Xero Limited

Thank you for standing by and welcome to the Zero Limited H1 FY21 results conference call. All participants are in a listen only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question you will need to press the star key followed by the number 1 on your telephone keypad. I would now like to hand the conference over to Mr Steve Vermoss, CEO. Please go ahead.

Well thank you and hello and welcome to our investor briefing covering Xero's financial and operating results for the six months ended 30 September 2020. I'm Steve Mamos, Xero's CEO and I'm joined by Kirsty Godfrey-Billy our CFO here at our headquarters in Wellington. Before I go over today's agenda I really do want to start by acknowledging the continuing uncertainties and challenges that COVID-19 has brought upon us all in different ways. I hope you and those you care about are all safe and well. On today's agenda, I'll provide a business update including our performance during the half before passing to Kirsty to cover our financial results in detail. I'll then close our presentation with an update on Xero's outlook before we move to the Q&A. So with respect to business update, let me start by giving an overview of Xero's results for the half. Business conditions during the first half of FY21 were challenging and highly uncertain due to the health and economic impacts of COVID-19. In reflecting on these operating conditions, we are pleased to report continued revenue growth of 21% and subscriber growth of 19% versus the prior year period. As Kirsty and I will discuss, the conditions in the period also saw positive movements in our profitability. which under more normal circumstances would have been offset by increased levels of spending and investment. Xero's total subscribers grew by 396,000 year-on-year to reach almost 2.5 million subscribers globally, and all our geographies recorded positive net subscriber additions over the half. Operating revenue increased to just under $410 million during the half. A 15% increase in annualized monthly recurring revenue, or AMRR, to $878 million was an outcome of the 19% subscriber growth offset by a small fall in ARPU, or average revenue per user, of 4%. Alongside the top line growth we're reporting today, Xero delivered a strong set of profit indicators. EBITDA of $120.8 million increased by 86% from the previous comparable half year period. Xero also delivered a net profit after tax of $34.5 million which was a $33.2 million increase following our first-ever full-year net profit in FY20. Free cash flow also improved by a similar degree, rising by $49.4 million to $54.3 million. These profit outcomes are a reflection of top-line growth combined with disciplined financial management during a highly uncertain, and I'd like to emphasize, unusual period. These results also reflect the ongoing support of our subscribers, underscore the importance of our service to them, and reflect some of the benefits of scaling our business. Kirsty will further elaborate on the approach we took to spending and investing during the period. Moving to the next slide, we maintained an intense focus on our customers and partners during the half. We prioritised and directed investment into product development and delivery across a number of areas. In September, towards the end of the half, we enhanced our small business starter plan and increased or removed the limits on plan inclusions. This allows us to better serve existing customers with less complex needs and to extend our product reach and serve more small businesses, including sole traders and new startups. We outlined our ongoing roadmap to Xero's practice management tools and delivered the first set of features in our vision of the next-gen practice. For example, in Xero HQ, we rolled out the monthly revenue export to make it easier for advisors to identify clients across their practice that needed government or additional support. We continue to build a platform experience for our partners that really streamlines their workflows from onboarding all the way to lodgements. We also announced further improvements to our existing integrations with payment service providers Stripe and GoCardless to make it even easier for small businesses to accept card and direct debit payments. At a time when sharing information and staying connected is more important than ever, we made sure to look after the well-being of Xero people as they transitioned to working from home and implemented a range of measures to support them in doing their best work for our customers and partners. We created our first ever digital customer and partner engagement series called Xero On Air, which covered key product announcements, shared best practices in how small businesses and accountants and bookkeepers were operating in response to COVID and insights into the current and evolving economic conditions around the world. We published zero small business insights research reports that showed how the small business economy was faring. These reports were based on zero anonymized and aggregated customer data across our largest markets, Australia, New Zealand and the UK. This data is being provided to governments and policymakers to help them understand the impacts of COVID on small business and plan for the future in supporting small business recovery. In navigating through COVID-19, we rolled out payroll product enhancements to ensure customers could efficiently administer their access to the latest government wage subsidies or other stimulus benefits. In Australia, for example, Xero is the first major cloud accounting provider to become JobKeeper-enabled for customers. Updates were also made to ensure other kinds of payroll changes were accommodated, such as new COVID-related leave types in the UK. We provided support to customers and partners where we could in areas including business performance, managing cash flow and helping them to apply for and access small business loans. A great example was a free business finance pack application which we developed to help our customers in New Zealand pull together the information they needed to apply for new finance. So moving to slide seven, I'll now elaborate a little bit on what we've seen in our customer