Xero Limited

Ladies and gentlemen, welcome to Xero's half-year results FY20 earnings call. I must advise that today's call is being recorded. There'll be a presentation followed by a question and answer session. I'll now hand you over to the first speaker today, Steve Bamos, Chief Executive Officer. Thank you. Please go ahead.

Well hello and thanks to all of you for joining us for Xero's financial and operating results for the half year to the 30th of September 2019. I'm Steve Vemos, Xero's CEO and I'm joined on our call by our CFO Kirsty Godfrey-Billy. This morning I'll share our latest performance highlights and the progress we've made against our strategic priorities during the period and then Kirsty will dive into the financial results in more detail before we move on to the outlook and Q&A. We're really pleased to update you today on Xero's performance in the first half. Our strong progress is evident across a number of areas including lifetime value, subscriber net ads and revenue. I thought we should start with subscriber growth on slide five. This first figure highlights the success we've had in the first half and underscores the cumulative progress we've made in recent years. A net 239,000 new subscribers joined Xero during the half. equaling our best ever result for a six-month period, which was the second half of fiscal year 19. Subscriber additions took the business through a significant milestone, 2 million. We ended the period with 2.06 million subscribers, up 30% on the same period last year. It's interesting it took more than a decade to add Xero's first million subscribers, but it's taken just two and a half years to add the next million, indicating the increasing momentum of our business. We've continued to drive the adoption of cloud accounting in New Zealand and Australia and we're expanding our presence in a number of international markets. Net subscriber ads of 130,000 during the half from Australia and New Zealand reflect a particularly strong performance from Australia. International net subscriber ads of 109,000 also increased markedly versus the same period last year. On slide six, we feature another highlight, AMRR, which is Xero's annualized monthly recurring revenue. AMRR increased by 175 million from the first half of fiscal year 19, and for the first time, exceeded three quarters of a billion dollars to reach $764 million. AMRR is an important forward-looking indicator of the value of our existing customer relationships and how our business is growing. Moving to slide seven, Here we have the main financial highlights for the period. We added more than $1.4 billion in lifetime value versus September 2018 to reach $5.4 billion in total lifetime value. Operating revenue for the half increased by 32% over the same period last year to $339 million. While subscriber numbers increased strongly, ARPU, or average revenue per user trends, were effectively flat. with a slight decrease of 0.4% to just under $31 and Kirsty is going to talk you through the underlying trends on ARPU later in this briefing. EBITDA excluding the impact of impairments increased by more than 90% or $31.4 million to $65.9 million. Moving to slide 8 and framing the remainder of my presentation are the three strategic priorities for Xero. These are to drive cloud accounting adoption, grow the Xero small business platform, and continue to build Xero for global scale and innovation. These haven't changed at the highest level we don't expect them to for some time. A tremendous amount of work has and continues to go on to further execute the initiatives supporting these priorities. Driving cloud accounting on slide nine is a core focus for us. And as our half-year results show, subscriber additions remain the single largest source of growth for Xero. We estimate global small business cloud accounting penetration is currently less than 20% in the countries in which we operate. So there remains significant headroom for growth, and we are incredibly excited about that. In Australia and New Zealand, we see aggregate cloud accounting adoption levels being over 50%. This is testament to our product innovation, the fact that Xero was born in this part of the world. The compliance needs of small business owners continue to play a big part in driving demand for cloud accounting. Government initiatives such as single touch payroll in Australia, payday filing in New Zealand and making tax digital in the UK all contributed to the 239,000 new subscribers added in the half. In addition to these growing digital connections between government and business, increasing adoption of cloud and innovation in financial services are significant trends that also support the growth of our business. Slide 10, and going around the regions, we see that Australia and New Zealand performed strongly in the period, with total subscribers now exceeding 1.2 million, an increase of 23%. AMRR within ANZ increased by 22% year on year. In Australia, subscribers increased by a net 114,000 and a half to 840,000. a 28% year-on-year increase. This was a new record for subscriber net additions for any region within a six-month period. Operating revenue performance in Australia was also strong, up 26% year-on-year. In New Zealand, where cloud accounting adoption is the highest in the world, our growth in subscribers remained strong at 13% year-on-year and in the period on 367,000. Subscriber net additions of 16,000 eased slightly versus the same period last year. The nine percentage point gap between operating revenue growth and subscriber growth in the first half of fiscal year 20 in New Zealand demonstrates progress we're making on upsell and adjacent product sales as we shift our emphasis to additional platform services such as payroll, expenses, projects and payments. Moving to the next slide. The results of our UK business in the half were strong. Our UK performance reflected the influence of HMRC's making tax digital initiative, which has sparked a shift in the way small businesses interact with government. Subscriber numbers