 35% compound annual growth revenue from non-Global customers, and this is in line with the market growth rate of the chart earlier in the deck. Finally, we are a profitable business, and we'll maintain that. We've set ourselves a long-term goal of 20% EBITDA margins. But our focus on revenue may impact near-term EBITDA margins and future dividend payout ratios. This long-term focus also means that we will no longer provide short-term EBITDA guidance. A few things, higher costs in the first half of '22, including the transformation office, investment in product and technology and share-based payment expenses will impact first half earnings this year. And there will be an earnings skew to the second half, which could be larger when compared to FY '21. In closing, I'd like to thank our customers for their support and especially to thank all of our talented and hard-working teammates around the world. We appreciate everything they do for us. This result is theirs, and I'd like to thank them. And now I'll hand it back to the moderator to take time for questions. Thanks very much.

Operator: [Operator Instructions]. Your first question comes from Josh Kannourakis with Barrenjoey.

Josh Kannourakis: Mark and Kevin, can you hear me okay?

Mark Brayan: Yes.

Josh Kannourakis: Yes. Just first question, just with regard to some of your core customers. You mentioned that the non-ad-related projects obviously saw some good growth in the period, and that was sort of on a project basis. Would you be able to give a bit more context on how that's come through on a revenue basis and just how -- I guess, your comfort sort of, I guess, in the future outlook of some of those non-ad-related projects?

Mark Brayan: Sorry. That -- the line on Page 26 that gets to 77%, that's revenue. So the non-ads revenue is 77%. Sorry if I misspoke.

Josh Kannourakis: Yes. No, that's fine. And so I guess in terms of those projects, though, in terms of -- because, obviously, they're still at early stages, is it too early also for you to say in terms of the potential materiality long term from those projects?

Mark Brayan: Yes. Hard on a project-by-project basis, but some of them are to do with augmented and virtual reality, for example, which we know is a growth focus for some of our customers. So it's hard to know how any individual project will play out, but they're in areas that are growth-focused for the customers. Another one is e-commerce, another growth area. Another area is mapping. So these are all in forward-looking areas, but hard to tell how an individual project may play out at this point.

Josh Kannourakis: Got it. And I guess some of our industry feedback has suggested data collection works have been quite a significant part of the market or a growing part of the market. Would you be able to comment on, I guess, how you're sort of seeing those trends there and Appen's ability to capture share of that market on a go-forward basis?

Mark Brayan: We have seen an uptick in data collection, and it is a competence of the business with our crowd-based model because, as I explained earlier in the presentation, a lot of the data collection needs humans; hence also the acquisition of Quadrant, which also goes to data collection. So yes, I agree with the industry feedback you're getting. It's very important, and we're very much in the thick of that. The reason why -- sorry, just to add one more thing. The reason why data collection's important is because the best-performing AI is typically narrow AI, something that doesn't reach a specific path. So correspondingly, you need data that's representative of that use case. Now not all the data may be available from current sources or by the customer. So if they need a specific piece of AI that needs specific data, they have to go find their data and collect it, and that's what we're doing. So yes, a lot of different data collection projects currently.

Josh Kannourakis: Got it. And just a final question. I'm sure there will be a few around margins, so I won't spend too much time on it. But in terms of, I guess, your longer-term commitment versus the shorter-term investment, should we be thinking about some of these shorter-term investments as transitory in nature or more in terms of a step change in terms of how the business needs to operate and the cost that needs to put in to fulfill those growth objectives?

Mark Brayan: Yes. So I think in the sort of the -- what we foresee immediately is more incremental, but we just need the flexibility to make those investments as and when they come up. It could be, for example, lining up a team of people to build a particular model to automate part of the business. So we don't just see any step change-type investments in the near term, but it's not to say they may not come along, but it's more likely to be sort of incremental at this point.

Josh Kannourakis: Got it. So is there any way or any comments you can make in terms of how you're thinking about, I guess -- obviously, you talked it's going to be below 20, but is there any numbers you're sort of comfortable talking about as being above in the period or on a go-forward basis to give people a bit of comfort?

Mark Brayan: Yes. We wouldn't want the percentages to go backwards. The objective is to keep going forward with a long-term view of getting to that 20% target.

Josh Kannourakis: Okay. That's great context.

Kevin Levine: Yes. Sorry, Josh, if I can just add to that as well. And that is, yes, obviously, we're going to manage the cost base and prioritize the spend to align with those long-term growth objectives, so around product development and expenses to support the growth and then, obviously, calling up to -- in the short term, as we called out just some impacts from some of the investments that we've been making in the transformation office and things like that. But we're very much aligning to the future growth and prioritizing the spend in order to achieve that.

