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Edited Transcript of APX.AX earnings conference call or presentation 29-Aug-19 1:00am GMT

Half Year 2019 Appen Ltd Earnings Call

CHATSWOOD Sep 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Appen Ltd earnings conference call or presentation Thursday, August 29, 2019 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Kevin B. Levine

Appen Limited - CFO

* Mark Ronald Gerard Brayan

Appen Limited - MD, CEO & Executive Director

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Conference Call Participants

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* Adam Dellaverde

Taylor Collison Limited, Research Division - Equities Analyst

* Garry Sherriff

RBC Capital Markets, LLC, Research Division - Analyst

* Josh Charles Kannourakis

UBS Investment Bank, Research Division - Research Analyst

* Paul Mason

Evans & Partners Pty. Ltd., Research Division - Research Analyst

* Quinn McComas Pierson

Crédit Suisse AG, Research Division - Co-head of the Small Cap Research

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Appen Limited FY '19 Half Year Earnings Conference Call. (Operator Instructions) I would now like to hand the conference over to Mr. Mark Brayan, CEO. Thank you. Please go ahead.

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [2]

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Thanks, Jenny. And hello and welcome, everybody, to the conference call for our first half results for 2019. Thank you, once again for your interest in the company, and thanks for joining the call.

I'm joined today by our CFO, Kevin Levine, and you'll hear from him later on in the call. Per the intro, we'll walk through the presentation, and then we'll open the call for questions.

So let's get underway. If you could turn to Page 4, first of all, for the results highlights. Look, the company has undoubtedly delivered once again for our customers, our staff, our crowd workers and of course, our shareholders. Revenue for the half, up to -- up to $245.1 million. That's a 60% increase on the first half of last year. Underlying EBITDA of $46.3 million was up 81%. At the same time and very pleasingly, our underlying EBITDA margin expanded from 16.8% to 18.9%. This is as a result of economies of scale and our investments in tech-led productivity improvements as they took effect this half. Underlying NPAT was also up on the last half -- sorry, on the first half of last year to be correct by 67% to $29.6 million.

From a divisional perspective, and these numbers on Page 4 relate to our core operating divisions and are independent of Figure Eight. Revenue for Speech & Image data of $39.9 million was up 85% on the first half of last year, and Relevance data was up 48% to $193.7 million. Now for those of you that have followed us for a while, Speech & Image data was formerly referred to as Language Resources, but we've renamed it given its broadening that now includes other data types such as image and video. Relevance data refers, of course, to our former Content Relevance division.

We're very pleased to declare a dividend of $0.04 a share. This is partially franked. This is consistent with last year's interim dividend and in line with our ongoing review of capital management.

Finally, Leapforce is now fully integrated and providing margin benefits, and Figure Eight is delivering on its thesis. More on both of these later in the presentation.

Turning to Page 5 and the divisional result. And at the outset of -- just explaining that we've restructured the business to be closer to the customer. That is we now sell Speech & Image data which was sold from Language Resources, and Content Relevance data or Relevance data, which was sold from the Content Relevance or CR division. We share resources across these divisions now. So we've allocated those resources largely based on revenue, and we've restated the 2018 numbers on this same basis. So the comparisons which you're getting on these page are on a like-for-like -- like-for-like comparison.

So first, Speech & Image. This is really gathering speed. The first half last year, we did $21.5 million, and then we topped that in the second half of last year with a revenue result of $29.9 million. And that's now being bettered this half with revenue of $39.9 million. So in round figures, the business has moved from $20 million to $30 million to $40 million in successive halves.

I'm often asked when will the world have enough speech data, and I can confidently say and this trend shows that I don't think it will be for quite a while. Our customers are continuing to ask for more data in many languages for new products and to improve their existing products. And it's not just audio speech data. We also provide text data for language-based products such as chat box, for example. The reason they need more data is that human speech and language is complex and building technology that mimics it is a very hard problem to solve. And the solution lies in more data, and we're happy to play our role by continuing to provide very large volumes of high-quality data for all manner of speech and natural language product.

Speech & Image, as the new name suggests, also provides image and video data. It's a growth area for us and one that requires special labeling technology. We're able to participate in it more fully now following the acquisition of Figure Eight.

Our Relevance business continues to be the cornerstone of the company. Revenue of $193.7 million in the first half was up 48% on the same period last year. This was largely from our anchor technology companies across new and existing projects, but we're also adding new Relevance customers as well.