in the UK increased by 51% year on year, and we added 73,000 subscribers in the half to reach 536,000 subs. Revenue in the UK also increased by 51% to 80 million. while AMRR grew by 56%. We're also heavily invested and we have also heavily invested to ready our customers for open banking and this has positioned us well in the UK and for similar initiatives in other markets. We see the open banking movement as positive for business and consumers alike. It will drive competition, innovation and create better value in financial services that drive or that small businesses rely on day to day. The pace of innovation within the FinTech space is exciting and we're pursuing potential opportunities to partner with others to deliver new financial services products. FinTech is going to feature in the announcements we're making next week at Xeracon in London where thousands of our partner community will be in attendance. We also opened a new office in Manchester earlier this week which complements our existing London and Milton Keynes locations. There's plenty of headroom for growth within the UK and it remains a top priority for Xero. Moving on to North America and slide 12. Our go-to-market team in North America continues to develop and execute our community-focused Partner Playbook that's proven successful in other markets. Subscriber numbers in North America increased by 21% versus the prior year to 215,000 subs, driven by steady progress in the US and our newer Canadian business. Overall North American operating revenues increased by 34% or 29% on a constant currency basis. In terms of forward looking indicators, year on year we have seen an uplift of more than 40% in partner channel capacity, that is being the number of small businesses we can reach through our partner community. We expect to see our strategy translate into revenue growth across North America as we gain further traction with new partners and drive increasing adoption. We're also encouraged by the level of engagement at our Xerocon San Diego event, which was held in June. We were joined at the event by more than 1,000 attendees, which is a positive indicator for the appetite and interest in Xero within the North America region. This under-penetrated market remains an attractive opportunity for us, with a huge TAM on offer. A key priority continues to be the enhancements of our local product fit and to build improved compliance functionality such as the work we've done on GST returns for Canada and tax mapping for the US. Now onto slide 13, the rest of world includes our businesses in Singapore, Hong Kong and South Africa. These markets remain a great opportunity for us and while still relatively new to the group, delivered impressive momentum during the half. Revenue for rest of world region grew 43% year on year and subscriber numbers grew 52% year on year to 99,000. Net subscriber ads more than doubled over the same period last year as we continue to benefit from our positioning and grow brand awareness in these growth markets. During the half, we launched a bank-free partnership with Hang Seng Bank, a leading provider for small to medium businesses in Hong Kong. In South Africa, the roadshows we hosted in Johannesburg and Cape Town during the half attracted over 1,200 attendees, which again is a great indicator of early stage interest and demand for Xerox. We also announced a number of alternative lending integrations in South Africa including with Bridgement, Retail Capital and Alula Lend, leveraging our global bank feed API. So that's a good segue to the next part of my presentation where I want to talk about our second strategic priority, the Xero Small Business Platform. The diagram on slide 14 is an illustration of the Xero platform and the surrounding ecosystem which is central to our strategy and future. I'll just take a moment to revisit the key elements of the diagram. Xero's birth in the cloud established us as a platform for collaboration between advisors and their small business clients. From these origins, we extended the platform beyond bank feed connections, which acted as the foundation stones to Xero's initial push into cloud accounting. By giving small business customers access to even better and more useful data and information regarding the financial performance and health of their business, The platform allows us to offer a much wider range of complementary services and applications. Growth of the Xero platform to date means we support more than 200 connections to banks and financial services partners around the world. We have more than 800 application solutions in our ecosystem and we support more than 50,000 users of Xero's API developer tools. This diverse and vibrant community gives our customers better access to data and insights to make their lives easier. We've also worked hard to develop a range of new partnerships that ensure even more opportunities for small business customers to benefit from being on the platform. For example, our app partner Figured in the agricultural space is working with us in a number of geographies beyond their Kiwi roots. Xero and Figured work together to support farmers and other agricultural business owners to manage their business and gain better access to capital. On slide 15 we show the progress and growth in the revenue performance of Xero's small business platform in the first half of fiscal year 20. The left-hand chart on this slide shows Xero's operating revenue composition and you can see from that slide that from there the platform and other non-core accounting revenues accounted for 11% of total operating revenue in the first half of the year, increasing from 9% of total revenue in the first half of fiscal year 19. The bar chart on the right-hand side shows the platform revenues in the form of add-ons like expenses, payroll, projects, Hubdoc, as well as FinWeb transaction revenues grew collectively by 116%. This growth reflects our focus on the small business platform and the work we're doing in areas such as payments. We're excited to have extended