Appen Limited (OTCPK:APPEF) Q2 2022 Earnings Conference Call August 24, 2022 9:00 PM ET
Company Participants
Mark Brayan – CEO
Kevin Levine – CFO
Conference Call Participants
Garry Sherriff – RBC Capital Markets
Bob Chen – JPMorgan
Siraj Ahmed – Citi
Josh Kannourakis – Barrenjoey
Chris Savage – Bell Potter
ZheWei Sim – Macquarie
Ross Barrows – Wilsons Advisory
Jacob Loi – Citi
Operator
Thank you for standing by, and welcome to the Appen Limited First Half of 2022 Results Release. All participants are in a listen-only mode. There’ll be a presentation, followed by a question-and-answer session. [Operator Instructions].
I would now like to hand the conference call over to Mr. Mark Brayan, CEO. Mr. Brayan, the floor is yours, sir.
Mark Brayan
Thank you very much, and good morning, everybody. Welcome to our FY ’22 first half results presentation. My name is Mark Brayan, I’m the Chief Executive Officer of Appen. I’m joined this morning by our CFO, Kevin Levine as well as our Head of Investor Relations, Rosalie Duff. Presentation will take about 20 or 30 minutes, and then we’ll take questions, and we aim to finish around 12 noon Sydney time. As a reminder before we get going, all the financials are reported in U.S. dollars.
So turning first of all to the agenda on Slide 3. Our presentation today follows our first half update of the 2nd of August. Today, we will discuss the results in more detail and provide further commentary on the outlook for the second half. So please turn to Slide five.
As we announced earlier this month, our half year results reflect lower earnings due to challenging external operating and macro conditions. Our large customers are being impacted by weaker demand for digital advertising. This has led them to cut costs and reprioritize their spend and this has impacted some of our large ad-related programs and had a flow-on effect to non-ad related projects. Pleasingly, our China team continues to deliver growth and the enterprise business is building momentum.
The fundamentals of our business is strong. Our business produces good cash flow conversion and is backed by a strong balance sheet with cash of $42.2 million. As we communicated in February this year, our costs are higher in the half due to investments in product, technology and transformation and in anticipation of second half growth.
The Board has determined not to pay a dividend to ensure appropriate allocation of capital. Importantly, we’re committed to our long-term strategy. We will continue to invest for growth, including investments in new markets to diversify revenue and lift productivity. We will also prudently manage costs.
I’ll now turn to the market environment in more detail. Over to Slide six. Some of our global customers are feeling the effects of a downturn in the digital ad market, and this makes them more cost conscious and has impacted the work we do for them. So we’ve seen a reduction in spending on large global programs. As an important part of our strategy, we’re very committed to growing and diversifying our revenue. Today, revenue from our non-global customers represent 19% of our total revenue, and that’s up from 13% last year. China has continued to grow, and the enterprise business is building momentum.
While we’re heading in the right direction, we need to further accelerate our strategy to achieve revenue diversification. We’re very confident in the long-term prospects for data labeling market. The market is expected to grow strongly. Also, our global project count this half is at an all-time high, but it’s been insufficient to offset the reduction in programs in core programs.
Please turn to Page seven. We are a clear market leader when it comes to the provision of data for the AI life cycle, and we remain confident of our prospects in the high-growth AI market. We offer the broadest range of data modalities amongst all of our competitors and we’ll continue to expand this capability, win more customers and to deliver scale, quality and margin expansion. And we’ll maintain our focus on our strategic pillars of grow, automate, expand and evolve.
While our long-term strategy remains unchanged, we’ll focus on near-term returns and productivity. In practical terms, this means we’ll look to accelerate investments in new markets with the greatest revenue potential to boost returns such as data collection. We’ll also look for ongoing improvements to our products and processes to improve productivity with a focus on crowd and project management, and we’ll prudently manage costs. This includes the increased use of offshoring facilities and rightsizing of our investments for growth opportunities.
Turning now to our financial highlights on Slide nine. Our revenue performance primarily reflects a lower contribution from the Global division. Key driver is the slowdown in spending from some of our global customers, which has caused a reduction in revenue in Global Services and Global Product. Excluding Global Product, our new markets revenue was up 35%, and that was driven by a strong performance in China.
Underlying EBITDA before foreign exchange fell 66% to $9.6 million and that was driven by lower revenue as well as increased costs associated with investments in product, technology and transformation. And as I mentioned earlier, the Board has decided not to pay a dividend.
So to Slide 10 and looking at Global Services in more detail. As stated previously, our customers are facing weaker demand for digital advertising. And as a result, some of our major customers have reduced their spend with us in their advertising programs, and we’ve seen a flow on impact of that to some of our non-ad programs. The chart on the left shows revenue and earnings by half, and you can see the reduction in both. Revenue reduced 7% to $137.8 million and EBITDA fell 24% to $26.2 million.
Pleasingly, we saw a slight increase in gross margins due to more favorable customer and project mix as well as internal efficiencies. However, EBITDA margins of 19% were impacted by lower revenue.
To our new markets business on Slide 11. Revenue for new markets fell 6% to $45 million, mainly impacted by lower Global Products, which declined 52%. Excluding Global Products, new market revenue was up 35%. China played a big role in this growth as we’ll see in later slides. We also saw good momentum in enterprise. Team has 71 new logo wins and are progressively signing larger deals.