Our technology-led productivity initiatives and economies of scale helped us grow our Relevance margins. And remember that this is on a like-for-like comparison with the prior half -- or the prior corresponding half. And we also continued, at the same time, to deliver high-quality work to our customers and fair wages to our crowd workers.

To Page 6 now and Figure Eight. Our investment in Figure Eight is delivering on its thesis. It's accelerating and derisking our technology strategy, and tech is essential to our business. It's diversifying our revenue and it's expanding our markets, most notably into the government market, of which more later.

Figure Eight's technology in the engineering, product and machine learning teams have been a very positive addition to the company. We are now firmly a data and machine learning technology company, building on our established brand as a language company. The Figure Eight platform is proven to be deeper than originally thought. And its security features, including its SOC 2 compliance, and this is a certification that relates to the security, availability, integrity and the data confidentiality of SaaS-based systems, is proving to be invaluable, particularly in the current climate of increasing scrutiny on data privacy.

The achievement of planned synergies and the path to profitability are on track, as is our full year EBITDA outlook. However, despite a strong first quarter, Q2 sales and retention were not where we would have liked them. The acquisition was distracting for staff, and it cost us some sales momentum. The sales team is also necessarily shifting to chase bigger deals, and some of these slipped outside the quarter.

That said, we've implemented some remedies and added management support from Appen. Our new Global Head of Sales, Jon Kondo, is spending much of his time with the Figure Eight team. Jon has a strong pedigree in sales growth and SaaS companies in particular, and his efforts are yielding benefits. We have over 30 cross-sell opportunities between Figure Eight and Appen, and the third quarter is off to a nice start.

We've revised our full year ARR target for Figure Eight, and we note that the revision had an immaterial effect on the overall Appen results. And further, investors are protected by the earn-out structure.

We view the current performance as temporary and retain a high conviction in Figure Eight and its thesis over the mid- to long term.

It's also worth noting that another company in our space called Scale recently raised capital at a valuation of $1 billion. And that was well up from its previous valuation less than 18 months ago of $93 million. And regardless of what you think of the valuation, this shows genuine interest in the data annotation market and reinforces the value of Figure Eight to Appen and to our future.

So we provide an updated customer cohort chart on Page 7. The chart shows our customers by annual cohort and the revenue for each cohort each successive year. We are clearly getting repeat from growing revenue from a number of these cohorts. The blue bars shows Speech & Image data revenue for the first half of this year, almost on par with the full year for 2017. And the red bars show Relevance revenue. While results are dominated by 2 customer cohorts, the repeat venture of that revenue underscores the importance of the data we provide to our customers and the quality of the work and service that we deliver. You'll also notice that Figure Eight hits the chart for the first time with the yellow bar for the first half of 2019.

To Page 8 and an update on our technology strategy. Recall that our investments in technology enable us to complete, deepen the moats around our business and future-proof the business. I'm very pleased to say that our tech team are now led capably by our CTO, Wilson Pang, who's delivering on that vision. And the tech team incidentally includes engineers from both Appen and Figure Eight working side by side under Wilson's leadership.

We rely on 3 core platform illustrated on the top right-hand side of the page: our crowd management platform, Appen Connect, acquired from Leapforce, helps us recruit, test, onboard, provide instruction, monitor quality and pay our crowd workers. We're paying in the order of 40,000 workers per month, and that number has peaked at over 18,000 workers. This system is the foundation of the business of our scale and fundamental to our performance. Our client workspace, acquired with Figure Eight, enables customers to fulfill their data needs through a SaaS-based interface. They can scribe their data requirements and quality standards, send jobs to crowd workers and manage data quality, all through an agile web-based interface. And our annotation tools, some of which are from Figure Eight and some from Appen, are used by crowd workers to collect and annotate data to the clients' requirements.

We're investing into the usability and automation of these tools to improve the worker experience and, of course, their productivity. We're delivering exciting new features across these platforms, including enhanced security features, very necessary in the current climate. We're also using advanced techniques such as machine learning to automate annotation tasks. We're already seeing productivity improvements from automated quality checking of transcription, for example.

Now remember that our crowd is one of our greatest assets, but it's also a large expense. So improvements in productivity go to a better crowd experience and better margins. We need to invest in technology to run, improve and future-proof the business. And the small table at the bottom of the page shows the substantial increase in investment from the first half of last year. This is an important part of our transition to a tech-led business.

Over to Page 9 and a brief update on the acquisitions. Leapforce is now fully integrated into Appen. The Appen Connect system came with Leapforce, and in addition to the system's recruiting and crowd management capabilities, we gained comprehensive project and resource management functionality as well as quality management and reporting features. The integration of Leapforce included a root and branch review of all of our crowd and customer-facing processes, the implementation of Appen Connect to codify these processes and in comprehensive training and change management to enable our recruiting and customer teams.

