Xero Limited (XRO) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Xero Limited FY '21 Results Conference Call. I am joined by Xero's Chief Executive Officer, Steve Vamos; and Chief Financial Officer, Kirsty Godfrey-Billy. [Operator Instructions] I would now like to hand the call over to Steve Vamos, CEO of Xero. Please go ahead.

Well, thank you, and good morning, everyone, from Wellington, New Zealand. Thanks for joining our investor briefing today covering Xero's financial and operating results for the 12 months ending 31 March 2021. As you know, I'm Steve Vamos, Xero's CEO; and I'm joined by Kirsty Godfrey-Billy, our CFO. Before I go over today's agenda, I do want to start by acknowledging that COVID does continue to create uncertainty and challenge for many. And so I do hope that you and the people you care about are safe and well. The first item on the agenda is the business update, including a review of our performance during the year. I'll pass then to Kirsty to cover our financial results in detail, before I provide an update on strategy and outline Xero's FY '22 outlook. We'll then move to Q&A. Now before I give an overview of the results for the year, I want to make a couple of initial remarks to sum up what has been a unique period. I'm really proud of Xero's people and the way they've supported our customers and each other through this time. We finished FY '21 strongly, and we entered FY '22 with increased momentum and confidence in our long-term strategy as we continue to invest and prepare to capitalize on the significant opportunities ahead of us. So moving on to a high-level summary of our results on Slide 5. First and foremost, it was pleasing to see growing momentum as the year progressed after initial disruption of COVID-19 in the early stages of FY '21. Xero's total subscribers increased by 456,000, to reach more than 2.7 million subscribers at the end of March. A more challenging operating environment in the first half was followed in the second half by our best-ever half year result in terms of subscriber additions, and in fact, it was our best ever March. Many geographies delivered record or close to record levels of subscriber additions. Our performance reflects the value of Xero to our customers. It may well also indicate that cloud accounting and other digital services are seen as increasingly essential by a growing number of both small businesses and their advisers. Overall, the 20% growth in subscribers contributed to a 17% increase in annualized monthly recurring revenue, or AMRR, which grew to $964 million. ARPU, or average revenue per user, at the end of the year was down 1% versus the prior year period on a constant currency basis. And Kirsty will talk more about ARPU in her remarks. Lifetime value increased $2.1 billion or 38% to $7.6 billion. This was driven by the AMRR performance, combined with a much lower level of churn and modest margin improvement. Our operating revenue for the year climbed 18% year-on-year to $849 million. I would also flag that while price rises and subscriber growth that occurred later in the year are fully captured in AMRR, their impact on our reported operating revenue was limited. Alongside the top line measure, Xero delivered a strong set of profit outcomes, even though the 2 halves of the year were very different. We reduced sales and marketing -- marketing in response to COVID-19 in the first half. And as conditions improved, we picked up our spending, which helped drive the higher subscriber additions in the second half. EBITDA for the full year of $191 million increased by 39% from the prior year period. We delivered a net profit after tax of $19.8 million, which was a $16.4 million increase on last year. This includes 2 largely offsetting one-off items related to the recognition of a deferred taxed asset and the refinancing of our convertible note, and Kirsty will talk to these. Free cash flow also increased by a similar degree, rising by $29.8 million to $56.9 million. I'll sum up by saying that while we had an unusual first half, momentum built during the year and the results reflect the ongoing growth of our customer base and the value they place on their Xero subscription. We can see this in the churn and customer activity metrics too, that I'll cover on Slide 6, the next slide. The table on the left shows a significant fall in churn, down by 12 basis points to 1.01% over the year. The middle chart shows a steady increase in employees paid through Xero payroll since January last year. And this increased 29% from the low point seen in May 2020. The right-hand chart shows monthly invoice payment value has grown by more than 50% on pre-COVID levels. I'll now update you on our operational achievements in the year under our 3 strategic priorities: driving cloud accounting; growing the small business platform; and building for global scale and innovation. So first on Slide 7, we have drive cloud -- driving cloud accounting. Now just to recap, this is about growing subscribers and increasing the penetration of small business cloud accounting software. We saw good growth in subscribers across all our markets, and I want to spend a few moments describing how we achieved this, and