base as they have traversed the COVID-19 environment. It has been a tough time for many businesses. It's also been different in each geography. However, it's clear from our observations that the small business community continues to demonstrate remarkable resilience and determination to get through this. The data on this slide show three customer activity indicators that illustrate what's been happening. Firstly, MRR, or monthly recurring revenue churn. We did see some elevation in churn over the first few months of the half, but it trended back towards pre-COVID-19 levels as the half progressed. As you can see from the table on the left, MRR churn stayed flat year on year at just over 1.1%. The second chart shows weekly usage levels by our subscribers based on average weekly logins per subscriber from January to September. These have remained steady overall, trending at levels similar to those before and during the onset of COVID-19. The third chart shows monthly invoice payment activity measured in total payment value where subscribers have attached a payment service such as Stripe or GoCardless. Invoice payment value for the second quarter of the financial year was up 33%. In the month of September, invoice payment value increased by 44% from the low seen in April. Overall, we're seeing that customers continue to make extensive use of Xero during challenging times and the business-critical tools for managing and administering small business finances have increased in relevance during COVID-19. While these metrics on the slide show that our customers have remained engaged over the six months to September, considerable uncertainty does remain and we'll continue to monitor conditions closely and respond to the operating environment with agility. So now moving to slide eight and framing the remainder of my presentation are Xero's three strategic priorities. These are to drive cloud accounting, which is about increasing the penetration of small business cloud accounting software. Secondly, to grow the small business platform, which is about extending and enriching Xero as a platform to help small businesses run their business. And then third, to build for global scale and innovation, which is about preparing Xero for realising our aspirations to become the most insightful and trusted small business platform. So first of all, to drive cloud accounting on slide nine, we're focused on executing our strategy to address the very significant long-term opportunity for Xero. We estimate the global rates of cloud accounting adoption still sit at less than 20% and that we are early in our journey. On this slide, you can see that the progress made in subscriber growth reflects a relatively less disruption from COVID-19 in the Australia and New Zealand segment when compared to the international segment. Let me cover each segment in more detail in the next two slides. Australia became Xero's first geography to pass through 1 million subscribers, growing 21% to reach 1.01 million subscribers. Revenue in Australia grew 18% to $184 million, or 17% on a constant currency basis. We were able to deliver this outcome with the support from a further push in the Australian Government's Single Touch Payroll, or STP, initiative for the smallest of employing businesses. Many small businesses also sought to become STP compliant in order to electronically apply for and access the Australian Government's JobKeeper wage subsidy payments. New Zealand also delivered a pleasing result with net ads in the half re-accelerating for the first time since the second half of FY17. Subscribers increased by 22,000 and a half, bringing total subscribers to 414,000, an increase of 13% year on year. Operating revenue also grew by 13% in New Zealand, which demonstrates ongoing opportunity for Xero in the market where we were founded. In New Zealand, we have seen an increased interest in partner migration to the cloud by those who have not yet adopted. We believe this is linked to the impact that COVID-19 has had on their practices This dynamic is also interesting because it could be an early indication of a potential for increased migration by later adopters as markets become more penetrated. Moving on to our international segment, the international segment broke through 1 million subscribers, another milestone that signposts the increasing scale of our global operations. This also came despite major markets in the international segment being more impacted by COVID-19 disruptions over the last six months. To break it down by region, in the UK we continue to make progress in the half, growing subscribers by 19% to 638,000. However, in making comparisons to the prior year, keep in mind the net additions were boosted last year by the first phase of making tax digital, or MTD, for VAT. Revenue in the UK increased by 33% to 107 million. During the half, the UK government revised its compliance deadlines for the next phases of MTD. These are now coming up in April 2022 for the second wave of VAT and April 2023 for income tax. We expect this to be a further catalyst for small business digitisation and cloud adoption and continue to prepare for the upcoming phases of MTD with further development of our zero tax product in the UK. In North America, we also saw continued growth and progress. A North American business passed a quarter of a million subscribers in the half, growing by 17%. Revenue grew to $29 million, an increase of 4% on the prior year. As Hubdoc subscriptions were most concentrated in North America, there was a more pronounced impact to revenue from the bundling of Hubdoc into core subscriptions near the end of FY20. The absence of any North American zero-con revenues also reflected in this revenue outcome. Without the impact of these factors, revenue growth in North America would have been in line with the growth seen in subscribers. Beyond the wider disruption from COVID-19, North America was also impacted by a prolonged tax season in the US. The end of the US tax season is usually a catalyst for new subscriptions. However, this year's deadline was extended from April to July due to COVID-19, which meant partners had less time than usual to migrate or onboard clients. We also signed a bank feed agreement with