Appen Connect also enabled the restructure around the customer, where we share resources now across Speech & Image projects, Relevance projects, et cetera. It was a nontrivial exercise, but we're already seeing resulting productivity benefits and has set the business up for far greater scale.

We've yet to fully embark on the integration of Figure Eight. It's running as is under the leadership of its COO, Becky Scott, to deliver the earn-out. But Appen management is leaning into coach -- scope the integration and set the business up for future success.

Independent of the integration, Figure Eight is providing us with substantial benefits, including putting us in a great position in the government market. This is highlighted on Page 10. The Figure Eight platform is being deployed behind government firewalls for large-scale data annotation for government AI projects. This is no mean feat. It required rigorous testing to the highest technical security standards and swift and agile responses from Figure Eight engineers to respond to issues and satisfy these standards.

It's interesting that the government came to Silicon Valley and Figure Eight rather than traditional government tech providers and shows both the uniqueness of Figure Eight solution and the government's intent to invest in AI. Also, the secure deployment of Figure Eight is a high barrier to entry, and it sets us up to fully serve the customers and participate in what can be a substantial opportunity for the company.

Page 11, we continue to invest in China, the second-largest AI market, and maybe the largest one day. We welcome Dr. Roc Tian to the management team as our Head of China. Roc has a strong technology pedigree through his career with IBM and HP in China as well as a Ph. D in computer science. His background with U.S. firms and China brings valuable cross-cultural business experience, and he operates with a high degree of communication. He's also hit the ground running, building the team and working with our customers.

Our data labeling facility in Wuxi, which is west of Shanghai, is implemented and operable. It's similar to our Philippine center but currently at a smaller scale.

I'd now like to hand it over to Kevin to take us through the financial pages of the presentation.

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Kevin B. Levine, Appen Limited - CFO [3]

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Thanks, Mark. And once again, it is a real privilege to report on such great result. The revenue increase of 60% has been driven by both divisions as well as Figure Eight. Out of the 60% growth, organic growth represented 53% and Figure Eight represented 7%. Growth of 85% in Speech & Image over the prior period was a standout and mainly came from expansion of existing projects continuing on from the previous half. There was also some growth in new projects. Relevance growth excluding Figure Eight of 48% was driven by major customers with growth in existing and new projects.

Underlying EBITDA was up 81%. This was achieved by efficiencies from the Leapforce integration as well as efficiencies from other process improvement initiatives. As we get bigger, we get better, and we continue to derive economies of scale.

Underlying NPAT was up 67%. This was mainly impacted by movement in effective tax rates to 28.2% from 21.2% in the prior comparative period where the prior period rate was abnormally low. In the prior period, the share-based payment deduction was significantly larger than the share-based payment expense, and that gets added back to taxable income, and that resulted in an abnormally lower tax expense.

Moving on to Slide 14 and to the balance sheet. Appen continues to strengthen its balance sheet. Receivables have increased due to increased volumes as well as the addition of Figure Eight. Noncurrent assets have increased significantly, mainly as a result of the Figure Eight acquisition. Of this increase of $311 million, goodwill associated with the Figure Eight acquisition represents $281 million and capitalization of rental leases represents $22 million.

Based on the revised Figure Eight ARR forecast, the corresponding estimated future value earn-out payment rate is $36 million to $50 million. The estimated earn-out liability has been booked at the low end of this range in order to be conservative.

Debt has significantly reduced. $45 million of debt was repaid during the period. $21 million was repaid as part of the capital raise in March, and the balance of $24 million was sourced from our own cash reserves. As a result of the low debt levels, Appen is in a net debt negative position of $59 million. Essentially, we have more cash than debt. And this compares with net debt leverage of 1.1x at the time of the Leapforce acquisition in December '17 and 0.26x at December '18.

Moving on to Slide 15 and our cash flow. Appen continues to execute well on converting earnings to cash and thereby increasing cash presence. Cash increased by $40 million in the period, driven by a 98% increase in cash flow from operations. Cash was directed to repay debt, fund CapEx and pay dividends in the period. And cash flow conversion increased to 92% from 84%.

On Slide 16, we talk about the impact of currency. And the Appen performance benefited from a weak Australian dollar in the period. Excluding the ForEx translation tailwinds, revenue and underlying EBITDA increased by 47% and 63%, respectively. And the EBITDA uplift that came from the ForEx translation, the spread between that and Appen, would be in accordance with each division's relevant earnings.