we'll start with Australia and New Zealand on Slide 8. In the first half, Australia became Xero's first geography to pass through 1 million subscribers, and that was a great milestone. We ended the year with more than 1.1 million subscribers, adding a record 201,000 net subscribers. In the first half, we benefited from single-touch payroll, which facilitated access to JobKeeper, and we also had an enhanced data plan and continued adoption that we saw by accounting and bookkeeping partners that helped drive subscribers in H2. Our New Zealand had its strongest net subscriber result in 3 years with 54,000 net adds. We finished FY '21 with 446,000 New Zealand subscribers, an increase of 14%. The start-up plan enhancements also contributed to New Zealand's subscriber growth result. And as we mentioned in the first half, we saw an increased partner channel adoption in New Zealand. This continued in the second half, and we believe it's evidence of the potential for increased migration by late adopters. Operating revenue grew by 12% year-on-year in New Zealand. Moving on to the international segment on Slide 9. This segment performed strongly despite being more impacted by the disruption of COVID-19, especially in our major Northern Hemisphere markets during H1. We saw a marked recovery in H2 and it was pleasing to see international break through 1 million subscribers over the year. We continue to make progress in the U.K., adding 107,000 subscribers to grow by 17% and reach 720,000 subscribers at year-end. The revised deadlines for the next phase of Making Tax Digital are now coming up in 2022 for the second phase of VAT and 2023 for income tax. We expect this to be a further catalyst for small business digitization and cloud adoption. Revenue in the U.K. increased by 22% to $224 million. In North America, we passed 0.25 million subscribers in half 1. In half 2, we went on to deliver our strongest ever net adds in the half year period. For the full year, we added 44,000 net subscribers, growing 18%. In difficult conditions, these results reflect underlying progress from execution of our partner-led strategy in this market. Revenue for North America grew to $57 million, an increase of 2% on the prior year or 6% in constant currency. This was below subscriber growth, but is largely explained by the absence of Xerocon revenue and the bundling of Hubdoc in FY '20. As Hubdoc's subscriptions were most concentrated in North America, there was a more pronounced impact to revenue in this market. Our rest of world subscribers grew by 40% to 175,000 and revenue by 27% or 32% in constant currency. In Singapore, we saw good traction with our go-to-market playbook. We now have live bank feeds with all major banks in Singapore, and government initiatives have helped drive the digitization of small business compliance. We will also align Singapore dollar billing from mid-July this year. We also acquired a technology solution called Invoici, which complements our acquisition of Tickstar by enhancing our local e-invoicing functionality in Singapore. In South Africa, we improved our local product fit, releasing improvements to our VAT solution and launching a VAT e-filing trial. Moving on to Slide 10 and our second strategic priority to grow the small business platform. This is really about extending, enriching Xero as a platform to drive customer value and adding new revenue streams to Xero's top line. Platform revenue grew 21% and now makes up 7% of total group revenue, consistent with last year. This reflects strong growth from our adjacent products and service-driven income, which was largely in the form of payments. Collectively, these grew at just under 40%. The result also includes a modest second half contribution from Waddle, which was acquired during the year. Other revenues, which includes nonrecurring revenue and WorkflowMax fell by 28% on the prior year. And as we mentioned at the half, these were impacted by the presence of physical events. Now I'll move on to our third strategic priority on Slide 11. Building for global scale and innovation is about preparing Xero to realize our long-term aspirations. When it comes to attracting, inspiring and retaining world-class talent, we continue to build and enhance our people capabilities as through recruiting and development of our teams in the year. Optimizing Xero's operational and financial structure is also a continuous focus. A great example in the period was our convertible note refinancing and use of some of these funds for 3 acquisitions over the year. We also continued our efforts with 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 and ensuring long-term trust with our stakeholders. A couple of highlights were: working on a plan to evaluate and increase the rational and ethnic diversity of our employees, beginning with North America; being included in the Bloomberg Gender-Equality Index for a second year; and further to our Net Zero @ Xero commitment, we were certified carbon neutral through the Australian government's Climate Active program. We're proud of our progress, but we know there is more to do in this domain. With that, I'll now hand over to Kirsty to take you through the financial results.

