Annual Report 2018 Appen is a global leader in the development of high-quality, human-annotated datasets for machine learning and artificial intelligence. Appen brings over 20 years of experience capturing and enriching a wide variety of data types including speech, text, image and video. With deep expertise in more than 180 languages and access to a global crowd of over 1,000,000 skilled contractors, Appen partners with technology, automotive and eCommerce companies – as well as governments worldwide – to help them develop, enhance and use products that rely on natural languages and machine learning. Chairman’s Report CEO’s Report Environmental, Social and Governance Summary Directors’ Report 2 4 6 9 27 Auditor’s Independence Declaration 28 Consolidated Statement of Profit or Loss and Other Comprehensive Income 29 Consolidated Statement of Financial Position 30 Consolidated Statement of Changes in Equity 31 Consolidated Statement of Cash Flows 32 Notes to the Consolidated Financial Statements 83 Directors’ Declaration 84 88 Shareholder Information 91 Corporate Directory Independent Auditor’s Report ABN 60 138 878 298 1 Appen helps leading search and social media companies deliver relevant content and news to their users. Appen creates training datasets that enable chatbots to interact with humans. Appen provides image and video data collection and annotation at scale, supporting industry-leading solutions for computer vision, image recognition and more. Appen helps the world’s leading vehicle makers develop hands- free, voice-activated systems for safer driving. Appen helps major eCommerce vendors improve search accuracy to make shopping easier, improve conversion rates and grow businesses. Appen’s work underpins speech recognition technologies for government and commercial applications such as Skype Translator which connects friends and businesses around the globe. Appen Limited 2018 Annual Report 2 Chairman’s Report Chris Vonwiller The full year financial performance has allowed the board to declare a final dividend of 4 cents per share. Together with the interim dividend of 4 cents per share paid last September, the total dividend for 2018 is 8 cents per share. This final dividend will be paid on 25 March 2018. The continued growth in Appen’s market capitalisation led to our inclusion in the ASX200 index during the first half of 2018. Late in 2017 we completed the acquisition of Leapforce and throughout 2018 we have implemented a detailed plan to integrate the Leapforce and Appen teams and assets. Although this work continues into the first quarter of 2019, we have already cemented the underlying structure to allow us to harvest many benefits which underpinned the strategic rationale of the purchase. The Leapforce software now forms the centrepiece of our highly automated Appen Connect platform. We are benefiting from increased scale and scope, and this is yielding a lower cost structure and improved margins, as well as improved responsiveness and value for our customers. Strategy and Outlook Appen provides large volumes of annotated data for training machine learning and artificial intelligence (AI) applications. The data we supply includes speech, text, image and video, and our customers are the world’s largest and most sophisticated IT companies. In previous reports the board has highlighted our strategic imperative of investing in new technology to reduce costs, improve margins and sharpen responsiveness to evolving customer requirements. We also stressed the objective of broadening our base of customers and establishing a presence in China to participate in the dramatic growth of artificial intelligence and machine learning take-up in that country. In 2018, we have made good progress in all these identified priorities. We continue to be optimistic about the ongoing growth potential in the broader AI space, and consequently for Appen. In addition to our established positions in the technology, automotive and government sectors, there are attractive opportunities in the medium term for machine learning applications in financial services and industrial sector. Success here will consolidate our existing leadership position. Management and Employees Under our CEO Mark Brayan’s leadership, the management team and staff have responded in outstanding fashion to the challenges and stress of continuing growth. During the year, we strengthened our top management with two significant hires - Tom Sharkey as SVP, Content Relevance in Client Services and Wilson Pang as Chief Technology Officer. We are investing in greater software development resources to enhance our competitive offering and position, and we have commenced recruitment in China to build our team. We have made excellent progress in 2018, both financially and strategically. Dear Shareholders We have made excellent progress in 2018, both financially and strategically. Appen is well positioned to build upon this for further growth. Financial Performance Our financial results for 2018 were very pleasing: – Revenue increased by 119% to $364.3M – Underlying EBITDA grew from $28.1M to $71.3M, a growth of 153%. Statutory EBITDA was $68.1M, 206% up from 2017 – Underlying NPAT increased from $19.7M to $49.0M, 148% up on the prior year. Statutory NPAT was $41.7M, a 192% increase on 2017 Appen Limited 2018 Annual Report 3 Total Revenue up 119% on FY2017 $364.3m EBITDA up 153% on FY2017 $71.3m NPAT up 148% on FY2017 $49.0m Overall, our workforce grew to 513 employees by the end of 2018, up from 374 at the end of 2017. The board is deeply appreciative of our employees’ sustained contributions throughout the year. We aim to pay management fairly and provide appropriate short-term and long-term incentives. The skills we require are sought after globally in one of the fastest growing business domains. The board is careful to design employee reward structures which are aligned with long-term shareholder wealth. Appen has a richly diverse employee base, with a blend of gender, nationalities, ethnicities and religion which we believe would be among the best of Australian enterprises. However, at the most senior management levels, and despite ongoing efforts, we have yet to achieve an acceptable balance of gender. The board has committed itself to remedy this, and we have implemented plans to progressively achieve an optimal and balanced outcome in this dimension. The board is active and engaged in oversight of the company and its strategy. Among the directors, there is a strong combination of industry expertise, finance, strategy formulation, governance and operations. We regularly review board effectiveness to ensure we can meet the challenges of the fast-moving and innovative industry in which we operate. I thank my fellow directors for their engagement and contributions. We appreciate your loyalty and trust as shareholders. Above all, we are conscious of our obligations to you for the future successful performance of our company. Sincerely Chris Vonwiller Chairman Appen Limited 2018 Annual Report 4 CEO’s Report Mark Brayan The growth in AI is driving the demand for high quality training data. Dear Shareholders We’re very pleased to report that Appen’s strong growth continues. We delivered strong financial results in 2018, with growth in revenue and earnings as well as margin expansion. Growth resulted from the accelerating AI market and the strong demand for high quality training data. Our existing customers were the major contributors to growth, through current and new projects, and we added new customers as more companies develop AI and need quality data. Content Relevance played its role as the Company’s growth engine with year on year revenue growth of 148%, from $126.2M to $312.8M, made up of strong organic growth and the integration of Leapforce, acquired in late 2017. The division expanded its operating margins from 17.6% to 23.9% due to Leapforce and economies of scale. Our Language Resources team delivered a very strong second half that resulted in a record revenue year for the division of $51.4M, up 27% on the prior year. While margins were off historic peaks due to the mix of work and less complex government work, our strategic focus on the technology sector proved worthwhile with a number of new projects contributing to the result. We delivered on a number of initiatives that supported growth in 2018. The integration of Leapforce is all but complete with roughly half the projects migrated onto the enhanced Leapforce system, now known as Appen Connect, between December 2018 and now, with the balance to migrated by end of April. The Company’s secure facilities, all operable with multiple clients, are a source of competitive advantage for Appen. We achieved ISO 27001 certification for information security for our Manila facility, increasing its attractiveness to security-aware customers and prospects. The growth in AI, fuelled by a growing range of use cases, the availability of enabling infrastructure and the need for businesses to harness its benefits to compete, is driving the demand for high quality training data. The performance of AI improves with the volume of data and its currency requires regular refresh, both of which contribute further to the demand for quality data. While Appen’s highly scalable crowd-sourced delivery model is proven and aligns well with our customers’ needs, our ability to deliver a step change in volume and quality depends on enabling technology that enhances the productivity of our crowd. Appen Limited 2018 Annual Report 5 The addition of our new CTO, Wilson Pang, and our growing engineering team will improve our existing products and add new products that will enable delivery of higher volumes of high- quality data at speed and cement our competitive advantage. We have identified circa $6M of efficiency gains from the integration with Leapforce and will redeploy these savings as investments in engineering in 2019. Along with technology, our plans for 2019 include two key initiatives. Effective January 2019, we unified our Language Resources and Content Relevance teams to provide greater customer focus and to optimize the customer experience. We now have a single global Sales team and a combined Client Services division. The unified Sales team will provide greater sales focus and growth and the single Client Services team will improve customer engagement, satisfaction and data quality. We’ll continue to report by data type, but our new structure places our customers at the centre of our attention. China remains an attractive market for us and we are investing judiciously to participate in this opportunity with a new office and staff in Shanghai that bring us closer to customers. While we benefit from a strong and well- earned position in a high growth market, our results are only possible through the hard work and dedication of our global staff. I thank all of them for their work and I enjoy working alongside them to deliver great quality outcomes for our customers and shareholders. We also commend the work of our global crowd of over 1 million in more than 130 countries worldwide. They provide the necessary human touch that delivers high quality data to our customers. Thank you for your valuable and ongoing support. Sincerely Mark Brayan Managing Director and Chief Executive Officer Appen Limited 2018 Annual Report 6 Environmental, Social and Governance Summary Appen is a truly global company, with over 1 million skilled contractors worldwide. We celebrate our diversity, as do our customers who value this as a core differentiator. Our work from home model provides a source of income to individuals that may otherwise find this difficult, including the disabled. Appen’s ESG (Environmental, Social, Governance) priorities are focussed on diversity of our workforce, social responsibility, environmental footprint, corporate governance and risk management. Diversity Social responsibility Environment Appen is proud of the cultural and ethnic diversity in our workforce, with crowd workers in 130 countries who speak 180 languages and dialects. Appen has a broadly-based diversity policy. https://appen.com/wp-content/ uploads/2017/08/Appen-Diversity- Policy-final24069684_6.pdf. Appen celebrates that our employee population is 61% female and 39% male. We are launching a new initiative in 2019 to further develop female leaders. The new initiatives will have both long- and short-term objectives and will include elements for all levels within the organization. We will focus on inclusion and career development to improve diversity among our workforce. Appen’s Board and CEO are committed to enhancing the gender diversity of our senior leadership team. Appen is an active supporter of people with disabilities. Through our Philippines operations we initially onboarded over 50 people with partial or full hearing impairment to support image annotation work, and have now expanded this group to over 200 people. Appen has an active Corporate Social Responsibility (CSR) program that supports those in need in the countries that we operate. Participation is encouraged, and community projects are publicised and celebrated via our intranet. On several occasions Appen has raised funds to support employees in need, with Appen matching all money raised. Appen also supports research, and has provided technical and linguistic resources to further research and community projects (https://appen. com/empowering-community-enabling- linguistic-research/). Appen’s corporate approach to CSR includes partnerships with organizations such as Translators without Borders and the National Council of Disability Affairs in Manila, Philippines. Employees also have a voice and are able to raise awareness around a need by contacting the CSR committee and asking for it to be a focus for employees around the globe. Funds raised are matched by the Company. Appen strives to ensure that crowd workers have sustainable conditions, with responsible renumeration at or above local minimum wage. Appen is a professional, knowledge- based workplace with minimal environmental footprint. Each of Appen’s offices includes recycling facilities and the Company encourages thoughtful use of resources. Appen has a low carbon footprint with the exception of air travel, which is necessary for some executives given the global nature of our business. Appen uses video and phone conferencing to reduce the extent of travel, and the travel budget is managed and monitored. Our million plus crowd workers work from home using internet-based tools, with minimal carbon impact. As a result, Appen rates reliance on carbon as low risk. Currently, there is no mandatory external reporting on carbon risk, but Appen will comply with any incoming legislation, regulation or best practice principles (such as ASX corporate governance principles) which require carbon reporting. Appen Limited 2018 Annual Report 7 Corporate Governance Risks Economic risks – the business is exposed to general economic conditions. Specifically, there is a material risk in customer concentration, however these customers are active with several separate projects across the business; Environmental risks – there is no current material exposure to environmental risks, however the Board monitors these risks and notes initiatives to lower the Company’s carbon footprint where possible by using video and phone conferencing to reduce the extent of travel, and has a million plus crowd workers that work from home using internet-based tools; and Social sustainability – there is risk associated with the engagement and conditions of crowd and remote workers to the extent that these workers may be incorrectly classified as employees and thus entitled to employee benefits. Appen has adopted a Modern Slavery policy in the UK and is in the process of codifying a global policy which incorporates our current practice of monitoring crowd and remote worker payment levels. The Board notes that part of the Company’s business is in the area of artificial intelligence and as such, it continues to monitor the social, ethical and political context in which the Company operates. Appen has a number of Board endorsed policies and statements which focus on company culture including corporate governance statement, code of conduct and diversity policy. Appen does not tolerate behaviours which are at odds with the Company’s culture and has taken action to address such behaviours, on the rare occasions that it is needed. Appen’s Corporate Governance Statement sets out how we meet or exceed the requirements of ASX Corporate Governance Council’s Principles and Recommendations. The Board and the Board Audit and Risk Committee spend time on ESG issues which include employee and crowd pay rates, privacy, community projects and, generally, the sustainability of the Appen businesses and business model. Appen tests its culture through employee annual surveys and root cause analysis of incidents or breaches. Appen Limited 2018 Annual Report 8 Appen Limited 2018 Annual Report Directors’ Report for the year ended 31 December 2018 9 The directors present their report, together with the financial statements, on the consolidated entity (referred to hereafter as the ‘Group’) consisting of Appen Limited (referred to hereafter as the ‘Company’ or ‘parent entity’) and the entities it controlled at the end of, or during, the year ended 31 December 2018. Supporting both divisions is a global on-demand crowd workforce providing customers with very flexible in-country linguistic and cultural expertise in support of 130 global markets. Appen was founded in 1996 and listed on the Australian Securities Exchange on 7 January 2015. Directors The following persons were directors of Appen Limited during the whole of the financial year and up to the date of this report, unless otherwise stated: Dividends Dividends paid during the financial year to the shareholders of Appen Limited were as follows: Christopher Charles Vonwiller – Chairman Mark Ronald Brayan Stephen John Hasker Robin Jane Low William Robert Pulver Deena Robyn Shiff Principal activities During the financial year the principal continuing activities of the Group consisted of the provision of quality data solutions and services for machine learning and artificial intelligence applications for global technology companies, auto manufacturers and government agencies. Appen operates through two operating divisions: – Content Relevance which provides annotated data used in search technology (embedded in web, e-commerce and social engagement) for improving relevance and accuracy of search engines, social media applications and ecommerce; and – Language Resources which provides annotated speech, natural language and image data used in speech and image recognisers, machine translation, speech synthesisers and other machine-learning technologies resulting in more engaging and fluent devices including internet-connected devices, in-car automotive systems and speech-enabled consumer electronics. Final dividend paid out of the profits reserve for the year ended 31 December 2017 of 3.0 cents per ordinary share (2017: 31 December 2016 of 3.0 cents) Interim dividend paid out of the profits reserve for the year ended 31 December 2018 of 4.0 cents per ordinary share (2017: 31 December 2017 of 3.0 cents) Group 31 Dec 2018 $’000 31 Dec 2017 $’000 3,174 2,928 4,258 7,432 2,933 5,861 Dividend declared On 25 February 2019, the Company declared a final dividend for the year ended 31 December 2018 of 4.0 cents per share, partially franked. The dividend is to be paid out of the profits reserve. The record date for determining entitlements to the dividend is 1 March 2019. The financial effect of these dividends has not been brought to account in the financial statements for the year ended 31 December 2018 and will be recognised in subsequent financial periods. Appen Limited 2018 Annual Report 10 Directors’ Report continued Review of operations The profit for the Group after providing for income tax amounted to $41,728k (31 December 2017: $14,282k). Financial performance Content Relevance Language Resources Other Total revenue from principal activities Underlying net profit after tax (‘NPAT’) Less: underlying adjustments (net of tax) Transaction costs Acquisition related share-based payments Amortisation of acquisition related identifiable intangible assets Statutory NPAT Add: tax Add: net interest expense/(income) EBIT* Add: Depreciation and amortisation Statutory EBITDA** Add: underlying adjustments Transaction costs Acquisition related share-based payments Underlying EBITDA Statutory diluted earnings per share (cents) Underlying diluted earnings per share (cents) % Statutory EBITDA/Sales % Underlying EBITDA/Sales % Segment Profit/Sales: Language Resources Content Relevance * EBIT is defined as earnings before interest and tax. ** EBITDA is EBIT before depreciation and amortisation. 2017 $’000 Change % Percentage change constant currency % 140% 25% – 112% 133% 148% 27% – 119% 148% 192% 173% 190% 173% 206% 190% 2018 $’000 312,846 51,361 82 126,160 40,397 14 364,289 166,571 49,028 19,749 (1,055) (1,666) (4,579) 41,728 14,226 3,185 59,139 8,941 68,080 1,507 1,666 (5,467) – – 14,282 6,093 3 20,378 1,863 22,241 5,877 – 71,253 28,118 153% 141% 38.55 45.29 18.7% 19.6% 21.8% 23.9% 14.36 19.86 13.4% 16.9% 30.1% 17.6% Total revenue for the financial year ended 31 December 2018 was $364,289k compared to 2017 revenue of $166,571k. The drivers behind this change in revenue were: – The Language Resources division recorded a 27% (constant currency: 25%) increase in revenue over the prior year, driven mainly by increased volumes from the technology sector, particularly in the second half of the year; and – The Content Relevance division delivered a 148% (constant currency: 140%) increase in revenue over the prior year. This was driven both by the Leapforce acquisition and significant increases in scope and volume from major customers as well as revenue from new customers. For the full year it is not possible to split out the revenue contribution from Leapforce as it has been combined with Appen, however Leapforce contributed 82% of the 146% revenue growth for the half year as compared to the previous corresponding period. Appen Limited 2018 Annual Report Directors’ Report continued 11 The Company reported statutory EBITDA of $68,080k representing a 206% (constant currency: 190%) increase over 2017. This result included transaction costs of $1,507k and share based payment expenses of $1,666k relating to the Leapforce acquisition. Excluding these costs, underlying EBITDA was $71,253k, representing a 153% (constant currency: 141%) increase over the prior year. This was driven by the Leapforce acquisition and significant organic revenue increase and operating cost efficiency through scalability of operations. This is evidenced by operating expenses (expenses excluding services purchased, depreciation, impairment, transaction costs and finance costs) for 2018 comprising 17% of revenue as compared to 24% in 2017. The underlying EBITDA margin of 19.6% as compared to the prior year margin of 16.9% underpins the scalable and successful delivery of the top line growth. This does not reflect any synergies from the Leapforce acquisition, which are expected to flow in 2019. The Company plans to reinvest these synergy savings back into the business in the form of engineering infrastructure and capability, to build platforms and tools to further enhance Appen’s competitive positioning as a world leader in the provision of data annotation services and products. The Language Resources division return on sales decreased to 21.8% as compared to 30.1% in the prior year, as the customer mix was adversely impacted by a significant reduction in complex, value added government work. The reduction in the operating margin is seen as a timing issue, not structural. However, as flagged at the half year, the planned strategic focus on expanding the sales pipeline in the technology sector was successful, resulting in a significant increase in revenue and earnings in the second half. The Content Relevance division return on sales of 23.9% was significantly higher than the 2017 return of 17.6%, due to continued improved gross margin, achieved through operating scale efficiencies and economies, and contribution from Leapforce earnings. For the full year it is not possible to split out the earnings contribution from Leapforce as it has been combined with Appen, however Leapforce contributed 129% of the 217% EBITDA growth for the half year as compared to the previous corresponding period. The impact of foreign exchange on revenue and EBITDA resulted in reported growth being higher than real growth. Growth over the prior year in constant currency amounted to 7% less revenue growth and 12% less underlying EBITDA growth as compared to reported revenue. Significant changes in the state of affairs There were no significant changes in the state of affairs of the Group during the financial year. Matters subsequent