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

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [4]

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Thanks, Kevin. So to Page 16 now. The AI market continues to grow very strongly. There's no doubt of that. There are many indicators and some are on the page. Gartner, for example, a leading tech analyst that many of you know, estimates that the number of AI projects per organization will grow at over 100% a year. KPMG found that most business have some adoption plans for AI varying in maturity from pilot projects to scaling up to in production and industrialize. And this is across a wide variety of use cases. Now none of this growth is possible without high-quality training data, and we're playing our role admirably in this regard.

Over to Page 17. We're uniquely and strongly positioned to win in this market. We have unparalleled suite of technologies, a proven and highly scalable crowd capability and an enviable track record. And as previously stated, our Speech & Image growth rate of, in round numbers, $20 million to $30 million to $40 million over the last 3 halves illustrates this demand, the data and our ability to deliver at scale. Our customers are demanding, but we meet those demands, and we continually improve to exceed them and meet [the next].

Finally to Page 18 for the summary and the outlook. We're really pleased to present the results and assure you that we remain committed to strengthening our position and continuing the company's growth in the dynamic market for AI training data. We'll continue to invest in technology, sales and marketing and the government markets in China in particular to achieve these objectives.

Our 2019 order book is in good shape with year-to-date revenue plus orders in hand for delivery in 2019 at approximately $380 million at mid-August. This includes Figure Eight. Our full year underlying EBITDA outlook for 2019 is trending to the upper end of the range of $85 million to $90 million. This also includes Figure Eight.

A few notes on the earnings figures. The second half is struck at a U.S. exchange rate of $0.74. We realize this is higher than the rate today, but it's our practice to maintain the rate that we struck at the beginning of the year for consistency. Note also that it took 3 months of Figure Eight losses in the first half amounting to $2.6 million and will take 6 months of losses in the second half. And the first half result benefited from a ForEx gain of $4.7 million.

Before we open for questions, I would like to thank our customers for their support, our global crowd for the work they do for us and the hard work, commitment and friendship of everyone at Appen and Figure Eight with a special thank you to Kevin for everything he does for everyone on the call and for all of our shareholders.

Pleasure working with such a great team and a pleasure to report the results of their efforts to all of you. So thank you. I'll now hand the call back to Jenny to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question is 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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I guess just firstly on Figure Eight and the slowing of the revenue growth there. So you've highlighted some transaction disruption. You've highlighted some, I guess, chasing some of the larger deals. But presumably, that would have been kind of known or understood when you were providing original guidance on that ARR growth rate. So could you maybe just talk us through kind of what is new or what has changed since March that has slowed the revenue growth momentum down?

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

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Yes. Quinn, I think, as we said, the transaction itself was more destabilizing than we thought for the team. It's the youngest team in a very dynamic environment in the Bay Area, and a lot of people were sort of fearful for their jobs initially and that kind of put them into a little bit of a funk, unfortunately. The good news was that the staff retention rates were high. So it didn't result in us losing staff, but it did result in some deal disruption.

The other thing, and you may noticed also, is that these businesses are very highly tuned towards the end of the quarter. So what we see in March and April and even May can be very different to what we see come the 30th of June in this instance. The end of the quarter is when the large deals are signed or re-signed or in this case, some of them not signed. So there was a bit of a swift transition to the visibility.

The good news is going into Q3, we're off to a fast start. Retention rates are high. And Jon Kondo, as I mentioned, has settled the team down and starting to add a lot of value there. So we're pretty confident with things going forward. We're also supportive of their push to focus on larger deals because we think the larger deals are out there, and we think that's how they're going to add a lot more value to the business.

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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 secondly and related to that, I think I heard you say that you're still confident on the previous target, which was second half '20 profitability for Figure Eight standalone. So I guess could you just kind of confirm I heard that correctly? And if that is the case, then presumably, that would mean your FY '20 revenue growth would be even higher than you had previously thought? In other words, kind of make up for the FY '19 disruption? Is that how to be thinking about it?

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

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So definitely, you're correct on the first question on profit. In terms of the full year next year, as we go into our planning towards the end of this year and as we bring the businesses together, clearly, we'll get an accelerating effect from the integration into Appen. But exactly how that will map itself is a little early to say at this point.

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

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Okay. Just to be clear, so you're still confident in the second half '20 profitability? Is there a chance that maybe the cost base would be lower to get there? So not necessarily the revenue hitting original expectations but kind of the net profit. Is that part of the...