our existing partnership with global payments platform, Stripe. On slide 16, I want to reinforce how our platform strategy is core to everything we do, including and beyond cloud accounting needs. Our customers' data is at the heart of Xero. Small business customers interact on a day-to-day basis with the data in Xero by the actions they or their advisors take. Our ambition is to help and encourage small business owners to manage as many of their workflows on our platform as possible. This will enhance the quality and quantity of customer data. Leveraging our machine learning capabilities, we can further optimize and improve the applications we build and the workflows managed on the Xero platform, which in turn further enhance the quality of data in a virtuous circle. We can also use artificial intelligence to generate applications which surface insights for our small business customers based on the underlying data that has been generated, also bringing the wisdom of the crowd to the individual. These insights might inform our customers as to what they should worry about, could do better or should do next. Going beyond what they're doing each day to consider the so what and the now what is very important to delivering the ultimate value of Xero as a small business platform that provides our customers with trusted human insights. Having talked to the opportunity, it's great to be able to provide you with a couple of examples of actions we've taken in the half to drive our platform agenda on slide 17. Since we acquired HubDoc just over a year ago, we've been working on how we can bring HubDoc smarts closer to more zero customers. HubDoc can make a big difference for small business owners and their advisors, saving them a significant amount of time. Over the past year, we've already seen a marked improvement in speed and accuracy of both data ingestion and coding functions within HubDoc. In April, we extended and expanded our partnership with Stripe to continue helping people in small business spend less time chasing payments. Small business customers can now open a new Stripe account within Xero, and existing Stripe customers can also log into their Stripe accounts as they create an invoice. The typical benefit of using a PayNow option such as Stripe is that an invoice can be paid up to two weeks faster. Additionally, Xero's auto-pay feature works with Stripe to allow you to set up and receive recurring card payments for repeat billing customers. The new Stripe feed means every Stripe transaction can now be accounted for and reconciled with one click in Xero. These are and have been among the top requested features from customers and will address key moments in their day-to-day activities where things can be done simpler and smarter so they can get back to focusing on running their business. On slide 18, Our third strategic priority is really critical for us as Xero continues to grow and evolve and reflects the need for us to build today the capabilities that will support a business in three or four years will be significantly larger than we are today. We're focused on growing our talent and tuning all our business processes for operational excellence. During the first half of fiscal year 20, we continue to invest significantly in developing capabilities across technology, data, product management, strategy, and M&A, to mention a few. We've hired several senior and experienced people to enhance our talent pool in all these areas. At the leadership team level, during the period, Damian Tampling joined Xero as Chief Strategy and Corporate Development Officer from Deloitte, bringing significant technology and digital experience. Tony Ward joined as President of the Americas, bringing deep technology industry sales, marketing, and product management skills, having held senior positions at Microsoft and LinkedIn, And as Xero continues to evolve, our Chief People Officer role has been re-established as a standalone role reporting directly to me. Rachel Powell, who was previously Chief Customer People and Marketing Officer, has been appointed Chief Customer Officer, now responsible for our global sales and marketing functions and leading and developing them. Nicole Reed is now Acting Chief People Officer until a formal recruitment process is completed. Nicole recently joined Xero with human resource and organisational development experience across both the financial services and technology sectors, and I feel very fortunate to be working with a talented group of executives who have the skills and passion required to help Xero grow and continue to evolve. Coming to the next and final slide I'm presenting before I hand over to Kirsty, I wanted to touch on social and environmental impacts. As we've said previously, at Xero we believe that beautiful business also means being a good corporate citizen. So we're pleased to announce we've made some meaningful early strides towards our social and environmental ambitions in the first half of fiscal year 20. We've been actively working with ESG rating houses to improve our ratings such as those you can see on the slide. We're also announcing today that we're taking action to reduce Xero's emissions footprint and we'll offset 100% of Xero's carbon emissions across all areas of the business covering last fiscal year, 19, and on a go-forward basis from this year onwards. We're calling this program Net Zero at Zero, and we'll share more details about our carbon offset provider and projects as they're finalised. We're also looking forward to providing future updates on our investment in our social and environmental impact programs as we explore a range of initiatives such as employee volunteering and support for non-profit and for-purpose organisations. Xero's purpose is to make life better for people in small business, their advisors and communities around the world. This is a purpose we believe in and we are committed to. So with that, I conclude my business update and I'll pass over to Kirsty who will take you through the details on the financials.