Thanks, Steve. Hello, everyone. I'm Kirsty Godfrey-Billy, Xero's CFO, and I'll now take us through our financial results for FY '21 in more detail, starting on Slide 13. To recap, at the start of FY '21 and just after COVID-19 was declared a pandemic, we implemented a scenario-based spending and investment plan. This looks to manage the business for a range of revenue scenarios while ensuring continued progress on our strategic priorities. Starting the year with this approach has seen us report strong growth in profitability and free cash for the full year period. However, it's really important to highlight the difference between the 2 halves. We said at our H1 results in November that a return toward more normal market conditions in H2 was likely to drive a return to positive sales and marketing cost growth. Though a lot of uncertainties remains, conditions did improve in H2, and we found new ways of working that give us the confidence to undertake a record level of investment in sales and marketing for a half year period. Examples of how we did things differently include focusing more on digital advertising and also holding online events, which reached wider audiences. This approach to sales and marketing contributed to the strong subscriber numbers we have reported, particularly in the later stages of the year. Annualized monthly recurring revenue, or AMRR, increased by 17% versus FY '20 to $964 million. When it comes to profitability indicators, EBITDA for the year rose 39% to $191 million. Free cash flow increased versus the prior year period by almost $30 million to $56.9 million. For the year, this is equivalent to 6.7% of Xero's operating revenues. Operating cash flows increased by 31% over the prior year period to $218.6 million. This was again in excess of EBITDA and reflects strong monetization. Investing cash flow, excluding investment and acquisitions, increased by 16% or $22 million to $162 million, reflecting higher capitalized development spend. The capital generated in the form of free cash in FY '21 is a demonstration of Xero's SaaS-driven business model and the settings under which we operate the business, particularly in the first half of the year. While a pleasing result for this year, it remains our absolute priority to reinvest capital generated by the business to drive long-term growth. On Slide 14, Xero's SaaS metric shows the strength of Xero's business model. I'd like to call out the key metrics on the left-hand side. ARPU $29 decreased by 1% in constant currency, as already discussed. This small change largely reflects a shift in mix due to growth within our international segment as our partner-focused strategy gained momentum. ARPU within the ANZ segment increased slightly with the announcement -- announced price rise in Australia, partially offset by some mix impact, including the enhanced data plan. As Steve had mentioned, churn fell in the period. Gross margin increased slightly to 86% due to further incremental efficiency gains. Overall, these movements contributed to a 15% year-on-year increase in LTV per subscriber to nearly $2,800. A key driver here was the decline in churn, and this supports our view that awareness of the value and importance of cloud accounting to our small business customers and their accountants for bookkeepers looks to be increasing. Total lifetime value on the bottom right increased by 38% over the year to reach $7.6 billion, adding over $2 billion. CAC months increased from 14 months at the end of FY '20 to 14.6 -- 14.8 months, reflecting the slowdown in H1 as well as the skew towards our international segment in H2. LTV to CAC increased to 6.4% from 5.8%, primarily from the growth in LTV per subscriber as discussed. Overall, our SaaS metrics for FY '21 showed clear evidence of the value we are creating in both the ANZ and the international segments. On the next slide, starting on the left-hand chart, incremental gains in cost to serve resulted in the gross margin moving up agents to 0.8 percentage points to 86%. When it comes to CAC in the middle, total cost as a percentage of revenue reduced by more than 7 percentage points to just over 36%. This decline was due mainly to our actions in H1 when spend was only 32% of revenue. This shifted to 40% of revenue in the second half, which was more consistent with levels seen in the pre-pandemic period and was a contributor to the higher subscriber additions. Looking to the right-hand chart, product costs, including OpEx and CapEx as a percentage of revenue, increased to almost 37%. This was a 5 percentage point increase on the prior year, in part reflecting timing differences between investment spend into product and our top line results for the year. Our investment into product is critical to supporting customers and delivering on our long-term product and strategic plans. So in summary, investments being continued during FY '21 with an eye on our long-term aspirations. Sales and marketing, or CAC, was more dynamic and reflected both the conditions and our disciplined spending and investment plan. On the other hand, product costs were a reflection of the multiyear spending plan, we haven't trained to execute our long-term