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

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Yes. It's a combination of revenue and cost management. So our -- we're managing the cost a little more prudently perhaps than the business did on its own. And obviously, we're confident in the Q3 and the Q4 revenue to get us to that, that EBITDA target by the end of the year.

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

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Helpful. And then just lastly, on your full year guidance. So you're tracking towards the top end of the range. It'd be $90 million. So if we look at $46 million at first half EBITDA, that implies about $44 million of second half EBITDA. So I'm cognizant there is a little bit of annualization of Figure Eight losses. But even kind of including that, call it kind of a somewhat flattish outcome there. Is there -- are there any kind of first half projects that will be rolling off to be cognizant of? Or is it more, I guess, a matter of conservatism where you're not baking in, I guess, potential or likely new work later in the year? I'm just trying to reconcile the first half, second half profit split.

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

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Yes. So you've got to take the impact of the foreign exchange into account, Quinn. We record actual results at the exchange rate on the day that we forecast the forward period, in this case, the second half at $0.74. So there's a dampening effect on the second half forecast due to currency. And as I explained or stated in the presentation, that's just been our practice. This year, it happened to swing quite a bit. So there was a $4.7 million benefit in currency in the first half. And you can assume that there will be some currency benefit in the second half. And overall, when you take into account currency benefits and the Figure Eight losses, we see growth from -- growth in the second half on the first half.

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Quinn McComas Pierson, Crédit Suisse AG, Research Division - Co-head of the Small Cap Research [10]

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Yes. Just at spot right now for FX, what would be the implied earnings uplift if you use that?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [11]

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I think you're going to have to do your own sums, Quinn.

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Kevin B. Levine, Appen Limited - CFO [12]

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Quinn, what you can do is you can look at the movement in H1 and you can see if that correlated to the 4.7. And essentially, if the currency movement is around there or similar, well then, that could point towards a similar kind of outcome.

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Operator [13]

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Your next question is from Garry Sherriff from Royal Bank of Canada.

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Garry Sherriff, RBC Capital Markets, LLC, Research Division - Analyst [14]

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Mark and Kevin, just a question around F Eight, particularly around the earn-outs. So it sounds like that earn-out has dropped materially. Can you just remind us what it was previously? Because I think you're now guiding to $36 million to $50 million earn-out.

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

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Yes, Garry. So basically, the earn-out is based on ARR contracted to the end of December. So essentially, what this means is any deals that really kick the ground up before the end of the year go into the mix. And the guidance we provided previously was USD 62 million -- sorry, USD 60 million to USD 80 million.

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Garry Sherriff, RBC Capital Markets, LLC, Research Division - Analyst [16]

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Okay. And again, you've got a number of figures here around Figure Eight in relation to ARR, and you've talked about being below plan at a certain line and then at plan at the EBITDA line. I wonder just for clarity, are you able to just tell us what those plans were? Because you're now saying ARR has dropped. So I'm just wondering what you're going for before. And also, you're now saying that EBITDA remains in a planned range. Can you just maybe just be a bit clearer on what those figures are?

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

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So essentially, yes, but when -- the work plan, you should read into the guidance, the guidance we provided at the time when we announced the acquisition. So we gave -- basically, we gave '18 numbers with Figure Eight. And then we basically said, okay, from an EBITDA perspective, what we expected, it was going to be a 25% to 35% reduction in the '18 number. And so what we -- we're confirming that position. There's no change in that. And once again, note when we're talking about ARR, it references back to the guidance that we gave at the time of the acquisition.

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Garry Sherriff, RBC Capital Markets, LLC, Research Division - Analyst [18]

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All right. Your year-to-date revenue plus orders on hand, last year, that ratio in terms of delivery to revenue was about 70%. Now should we be assuming a similar ratio conversion for '19?

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

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There's a few factors that impact it, Garry. As we win more customers, we get a better spread of revenue through the year, which is to say that there are bigger orders to come year-on-year. So it's a good starting point, but it's going to vary year-on-year, but it's a good starting point.

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Garry Sherriff, RBC Capital Markets, LLC, Research Division - Analyst [20]

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Final question on capital management. You've stated an ongoing review of capital management priorities, including your dividend policy. You've just got net cash of $59 million. Can you just remind us what your current dividend policy is and maybe give us a sense of whether you're planning to build up more of a cash war chest for future growth? Or are we thinking that's not the case and now you're going to lift the payout ratio? I just wanted to be a bit clearer around that if possible.

