Xero Limited

Thank you for standing by and welcome to the Xero Limited full year 2022 results conference call. I'm joined by Xero's Chief Executive Officer, Steve Vamos, and Chief Financial Officer, Kirsty Godfrey-Billy. 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 one on your telephone keypad. Please limit your questions to one question at a time. If you wish to ask a further question, please rejoin the queue. I would now like to hand the conference over to Steve Ramos, CEO of Xero. Please go ahead.

Kia ora. Tēnā koutou katoa from Wellington, New Zealand. Thank you for joining our investor briefing today covering Xero's financial and operating results for the year ending 31 March 2022. I'm Steve Ramos, the CEO of Xero, and I am with Kirsty Godfrey-Billy, our CFO. The first item on our agenda is a business update including a review of Xero's performance during the year. I'll then pass to Kirsty to cover our financial results in detail before I finish with Xero's FY23 outlook and then we'll move to Q&A. FY22 has been another very important year for Xero and we're really pleased with our strategic progress and financial performance. Our financial performance has been strong. The group's revenue growth profile rebounded, and our SaaS metrics, a measure of the value of our customer base, remain robust with good progress on subscriber growth and average revenue per user, or APU. This performance reflects investment over a number of years in pursuing the very large opportunity we have. The use of digital solutions by small business is continuing to gather pace. We are confident in our strategy to drive cloud accounting adoption, supported by significant trends, such as government initiatives to encourage digitization and innovation. So moving to a summary of our results on slide five. As I said, this is a strong result. Operating revenue exceeded the milestone of $1 billion, rebounding to grow 29% on the prior year, including 5% from acquired businesses. Subscribers grew to 3.27 million, up 19% on the prior year, Net subscriber additions totaled 530,000 over the year. Annualized monthly recurring revenue, or AMRR, grew to exceed $1.2 billion, increasing 28%, largely reflecting subscriber growth of 19% and higher ARPU. ARPU increased 7% versus the prior year. Kirsty will talk more about our actions that contributed to this movement in her remarks. Subscriber lifetime value, or LTV, increased to $10.9 billion from $7.6 billion, driven by good progress on subscriber growth, higher ARPU and monthly churn, which remains below pre-COVID levels at 0.9%. EBITDA increased 11% versus the prior year to $213 million, reflecting a balance between gross margin expansion, which increased to 87.3%, and increased operating costs in line with our outlook for the year. We reported a net loss of $9.1 million, which was down 29 million on the prior year, and free cash flow declined 55 million to $2.1 million, and these outcomes were consistent with our preference to reinvest capital generated back into the business. Our ability to invest is a function of the strength of our business model and sustained revenue momentum, which is shown on the next slide. You can see in the chart that Xero has delivered a high level of annual top-line growth against what has at times been a challenging backdrop. The rebound in revenue growth this year reflects subscriber growth, price changes during the year and higher contribution from platform revenues. Platform revenues grew 113% or 43% if we adjust for businesses acquired during the year, as take-up and usage of our financial services offerings and adjacent products continue to grow. Platform revenues are now at 11% of operating revenues, up from 7% in FY21. Our continued expansion in platform revenues is evidence of our success in executing our strategy. Moving to slide seven, I'd like to spend some time discussing the activity indicators for the three largest elements of platform revenues, plan day, payroll and payments. Plan day continues to perform well. We're working towards a launch in Australia and rolling out a closer integration between Plan Day and Xero for the UK market. On the left, we show the number of Plan Day employee users each quarter since March 2021. Average employee users increased by approximately 19% from the prior year period in the three months to end March 2022. The middle chart shows employees paid through Xero Payroll over the same time. This has grown by 19% since this time last year. across Australia, New Zealand and the UK where we offer this product. The right-hand chart shows monthly invoice payment value has grown by 41% since March 2021. I'd now like to discuss the results of our operations by geography. So starting with Australia and New Zealand on slide 8, both countries delivered ongoing momentum in subscriber and revenue growth, a pleasing outcome in markets where cloud adoption is relatively high and demonstrating the potential for our international segment. In Australia, revenue increased by 26% to $483 million. We added 229,000 subscribers in the half, reaching 1.34 million subscribers in total. New Zealand revenue increased by 15% to $149 million. We added 66,000 subscribers in the half to reach 512,000 subscribers in total. As I said earlier, Australia and New Zealand are well ahead of our other markets in terms of the adoption of digital solutions by small business. We continue to see further support from government initiatives such as the technology investment boost in the recent Australian budget. Turning to our international segment, starting with the UK, revenue increased by 30% to $292 million. Net subscriber additions of 130,000 for the period brought subscribers in total to 850,000. We are well positioned in the UK and continue to deliver product enhancements such as our personal tax product this year. Revenue growth was pleasing, however second half subscriber growth was disappointing. This reflected a