Bank of America, which completes our coverage of all top tier banks in the U.S. We continue to focus on growing subscribers through our partner network in the U.S. and Canada. And partner channel capacity continues to expand to over 1.5 million estimated small businesses in the half. Before I move on from North America, I also wanted to flag that we recently launched Canadian dollar billing for our Canadian customers as part of our local product market fit playbook. In the rest of the world markets, South Africa and Singapore, two of our newer geographies, contribute to total subscribers across the rest of the world, growing 37% to 136,000 and revenue growing 38% to $27 million. Government initiatives continue to drive the digitization of small business compliance in Singapore, including incentives related to the adoption of e-invoicing under the e-invoicing registration grant and other software solutions under the Digital Resilience Bonus, which was introduced during COVID-19. And in South Africa, we've signed a bank feed agreement with a major South African bank, Nedbank, and released improvements to our VAT solution, enhancing our local market product fit in South Africa. Now moving to the next slide. Our second strategic priority is to grow the small business platform. And platform revenues comprise 6% of total group revenues, which is the same percentage as a year ago, however reflecting the inclusion of Hubdoc in our core business edition products now. Looking beyond this one-time revenue movement related to Hubdoc, the actual growth of the other two contributors to platform revenues was more than 50%. Our ambition remains to grow the small business platform and drive growth through additional revenue streams including adjacent products such as payroll expenses and projects and financial services related revenues such as payments and bill payables. Also with our physical events like Xeracon and roadshows which we typically hold in the period, non-recurring revenues fell by 87% when compared to the prior year. Now with this in mind I'd like to touch on our recent acquisition of WADL. We announced this acquisition back in August and completed it in October, after the end of our half-year balance date, and as such, there is no Wattle-related contribution to our H1 results. Wattle is a cloud-based lending platform that helps small businesses access capital through invoice financing by addressing pain points in the traditional invoice lending process. For a small business, this means they're able to unlock capital that's otherwise tied up in their invoices to get access to finance, and often, This means they can source working capital for their business without having to put up their own home as security for loan. WADL aims to streamline the flow of information interaction between the small business customer and the lender, automating many of the manual processes involved in assessing credit, underwriting and monitoring. The access to a small business customer's accounting data that a lender gets through a connection to a platform like Xero is at the core of the proposition with WADL. Currently with a presence in Australia and the UK, we are excited about the potential benefits that Waddle can bring over time to our customers and banking partners around the world. We're keen to have a range of lenders participate on the platform. Greater choices benefits for our small business customers. We're excited about this acquisition. We'll continue to grow the small business platform to help solve the customer financial needs like managing cash flow and accessing capital. So I'll now close my presentation by outlining some of the progress we've made against our third strategic priority, which is to build Xero for global scale and innovation. As I outlined at our FY20 results, for Xero to scale and innovate effectively and at speed, we need to really focus on the strategic investments we need to make to drive this outcome. We made good progress during the half in a number of investment areas that support this priority. When it comes to attracting, inspiring and retaining world-class talent, Despite COVID-19, we continue to build and enhance our people capabilities by acquiring new talent and developing our teams. In particular, we focused on hiring people in our technology, data and product teams. Optimising Xero's operational financial structure is effectively a continuous improvement project that alongside our work on talent, considers how the right people are doing the right things in the right way within our business. I've previously detailed changes we made to the operation of our global sales and customer functions under Xero's Chief Customer Officer, Rachel Power. In the half, Rachel and her team have continued to ensure that there's alignment of global and regional sales and customer teams as Xero's customer base grows globally. As Kirsty will outline shortly, when it comes to our financial structure, we ended the half in a strong financial position. Our need to assess the capital requirements to execute our strategy remains an ongoing area of focus. I also wanted to highlight the progress we've made in integrating and aligning our social and environmental impact activities with our wider business functions. Our efforts in this area are an important element of pursuing Xero's purpose, which is to make life better for people in small business, their advisors and communities around the world. This is a purpose we believe in deeply and drives us to do what we do. Our approach is outlined by the framework shown on this slide and I wanted to elaborate briefly on three elements. When it comes to the environment, we remain committed to maintaining a net zero carbon footprint through our carbon offset program, Net Zero at Zero. In terms of our communities, in July we launched the Zero Community Appeal that supports multiple charities across our regions around the world. And in the center of our framework are our people. During the half, we appointed a global head of well-being who's dedicated to developing and leading programs that provide our people with the support they need. With that, I'll now hand over to Kirsty, who is going to take you through the financial results.