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

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Yes. So we don't have a sort of a stated policy on dividend, Garry. And we are -- we've got some debt now. So we need to manage that. To the extent to which we can find attractive opportunity for acquisition, having more cash for that is always handy and also having cash to invest into such markets as the U.S. government market and the Chinese market. So I think you certainly get the view from us that we like to do things reasonably conservatively, and we think that using that cash for investment is probably a good thing to do.

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Operator [22]

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Your next question is from Paul Mason from Evans & Partners.

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Paul Mason, Evans & Partners Pty. Ltd., Research Division - Research Analyst [23]

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Just a few from me. The first one, your investment in engineering at $13.1 million. Perhaps give us some context around that. I thought you'd sort of guided to about a $6 million annual budget for that for this year. Can you maybe -- I know I've got a $6 million number from one of your presentations, but maybe just explain the differences going on there? Is that just actually much more expense? Or was that $6 million like an incremental thing and I'm officially interpreting history wrong?

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Kevin B. Levine, Appen Limited - CFO [24]

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Paul, so the $6 million figure was initially savings from the integration of Leapforce. That will be cloud into R&D prior to the acquisition of Figure Eight. When we made the acquisition of Figure Eight, we were still using most of that $6 million for R&D. But of course, we ended up where we are now spending more than the $6 million on R&D because we have a larger team of engineers and data scientists and product managers. So that $13 million figure refers to the total spend in engineering across Appen and Figure Eight. So the $6 million is buried within it, but the reason it's gone up so dramatically is because we've added the Figure Eight engineering team.

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Paul Mason, Evans & Partners Pty. Ltd., Research Division - Research Analyst [25]

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Okay. So just on margins in Speech & Image. So second half last year, you guys saw like effectively like a very down year. I think your explanation at the time was that a whole bunch of government or secure facility work at least anyway had temporarily disappeared. And you were planning it was coming back. Is that the big driver of the margin recovery in this half? Or is that more attributable to like the Speech & Image recognition stuff, the AI that's gone in as opposed to sort of the more legacy half of that business that were lower margin historically?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [26]

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Yes. So we haven't seen a strong return to that previous very high margin government work. But the revenue growth in Speech & Image is coming largely from the technology sector, from commercial clients. And the margins are sort of generally consistent. And just for clarity, the government work that I referred to with Figure Eight is a different part of the government altogether. So it's not that very high-value speech -- or very high margin speech work that we have historically enjoyed. So overall, the revenue growth is coming from the tech sector and the margins are about where they were.

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Paul Mason, Evans & Partners Pty. Ltd., Research Division - Research Analyst [27]

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Okay. And just sort of last one for me. On the Leapforce integration, just noting what you -- sort of in your prior answer that you'd flagged $6 million of savings for this year. But just going through the Slide 7, it sort of indicates that in Relevance, about 50% is done at the moment. And then in speech, image and video, you're expecting staff to migrate in Q2. Could you -- so just 2 elements to this, if you could. Just in terms of what you said, Q1 and Q2, is that a reference to like sort of financial year Q1 and Q2 or calendar year Q1 and Q2 like Q1 ending in September? Or does it end in March? And then secondarily, given that there's clearly like not a -- it's not a 100% run rate, could you give us an idea of like the annualized full -- efficiency benefit given $6 million clearly got like a ramp profile for it?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [28]

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I don't -- sorry, Paul, I do not understand your question. Can you break it down a bit? There's a whole bunch of stuff in there.

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Paul Mason, Evans & Partners Pty. Ltd., Research Division - Research Analyst [29]

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Maybe I'll ask it as 2 questions then. So just the first one, on Slide 7, you've made comments about Relevance projects getting onto Appen Connect, 50% now or by the end of Q1. And then for speech, image, video work, end of Q2 on Appen Connect. And so can you just clarify what Q1 and Q2 means in terms of the exact dates, how you're chopping the year off?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [30]

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I think you might be using an older presentation, Paul.

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Operator [31]

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Your next question is from Josh Kannourakis from UBS.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [32]

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Just first question around the Relevance division. So obviously, you mentioned some restatement there. But the delta in margins year-on-year are actually really large. And I guess just trying to understand a little bit more context around how those margins changed from second half '18 as well and whether you expect sort of a continued benefit and just maybe a little bit around where that benefit is coming from, obviously, a strong result.