strategy. Moving to Slide 16. Here, we have our summary income statement for FY '21 showing year-on-year changes. Alongside the usual indicators, there are some different outcomes this year that I'd just like to highlight. Operating revenue increased 18% to just under $849 million. Revenue growth for the year tracked relatively closely to the 20% growth seen in subscribers, but a couple of factors are worth considering. Firstly, this result was dampened by the absence of revenues from in-person events such as Xerocon. This had a 1 percentage point impact on operating revenue. Secondly, the timing of subscriber additions during the second half of the year, particularly the strong additions seen in the first quarter, limits the contribution to the current year operating revenue results -- sorry, that was in the final quarter. As I've already called out, gross margin improved versus the prior year period to 86%. Moving to operating expenses. I've already outlined the decision making behind these trends. The overall flex in sales and marketing spend in H1 saw them falling 2% in the year. Product spend increased by 40% year-on-year as we supported our customers and continued to invest. There are some specific examples of variable costs that have contributed to changes in our expense ratio in the current environment. Advertising and marketing costs increased significantly from the first half to the second. These costs were running at roughly half of pre-pandemic levels in H1, but rebounded to similar to prior year levels in H2. We've mentioned Xerocon revenues, but associated costs from these events were also absent from our FY '21 cost structure. Overall, advertising and marketing costs were down 18% for the year. Travel costs in the first 6 months of FY '21 fell by 99%. As some travel resumed in the second half, travel and related expenses did increase but only really modestly. For the full year, travel costs were down 97% versus the prior year. These costs would be expected to change [ further risk ] conditions, border protections and travel practices continue to normalize. EBITDA was $191 million, which is $53 million increase year-on-year. The EBITDA margin of 22.5% improved by 3 percentage points year-on-year. Net profit of $19.8 million was $16.4 million higher and included a net $7.8 million negative impact from 2 largely offsetting one-offs. After demonstrating a history of taxable profits in New Zealand, Xero has, this year, recognized a deferred tax asset on its accumulated New Zealand tax losses. This, combined with the related benefit from R&D expenditure, has resulted in a $65 million benefit to Xero's FY '21 tax expense. This was more than offset by losses in transaction costs related to the concurrent issuance of Xero's 2025 convertible notes and buyback of Xero's 2023 convertible notes with $72.8 million drag. Moving to Slide 17. Total liquid resources stood at just under $1.3 billion at the 31st of March. The main movement in our cash position over the year has come from the convertible note issuance that I'll talk about in more detail in a moment. Our overall liquidity position comprises cash and cash equivalents, short-term deposits and undrawn committed debt facilities of $150 million. Deducting our term debt liability of $854 million, our net cash position at the end of FY '21 was $257 million, up from $111 million at the end of FY '20. These figures do not reflect initial payments of $150 million on the completion of our Planday and Tickstar acquisitions, which closed post the period end. Our existing liquid resources, adjusted for these amounts, continue to support our strategy as we drive the business forward. Before I finish, I just wanted to provide some commentary around the new convertible notes, which were issued late last year. This transaction was Xero's largest ever capital raised to date and was a strategic step in optimizing Xero's financial structure to support our strategy. To recap, there were 4 elements to these transactions. Firstly, the issuance of the new zero-coupon USD 700 million convertible notes due in 2025 with a 35% conversion premium to the share price at the time. These are improved terms on the existing notes. Secondly, the buyback of the existing notes to reduce dilution financed in part from the proceeds of the new notes and the remainder from new shares. Thirdly, unwind of the existing call spread arrangement, which realized proceeds of USD 77 million. And finally, dilution of the new notes was reduced through a new call spread at a cost of USD 57 million to raise the effective conversion premium to 75%. Net funds raised from these transactions were USD 408 million or NZD 577 million. When it comes to total interest costs on the new notes, we expect those to be broadly similar to the costs incurred on the old notes, but with no cash element. Greater detail on the convertible can be found in our annual report on Notes 6 and 15. So to finish, the actions we took from a financial perspective to support the group strategy this year has been significant and have put us in a really strong position. I'll now pass back to Steve to provide some more detail on our other strategic achievements in FY '21.

