Xero Limited

Thank you for standing by and welcome to the Xero Limited Half Year 2025 Results Conference Call. I'm joined by Xero's Chief Executive Officer, Sukhinder Singh-Cassidy, 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 call over to Sukhinder Singh-Cassidy, Chief Executive Officer of Xero. Please go ahead.

Thank you. Good morning from Sydney, Australia. Thank you for joining our investor briefing today covering Xero's financial and operating results for the half year ending September 30th, 2024. I'm Sukhinder Singh-Cassidy and I'm here with Kirstie, our CFO. Our first agenda item is a summary of Xero's performance during the half year. I'll then pass over to Kirstie to cover our financial results in detail before I finish with strategic priorities in Xero's outlook. After that, we'll move to Q&A. So, moving to a summary of our results on slide five. We're really pleased with this result, and in particular, our ability to deliver strong financial outcomes while executing our strategy with focus and purpose. You'll see that Xero has continued its track record of strong revenue growth with each of our large markets contributing. At the same time, we've delivered a meaningful increase in profitability, and that's led us to once again generate a greater-than-rule-of-40 outcome. I'm going to touch on the key metrics here, and Christy will discuss them in more detail later. Revenue grew 25% to $996 million, or 23% in constant currency year over year. Adjusted EBITDA of $312 million was up $107 million, or 52%, on last year. Together, the strong operating result and improved free cash flow generation resulted in a Rule of 40 outcome of 43.9, up by 10.3 points year over year. Continuing on to the next slide, we're going to talk about Xero's track record. Xero is a macro resilient business that consistently delivers strong top line growth, and you can see it in the chart on the left. The charts in the middle and on the right show subscriber growth in ARPU. We've provided both reported and underlying subs in ARPU on the slide. However, I will talk to underlying, which excludes the impact of the removal of long idle subscriptions. You will recall that we identified the need to remove unused long idle subscriptions almost a year ago. I'm glad this program is now complete with 160,000 subscriptions removed. You can see contribution to revenue growth was balanced across subscriber growth up 10% year-over-year and ARPU expansion up 11%. Subscriber additions were 401,000 year-over-year, reflecting double-digit year-over-year growth in each of our large markets. Underlying net additions for the half were 186,000. Price changes across our markets were a key driver of ARPU expansion, along with better payments revenue and some mixed benefits. I'll now spend a few minutes outlining the regional contributions to our revenue growth. As I said earlier, we saw each of our largest markets, Australia, the UK, and the US, make a strong contribution. Australia and New Zealand continues to deliver strong revenue growth, demonstrating the importance of this region for us. As I said, I'll talk to these outcomes on an underlying basis, or before the impact of the removal of long idle subscriptions. We show both outcomes on the slide. We delivered 24% revenue growth year on year. Within this, subscribers grew 10% and ARPU grew 11%. Australia made a strong contribution with revenue growing by 27%. Subscribers were up 11% year over year, adding a further 103,000 underlying net subscribers and a half. New Zealand revenue grew by 13% with net additions in the half of 9K, reflecting the level of penetration in this market. Overall, this is a great outcome in a region with high cloud accounting penetration, reflecting our strong brand presence and product offering in these markets, alongside our ability to continue to bring small businesses to the cloud and offer more services. In the half, we're also pleased to have announced the appointment of Angad Soin to the MD of ANZ roles. Turning to the international segment, which is home to two of our largest markets, the UK and the US, we're again pleased with the results. Both of these markets were strong contributors to the 25% revenue growth, 23 in constant currency, that we saw. Within this, subscribers grew 11% and ARPU grew 12%. The UK delivered strong revenue growth with good momentum in subscriber growth. Revenue increased 26% or 22% in constant currency terms. Subscribers were up 11% year on year, with net additions of 49,000 and a half. This reflected progress in cloud penetration in the absence of any regulatory tailwinds, which shows the opportunity we have in this market. Now that the new government has confirmed MTD phase three, we expect some further tailwinds in subscriber growth. While many of these customers who will adopt MTD for income tax are non-employing SMBs, they are important for Xero and for our AB partners to serve. We will provide functionality to meet their needs through our lower tier cash book product. At the same time, we'll maintain our focus on adding higher value subscriptions for our primary segments. North America continues to see good momentum, with revenue increasing by 25%. Subscribers grew 10% year on year, with net additions in the half of 12,000. US subscriber growth was solid in the half, in a half that is seasonally weaker. In Canada, subscriber growth was limited, reflecting the current continued subdued backdrop with a lack of adoption, momentum, and tailwinds for cloud. We have successfully restructured our business to align with the backdrop and are seeing better efficiency in that market. Rest of World delivered another period of robust revenue growth also. Revenue grew 23% or 22% in constant currency. Total subscribers were 12% up year on year with net additions of 13,000 and a half. South Africa was the largest contributor. So in summary, in our international regions, you can see the clarity of our strategy as we focus on the 3x3, while continuing to support growth opportunities in our other markets. The next slide brings all the key financial outcomes together as we balance growth and profitability. If you move from left to right, the chart on the left shows the meaningful change in adjusted EBITDA year-on-year, up 52%. This contributed to a strong free cash flow margin of 21%, which you can see in the middle chart. Adding this to the revenue growth in the chart on the far right, where we use the 23% constant currency metric, is the result of our Rule of 40 outcome of 43.9%. This shows how we've continued delivering profitability while at the same time adding value for customers and generating strong top-line growth. Now I'm going to turn it over to Kirsty to pick up in more detail.