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [33]

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Yes. Thanks. So there's 3 sources of the benefit. One is step change. The other 2 should continue to yield benefits going forward. The first is just the full integration of the Leapforce work. Leapforce operated at higher margins than Appen historically due to its high degree of efficiency. And so just blending the Leapforce work and the Appen work gave us a lift of margins, the first source. The second source is technology-led productivity improvements. So we've implemented the Leapforce platform now across all of our projects, Speech & Image and our Relevance projects. And that just improves efficiency and goes to margin. And then the third source is just economies of scale. The bigger the projects get, the bigger the business gets. We get to share cost and that goes to margin as well.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [34]

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Got it. And so in terms of the continued -- the benefit throughout the year, have we seen a full heat-up of, I guess, the -- especially the tech-led and obviously Leapforce-led benefit within this first half? Like is there any more benefits to come in the second half?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [35]

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So there should be to the extent that we don't get price pressure. So remember that the thesis around technology is to improve productivity through technology and position us to manage price pressure if it should come along. So we've always targeted, at a group level, margins in the mid-teens. We've exceeded that at the moment. And we continue to deliver technology that improves productivity, but of course, we can't predict price pressure at this point.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [36]

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Got it. That was actually my next question. Just to get a little bit of context, Mark, around the customer environment and what you're seeing out there in terms of pricing across some of your large clients.

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [37]

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So the larger the clients, the greater the demand for volume discount. And we work with our clients in that regard. But most of the pressure that we see comes from demand more so than price at this point. We are being proactive with our customers to provide them with good pricing. And they're very happy in that regard. But we also have seen most of our pressure on the demand side. And our ability to scale up with crowd workers, for example, is very helpful in that regard.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [38]

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Got it. And so just following on from that though. In terms of, I guess, the competitive landscape, are you seeing any new entrants in your core markets? Obviously, we talked about some other guys on the autonomous side like Scale AI and the like, which you mentioned earlier, but in your sort of core Relevance markets, in social media and search, it's the still same players, no new entrants at the moment?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [39]

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That's correct.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [40]

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Okay. Great. And then just final one. Just in terms of the Speech & Image division, are you able to give any context around just what amount of sort of speech versus image? I imagine image is small, but just to try and get some context on how that part of the business has been growing.

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [41]

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Yes. The bulk of it is speech work. And as I said in the presentation, our ability to participate at scale in the image and video world requires certain technologies, which we now have with the acquisition of Figure Eight. So Speech & Image is predominantly speech and other natural language data. But we're confident we'll see more image and video data going forward.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [42]

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Got it. And just in terms of the cost base, corporate overhead, so is it fair to expect that to sort of continue at a similar run rate into the second half? Or is there any other sort of movements we should be aware about?

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Kevin B. Levine, Appen Limited - CFO [43]

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Yes. Josh, I think that's indicative of normalization. Obviously, we'll -- if there's special areas we need to invest in to further grow, we'll do that. But if you look at -- we finished -- full year '18 was $11.1 million, 6.5% for the first half year. That's indicative of the best view of what we have right now with corporate overhead.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [44]

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Yes, yes. And definitely final one for me. You mentioned the $13 million -- I think Paul mentioned the $13 million invested in the business. Can you just give a bit of context around what was, I guess, capitalized versus what was expense of that? Or was that just a pure expense number?

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Kevin B. Levine, Appen Limited - CFO [45]

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So that's the total investment. And if you go back to the guidance, generally our policy is a 3-year amortization policy. So essentially work on -- essentially 1/3 of that is being capitalized and 2/3 is being expensed.

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Operator [46]

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Your next question is from Adam Dellaverde from Taylor Collison.

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Adam Dellaverde, Taylor Collison Limited, Research Division - Equities Analyst [47]

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Just as we talk about retaining cash for acquisitions, I'm just interested in your thoughts in terms of deploying capital into China, maybe in the context of one of the big tech companies in the U.S. being criticized for aiding the Chinese government indirectly.

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Kevin B. Levine, Appen Limited - CFO [48]

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Adam, yes, I don't know how to answer that question. We're going to be fairly prudent in the way we deploy cash into China to manage the risk of our business. How that impacts the way -- yes, I'm not 100% sure what you're after, but I will say that we're going to be fairly prudent in the way we deploy the company's cash in China.

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Adam Dellaverde, Taylor Collison Limited, Research Division - Equities Analyst [49]

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So maybe I'll -- I guess I'm just alert to on the risk side, you did this fantastic business growing like crazy in sort of, let's say, Western customer base. As you push into China, how do you protect systems? How do you protect data? How do you do that to make sure that those customers are happy and all of the work you're doing for them is sort of siloed? And how do you hire, I guess?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [50]

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Yes. No, that makes sense. So we are very aware of the risk of the nature of our business in China, being a data-based business. So we have deployed a completely separate tech stack into China. So our core platforms, our Appen Connect platform and our Figure Eight platform are not being sold into China or being used in China. So China has its own tech stack. And so that keeps the IP and the data completely separate.

