Xero Limited

Ladies and gentlemen, thank you for standing by, and welcome to the Zero Limited FY20 results. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question at that time, you'll need to press star 1 on your telephone. I'd now like to hand the conference over to your first speaker today, CEO Steve Bama. Thank you. Please go ahead.

Hi everyone, and thank you for joining us today for our briefing on Xero's financial and operating results for the year ended 31 March 2020. I'm Steve Damos, Xero's CEO, and I'm joined by our CFO, Kirsty Godfrey-Billy. We come together at a time of increased uncertainty and social and economic challenges due to COVID-19. So first up, I want to send you my best wishes and hope that you and those you care about are all safe and healthy. On today's agenda, I'll cover our performance during the year before passing to Kirsty who will run through the financial results in more detail. I'll then finish by covering our strategy and close with the outlook followed by Q&A. Before I go over Xero's performance, I'd like to spend a few minutes explaining how Xero is responding to COVID-19. The environment has evolved quickly over the past couple of months and is being felt in every aspect of our lives. This is particularly the case for our small business customers and advisors, being bookkeepers, accountants, and ecosystem partners who are facing significant pressure to adapt the way they operate. In addition to making sure our people are safe and effectively working from home, our focus has been and still is on supporting our customers and maintaining the quality and continuity of our 100% cloud-based products and services. Moving to slide five, this highlights some of the actions we've taken over the last couple of months. We temporarily closed our Xero offices globally and we're now fully operational from our homes around the world. Productivity remains high across our workforce and our engagement survey scores indicate that our people have adapted well to the new way of working. With the restrictions on travel and large-scale in-person events, we made the tough decision to cancel our annual XeroCon events planned for September in Sydney. As an alternative, we're planning an online experience around that time and expect to be back with Xerocon Sydney in 2021. We also moved quickly to help our customers and partners meet their immediate needs for information and support through a number of initiatives. We launched a business continuity hub on Xero Central with resources tailored to each region of the world. The hub includes content that provides help on business continuity planning, managing cash flow, live webinars as well, explaining how to access government support. We established a dedicated customer response team that's available 24-7 to provide case-by-case support and guidance. We've always given customers flexibility and provide those who are facing hardship with options to downgrade, suspend, or cancel their subscriptions. When customers who suspend are ready to return, the data is available to them to pick up from where they left off. We've also prioritized product development in key areas making changes in particular to simplify and automate the reporting and filing of financial data with government. By leveraging existing integration with government bodies, we're helping our customers with their eligibility requirements for benefits and with accessing funds from stimulus packages. And Kirsty will provide more detail on the actions we've taken regarding our own financial resources and cost structure. Slide six outlines what we're seeing in the market and what our customers are experiencing right now. You can see on the left-hand chart subscriber login activity from January through to the end of April. And with the exception of an expected dip in usage during the April Easter holiday period, overall usage levels across our markets remain stable. This is an important indicator for us because we see our subscribers continuing to benefit from the trusted Insight Zero offer soon. This also aligns with feedback we're getting from our accountant and bookkeeping partners that they are extremely busy helping clients at this time. As I mentioned earlier, we've also been impressed with how some of our customers have pivoted so quickly adopting digital models to change their way of doing business. One of my favourites is the event company Stage Kings, who responded to the increasing demand for work from home equipment by designing, producing and selling self-assembly stand up desks. At a headline level, we see indicators of accelerated interest and adoption of digital technology and different ways of working. Slide seven summarizes our financial results for the year. With COVID-19 falling late in the year, its impact on Xero's operating and financial performance for fiscal year 20 was modest. Xero's growth over the past year drove a range of strong financial results for the year. Operating revenue increased by 30% in FY20 to $718.2 million. 467,000 subscribers joined Xero over the past year, taking subscriber numbers to just under 2.3 million. Net profit after tax was positive for the full year for the first time at $3.3 million, while free cash flow was also firmly positive at $27.1 million, an increase of $20.7 million on the prior year. Our 26% increase in subscribers combined with a modest rise in ARPU, or average revenue per user, to just under $30 resulted in a 29% increase in annualized monthly recurring revenue to $820.6 million. The impact of COVID-19 was felt in the later stages of March, which will result in some drag on this measure. On slide eight, we've broken our subscriber and revenue results down by region. We monitor global cloud adoption rates closely and estimate the cloud accounting penetration remains at less than 20% globally, whilst Australia and New Zealand cloud penetration is well over 50%. It's important to remember that we're still early in our journey and many small businesses around the world are yet to make use of cloud accounting. Moving to slide nine, across Australia and New Zealand, subscriber numbers grew by 21% to exceed 1.3 million. AMRR for the region increased by 18% year on year. Subscriber numbers in Australia increased by 188,000 over the year to 914,000, a 26% increase year on year. This outcome reflected a strong first half performance boosted by single touch payroll, which is accelerating