Thanks, Akenda, and good morning, everyone. Before turning to the details, I want to echo Sikinder's commentary on our H1 FY25 financial performance. We have delivered a strong financial result underpinned by disciplined capital allocation that supported our continued delivery a rule of 40 outcome for a second half. So let's start by taking a deeper look at top line growth starting on slide 11. We are delivering broad-based revenue growth across our portfolio with strength in both subscription and platform revenues. This slide shows the breakdown of our revenue growth between core accounting revenues and platform add-ons. Core accounting revenue growth was 25% or 24% in constant currency. This reflected both subscriber growth and ARPU expansion. Platform revenue growth accelerated to reach 28% or 27% in constant currency and contributed 11% of operating revenues. The acceleration here reflected stronger payments performance. The decrease in other revenues largely reflects our exit from workflow max, partly offset by higher zero-con revenue as we held two events in the half versus one last year. The continued strength of our revenue growth reflects both the momentum in our business and our focused execution to drive both subscriber and ARPU growth. So let's turn to that. This slide shows our continued strong AMRR performance alongside its key drivers, subscriber growth and ARPU expansion. AMRR passed $2 billion, reflecting our continued top line momentum with 22% growth. As a reminder, this metric reflects the annualized benefit of our subscriber base and ARPU as at the 30th of September, and it's based on FX rates at that time. On the right-hand side, you can see the underlying contribution of subscriber growth and ARPU expansion to this outcome. This excludes the impact of long idle subscriptions removed in the period. On this basis, you can see the balance between the two drivers during the period, with ARPU contribution expanding to reach 11.1% in constant currency this year, while subscriber growth was 9.7%. This shows our continued focus on driving both volume and also value to support strong top-line growth. APU, along with our other SAS metrics, were impacted by the removal of long idle subscriptions in this period. To explain this impact a little further, these subscribers were low value. This meant that while removing them reduced headline subscriber growth, it increased APU. To assist in understanding the trends and drivers of our performance during the half, as Sukinda mentioned, our presentation refers to underlying metrics. So this excludes the impact of removing the long idle subscribers. Now please refer to the appendix of the pack and our interim report for further details. Now that this process is complete, our go-to-market teams can focus more on solving the multiple jobs to be done by our small businesses to drive max. So let's look at how this is flowing through in Apu in more detail. Apu growth remains strong, as you can see on the left-hand side of slide 13. As we show, price changes remain the largest driver of the increase in ARPU, followed by changes in mix. The improvements in mix include the impact of removing long idle subscriptions. Removing these subscriptions contributed $1.43 to ARPU growth. In this bucket, we also realised a small benefit from some customer migrations associated with changes to our product ladder in Australia and the UK. The changes made are focused on providing a strong foundation for our go-forward growth by making it easier for both new customers and our sales teams to identify the correct product for the particular small business. These plans were launched in Australia in July and in the UK and New Zealand in September. We have seen some early positive signs in Australia with new customer product mix and our business edition products reflected an increased uptake and higher end plans. However, it's early days and more work is required across our go-to-market engine to build out our capabilities and incentives so we can use this growth lever effectively. Now moving on to platform contribution where we saw a small benefit to APU, this largely reflected improved payments performance. So let's turn to the detail on slide 14. This slide shows the activity drivers for our main contributors to platform revenue, payments, payroll and plan day. We saw strong growth in payments, partly offset by slower growth in payroll and plan day. The clarity provided by our strategy, in particular our focus on winning the 3x3, is starting to improve execution and momentum in our platform offerings. At our last results, I talked to areas where we see opportunities to drive growth here and we have made some progress. Firstly, our product ladder changes went live in the UK and New Zealand at the end of the half. These add value for customers by including certain payroll functionality, depending on the plan, in order to help customers adopt and use this product. However, it is early days. Secondly, we targeted investment and product functionality to improve the customer experience. This has been a key focus in our payments product, where we are rolling out more ways to pay, including buy now, pay later functionality, as well as streamlining the process both for small businesses and the end customer, through one-page checkout and continued onboarding improvement. The improvement in focus and execution is evident in the strength of our payments performance. TPV