The government team had a disappointing half reporting lower revenue. This was due to the non-renewal of a large contract. The sales and budget cycles are also typically longer for government work, and it’s taking the team longer than anticipated to get traction. While the EBITDA loss is disappointing, it does in part, reflect higher investment spending during the half. As I stated earlier, our strategy remains unchanged, and we will continue to strategically invest in new product and new processes to transform our business.
Slide 12 and our global customers in more detail. Global Services revenue declined 7% to $137.8 million. Non-ad related projects comprised 74% of total revenue, which is closely in line with the 75% reported in the prior corresponding period. Global Product revenue was down 52%. This is due to our customers reducing their spend for project work on our platform and a large project from one customer ending in the prior corresponding period.
Our performance has also been impacted as some customers have not fulfilled their purchase orders to the same rates as prior years. Importantly, we do not believe we are losing market share with our largest customers. We monitor the website visits to customer annotation sites, which confirms our confidence in our market share position. Despite the challenging external environment, the global business unit won 99 new deals compared to 75 new deals in the prior corresponding period, and most of this work is non-ad related. The chart on the right-hand side of the slide shows the ramp-up in new projects.
As I mentioned earlier, our global project count is at an all-time high. We’re seeing a greater proportion of lower revenue projects, however. At this point in time, size and ramp for these new projects is insufficient to offset the reduction in some of the larger core programs.
On Slide 13 and our other business units, Enterprise, China, Government and Quadrant. Excluding Global Products, new markets revenue was up 35% on the first half of last year, driven by a strong growth in China. As I mentioned previously, our revenue from non-global customers is 19% of the total, which is up from 13% in the prior corresponding period. The Enterprise team is building momentum and had some good wins in the half. Some good wins recently, to be correct, including an $8.7 million order with an existing large social media company in July and a $2.5 million contract with a global car manufacturer.
Enterprise bookings in the first half were up 9% compared to the first half of ’21 and the average deal size signed in the first half, 37% from the average deal size in the prior corresponding period. Our Quadrant business is also building momentum, and we are seeing strong opportunities to cross-sell Quadrant into our Global and Enterprise customers.
Over to Slide 14, on the chart on the left-hand side of the page shows that our China team delivered revenue growth of 141% from the first half of ’21. They secured several new projects and new logo wins. In line with higher revenues, we’re seeing a continued improvement in our gross margins. We are a leader in the AI market in China, and we’re growing across all data modalities. We support 11 major car manufacturers and 20 other autonomous mobility providers, and around 40% of our revenue in China comes from autonomous vehicle work. We also service 9 of the top 10 Internet companies in China and all of the top mobile companies. We’re very pleased with our progress in China.
Importantly, we achieved ISO 27001 and ISO 27701 certification and this strengthens our position and also improves the confidence that our customers have in us.
Leveraging off the growth and support infrastructure in China, we also invested in dedicated local sales teams in Japan and Korea, where we had several new customer wins during the half year. Japan and Korea are relatively new markets for Appen with high-growth potential. We’re still in an early stage there, but we’re excited about the huge growth potential in these countries.
I’ll now hand it over to Kevin, who will take you through the financials in more detail.
Kevin Levine
Thank you, Mark. Starting on Slide 15. Our total revenue decreased 6.9% to $182.9 million. This primarily reflects the reduced spend by some of our global customers in response to lower revenues and weaker digital advertising demand they are experiencing. New markets were also impacted as we saw a decrease in Global Product revenue. If we exclude Global Product revenue, the new markets business recorded a strong performance, with revenue up 35% on the prior corresponding period. China was an important driver of this result.
We saw an improvement in gross margins. This is mainly due to improved gross margins in Global Services from a more favorable customer project mix as well as some internal efficiencies. Pleasingly, we also saw improving gross margins in China in line with increased revenue. As we first flagged in February, expenses were high in this half primarily due to investments in product and technology, growth investments and transformation costs. These resulted in higher employee expenses, recruitment and IT costs.
Our retention strategies have resulted in an increase in share-based payment expense. However, this has been offset by true-up adjustments for non-vesting due to performance hurdles not being met.
Underlying EBITDA and associated margins have been significantly impacted by the lower-than-expected revenue as well as the expected impact of the higher cost base. We recorded an underlying net loss of $3.8 million, which has been impacted by increased amortization of our investment in product development.
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 rate. Excluding these fluctuations, our normalized tax rate is around $0.25.
Over the page and on to the balance sheet on Slide 16. Appen’s balance sheet remains strong and resilient with no debt and with a cash balance of $42.2 million at the end of June. Trade receivables decreased $43.9 million to $45.3 million due to lower volumes. The reduction comes from the comparison of strong Q4 ’21 volumes versus lower Q2 ’22 volumes. This also excludes work completed in June, not invoiced at the end of June as time-based billing milestones were not met and this is reflected in the increase in contract assets. This work was invoiced in early July.
Non-current assets comprise mainly goodwill and identifiable intangible assets, or IIA, mostly arising through acquisition. Goodwill and IIA were reviewed by management and the auditors for indicators of impairment with a further review to be conducted at year-end. Goodwill of $45.4 million was initially recorded in respect of the Quadrant acquisition. In the half, it has been adjusted by $5.8 million to recognize the identified and intangible assets as part of the provisional purchase price adjustment process. Total liabilities include an earn out liability of $18.6 million in respect of Quadrants. As noted by Mark, the Board has determined not to pay a dividend this half.