Operator: Your next question comes from Siraj Ahmed with Citi.

Siraj Ahmed: A few questions. Just first one on the work in hand and conversion to revenue. Any change in how we should think about it? Last year, obviously, there's second half skewed because of the major customers. How are the discussions tracking this year? It's up 15% year-on-year, that's pretty good. But just keen to understand how we should think about conversion.

Mark Brayan: Yes, I think -- hey, Siraj, I would -- on a full year basis side, I wouldn't think any different to prior years. There's always subtle differences year-on-year, but in general, I think about it in a similar way.

Siraj Ahmed: Okay. And second thing, you're going 6-year -- a 5-year target of more than doubling revenue, sort of a -- so I was just trying to understand, when you think about the growth trajectory over that 5 years, are you expecting growth to be faster in the first few years, slower later? Or is it just consistent revenue growth?

Mark Brayan: We've obviously got a bunch of models that get us to those figures, and there's different trajectories. I think the shape of the curve will depend upon the non-Global customers more so than the Globals. As you can see with the China chart, that had a slower start and then got some momentum. So I'd expect a little bit of a build that -- probably more so from the non-Global customers than the Globals. Globals will be a little steadier.

Siraj Ahmed: Sure. And actually, just on the Globals. Again, the target sort of implies, I think, Global is growing at 7% year-on-year. It grew 3% this year. So the -- how -- just keen to understand how you're thinking about that? And what gives you confidence that growth will be at -- around those high single digits?

Mark Brayan: Yes. We -- there are 5 customers in that cohort. They all have their own characteristics and challenges. And if we look at some of the things they faced last year versus this year, we're pretty optimistic given the book of projects we've got with them compared to where we were at this point last year.

Siraj Ahmed: Got it. That's helpful. Last one, just maybe for Kevin. Just regarding the margin comment. Just confirming that we shouldn't be expecting margin to go backwards next year. That's a thing. And would you be able to quantify the level of investment? I mean given the project office, but you also mean to take costs out. Just keen to understand the level of investment that you're thinking about.

Kevin Levine: Yes. So we keep the guidance of up to 10% in any one year. In terms of for this next year, probably a range of 8% to 9% is how we're thinking about our investment. But, as to Mark's point, the key thing for us is to build the foundation and the pathway for that future growth, which means we may accelerate or decelerate at any point in time in order to do that. But within that overall framework of the 10%, probably around 8% to 9% for the '22 in terms of how we're seeing it this year. And then in terms of the margins, obviously, we have some which we've called out. We've obviously got some -- something that's going on, particularly just in '22 when you compare to '21 unless they're like cost of the transformation office. This will give us a positive benefit probably from '23. We've also -- when you look at the share-based payment costs, '22 versus was '21, '21 had an adjustment in the downward adjustment. So obviously, expect normalized, share-based payment costs coming through 2022 and note the comparison with '21, which is going to impact things as well. So once again, these are -- these aren't anything that is really impacting us or banning us from our long-term positioning, but just letting the market know in terms of how we think we're seeing things just in the immediate short term.

Siraj Ahmed: Okay. So the earnings skew is more about those costs coming in the first half rather than the second half compared to last year. That's why the earnings skews -- more skew to the second half.

Kevin Levine: Yes, yes. There's a couple of comparative pressures that impact that I've called out. And obviously, that impacts that skew, as we've called out.

Operator: Your next question comes from Michael Aspinall with Jefferies.

Michael Aspinall: I might just start on the order book. I mean Siraj kind of touched on this, but it's plus 15% year-on-year so far. Would you expect the first half or the full year to reflect that at the top line based on what you're seeing so far?

Mark Brayan: Michael, so we do expect a half-on-half revenue skew, as we call out there if you look at the year's prior to 2020 as a guide.

Michael Aspinall: Yes. Just thinking about the 15%, though, growth you're seeing kind of in the first 2 months, call it, of the year, would you expect at least the first half to, say, reflect that given it's kind of revenue already received for the first 2 months of the year?

Mark Brayan: So this certainly includes revenue for January, to be clear. And I'm not sure I understand the question, given we're calling out that half-on-half skew. I think that's your answer there.