growth has accelerated compared to last year, up 34% year-on-year. Revenue growth for the year to September was even stronger at 65%. This incorporated both the improved volumes and better unit economics. as margins with our partners improved as we reached key growth and product development milestones. The middle chart shows employees paid through zero payroll. This increased 6% since this time last year across Australia, New Zealand and the UK where we offer this product. There has been strong payroll uptake in Australia over the 10 years we've had this product to market, with now more than 2.5 million Australians paid through zero. Driving adoption in the UK and New Zealand will require more effort. Our latter changes in these markets are a first step in this process. However, there is further work to do, both in improving product market fit for different use cases, as well as evolving our go-to-market motions for this product. The right-hand chart shows the number of planned day users at the end of each quarter since September 22, which increased by approximately 7% from the prior year period. PlanDay has transitioned its focus back to its European home markets, and we are starting to build momentum. However, this will take time to flow through. We will continue to invest with discipline and focus in our platform products, where there is tight alignment with our 3x3 strategic priority to solve more of the key jobs to be done for customers. This will support our ARPU growth in this space and improve the value we deliver to SMBs around the world. The value that SMBs place in Xero continues to be reflected in our churn metrics on slide 15. We continue to monitor the economic backdrop closely through both internal metrics, such as our Xero small business insights, as well as net business formation rates and broader macroeconomic indicators across all our regions. Across these indicators, we can see that small businesses are facing a complex backdrop and managing it well, particularly in our home ANZ markets where net business formation has held up well and hiring trends remain positive. This is also reflected in our churn, with only one basis point increase half on half to reach 1%. This reflects only a slight uptick in MRR churn from the all-time low we reached post-COVID and remains below our long-term pre-pandemic average. This partly reflects the significant value that Xero provides to our customers by helping SMBs manage their cash flow. Turning to slide 16, LTV is a measure of the value customers bring to zero over their lifetime, which at a group level is over eight years. This chart highlights how the balance between APU and subscriber growth we delivered resulted in a $1.5 billion increase in LTV over the past six months. As we create long-term value, we aim to do so efficiently. So I want to touch on some of the related metrics presented in the middle of the slide. LTV per subscriber, CAC per gross add, and LTV to CAC. LTV per subscriber grew 9% over the year to $4,063 in line with ARPU growth. The increase in CAC spend per gross add was largely offset by ARPU expansion. This resulted in LTV to CAC only falling slightly to 6.3, reflecting a slight contraction in ANZ. This region continues to be our most efficient market with and LTV to CAC of 14. The strength of unit economics here reflects the value that Xero can deliver in a more developed market. While we don't expect to reach the same LTV to CAC in our international segment, over the long term, we expect to see an improvement. Albeit, it may move around as we see specific opportunities to invest to capture the long-term opportunity. Moving to costs, and you can see the downward slope in each of the cost buckets on slide 17. which shows the flow through over the last year of our organisation restructure, as well as scale benefits as we remain disciplined in our capital allocation. This has been partly offset by planned reinvestment in line with our strategy, particularly in product. There is still more product reinvestment which is expected to flow through in the second half. I'll talk through this shortly. Starting on the left, sales and marketing costs increased 15% against the revenue growth of 25%, which resulted in these costs falling to 32% of revenue. Spend during the period included hosting Xerocon in London and Nashville, which contributed 1.9 percentage points to the ratio. Excluding this, sales and marketing as a percentage of revenue was 30.1%. Investment focused on our international markets in particular, with a higher digital performance marketing investment. This was partly offset by lower fee for sponsorship cost and continued headcount efficiency. Now moving to product investment. Product design and development cost as a percentage of revenue fell 3.4 percentage points to 28.7%. There was a difference between our gross product cost and our P&L that I'd like to highlight. Total or gross product and development costs excluding depreciation and amortization grew 19%. This was greater than our P&O expense growth of 11%. The higher growth in total investment reflects our allocation of capital to drive product diversity in our 3x3, particularly in the lead-up to Xerocon London and Nashville. This resulted in our developers spending more time on releasing new product features for customers, which drove a 3.4 percentage point increase in the capitalisation rate. This was the main driver of the difference between