the digitisation of payroll compliance among small business employers across Australia. Momentum in the second half was also good, with the Australian business reporting its strongest ever second half level of subscriber additions. As Kirsty will discuss, operating revenue in Australia was impacted by currency headwinds, climbing by 23% year-on-year to 320 million. In New Zealand, net subscriber ads of 41,000 were down 18% on the prior year as the market reflects high levels of penetration. These additions saw subscriber numbers grow by 12% year-on-year to 392,000. Our focus on ARPU growth in the form of product upsell and additional platform solution add-ons continued to contribute well to operating revenue which increased by 19% year-on-year to $116 million, exceeding $100 million for the first time. Our New Zealand go-to-market strategy saw us engage more directly with small businesses through our nationwide roadshows, resulting in more than 1,500 small businesses attending our roadshows across New Zealand. Moving to slide 10, in international markets, collectively these regions grew subscribers by 32% year-on-year to just under 1 million subscribers, This reflects the growing geographic spread of our subscriber base. In the UK, we saw the business deliver strong results against an uncertain economic backdrop and continued political uncertainty. In addition, disruption from COVID-19 impacted on the final weeks of the year. UK subscriber numbers increased by 32% year on year, rising by 150,000 to 613,000. Net additions were consistent with the prior year, which benefited to a greater extent from making tax digital or MTD. Revenue in the UK increased by 54% to $184 million. For the UK business, the deadline set by HMRC for the first VAT phase of MTD are behind us. We launched zero tax during the year and remain focused on the potential for future government initiatives, driving greater need for digitized tax solutions for small business customers. In North America, we made continued progress in FY20 with subscriber numbers growing by 25% year on year to 241,000 and with net ads of 46,000 new subscribers. Revenues increased by 25% to 55 million or 19% on a constant currency basis. Our North American team continues to focus on developing our partner channel to grow subscriptions. We estimate we now have under 1.5 million small businesses connected with our accounting and bookkeeping partners. Since we acquired Hubdoc in August 2018, our Canadian business has become an important part of Xero. Canada's attractive market represents a very good opportunity for us, given its size and current low levels of cloud accounting penetration. The rest of world segments saw subscribers grow by 51% to 125,000, while revenues climbed by 43% to $43 million. The performance was broad-based with strong results in Hong Kong, Singapore and South Africa. On slide 11, you can see on the left-hand chart how our platform strategy continues to drive growth and change the composition of our revenue. Platform and other non-core accounting revenues accounted for 11% of total operating revenue in fiscal year 20, increasing from 9% in fiscal year 19. On the right-hand side of the slide, you'll see how the components of our revenue have grown over the last year. Platform revenues grew 82% year-on-year and include add-ons such as expenses, projects, payroll, and adjacent products like Hubdoc and financial transactions, which include invoice and bill payments. As our business evolves, so will these new revenue streams and the way we present them to you in the future. Specifically, our decision to bundle Hubdoc for all our business edition subscribers around the world is a major step towards our vision of code-free accounting and changes how our revenue composition is made up and therefore needs to be presented. Going forward, HubDoc will be incorporated into our core accounting revenues. Turning to slide 12 and a few key updates around products. In H2, we accomplished two significant milestones with HubDoc and Instafile. Our two most recent acquisitions being successfully integrated into Xero and launched as key components of our mainstream offering. With Hubdoc, our customers now have the powerful data capture and machine learning capabilities included in their Xero Business Edition subscription. Late in 2018, we acquired Instify in the UK to help us accelerate the development of our tax solution. In FY20, we formally launched the first phase of Xero Tax with a range of great new features at no extra cost to our UK partners. These changes make it much faster to prepare and submit returns. We also prioritise the release of two great feature pilots in response to COVID-19. These are short-term cash flow and business snapshot, and we're in the process of extending them to all Business Edition customers. We hope these features will help our customers at a time when cash flow visibility and insights are more important than ever. We're proud of the progress we've made, and we're pleased to be named an industry leader by global market intelligence firm IDC. Moving on to slide 13, we believe Xero can continue to grow our role in helping customers receive payments, pay bills, and get access to capital. We've made a number of announcements in these areas over the last year. On the receiving payments front, we announced worldwide agreements with Stripe and GoCardless as our partners. These partners, along with many others we're working with, offer contemporary features and functions that dial up speed, convenience and security of small business invoice payments. When it comes to bill payments, we announced two key launches during the year. In Australia, we received recognition alongside our partner NAB for an innovative bill payment solution. In the UK, we launched a similar partnership with TransferWise to offer bank agnostic bill payments via open banking. Automating bill payment processes using these tools really helps to simplify repetitive tasks reduce the risk of human error, and improve security. Gaining access to capital is often fundamental to the success of a small business. Xero with Partners offers a range of support throughout the life cycle of the business, from short-term working capital-related options right through to more traditional long-term lending. So with that, I conclude my business update, and I'll pass over to Kirsty to provide you with insight on our fiscal year 20 financials.