Kevin Levine: Yes. Actually, Michael, just to take away. I mean basically, the methodology here is that this is -- these orders are for the whole year. So you can't really draw any necessary comparisons as to a certain period. It's just -- most represented over the full year period is the first data point and then take the other one where we talk about the skew. So that -- those data points will help you with that.

Michael Aspinall: Okay. So the full year should be 15% growth, but the first half might not be?

Kevin Levine: Yes. You've got the data points that help you with that skew.

Michael Aspinall: And it sounds like you saw a return to growth in the large legacy projects in the second half. Just confirming that, that's right. And what drove the customers to return to investing in that area?

Mark Brayan: So this is -- I don't know if legacy programs is the right way to put it. So there are a number of large programs that we support with our customers, and there's inbuilt seasonality in some of those programs. For example, those that deal with advertising tend to pick up in the second half because of the retail season. So I think that was sort of as the season would have it. Really, what we saw was newer projects picking up in the second half that were consistent with customer strategy to build non-ad-related projects, for example. So it's a blend of both. But I think on the large core programs that we support, there's always a degree of seasonality there.

Michael Aspinall: Okay. And you showed us some numbers at the half. I think it was projects started prior to calendar year '21 and projects started in calendar year '21. I mean if we just have that in the back of our minds, it sounds like we should expect those projects that started this calendar year have contributed more than what they had in the first half on a proportional basis.

Mark Brayan: Yes, yes. So we get new project starts over time, and sometimes they take a little while to ramp up, sometimes they ramp up very quickly. And yes, we had some projects start in the first half that ramped up into the second and then some that started fresh in the second half that delivered material revenue as well.

Michael Aspinall: Okay. Yes. That's interesting. Last one for me, just kind of a follow-up on Siraj's question. You mentioned that the target in '26 is for 1/3 of revenue to be from non-Global customers, which kind of implies that 2/3 will be from Global customers or revenue going from $340 million-odd last year to $600 million in '26. So I'm just interested in how much consultation you've had with your Global customers kind of on that medium-term perspective.

Mark Brayan: So we obviously work very closely with our customers on their MAUs, and that gives us a view of the demand for data. It's a combination of existing projects and some assumptions for new projects. So yes, there's some customer input there, but there's also -- we're backing our ability to find new projects and continue to deliver into existing ones.

Michael Aspinall: Okay. But there is some input there from customers in terms of that kind of 3-, 4-, 5-year outlook?

Mark Brayan: Yes. The customers just want to make sure that we have -- in addition to the quality of data that we provide for them, the customers are always keen to know that we've got sort of new ideas to bring to them. So we do have forward-looking conversations that inevitably go to some discussion around capacity and volume. Having said that, I don't lay out specifically what their requirements are because their businesses are very dynamic. And they rely on us to be dynamic and agile to support them as their needs arise.

Operator: Your next question comes from Xavier Waterstone with QuayStreet Asset Management.

Xavier Waterstone: Just a couple from me. So first one, positive to note that there's a clear disclosure of the development capitalization and amortization on Slides 33 and 38. I'm just curious, though, given the enduring nature of a lot of these costs, especially the development spend, whether EBIT margin should be the focus rather than EBITDA as a better reflection of economic profitability.

Kevin Levine: Yes. I'll take this one, Mark. Yes. We certainly consider this. What we do as well is we look at ourselves compared to our peers as well, and we look at those levels of development as a percentage of revenue. And essentially, what we've derived from that research and comparison is that a lot of companies -- similar top-tier companies and other companies all disclose on an EBITDA basis, even though they have higher levels of development as a percentage of revenue. So at this point in time, we would consider ourselves an outlier just going to the EBIT -- relative to everyone else that's on the EBITDA, but it is something that we consider. But given our levels of spend lower than a lot of others, we're reflecting and we're looking to report at this level for the time being.

Xavier Waterstone: All right. Cool. And the second one was, I guess, I understand your -- the comment about no longer providing short-term guidance. It's understandable given the volatility of some of these revenue and contracts. So second question, I guess, is it looks like given the surprise magnitude of today's share price reaction probably reflects a bit of a lack of confidence in timeliness and continuous disclosure. Can the market expect anything in terms of more frequent or substantial just kind of business operational updates to help address this trust and information gap?

Mark Brayan: I'm sorry, I was off-line talking to the moderator. Could you repeat the question?

Xavier Waterstone: The question was, I guess, I understand your comment about no longer providing short-term guidance, given the surprise magnitude of today's share price movement and some of that being a lack of confidence in timeliness and continuous disclosure, whether the market can expect anything in terms of a more frequent or substantial business updates to help address this information gap.