to the end of the financial year Apart from the dividend declared as discussed above, no other matter or circumstance has arisen since 31 December 2018 that has significantly affected, or may significantly affect the Group’s operations, the results of those operations, or the Group’s state of affairs in future financial years. Likely developments and expected results of operations The Group will continue to pursue its strategy to grow profitability in Content Relevance and Language Resources across a wider customer base. Environmental regulation The Group is not subject to any significant environmental regulation under Australian Commonwealth or State Law. The Board believes that the Group has adequate systems in place for the management of its environmental requirements and is not aware of any breach of those environmental requirements as they may apply to the Group during the period covered by this report. Appen Limited 2018 Annual Report 12 Directors’ Report continued Information on directors Name: Title: Qualifications: Experience and expertise: Special responsibilities: Interests in shares: Interests in options: Interests in rights: Name: Title: Qualifications: Experience and expertise: Special responsibilities: Interests in shares: Interests in options: Interests in rights: Name: Title: Qualifications: Experience and expertise: Special responsibilities: Interests in shares: Interests in options: Interests in rights: Christopher Charles Vonwiller Non-Executive Chairman BSc, BE (Hons), MBA, FIE (Aust.), FTSE Chris is the Non-Executive Chairman of Appen having formerly served as Appen CEO from 1999-2010. Prior to joining Appen, Chris served for 20 years in senior executive positions with the Australian telecommunications carrier Telstra Corporation Limited, playing a leading role in the development and deployment of innovative internet services, multimedia, and pay television. Chris is a former Chairman of the Warren Centre for Advanced Engineering at The University of Sydney. Chris holds degrees in science and engineering, with honours, from The University of Sydney and an MBA from Macquarie University. He was elected a Fellow of the Australian Academy of Technological Sciences and Engineering in 2007. Chair of the Board 11,060,083 ordinary shares (indirectly) None None Mark Ronald Brayan Managing Director and Chief Executive Officer MBA, BSurv (Hons) Mark joined Appen in July 2015 as CEO and is responsible for the company’s leadership, strategy and culture. Mark has over twenty-five years’ experience in technology and services. Prior to joining Appen, Mark was CEO of MST Global, a provider of technology solutions to the resources sector. Before that he was the CEO of Integrated Research Limited (ASX:IRI), an international software company listed on the Australian Stock exchange. Mark was also COO of the HR outsourcing company Talent2 (ASX:TWO) and CEO of Concept Systems (ASX:CSI) before its merger with Talent2. Mark has an MBA from the Australian Graduate School of Management and Bachelor of Surveying with 1st Class Honours from the University of NSW. None 358,676 ordinary shares (directly/indirectly) None 378,118 performance rights William Robert Pulver Non-Executive Director BCom (Marketing) William (Bill) has been a non-executive director of Appen since 31 January 2013. He is also a non- executive director of Smartpay Holdings Limited (ASX: SMP). Bill was the CEO of the Australian Rugby Union from 2013-2018 having formerly served as Appen CEO from 2010-2012. Previously he was the President and CEO of NetRatings, Inc., a NASDAQ-listed company (NTRT), specializing in Internet media and market research. Prior to this Bill held leadership roles at ACNielsen with eRatings.com, Pacific region and Australia. Bill holds a Bachelor of Commerce degree, with a major in marketing, from the University of New South Wales, Australia. Chair of Nominations and Remuneration Committee 1,000,000 ordinary shares (indirectly) None None Appen Limited 2018 Annual Report Directors’ Report continued 13 Name: Title: Qualifications: Experience and expertise: Special responsibilities: Interests in shares: Interests in options: Interests in rights: Name: Title: Qualifications: Experience and expertise: Special responsibilities: Interests in shares: Interests in options: Interests in rights: Name: Title: Qualifications: Experience and expertise: Special responsibilities: Interests in shares: Interests in options: Interests in rights: Robin Jane Low Independent Non-Executive Director BCom, FCA, GAICD Robin has been a non-executive director of Appen since 30 October 2014. Her other listed company directorships include AUB Group Limited (ASX: AUB), CSG Limited (ASX: CSV) and IPH Limited (ASX: IPH). Robin is also on the board of Australian Reinsurance Pool Corporation and she is the Deputy Chair of the Auditing and Assurance Standards Board. Previously Robin had a 28 year career at PricewaterhouseCoopers where she was a partner specialising in assurance and risk, mainly in financial services. Robin is also involved with not-for-profit organizations and serves on the boards of Public Education Foundation, Primary Ethics and Sydney Medical School Foundation. Robin has a Bachelor of Commerce from the University of New South Wales and is a Fellow of the Institute of Chartered Accountants Australia and New Zealand. Chair of the Audit and Risk Committee 172,743 ordinary shares (indirectly) None None Stephen John Hasker Non-Executive Director B.Com, MBA, MIA, ACAA Steve has been a non-executive director of Appen since 7 April 2015. Steve is Chief Executive Officer of Creative Artists Agency Global, based in Los Angeles where he oversees CAA’s commercial activities. Prior to joining CAA in January 2018, Steve was Global President and COO of Nielsen, based in New York, responsible for Nielsen’s commercial and product activities across all of its media and consumer businesses. Prior to joining Nielsen in 2009, he was a partner at McKinsey & Company’s Global Media, Entertainment and Information practice in New York. Before joining McKinsey, Steve spent five years in several financial roles in the U.S., Russia and Australia. Steve holds an undergraduate economics degree from the University of Melbourne and has an MBA and a master’s in international affairs, both with honours, from Columbia University. He is also a non-executive director of Global Eagle, and is a member of Institute of Chartered Accountants Australia and New Zealand. None 50,000 ordinary shares None None Deena Robyn Shiff Non-Executive Director B.Sc. (Econ); B.A. (Law) Deena has been a Non-Executive Director since May 2015. Deena has enjoyed a distinguished business career covering senior roles in the legal profession and in corporate positions. She was a partner in the leading law firm Mallesons Stephen Jaques before rejoining Telstra Corporation where she rose to Group Managing Director. She holds several other non-executive director roles, including Chair of Marley Spoon AG (ASX: MMM), Chair of BAI Communications and director on the board of Infrastructure Australia. She was previously a director of the Citadel Group Limited (ASX:CGL). Deena holds a degree in law from Cambridge University and a degree in economics from the London School of Economics, both with honours. She is a Fellow of the Australian Institute of Company Directors. None 50,229 ordinary shares (indirectly) None None Appen Limited 2018 Annual Report 14 Directors’ Report continued Company secretary Carl Middlehurst was appointed as Company Secretary on 8 February 2019. Carl was admitted to practice as a solicitor in NSW in 1988. In addition, he is also a member of the California bar. He was an adjunct professor at Santa Clara University Law School where he taught internet, ecommerce and privacy law in the late nineties. He has worked in Australia and United States and has held the position of General Counsel for various companies and been Company Secretary for an unlisted public company and private companies in Australia. Leanne Ralph resigned as Company Secretary on 8 February 2019. Meetings of directors The number of meetings of the Company’s Board of Directors (‘the Board’) and of each Board committee held during the year ended 31 December 2018, and the number of meetings attended by each director were: Christopher Vonwiller William Pulver Mark Brayan Deena Shiff Stephen Hasker Robin Low Full Board Audit and Risk Management Committee Nomination and Remuneration Committee Attended Held Attended Held Attended Held 14 14 14 14 14 14 14 14 14 14 14 14 4 – – 4 – 4 4 – – 4 – 4 – 2 – – 2 2 – 2 – – 2 2 Held: represents the number of meetings held during the time the director held office or was a member of the relevant committee. Remuneration report (audited) This report outlines the remuneration arrangements in place for key management personnel (‘KMP’) of the Company in connection with the management of the affairs of the entity and its subsidiaries during the year to 31 December 2018 (‘Remuneration Report’). KMP have authority and responsibility for planning, directing and controlling the activities of the Company and the consolidated entity, including Directors of the Company and other executives. KMP comprise the Directors of the Company and executives of the Company and the consolidated entity. This Remuneration Report has been audited and an opinion provided as required by section 308(3C) of the Corporations Act 2001 (Cth). The Remuneration Report is set out under the following main headings: 1. Remuneration Philosophy – Governance & Principles 2. Nomination and Remuneration Committee 3. Audit and Risk Management Committee 4. Non-Executive Director Remuneration and Shareholding 5. Executive Remuneration 6. Executive Shareholdings and Performance Rights The figures are in Australian Dollars unless otherwise noted. Appen Limited 2018 Annual Report Directors’ Report continued 15 Details of KMP for 2018 C Vonwiller S Hasker R Low W Pulver D Shiff And the following persons: M Brayan K Levine T Sharkey Non-Executive Chairman Independent Non-Executive Director Independent Non-Executive Director Independent Non-Executive Director Independent Non-Executive Director Managing Director and Chief Executive Officer Chief Financial Officer Senior Vice-President, Content Relevance 1. Remuneration Philosophy – Governance & Principles The Company’s objective is to provide the maximum benefit to shareholders. The Board believes that the Company will achieve this objective by retaining a high-quality Board and executive team remunerated fairly and appropriately. The Company’s remuneration philosophy is to ensure that the level and composition of remuneration is both competitive and reasonable. Remuneration should be linked to performance and appropriate for the results delivered. The Company’s policies are designed to attract and maintain talented and motivated Directors and employees, thereby raising the level of performance of the Company and enhancing shareholder value. The Company’s remuneration policy is to: – implement remuneration structures designed to attract and retain high quality directors and be globally competitive and continually benchmarked to attract, retain and motivate senior executives with the expertise to enhance the performance and growth of the Company and create value for shareholders; – ensure that: – executive directors and senior executives are encouraged to pursue the growth and success of the Company (both in the short-term and over the longer term), without taking undue risks; and – non-executive directors’ remuneration is consistent with their obligation to bring an independent judgement to matters before the Board; – review the employment conditions of Appen’s employees on an ongoing basis to ensure the Company remains competitive in terms of remuneration and other incentives; and – review employee incentive plans from time to time with a view to further aligning management and employees’ interests with those of the Company and shareholders. In accordance with best practice corporate governance, the structure of Non-Executive Director and executive remuneration is separate and distinct. 2. Nomination and Remuneration Committee The Board has established a Nomination and Remuneration Committee, which provides advice, recommendations and assistance to the Board in relation to compensation arrangements for Directors and executives. The Nomination and Remuneration Committee assesses the appropriateness of the nature and amount of emoluments of officers on a periodic basis by reference to relevant employment market conditions, with the overall objective of ensuring maximum shareholder benefit from the retention of a high quality Board and executive team. It is intended that any schemes or other structures chosen will be optimal for the recipient without creating undue cost for the Company. The members of the Nomination and Remuneration Committee during the reporting period were: William Pulver, Committee Chair; Robin Low; and Stephen Hasker. The number of meetings of the Nomination and Remuneration Committee held during the reporting period, and attendance by the Nomination and Remuneration Committee members, is set out in the ‘Meetings of directors’ section of the Directors’ Report. Further information about the Nomination and Remuneration Committee is set out in the Company’s Corporate Governance Statement, which is available at https://appen.com/investors/corporate-governance/. Appen Limited 2018 Annual Report 16 Directors’ Report continued 3. Audit and Risk Management Committee The Board has established an Audit and Risk Management Committee to assist the Board in fulfilling its statutory, corporate governance, risk management and compliance practices and responsibilities. The Audit and Risk Management Committee monitors and reviews the integrity of the Company’s internal financial reporting and external financial statements, the effectiveness of internal financial controls, the independence, objectivity and performance of external auditors, the policies on risk oversight and management and makes recommendations to the Board in relation to the appointment of external auditors and approves the remuneration and terms of their engagement. The members of the Audit and Risk Management Committee during the reporting period were: Robin Low, Committee Chair; Chris Vonwiller; and Deena Shiff. The number of meetings of the Audit and Risk Committee held during the reporting period, and attendance by the Nomination and Remuneration Committee members, is set out in the ‘Meetings of directors’ section of the Directors’ Report. Further information about the Audit and Risk Management Committee is set out in the Company’s Corporate Governance Statement, which is available at https://appen.com/investors/corporate-governance/. 4. Non-Executive Director Remuneration and Shareholdings Remuneration Non-Executive Directors are remunerated by way of Board and Committee fees that were set prior to the Company’s listing on the ASX. The current fee structure for Non-Executive Directors (effective 1 May 2018) is as follows: Role Board Chair Non-Executive Director Audit and Risk Committee Chair Nomination and Remuneration Committee Chair * All fees are inclusive of statutory superannuation. Fee* $125,000 $85,000 $15,000 $15,000 The Non-Executive Directors are remunerated from the maximum aggregate amount approved by shareholders. The current fee pool limit of $800,000 was approved by shareholders at the annual general meeting in 2018. Details of fees paid to directors in 2018 and 2017 are outlined below: Amounts paid to Non-Executive Directors Director C Vonwiller W Pulver R Low J Samuel* D Shiff S Hasker 2018 2017 Fees $ Superannuation $ Total $ Fees $ Superannuation $ Total $ 113,333 82,002 87,563 – 69,635 76,250 2,969 116,302 7,790 89,792 3,687 91,250 – – 6,615 76,250 – 76,250 60,750 63,356 67,352 9,167 53,653 58,750 33,000 93,750 6,019 6,398 – 69,375 73,750 9,167 5,097 58,750 – 58,750 428,783 21,061 449,844 313,028 50,514 363,542 * Jeremy Samuel resigned as Non-Executive Director on 29 November 2016. Appen Limited 2018 Annual Report Directors’ Report continued 17 The amount of aggregate remuneration sought to be approved by shareholders and the manner in which it is apportioned among Directors will be reviewed annually. The Board seeks to set aggregate Director remuneration at a level that provides the Company with the ability to attract and retain Directors of the highest calibre, while incurring a cost that is acceptable to shareholders. The Board will consider fees paid to Non-Executive Directors of comparable companies when undertaking the annual review, as well as any additional time commitment of Directors who serve on one or more Committees, and any other assistance to the Company in respect of specific projects or transactions. The remuneration packages of Non-Executive Directors are fee-based. Non-Executive Directors do not participate in the schemes designed for the remuneration of executives, or performance-based schemes or awards such as options or bonus payments. Non- Executive Directors are not entitled to any retirement benefits other than statutory superannuation. Non-Executive Director Shareholdings The Company does not currently have a formal minimum shareholding requirement for Non-Executive Directors, however Non- Executive Directors are encouraged by the Board to hold shares purchased on-market in accordance with the Company’s Securities Dealing Policy. The Board considers that by holding shares in the Company, Directors align themselves with the interests of the shareholders as a whole. As at the date of this Remuneration Report the Directors held the following shareholdings in the Company: Director C Vonwiller W Pulver M Brayan R Low D Shiff S Hasker Number of shares Purchased/ vested during the year No. Sold during the year No. 31 December 2018 No. – – 192,768 – – – (2,000,000) 11,060,083 (800,495) (29,000) – – – 1,000,000 358,676 172,743 50,229 50,000 1 January 2018 No. 13,060,083 1,800,495 194,908 172,743 50,229 50,000 15,328,458 192,768 (2,829,495) 12,691,731 5. Executive Remuneration The Company aims to reward executives with a level and mix of remuneration commensurate with their position and responsibilities within the Company so as to: – reward executives by reference to both company and individual performance; – align the interests of executives with those of shareholders; – encourage retention of executives and other employees; – link reward with the strategic goals and performance of the Company; and – ensure total remuneration is competitive by market standards. Appen Limited 2018 Annual Report 18 Directors’ Report continued In considering the Group’s performance and benefits for shareholder wealth, the Remuneration and Nomination Committee considered the following metrics over the last five years: Net profit after tax Underlying net profit after tax* Underlying EBITDA** Dividends Basic earnings per share - cents per share Basic underlying earnings per share - cents per share* 2018 $’000 41,728 49,028 71,253 7,432 39.25 46.11 2017 $’000 14,282 19,749 28,118 5,861 14.55 20.12 2016 $’000 10,489 10,620 17,312 4,851 10.81 10.95 2015 $’000 8,308 8,308 13,822 1,155 8.67 8.67 2014 $’000 1,616 1,616 6,674 1,188 2.15 2.15 Before amortisation of identifiable assets (tax adjusted). * ** Earnings before interest, tax, depreciation, amortisation, change in fair value of contingent consideration, transaction costs and excise tax refund. Executive remuneration comprises of: – fixed remuneration; – short term incentives; and – long term incentives through equity based compensation. Service Contracts Remuneration and other terms of employment for KMP are formalised in service contracts. All executive KMP service contracts provide for immediate termination in the event of serious misconduct. Details of other key terms are summarised below: Executive Role M Brayan K Levine T Sharkey Managing Director CFO SVP, Content Relevance Contract Term No fixed term No fixed term No fixed term Annual Salary Review Notice Period by either party 1 March 1 March 1 March 6 months 3 months 90 days Fixed Remuneration Fixed remuneration consists of base pay, superannuation and other non-monetary benefits and is designed to reward for: – the scope of the executive’s role; – the executive’s skills, experience and qualifications; and – individual performance. Executives are offered a competitive base pay. Reference is made to industry benchmarks to ensure that the base pay is set to reflect the market for a comparable role. Base pay is reviewed annually by reference to both the individual’s and the consolidated entity’s performance, and alignment with market remuneration levels. There are no guaranteed base pay increases included in any executive contracts. Short Term Incentives Executive service contracts recognise the potential for the award of short term incentives linked to specific performance criteria. The Company operates an executive bonus plan that entitles certain executives of the Company to a cash bonus ranging from 0% to 150% of a target bonus, which is typically a percentage of the relevant executive’s annual salary. Appen Limited 2018 Annual Report Directors’ Report continued 19 Key performance measures for payment of a bonus and the typical percentage weighting for each measure are as follows: Performance Measure Revenue EBITDA 2018 Weighting 2017 Weighting 33% 67% 33% 67% The bonus is calculated based on the combined result of all the performance measures. Therefore, if the Company achieves 50% of the revenue target and 100% of the EBITDA target, the overall score for the purposes of the calculation of any bonus (‘Financial Metric’) that may be awarded would be 83.5% of the relevant executive’s on-target bonus. Any actual bonus that may be awarded is calculated on a sliding scale between 0% and 150% - for example: Financial Metric Below 80% 80% 90% 122.25% or more Potential Bonus amount – % of target bonus Nil 64% 81% 150% Using the performance measures and personal performance objectives assessed against key performance indicators (‘KPIs’), the Company ensures variable rewards are only paid when the relevant KMP have met or exceeded their agreed individual work plan objectives, financial metrics have been achieved and value has been created for shareholders. The Board reviews the Financial Metric on an annual basis. Any bonus payment is at the discretion of the Board and is subject to Board approval. Performance and Remuneration Outcomes At the end of the financial year, the Remuneration and Nomination Committee reviewed the performance against each of the metrics to determine a recommended short-term incentive (‘STI’) payment for the relevant executive KMPs. This recommendation was subsequently reviewed and approved by the Board. The tables below outline the performance results against these metrics and the final STI payment made to the executives. 2018 Results and STI Payments Revenue Underlying EBITDA * Payout capped at 150%. Target Actual % Actual/ Target % Payout* $274,933,515 $364,207,316 $51,553,054 $71,253,243 132% 138% 150% 150% Appen Limited 2018 Annual Report 20 Directors’ Report continued Weighted average performance payout is 150% Executive M Brayan K Levine P Hall(a) T Garves(b) T Sharkey(c) Fixed remuneration* $ Currency STI Target % Performance Payout % (max 150%) % AUD AUD AUD USD USD 500,000 350,000 67,798 107,003 167,346 50% 30% 30% 30% 40% 150.0% 150.0% – – Total STI Payout $ 375,000 157,500 – – Total STI Payout (AUD) $ 375,000 157,500 – – 150.0% 100,408 134,193 Includes superannuation for Australian-based executives. * (a) Retired 29 March 2018. (b) Exited 4 May 2018. (c) Commenced 9 July 2018. Certain executives have a divisional metric in addition to the metrics detailed above. 