Thanks, Steve. Hello, everyone. I'm Kirsty Godfrey-Billy, Xero's CFO, and I'll now cover our financial results for FY20 in more detail. Before I get to my FY20 financial results, I would like to provide some detail on what we're doing to manage the business under the current circumstances. While there has been some easing and lockdown measures in some parts of the world in recent days, the COVID-19 environment continues to create many unknowns. To consider the near and long-term impacts on the small business economy in Xero, we're evaluating a number of revenue scenarios for both the year ahead and thereafter. These scenarios range from a severe downside outcome through to a more stable performance. The high-level inputs and assumption used in our modeling are outlined on the left side of the slide. Gross subscriber additions under each scenario are modeled using assumed macro conditions. as well as lead indicators external to Xero, such as web traffic volume, trials, business closures, and over time, the creation rate of new businesses. Subscription cancellations and other form of churns, such as downgrading, are models based on macro inputs, customer sentiment, and other feedback indicators. We have considered how we could recalibrate our spending and investment plans in line with the revenue scenarios while still driving towards our strategic priorities. You will see on the right side of the slide we show a breakdown of our expense base, which is based on our income statement disclosures, the majority of which are variable in nature. We've taken many actions to manage our cost structure, such as selective hiring arrangements, a pause in merit compensation, and vendor agreement reassessments. While our long-term strategy remains unchanged, we have undertaken some reprioritisation of our short-term investment and capital allocation decisions. We've also ensured that our investment spend in products and technology can adapt under all scenarios so that Xero is in a strong position to perform well in the post-COVID-19 world. Now moving on to our FY20 financial results on slide 16. With Xero's financial year ending in March, just as COVID-19 was starting to negatively impact the global economy, our FY20 performance was only modestly impacted. Hotline trends versus prior year period remained strong, with annualized monthly recurring revenue, or AMRR, rising by 29% to $821 million. The pace of AMRR growth seen in FY20 is broadly consistent with the momentum seen in recent periods, but the result was impacted. We took the decision to defer a planned price rise in the majority of regions that was scheduled to take place in March. Subscriber growth trends, while also strong, did slow somewhat in March, with our UK business most affected. The sources of growth in AMRR were also consistent with what we have seen in recent periods, with more than half of the uplift in AMRR coming from our international segment, as our global model continues to scale. As the right-hand chart shows, we delivered a good uplift in free cash flow, which increased to just over $27 million. This is a rise of more than $20 million from the prior year. This amount was equivalent to 3.8% of Xero's FY20 operating revenues and reflects our continued efforts to scale the business, as well as some conservatism in spending as COVID-19 took hold. This positive free cash flow profile means we have the flexibility to continue deploying capital towards strategic investments and initiatives. Our priority will remain to invest in preparing the business for growth. Moving to slide 17, we show how cash generation in the period and other movements contributed to total liquid resources of $686 million. This comprises cash and cash equivalents, short-term deposits including proceeds from convertible notes, and undrawn committed debt facilities. Operating cash flows increased by 46% versus the prior year to $167 million. well ahead of the EBITDA result for the year and indicative of Xero's strong underlying monetisation profile. Investing cash flows increased to $140 million, or 27% year-on-year, excluding M&A. Total cash and short-term deposits at 31 March 2020 were $536 million. Deducting our term debt liability of $425 million, in respect of the US $300 million convertible notes issued last financial year, our net cash position at the end of FY20 was $111 million. Our standby debt facility was refinanced with a three-year term and upsized by 50% to $150 million during the first half of the year. As Steve and I have already mentioned, COVID-19 creates uncertainty that is difficult to avoid. The cash we have on hand and additional liquidity we have access to, combined with the business's underlying capacity to generate free cash flows, provide comfort. We remain committed to realising our strategic ambitions and will invest accordingly. This will be in the form of targeted acquisitions and investments that extend and enhance our small business platform and ecosystem. It will also come through investment in product and technology development, we believe necessary to best position Xero for the post-COVID-19 economy. Moving now to our SAS indicators. On slide 18, we show how lifetime value per subscriber and the total lifetime value of Xero subscriber base has developed over the past year. Lifetime value, or LTV, is widely used across the business to track performance of value creation and aid strategic decision making. It is representative of the value created that is not captured elsewhere in our financial statements. Overall, LTV per subscriber was effectively flat over the year at $2,422, with increased gross margin and ARPU offset by some deterioration in churn. As was the case in the first half of the year, there were a couple of opposing trends that contributed to the ARPU outcomes that are