Over to page on to Slide 17. In the first half of this year, we invested $18.3 million in product development, representing 10% of revenue. This spend was up 18.4% on the first half spend last year of $15.5 million. This focus is important to drive customer growth and repeatability as well as quality improvements and margin expansion.
In this half, 55% of our product development spend was capitalized, which is lower than historical levels, as we focus on addressing customer requirements following extensive product review. We expect our investment in product development to be around 10% of annual revenue for this year.
Moving on to Slide 18, cash flow. Compared to the prior corresponding period, our cash on hand decreased $23.8 million, mainly due to the upfront payment for Quadrants of $25.3 million in September last year. Cash balance and cash conversion were impacted by working capital timing, with collections from the strong Q4 ’21 volumes occurring in the first half. Cash flow from operations decreased 34%, impacted by reduced trading volumes, which was somewhat offset by working capital impacts and low tax payments.
During the half, we deployed cash to pay for tax, dividends, CapEx and growth investments, including a minority investment in Mindtech. Despite the lower revenues and reduced cash flow from operations, the cash flow conversion from EBITDA improved from 101% to 211% due to cash flow cycle timing, as mentioned previously.
Thank you, and I’ll hand you back to Mark now.
Mark Brayan
Thanks, Kevin. So to Slide 20. As of the August 2022, our revenue order book including year-to-date revenue plus orders in hand stands at $360 million, and that’s in line with August 2021. The customer delivery schedule is skewed to the fourth quarter of FY 2022.
In July and August, we haven’t seen a material improvement in our trading performance, and there also remains uncertainty about a continued slowdown of spending from our global customers. Compared to prior years, we believe the conversion of forward orders and sales will happen at a lower rate.
However, we still expect to see higher volumes in the latter part of the second half from the delivery of seasonal global projects and ramp-up in existing global projects, our continued growth in China and the ramp-up of Quadrant into global customers and enterprise customers. We expect FY ’22 revenue to be skewed to the second half, although revenue will not be to prior year levels due to the slowdown in global customers.
As I explained earlier, we continue to implement the company’s long-term strategy but we’ll have a focus on near-term returns, managing costs and prioritizing several initiatives. We remain focused on investing in technology and expect investment in product development to be around 10% of revenue, primarily because of lower revenue as well as investments in product, technology and transformation, our FY 2022 EBITDA and EBITDA margin is expected to be materially lower than FY ’21.
This concludes the presentation. I’ll now hand it back to the moderator to take time for questions. Thank you very much.
Question-and-Answer Session
Operator
[Operator Instructions] And the first question we have will come from Garry Sherriff of the Rural Bank of Canada.
Garry Sherriff
Good morning, Mark and Kevin. Just confirm, can you hear me, okay.
Mark Brayan
Yes, hi Garry, how you’re doing?
Garry Sherriff
Yes, doing well. Thank you. Three questions. One on churn, the second one on your outlook and a third one on strategy. The first one on churn. Can you provide us with some revenue churn metrics? Because I’ve noted you’ve talked around non-renewals of some sizable contracts, you talked about the government space. Just trying to get a bit more understanding of what’s happening from a churn perspective. And also what’s happening for those larger contracts? Are they going elsewhere? Are they going in-house? Just some more detail there would be great.
Mark Brayan
So we don’t disclose that level of detail, but I can say, Garry, that there’s a few things going on. First of all, some projects that we work on don’t materialize into larger production level programs. So it goes nowhere in effect. In most cases, however, particularly the case with our global customers, they’re just reducing the volumes of the large programs in line with their spending reprioritization and cost management. So they’re still getting better into the algorithms that we support, but just at lower volumes. Occasionally, we lose a program to a competitor, but that tends to be the minority — most of the impact on the vast majority of impact on the current result is just lower volumes on the core programs.
Kevin Levine
Yes. The other point to add, Garry, is that as part of our FY ’26 strategy and targets. We move to focus on pure revenue growth, not necessarily focusing on where it’s coming from, the nature of it as to whether it’s committed or not committed. And so as a result of that, and that focus there’s less focus on us on the committed and more focused on revenue growth per se.
Garry Sherriff
Okay. And that government — that large government contract, is that a competitor?
Mark Brayan
I believe some of it did, but it’s been also diffused into other areas, other agencies within the government.
Garry Sherriff
Okay. The next one on the calendar year ’22 outlook, should we assume a similar work in hand to revenue conversion in the second half ’22 likely did, say, in second half last year?
Mark Brayan
No, we’re specifically pointing out that the order book is going to convert at lower rates than prior years.
Garry Sherriff
Yes. Okay. And so I’m just trying to figure that out, like if you’re saying that your work in hand orders are x, but the revenue conversion is going to be, it sounds like materially lower. Why is that? That’s something I don’t understand. I guess, if you work in hand, it’s similar, why would the revenue conversion not be similar?
Mark Brayan
So the order book consists of year-to-date revenue, work in hand and purchase orders received and yet to be delivered. And purchase orders that we received at the beginning of the year have been — we’re getting less work from the customer as they pull back. So those purchase orders aren’t committed. It provides an indication of us — for us of the amount of budget, for example, that they’ve allocated to the program. They do not commit to that spend. And as we’ve seen in the first half of this year, and we expect it to continue into the second half, they’re spending at a lower rate than those purchase orders.