Thank you, Kirsty. So having given you the update on our operational performance, I'll talk now about progress we've made executing our strategy. Now our 3-year strategy was developed with a 10-year lens to ensure that we do as much as we can now to see the opportunities for growth that we believe will be substantial contributors to our business and success in the future. So moving to Slide 19. I want to start by reflecting on product investments. As Kirsty said, our product investments continue to be a significant priority despite the challenges we saw in H1, and they remain an important part of our natural rhythm as a SaaS business. Our product investments are inclusive of everything from improvements in response to customer feedback, through to the work being done on a range of opportunities for the long term. During FY '21, in addition to the enhanced data plan, we increased functionality and added value for our customers in a number of ways. For example, we enabled our U.K. accountants and bookkeepers to lodge company tax for their clients directed with HMRC using Xero Tax. We made it easier for Australian accountants and bookkeepers to collate client documents and get digital signatures with Xero HQ using document packs. In Australia, we also delivered tools to help customers assess their eligibility for the JobKeeper wage subsidy, make payments to employees and file the required information with the Australian tax office. In the U.S., we enhanced our local product through the addition of forms and schedules to help accountants and bookkeepers prepare for and file their clients' tax returns. We also continue to invest in the capabilities of our product and technology teams and the reliability, scalability and security of Xero's platform. Moving to Slide 20. I want to talk about the acquisitions we made in FY '21. This was, by far, the most productive period of M&A we've had to date. And we really did leverage the capabilities we've built and added in FY '20. As you know we announced the acquisitions of Waddle, Tickstar and Planday. They vary in size from a consideration of up to $25 million for Tickstar, $87 million for Waddle and $305 million for Planday. The acquisition of Waddle reflects our ambition to continue to grow the small business platform and help solve customers' financial needs by managing the cash flow and accessing capital. We announced this acquisition back in August 2020 and completed it in October. So Waddle's contribution is relatively modest at this point. We are progressing a number of connections right now with lenders who share our vision of improving access to capital to small and medium businesses. And for example, we are piloting in-product referrals with NatWest in the U.K. In March, we announced the acquisition of Tickstar, a provider of e-invoicing infrastructure. We believe e-invoicing is likely to be adopted by more governments and countries around the world. Just this month, the Australian government reinforced its commitment to increasing the awareness and adoption of e-invoicing through their digital business plan. Both Tickstar and Planday were completed on the 1st of April, 2021, so they'll contribute to our FY '22 results. We expect all 3 transactions to have an impact on Xero's operating expenses in FY '22 that I'll cover in my outlook remarks. If I now move to the next slide, I want to talk a bit more about Planday. As our largest transaction to date, this acquisition has had a lot of interest. So I want to give you a little bit more color on how we think about Planday's use case and TAM. The acquisition of Planday marks a key step for Xero and our entry into workforce management as a category, a new category. This extends a small business platform to better serve employers and their