Thanks, Steve. Hi, everyone. I'm Kirsty Godfrey-Billy, Xero's CFO, and I'll now take us through Xero's financial results for H1 in further detail. As we outlined at the FY20 results back in May, in the uncertain COVID-19 environment, we have taken a somewhat different approach when it comes to running the business. To recap, at the start of this financial year and just after COVID-19 was declared a pandemic, we implemented a scenario-based spending and investment plan. This approach looked to manage the business for a range of potential revenue scenarios while continuing to drive progress on our strategic priorities. I'm really pleased to report today that this approach has had a positive impact on performance over the last six months, with Xero reporting strong EBITDA, net profit and free cash flow results. However, it's important to consider that should we see a return towards more normal operating conditions, we would expect to see an increase in our spending and investment levels as we look to address the opportunity. In particular, this would result in higher sales and marketing costs with a resultant shift in our profitability indicators. In terms of the headline financial measures, the top-line results we are reporting today reflect the resilience of Xero's business model and that of our customers and partners. Annualized monthly recurring revenue, or AMRR, increased by 15% versus H1FY20 to $878 million. The growth seen in AMRR reflects the 19% growth in subscribers, offset by a 4% drop in APU versus the prior year period. The year-on-year movement in ARPU was driven in part by the previously communicated decision to bundle Hubdoc into all business edition plans and to defer a related price rise in the majority of regions from March 2020. This change was undertaken prior to the end of FY20 and so, when compared to the end of FY20, H1 ARPU was effectively unchanged at the group level. When it comes to profitability indicators, EBITDA for the half almost doubled to $121 million. This was a record result for a six-month period, but as I've mentioned and will discuss further, specific factors have contributed to this outcome. Free cash flow for the half increased markedly, rising from $5 million to $54 million over the prior year period. This is equivalent to 13% of Xero's first-half operating revenues and reflects the top-line progress made combined with the dynamic and relatively conservative spending and investment plan the business has operated under. It remains our priority at Xero to reinvest significant majority of capital generated by the business to drive long-term growth. The additional funds generated during the half, combined with our existing liquid resources, represent significant optionality as we drive the business forward. On slide 16, zero SAS metrics continue to show the strength of the business model, despite the difficulties of the COVID-19 environment. I'll discuss each of the customer-level metrics on the left-hand side before moving to the group-level movement and total lifetime value, or LTV. ARPU of nearly $30 was flat against the prior half, with a 4% year-on-year decline as already discussed. As Steve has already mentioned, churn varied in the half, but an aggregate was consistent with the first half of FY20 at 1.1%. Gross margin increased slightly to 86%. In aggregate, these changes brought about a 3.9% reduction in LTV per subscriber versus the same period last year to just over $2,500. Total lifetime value increased by 15% over the last 12 months to reach $6.2 billion, adding almost $800 million. When it comes to CAC or customer acquisition cost, our reported efficiency metric were as follows. CAC months increased from 14 months at the end of FY20 to 14.9 months, and LTV to CAC decreased slightly from 5.7 to 5.7 from 5.8. Most of the softness in our CAC efficiency measures came in our international segment, where the business was more impacted by COVID-19 disruption when compared to the Australia and New Zealand segment, where our CAC efficiency measures actually improved. It's important to note that CAC spending in any period targets both future growth as well as the subscribers added in that period. Against a tough backdrop, reported SAS metrics continue to demonstrate the resilience of Xero's business model. Gross margin improved slightly versus the prior year period, driven by continuing efficiencies in Xero's customer support team and minor improvements in security and bank fee costs. The second chart shows a marked shift in CAC trends that reflects the settings under which we have run the business, and also the slower rate of subscriber growth seen over the first half of the year. CAC is a percentage of revenue reduced by more than 11 percentage points to an all-time low of 32%, down from 43% in the prior year period. As I have already mentioned, this trend is largely a function of the current circumstances and does not represent a change in how we are running or plan to run the business. Looking to product spend in the right-hand chart, as a percentage of revenue, product costs, including both OPEX and CAPEX, increased to 34%. This was a two percentage point increase on the prior year period and reflects our unwavering prioritisation of investment into product