Thank you. Thanks, Steve. Hello, everyone. I'm Kirsty Godfrey-Billy, Xero's CFO, and I'll now cover our financial performance for a half year in more detail. Turning to slide 21. Results for the first six months of FY20 are a great indicator of the business's continued top-line momentum, alongside an increasing number of strong financial performance indicators. Two of the most important financial metrics to us in terms of managing the day-to-day business are our annual monthly recurring revenue, or AMRR, when talking to the top line, and free cash flow when it comes to returns and efficient capital allocation. As Steve has mentioned, AMRR was a key performance highlight growing by 30% over the same period last year. Of this growth, more than half came from our international segment. This is further evidence of Xero's progress as a global business. Looking at the chart on the right, we recorded a positive free cash flow performance for the period. This was the first in Xero's history for an interim result. Free cash flow of $4.8 million was equivalent to 1.4% of Xero's first half operating revenues and an increase in dollar terms of $14.6 million on the same period last year. This positive evolution in our free cash flow profile is a strong indicator of the underlying trends as we scale the business. Positive free cash flows provides us with the flexibility to deploy capital towards investments and initiatives that support further growth and value creation. As we'll get into in the outlook, we continue to anticipate a positive free cash flow profile for the current year. Our priority will remain to reinvest or invest in growing the business in order to address the significant opportunities that lie ahead. Turning to slide 22. Positive contribution margins in both Australia and New Zealand and the international segments for the year signal that we're another step closer to really uncovering the long-term economics of our business model. In Australia and New Zealand, segment contribution grew 33 million, or 34% year on year. Contribution growth for ANZ continues to exceed revenue trends, and this highlights our ongoing operating discipline and scale benefits. What's exciting about our international segment is that we achieved a positive contribution margin in the half for the first time. This improved by $12 million over the year to reach $11 million, while supporting an increase in revenue of $40 million, or 46%. This outcome was due to the realization of scale and customer acquisition cost efficiencies, despite growth investment and a focus on subscriber additions. On slide 23, we show how lifetime value per subscriber and the total lifetime value of zero subscriber base has increased over the past 12 months. Lifetime value, or LTV, is a key metric used across the business to guide decision making on where and how to invest. It shows the value created that is not captured elsewhere in a financial statement. Overall, LTV per subscriber climbed 5% over the year to $2,619. This was driven by a lift in gross margin, while churn and ARPU trends were consistent at a group level with the same period last year. There were a couple of opposing trends that contributed to the APU outcome that are worth looking at in more detail. In Australia, the onset of single-touch payroll afforded us an opportunity to serve a fast-growing area of the market with a payroll-only product at a competitive price point. STP was extended to businesses of all sizes from the 1st of July this year, and we moved quickly to support the changes that many Australian employers were required to implement. The success of our payroll-only product in Australia resulted in a small shift in product mix and some downward movement on ARPU. The new connections were established with these Australian customers give us the potential to offer further value-add services in the future. The ARPU trend in Australia was offset by the positive progress on ARPU made in the period through upsell and cross-sell within New Zealand. Pleasingly, ARPU trends internationally were consistent with the same period last year. With the increase in LTV per subscriber and a 30% increase in subscriber numbers, total LTV added in the past 12 months was over $1.4 billion. I'm pleased to highlight that over $1 billion of that $1.4 billion was added in the last six months. This took our total LTV to $5.4 billion, up 37% from the previous 12 months, which is a great result. On slide 24, I'd like to give some more color on the compelling SAS metrics that the business is currently delivering. In the first half of FY20, CAC months of 12.3 indicate the time it takes for us to recover the cost of acquiring a new subscriber through subscription payments. An LCV to CAC ratio of 6.9 remains a very strong indicator of the significant value created by adding a customer to the platform. It means we