subdued Q3 due to partner channel productivity and service related challenges. Performance did improve in Q4. Additionally, take up expected from the final stage of MTD for VAT has been slower to materialize than expected. And from what we can see, this is industry-wide and points to the potential for delayed sign-ups in FY23 to materialize. While on the back of FY22, there's reason to be cautious. We go into FY23 with confidence and believe fundamentals for the long term remain very good, with further rounds of making tax digital ahead and overall cloud accounting penetration still low in this very important market. In North America, we added 54,000 net subscribers, and subscribers reached 339,000, which is up 19% on the prior year period. Revenue increased by 28% to $73 million. In constant currency, revenue grew 31%. We continue to further invest in the localization of our product to North America, as evidenced by our acquisition of Locate Inventory last half and the tax cycle acquisition more recently. We've signed a partnership with cloud-based tax compliance solutions provider Avalara, and we'll give further details of this at Xerocon New Orleans in August. In our rest of world markets, revenue grew 85% or 90% in constant currency to $100 million. This included the majority of the revenue contribution from plan day. We ended the period with 226,000 subscribers in rest of world after adding 51,000 during the year. So we are pleased with operational progress and the revenue momentum we're delivering. Over the next few slides, I'm going to update you on the progress we've made on key elements of executing our strategy in the year. Our strategic priorities are to drive cloud accounting adoption, grow the small business platform, and build Xero for global scale and innovation. Let me touch on each of these. We continue to drive cloud accounting adoption. As we've said before, we estimate the total addressable market is more than 45 million small businesses in the markets we operate in currently. With low levels of adoption, this reflects substantial opportunities in our international segment. We also see further opportunities for growth in our more established regions, Australia and New Zealand. We're making good progress in growing the small business platform. Small businesses are increasingly seeking services beyond cloud accounting, and we're responding to this with investments to extend and enrich Xero's platform products and the wider ecosystem. To fulfill our purpose, we need to continually invest to build capabilities that enable innovation and our people to work productively at global scale. A key focal point has and continues to be investing in our people and acquiring new talent. On this front, we've had our biggest year yet in talent acquisition. Touching briefly on recent acquisitions, we've made good progress on the four businesses we acquired this financial year. PlanDay, TicStar, TaxCycle, and Locate Inventory. Overall, these contributed $41.7 million of operating revenue in FY22. Acquired in FY21, Wattle is a business with an early stage revenue profile, which we have reduced after consideration of the progress made during FY22. Kirsty will talk more about the detail on the related accounting adjustments. And while we're disappointed with this outcome, we continue to have confidence in the Wattle platform and the opportunity to provide small business customers with access to capital. I'd now like to touch on two areas of investment in our strategy this year in a bit more detail. Firstly, as I mentioned earlier, we continue to invest in the localisation of our product for North America to better meet our customers' needs. Our product roadmap is key to our execution in North America, supported by acquisitions such as TaxCycle and the partnerships such as the one I just mentioned with Avalara. Regarding tax cycle, the opportunity in Canada is very attractive. There are a number of similarities between Canada and other countries where Xero has been successful to date, including the tax systems and the role that accountants and bookkeepers play in supporting small businesses. Canada has a TAM, total addressable market of opportunity of about 4 million small businesses and low levels of cloud accounting adoption. representing a very important opportunity for Xero. We first established a presence there in FY18 and now have office locations in Toronto and Calgary with a team of more than 200 people. It was great for me to be able to visit for the first time in over two years last month. The acquisition of TaxCycle in December 2021 provides immediate access to an income tax product that increases our relevance and connections with accountants and bookkeepers in Canada. This is also a step up in localisation by adding end-of-year tax capability in key filing categories with support for others to come. Now on slide 12, I want to spend a little bit of time on the achievements we've made this year attracting talent. As I said earlier, Xero had its most successful year ever in terms of talent acquisition in FY22. In a competitive hiring market, we've expanded our global team to 4,784 FTEs, And with a focus on product and technology talent, our FTEs increased 31% year on year, or 24% excluding acquired businesses. Our ability to attract people to Xero reflects how our purpose to help make life better for people in small business and their advisors resonates with candidates, along with other aspects of our strong employee value proposition. These include the ability to continue to leverage our global footprint, our flexible working policy, and fully remote roles which we introduced in August for product and technology roles and have already seen 25% of those hires choose to work this way since. So in conclusion, we're pleased with our progress on strategy. So I'll now pass to Kirsty to cover our financial results before coming back to you to talk about Xero's FY23 outlook.