development and commitment to support customer needs as signalled at the end of FY20. Turning to slide 18, H1 segment contributions from both our Australia and New Zealand and international segments increased markedly. This was primarily due to the responsive spending and investment management approach we have taken in the period. The Australia and New Zealand market segment contribution grew by $38 million, or 29% year-on-year, to $169 million. Revenue growth for this segment of 17% was achieved alongside a conscious focus on cost, particularly in the first few months. This resulted in an absolute fall in sales and marketing costs, but the segment still added 122,000 subscribers, similar to the level of additions achieved in H1 FY20. This demonstrates the benefits of our focus on CAC efficiency in our most developed markets and the opportunity which still exists within these markets. In our international segment, there was also a significant improvement in contribution. This was again due to a fall in sales and marketing spend that would otherwise be expected to rebound under more normal operating conditions. The decline in CAC spend combined with a 28% increase in revenues for international contribution improved by $40 million to $51 million over the prior year period. Echoing my earlier comments, I also wanted to briefly mention how we might expect contribution margins to evolve going forward. Contribution margins incorporate the cost to serve customers in each segment and the cost of growing the subscriber base through sales and marketing, or CAC. All else being equal, we would expect to return to higher rates of subscriber growth in both the current and future periods to be driven by a necessary increase in sales and marketing expenditure. This, in turn, would moderate any improvement in segment contribution results over the short to medium term. Moving to slide 19. Here we have a summary income statement for H1 showing year-on-year changes from H1 FY20. There are some different outcomes this half year that I'd like to highlight. Operating revenue increased 21% to just under $410 million. This result connects relatively closely to the 19% growth seen in subscribers across all markets. Revenues were impacted by the absence of non-recurring revenues, which declined to almost nil, primarily due to cancellation of planned in-person events such as Xerocon Sydney in the first half. XeroCon revenues are typically offset by costs within the sales and marketing line. In addition, our XeroCon UK event, originally planned for later this month, has also been cancelled. As I've already called out, gross margin improved versus the prior year period by 0.5% to 85.7%. Moving to expenses, I want to mention a couple of specific examples of variable expense management that contributed to our performance. Advertising and marketing costs declined by 46% from $50 million to $27 million, and travel-related costs fell by 99% from $8 million in H1FY20. Further detail of our expenses can be found in Note 5 on page 27 of the interim report. EBITDA for the first half was $121 million, which is a $56 million improvement year-on-year. The EBITDA margin of 29.5% improved by 10 percentage points year-on-year. The significant margin improvement has flowed down to the bottom line with our fourth consecutive net profit for a six-month period of $34.5 million. Moving to slide 20, cash generation and other movements in the period brought total liquid resources to $723 million. These consist of cash and cash equivalents, short-term deposits including proceeds from convertible notes, and also the undrawn committed debt facilities. Operating cash flows increased by 77% over the prior period year to $127 million, ahead of the EBITDA result and indicative of zero strong monetization profile. Investing cash flows increased by 9% to $72 million. Spending on fixtures and fittings was an example of spend that has been largely paused. Cash flows relating to the acquisition of water will be presented in our FY21 accounts as the transaction closed in October after this period end. Total cash and short-term deposits at September 2020 were $573 million. Deducting our term debt liability of $395 million associated with the US $300 million convertible notes we issued in 2018. Our net cash position at the end of the half was $178 million, up from $101 million at the end of H1 FY20. The uplift in our cash position has strengthened our liquid resources. However, as Steve has already mentioned, we remain focused on optimising Xero's financial structure. This is to ensure we have the right settings to power growth and deliver on our strategic priorities. We continue to prioritise reinvestment of capital generated and we don't believe this position will change for some time. This is driven by the potential we have to create significant long-term value through successful execution of our strategy. When it comes to organic growth, most of our investment will focus on the areas of go-to-market and product development. We also continue to evaluate potential investment opportunities that can extend and enhance our small business platform and broader ecosystem. I'll now hand back to Steve to take you through our outlook before we move on to Q&A. Thank you.