Kevin Levine
Yes, Garry, in essence, it does absolutely reflects the situation that we’re in. And that means these purchase orders were approved by the customer in line with their budget at the start of the year. However, given the impacts that they are experiencing around the digital ad market and other macroeconomic conditions as well as some of our customers reporting a downturn in revenue for the first time in their history, have got them to actually reconsider that spend, notwithstanding that it was approved and was for a certain standing value.
And so therefore, the fact that we have the order for a certain value that’s not necessarily demand spend that they’re actually going to translate as what we’ve seen so far and what we expect to continue to see for the rest of the half.
Garry Sherriff
Okay. And so I mean, shouldn’t that therefore mean that the work in hand number gets revised lower? I mean what’s a realistic work in hand number then? That’s — I don’t quite get the — I sort of get what you’re saying, but doesn’t that therefore mean your work in hand number should be revised lower?
Mark Brayan
So the order book is — we have a methodology around the order book, and we report that very consistently. And it includes year-to-date revenue project work that we’ve got ongoing, but have yet to bring to revenue and then the open purchase orders. And so we’ve reported that on exactly the same metric is — in exactly the same way as last year, but it’s going to convert to revenue at a lower rate. And we’re basing that decision on what we’ve seen year-to-date. So the order book reflects what the purchase orders we’ve got. It’s not a forecast.
Kevin Levine
Yes. And I think, Garry, the other key point here is what we’re making is that in the past, I think when you guys try and take the order book as an indicator of revenue and you look at last year’s conversion of orders to revenue, what we’re really saying is that is not representative this year. The fact just given from what we’ve seen and what we’re experiencing, what we’re calling out is that if you apply that ratio to the order book, that’s not what we’re expecting to see.
Garry Sherriff
Okay. Understood. The last question, just around the strategy, you mentioned you’re very confident in the data labeling market. What gives you that confidence? And you’ve also talked a big Q4 customer entry schedule. If that doesn’t drop as expected, I mean, does that mean the strategy gets reviewed?
Mark Brayan
So the confidence comes from the work we’re doing outside of the global customers. Our global customers are heavily skewed to digital advertising and weaker digital ad demand has got them to rethink not only their ad related programs, but some of their other programs as well.
However, outside of that, we see growth in China. We see strong momentum in the enterprise business. We see a large uptick in the number of projects that we’re doing. We see some big wins outside of the globals, and we point to a couple of those with the Enterprise business, for example. So there’s a lot of healthy signals outside of our global customers. And we’ve just got to ride through this this passage with the global customers. But outside of that, we see strong demand for training data. And of course, the megatrends around AI are unchanged.
Garry Sherriff
Okay, thank you. I’ll step back in the queue.
Operator
And next, we have Bob Chen of JPMorgan.
Bob Chen
Good morning, guys. Just a few questions for me. Maybe one follow-up just on that order book in hand and how that sort of converts into revenue. I think historically, that order book, when you sort of present the there’s a probability weighted basis on what gets included and what doesn’t get included. But it sounds like because that conversion to revenue is a little bit slower, shouldn’t that mean that, that probability weights us towards some of these projects that you don’t think will get included should be reduced and sort of stripped out of that $360 million number?
Mark Brayan
So Bob, the order book is — it’s a pretty simple construct. We get year-to-date revenue, work in progress and outstanding POs. Now the number of POs that we’ve got between when we last provided the order book and now is lower than prior years and that’s indicative of the market conditions. But the conversion of those POs is happening at a lower rate than last year. So that order book is converting to revenue at a lower rate. We don’t factor the order book, we just report it. So we don’t make any statistical based adjustment to that order book. We added up, we report it. And what we’re seeing now is that the conversion rates we’ve used historically aren’t going to apply going forward because of what we’ve seen year-to-date.
Bob Chen
Okay. Perfect. And then just some of the comments you made in your trading up a few weeks ago around reviewing investments across the business to look at margin improvements. Can you just elaborate a little bit on what you’re looking at and how do you measure sort of returns from some of these investments that you’re currently making as well?
Mark Brayan
Yes. So we’re investing in technology that supports our internal operations as well as technology that our customers and our crowd use. And some of those investments are going to yield near-term returns and some are going to be yielding longer-term returns.
Given where we are, we’re going to focus in on those ones that are going to yield near-term returns. For example, driving up the productivity of the way that we allocate crowd workers to projects will give us a near-term return because the crowd work has flowed directly to revenue. So we’re going to accelerate investments in those areas. For example, there may be other things that we’re working on that are a little more long-term, and we’re just going to tap the brakes on those and allocate the resources for the near-term things. So we’re not going to derail our strategy here. We’re just going to prioritize things in order to stay on strategy but to get more immediate returns.
Bob Chen
Okay. Great. That makes sense. And then maybe just a broader question around the weak performance of Appen over the last couple of years. Can you just provide a little bit of color on how much of that was largely driven by our clients versus what’s actually in your control and what you guys could have done better to limit that impact?