worth revisiting. In Australia, we were able to introduce a new competitively priced payroll-only product to maximise the opportunity from single-touch payroll. STP still remains an attractive opportunity for us, and take-up has been strong. The success of our payroll-only product in Australia resulted in a small shift in product mix, and as a result, some downward movement on APU, which was further amplified by adverse currency movements. The new connections we established with these Australian customers give us the potential to offer further value-added services in the future. ARPU headwinds in Australia were partially offset by further positive progress on ARPU through upsell and cross-sell within New Zealand. Internationally, ARPU trends were positive on a constant currency basis, but markedly higher on a reported basis due to currency movements in the period. Churn deteriorated slightly versus the prior year. This was driven by stronger growth from our faster growing markets, including all international markets in Australia. With the above movements and the positive move in gross margin, we saw a small increase in LTV per subscriber. Subscriber numbers increased by 26%, taking total LTV added in the past 12 months to over $1.1 billion and our total LTV to just over $5.5 billion, up 27% on the prior year. On slide 19, I'd like to also provide detail on the SAS metrics that the business has delivered. CAC months indicate the time it takes for us to recover the upfront cost of acquiring a new subscriber through subscription payments. This increased slightly year on year from 13.6 months to 14 months, as higher growth markets increased their share of new subscriber additions in the period. An LCB to CAC ratio of 5.8 remains a very strong indicator of the significant value created by adding a customer to the platform. It means we've added almost $6 of lifetime value for every dollar we spend on CAC. This measure declined slightly year on year, with segmental trends slightly better in our international segment, offset by a small reduction in our Australia and New Zealand segment. Turning to slide 20. The strength of the underlying unit economics of our SAS business model has increasingly flowed through our financial statements over the last few years. FY20 segment contributions from both our Australia and New Zealand and international segments were pleasingly positive for a full year period for the first time. The Australian and New Zealand segment contribution grew by 53 million, or 24% year-on-year, exceeding revenue trends and demonstrating our ongoing focus on operating discipline scale. Our international segment achieved a first-time positive contribution margin for the full year. This improved by $32 million over the year to reach $27 million, which supported an increase in revenues of $88 million, or 45%. This outcome was due to the realization of scale-driven cost-to-serve efficiencies and greater sales and marketing spend leverage. Moving to slide 21, here we outline our summary income statement for the year, showing year-on-year changes from FY19. Operating revenue increased 30% in FY20 to 718 million. This was driven primarily by subscriber growth in all markets. Gross margin increased by 1.6 percentage points to 85.2%. EBITDA on a reported basis was 138 million, which is a 65 million improvement on the prior year. The EBITDA margin of 19.2% improved by 6 percentage points versus the prior year. or 2.8 percentage points excluding the impact of impairments. This reflects the continuing benefits of scale and efficiency improvements, particularly on our cost to serve in sales and marketing lines. We also reported significantly lower impairment charges, which at $1.4 million for the full year was $17 million lower than the prior year. I'm also pleased to highlight that we've reported a first full year accounting profit with a net profit after tax of $3.3 million. Now, before I cover the three largest expense items on the next slide, I wanted to flag that we have undertaken some investment in G&A in areas such as strategy and corporate development, which added around a point to our G&A ratio over the year. This additional spend is linked to our strategic priority building for global scale and innovation. Moving to slide 22, as we've already stated, we saw positive contribution margin progress in both our Australia and New Zealand and international segments. This contributed to improvement in gross margin that can be seen in the first chart on the slide. The gross margin continued to gain from cost-of-serve efficiencies and additional functionality that our cloud hosting provider offers. The increased use of self-serve features and machine learning capabilities within our customer experience portal, Zero Central, reduce the need to add headcount to support our growing customer base. In the next chart, you'll see we have delivered further improvement in CAC efficiency. CAC as a percentage of revenue reduced to 44%, down from 45% in the prior year. Looking to product spend in the third chart, as a percentage of revenue, product costs, including OPEX and CAPEX, increased slightly to 31%. As Steve has outlined, we announced a number of great product initiatives during the year, and the investment made was consistent with our preference for investing cash generated to drive long-term value. Looking beyond the COVID-19 environment, we anticipate the need to continue with our product and development plans, which could put pressure on associated efficiency ratios under certain scenarios. We would be comfortable doing this if needed to position ourselves with great products and services for the opportunities that could emerge. So with that, I'll hand back to Steve to take you through an update on our strategy before the outlook and Q&A. Thank you.