Mark Brayan: So we've always provided information as we've been required to do so, and we'll continue with that policy. And if there's anything that we feel is in the interest of the shareholders, then we'll provide that.

Operator: Ladies and gentlemen, we have five minutes remaining with us. Your next question comes from Garry Sherriff with RBC.

Garry Sherriff: Mark and Kevin, a couple of questions. First, the FY '26 goals, they're looking ambitious. Does that include any acquisitions for those goals, if you could clarify for us?

Mark Brayan: Not material acquisitions, Garry.

Garry Sherriff: Understood. And thank you for that graph on the competitive landscape, it's very helpful. You flagged after Lionbridge's scale, the next largest competitor. Who is that? And the follow-up question is do you find any of the assets that you've flagged or companies you flagged, does that have anything attractive that you think could be beneficial under the Appen umbrella?

Mark Brayan: So the fourth one is sort of a blend of information that we've picked up in the market. There are some competitors in the tens of millions of revenue in the sort of the $30 million to $50 million range. So it's just a sort of a blend of people that the point of the chart is to show that Scale has put out a figure about their revenue. The others can pick up things from time to time, but they're going to be around that size. So it's not a specific company. It's just sort of representative of where the fourth place competitor is. In terms of other companies on the slide and do they have things that would be beneficial, look, we look all the time, Garry, at companies in the space and whether or not we could combine with them, bringing them under the Appen umbrella, as you say. Oftentimes, though, they're fairly early and loftily valued, to be candid. So we just have to be very careful and strategic about some of the things that we look at. But I'd also say that most of the things -- most of the companies on the chart have -- sort of tech forward. And when we look at the technology and the capabilities we've got, there's a fair chance we can build it ourselves at a better return to shareholders than buying them.

Garry Sherriff: Understood. Just going back to the ad-related revenue being, call it, 25% of group revenue. Have there been any insights in terms of your discussions with Facebook in terms of volumes for calendar year '22 versus last year, given that they're clearly a big contributor to your ad-related revenue?

Mark Brayan: Yes. So the order book number is obviously inclusive of a lot of work with our major customer, and I think that's probably the best answer I can give you there, Garry. You can draw some inference from the size of the order book number.

Garry Sherriff: Yes. No trouble. Last one on China. Maybe let us know who some of those customers are. And if you could provide us any detail on the margins, gross margin or EBITDA margin, that would be beneficial.

Mark Brayan: Yes. So many of our customers, as you know, are building future-facing products, and they're not keen to -- for us to talk about who they are. We've managed to get permission for a number of logos, as you can see throughout the deck. None from China, though. But I can tell you that all of the China tech giants are our customers. I can also tell you that the major mobile companies are our customers as are the major autonomous vehicle companies. So you can probably find a bunch of them pretty quickly just with some searching. In terms of gross margins and EBITDA margins, we haven't disclosed those, but I can say that we're still investing into China, and I can also say that the gross margins are improving. That said, the focus in China is very firmly on growth, and you can see that, that's paying dividends for us.

Garry Sherriff: And so when you talk about some of those large Chinese tech giants, is there any reason why then you'd classify China as being non-Global in terms of when we segment them as customers? I just noticed that in terms of that non-Global customer base, you've flagged China as being non-Global, but I would have thought some of those Chinese tech giants would be.

Mark Brayan: Yes. I guess it's in the name. I mean we -- our Global customer base is the 5 big U.S. giants because that's where we derive the bulk of our revenue, and everything outside of that is non-Global. Some of our customers outside of that are sizable, but just by our definition, the Global is those 5 U.S. tech giants. I assume that's it, Garry?

Garry Sherriff: Yes. Sorry. Yes. Fine for me. I thought the moderator had cut me off, but yes, that's great.

Operator: Ladies and gentlemen, that was the last question for today. I'll now hand back to Mr. Brayan for closing remarks.

Mark Brayan: Yes. Thank you very much, and thank you, everybody, for joining the call today. As I said earlier, we are pleased with our results this year and firmly focused on those 5-year goals to reiterate or to at least double our '21 revenue by 2026 to have 1/3 of our revenue from our non-Global customers. And as per the response to Garry there, the Globals are the big 5 U.S. tech giants, and we have 1/3 of our revenue from outside of that. And finally, to continue to be a profitable company with an EBITDA margin target of 20%. So thank you once again. And I'm looking forward to me and you in one-on-one meetings that we may have. Thanks very much.

Operator: Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.