Mark Brayan
So we’re heavily skewed to the tech giants, as you know. And if you reflect their journey over the last few years, it’s been a bit choppy and that’s had a flow-on effect to our business. If we could have done anything, we could have implemented our strategy quicker, but we’ve got good momentum. China is a great example. Enterprise is building momentum.
Our strategy is really on two core pillars: one, to expand our customers and revenue beyond the Internet giants beyond the globals, and then it’s also about technology that enables us to deliver higher levels of service to our customers and improve internal productivity. So I’m very confident that we’re on the right path, Bob. I wish we gone a bit quicker, but I think CEOs are generally impatient, but I’m very confident we’re on the right path.
Kevin Levine
Just to that point as well, though, I think the strategy around revenue diversification has been well thought out and has been in play for quite a while. But essentially, it is largely organic. The China buildup is organic and building into other markets or where we have made investments, for example, Quadrant that early stage, Government same thing. So essentially a strategy there, but it’s largely organic, which means it takes time, it needs time. And I think we’re just in an unfortunate position right now where we’ve had this reduction in some of the globals and just haven’t had sufficient time yet in terms of this organic build on as part of our revenue diversification strategy.
Operator
And next, we have Siraj Ahmed of Citi.
Siraj Ahmed
Hi, Mark, hi, Kevin. Just in terms of the order book conversion, just maybe if you could just help us in terms of what went — in terms of the first half that just passed or maybe in the month of May and June, can you just — can you give us a percentage of where the conversion actually declined to? Like if you’re expecting, let’s say, 60%, it actually came in at 50% because that will be quite helpful for us?
Mark Brayan
We haven’t — I mean we’ve done some internal modeling, Siraj, but what we can tell you is that it’s going to be at a lower rate. That’s our view presently.
Siraj Ahmed
Okay. Okay. And just clarifying on that. So you’re saying full year revenue is expectedly down. Does that — should we also be thinking that second half revenue will be down a similar rate as for staff because you are cycling a record half from last year?
Kevin Levine
Yes. So I think that’s exactly right. We’re lapping a very strong second half last year, particularly a strong Q4. We’re not seeing that at the moment, we’re seeing the opposite, right, where we’re seeing a reduction in spend from some of the core programs. So I think take all of those factors to say, you’re actually comparing a very strong half and a very strong Q4 with a much weaker half and a much weaker Q4 this time around.
Siraj Ahmed
So Kevin, would that sort of mean that the decline in the second half is actually higher than the, I think, 7% or whatever that you delivered in first half? Is that the way we should be thinking?
Kevin Levine
Yes. I mean just take — if you just consider everything that I said, you’ll probably get to those kind of conclusions.
Siraj Ahmed
Okay. Okay. Just a couple more in terms just clarifying. So Mark, you’re clearly saying you’ve not lost market share based on trend what you’re looking at. So just — I mean, your key competitor is calling out accelerating that 40% year-on-year growth. So just keen to end this weakness that you’re seeing, is it just one customer is it broad-based? Or if you could just give us some color, that would be quite helpful.
Mark Brayan
So I think there’s a couple of things. First of all, it’s not 100% clear whether that competitor is, whether it’s apples for apples in terms of what they consider in their directly competitive with us. And secondly, when we say we’re not losing share, we don’t see that in our major customers. So that doesn’t mean they’re not winning business in other places, but we don’t see a lot of share in our major customers.
Siraj Ahmed
Yes. So from your perspective, the performance that you’re seeing with the weakness in terms of projects, it’s not just one customer specific, it across multiple customers?
Mark Brayan
Well, we call out our largest customers. So many of our big customers rely on digital advertising, and they’re the ones that have been impacted by the current slowdown and that’s having a slowdown effect to us.
Siraj Ahmed
Okay. And last one, in terms of your investment, just how we should think about OpEx, right? I think your first half OpEx was around $65 million excluding cost of sales. So is that — like do you expect that to come down? Or should we expect that to increase in the second half?
Kevin Levine
Yes. So I think the way to think about that is, as we’ve said, we’re going to — we’ve got our strategies. We’re looking at reprioritizing, but at the same time, we’re still working on strategy, and we’re also working — I guess we’re going to be favoring process improvements over time rather than accelerated. So all of that is to suggest that there’s not going to be much factored into the rest of this year around some of that reprioritization. We’re taking a short-term to medium-term view on that. So I think just consider the OpEx accordingly with that. And we’re talking about similar levels, maybe with some slight increases.
Siraj Ahmed
Okay. Some slight increases in terms of OpEx. Thank you. Thanks, Kevin, thanks, Mark.
Operator
And next, we have Josh Kannourakis of Barrenjoey.
Josh Kannourakis
Hi, Mark and Kevin. Thanks for taking my call. First question, just with regard to the new markets business, still obviously investing quite heavily in that. Can you give us a bit of an idea of the flight path or the guide path in terms of margin profile and leverage and where that business should be able to get to it in a more mature state?
Mark Brayan
Yes. Josh. So we’re seeing a fairly good trend in China, and you can see that on — in the deck, and we’re also seeing improvements in gross margins there. So over time, we expect to see fairly consistent revenue growth in China and steady improvements in gross margins. The enterprise business is a little behind that. We’re seeing a good uptick in bookings, in orders, and we call out a couple of those in the deck. And we’re also seeing healthy gross margins in that business as well with improvement to go or to come, sorry.