employees. There's more detail on the slide, Slide 21. I encourage you to visit Planday's website. But I wanted to give you a very simple example of how our business uses Planday. So let's consider Ingrid, a business owner who runs a cafe employing 15 staff in Frankfurt. Ingrid knows that her business' biggest asset is her team, and scheduling staff time can be a headache. She chooses the Planday Plus plan and pays EUR 4.49 per employee user per month, or just under EUR 70 every month in total. This gives her access to the platform where she can manage shifts and also work with a bookkeeper to make sure she runs the payroll effectively and remains compliant with the local working regulations. Planday's mobile app allows Ingrid's employees to communicate easily with her and each other to book or swap shifts and track hours worked. We estimate that across Xero's existing markets, plus those in which Planday currently operates, there's a TAM, or addressable -- total addressable market, in excess of 100 million employee users of businesses like Ingrid's. Overall, we see a significant opportunity within the workforce management category. Now to the outlook on Slide 22. You can read our full statement on the slide, but I thought I'd call out a couple of key elements here and provide some context. Firstly, we are reiterating that we are a business with a focus on growth, and our preference is to reinvest cash generated. This has been an unusual year. And as we've discussed, the 2 halves were very different. As FY '21 progressed, we moved from responding to the uncertainty of the pandemic back towards a growth setting, and we think it's helpful as a result to provide expense guidance to reflect this. For FY '22, total operating expenses, excluding acquisition integration costs, as a percentage of operating revenue, are expected to be in the range of 80% to 85%. This is consistent with levels seen in the second half of FY '21 and the pre-pandemic period. Integration costs associated with acquisitions announced during FY '21 are expected to increase total operating expenses as a percentage of operating revenue by up to 2% for FY '22. And as stated before, Planday is expected to contribute approximately 3 percentage points of additional operating revenue growth in FY '22. So to close out, I wanted to finish my remarks with a quick summary of our position. In a challenging year, we continue to demonstrate our ability to execute our strategy. We talked you through evidence of that through our strong results and progress on M&A over the year. We continue to deliver sustained growth, adding subscribers, enhancing our core product proposition and further activating growth opportunities in financial services and adjacencies. We've built a business that our customers and partners really value, and you can see that in our total lifetime value of $7.6 billion. What you see today is a result of investments made over many preceding years. The investments we are making today are crucial to the development of the additional growth opportunities we have over the long term. We're always learning and each day getting a better sense than ever of the long-term opportunity and how we capitalize on that. Our capacity to generate free cash flow, combined with our capital allocation framework and existing financial resources, puts us in a strong position. When we see fit, this gives us the capacity to adapt quickly to changing conditions and vary the pace of our investment spend as we move towards our long-term objectives. Before I conclude, I want to acknowledge and thank the entire team across Xero for their hard work this year. I also want to thank all of you online and on the phone today for joining us, and I'll now hand back to the moderator for your questions.