our P&L and gross product spend, and this was one of the reasons for the moderation in our P&T OPEX guidance for the full year. Sekinder will cover our guidance in more detail. Capitalisation rates can fluctuate depending on the phase of the development, the resources allocated, and the nature of investment. So for example, we may have phases during the year where developers are focused on research, developing new product, or where we focus on reviewing existing code base. This translates through to fluctuations in our capitalization rate. Finally, on G&A expenses, these fell to 10.5% of revenue, reflecting robust cost control. To help you understand the drivers of our investment, the next slide looks at our total expenses by functional components. There are three key areas that we invest in over the first half to support our strategy. people, product, and marketing. Starting with people, staff costs were the key driver of spend increases. There are two components here. In line with our focus strategy to win on purpose, we have implemented a new performance management framework. This has included an increase in performance linked remuneration. Now, our hiring has been targeted, focusing on key domain experts to strengthen our capabilities, increase our capacity, and enhance overall product delivery. This talent tends to be located in higher cost markets, mainly the US. Secondly, new product development, which is largely reflected in our capitalized costs and therefore reduces P&L expenses. As I said on the previous slide, we had higher capitalization rates and this has flowed through here. Finally, marketing. Investment to date has been primarily in our brand marketing, particularly in our international markets where awareness is low. Michael Strickman, our CMO, has brought new capabilities and is wiring our business up to better identify, target and convert opportunities across our channels. As we dial up these capabilities, we will become more dynamic in our capital allocation in this area, particularly through digital channels. So wrapping this up, we will continue to invest in these key areas, which is reflected in our full year guidance for operating expenses as a percentage of revenue to be around 73% in FY25. which Sukhinder will talk to in more detail. Slide 19 breaks down the near doubling of our free cash flow to $209 million, highlighting both our continued strong growth and the operating leverage a SAS business model delivers. Taking a look at the key components of free cash flow. So starting with customer receipts, where we continue to see strong growth. This is mainly from subscriber and ARPU growth and trends closely following the growth in our reported revenue. including the benefit from the flow-through of early price changes in Australia. Moving across the chart to payments to suppliers and employees. The prior period included 31 million of redundancy payments from our restructure. Adjusting for this, underlying growth here was around 86 million. This was partly offset by growth in share-based payments associated with our investment in people with a specific performance focus. We continue to generate net cash interest receipts during the half. The improvement here reflects increased cash balances from our convertible note refinance alongside operating cash generation and higher effective rates. I'd remind you that following our convertible note refinance, we will see increased P&L interest expenses, but these will mainly be non-cash amortization. However, we will begin to pay US $15 million annually of cash interest expense with our first payment occurring next half. Income tax payments had a small impact on our cash flows in the period. We are monitoring our tax payments carefully as we utilise our accumulated New Zealand tax losses. We currently have 46 million remaining of New Zealand tax losses and have begun planning for a tax payment profile with $45 million of prepaid tax expenses to date, which you can see in our balance sheet disclosures. Finally, the increase in capitalised costs reflected our investment in the 3x3 and the increase in capitalisation rates I mentioned earlier. Altogether, this resulted in a 7.7 percentage point increase in our free cash flow margin to 21%. Improved cash generation has further strengthened our balance sheet, as you can see on the next slide. The increase in cash generation alongside the net new funds from our convertible note refinance were the key contributors to the $692 million increase in Xero's total cash balance. Including short-term deposits, we currently have around $2 billion at the 30th of September which is invested at market interest rates. Our term debt liability entirely reflects the 1.625% coupon convertible notes that mature in June 31. This has had some one-off impacts in our P&L this half. This is attractive funding as it provides optionality for inorganic investment at a lower cost than bank debt with limited cash impact. Similar to previous notes, we have mechanisms in place that provide us flexibility in managing the dilution through our call spread and the choice whether or not to settle in cash or shares. Given the flexibility that our convertible note funding provides us, the continued improvement in our cash generation and the growth we are delivering, we have a strong balance sheet with our net cash position increasing by $373 million from this time last year. Thank you. I'll now pass back to Secinda.