And then in terms of operating expense for both businesses, managing that fairly prudently, but also investing in growth where we can. So we’ve laid out our long-term targets and both enterprise and China will contribute to all of that, both the revenue and the margin targets over time. But suffice to say, we just expect continued improvement from where we are today over the course of the next few years.
Josh Kannourakis
Got it. So in terms of that, just in terms of into the second half that continued growth in revenue and sort of strengthening GP should see that loss narrowing half-on-half?
Mark Brayan
We’re not calling out anything in the near term, looking more long term. But I think in drawing conclusions from the charts and the trajectory.
Josh Kannourakis
Okay. Got it. Thank you. Just maybe one for Kevin, just in terms of the cost base into the second half. On the share-based payments, you mentioned that true-up that happened. Could you quantify or give us a bit more detail on that and just how we should be thinking of a reasonable go-forward for share-based payments, both into sort of second half and into the following years?
Kevin Levine
Yes. And yes, Josh. So the share-based payment is a driver — is certainly a driver of an increase in costs, H2 of H1, given that H1 we had the true-up adjustment. So essentially absent to any other true-up adjustments, we expect the share-based payment will get back to more normal kind of levels. And obviously, that is going to be one of the drivers in the comment I made earlier just around that increase in the cost in H2.
Josh Kannourakis
Got it. And just final one for me. A lot of people obviously inflation is on the mind of a lot of companies at the moment, this reporting season. Could we talk a little bit about that just in terms of your general cost base, but more specifically to the crowd and I guess, your ability to pass that on to your customers?
Mark Brayan
Yes. So it’s mixed. In some cases, we see an impact on crowd rates, and we are passing that on to the customers. In other cases, the impact is as high. We also are on the full-time workforce, I think it’s been ongoing for a little while now, a bit of salary pressure in the tech market, but I don’t think that’s unusual to us.
We will be making greater use of our offshore facilities over time as we grow. We found that to be a really good solution for us in terms of productivity. But I think in general, Josh, where it’s material, we’re able to pass it on and where it’s not we carry on.
Josh Kannourakis
Okay, great. Thanks, Mark and Kevin.
Operator
And next, we have Chris Savage of Bell Potter.
Chris Savage
Thank you. Good morning, Mark and Kevin. Without getting too granular on the outlook statement, you made one comment saying revenue is not expected to be at prior year levels, the emphasis being on levels being plural. So easy conclusion is you expect revenue to be below 2021, but does levels imply you also expect it to be below 2020 as well as in multiple years gone by?
Kevin Levine
Yes. I think maybe Chris is reading a bit too much into that. I think we’re just really comparing to the prior year there.
Chris Savage
Okay. Secondly, can you just give us some idea around the conversations you’re having with your key global customers? Are they saying to you to sort of sit tight when digital advertising comes back, the levels of spend will rebound? Or are they staying mute? I’m just trying to work out, is this structural or is this a cyclical change do you think from these customers?
Mark Brayan
It’s certainly more the former as in the conversation that is a cyclical issue. They value what we do. We have positive and collaborative relationships with our largest customers. As I said, we’re winning or as the deck shows, we’re winning a lot of new projects with our large customers. So they continue to invest in training data in AI.
However, they’ve got this headwind around weaker demand for digital advertising for reasons that they’ve been very clear about, and that’s impacting the spend and it’s a flow-on effect to us. So it’s definitely a collaborative situation and they view what we do for them very important. And we’ve just got to ride through this phase.
Chris Savage
So they are literally saying they do expect their spend to rebound at some stage?
Mark Brayan
So they’re saying that they’ve got to tighten down costs in the current environment. I think the implication is that when the environment changes, they’ll be able to increase their spending, but they’re certainly saying it’s certainly giving us the impression that it’s a temporary manner.
Chris Savage
And just last question, maybe one more for Kevin. In the notes, there was a loss on revaluation of inventory and you called out cryptocurrency. Have you actually invested in crypto? Are you getting paid in crypto? Or what’s the story there?
Kevin Levine
Yes. Firstly, it’s a very small part of the business, and it came alongside with the Quadrant acquisition. So actually, one of the key strengths that Quadrant has in terms of how they manage their crowd is they actually — they pay their crowd in crypto. And how this — and so essentially — and so there’s benefits with that. There’s two benefits to that: The first is that near real-time settlement is the first one. And the second one is micro payments because a lot of the tasks that the GLN has performed very small amounts, and so it can handle kind of market payments without necessarily imposing fees, et cetera, onto the recipients.
So that’s very much part and parcel of the business. They operate their platform under a blockchain protocol and have associated payments to cloud workers in crypto. And so we hold — in order to manage the payments through the GLNs and also to do further development and data collection work of data sets, we maintain that balance, some balance in crypto assets. And then we convert those crypto assets into the digital currency that’s used to pay the GLNs. And so essentially, that reduction that we talked about was largely a revaluation relating to our holding ethereum, which is, once again, a small amount but necessary just to maintain the economics and the ecosystem that Quadrant maintains.
Chris Savage
And it sounds like that’s not going to change. Quadrant is going to continue to pay add in crypto?