Thanks Steve and hi everybody. I'll now provide some further detail on our financial results for FY22 starting on slide 14. The full results Xero has delivered show rebounding growth across the group following the disruption seen over the last two years. As you can see on the left, subscriber growth of 19% and APU increases of 7% contributed to an AMRR increase of 28% to just over $1.2 billion. The chart in the middle and on the right show EBITDA of $212.7 million and free cash flow of $2.1 million. The modest EBITDA increase versus the prior year is due to the increase in investment spend on product and customer acquisition being offset by the increased operating revenue performance. It also reflects the business maintaining a higher growth profile throughout the whole year. Our focus on reinvesting into the business also contributed to the positive free cash flow result that shows how we have balanced returns generated and our investment objectives. Overall, operating expenses for the year are consistent with the guidance provided at our FY21 results, and these indicators reflect this. Moving to the next slide, Xero's customer franchise remains very strong, as evidenced by the SAS metrics we are reporting today and the continued growth in LTV. On the left, you can see Xero's total LTV increased by $3.3 billion versus the prior year to just under $11 billion. which is a 43% increase. Breaking this down by segment, in ANZ, LTV increased by 36%, and LTV of our international markets increased by 61%. Subscriber growth and growth in LTV per subscriber was strong in Xero's international markets, assisted in part by acquisitions in the period. Before I discuss the movements in LTV at a headline level, I want to touch on some of the related metrics. LTV per subscriber, CAC or Customer Acquisition Cost Months, and LTV to CAC. You'll find these metrics in the appendix. The growth in total LTV has come from the 19% increase in subscribers, together with a 20% increase in LTV per subscriber, bringing the LTV per subscriber to just over $3,300. CAC months increased slightly from 14.8 months in FY21 to 15.5 months. This reflects stable trends within the ANZ segment and an increase in the international segment. The international increase was due to acquisitions and a higher contribution to subscriber growth from less developed markets such as North America. LTV to CAC increased to 6.9 from 6.4 in FY21, reflecting an improvement across both segments of the group. CAC per gross subscriber addition was essentially unchanged in the period within the ANZ segment, as has been the case for some time. Overall, CAC per gross addition has increased due to stronger subscriber growth within the less developed international segment. In particular, I would flag growth within our North American markets and the inclusion of CAC from Plan Day, which has a different ARPU and CAC signature when compared to the rest of Xero. In the chart on the right-hand side, we show development of Xero's LTV over the year by driver. APU represents the monthly recurring revenue per subscriber at the end of the period. This increased by 7% or 9% in constant currency to $31.36. Gross margin increased slightly to 87.3%. As we highlighted at the half year, churn has had a positive impact on the LTV and I will discuss churn trends in a bit more detail on the next slide. New subscriber additions were the largest contributor to the movement in LTV, with the acquisitions of PlanDa and TickStar also adding to the overall movement as shown on the slide. I now want to come back to Apu and churn. As we show on the left-hand side of slide 16, Apu has increased by 7% or just over $2 in the year. The main elements of the movement are The price increases, which came into effect during FY22, across business edition plans in all markets and some partner edition plans in ANZ. Acquisitions, namely Plan Day, have contributed positively to ARPU. A typical Plan Day subscriber has a much higher ARPU than a zero one. FX movements were overall unfavorable, reducing ARPU by approximately 2%. And product mix and other factors, including take-up of financial services and ecosystem, accounted for the remainder of the YAPU increase. As the right-hand chart shows, after the decline seen in churn over the last few halves, this has remained largely stable at below pre-COVID levels and under 1% per month. We continue to view the disruption caused by the pandemic as having contributed to greater awareness of the value and the importance of cloud accounting to our small business customers and accountants and bookkeepers. While these trends are reassuring, we're monitoring the macro environment closely, as you would expect. Having discussed our key SAS metrics, I'll move on to gross profit and expenses. Together, these charts show the benefit that our continued discipline investment has delivered in the form of gross profit. On the left-hand chart, our strong gross margin, combined with the revenue result for this year, has seen gross profit increase by 31% to $957 million. Total operating expenses increased by 39% to $922 million, as we show in the right-hand chart. This equated to 84% of operating revenue, inclusive of M&A integration costs equivalent to under 1%. This is consistent with the outlook commentary we provided at the prior year results. Digging into expenses by type, sales and marketing costs increased by 32% year-on-year just ahead of our operating revenue growth. Amounting to 37% of operating revenue, the cadence of CAC spend has normalised after the more varied pattern of spending incurred last year. While we have remained within a fairly consistent cost envelope overall, we have put sales and marketing dollars to use in many varying ways as the environment has changed and we have found new ways of connecting with new and existing