2017 Results and STI Payments Revenue** EBITDA** Payout capped at 150%. * ** Excludes contribution from Leapforce and transaction costs. Weighted average performance payout is 149% Target Actual % Actual/ Target % Payout* $132,724,000 $160,546,995 $21,401,000 $26,574,323 121% 124% 146% 150% Executive M Brayan K Levine P Hall T Garves T White(a) Fixed remuneration* $ Currency AUD AUD AUD USD USD 475,000 325,000 261,500 256,053 94,789 STI Target % Performance Payout % (max 150%) % 50% 30% 30% 30% 30% 149.0% 149.0% 122.8% 149.0% – Total STI Payout $ 353,850 145,265 96,337 114,447 – Total STI Payout (AUD) $ 353,850 145,265 96,337 149,250 – Includes superannuation for only Australian-based executives. * (a) Exited 17 May 2017. Long Term Incentives Long-term incentives to the Managing Director, other executive KMP and employees are provided by the Company’s long-term incentive plan, which is designed to align the interests of management and shareholders and assist the Company in the attraction, motivation and retention of executives. The Appen Long Term Incentive Plan (‘LTIP’) is intended as the primary vehicle for aligning the interests of the Company’s senior management and shareholders, and for the retention of key executives. It is intended that the LTIP will be used to deliver awards to employees in all countries, subject to variations to meet specific legal or tax requirements. Appen Limited 2018 Annual Report Directors’ Report continued 21 Current LTI Plans Performance Rights Plan The Company developed a long-term incentive plan that incorporates performance conditions and was effective from 1 January 2015. The long-term incentive plan provides for annual grants of performance rights to senior management and are subject to an employment condition and annual performance hurdles (refer table below for further detail on how achievement is measured and assessed). Vesting of performance rights aligns with local practices, and as such, performance rights vest as follows: – Performance rights issued to executives in Australia - vest at the end of 3 years from grant date.; and – Performance rights issued to executives in United States - vest evenly on an annual basis over a 3 year period from the grant date. The performance rights will only vest subject to: – achievement of an underlying Basic Earnings Per Share (‘EPS’) performance condition for the three consecutive years applicable to the grant, tested annually and measured on the performance for that period. If a performance condition is missed in a particular year it can be caught up in subsequent years; and – continuation of employment until the beginning of the calendar year in which the performance rights are subject to vesting. Shareholder alignment is achieved through senior management being incentivised to grow the share price through the three year vesting period, to maximise the value of any award. If a recipient leaves before the performance rights vest (and despite one or multiple EPS conditions being met), the rights lapse. The plan also acts as a retention tool. Vested performance rights will convert to ordinary shares in the Company on a one-for-one basis for nil financial consideration. The Board has adopted an EPS performance condition for the LTIP, using a consistent EPS growth method that applies each year. Under this calculation method, an annual EPS growth target is set at the beginning of each performance period. A key factor in the Board‘s considerations is that the LTIP should be both simple to understand and provide both a performance and retention element for participants. The Board considers that a consistent EPS growth method is best aligned to these principles and best provides a long term EPS growth element that is predicated on the maximisation of shareholder value. Appen Limited 2018 Annual Report 22 Directors’ Report continued Overview of Performance Rights and Conditions Plan Grant date Expiry date1 Exercise price Tranche Performance measurement Performance target Performance target measurement date Target achieved2 Vesting condition Vesting date Value per right at grant date 2016 1 Mar 2016 N/A 2016 1 Mar 2016 N/A 2016 1 Mar 2016 N/A 2017 1 Mar 2017 N/A 2017 1 Mar 2017 N/A 2017 1 Mar 2017 N/A 2018 20 Feb 2018 N/A 2018 20 Feb 2018 N/A 2018 20 Feb 2018 N/A 2018 STI 20 Feb 2018 N/A 2018 Special 2018 Special 2018 Special 20 Feb 2018 N/A 20 Feb 2018 N/A 20 Feb 2018 N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A 1 2 3 1 2 3 1 2 3 1 1 2 3 EPS EPS EPS EPS EPS EPS EPS EPS EPS Completion of Leapforce acquisition EPS EPS EPS 10.0% End 2016 10.0% End 2017 10.0% End 2018 10.0% End 2017 10.0% End 2018 Yes Yes Yes Yes Yes Employed at 1 Jan 2019 Employed at 1 Jan 2019 1 Jan 2019 $1.41 1 Jan 2019 $1.41 Employed at 1 Jan 2019 Release of 2018 results $1.41 Employed at 1 Jan 2020 Employed at 1 Jan 2020 1 Jan 2020 $2.58 1 Jan 2020 $2.58 10.0% End 2019 Pending Employed at 1 Jan 2020 Release of 2019 results $2.58 10.0% End 2018 Yes Employed at 1 Jan 2021 1 Jan 2021 $8.15 10.0% End 2019 Pending 10.0% End 2020 Pending N/A Completion date 20.0% End 2018 Yes Yes 20.0% End 2019 Pending Employed at 1 Jan 2021 1 Jan 2021 $8.15 Employed at 1 Jan 2021 Release of 2020 results $8.15 N/A 20 Feb 2018* $8.15 Employed at 1 Jan 2021 Employed at 1 Jan 2021 1 Jan 2021 $8.15 1 Jan 2021 $8.15 20.0% End 2020 Pending Employed at 1 Jan 2021 Release of 2020 results $8.15 * 1 2 The equity-settled performance rights for the successful completion of the Leapforce acquisition on 7 December 2017 were vested immediately on grant date of 20 February 2018. Rights are automatically converted to shares on the vesting dates, assuming all the performance conditions of the plan and the employment condition are met. Target achievement table: EPS Target Achieved 100% or more of EPS Target 90-99% of EPS Target* Less than 90% * At the board’s discretion. % Performance Rights Allocated 100% 50-80% Nil Appen Limited 2018 Annual Report Directors’ Report continued 23 The number of performance rights allocated to executives at the end of the year are: Plan 2016 2017 2018 2018 Special Total M Brayan No. K Levine No. T Sharkey No. 95,535 59,430 23,153 150,000 328,118 63,690 35,022 12,155 100,000 210,867 – – 8,518 – 8,518 The movement during the reporting period of performance rights owned by executive KMP are outlined in the table below: Executive Plan Held at 1 January 2018 Granted during the year Exercised during the year* Forfeited during the year Held at 31 December 2018 Vested during the year Vested and exercisable at 31 December 2018 M Brayan K Levine 2015 2016 2017 2018 2018 STI 2018 Special 2016 2017 2018 2018 STI 2018 Special T Sharkey 2018 142,768 95,535 59,430 – – – 297,733 63,690 35,022 – – – 98,712 – – – – 23,153 50,000 150,000 223,153 – – 12,155 33,334 100,000 145,489 8,518 (142,768) – – – (50,000) – (192,768) – – – (33,334) – (33,334) – – 8,518 – * Details of the performance rights exercised are detailed in the table below: Executive M Brayan K Levine – – – – – – – – – – – – – – – – 142,768 95,535 59,430 23,153 – – – – 50,000 150,000 328,118 63,690 35,022 12,155 – 192,768 – – – – 33,334 100,000 210,867 8,518 8,518 – 33,334 – – – – – – – – – – – – – – – – – Number of rights exercised Value of rights at grant date Value of rights at exercisable date 192,768 33,334 $506,010 $1,434,002 $271,672 $271,672 Appen Limited 2018 Annual Report 24 Directors’ Report continued Summary of Executive Remuneration Details of the remuneration of the KMP of the Group are set out in the tables below: 31 Dec 2018 Short-term benefits Post-employment benefits Long-term benefits Share-based payments M Brayan K Levine P Hall(a) T Garves(b) T Sharkey(c) Cash salary $ STI $ Super- annuation* $ Termination payments $ Leave entitlements $ Equity- settled Rights $ Cash- settled $ 484,960 375,000 332,791 157,500 62,785 143,007 – – 223,654 134,193 1,247,197 666,693 15,041 17,209 5,012 21,554 20,949 79,765 – – – – – – 28,698 828,921 6,744 544,078 – – – – 18,688 18,377 54,130 1,391,376 – – – – – – Total $ 1,732,620 1,058,322 67,797 164,561 415,861 3,439,161 Includes discretionary company contributions to an approved 401k pension fund and insurance contributions in US. * (a) Retired 29 March 2018. (b) Exited 4 May 2018. (c) Commenced 9 July 2018. 31 Dec 2017 Short-term benefits Post-employment benefits Long-term benefits Share-based payments Cash salary $ STI $ Super- annuation* $ Termination payments $ Leave entitlements $ M Brayan K Levine P Hall T Garves T White(a) 459,631 353,850 305,294 145,265 238,813 96,337 333,916 149,250 123,613 – 15,369 19,707 22,687 38,210 30,385 1,461,267 744,702 126,358 – – – – – – 38,354 24,928 36,888 34,483 25,659 160,312 188,853 Equity- settled Rights $ 66,671 34,914 36,401 50,867 – Cash- settled $ – – – – – – Total $ 933,875 530,108 431,126 606,726 179,657 2,681,492 Includes discretionary company contributions to an approved 401k pension fund and insurance contributions in US. * (a) Exited 17 May 2017. The proportion of remuneration linked to performance and the fixed proportion are as follows: Name M Brayan K Levine P Hall T Garves T Sharkey Proportion of remuneration performance related Value of equity as proportion of remuneration 31 Dec 2018 31 Dec 2017 31 Dec 2018 31 Dec 2017 69% 66% – – 37% 45% 34% 31% 33% – 48% 51% – – 4% 7% 7% 8% 8% – Appen Limited 2018 Annual Report Directors’ Report continued 25 6. Executive Shareholdings and Performance Rights The table below outlines the current shares and performance rights held by the executive KMP as at 31 December 2018: Executive M Brayan K Levine T Sharkey Number of ordinary shares currently held (direct and indirect) Security Number 172,743 Rights 109,916 Rights – Rights 328,118 210,867 8,518 It is company policy that Directors and KMP must not enter into transactions in associated products that operate to limit the economic risk of security holdings in the Company. A copy of the Company’s Securities Dealing Policy is available at https://appen.com/investors/corporate-governance/. This concludes the remuneration report, which has been audited. Shares under option Unissued ordinary shares of the Company under option at the date of this Remuneration Report are as follows: Expiry date 1 March 2019 Exercise price Number of options $0.494 40,900 No person entitled to exercise the options had or has any right by virtue of the option to participate in any share issue of the Company or of any other body corporate. Shares under performance rights Unissued ordinary shares of Appen Limited under performance rights at the date of this report are as follows: Plan 2016 2017 2018 2018 Special Number of rights 303,273 252,327 113,914 464,718 1,134,232 No person entitled to exercise the performance rights had or has any right by virtue of the performance right to participate in any share issue of the Company or of any other body corporate. Shares issued on the exercise of options During the year, 67,463 ordinary shares of the Company were issued and fully paid for on the exercise of options during the year ended 31 December 2018 and up to the date of this Remuneration Report as outlined below (there are no amounts unpaid on the shares issued). Shares issued on the exercise of performance rights During the year, 603,374 ordinary shares of the Company were issued on the exercise of performance rights during the year ended 31 December 2018 and up to the date of this Remuneration Report. Appen Limited 2018 Annual Report 26 Directors’ Report continued Indemnity and insurance of officers The Company has indemnified the current and former directors and executives of the Company and its controlled entities for costs incurred, in their capacity as a director or executive, for which they may be held personally liable, except where there is a lack of good faith. During the financial year, the Company paid a premium in respect of a contract to insure the current and former directors and executives of the Company and its controlled entities against a liability to the extent permitted by the Corporations Act 2001. The contract of insurance prohibits disclosure of the nature of liability and the amount of the premium. Executives include all the key management personnel as defined in the remuneration report as well as their direct reports. Indemnity and insurance of auditor The Company has not, during or since the end of the financial year, indemnified or agreed to indemnify the auditor of the Company or any related entity against a liability incurred by the auditor. During the financial year, the Company has not paid a premium in respect of a contract to insure the auditor of the Company or any related entity. Proceedings on behalf of the Company No person has applied to the Court under section 237 of the Corporations Act 2001 for leave to bring proceedings on behalf of the Company, or to intervene in any proceedings to which the Company is a party for the purpose of taking responsibility on behalf of the Company for all or part of those proceedings. Auditor independence and non-audit services The directors received an independence declaration from KPMG as required under section 307C of the Corporations Act 2001. It is set out immediately after the Directors’ report. During the year KPMG, the Group’s auditor, has performed certain other services in addition to the audit and review of the financial statements. These relate to transfer pricing, employee share scheme, transaction assistance and taxation services, including US excise services. Details of the amounts paid or payable to the auditor for non-audit services provided during the financial year by the auditor are outlined in Note 25 to the financial statements. The directors are satisfied that the provision of non-audit services during the financial year, by the auditor (or by another person or firm on the auditor’s behalf), is compatible with the general standard of independence for auditors imposed by the Corporations Act 2001. Auditor KPMG continues in office in accordance with section 327 of the Corporations Act 2001. Rounding of amounts The Company is of a kind referred to in ASIC Corporations (Rounding in Financial/Directors Reports) Instrument 2016/191 (Rounding Instrument), issued by the Australian Securities and Investments Commission, relating to ‘rounding-off’. Amounts in this report have been rounded off in accordance with that Corporations Instrument to the nearest thousand dollars, or in certain cases, the nearest dollar. This report is made in accordance with a resolution of directors, pursuant to section 298(2)(a) of the Corporations Act 2001. On behalf of the directors Christopher Vonwiller Director 25 February 2019 Sydney Appen Limited 2018 Annual Report Auditor’s Independence Declaration to the directors of Appen Limited 27 Appen Limited 2018 Annual Report 28 Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2018 Revenue Interest income calculated using the effective interest method Net foreign exchange gain Expenses Services purchased - data collection Employee benefits expense Share-based payments expense Depreciation and amortisation expense Impairment of receivables Travel expense Professional fees Rental expense Communication expense Transaction costs Net foreign exchange loss Other expenses Finance costs Profit before income tax expense Income tax expense Profit after income tax expense for the year attributable to the owners of Appen Limited Other comprehensive income/(loss) Items that may be reclassified subsequently to profit or loss Foreign currency translation Other comprehensive income/(loss) for the year, net of tax Total comprehensive income for the year attributable to the owners of Appen Limited Basic earnings per share Diluted earnings per share Group Note 31 Dec 2018 $’000 31 Dec 2017 $’000 6 7 7 7 8 23 38 38 364,273 166,561 16 – (228,338) (43,813) (4,017) (8,941) (100) (1,503) (3,787) (1,915) (911) (1,507) (116) (10,186) (3,201) 55,954 (14,226) 10 969 (99,816) (29,117) (410) (1,863) – (1,064) (1,920) (894) (337) (5,877) – (5,854) (13) 20,375 (6,093) 41,728 14,282 7,643 7,643 (882) (882) 49,371 13,400 Cents 39.25 38.55 Cents 14.55 14.36 Refer to Note 4 for detailed information on Restatement of comparatives - adoption of AASB 9 ‘Financial Instruments’ and AASB 15 ‘Revenue from Contracts with Customers’. The above consolidated statement of profit or loss and other comprehensive income should be read in conjunction with the accompanying notes Appen Limited 2018 Annual Report Consolidated Statement of Financial Position as at 31 December 2018 29 Assets Current assets Cash and cash equivalents Trade and other receivables Contract assets Derivative financial instruments Income tax refund due Prepayments Total current assets Non-current assets Property, plant and equipment Intangibles Other non-current assets Total non-current assets Total assets Liabilities Current liabilities Trade and other payables Contract liabilities Derivative financial instruments Income tax Provisions Total current liabilities Non-current liabilities Borrowings Deferred tax Provisions Total non-current liabilities Total liabilities Net assets Equity Issued capital Reserves Accumulated losses Total equity Group 31 Dec 2018 $’000 31 Dec 2017 $’000 Restated Note 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 40,045 60,469 10,354 – 588 2,859 24,015 31,638 11,270 123 – 1,121 114,315 68,167 4,906 119,144 37 124,087 238,402 1,762 116,253 1,866 119,881 188,048 37,015 1,535 249 – 1,529 21,173 1,237 46 1,303 1,151 40,328 24,910 56,330 1,965 379 58,674 99,002 139,400 69,602 73,668 (3,870) 139,400 67,885 1,369 473 69,727 94,637 93,411 69,569 27,712 (3,870) 93,411 Refer to Note 4 for detailed information on Restatement of comparatives - adoption of AASB 9 ‘Financial Instruments’ and AASB 15 ‘Revenue from Contracts with Customers’. The above consolidated statement of financial position should be read in conjunction with the accompanying notes Appen Limited 2018 Annual Report 30 Consolidated Statement of Changes in Equity for the year ended 31 December 2018 Group Balance at 1 January 2017 Profit after income tax expense for the year Other comprehensive loss for the year, net of tax Total comprehensive income/(loss) for the year Transfer between reserves Transactions with owners in their capacity as owners: Issue of ordinary shares, net of transaction costs (Note 21) Share-based payments Dividends paid (Note 24) Balance at 31 December 2017 Issued capital $’000 Reserves $’000 Accumulated losses $’000 19,510 19,763 – – – – 50,059 – – 69,569 – (882) (882) 14,282 – 410 (5,861) 27,712 (3,870) 14,282 – 14,282 (14,282) – – – (3,870) Total equity $’000 35,403 14,282 (882) 13,400 – 50,059 410 (5,861) 93,411 Refer to Note 4 for detailed information on Restatement of comparatives - adoption of AASB 9 ‘Financial Instruments’ and AASB 15 ‘Revenue from Contracts with Customers’. Group Balance at 1 January 2018 Profit after income tax expense for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year Transfer between reserves Transactions with owners in their capacity as owners: Issue of ordinary shares, net of transaction costs (Note 21) Share-based payments Dividends paid (Note 24) Balance at 31 December 2018 Issued capital $’000 Reserves $’000 Accumulated losses $’000 69,569 27,712 – – – – 33 – – – 7,643 7,643 41,728 – 4,017 (7,432) (3,870) 41,728 – 41,728 (41,728) – – – Total equity $’000 93,411 41,728 7,643 49,371 – 33 4,017 (7,432) 69,602 73,668 (3,870) 139,400 The above consolidated statement of changes in equity should be read in conjunction with the accompanying notes Appen Limited 2018 Annual Report Consolidated Statement of Cash Flows for the year ended 31 December 2018 31 Cash flows from operating activities Receipts from customers (inclusive of GST) Payments to suppliers and employees (inclusive of GST) Interest received Interest paid Income taxes paid Net cash from operating activities Cash flows from investing activities Payments for acquisition Cash acquired on acquisition Transaction costs paid for acquisition Payments for property, plant and equipment Payments for intangibles Net cash used in investing activities Cash flows from financing activities Proceeds from issue of shares, net of transaction costs Proceeds from borrowings Repayment of borrowings Dividends paid Net cash from/(used in) financing activities Net increase in cash and cash equivalents Cash and cash equivalents at the beginning of the financial year Effects of exchange rate changes on cash and cash equivalents Cash and cash equivalents at the end of the financial year Group Note 31 Dec 2018 $’000 31 Dec 2017 $’000 340,353 (274,974) 65,379 16 (2,994) (15,602) 46,799 157,706 (136,772) 20,934 10 (13) (7,547) 13,384 (1,308) (93,127) – (2,300) (2,826) (1,162) (7,596) 33 – (17,830) (7,432) (25,229) 13,974 24,015 2,056 40,045 4,915 (3,577) (3,174) (2,628) (97,591) 29,428 69,241 – (5,861) 92,808 8,601 16,471 (1,057) 24,015 36 33 33 21 24 9 The above consolidated statement of cash flows should be read in conjunction with the accompanying notes Appen Limited 2018 Annual Report 32 Notes to the Consolidated Financial Statements for the year ended 31 December 2018 1. General information The financial statements cover Appen Limited as a Group consisting of Appen Limited and the entities it controlled at the end of, or during, the year. The financial statements are presented in Australian dollars, which is Appen Limited’s functional and presentation currency. Appen Limited is a listed public company limited by shares, incorporated and domiciled in Australia. Its registered office and principal place of business is: Level 6 9 Help Street Chatswood NSW 2067 introduced a new contract-based revenue recognition model with a measurement approach that is based on an allocation of the transaction price. This is described further in the accounting policies below. Contracts with customers are presented in an entity’s statement of financial position as a contract liability, a contract asset, or a receivable, depending on the relationship between the entity’s performance and the customer’s payment. Customer acquisition costs and costs to fulfil a contract can, subject to certain criteria, be capitalised as an asset and amortised over the contract period. Determining the timing of the transfer of promised goods and services at either a point in time or over time requires judgement. No customer acquisition costs have been capitalised up to the reporting date. The financial statements were authorised for issue, in accordance with a resolution of directors, on 25 February 2019. Type of service 2. Significant accounting policies The principal accounting policies adopted in the preparation of the financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated. New or amended Accounting Standards and Interpretations adopted The Group has adopted all of the new or amended Accounting Standards and Interpretations issued by the Australian Accounting Standards Board (‘AASB’) that are mandatory for the current reporting period. The adoption of these Accounting Standards and Interpretations did not have any significant impact on the financial performance or position of the Group. The principal accounting policies adopted are consistent with those of the previous financial year and corresponding interim reporting period, except for the policies stated below. Initial adoption of AASB 15 ‘Revenue from contracts with customers’ The Group has adopted AASB 15 from 1 January 2018 and has elected to use the full retrospective transition method and applies the practical expedient on the completed contracts, and will record any transition adjustments only for contracts not considered complete at the beginning of the earliest period presented. Under AASB 15, revenue is recognised to depict the transfer of promised goods or services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those annotated and/ or collected data as per customer requirement. The standard Content Relevance Content Relevance provides annotated data used in search technology (embedded in web, e-commerce and social engagement) for improving relevance and accuracy of search engines, social media applications and e-commerce. Language Resources Language Resources provides annotated speech, natural language and image data used in speech recognisers, machine translation, speech synthesisers and other machine-learning technologies resulting in more engaging and fluent devices including internet-connected devices, in-car automotive systems and speech-enabled consumer electronics. Timing of satisfaction of performance obligations and significant payment terms The Group has determined that for both Content Relevance and Language Resources services, the customer obtains control of the data as the services are being performed. This is because under those contracts, the services are provided to a customer’s specification and if a contract is terminated by a customer, then the Group is entitled to the payment for services performed to date, calculated via cost or cost plus method as agreed with customer. Therefore, revenue from these contracts and the associated costs are recognised over time i.e. before the date of delivery to the customer. Under AASB 15, the total consideration in the contract is allocated to each service based on the stand alone selling prices. Invoices are issued according to contractual terms and are payable with varying payment terms. Uninvoiced amounts are presented as contract assets. Amounts invoiced in advance of the service are presented as contract liabilities. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 33 2. Significant accounting policies (continued) Nature of change in accounting policy AASB 15 did not have a significant impact on the Group’s accounting policy. In 2017, under AASB 118, uninvoiced amounts were presented as work in progress. Under AASB 15, as control passes to the customer over time, uninvoiced amounts are presented as contract assets. On transition to AASB 15, other liabilities were reclassified as contract liabilities. There was no impact of transition to AASB 15 on the opening balance of retained earnings. Initial adoption of AASB 9 ‘Financial Instruments’ The Group has adopted AASB 9 from 1 January 2018. There was no impact of transition to AASB 9 on the opening balance of retained earnings. The details of new significant accounting policies are set out below. AASB 9 sets out the requirements to recognise and measure financial assets and financial liabilities. This standard replaces AASB 139 ‘Financial Instruments: Recognition and Measurement’. With the exception of hedge accounting, which the Group applied prospectively, the Group has applied AASB 9 retrospectively, with the initial application date of 1 January 2018 and adjusting the comparative information for the period beginning 1 January 2017. held within a business model whose objective is to hold assets in order to collect contractual cash flows; (ii) the contractual terms of the financial asset represent contractual cash flows that are solely payments of principal and interest, and (iii) is not designated as at FVTPL. All financial assets not measured at amortised cost as described above are measured at FVTPL. This includes all derivative assets. On initial recognition, the Group may irrevocably designate a financial asset that otherwise meets the requirements to be measured at amortised cost as at FVTPL if doing so eliminates or significantly reduces an accounting misstatement that would otherwise arise. The following accounting policies apply to the subsequent measurement of financial assets: Financial assets at FVTPL These assets are subsequently measured at fair value. Net gains or losses, including interest or dividend income are recognised in profit or loss. Financial assets at amortised cost These assets are subsequently measured at amortised cost using the effective interest method. The amortised cost is reduced by impairment losses (see impairment of financial assets). Financial assets Under AASB 9, on initial recognition, a financial asset is classified at amortised cost or fair value through profit or loss (‘FVTPL’). The classification under AASB 9 is based on the Group’s business model for managing the financial assets and the contractual cash flow characteristics of the financial assets. A financial asset is measured at amortised cost only if: (i) it is Interest income, foreign exchange gains and losses and impairment are recognised in profit or loss. Any gain or loss on derecognition is recognised in profit or loss. The following table and accompanying notes below explain the original measurement categories under AASB 139 and the new measurement categories under AASB 9 for each class of the Group’s financial assets as at 1 January 2018. Financial assets Original classification New classification Change in carrying amount Trade and other receivables Loans and receivables Amortised cost Cash and cash equivalents Loans and receivables Amortised cost There was no impact on the carrying amount from the transition to AASB 9 Forward foreign exchange contract (derivative financial instruments) Held-for-trading FVTPL Appen Limited 2018 Annual Report 34 Notes to the Consolidated Financial Statements continued 2. Significant accounting policies (continued) Impairment of financial assets The AASB 9 impairment model is based on an expected credit loss (‘ECL’) methodology instead of the incurred loss methodology of AASB 139. Impairment of receivables The adoption of AASB 9 has changed the Group’s accounting for impairment loss for trade and other receivables by replacing AASB 139’s incurred loss approach with a forward- looking expected credit loss (‘ECL’) approach. AASB 9 required the Group to record an allowance for ECLs for trade and other receivables not held at fair value through profit or loss (‘FVPL’). For trade and other receivables, the Group has applied the standard’s simplified approach and has calculated ECLs based on lifetime expected credit losses. The Group has established a provision matrix that is based on the Group historical credit loss experience over the past five years, adjusted for forward- looking factors specific to the debtors and the economic environment. The Group has determined that the application of AASB 9’s impairment requirement at 1 January 2018 did not result in any change to the impairment allowance. Basis of preparation Statement of compliance These general purpose financial statements have been prepared in accordance with Australian Accounting Standards and Interpretations issued by the Australian Accounting Standards Board (‘AASB’) and the Corporations Act 2001, as appropriate for for-profit oriented entities. These financial statements also comply with International Financial Reporting Standards as issued by the International Accounting Standards Board (‘IASB’). Historical cost convention The financial statements have been prepared under the historical cost convention, except for, where applicable, the revaluation of financial assets at fair value through profit or loss, financial assets at fair value through other comprehensive income, investment properties, certain classes of property, plant and equipment, derivative financial instruments and share-based payments, which are measured at fair value. Critical accounting estimates The preparation of the financial statements requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Group’s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the financial statements, are disclosed in Note 3. Parent entity information In accordance with the Corporations Act 2001, these financial statements present the results of the Group only. Supplementary information about the parent entity is disclosed in Note 32. Principles of consolidation The consolidated financial statements incorporate the assets and liabilities of all subsidiaries of Appen Limited (‘Company’ or ‘parent entity’) as at 31 December 2018 and the results of all subsidiaries for the year then ended. Appen Limited and its subsidiaries together are referred to in these financial statements as the ‘Group’. Subsidiaries are all those entities over which the Group has control. The Group controls an entity when the Group is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power to direct the activities of the entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are de-consolidated from the date that control ceases. Intercompany transactions, balances and unrealised gains on transactions between entities in the Group are eliminated. Unrealised losses are also eliminated unless the transaction provides evidence of the impairment of the asset transferred. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Group. The acquisition of subsidiaries is accounted for using the acquisition method of accounting. A change in ownership interest, without the loss of control, is accounted for as an equity transaction, where the difference between the consideration transferred and the book value of the share of the non-controlling interest acquired is recognised directly in equity attributable to the parent. Where the Group loses control over a subsidiary, it derecognises the assets including goodwill, liabilities and non-controlling interest in the subsidiary together with any cumulative translation differences recognised in equity. The Group recognises the fair value of the consideration received and the fair value of any investment retained together with any gain or loss in profit or loss. Operating segments Segment results that are reported to the Group’s CEO (the Chief Operating Decision Maker (‘CODM’)) includes items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Unallocated items comprise mainly corporate assets, head office expenses and income tax assets and liabilities. Foreign currency translation The financial statements are presented in Australian dollars, which is Appen Limited’s functional and presentation currency. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 35 2. Significant accounting policies (continued) Foreign currency transactions Foreign currency transactions are translated into Australian dollars using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at financial year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in profit or loss. Foreign operations The assets and liabilities of foreign operations are translated into Australian dollars using the exchange rates at the reporting date. The revenues and expenses of foreign operations are translated into Australian dollars using the average exchange rates, which approximate the rates at the dates of the transactions, for the period. All resulting foreign exchange differences are recognised in other comprehensive income through the foreign currency reserve in equity. Revenue recognition The Group recognises revenue as follows: Revenue from contracts with customers Revenue is recognised at an amount that reflects the consideration to which the Group is expected to be entitled in exchange for transferring annotated and/or collected data as per customer requirement. For each contract with a customer, the Group: identifies the contract with a customer; identifies the performance obligations in the contract; determines the transaction price which takes into account estimates of variable consideration and the time value of money; allocates the transaction price to the separate performance obligations on the basis of the relative stand-alone selling price of each distinct good or service to be delivered; and recognises revenue when or as each performance obligation is satisfied in a manner that depicts the transfer to the customer of the data required. Variable consideration within the transaction price, if any, reflects concessions provided to the customer such as discounts, rebates and refunds, any potential bonuses receivable from the customer and any other contingent events. Such estimates are determined using either the ‘expected value’ or ‘most likely amount’ method. The measurement of variable consideration is subject to a constraining principle whereby revenue will only be recognised to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur. The measurement constraint continues until the uncertainty associated with the variable consideration is subsequently resolved. Amounts received that are subject to the constraining principle are initially recognised as deferred revenue in the form of a separate refund liability. Services Revenue from services represents the sale of contract service or licence products and database. Revenue is recognised in profit or loss progressively as the annotated and/or collected data is completed and validated or approved by the customers. Stage of completion of transactions involving the rendering of services is determined by reference to the services performed to date as a percentage of total services to be performed on cost to cost basis. No revenue is recognised if there are either significant uncertainties regarding recovery of the consideration due, the costs incurred or to be incurred cannot be measured reliably, there is a risk of disputes on service quality, or there is continuing management involvement with the products. Interest Interest revenue is recognised as interest accrues using the effective interest method. This is a method of calculating the amortised cost of a financial asset and allocating the interest income over the relevant period using the effective interest rate, which is the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset to the net carrying amount of the financial asset. Other revenue Other revenue is recognised when it is received or when the right to receive payment is established. Income tax The income tax expense or benefit for the period is the tax payable on that period’s taxable income based on the applicable income tax rate for each jurisdiction, adjusted by the changes in deferred tax assets and liabilities attributable to temporary differences, unused tax losses and the adjustment recognised for prior periods, where applicable. Deferred tax assets and liabilities are recognised for temporary differences at the tax rates expected to be applied when the assets are recovered or liabilities are settled, based on those tax rates that are enacted or substantively enacted, except for: – When the deferred income tax asset or liability arises from the initial recognition of goodwill or an asset or liability in a transaction that is not a business combination and that, at the time of the transaction, affects neither the accounting nor taxable profits; or – When the taxable temporary difference is associated with interests in subsidiaries, associates or joint ventures, and the timing of the reversal can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred tax assets are recognised for deductible temporary differences and unused tax losses only if it is probable that future taxable amounts will be available to utilise those temporary differences and losses. Appen Limited 2018 Annual Report 36 Notes to the Consolidated Financial Statements continued 2. Significant accounting policies (continued) The carrying amount of recognised and unrecognised deferred tax assets are reviewed at each reporting date. Deferred tax assets recognised are reduced to the extent that it is no longer probable that future taxable profits will be available for the carrying amount to be recovered. Previously unrecognised deferred tax assets are recognised to the extent that it is probable that there are future taxable profits available to recover the asset. Deferred tax assets and liabilities are offset only where there is a legally enforceable right to offset current tax assets against current tax liabilities and deferred tax assets against deferred tax liabilities; and they relate to the same taxable authority on either the same taxable entity or different taxable entities which intend to settle simultaneously. Appen Limited (the ‘head entity’) and its wholly-owned Australian subsidiaries have formed an income tax consolidated group under the tax consolidation regime. The head entity and each subsidiary in the tax consolidated group continue to account for their own current and deferred tax amounts. The tax consolidated group has applied the ‘separate taxpayer within group’ approach in determining the appropriate amount of taxes to allocate to members of the tax consolidated group. A liability is classified as current when: it is either expected to be settled in the Group’s normal operating cycle; it is held primarily for the purpose of trading; it is due to be settled within 12 months after the reporting period; or there is no unconditional right to defer the settlement of the liability for at least 12 months after the reporting period. All other liabilities are classified as non-current. Cash and cash equivalents Cash and cash equivalents includes cash on hand, deposits held at call with financial institutions, other short-term, highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Trade and other receivables Trade receivables are initially recognised at fair value and subsequently measured at amortised cost using the effective interest method, less any allowance for expected credit losses. Trade receivables are generally due for settlement within 30 days. The Group has applied the simplified approach to measuring expected credit losses, which uses a lifetime expected loss allowance. To measure the expected credit losses, trade receivables have been grouped based on days overdue. In addition to its own current and deferred tax amounts, the head entity also recognises the current tax liabilities (or assets) and the deferred tax assets arising from unused tax losses and unused tax credits assumed from each subsidiary in the tax consolidated group. Contract assets, for the year 2017, includes those projects fully completed or significantly completed by year-end, but invoices have been issued after year-end, due to the milestones for invoicing yet to be reached, or customers’ approval procedure being delayed. Assets or liabilities arising under tax funding agreements with the tax consolidated entities are recognised as amounts receivable from or payable to other entities in the tax consolidated group. The tax funding arrangement ensures that the intercompany charge equals the current tax liability or benefit of each tax consolidated group member, resulting in neither a contribution by the head entity to the subsidiaries nor a distribution by the subsidiaries to the head entity. Current and non-current classification Assets and liabilities are presented in the statement of financial position based on current and non-current classification. An asset is classified as current when: it is either expected to be realised or intended to be sold or consumed in the Group’s normal operating cycle; it is held primarily for the purpose of trading; it is expected to be realised within 12 months after the reporting period; or the asset is cash or cash equivalent unless restricted from being exchanged or used to settle a liability for at least 12 months after the reporting period. All other assets are classified as non-current. Other receivables are recognised at amortised cost, less any provision for impairment. Contract assets Contract assets are recognised when the Group has transferred goods or services to the customer but where the Group is yet to establish an unconditional right to consideration. Contract assets are treated as financial assets for impairment purposes. Derivative financial instruments Derivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently remeasured to their fair value at each reporting date. The accounting for subsequent changes in fair value depends on whether the derivative is designated as a hedging instrument, and if so, the nature of the item being hedged. Derivatives are classified as current or non-current depending on the expected period of realisation. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 37 2. Significant accounting policies (continued) Cash flow hedges Cash flow hedges are used to cover the Group’s exposure to variability in cash flows that is attributable to particular risks associated with a recognised asset or liability or a firm commitment which could affect profit or loss. Under AASB 139, all gain and loss arising from the Group’s cash flow hedging relationships were eligible to be subsequently reclassified to profit or loss. However, under AASB 9, gains and losses arising on cash flow hedges of forecast purchases of non-financial assets need to be incorporated into initial carrying amounts of the non-financial assets. Therefore, upon adoption of AASB 9, the gain or loss on cash flow hedge is recognised in other comprehensive income, whilst the ineffective portion is recognised in profit or loss. Amounts taken to equity are transferred out of equity and included in the measurement of the hedged transaction when the forecast transaction occurs. Cash flow hedges are tested for effectiveness on a regular basis both retrospectively and prospectively to ensure that each hedge is highly effective and continues to be designated as a cash flow hedge. If the forecast transaction is no longer expected to occur, the amounts recognised in equity are transferred to profit or loss. If the hedging instrument is sold, terminated, expires, exercised without replacement or rollover, or if the hedge becomes ineffective and is no longer a designated hedge, the amounts previously recognised in equity remain in equity until the forecast transaction occurs. Property, plant and equipment Plant and equipment is stated at historical cost less accumulated depreciation and impairment. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Depreciation is calculated on a straight-line basis to write off the net cost of each item of property, plant and equipment (excluding land) over their expected useful lives as follows: Leasehold improvements Over the lease term Fixtures and fittings 3 - 13 years Computer equipment Audio equipment 1 - 4 years 1 - 4 years Make good Over the lease term The residual values, useful lives and depreciation methods are reviewed, and adjusted if appropriate, at each reporting date. Leasehold improvements and plant and equipment under lease are depreciated over the unexpired period of the lease or the estimated useful life of the assets, whichever is shorter. An item of property, plant and equipment is derecognised upon disposal or when there is no future economic benefit to the Group. Gains and losses between the carrying amount and the disposal proceeds are taken to profit or loss. Any revaluation surplus reserve relating to the item disposed of is transferred directly to retained profits. Leases The determination of whether an arrangement is or contains a lease is based on the substance of the arrangement and requires an assessment of whether the fulfilment of the arrangement is dependent on the use of a specific asset or assets and the arrangement conveys a right to use the asset. A distinction is made between finance leases, which effectively transfer from the lessor to the lessee substantially all the risks and benefits incidental to the ownership of leased assets, and operating leases, under which the lessor effectively retains substantially all such risks and benefits. Finance leases are capitalised. A lease asset and liability are established at the fair value of the leased assets, or if lower, the present value of minimum lease payments. Lease payments are allocated between the principal component of the lease liability and the finance costs, so as to achieve a constant rate of interest on the remaining balance of the liability. Leased assets acquired under a finance lease are depreciated over the asset’s useful life or over the shorter of the asset’s useful life and the lease term if there is no reasonable certainty that the Group will obtain ownership at the end of the lease term. Operating lease payments, net of any incentives received from the lessor, are charged to profit or loss on a straight-line basis over the term of the lease. Intangible assets Intangible assets acquired as part of a business combination, other than goodwill, are initially measured at their fair value at the date of the acquisition. Intangible assets acquired separately are initially recognised at cost. Indefinite life intangible assets are not amortised and are subsequently measured at cost less any impairment. Finite life intangible assets are subsequently measured at cost less amortisation and any impairment. The gains or losses recognised in profit or loss arising from the derecognition of intangible assets are measured as the difference between net disposal proceeds and the carrying amount of the intangible asset. The method of amortisation and useful lives of finite life intangible assets are reviewed annually. Changes in the expected pattern of consumption or useful life are accounted for prospectively by changing the amortisation method or period. Appen Limited 2018 Annual Report 38 Notes to the Consolidated Financial Statements continued 2. Significant accounting policies (continued) Goodwill Goodwill arises on the acquisition of a business. Goodwill is not amortised. Instead, goodwill is tested annually for impairment, or more frequently if events or changes in circumstances indicate that it might be impaired and it is carried at cost less accumulated impairment losses. Impairment losses on goodwill are taken to profit or loss and are not subsequently reversed. Systems implementation Significant costs associated with systems implementation are deferred and amortised on a straight-line basis over the period of their expected benefit, being their finite life of 7 years. Platform development Platform development costs are capitalised at the direct costs incurred and amortised on a straight-line basis over the period of their expected benefit being their finite life from 3 to 7 years. Amortisation starts at the time that the technology is activated and is used by both internal and external customers. The capitalised costs of platform technology include the direct costs of internal staff and any supporting software acquired from a third party. Leapforce platform development costs acquired are capitalised and amortised on a straight-line base over the period of their expected benefit, being their finite life of 7 years. Customer relationships Customer relationships acquired in a business combination are amortised on a straight-line basis over the period of their expected benefit, being their finite life of 7 years. Crowd database Crowd database products are capitalised at the direct costs incurred. The capitalised costs of database products include direct costs of internal staff, services purchased from overseas’ field partners, and supporting software acquired from a third- party supplier. Crowd database costs are amortised on a straight-line basis over the period of their expected benefit, being their finite life of up to one year. Customer contracts Customer contracts acquired in a business combination are amortised on a straight-line basis over the period of their expected benefit, being their finite life of 5 years. Other intangibles Costs in relation to other intangibles are capitalised as an asset and amortised on a straight-line basis over the period of their expected benefit being 3 to 5 years. Impairment of non-financial assets Goodwill and other intangible assets that have an indefinite useful life are not subject to amortisation and are tested annually for impairment, or more frequently if events or changes in circumstances indicate that they might be impaired. Other non-financial assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset’s carrying amount exceeds its recoverable amount. Recoverable amount is the higher of an asset’s fair value less costs of disposal and value-in-use. The value-in-use is the present value of the estimated future cash flows relating to the asset using a pre-tax discount rate specific to the asset or cash-generating unit to which the asset belongs. Assets that do not have independent cash flows are grouped together to form a cash-generating unit. Trade and other payables These amounts represent liabilities for goods and services provided to the Group prior to the end of the financial year and which are unpaid. Due to their short-term nature they are measured at amortised cost and are not discounted. The amounts are unsecured and are usually paid within 30 days of recognition. Contract liabilities Contract liabilities represent the Group’s obligation to transfer goods or services to a customer and are recognised when a customer pays consideration, or when the Group recognises a receivable to reflect its unconditional right to consideration (whichever is earlier) before the Group has transferred the goods or services to the customer. Refund liabilities Refund liabilities are recognised where the Group receives consideration from a customer and expects to refund some, or all, of that consideration to the customer. A refund liability is measured at the amount of consideration received or receivable for which the Group does not expect to be entitled and is updated at the end of each reporting period for changes in circumstances. Historical data is used across product lines to estimate such returns at the time of sale based on an expected value methodology. Borrowings Loans and borrowings are initially recognised at the fair value of the consideration received, net of transaction costs. They are subsequently measured at amortised cost using the effective interest method. Where there is an unconditional right to defer settlement of the liability for at least 12 months after the reporting date, the loans or borrowings are classified as non-current. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 39 2. Significant accounting policies (continued) Finance costs Finance costs attributable to qualifying assets are capitalised as part of the asset. All other finance costs are expensed in the period in which they are incurred. Provisions Provisions are recognised when the Group has a present (legal or constructive) obligation as a result of a past event, it is probable the Group will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. The amount recognised as a provision is the best estimate of the consideration required to settle the present obligation at the reporting date, taking into account the risks and uncertainties surrounding the obligation. If the time value of money is material, provisions are discounted using a current pre-tax rate specific to the liability. The increase in the provision resulting from the passage of time is recognised as a finance cost. Employee benefits Short-term employee benefits Liabilities for wages and salaries, including non-monetary benefits, annual leave and long service leave expected to be settled wholly within 12 months of the reporting date are measured at the amounts expected to be paid when the liabilities are settled. Other long-term employee benefits The liability for annual leave and long service leave not expected to be settled within 12 months of the reporting date are measured at the present value of expected future payments to be made in respect of services provided by employees up to the reporting date using the projected unit credit method. Consideration is given to expected future wage and salary levels, experience of employee departures and periods of service. Expected future payments are discounted using market yields at the reporting date on high-quality corporate bonds with terms to maturity and currency that match, as closely as possible, the estimated future cash outflows. Share-based payments Equity-settled share-based compensation benefits are provided to employees. Equity-settled transactions are awards of shares, or options over shares, that are provided to employees in exchange for services. The cost of equity-settled transactions is measured at fair value on grant date. Fair value is independently determined using the Binomial option pricing model that takes into account the exercise price, the term of the option, the impact of dilution, the share price at grant date and expected price volatility of the underlying share, the expected dividend yield and the risk free interest rate for the term of the option, together with non-vesting conditions that do not determine whether the Group receives the services that entitle the employees to receive payment. No account is taken of any other vesting conditions. The cost of equity-settled transactions is recognised as an expense with a corresponding increase in equity over the vesting period. The cumulative charge to profit or loss is calculated based on the grant date fair value of the award, the best estimate of the number of awards that are likely to vest and the expired portion of the vesting period. The amount recognised in profit or loss for the period is the cumulative amount calculated at each reporting date less amounts already recognised in previous periods. All changes in the liability of the employee benefits are recognised in profit or loss. The ultimate cost of cash-settled transactions is the cash paid to settle the liability. Market conditions are taken into consideration in determining fair value. Therefore, any awards subject to market conditions are considered to vest irrespective of whether or not that market condition has been met, provided all other conditions are satisfied. If equity-settled awards are modified, as a minimum an expense is recognised as if the modification has not been made. An additional expense is recognised, over the remaining vesting period, for any modification that increases the total fair value of the share-based compensation benefit as at the date of modification. If the non-vesting condition is within the control of the Group or employee, the failure to satisfy the condition is treated as a cancellation. If the condition is not within the control of the Group or employee and is not satisfied during the vesting period, any remaining expense for the award is recognised over the remaining vesting period, unless the award is forfeited. If equity-settled awards are cancelled, it is treated as if it has vested on the date of cancellation, and any remaining expense is recognised immediately. If a new replacement award is substituted for the cancelled award, the cancelled and new award is treated as if they were a modification. Fair value measurement When an asset or liability, financial or non-financial, is measured at fair value for recognition or disclosure purposes, the fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date; and assumes that the transaction will take place either: in the principal market; or in the absence of a principal market, in the most advantageous market. Appen Limited 2018 Annual Report 40 Notes to the Consolidated Financial Statements continued 2. Significant accounting policies (continued) Fair value is measured using the assumptions that market participants would use when pricing the asset or liability, assuming they act in their economic best interests. For non-financial assets, the fair value measurement is based on its highest and best use. Valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, are used, maximising the use of relevant observable inputs and minimising the use of unobservable inputs. Assets and liabilities measured at fair value are classified into three levels, using a fair value hierarchy that reflects the significance of the inputs used in making the measurements. Classifications are reviewed at each reporting date and transfers between levels are determined based on a reassessment of the lowest level of input that is significant to the fair value measurement. For recurring and non-recurring fair value measurements, external valuers may be used when internal expertise is either not available or when the valuation is deemed to be significant. External valuers are selected based on market knowledge and reputation. Where there is a significant change in fair value of an asset or liability from one period to another, an analysis is undertaken, which includes a verification of the major inputs applied in the latest valuation and a comparison, where applicable, with external sources of data. Issued capital Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds. Dividends Dividends are recognised when declared during the financial year and no longer at the discretion of the Company. Business combinations The acquisition method of accounting is used to account for business combinations regardless of whether equity instruments or other assets are acquired. The consideration transferred is the sum of the acquisition- date fair values of the assets transferred, equity instruments issued or liabilities incurred by the acquirer to former owners of the acquiree and the amount of any non-controlling interest in the acquiree. All acquisition costs are expensed as incurred to profit or loss. On the acquisition of a business, the Group assesses the financial assets acquired and liabilities assumed for appropriate classification and designation in accordance with the contractual terms, economic conditions, the Group’s operating or accounting policies and other pertinent conditions in existence at the acquisition-date. Contingent consideration to be transferred by the acquirer is recognised at the acquisition-date fair value. Subsequent changes in the fair value of the contingent consideration classified as an asset or liability is recognised in profit or loss. Contingent consideration classified as equity is not remeasured and its subsequent settlement is accounted for within equity. The difference between the acquisition-date fair value of assets acquired, liabilities assumed and any non-controlling interest in the acquiree and the fair value of the consideration transferred and the fair value of any pre-existing investment in the acquiree is recognised as goodwill. Business combinations are initially accounted for on a provisional basis. The acquirer retrospectively adjusts the provisional amounts recognised and also recognises additional assets or liabilities during the measurement period, based on new information obtained about the facts and circumstances that existed at the acquisition-date. The measurement period ends on either the earlier of (i) 12 months from the date of the acquisition or (ii) when the acquirer receives all the information possible to determine fair value. Earnings per share Basic earnings per share Basic earnings per share is calculated by dividing the profit attributable to the owners of Appen Limited, excluding any costs of servicing equity other than ordinary shares, by the weighted average number of ordinary shares outstanding during the financial year, adjusted for bonus elements in ordinary shares issued during the financial year. Diluted earnings per share Diluted earnings per share adjusts the figures used in the determination of basic earnings per share to take into account the after income tax effect of interest and other financing costs associated with dilutive potential ordinary shares and the weighted average number of shares assumed to have been issued for no consideration in relation to dilutive potential ordinary shares. Goods and Services Tax (‘GST’) and other similar taxes Revenues, expenses and assets are recognised net of the amount of associated GST, unless the GST incurred is not recoverable from the tax authority. In this case it is recognised as part of the cost of the acquisition of the asset or as part of the expense. Receivables and payables are stated inclusive of the amount of GST receivable or payable. The net amount of GST recoverable from, or payable to, the tax authority is included in other receivables or other payables in the statement of financial position. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 41 2. Significant accounting policies (continued) Cash flows are presented on a gross basis. The GST components of cash flows arising from investing or financing activities which are recoverable from, or payable to the tax authority, are presented as operating cash flows. Commitments and contingencies are disclosed net of the amount of GST recoverable from, or payable to, the tax authority. impact of the new accounting standard. Based on the work performed to date, the management team expects the new accounting standard to have the following impact: – increase in total assets of $9,490,000 – increase in total liabilities of $9,929,000 – increase in earnings before interest, tax, depreciation and amortisation of $1,508,000. Rounding of amounts The Company is of a kind referred to in ASIC Corporations (Rounding in Financial/Directors Reports) Instrument 2016/191, issued by the Australian Securities and Investments Commission, relating to ‘rounding-off’. Amounts in this report have been rounded off in accordance with that Corporations Instrument to the nearest thousand dollars, or in certain cases, the nearest dollar. New Accounting Standards and Interpretations not yet mandatory or early adopted Australian Accounting Standards and Interpretations that have recently been issued or amended but are not yet mandatory, have not been early adopted by the Group for the annual reporting period ended 31 December 2018. The Group’s assessment of the impact of these new or amended Accounting Standards and Interpretations, most relevant to the Group, are set out below. AASB 16 Leases This standard is applicable to annual reporting periods beginning on or after 1 January 2019. For lessee accounting, the standard eliminates the ‘operating lease’ and ‘finance lease’ classification required by AASB 117 ‘Leases’. Subject to exceptions, a ‘right-of-use’ asset will be capitalised in the statement of financial position, representing its rights to use the underlying assets. The exceptions relate to short-term leases of 12 months or less and leases of low-value assets (such as personal computers and office furniture) where an accounting policy choice exists whereby either a ‘right-of- use’ asset is recognised or lease payments are expensed to profit or loss as incurred. A liability corresponding to the capitalised lease will also be recognised, adjusted for lease prepayments, lease incentives received, initial direct costs incurred and an estimate of any future restoration, removal or dismantling costs. Straight-line operating lease expense recognition will be replaced with a depreciation charge for the leased asset (included in operating costs) and an interest expense on the recognised lease liability (included in finance costs). For classification within the statement of cash flows, the lease payments will be separated into both a principal (financing activities) and interest (either operating or financing activities) components. For lessor accounting, the standard does not substantially change how a lessor accounts for leases. The Group will adopt this standard from 1 January 2019. Management has commenced a project to understand the 3. Critical accounting judgements, estimates and assumptions The preparation of the financial statements requires management to make judgements, estimates and assumptions that affect the reported amounts in the financial statements. Management continually evaluates its judgements and estimates in relation to assets, liabilities, contingent liabilities, revenue and expenses. Management bases its judgements, estimates and assumptions on historical experience and on other various factors, including expectations of future events, management believes to be reasonable under the circumstances. The resulting accounting judgements and estimates will seldom equal the related actual results. The judgements, estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities (refer to the respective notes) within the next financial year are discussed below. Share-based payment transactions The Group measures the cost of equity-settled transactions with employees by reference to the fair value of the equity instruments at the date at which they are granted. The fair value of options is determined by using the Binomial model taking into account the terms and conditions upon which the instruments were granted. Performance rights are valued on a discounted dividend stream method. The accounting estimates and assumptions relating to equity-settled share-based payments would have no impact on the carrying amounts of assets and liabilities within the next annual reporting period but may impact profit or loss and equity. Determination of variable consideration Judgement is exercised in estimating variable consideration which is determined having regard to past experience with respect to the goods returned to the Group where the customer maintains a right of return pursuant to the customer contract or where goods or services have a variable component. Revenue will only be recognised to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised under the contract will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Appen Limited 2018 Annual Report 42 Notes to the Consolidated Financial Statements continued 3. Critical accounting judgements, estimates and assumptions (continued) Allowance for expected credit losses The allowance for expected credit losses assessment requires a degree of estimation and judgement. It is based on the lifetime expected credit loss, grouped based on days overdue, and makes assumptions to allocate an overall expected credit loss rate for each group. These assumptions include recent sales experience and historical collection rates. Impairment of non-financial assets other than goodwill and other indefinite life intangible assets The Group assesses impairment of non-financial assets other than goodwill and other indefinite life intangible assets at each reporting date by evaluating conditions specific to the Group and to the particular asset that may lead to impairment. If an impairment trigger exists, the recoverable amount of the asset is determined. This involves fair value less costs of disposal or value-in-use calculations, which incorporate a number of key estimates and assumptions. Fair value measurement hierarchy The Group is required to classify all assets and liabilities, measured at fair value, using a three level hierarchy, based on the lowest level of input that is significant to the entire fair value measurement, being: Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date; Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and Level 3: Unobservable inputs for the asset or liability. Considerable judgement is required to determine what is significant to fair value and therefore which category the asset or liability is placed in can be subjective. The fair value of assets and liabilities classified as level 3 is determined by the use of valuation models. These include discounted cash flow analysis or the use of observable inputs that require significant adjustments based on unobservable inputs. Goodwill and other indefinite life intangible assets The Group tests annually, or more frequently if events or changes in circumstances indicate impairment, whether goodwill and other indefinite life intangible assets have suffered any impairment, in accordance with the accounting policy stated in Note 2. The recoverable amounts of cash- generating units have been determined based on value- in-use calculations. These calculations require the use of assumptions, including estimated discount rates based on the current cost of capital and growth rates of the estimated future cash flows. Estimation of useful lives of assets The Group determines the estimated useful lives and related depreciation and amortisation charges for its property, plant and equipment and finite life intangible assets. The useful lives could change significantly as a result of technical innovations or some other event. The depreciation and amortisation charge will increase where the useful lives are less than previously estimated lives, or technically obsolete or non- strategic assets that have been abandoned or sold will be written off or written down. Income tax The Group is subject to income taxes in the jurisdictions in which it operates. Significant judgement is required in determining the provision for income tax. There are many transactions and calculations undertaken during the ordinary course of business for which the ultimate tax determination is uncertain. The Group recognises liabilities for anticipated tax audit issues based on the Group’s current understanding of the tax law. Where the final tax outcome of these matters is different from the carrying amounts, such differences will impact the current and deferred tax provisions in the period in which such determination is made. Recovery of deferred tax assets Deferred tax assets are recognised for deductible temporary differences only if the Group considers it is probable that future taxable amounts will be available to utilise those temporary differences and losses. Business combinations As discussed in Note 2, business combinations are initially accounted for on a provisional basis. The fair value of assets acquired, liabilities and contingent liabilities assumed are initially estimated by the Group taking into consideration all available information at the reporting date. Fair value adjustments on the finalisation of the business combination accounting is retrospective, where applicable, to the period the combination occurred and may have an impact on the assets and liabilities, depreciation and amortisation reported. 4. Restatement of comparatives - adoption of AASB 9 ‘Financial Instruments’ and AASB 15 ‘Revenue from Contracts with Customers’ Adoption of AASB 9 ‘Financial Instruments’ The Group has adopted AASB 9 from 1 January 2018, using the full retrospective approach of adoption (with the exemption of hedge accounting) and comparatives have been restated. The investment classifications ‘Available-for-sale financial assets’ and ‘Held-to-maturity investments’ are no longer used and ‘Financial assets at fair value through other comprehensive income’ was introduced. There were no investments held in these categories as at 31 December 2017. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 43 4. Restatement of comparatives - adoption of AASB 9 ‘Financial Instruments’ and AASB 15 ‘Revenue from Contracts with Customers’ (continued) ‘Interest revenue’ is no longer included in the ‘Revenue’ note and is now shown separately on the face of the statement of profit or loss and other comprehensive income, resulting in a reclassification of $10,000 for the year ended 31 December 2017. The consolidated entity has applied the simplified approach to measuring expected credit losses, resulting in an additional impairment expense of $nil (and a total impairment expense of $75,000) for the year ended 31 December 2017 and an additional allowance for expected credit losses of $nil and an additional deferred tax asset of $nil as at 31 December 2017. Adoption of AASB 15 ‘Revenue from Contracts with Customers’ The consolidated entity has adopted AASB 15 from 1 January 2018, using the full retrospective transition method showing no impact on the statement of profit or loss and other comprehensive income for the year ended 31 December 2017 and resulting in the restatement of comparatives for the statement of financial position as at 31 December 2017. The impact on the statement of profit or loss and other comprehensive income and statement of financial position is as follows: Statement of profit or loss and other comprehensive income Revenue Interest income calculated using the effective interest method Net foreign exchange gain Expenses Services purchased - data collection Employee benefits expense Share-based payments expense Depreciation and amortisation expense Travel expense Professional fees Rental expense Communication expense Transaction costs Other expenses Finance costs Profit before income tax expense Income tax expense Profit after income tax expense for the year attributable to the owners of Appen Limited Other comprehensive loss Foreign currency translation Other comprehensive loss for the year, net of tax Total comprehensive income for the year attributable to the owners of Appen Limited Basic earnings per share Diluted earnings per share 31 Dec 2017 $’000 Reported 166,571 – 969 Group $’000 Adjustment (10) 10 – 31 Dec 2017 $’000 Restated 166,561 10 969 (99,816) (29,117) (410) (1,863) (1,064) (1,920) (894) (337) (5,877) (5,854) (13) 20,375 (6,093) 14,282 (882) (882) 13,400 – – – – – – – – – – – – – – – – – (99,816) (29,117) (410) (1,863) (1,064) (1,920) (894) (337) (5,877) (5,854) (13) 20,375 (6,093) 14,282 (882) (882) 13,400 Cents Reported Cents Adjustment Cents Restated 14.55 14.36 – – 14.55 14.36 Appen Limited 2018 Annual Report 44 Notes to the Consolidated Financial Statements continued 4. Restatement of comparatives - adoption of AASB 9 ‘Financial Instruments’ and AASB 15 ‘Revenue from Contracts with Customers’ (continued) Statement of financial position at the beginning of the earliest comparative period Assets Current assets Cash and cash equivalents Trade and other receivables Contract assets Prepayments Total current assets Non-current assets Property, plant and equipment Intangibles Other non-current assets Total non-current assets Total assets Liabilities Current liabilities Trade and other payables Contract liabilities Derivative financial instruments Income tax Provisions Revenue received in advance Total current liabilities Non-current liabilities Borrowings Deferred tax Provisions Total non-current liabilities Total liabilities Net assets Equity Issued capital Reserves Accumulated losses Total equity 1 Jan 2017 $’000 Reported Group $’000 Adjustment 1 Jan 2017 $’000 Restated 16,471 21,861 – 415 38,747 725 14,543 12 15,280 54,027 12,177 – 199 1,447 884 716 15,423 6 2,778 417 3,201 18,624 35,403 19,510 19,763 (3,870) 35,403 – (7,184) 7,184 – – – – – – – – 716 – – – (716) – – – – – – – – – – – 16,471 14,677 7,184 415 38,747 725 14,543 12 15,280 54,027 12,177 716 199 1,447 884 – 15,423 6 2,778 417 3,201 18,624 35,403 19,510 19,763 (3,870) 35,403 Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 45 4. Restatement of comparatives - adoption of AASB 9 ‘Financial Instruments’ and AASB 15 ‘Revenue from Contracts with Customers’ (continued) Statement of financial position at the end of the earliest comparative period Assets Current assets Cash and cash equivalents Trade and other receivables Contract assets Derivative financial instruments Prepayments Total current assets Non-current assets Property, plant and equipment Intangibles Other non-current assets Total non-current assets Total assets Liabilities Current liabilities Trade and other payables Contract liabilities Derivative financial instruments Income tax Provisions Revenue received in advance Total current liabilities Non-current liabilities Borrowings Deferred tax Provisions Total non-current liabilities Total liabilities Net assets Equity Issued capital Reserves Accumulated losses Total equity 31 Dec 2017 $’000 Reported Group $’000 Adjustment 31 Dec 2017 $’000 Restated 24,015 42,908 – 123 1,121 68,167 1,762 116,253 1,866 119,881 188,048 21,173 – 46 1,303 1,151 1,237 24,910 67,885 1,369 473 69,727 94,637 93,411 69,569 27,712 (3,870) 93,411 – (11,270) 11,270 – – – – – – – – – 1,237 – – – (1,237) – – – – – – – – – – – 24,015 31,638 11,270 123 1,121 68,167 1,762 116,253 1,866 119,881 188,048 21,173 1,237 46 1,303 1,151 – 24,910 67,885 1,369 473 69,727 94,637 93,411 69,569 27,712 (3,870) 93,411 Appen Limited 2018 Annual Report 46 Notes to the Consolidated Financial Statements continued 5. Operating segments Identification of reportable operating segments The Group is organised into two operating segments based on differences in products and services provided: Content Relevance and Language Resources. These operating segments are based on the internal reports that are reviewed and used by the Group’s Chief Executive Officer (‘CEO’), who is identified as the Chief Operating Decision Maker, in assessing performance and in determining the allocation of resources. There is no aggregation of operating segments. The CEO reviews a set of financial reports which covers EBITDA (earnings before interest, tax, depreciation and amortisation), revenue and operating segment reports on a monthly basis. The accounting policies adopted for internal reporting to the CEO are consistent with those adopted in the financial statements. Types of products and services The principal products and services of each of these operating segments are as follows: Content Relevance Content Relevance provides annotated data used in search technology (embedded in web, e-commerce and social engagement) for improving relevance and accuracy of search engines, social media applications and e-commerce. Language Resources Language Resources provides annotated speech, natural language and image data used in speech recognisers, machine translation, speech synthesisers and other machine-learning technologies resulting in more engaging and fluent devices including internet-connected devices, in-car automotive systems and speech-enabled consumer electronics. Intersegment transactions Intersegment transactions were made at market rates. Intersegment transactions are eliminated on consolidation. Intersegment receivables, payables and loans Intersegment loans are initially recognised at the consideration received. Intersegment loans receivable and loans payable that earn or incur non-market interest are not adjusted to fair value based on market interest rates. Intersegment loans are eliminated on consolidation. Major customers During the year ended 31 December 2018 approximately 89.1% (2017: 86%) of the Group’s external revenue was derived from sales to five major customers. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued Content Relevance $’000 Language Resources $’000 Other segments $’000 312,846 51,361 – – – – 312,846 51,361 74,800 11,177 – 16 66 82 66 5. Operating segments (continued) Operating segment information Group - 31 Dec 2018 Revenue Services revenue Interest Other income Total revenue Segment result Corporate overhead Marketing expenses Net foreign exchange loss Share-based payment - employees Share-based payment - Leapforce Transaction costs Depreciation and amortisation Interest Profit before income tax expense Income tax expense Profit after income tax expense 47 Total $’000 364,207 16 66 364,289 86,043 (11,056) (1,479) 112 (2,351) (1,666) (1,507) (8,941) (3,201) 55,954 (14,226) 41,728 Appen Limited 2018 Annual Report 48 Notes to the Consolidated Financial Statements continued 5. Operating segments (continued) Group - 31 Dec 2017 Revenue Services revenue Interest Other income Total revenue Segment result Corporate overhead Marketing expenses Net foreign exchange gain Share-based payments - employees Transaction costs Depreciation and amortisation* Interest Profit before income tax expense Income tax expense Profit after income tax expense Content Relevance $’000 Language Resources $’000 Other segments $’000 126,160 40,397 – – – – 126,160 40,397 – 10 4 14 22,147 12,176 (256) Total $’000 166,557 10 4 166,571 34,067 (5,557) (919) 937 (410) (5,877) (1,863) (3) 20,375 (6,093) 14,282 * Amortisation expense includes AUD$572,719 for the disposal of ERP system purchased in March 2014, since there is no probable future economic benefits. Geographical information Australia US Other countries Services revenue Geographical non-current assets 31 Dec 2018 $’000 31 Dec 2017 $’000 31 Dec 2018 $’000 31 Dec 2017 $’000 40,583 316,480 7,144 40,393 126,164 – 1,250 117,143 6,175 1,106 114,035 4,740 364,207 166,557 124,568 119,881 Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 49 6. Revenue Revenue from contracts with customers Services revenue Other income Other income Revenue Group 31 Dec 2018 $’000 31 Dec 2017 $’000 364,207 166,557 66 4 364,273 166,561 Disaggregation of services revenue Services revenue is disaggregated by type of service and primary geographical country as follows: Group - 31 Dec 2018 Geographical regions Australia US Other countries Group - 31 Dec 2017 Geographical regions Australia US Content Relevance $’000 Language Resources $’000 – 312,846 – 40,583 3,634 7,144 Total $’000 40,583 316,480 7,144 312,846 51,361 364,207 Content Relevance $’000 Language Resources $’000 – 40,393 Total $’000 40,393 126,164 126,160 126,160 4 40,397 166,557 Appen Limited 2018 Annual Report 50 7. Expenses Notes to the Consolidated Financial Statements continued Profit before income tax includes the following specific expenses: Depreciation Leasehold improvements Fixtures and fittings Computer equipment Audio equipment Make good Total depreciation Amortisation Systems implementation* Platform development Customer relationships Crowd database Customer contracts Other intangibles Total amortisation Total depreciation and amortisation Finance costs Interest and finance charges paid/payable Employee benefits expense Defined contribution superannuation expense Employee benefits expense Total employee benefits expense Group 31 Dec 2018 $’000 31 Dec 2017 $’000 570 124 801 16 – 1,511 476 782 5,005 1,067 70 30 7,430 8,941 120 43 207 17 5 392 930 460 – – 67 14 1,471 1,863 3,201 13 1,817 41,996 43,813 1,194 27,923 29,117 * Amortisation expense in 2017 includes $572,719 for the disposal of ERP system purchased in March 2014, since there is no probable future economic benefits. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 51 8. Income tax expense Income tax expense Current tax Deferred tax - origination and reversal of temporary differences Aggregate income tax expense Deferred tax included in income tax expense comprises: Increase/(decrease) in deferred tax liabilities (Note 19) Numerical reconciliation of income tax expense and tax at the statutory rate Profit before income tax expense Tax at the statutory tax rate of 30% Tax effect amounts which are not deductible/(taxable) in calculating taxable income: Amortisation of intangibles Depreciation of property, plant and equipment Entertainment expenses Share-based payment expense Year end accruals deductible in future years Difference in overseas tax rates Income tax expense 9. Current assets - cash and cash equivalents Cash on hand Cash at bank 10. Current assets - trade and other receivables Trade receivables Less: Allowance for expected credit losses Other receivables GST receivable Group 31 Dec 2018 $’000 31 Dec 2017 $’000 13,630 596 14,226 7,502 (1,409) 6,093 596 (1,409) 55,954 16,786 93 371 5 4,017 (5,735) 15,537 (1,311) 14,226 20,375 6,113 60 12 5 (123) 159 6,226 (133) 6,093 Group 31 Dec 2018 $’000 31 Dec 2017 $’000 2 40,043 40,045 3 24,012 24,015 Group 31 Dec 2018 $’000 31 Dec 2017 $’000 59,628 (184) 59,444 908 117 30,923 (75) 30,848 498 292 60,469 31,638 Appen Limited 2018 Annual Report 52 Notes to the Consolidated Financial Statements continued 10. Current assets - trade and other receivables (continued) Allowance for expected credit losses The Group has recognised an additional provision of $100,000 (2017: $nil) in profit or loss in respect of impairment of receivables for the year ended 31 December 2018. The ageing of the receivables and allowance for expected credit losses provided for above are as follows: Group Not overdue 0 to 3 months overdue 3 to 6 months overdue Over 6 months overdue Expected credit loss rate Carrying amount Allowance for expected credit losses 31 Dec 2018 % 31 Dec 2017 % 31 Dec 2018 $’000 31 Dec 2017 $’000 31 Dec 2018 $’000 31 Dec 2017 $’000 – – 100% – – – – 100% 51,648 7,796 184 – 27,130 3,701 60 32 59,628 30,923 – – 184 – 184 – – – 32 32 Movements in the allowance for expected credit losses are as follows: Opening balance Additional provisions recognised Foreign currency revaluation on opening balance Closing balance 11. Current assets - contract assets Contract assets Reconciliation Reconciliation of the written down values at the beginning and end of the current and previous financial year are set out below: Opening balance Additions Transfer to trade receivables Revaluation Closing balance Group 31 Dec 2018 $’000 31 Dec 2017 $’000 75 100 9 184 81 – (6) 75 Group 31 Dec 2018 $’000 31 Dec 2017 $’000 10,354 11,270 11,270 44,272 (46,713) 1,525 10,354 7,184 11,659 (7,811) 238 11,270 Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 53 12. Current assets - derivative financial instruments Forward foreign exchange contracts - cash flow hedges Refer to Note 26 for further information on fair value measurement. 13. Non-current assets - intangibles Goodwill - at cost Systems implementation - at cost Less: Accumulated amortisation Platform development - at cost Less: Accumulated amortisation Customer relationships - at cost Less: Accumulated amortisation Crowd database - at cost Less: Accumulated amortisation Customer contracts - at cost Less: Accumulated amortisation Other intangibles - at cost Less: Accumulated amortisation Group 31 Dec 2018 $’000 31 Dec 2017 $’000 – 123 Group 31 Dec 2018 $’000 31 Dec 2017 $’000 Restated 81,055 5,284 (2,498) 2,786 5,137 (1,892) 3,245 36,994 (5,285) 31,709 1,134 (1,134) – 3,337 (3,126) 211 529 (391) 138 71,615 4,732 (1,802) 2,930 4,162 (968) 3,194 36,994 – 36,994 1,134 – 1,134 3,035 (2,765) 270 467 (351) 116 119,144 116,253 Appen Limited 2018 Annual Report 54 Notes to the Consolidated Financial Statements continued 13. Non-current assets - intangibles (continued) Reconciliations Reconciliations of the written down values at the beginning and end of the current and previous financial year are set out below: Group Balance at 1 January 2017 Additions Additions through business combinations (Note 33) - Restated Reclassifications Exchange differences Amortisation expense* Balance at 31 December 2017 - Restated*** Additions Additions through business combinations (Note 33) Disposals Exchange differences Amortisation expense Balance at 31 December 2018 Systems implement- ation $’000 Goodwill** $’000 Platform development $’000 Customer relationships $’000 Crowd database $’000 Customer contracts $’000 Other intangibles $’000 Total $’000 11,463 – 1,967 2,022 1,090 502 – – – – 60,485 (333) – – – (107) (22) (930) 2,126 36,994 1,134 107 (171) (460) – – – – – – 71,615 – 2,930 227 3,194 886 36,994 – 1,134 – 1,308 – 8,132 – – – 105 (476) – – (53) (782) – – – – (281) (5,004) (67) (1,067) – – – 333 4 (67) 270 – – – 11 (70) 23 104 14,543 2,628 – – 3 (14) 101,739 – (186) (1,471) 116 49 116,253 1,162 – (1) 5 (31) 1,308 (1) 7,852 (7,430) 81,055 2,786 3,245 31,709 – 211 138 119,144 Amortisation expense includes $572,719 for the disposal of ERP system purchased in March 2014, since there is no probable future economic benefits. * ** Goodwill has been adjusted to recognise the separately identifiable intangible assets associated with the Leapforce acquisition. *** 31 December 2017 balances have been restated to reflect the impact of acquisition accounting adjustments made during the period on opening balances. Refer to Note 33. Valuations For the purposes of impairment testing, identifiable intangible assets have been valued according to the following valuation methodologies: Customer relationships Crowd database Platform development Customer relationships were valued on an excess earnings basis. The excess earnings method is predicated on the basis that the value of an intangible asset is the present value of the earnings it generates, net of a reasonable return on other assets also contributing to that stream of earnings. Crowd database was valued on a replacement cost basis. Under the replacement cost-based methodology, the value of an intangible asset is estimated by reference to the costs that would have to be expended in order to recreate the asset or the cost historically incurred to create the asset. Platform development was valued on a replacement cost basis. Under the replacement cost-based methodology, the value of an intangible asset is estimated by reference to the costs that would have to be expended in order to recreate the asset or the cost historically incurred to create the asset. This was cross checked to the relief from royalty methodology. The relief from royalty methodology involves estimating the amount of hypothetical royalty that would be paid if the identifiable intangible asset was licensed from an independent third party owner. The fair value of the identifiable intangible asset is the net present value of the prospective stream of hypothetical royalty savings that would be generated over the expected useful life of the intangible asset. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 55 13. Non-current assets - intangibles (continued) Impairment of intangible assets Goodwill relates to the acquisition of Butler Hill, Inc., Leapforce, Inc. and Raterlabs, Inc. in the United States, and Mendip Media Group Limited ‘MMG’) in the United Kingdom. The recoverable amount of this business, at balance date, was estimated based on its value in use. Butler Hill, Inc., Leapforce, Inc. and Raterlabs, Inc. Value in use for the Content Relevance cash-generating unit (‘CGU’) was determined by discounting the future cashflows to be generated from the Content Relevance division and is based on the following key assumptions: – Cashflows were projected based on forecast operating results over a 5 year period. – Average annual revenue growth rates of 8% for 2019 to 2023 were used for revenue projections. This growth was referenced against the average annual historical growth rates over the past 4 years and the long-term growth rate of the industry. All future years of the model use a constant rate of 3%; and – A pre-tax discount of 15.4% based on the weighted average cost of capital. The Goodwill carrying value of $79,045,000 has been allocated to the Content Relevance CGU. Mendip Media Group Limited Value in use for the Language Resources CGU was determined by discounting the future cash flows to be generated from the Language Resources division and is based on the following key assumptions: – Cashflows were projected based on forecast operating results over a 5 year period. – Average annual revenue growth rates of 10% for 2019 to 2023 were used for revenue projections. This growth was referenced against average annual historical growth rates over the past 4 years and the long-term growth rate of the industry. All future years of the model use a constant rate of 3%; and – A pre-tax discount of 16.4% based on the weighted average cost of capital. The Goodwill carrying value of $2,010,000 has been allocated to the Language Resources CGU. 14. Current liabilities - trade and other payables Trade payables Other payables and accrued expenses Refer to Note 25 for further information on financial instruments. Group 31 Dec 2018 $’000 31 Dec 2017 $’000 20,709 16,306 37,015 9,240 11,933 21,173 Appen Limited 2018 Annual Report 56 Notes to the Consolidated Financial Statements continued 15. Current liabilities - contract liabilities Invoices issued/deposits received in advance Reconciliation Reconciliation of the written down values at the beginning and end of the current and previous financial year are set out below: Opening balance Payments received in advance Transfer to revenue Revaluation Closing balance Group 31 Dec 2018 $’000 31 Dec 2017 $’000 1,535 1,237 1,237 802 (566) 62 1,535 716 990 (443) (26) 1,237 Unsatisfied performance obligations The aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied at the end of the reporting period was $1,535,000 as at 31 December 2018 ($1,237,000 as at 31 December 2017) and is expected to be recognised as revenue in future periods as follows: Less than 3 months Over 3 months 16. Current liabilities - derivative financial instruments Forward foreign exchange contracts Foreign exchange contracts - Collars Refer to Note 25 for further information on financial instruments. Refer to Note 26 for further information on fair value measurement. Group 31 Dec 2018 $’000 31 Dec 2017 $’000 1,048 487 1,535 421 816 1,237 Group 31 Dec 2018 $’000 31 Dec 2017 $’000 249 – 249 – 46 46 Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 57 17. Current liabilities - provisions Annual leave Lease make-good Group 31 Dec 2018 $’000 31 Dec 2017 $’000 1,429 100 1,529 1,051 100 1,151 Lease make-good The provision represents the present value of the estimated costs to make good the premises leased by the Group at the end of the respective lease terms. Movements in provisions Movements in each class of provision during the current financial year, other than employee benefits, are set out below: Group - 31 Dec 2018 Carrying amount at the start of the year Carrying amount at the end of the year 18. Non-current liabilities - borrowings Facility A (Senior debt) Facility B (Working capital) Lease liability Lease make- good $’000 100 100 Group 31 Dec 2018 $’000 31 Dec 2017 $’000 56,330 – – 50,843 17,038 4 56,330 67,885 Refer to Note 25 for further information on financial instruments. Facility A The facility was established in December 2017 with a limit of US$40 million. This facility has a three year term with a bullet repayment at the end of the term and is not subject to annual review. Mandatory prepayment of 7.5% of the outstanding principal balance of the facility is required if certain metrics are triggered, measured at each six monthly reporting period ending on or after 30 June 2018. The facility was used to fund the Leapforce acquisition and is fully drawn. This facility attracts interest at a margin over bank reference rates, based on the net leverage ratio. The value disclosed above is net of borrowing costs of $365,000 (2017: $394,000). Facility B The facility was established in December 2017 with a limit of A$20 million. This facility has a three year term and is not subject to annual review. Technically, each drawing under this facility is required to be rolled over at the end of its interest period and available for automatic re-draw if no default is existing. The facility is used to fund working capital in connection with the Leapforce acquisition and general working capital requirements. This facility attracts interest at a margin over bank reference rates, based on the net leverage ratio. The facility B of $17,038,000 was fully repaid in 2018. Appen Limited 2018 Annual Report 58 Notes to the Consolidated Financial Statements continued 18. Non-current liabilities - borrowings (continued) Total secured liabilities The total secured liabilities (current and non-current) are as follows: Facility A (Senior debt) Facility B (Working capital) Lease liability Group 31 Dec 2018 $’000 31 Dec 2017 $’000 56,330 – – 50,843 17,038 4 56,330 67,885 Assets pledged as security The bank loans are secured by a fixed charge over the assets of the Group. The lease liabilities are effectively secured as the rights to the leased assets, recognised in the statement of financial position, revert to the lessor in the event of default. Financing arrangements Unrestricted access was available at the reporting date to the following lines of credit: Total facilities Facility A (Senior debt)* Facility B (Working capital) Used at the reporting date Facility A (Senior debt)* Facility B (Working capital) Unused at the reporting date Facility A (Senior debt)* Facility B (Working capital) * Balance excludes borrowing cost of $365,000 (2017: $394,000). Group 31 Dec 2018 $’000 31 Dec 2017 $’000 56,695 20,000 76,695 56,695 – 56,695 – 20,000 20,000 51,237 20,000 71,237 51,237 17,038 68,275 – 2,962 2,962 Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 59 19. Non-current liabilities - deferred tax Deferred tax liability comprises temporary differences attributable to: Amounts recognised in profit or loss: Platform development costs Impairment of receivables Property, plant and equipment Intangible assets Employee benefits Accrued expenses Contract assets Foreign currency revaluation and other expense Deferred tax liability Movements: Opening balance Charged/(credited) to profit or loss (Note 8) Closing balance Group 31 Dec 2018 $’000 31 Dec 2017 $’000 337 (45) (302) 1,949 (1,132) (327) 2,845 (1,360) 1,965 1,369 596 1,965 298 (20) 62 929 (893) (955) 1,962 (14) 1,369 2,778 (1,409) 1,369 The Corporate Federal tax rate for company registered in United States changed to 21% effective from 1 January 2018. The deferred tax reported has been computed with the new Federal tax rate. 20. Non-current liabilities - provisions Long service leave Group 31 Dec 2018 $’000 31 Dec 2017 $’000 379 473 Appen Limited 2018 Annual Report 60 Notes to the Consolidated Financial Statements continued 21. Equity - issued capital Group 31 Dec 2018 Shares 31 Dec 2017 Shares 31 Dec 2018 $’000 31 Dec 2017 $’000 Ordinary shares - fully paid 106,599,647 105,804,907 69,602 69,569 Movements in ordinary share capital Details Balance Issue of shares on exercise of options Issue of shares on exercise of options Issue of shares on exercise of options Issue of shares on exercise of options Issue of shares on exercise of options Issue of shares on exercise of performance rights Issue of shares on exercise of options Issue of shares on exercise of options Issue of shares on exercise of options Issue of shares as consideration of acquisition of Leapforce, Inc and RaterLabs, Inc. Issue of shares as consideration of acquisition of Leapforce, Inc and RaterLabs, Inc. Shares issued under Share Purchase plan Share issue transaction costs Balance Issue of shares on exercise of performance rights Issue of shares on exercise of performance rights Issue of shares on exercise of options Issue of shares on exercise of options Issue of contingent Leapforce shares Balance Date Shares Issue price $’000 1 January 2017 97,180,407 1 March 2017 1 March 2017 1 March 2017 3 March 2017 9 March 2017 10 April 2017 16 June 2017 8 November 2017 22 November 2017 318,750 20,450 20,450 53,125 106,250 9,398 53,125 40,900 40,900 $0.500 $0.489 $0.432 $0.500 $0.500 $0.500 $0.412 $0.412 19,510 159 10 9 27 53 – 27 17 17 6 December 2017 4,310,345 $5.800 25,000 7 December 2017 21 December 2017 2,787,826 862,981 $7.400 $5.800 31 December 2017 1 March 2018 4 June 2018 28 June 2018 27 September 2018 7 December 2018 105,804,907 520,040 83,334 40,900 26,563 123,903 $10.600 $10.210 $0.494 $0.500 20,630 5,005 (895) 69,569 – – 20 13 – 31 December 2018 106,599,647 69,602 Ordinary shares Ordinary shares entitle the holder to participate in dividends and the proceeds on the winding up of the Company in proportion to the number of and amounts paid on the shares held. The fully paid ordinary shares have no par value and the Company does not have a limited amount of authorised capital. On a show of hands every member present at a meeting in person or by proxy shall have one vote and upon a poll each share shall have one vote. Share buy-back There is no current on-market share buy-back. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 61 21. Equity - issued capital (continued) Capital risk management The Group’s objectives when managing capital is to safeguard its ability to continue as a going concern, so that it can provide returns for shareholders and benefits for other stakeholders and to maintain an optimum capital structure to reduce the cost of capital. Capital is regarded as total equity, as recognised in the statement of financial position, plus net debt. Net debt is calculated as total borrowings less cash and cash equivalents. In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debt. The Group would raise capital when an opportunity to invest in a business or company was seen as value adding relative to the current Company’s share price at the time of the investment. The capital risk management policy remains unchanged from the 31 December 2017 Annual Report. 22. Equity - reserves Common control reserve Foreign currency translation reserve Share-based payments reserve Profits reserve Other reserves Group 31 Dec 2018 $’000 31 Dec 2017 $’000 (1,416) 10,433 5,996 56,796 1,859 73,668 (1,416) 2,790 1,979 22,500 1,859 27,712 Common control reserve The reserve represents the difference between the consideration transferred by the Company for the acquisition of commonly controlled entities and the existing book value of those entities immediately prior to the acquisition. Foreign currency translation reserve The reserve is used to recognise exchange differences arising from translation of the financial statements of foreign operations to Australian dollars. Share-based payments reserve The reserve is used to recognise the value of equity benefits provided to employees and directors as part of their remuneration, and other parties as part of their compensation for services. Profits reserve The Profits reserve represents current year profits transferred to a reserve to preserve the characteristic as a profit so as to quarantine from being appropriated against prior year accumulated losses. Such profits are available to enable payment of franked dividends in the future should the directors declare so by resolution. Other reserves This reserve represents the equity settled portion of contingent consideration together with any capital raising expenses that are allocated to equity, in connection with the acquisition of Butler Hill, Inc. Appen Limited 2018 Annual Report 62 Notes to the Consolidated Financial Statements continued 22. Equity - reserves (continued) Movements in reserves Movements in each class of reserve during the current and previous financial year are set out below: Group Balance at 1 January 2017 Foreign currency translation Share-based payments Transfer from accumulated losses Dividends paid Balance at 31 December 2017 Foreign currency translation Share-based payments Transfer from accumulated losses Dividends paid Foreign currency translation $’000 Share-based payments $’000 Common control $’000 (1,416) – – – – 3,672 (882) – – – (1,416) – 2,790 7,643 – – – – – – 1,569 – 410 – – 1,979 – 4,017 – – Profits $’000 14,079 – – 14,282 (5,861) 22,500 – – 41,728 (7,432) 56,796 Balance at 31 December 2018 (1,416) 10,433 5,996 23. Equity - accumulated losses Accumulated losses at the beginning of the financial year Profit after income tax expense for the year Transfer to Profits reserve Accumulated losses at the end of the financial year 24. Equity - dividends Dividends Dividends paid during the financial year were as follows: Final dividend paid out of the profits reserve for the year ended 31 December 2017 of 3.0 cents per ordinary share (2017: 31 December 2016 of 3.0 cents) Interim dividend paid out of the profits reserve for the year ended 31 December 2018 of 4.0 cents per ordinary share (2017: 31 December 2017 of 3.0 cents) Other $’000 1,859 – – – – 1,859 – – – – Total $’000 19,763 (882) 410 14,282 (5,861) 27,712 7,643 4,017 41,728 (7,432) 1,859 73,668 Group 31 Dec 2018 $’000 31 Dec 2017 $’000 (3,870) 41,728 (41,728) (3,870) (3,870) 14,282 (14,282) (3,870) Group 31 Dec 2018 $’000 31 Dec 2017 $’000 3,174 2,928 4,258 7,432 2,933 5,861 Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 63 24. Equity - dividends (continued) Dividend declared On 25 February 2019, the Company declared a final dividend for the year ended 31 December 2018 of 4.0 cents per share, partially franked. The dividend is to be paid out of the profits reserve. The record date for determining entitlements to the dividend is 1 March 2019. The financial effect of these dividends has not been brought to account in the financial statements for the year ended 31 December 2018 and will be recognised in subsequent financial periods. Franking credits Group 31 Dec 2018 $’000 31 Dec 2017 $’000 Franking credits available for subsequent financial years based on a tax rate of 30% 1,326 3,446 The above amounts represent the balance of the franking account as at the end of the financial year, adjusted for: – franking credits that will arise from the payment of the amount of the provision for income tax at the reporting date – franking debits that will arise from the payment of dividends recognised as a liability at the reporting date – franking credits that will arise from the receipt of dividends recognised as receivables at the reporting date 25. Financial instruments Financial risk management objectives The Group’s activities expose it to a variety of financial risks: market risk (including foreign currency risk, price risk and interest rate risk), credit risk and liquidity risk. The Group’s overall risk management program focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the financial performance of the Group. The Group uses derivative financial instruments such as forward foreign exchange contracts to hedge certain foreign currency risk exposures. Derivatives are exclusively used for hedging purposes, i.e. not as trading or other speculative instruments. The Group uses different methods to measure different types of risk to which it is exposed. These methods include sensitivity analysis in the case of interest rate, foreign exchange and other price risks, ageing analysis for credit risk and beta analysis in respect of investment portfolios to determine market risk. Risk management is carried out by senior finance executives (‘finance’) under policies approved by the Board of Directors (‘the Board’). These policies include identification and analysis of the risk exposure of the Group and appropriate procedures, controls and risk limits. Finance identifies, evaluates and hedges financial risks within the Group’s operating units. Finance reports to the Board on a monthly basis. Appen Limited 2018 Annual Report 64 Notes to the Consolidated Financial Statements continued 25. Financial instruments (continued) Market risk Foreign currency risk The Group undertakes certain transactions denominated in foreign currency and is exposed to foreign currency risk through foreign exchange rate fluctuations. Foreign exchange risk arises from future commercial transactions and recognised financial assets and financial liabilities denominated in a currency that is not the entity’s functional currency. The risk is measured using sensitivity analysis and cash flow forecasting. In order to protect against exchange rate movements, the Group has entered into forward foreign exchange contracts. These contracts are hedging highly probable forecast cash flows for the ensuing financial year. Appen’s policy is to hedge at least 80% of its US denominated revenues generated by its Language Resources division for the subsequent 12 months. The maturity, settlement amounts and the average contractual exchange rates of the Group’s outstanding forward foreign exchange contracts and foreign exchange - collars at the reporting date were as follows: Sell United States dollars Foreign exchange forward contract maturity: 0 - 3 months 3 - 6 months Sell United States dollars Foreign exchange option contract maturity: 0 - 3 months 3 - 6 months Buy Australian dollars Average exchange rates 31 Dec 2018 $’000 31 Dec 2017 $’000 31 Dec 2018 31 Dec 2017 13,260 2,784 7,180 3,247 0.7164 0.7185 0.7591 0.7700 Buy Australian dollars Average exchange rates 31 Dec 2018 $’000 31 Dec 2017 $’000 31 Dec 2018 31 Dec 2017 – – 1,300 3,247 – – 0.7690 0.7687 The average exchange rates and reporting date exchange rates applied were as follows: Australian dollars United States Dollars European Economic and Monetary Union Euro United Kingdom Pound Sterling Hong Kong Dollars Philippine Pesos Chinese Yuan Average exchange rates Reporting date exchange rates 31 Dec 2018 31 Dec 2017 31 Dec 2018 31 Dec 2017 0.7450 0.5596 0.6317 5.8368 39.2972 4.9333 0.7692 0.5930 0.6773 5.9946 39.8340 – 0.7055 0.6164 0.5540 5.5230 37.1044 4.8497 0.7809 0.5787 0.6517 6.0994 39.0305 – Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 65 25. Financial instruments (continued) The carrying amount of the Group’s foreign currency denominated financial assets and financial liabilities at the reporting date were as follows: Group United States Dollars European Economic and Monetary Union Euro United Kingdom Pound Sterling Hong Kong Dollars Philippine Pesos Chinese Yuan Assets Liabilities 31 Dec 2018 $’000 31 Dec 2017 $’000 31 Dec 2018 $’000 31 Dec 2017 $’000 95,610 2,228 533 1 1,011 205 47,283 1,313 351 1 913 – 78,048 58,431 – 85 – 297 – – 81 – 177 – 99,588 49,861 78,430 58,689 The Group had net assets denominated in foreign currencies of $21,158,000 (assets $99,588,000 less liabilities $78,430,000) as at 31 December 2018 (2017: net liabilities of $8,828,000 (assets $49,861,000 less liabilities $58,689,000)). Based on this exposure, had the Australian dollar weakened by 5% or strengthened by 5% (2017: weakened by 5% or strengthened by 5%) against these foreign currencies with all other variables held constant, the Group’s profit before tax for the year based on the assets dominated in foreign currency, excluding the translation difference for consolidated reporting purpose, and the Group’s equity would have been lower or higher by the following: AUD strengthened AUD weakened Group - 31 Dec 2018 % change United States Dollars European Economic and Monetary Union Euro United Kingdom Pound Sterling Hong Kong Dollars Philippine Pesos Chinese Yuan 5% 5% 5% 5% 5% 5% Effect on profit before tax $’000 Effect on equity $’000 2,278 (3,476) (111) (12) – – – – (21) – (36) (10) Effect on profit before tax $’000 Effect on equity $’000 (2,278) 3,476 111 12 – – – – 21 – 36 10 % change 5% 5% 5% 5% 5% 5% 2,155 (3,543) (2,155) 3,543 Appen Limited 2018 Annual Report 66 Notes to the Consolidated Financial Statements continued 25. Financial instruments (continued) AUD strengthened AUD weakened Group - 31 Dec 2017 % change United States Dollars European Economic and Monetary Union Euro United Kingdom Pound Sterling Hong Kong Dollars Philippine Pesos 5% 5% 5% 5% 5% Effect on profit before tax $’000 Effect on equity $’000 2,343 (1,929) (66) (10) (3) – – (11) (8) (37) Effect on profit before tax $’000 Effect on equity $’000 (2,343) 1,929 66 10 3 – – 11 8 37 % change 5% 5% 5% 5% 5% 2,264 (1,985) (2,264) 1,985 The percentage change is the expected overall volatility of the significant currencies, which is based on management’s assessment of reasonable possible fluctuations taking into consideration movements over the last 12 months each year and the spot rate at each reporting date. Price risk The Group is not exposed to any significant price risk. Interest rate risk The Group’s main interest rate risk arises from long-term borrowings. Borrowings issued at variable rates expose the Group to interest rate risk. As at the reporting date, the Group had the following variable rate borrowings: Group Facility A Facility B Net exposure to cash flow interest rate risk 31 Dec 2018 Balance $’000 31 Dec 2017 Balance $’000 56,695 – 56,695 51,237 17,038 68,275 An analysis by remaining contractual maturities in shown in ‘liquidity and interest rate risk management’ below. For the Group the net exposure to interest rate risk totalled $56,695,000 (2017: $68,275,000). Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 67 25. Financial instruments (continued) Cash flow sensitivity analysis for variable-rate instruments A reasonable possible change of 100 base points in interest rates at the reporting date would have increased or decreased equity and profit or loss by the amounts below. This analysis assumes that all other variables, in particular foreign currency exchange rates, remain constant. Group - 31 Dec 2018 Facility A Facility B Group - 31 Dec 2017 Facility A Facility B Basis points increase Basis points decrease Basis points change Effect on profit before tax $’000 Effect on equity $’000 Basis points change Effect on profit before tax $’000 Effect on equity $’000 100 100 (567) – (567) (567) – (567) 100 100 567 – 567 567 – 567 Basis points increase Basis points decrease Basis points change Effect on profit before tax $’000 Effect on equity $’000 Basis points change Effect on profit before tax $’000 Effect on equity $’000 100 100 (512) (170) (682) (512) (170) (682) 100 100 512 170 682 512 170 682 Credit risk Credit risk refers to the risk that a counterparty will default on its contractual obligations resulting in financial loss to the Group. The Group has a strict code of credit, including obtaining agency credit information, confirming references and setting appropriate credit limits. The Group obtains guarantees where appropriate to mitigate credit risk. The maximum exposure to credit risk at the reporting date to recognised financial assets is the carrying amount, net of any provisions for impairment of those assets, as disclosed in the statement of financial position and notes to the financial statements. The Group does not hold any collateral. The Group has adopted a lifetime expected loss allowance in estimating expected credit losses to trade receivables through the use of a provisions matrix using fixed rates of credit loss provisioning. These provisions are considered representative across all customers of the Group based on recent sales experience, historical collection rates and forward-looking information that is available. Generally, trade receivables are written off when there is no reasonable expectation of recovery. Indicators of this include the failure of a debtor to engage in a repayment plan, no active enforcement activity and a failure to make contractual payments for a period greater than 1 year. Liquidity risk Liquidity risk requires the Group to maintain sufficient liquid assets (mainly cash and cash equivalents) and available borrowing facilities to be able to pay debts as and when they become due and payable. The Group manages liquidity risk by maintaining adequate cash reserves and available borrowing facilities by continuously monitoring actual and forecast cash flows and matching the maturity profiles of financial assets and liabilities. Appen Limited 2018 Annual Report 68 Notes to the Consolidated Financial Statements continued 25. Financial instruments (continued) Financing arrangements Unused borrowing facilities at the reporting date: Facility B (Working capital) Group 31 Dec 2018 $’000 31 Dec 2017 $’000 20,000 2,962 Remaining contractual maturities The following tables detail the Group’s remaining contractual maturity for its financial instrument liabilities. The tables have been drawn up based on the undiscounted cash flows of financial liabilities based on the earliest date on which the financial liabilities are required to be paid. The tables include both interest and principal cash flows disclosed as remaining contractual maturities and therefore these totals may differ from their carrying amount in the statement of financial position. Group - 31 Dec 2018 Non-derivatives Non-interest bearing Trade payables Other payables Interest-bearing - variable Facility A - Senior debt Total non-derivatives Derivatives Forward foreign exchange contracts net settled Total derivatives Group - 31 Dec 2017 Non-derivatives Non-interest bearing Trade payables Other payables Interest-bearing - variable Facility A - Senior debt Facility B - Working capital Lease liability Total non-derivatives Derivatives Foreign exchange contracts - Collars Total derivatives Weighted average interest rate % 1 year or less $’000 Between 1 and 2 years $’000 Between 2 and 5 years $’000 Over 5 years $’000 Remaining contractual maturities $’000 – – – – 20,709 16,306 1,106 38,121 – – – – 1,106 1,106 57,801 57,801 249 249 – – – – – – – – – – 20,709 16,306 60,013 97,028 249 249 Weighted average interest rate % 1 year or less $’000 Between 1 and 2 years $’000 Between 2 and 5 years $’000 Over 5 years $’000 Remaining contractual maturities $’000 – – – – – – 9,240 681 999 332 – – – 999 332 4 11,252 1,335 46 46 – – – – 52,237 17,370 – 69,607 – – – – – – – – – – 9,240 681 54,235 18,034 4 82,194 46 46 The cash flows in the maturity analysis above are not expected to occur significantly earlier than contractually disclosed above. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 69 26. Fair value measurement Fair value hierarchy The following tables detail the Group’s assets and liabilities, measured or disclosed at fair value, using a three level hierarchy, based on the lowest level of input that is significant to the entire fair value measurement, being: Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly Level 3: Unobservable inputs for the asset or liability Group - 31 Dec 2018 Liabilities Forward foreign exchange contracts Total liabilities Group - 31 Dec 2017 Assets Forward foreign exchange contracts Total assets Liabilities Foreign exchange contracts - Collars Total liabilities Level 1 $’000 Level 2 $’000 Level 3 $’000 – – 249 249 – – Level 1 $’000 Level 2 $’000 Level 3 $’000 – – – – 123 123 46 46 – – – – Total $’000 249 249 Total $’000 123 123 46 46 There were no transfers between levels during the financial year. The carrying amounts of trade and other receivables and trade and other payables are assumed to approximate their fair values due to their short-term nature. Valuation techniques for fair value measurements categorised within level 2 Derivative financial instruments have been valued using quoted market rates. This valuation technique maximises the use of observable market data where it is available and relies as little as possible on entity specific estimates. Appen Limited 2018 Annual Report 70 Notes to the Consolidated Financial Statements continued 27. Key management personnel disclosures Compensation The aggregate compensation made to directors and other members of key management personnel of the Group is set out below: Short-term employee benefits Post-employment benefits Long-term benefits Share-based payments Group 31 Dec 2018 $ 31 Dec 2017 $ 2,342,673 2,518,996 100,826 54,130 1,391,376 176,873 160,312 188,852 3,889,005 3,045,033 28. Remuneration of auditors During the financial year the following fees were paid or payable for services provided by KPMG, the auditor of the Company, and its network firms: Audit services - KPMG Audit or review of the financial statements Other services - KPMG Taxation and compliance services - Australia Other services Audit services - network firms Audit or review of the financial statements Other services - network firms Taxation and compliance services - USA Other services Group 31 Dec 2018 $ 31 Dec 2017 $ 210,770 212,534 256,802 – 256,802 72,514 153,750 226,264 467,572 438,798 47,762 33,197 463,269 – 85,793 42,561 463,269 128,354 511,031 161,551 29. Contingent liabilities The Group has given bank guarantees as at 31 December 2018 of $133,000 (2017: $133,000) in satisfaction of its performance obligations with respect to rental premises. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 71 30. Commitments Lease commitments - operating Committed at the reporting date but not recognised as liabilities, payable: Within one year One to five years More than five years Group 31 Dec 2018 $’000 31 Dec 2017 $’000 1,608 3,524 207 5,339 1,505 4,519 – 6,024 Operating lease commitments includes a contracted amount for an office under a non-cancellable operating lease expiring within 5 years with an option to extend. The leases have various escalation clauses. On renewal, the terms of the lease are renegotiated. 31. Related party transactions Parent entity Appen Limited is the parent entity. Subsidiaries Interests in subsidiaries are set out in Note 34. Key management personnel Disclosures relating to key management personnel are set out in Note 27 and the remuneration report included in the directors’ report. Transactions with related parties There were no transactions with related parties during the current financial year. Receivable from and payable to related parties There were no trade receivables from or trade payables to related parties at the current and previous reporting date. Loans to/from related parties There were no loans to or from related parties at the current and previous reporting date. 32. Parent entity information Set out below is the supplementary information about the parent entity. Statement of profit or loss and other comprehensive income Profit after income tax Total comprehensive income Company 31 Dec 2018 $’000 31 Dec 2017 $’000 6,653 6,653 3,183 3,183 Appen Limited 2018 Annual Report 72 Notes to the Consolidated Financial Statements continued 32. Parent entity information (continued) Statement of financial position Total current assets Total assets Total current liabilities Total liabilities Equity Issued capital Share-based payments reserve Profits reserve Other reserves Accumulated losses Total equity Company 31 Dec 2018 $’000 31 Dec 2017 $’000 66,543 80,731 380 1,050 68,705 80,712 3,991 4,337 69,602 69,569 5,997 7,828 1,859 (5,605) 79,681 1,980 8,572 1,859 (5,605) 76,375 Guarantees entered into by the parent entity in relation to the debts of its subsidiaries The parent entity had a deed of cross guarantee in relation to the debts of its subsidiaries as at 31 December 2018 and 31 December 2017. Contingent liabilities The parent entity had no contingent liabilities as at 31 December 2018 and 31 December 2017. Capital commitments - Property, plant and equipment The parent entity had no capital commitments for property, plant and equipment as at 31 December 2018 and 31 December 2017. Significant accounting policies The accounting policies of the parent entity are consistent with those of the Group, as disclosed in Note 2, except for the following: – Investments in subsidiaries are accounted for at cost, less any impairment, in the parent entity. – Dividends received from subsidiaries are recognised as other income by the parent entity and its receipt may be an indicator of an impairment of the investment. 33. Business combinations 2018 An additional amount of $1,308,000 was paid in 2018 for the Leapforce acquisition in 2017. There were no business combinations in the year to 31 December 2018. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 73 33. Business combinations (continued) 2017 On 7 December 2017, Appen Limited acquired 100% of the ordinary shares of Leapforce Inc. and RaterLabs Inc. (‘Leapforce’) for the total consideration of USD$80,000,000 plus working capital. Leapforce is a leading provider of search relevance services in the United States of America. This was a strategic acquisition to secure the services of Leapforce to enable Appen to grow its position as a global leader of high quality data provision for machine learning and artificial intelligence. The goodwill of $61,793,000 represents the difference in the fair value of assets acquired to consideration paid. The values identified in relation to the acquisition of Leapforce are final as at 31 December 2018. Details of the acquisition are as follows: Cash and cash equivalents Trade receivables Prepayments Fixtures and fittings Customer relationships Other intangible assets Crowd database Trade payables Employee benefits Accrued expenses Share–based payment Working capital adjustment Net assets acquired Goodwill Acquisition-date fair value of the total consideration transferred Representing: Cash paid or payable to vendor Cash paid to vendor for working capital Appen Limited shares issued to vendor Contingent consideration Acquisition costs expensed to profit or loss Cash used to acquire business, net of cash acquired: Acquisition-date fair value of the total consideration transferred Less: cash and cash equivalents Less: shares issued by Company as part of consideration Less: contingent consideration Net cash used Provisional amount disclosed at 31 Dec 2017 Fair value $’000 Acquisition adjustments Fair value $’000 Restated balance at 31 Dec 2017 Fair value $’000 4,915 12,548 32 102 – – – (4,348) (112) (156) 5,260 37 18,278 100,739 119,017 84,155 8,972 20,630 5,260 119,017 5,877 119,017 (4,915) (20,630) (5,260) 88,212 – – – – 2,126 36,994 1,134 – – – – – 40,254 (38,946) 4,915 12,548 32 102 2,126 36,994 1,134 (4,348) (112) (156) 5,260 37 58,532 61,793 1,308 120,325 1,308 – – – 85,463 8,972 20,630 5,260 1,308 120,325 – 5,877 1,308 120,325 – – – 1,308 (4,915) (20,630) (5,260) 89,520 Appen Limited 2018 Annual Report 74 Notes to the Consolidated Financial Statements continued 34. Interests in subsidiaries The consolidated financial statements incorporate the assets, liabilities and results of the following subsidiaries in accordance with the accounting policy described in Note 2: Name Principal place of business/ Country of incorporation Appen Butler Hill Pty Limited Australia Appen Butler Hill Inc.* Appen (Europe) Limited* Mendip Media Group Limited Appen (Hong Kong) Limited* Beijing Appen Technology Co., Ltd* Leapforce Inc. RaterLabs Inc. United States of America United Kingdom United Kingdom Hong Kong China United States of America United States of America Appen Financial Services Pty Ltd Australia * Wholly-owned subsidiaries of Appen Butler Hill Pty Limited. Ownership interest 31 Dec 2018 % 31 Dec 2017 % 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 35. Deed of cross guarantee The following entities are party to a deed of cross guarantee under which each company guarantees the debts of the others: Appen Limited Appen Butler Hill Pty Limited By entering into the deed, the wholly-owned entities have been relieved from the requirement to prepare financial statements and directors’ report under Corporations Instrument 2016/785 issued by the Australian Securities and Investments Commission. The above companies represent a ‘Closed Group’ for the purposes of the Corporations Instrument, and as there are no other parties to the deed of cross guarantee that are controlled by Appen Limited, they also represent the ‘Extended Closed Group’. Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 75 35. Deed of cross guarantee (continued) Set out below is a consolidated statement of profit or loss and other comprehensive income and statement of financial position of the ‘Closed Group’. Statement of profit or loss and other comprehensive income 31 Dec 2018 $’000 31 Dec 2017 $’000 Revenue Services purchased - data collection Employee benefits expense Depreciation and amortisation expense Travel expense Professional fees Rental expense Communication expense Transaction costs Other expenses Finance costs Profit before income tax (expense)/benefit Income tax (expense)/benefit Profit after income tax (expense)/benefit Other comprehensive income/(loss) Foreign currency translation Other comprehensive income/(loss) for the year, net of tax Total comprehensive income for the year Equity - retained profits Retained profits at the beginning of the financial year Profit after income tax (expense)/benefit Transfer to Profits reserve Retained profits at the end of the financial year 56,195 (6,629) (25,621) (1,393) (700) (1,661) (1,180) (1,546) 547 (3,608) – 14,404 417 14,821 (17) (17) 42,082 (7,844) (14,141) (339) (575) (994) (504) (748) (3,873) (1,599) (1) 11,464 (2,871) 8,593 66 66 14,804 8,659 31 Dec 2018 $’000 31 Dec 2017 $’000 – 14,821 (14,821) – – 8,593 (8,593) – Appen Limited 2018 Annual Report 76 Notes to the Consolidated Financial Statements continued 35. Deed of cross guarantee (continued) Statement of financial position Current assets Cash and cash equivalents Trade and other receivables Derivative financial instruments Income tax refund due Prepayments Non-current assets Investments accounted for using the equity method Property, plant and equipment Intangibles Deferred tax Intercompany loan Other non-current assets Total assets Current liabilities Trade and other payables Derivative financial instruments Income tax Provisions Revenue received in advance Non-current liabilities Borrowings Deferred tax Provisions Total liabilities Net assets Equity Issued capital Reserves Total equity 31 Dec 2018 $’000 31 Dec 2017 $’000 11,412 14,296 – 46 1,783 27,537 6,593 4,310 265 2,212 54,914 159 68,453 95,990 4,639 249 752 756 1,274 7,670 – 670 379 1,049 8,719 87,271 69,602 17,669 87,271 10,025 9,783 123 – 437 20,368 6,337 1,363 328 – 55,070 1,866 64,964 85,332 5,888 46 1,584 606 473 8,597 4 343 473 820 9,417 75,915 69,569 6,346 75,915 Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 77 36. Reconciliation of profit after income tax to net cash from operating activities Profit after income tax expense for the year Adjustments for: Depreciation and amortisation Net loss on disposal of property, plant and equipment Share-based payments Foreign exchange differences Transaction costs paid for acquisition Change in operating assets and liabilities: Increase in trade and other receivables Increase/(decrease) in trade and other payables Increase in employee benefits and provisions Increase in contract liabilities Decrease in provision for income tax Increase/(decrease) in deferred tax liabilities Net cash from operating activities 37. Changes in liabilities arising from financing activities Group Balance at 1 January 2017 Net cash from/(used in) financing activities Other changes Balance at 31 December 2017 Net cash used in financing activities Revaluation Other changes Balance at 31 December 2018 Facility A $’000 Facility B $’000 Lease $’000 – 51,808 (1,360) 50,448 – 5,882 – 56,330 – 16,861 – 16,861 (17,830) 969 – – 6 (2) – 4 – – (4) – Group 31 Dec 2018 $’000 31 Dec 2017 $’000 41,728 14,282 8,941 3 4,017 5,246 1,507 (29,652) 12,228 3,778 298 (1,891) 596 46,799 1,863 – 410 (975) 3,577 (9,166) (773) 5,198 521 (144) (1,409) 13,384 Total $’000 6 68,667 (1,360) 67,313 (17,830) 6,851 (4) 56,330 Appen Limited 2018 Annual Report 78 Notes to the Consolidated Financial Statements continued 38. Earnings per share Profit after income tax attributable to the owners of Appen Limited Group 31 Dec 2018 $’000 31 Dec 2017 $’000 41,728 14,282 Number Number Weighted average number of ordinary shares used in calculating basic earnings per share 106,324,919 98,150,474 Adjustments for calculation of diluted earnings per share: Options and rights over ordinary shares 1,932,042 1,275,102 Weighted average number of ordinary shares used in calculating diluted earnings per share 108,256,961 99,425,576 Basic earnings per share Diluted earnings per share 39. Share-based payments Performance rights Cents Cents 39.25 38.55 14.55 14.36 Long-term incentive plan The Company has developed a long term incentive plan (‘LTIP’) which incorporates performance conditions and was effective from 1 January 2015. The long term incentive plan provides for awards of Performance Rights to senior management, vesting at the end of a three year period and subject to an annual earnings per share non-market performance condition tested over each year within the three year period. Even if the EPS target is satisfied, the Performance Rights will continue, but will lapse if an employee ceases employment with the Company. Details are outlined in the table below. The fair value of the performance rights has been measured based on the share price at the date of the grant less the present value of the future dividend stream. The dividend stream has been based on a payout ratio of 30% - 46%, discounted at a discount rate of 2.25%. Appen Limited 2018 Annual Report 79 Balance at the end of the year – 303,273 252,327 113,914 464,718 – Notes to the Consolidated Financial Statements continued 39. Share-based payments (continued) Set out below are summaries of performance rights granted under the plan: 31 Dec 2018 Plan 2015 2016 2017 2018 2018 Special 2018 STI 31 Dec 2017 Plan 2015 2016 2017 Balance at the start of the year 520,040 423,160 315,390 – – – 1,258,590 Balance at the start of the year 820,648 544,575 – 1,365,223 Granted Exercised Expired/forfeited/ other – – – 113,914 464,718 83,334 661,966 (520,040) – – – – (83,334) (603,374) – (119,887) (63,063) – – – (182,950) 1,134,232 Granted Exercised Expired/forfeited/ other – – 315,390 315,390 (9,398) – – (291,210) (121,415) – (9,398) (412,625) 1,258,590 Balance at the end of the year 520,040 423,160 315,390 The weighted average remaining contractual life of performance rights outstanding at the end of the financial year was 1.16 years (2017: 1.00 years). Appen Limited 2018 Annual Report 80 Notes to the Consolidated Financial Statements continued 39. Share-based payments (continued) Overview of Performance Rights and Conditions Plan Grant date Expiry date1 Exercise price Tranche Performance measurement Performance target Performance target measurement date Target achieved2 Vesting condition Vesting date Value per right at grant date 2016 1 Mar 2016 N/A 2016 1 Mar 2016 N/A 2016 1 Mar 2016 N/A 2017 1 Mar 2017 N/A 2017 1 Mar 2017 N/A 2017 1 Mar 2017 N/A 2018 20 Feb 2018 N/A 2018 20 Feb 2018 N/A 2018 20 Feb 2018 N/A 2018 STI 20 Feb 2018 N/A 2018 Special 2018 Special 2018 Special 20 Feb 2018 N/A 20 Feb 2018 N/A 20 Feb 2018 N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A 1 2 3 1 2 3 1 2 3 1 1 2 3 EPS EPS EPS EPS EPS EPS EPS EPS EPS Completion of Leapforce acquisition EPS EPS EPS 10.0% End 2016 10.0% End 2017 10.0% End 2018 10.0% End 2017 10.0% End 2018 Yes Yes Yes Yes Yes Employed at 1 Jan 2019 Employed at 1 Jan 2019 1 Jan 2019 $1.41 1 Jan 2019 $1.41 Employed at 1 Jan 2019 Release of 2018 results $1.41 Employed at 1 Jan 2020 Employed at 1 Jan 2020 1 Jan 2020 $2.58 1 Jan 2020 $2.58 10.0% End 2019 Pending Employed at 1 Jan 2020 Release of 2019 results $2.58 10.0% End 2018 Yes Employed at 1 Jan 2021 1 Jan 2021 $8.15 10.0% End 2019 Pending 10.0% End 2020 Pending N/A Completion date 20.0% End 2018 Yes Yes 20.0% End 2019 Pending Employed at 1 Jan 2021 1 Jan 2021 $8.15 Employed at 1 Jan 2021 Release of 2020 results $8.15 N/A 20 Feb 2018* $8.15 Employed at 1 Jan 2021 Employed at 1 Jan 2021 1 Jan 2021 $8.15 1 Jan 2021 $8.15 20.0% End 2020 Pending Employed at 1 Jan 2021 Release of 2020 results $8.15 * 1 2 The equity-settled performance rights for the successful completion of the Leapforce acquisition on 7 December 2017 were vested immediately on grant date of 20 February 2018. Rights are automatically converted to shares on the vesting dates, assuming all the performance conditions of the plan and the employment condition are met. Target achievement table: EPS Target Achieved 100% or more of EPS Target 90-99% of EPS Target* Less than 90% * At the board’s discretion. % Performance Rights Allocated 100% 50-80% Nil Appen Limited 2018 Annual Report Notes to the Consolidated Financial Statements continued 81 39. Share-based payments (continued) The number of performance rights allocated to executives are: Plan 2016 2017 2018 2018 STI 2018 Special Total Options M Brayan No. K Levine No. T Sharkey No. 95,535 59,430 23,153 50,000 150,000 378,118 63,690 35,022 12,155 33,334 100,000 244,201 – – 8,518 – – 8,518 Subscription deeds The Options may be exercised for the exercise price specified on grant of the Option. The Options may only be exercised during the designated exercise period for the relevant tranche of Options. The Options may be exercised by lodging the option certificate, a signed exercise notice and an amount equal to the exercise price multiplied by the number of Options being exercised at the Company’s registered office. On exercise, the holder will be issued one ordinary share for each Option exercised. The Options lapse automatically: – if the Subscriber ceases to be a full-time employee of the Company, subject to the discretion of the Board; or – at the end of the designated exercise period for the relevant tranche of Options. The Company may, with 5 days’ written notice, elect to purchase all of the Options held by the holder for the “option value”, being the value of the shares that would be issued on exercise of the Options, less the relevant exercise price. Employee Share Option Plan The Board may invite employees of the Group to participate in the Plan. The Options may be exercised for the exercise price specified in the relevant invitation. The Options may only be exercised during a specified exercise period, after the vesting conditions and any other exercise conditions specified in the invitation have been met. The Options may be exercised by delivering an exercise notice to the Company and paying the exercise price. On exercise, the holder will be issued one ordinary share for each Option exercised. Each share acquired on exercise of an Option ranks equally in all respects with all other Shares. All unvested Options lapse automatically if the holder ceases to be employed by the Company. Any vested Options lapse automatically: – if the holder leaves the Company in circumstances which make them a “non-qualifying leaver” including termination for a material breach of their employment agreement, non-performance, fraud, wilful or serious misconduct; or – on the earlier of the expiry date of the Options set out in the invitation and the fifth anniversary of the grant of the Options. In the event of a reconstruction of share capital prior to the exercise of the Options, the number of Shares to be issued on the exercise of the Option and/or the exercise price must be reconstructed accordingly. A holder cannot dispose of their Options without the prior written consent of the Board. Appen Limited 2018 Annual Report 82 Notes to the Consolidated Financial Statements continued 39. Share-based payments (continued) Set out below are summaries of Options granted under the plans: 31 Dec 2018 Grant date Expiry date 31/08/2013 01/03/2019 24/12/2014 01/03/2020 24/12/2014 01/03/2021 Exercise price $0.494 $0.500 $0.500 Balance at the start of the year 81,800 13,281 13,281 108,362 Granted Exercised Forfeited* – – – – (40,900) (13,281) (13,281) (67,462) – – – – Weighted average exercise price $0.495 $0.000 $0.496 $0.000 * Options forfeited due to participants leaving Appen. All options above were granted under the terms of the Employee Share Option Plan. 31 Dec 2017 Grant date Expiry date 31/08/2013 01/03/2018 31/08/2013 01/03/2019 31/03/2014 01/03/2018 31/03/2014 01/03/2019 24/12/2014 01/03/2020 24/12/2014 01/03/2021 Exercise price Balance at the start of the year Granted Exercised Forfeited* $0.412 $0.494 $0.432 $0.489 $0.500 $0.500 81,800 81,800 20,450 20,450 119,531 438,281 762,312 – – – – – – – (81,800) – (20,450) (20,450) (106,250) (425,000) (653,950) – – – – – – – Balance at the end of the year 40,900 – – 40,900 $0.494 Balance at the end of the year – 81,800 – – 13,281 13,281 108,362 Weighted average exercise price $0.488 $0.000 $0.487 $0.000 $0.495 * Options forfeited due to participants leaving Appen. Set out below are the options exercisable at the end of the financial year: Grant date Expiry date 31/08/2013 24/12/2014 24/12/2014 01/03/2019 01/03/2020 01/03/2021 31 Dec 2018 Number 31 Dec 2017 Number 40,900 – – 81,800 13,281 13,281 40,900 108,362 The weighted average share price during the financial year was $11.645 (2017: $4.872). The weighted average remaining contractual life of options outstanding at the end of the financial year was 0.17 years (2017: 1.54 years). 40. Events after the reporting period Apart from the dividend declared as disclosed in Note 24, no other matter or circumstance has arisen since 31 December 2018 that has significantly affected, or may significantly affect the Group’s operations, the results of those operations, or the Group’s state of affairs in future financial years. Appen Limited 2018 Annual Report Directors’ Declaration 83 In the directors’ opinion: – the attached financial statements and notes comply with the Corporations Act 2001, the Australian Accounting Standards, the Corporations Regulations 2001 and other mandatory professional reporting requirements; – the attached financial statements and notes comply with International Financial Reporting Standards as issued by the International Accounting Standards Board as described in Note 2 to the financial statements; – the attached financial statements and notes give a true and fair view of the Group’s financial position as at 31 December 2018 and of its performance for the financial year ended on that date; – there are reasonable grounds to believe that the Company will be able to pay its debts as and when they become due and payable; and – at the date of this declaration, there are reasonable grounds to believe that the members of the Extended Closed Group will be able to meet any obligations or liabilities to which they are, or may become, subject by virtue of the deed of cross guarantee described in Note 35 to the financial statements. The directors have been given the declarations required by section 295A of the Corporations Act 2001. Signed in accordance with a resolution of directors made pursuant to section 295(5)(a) of the Corporations Act 2001. On behalf of the directors Christopher Vonwiller Director 25 February 2019 Sydney Appen Limited 2018 Annual Report 84 Independent Auditor’s Report to the members of Appen Limited Appen Limited 2018 Annual Report Independent Auditor’s Report continued 85 Appen Limited 2018 Annual Report 86 Independent Auditor’s Report continued Appen Limited 2018 Annual Report Independent Auditor’s Report continued 87 Auditor's responsibilities for the audit of the Financial Report Our objective is: • • to obtain reasonable assurance about whether the Financial Report as a whole is free from material misstatement, whether due to fraud or error; and to issue an Auditor's Report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Australian Auditing Standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error. They are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the Financial Report. A further description of our responsibilities for the audit of the Financial Report is located at the Auditing and Assurance Standards Board website at: http://www.auasb.qov.au/auditors responsibilities/ar1 .pdf. This description forms part of our Auditor's Report. Report on the Remuneration Report Opinion Directors' responsibilities In our opinion, the Remuneration Report of Appen Limited for the year ended 31 December 2018 complies with Section 300A of the Corporations Act 2001. The Directors of the Company are responsible for the preparation and presentation of the Remuneration Report in accordance with Section 300A of the Corporations Act 2001. Our responsibilities We have audited the Remuneration Report included in pages 14 to 25 of the Directors' report for the year ended 31 December 2018. Our responsibility is to express an opinion on the Remuneration Report, based on our audit conducted in accordance with Australian Auditing Standards. KPMG Tony Nimac Partner Sydney 25 February 2019 83 Appen Limited 2018 Annual Report 88 Shareholder Information 31 December 2018 Additional information required under ASX Listing Rule 4.10 and not shown elsewhere in this Annual Report is as follows. This information is current as at 7 February 2019. Distribution of shareholders The distribution of issued capital is as follows: 100,001 and over 10,001 to 100,000 5,001 to 10,000 1,001 to 5,000 1 to 1,000 Total Distribution of optionholders The distribution of unquoted options on issue are as follows: 100,001 and over 10,001 to 100,000 5,001 to 10,000 1,001 to 5,000 1 to 1,000 Total Number of shareholders Ordinary shares % of issued capital % 34 408 670 4,545 8,352 14,009 78,623,683 9,332,637 4,697,297 10,572,509 3,373,521 106,599,647 73.76 8.75 4.41 9.92 3.16 100.00 Number of optionholders Unlisted options – 1 – – – 1 – 40,900 – – – 40,900 % of total options % – 100.00 – – – 100.00 The options on issue are unquoted and have been issued under an employee incentive scheme. Distribution of performance right holders The distribution of unquoted options on issue are as follows: 100,001 and over 10,001 to 100,000 5,001 to 10,000 1,001 to 5,000 1 to 1,000 Total Number of performance rights holders Unlisted performance rights % of total performance rights % 3 10 13 36 6 68 723,982 234,214 88,309 84,687 3,040 1,134,232 63.82 20.65 7.79 7.47 0.27 100.00 The performance rights on issue are unquoted and have been issued under an employee incentive scheme. Less than marketable parcels of ordinary shares There are 149 shareholders with unmarketable parcels totalling 584 shares. Appen Limited 2018 Annual Report Shareholder Information continued 89 Equity security holders Twenty largest quoted equity security holders The names of the twenty largest security holders of quoted equity securities are listed below: HSBC CUSTODY NOMINEES (AUSTRALIA) LIMITED J P MORGAN NOMINEES AUSTRALIA PTY LIMITED C & J VONWILLER PTY LIMITED CITICORP NOMINEES PTY LIMITED NATIONAL NOMINEES LIMITED BNP PARIBAS NOMINEES PTY LTD CITIBANK NA NATIONAL NOMINEES LIMITED DAREN JACKSON NEW GREENWICH PTY LTD BNP PARIBAS NOMS PTY LTD GINGA PTY LTD SIDMOUTH PTY LIMITED AMP LIFE LIMITED CITICORP NOMINEES PTY LIMITED NAMAL (L) LTD BNP PARIBAS NOMINEES PTY LTD HUB24 CUSTODIAL SERV LTD DRP BNP PARIBAS NOMINEES PTY LTD MR WILLIAM JOHN LAUKKA & MRS ELIZABETH ANNE LAUKKA HSBC CUSTODY NOMINEES (AUSTRALIA) LIMITED-GSCO ECA Total number of ordinary shares on issue Unquoted equity securities The Company had the following unquoted securities on issue as at 7 February 2019: Options over ordinary shares issued Performance rights over ordinary shares issued Ordinary shares Number held % of total shares issued 22,741,189 19,135,085 11,060,083 7,086,084 5,422,524 1,960,541 1,672,696 1,390,100 1,115,130 1,000,000 870,003 500,000 400,000 372,327 349,386 300,000 280,323 271,032 250,229 236,015 21.33 17.95 10.38 6.65 5.09 1.84 1.57 1.30 1.05 0.94 0.82 0.47 0.38 0.35 0.33 0.28 0.26 0.25 0.23 0.22 76,412,747 71.69 30,186,900 106,599,647 Number on issue Number of holders 40,900 1,134,232 1 68 Appen Limited 2018 Annual Report 90 Shareholder Information continued Substantial Shareholders The names of the Substantial Shareholders listed in the Company’s Register as at 7 February 2019 as advised by notices lodged with ASX: C & J Vonwiller Pty Limited Vinva Investment Management Restricted securities Class Ordinary shares, in respect of the Leapforce acquisition Ordinary shares Number held 11,060,083 5,393,221 % of total shares issued 10.38 5.06 Expiry date Number of shares 7 December 2019 1,115,130 7 December 2020 557,566 1,672,696 Voting rights In accordance with the Constitution each member present at a meeting whether in person, or by proxy, or by power of attorney, or in a duly authorised representative in the case of a corporate member, shall have one vote on a show of hands, and one vote for each fully paid ordinary share, on a poll. Options and performance rights have no voting rights. On-market buy-backs There is no current on-market buy-back in relation to the Company’s securities. Appen Limited 2018 Annual Report Corporate Directory 91 Directors Christopher Charles Vonwiller – Chairman Mark Ronald Brayan – Managing Director and Chief Executive Officer Stephen John Hasker Robin Jane Low William Robert Pulver Deena Robyn Shiff Company secretary Carl Middlehurst (appointed 8 February 2019) Leanne Ralph (resigned 8 February 2019) Registered office Level 6 9 Help Street Chatswood NSW 2067 Tel: 02 9468 6300 Share register Link Market Services Limited Level 12 680 George Street Sydney NSW 2000 Telephone: 1300 554 474 Facsimile: (02) 9287 0303 Auditor KPMG Tower Three International Towers Sydney 300 Barangaroo Avenue Sydney NSW 2000 Stock exchange listing Appen Limited shares are listed on the Australian Securities Exchange (ASX code: APX) Website www.appen.com Corporate Governance Statement https://appen.com/investors/corporate-governance/ Appen Limited 2018 Annual Report Level 6 9 Help Street Chatswood NSW 2067 Tel: 02 9468 6300 www.appen.com