Kevin Levine
Yes. I mean we don’t see any need to change right now. As I said, there are some benefits, and they haven’t experienced any issues with supply around that. In fact, that engaged with the community that’s really engaged with that. So I think we’re reviewing stuff across the Board and whether that’s some benefits there, we can provide or not. But at the same time, I think what it’s fair to say as well is that if we decide to move — if we had to move off crypto to cash, it doesn’t actually preclude us from anything that doesn’t interact with the blockchain technology in any way. So we’ve got flexibility. But at the moment, it’s working, it’s a small investment and we don’t see a need to change at this point in time.
Chris Savage
Alright. Thanks, Kevin, thanks, Mark.
Operator
The next question we have will come from Wei Sim of Macquarie.
ZheWei Sim
Hi, Kevin, hi, Mark. Thanks for hosting the call today. Just one question for me, which is regarding in the slide deck we talk about wellbeing reviewed for indicators of impairment with full review to be conducted at the end of the year. Just wondering if you could give a bit more detail on that as to what initial reviews may have pointed out and what kind of risk we would be potentially looking at for impairments at the full year? Thanks.
Kevin Levine
Yes. So formally, full review needs to be done once a year, but in the interviewing periods, essentially, what we do is we perform an analysis and we look for indicators of impairment. And those kind of things is we look at performance, we look at growth, we look at momentum, we look at pipeline, we look at all those things. And obviously, our modeling is its multi-years and particularly with the terminal year driving a lot of the value.
So, all that is to say we consider all of that, and we’re comfortable that in terms of what we’re seeing or how we’re seeing things. And given that we’re so early into our, I guess, FY ’26 target positioning that the conclusion was, yes, we need more time to make an assessment. We don’t see anything at the moment, but we’ll continue to look at those kind of things and look to see how they’re aligned with the growth rates that are in our model and to determine whether there is any impairment that needs to be taken or not.
ZheWei Sim
Okay, perfect. Understood. Thank you very much.
Operator
Next, we have Ross Barrows of Wilsons Advisory.
Ross Barrows
Hi, Mark, hi, Kevin. A couple of questions, just in terms of purchase orders. Can you just remind us, I guess, how that process works? Are there more purchase orders placed in the first half or the second half? Is that purchase order process changing, those type of things, just so we can get a better feel I guess, with the process and any indication or comments you can make around first half, second half skew over what you’ve seen in the past would be helpful as well? Thanks.
Mark Brayan
Yes. Ross. The receipt of orders does change over time based on customer wins. Our large customers have a cadence around their purchase orders, which might be annual or quarterly, but as we win new customers, obviously, we get the purchase orders as and when we win those. So it does vary from year to year.
Having said that, there’s a degree of a patent given the amount of POs we get from our large customers. And hence, per our response to some of the earlier questions, prior year ratio is a conversion have been helpful to get an indication of where we might end up. Having said that, as we point out in the release this year, the conversion rate’s been slower in the first half, and we anticipate it to be slower in the second half as well. But exactly what the change in rate is too early to tell.
Ross Barrows
Maybe just expanding on that a little bit more. Could you talk about the, I guess, the scope of work within any given purchase order? And if maybe we can focus on your more traditional larger technology customers without naming names, but just holistically, do you feel like the scope of work coming into Appen from them is higher the same or, I guess, lower than this time last year? So I’m not really talking about the volume of purchase orders but more about what you’re being asked to do within them?
Mark Brayan
Yes. So clearly, the volume is the issue, but the scope is expanding. If you look at the number of orders that we’re getting, those orders are expanding. And typically, in order relates to a different project, which is if I understand what you mean by scope is a broader scope. So the scope is expanding. It’s just the volume of the large programs has come off as a direct result of them looking to manage their costs given the decline in advertising demand and the impact on their revenue.
Ross Barrows
Okay, thanks. Just the last quick one on China. It’s gone from about $7 million to $18 million, and that’s taking it from 4% of revenue to nudging 10%. Obviously, the group revenue is down a little bit, which has helped that, but still China is still 2.5 times where it was. Can you help us think or share your thoughts around how we should think about that opportunity? Obviously, it’s growing well. It’s softened a little bit half on half. It’s still up considerably year-on-year. Maybe just some more color on that. And I’m not sure you’re going to give us any percentage of revenue going forward, but maybe some thoughts about how we could think about it?
Mark Brayan
Yes. So first of all, just a little bit on the near-term softness. We do a lot of work in the autonomous vehicle space and various cities in China have gone through pretty strict lockdowns, and that impacted some of the data collection that our customers did and consequent to the word that we did. So there was a sort of a temporary hit there due to COVID lockdowns. That aside, it continues to grow very, very well as you point out.
And we expect good solid growth over time. We’ve got a really well-established position there, and we’ve done a good job of winning a broader range of customers and a broader range of data modalities in China than elsewhere in the world where we have a very high reliance on relevance and the tech giants. So we’ve done a better job of managing customer and revenue diversity there.
So we anticipate strong growth going forward. We’re also winning a lot of work off of our competitors. We know that for a fact. There are some public companies in China that we can see their growth slowing, and we think we’re having a direct impact on that. So overall, we’re pretty positive about China.
Kevin Levine
We also see expanded addressable market into Japan and Korea. It’s early days there but we’re investing in sales teams, and we’ve got a couple of wins, and we see potential there to continue to fuel the growth.
Ross Barrows
And just to be quick, the purchase order profile and China would be similar to what you’re experiencing across the broader group in terms of timing and duration?