customers. We've made a lot of great progress when it comes to brand awareness with campaigns across TV, online and out of home. There are plenty of examples of the work we've done here, but perhaps the most prominent is the recent partnership we announced with FIFA World's Women's Football. This multi-year partnership will cover the FIFA Women's World Cup Australia and New Zealand in 2023 and other tournaments through to 2026. We're really excited by the potential of this partnership to help build brand awareness for Xero around the world as we look to support the communities that work in and around the game. Building the products and the technology that will underpin the beautiful experiences our customers will enjoy long into the future means prioritising investment today. On top of the more normal spend on product, we have also been supporting the five acquisitions that have completed since the start of last calendar year. Product design and technology costs accounted for 34% of the operating revenue, up from 29% in FY21. Reflecting the increased level of corporate activity, G&A costs did increase slightly ahead of growth in the group, lifting to 13% of operating revenue. Overall, our results show healthy progress in gross profit and top-line growth, which we have reinvested into CAC and product development to drive momentum this year and help build towards our longer-term objectives. Moving to slide 18. Here we present a summary income statement for FY22 showing year-on-year changes. Operating revenue increased 29% to reach just under $1.1 billion. Revenue progress was above the growth seen in subscribers of 19%, with the ARPU drivers already discussed and the contribution from M&A, particularly plan date, both a factor. As I've already mentioned, gross margin increased to 87.3%. As we have in previous results, I thought it would be useful to provide some further detail on operating expense movements, which is shown in Note 5 of our FY22 report. Employee costs, both in the form of salaries and in the form of share-based payments, increased by 34%. This included a one-time impact from the restructuring of equity-based compensation. Under this change, vesting of share-based remuneration has changed from three years to one year for all employees except the Xero leadership team and senior leaders. The new vesting profile improves the competitiveness of Xero's total annual remuneration offering. Advertising and marketing costs increased by 56%, which reflects the varied level of spending on advertising in the prior year period. Spending contracted in H1 FY21, but has remained consistent with top-line trends over the following three halves. Travel costs have increased as travel has recommenced, but spend within FY22 remains more than 80% below pre-pandemic levels. We expect a further increase in travel costs during FY23 as travel returns, and staff are engaged in supporting more in-person events such as roadshows and zero-cons. Increasing consultant and contractor costs support our strategic investment into people and the ways we have access to people resources to build products and the integration of our recent acquisitions. All of this contributed to an EBITDA margin of 19.4%, which was a decrease of 3.1 percentage points versus the prior year. We recorded a net loss of 9 million, which was 29 million lower than the prior year net profit of 20 million. There are some one-off items to mention within this. Two of these relate to the treatment of WADL that Steve has already talked to. Firstly, other income increased due mostly to the recognition of a fair value gain on contingent consideration relating to WADL of $30 million. Impairment charges totaling $25 million relate mostly to the impairment of WADL goodwill. The partial revaluation and restructuring of an element of contingent consideration relating to plan day had a total negative impact of $2.2 million. And finance costs at just under $44 million are largely consistent with the prior year when we adjust for the non-cash loss in FY21 that was incurred on the buyback of our first convertible note in December 2020. Moving to slide 19, cash generation offset by investing activity in the period leaves Xero's overall liquid resources at just over $1.1 billion at the 31st of March. This comprises cash and cash equivalents, short term deposits and undrawn committed debt facilities of $150 million. Deducting our total debt liability of $885 million, our net cash position at the end of the year was $51 million, down $205 million from the end of FY21. The main movement in our cash position over the period came from $196 million in acquisition and related payments. These payments mostly comprised initial cash consideration for acquisitions completed during the year. Before I hand back to Steve for the outlook, I wanted to again reiterate our approach to capital allocation. We continue to prioritise reinvestment in cash that we generate in order to support our strategy and the potential we have to create significant long-term value. Day-to-day, most of our investment will focus on the areas of go-to-market and product development to drive top line growth. We also continue to evaluate potential investment opportunities, including M&A, that can further enhance or complement our strategy. I also wanted to express that we are delighted to share an expanded range of non-financial indicators with you in our FY22 annual report. For the first time, our annual report has been prepared with reference to the Value Reporting Foundation's integrated reporting framework. We really hope you find it useful in understanding how Xero creates value for all of our stakeholders and we look forward to your feedback and continuing to involve and enhance our reporting. I'll now hand back to Steve to provide some more detail on our outlook for FY23.