have added almost $7 of lifetime value for every dollar we spend on CAC. This measure has improved over the last six months from 6.0 and from 6.2 this time last year. Moving to slide 25. Here we summarize our financial performance measures for the year, showing year-on-year changes from the first half of FY19. Operating revenue increased 32% to $339 million. This was driven primarily by subscriber growth in all markets. Gross margin lifted by a further two percentage points to 85%. EBITDA on a reported basis was $65 million, which is a $48 million improvement on the same period last year and a major and almost three-fold increase. This reflects the continuing benefits of scale and efficiency improvements, as well as the significantly lower impairment charges incurred, which at $1 million was $17 million lower than the same period last year. We've also reported a great bottom line accounting result with a first time interim net profit of $1.3 million. This is the second consecutive net profit we've had for a six month period after we achieved a positive net profit for the second half of FY19. I'll now break down some of the key trends within our financial performance, moving to the next slide. Here you'll see we've continued our gross margin improvement to 85.2%, an increase of 2.4 percentage points over the same period last year. It's pleasing to see this upward trend continue across the ANZ and international segments. Gross margin continues to reflect the efficiency improvements we've gained. This includes economies of scale realized in hosting costs and the use of machine learning for our customer experience portal, Zero Central, to deliver better service outcomes at a lower cost. In the next slide, you'll see we have maintained a focus on efficiency benefits in CAC and product spend over the half year. CAC is a percentage of revenue reduced to 43%, down from 45% in the same period in FY19. This result was achieved despite the continued significant investment in both new and existing markets. In addition, CAC spend over the past six months has included additional technical spending to help address single touch payroll in Australia and making tax digital in the UK. Looking to product spend, as a percentage of revenue, product costs, including OPEX and CAPEX, increased slightly to 31% over the same period last year. Product investment in the first half of FY20 targeted a range of initiatives that will support near-term products and customer objectives, as well as longer-term strategic and technological needs. We recently launched some exciting new product features including single sign-on, advisor app recommendations, in-app account provisioning, and Stripe transaction feeds. Moving to slide 28 on our cash generation and our capital position. As already mentioned, we delivered a positive free cash flow result in the first half of FY20 of $4.8 million, which is equivalent to 1.4% of Xero's first half operating revenues and an increase in dollar terms of $14.6 million. Operating cash flows improved significantly, coming close to doubling to $71.5 million, which, given a monetisation ratio in excess of 100%, shows the underlying quality of our EBITDA result. Investing cash flows for the period were $66.7 million, an increase of $21 million or 46% year-on-year, excluding M&A. In terms of our capital structure, total cash and short-term deposits at 30 September 2019 were $496 million. Our net cash position at the end of the first half was $101.4 million. The $300 million USD of capital raised last year from the convertible notes provides provides us with considerable flexibility to assess future investment opportunities. At the end of the period, we recognised a term debt liability of $395 million New Zealand dollars. We also renewed our standby debt facility during the half. The new facility has a three-year term and we increased its size from $100 to $150 million. We added two new global banks to the syndicate, HSBC and Citibank, and continue to be supported by the BNZ and ANZ. Despite the 50% increase in size, we were able to secure more flexible terms while maintaining broadly the same annual cost to zero. Although there are no immediate plans to draw in the facility, the scope has been expanded to include short-term liquidity requirements should they arise. The capital we have on hand, combined with the ongoing capital generated by the business, enables us to pursue acquisitions and investments that extend and enhance our small business platform and ecosystem. We're carefully reviewing future opportunities to do this through both organic and inorganic avenues as we continue to develop our strategy and apply our capital allocation framework. In summary, we've put together a really exciting strategic launchpad for growth. So with that, I'll hand back to Steve to comment on our outlook before the Q&A. Thank you.