Mark Brayan
Probably with the nuance that they have a broader sort of probably a better mix of customers. So it’s probably much more of a steady uptake of POs through the year rather than big ones at the beginning of the year would be the difference there.
Kevin Levine
And probably also more evenly distributed from a value point of view.
Ross Barrows
Thank you.
Operator
Next we have Jacob Loi of Citi.
Jacob Loi
Hi, Mark, hi Kevin. Just a couple of questions from me. How should we [indiscernible] in the second half? You saw an improvement in the first half, but again, your pipeline going volumes in the second half against in the prior compared period?
Mark Brayan
Sorry, your line broke up the second there. I didn’t get the question.
Jacob Loi
How should we think about gross margins in the second half? You saw an improvement in the first half, but just because you’re cycling strong volumes in the second half in the prior parity period?
Kevin Levine
Yes. Look, gross margins in the first half were good and impacted by customer project mix. Once again, that is a very big driver of the margins. And so that is going to dictate how the second half margins go. It’s going to be very much dependent on which customers and which projects that activity comes from, and then that would inform the gross margins.
Jacob Loi
Yes. And just another one. Are you currently seeing any pressure from a pricing perspective from the global customers?
Mark Brayan
Not really, no. It’s all in equation is the issue.
Jacob Loi
Sure. And just the last one for me. Just on China, given first half was constrained due to the lockdowns, would you — I mean, should we sort of assume a catch-up in work or revenue in the second half?
Mark Brayan
It’s a little early in the half to see. As I said, the issue was that in the world of autonomous vehicles, vehicles drive around collect data. We get that data and we label it but the volumes of that data collection was lower because people couldn’t drive their cars around. So we certainly know they’re on a catch-up. But to the extent to which that comes back is not entirely clear just yet. That said, the team continued to win projects in a variety of areas in China, and we’re confident in continued growth. It’s a little early to see if we’ll get all of that AV work back on it.
Jacob Loi
Great, thanks. That’s all for me.
Operator
And next with Garry Sherriff of Royal Bank of Canada.
Garry Sherriff
Two questions. Firstly, your intangibles, you’ve got about $315 million of intangibles on the balance sheet. Can you maybe talk to the impairment risk here? And is there any risk that this may impact debt covenants?
Kevin Levine
Yes. Sure, Garry. So just quickly, so we’ve got two segments. We’ve got the Global Services segment, and then we’ve got the new market segments essentially. And so when we think about our current position that we’re calling out and obviously, it’s impact on our global division from our global customers. That’s a CGU that has very strong earnings and cash flow relative to the investments that we’ve made. So essentially, that’s a strong CGU. The new market segment is one that has a fair — that’s where a lot of the recent acquisition has gone in, and that’s an emerging segment. So that’s one where we obviously — we look at performance, we look at growth rates, and we look at things like that in terms of identifying that.
So I think that the takeaway though is what we’re seeing in as impacting our results here, we don’t see any potential impairment from that. We continue to obviously review that and review our new market segments as well as to whether there’s any indicators of impairment there.
Garry Sherriff
Okay. Got you. And when you talk about that new markets business, what chunk of that intangibles are sitting there because it sounds like that’s where the risk may be?
Kevin Levine
So the Figure Eight acquisition, and the Quadrant acquisition. The good — or — yes, the good word associated with those acquisitions and the intangibles.
Garry Sherriff
Okay. And can you recall just roughly how much that was off the top of your head? Or if you’ve got it there?
Kevin Levine
Yes, I don’t know — well, I don’t have it broken up here in front of me. I can get back to you. But essentially, it’s — yes, circa $200 million of that.
Garry Sherriff
Okay. And if that did get impacted materially, would that have an impact on debt covenants?
Kevin Levine
So we currently — we have debt facilities, but they are not drawn. So the short answer is no. And obviously, we’ll review that. But generally, we’ve got EBITDA covenants and interest covenants. So generally, we don’t have a market cap covenants, something that that’s a low exposure there, Garry.
Garry Sherriff
Okay. Got you. And the last one, just on your ’26 targets. To give the market some sort of comfort on those long-term targets, certainly other companies will provide a revenue bridge on how you get there. Are you planning on giving us that bridge just to try because I think market estimates are way, way below that? Are you able to give us some form of bridge on how you get to those lofty targets?
Mark Brayan
We haven’t provided that, Garry. We’ve got our internal models and targets that get us there. The long-term targets are important. The long-term strategy is important. But no, we haven’t provided a bridge externally.
Kevin Levine
But obviously, we do call out key things, which are helpful to you in terms of the modeling, and that is at least the doubling of the revenue and where it’s coming from. That’s a third of the revenue is coming from non-global customers. So you can pretty much draw the lines from the data you have kind of get a sense of that of that build.
Garry Sherriff
Okay. Thank you.
Operator
Well, there are no further questions at this time. I will now hand the conference call back over to Mr. Brayan for the closing remarks. Sir?
Mark Brayan
Yes. Thank you very much, and thank you, everybody, for attending today. Thank you also for your questions. We look forward to any follow-up meetings with yourselves or your clients over the next little while. And thanks again for your interest. I hope you all have a good afternoon. Thanks again. Bye for now.
Operator
Thank you all for participating. You may now disconnect.
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