We're also setting up China as pretty much a standalone entity for reasons of protection of IP and data but also to be able to respond to the local culture and the pace of business there. We've been very open and transparent with our customers about our activities in China, and they're very pleased with the way that we're structuring things. They maintain some interest in Chinese data. So they're pleased that we're there, but they're also doubly pleased that we're going to the trouble to structure things in such an [A-cut] fashion.

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Adam Dellaverde, Taylor Collison Limited, Research Division - Equities Analyst [51]

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Great. And I guess in terms of the customer base, the established customer base, which is showing amazing organic growth again, are you sensing any change in the way they are tendering, I guess in some way, your exclusive? Are you hanging on to that exclusivity to the best of your knowledge?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [52]

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Again, I don't think we've ever said that we have exclusive relationships. But I will say that, and just echoing my earlier comment around demand, the most important thing for the customer is a reliable source -- a reliable supply of high-quality data at speed for a good price. And as long as we continue to deliver, our customers continue to be very happy.

Per the earlier question, I think, from Josh or maybe Paul, there was a question about competition. We don't see any change in the competitive landscape at the large scale. There are smaller start-ups on a regular basis providing annotation services but not to the level or the scale or the quality that our large customers -- that's why we're comfortable [trying out].

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Adam Dellaverde, Taylor Collison Limited, Research Division - Equities Analyst [53]

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Right. Great. And I guess as you retain some capital and look to deploy it into acquisitions, if I sort of think about the acquisitions you've done so far, there's been an element of, I guess, productivity technology benefit to the core business and then something new on the other hand, maybe a new customer or maybe a new SaaS business. As you're looking forward, do you think it will be a similar story where you kind of justify part of it based on improvement to the core? Or is there some new capability or some new SaaS or new sector that you're looking at when you talk about that kind of opportunity?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [54]

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Yes. So we don't see -- I think we've got a pretty good set of technologies at the moment. So we don't see a technology acquisition in our space. At the moment, I think we're pretty solid there. We'd love to find the opportunity to add customers or add markets or add a related capability. But I don't think we'll be going for a purely tech play at this point. It's just my sense. We keep our eyes open for opportunities. But I think we've got a pretty good set of technologies at the moment.

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Operator [55]

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Your next question is from [Stella Wang], private investor.

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Unidentified Participant, [56]

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Great choice of Wuxi as your processing center. Great location, close to Shanghai and Hangzhou and not as expensive. I got 2 questions. The first one is on RMB 30 million, I think the previously guided equivalent or comparable is about 12 million. So should we expect the 30 million to continue? Or is there any synergy you can strip out of that? Could you give us a bit of an updated guidance on that front?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [57]

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Yes. So I'm not sure of the $12 million number, Stella. But certainly, R&D costs -- or R&D is important for the business. And I think we'll see R&D being the future of the business going forward. But it's not going to jump up at the rate that it has as their table illustrates because we started from a pretty low base and also with the acquisition of the Figure Eight, that has added a lot of cost. But we will continue to invest in R&D going forward. It's necessary for the future growth of the business.

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Unidentified Participant, [58]

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Okay. Fair enough. And last question, in your relevant segment, could you comment on how much of that work is done on data sourced by your customers from their end users? As you all know, there are lots of regulatory interrogation into transparency and privacy issues there. Just want to get some idea of whether that would impact the company in any shape or form in short or longer terms.

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [59]

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Yes. You're correct, data privacy is very important. And we always have and will continue to comply with the privacy regulations. And we work closely with our customers to ensure that they and us comply with the privacy regulations. From time to time, there are projects that need processes adjusted to comply. But we don't see a material difference in the work we're doing, the projects we're working on and the trajectory of the business. But it is something that we're super aware of.

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Unidentified Participant, [60]

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Okay. So we shouldn't expect any material changes in that area for you?

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [61]

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We can't see it. No.

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Operator [62]

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(Operator Instructions) There are no further questions at this time. I will now hand back to Mr. Brayan for any closing remarks.

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Mark Ronald Gerard Brayan, Appen Limited - MD, CEO & Executive Director [63]

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Thanks, Jenny, and thanks again to everybody for joining the call and for your interest in the company. And just to reinforce that we're very pleased to bring you these results. We're very positive about not only these results but the trajectory of the business. And looking forward to meeting many of you face to face over the coming roadshow. So thanks once again.

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Operator [64]

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Thank you very much. That does conclude our conference for today. Thank you all for participating. You may now disconnect your lines.