[Operator Instructions] Your first question comes from Paul Mason from E&P.

Just first one for me is about Tickstar. I was hoping you could maybe expand on the functionality that it gives you, given you already have invoicing capabilities in your key markets, what the extra functionality it's delivering for you, sort of it's going to provide to customers that they didn't have before?

Yes. Thanks for the question, Paul. So when we talk about e-invoicing, there's a number of layers to it. There's the application layer, which is about sending and receiving e-invoices in and out of the Xero application or Xero platform. Then there's another layer, which is where Tickstar comes to play, and that is the access points. So how and where you and your customers connect into the e-invoicing infrastructure. And as we see that as important and developing and scaling, we want to make sure that we can expand our e-invoicing capabilities and service with a level of reliability and robustness that we would want. So that's why, given its early stage and a growing area, we felt it was really important for us to go beyond the application layer into that next layer of the infrastructure as well.

Your next question comes from Garry Sherriff from Royal Bank of Canada.

A question in terms of subs momentum over the last 6 weeks, post the March year-end, particularly around the U.K.'s lockdowns have eased. And secondly, whether or not you've seen any change in the Aussie market as JobKeeper ended at the end of March.

So Garry, thanks. The U.K. performance, I think, obviously, the first half was very, very challenging. I think as we saw everywhere, there was a period of adjustment for all businesses. The position we have in the U.K. market is strong. We have accounting and bookkeeping partners. We've got momentum and a significant position in that market. So I do think the second half really reflected the fact that we got going again, that our accounts and bookkeepers and their clients operated and responded to the changing conditions, and we were able to engage and adapt our working conditions as well to working more remotely and dealing with the challenges of COVID. I mean it's still challenging in the U.K. environment. But it was pleasing to see that performance, for sure, in the second half. In terms of what lies ahead with JobKeeper, look, one of the things that we're definitely observing is -- and I think it's reflected in the discussion around churn that Kirsty touched on. We do think there's a strong evidence that these SaaS services, online services, the cloud and applications like Xero are more important than ever, and that customers are embracing that and needing them and seeing the importance of them. In terms of -- so it's a real positive effect. In terms of what we can expect in the macro environment as JobKeeper and other assistance rolls off, we'll just have to wait and see. Obviously, we'll take close note of that, and that is one of the macro factors we'll keep our eye on.

Your next question comes from Kane Hannan from Goldman Sachs.

Just on that rebound in your international sub growth across the board. I'm just interested if there's any comments you can make around whether that snapped back at the start of the half and then gave a pretty consistent sort of run rate? Or whether the momentum built across the half? You got that record March, I think you mentioned, Steve.

Yes. Thanks, Kane. I mean, we -- as you've seen, we certainly did have a stronger H2, and it has sort of ramped up, particularly in that international market throughout the half. And that's where you see the difference between, for example, our sub growth and our revenue growth, where we've picked up the subscribers by the end of the year and had slightly sort of tail end percentage of revenue growth.

Your next question comes from Lucy Huang from Bank of America.

I guess one question, just with the FY '22 OpEx guidance. So where are you seeing a greater uplift moving forward? Is it mainly in sales and marketing or more so in product development? And if you can maybe give us some color around which regions or what type of capability you're stepping up investment in. That would be great.

Yes. Thanks, Lucy. Look, I think it's important that we maybe give you a little bit more insight to what we're looking at here. So when we are setting our investment levels, there are a bunch of factors that we really consider carefully. It starts with our strategy and the opportunities we have to serve customers and solve or address the needs of small business customers. And that's very much anchored in those 3 pillars of our strategy, and we can talk more about that as well. So it starts there. Then what we do is we look at that range of things that we can be doing to help our customers driven by our thinking around strategy and we drive -- we look at capability. Do we need to build the capabilities? Do we have the capabilities? Do we partner? Do we acquire? Then we look at capacity. Do we have the resources? And have we prioritized? So we're always looking at the relative prioritization and the sequence of things because we have a range of opportunities and sequencing them is also a factor. Then you get to things like the stage of development and how much capital you allocate to things that might be in discovery mode versus those initiatives that are in delivery mode. We also look short term and long term and look at the mix of what are the things we're doing to serve our customers' needs now. So obviously, in H1, we looked at cash flow, forecasting, business dashboards and the ability for our customers to access and administer subsidy through -- subsidies through payroll. They were short-term priorities that receive capital, but we've got many that are more longer-term initiatives that around the development of financial services, the link of Xero workflows to money flows and also we're now looking at extending payroll and expenses into the realm of time scheduling and attendance. So that short-term, long-term dimension. We then also look at the macro environment and consider that, and then really tie it together by looking at the economics, the relative return on investment of these initiatives that we can be pursuing and how that plays out then in our overall settings. So it's a very -- it's a -- I think really 2 things. It's a very disciplined approach. It considers a whole range of factors, and there is very strong competition in Xero given the breadth of our strategy and the size of our opportunity. There's strong competition across a whole range of initiatives where we can allocate capital with confidence that will deliver short- and long-term benefit, which means new subscribers, it means new revenue streams and ultimately flow through the ARPU.

And I think just, Lucy, if I can add to what Steve says. The outlook specifies that range of 80% to 85%. And really, with it coming from is just accepting the fact that throughout FY '21, there was a very, very abnormal first half. And so we're just putting everyone's focus back on to the fact that we are, in the future, are going to be running our business back to normal, back to pre-pandemic levels, and that's where we link back to that 80% to 85%.

Your next question comes from Roger Samuel from Jefferies.

My question is around product investments and new geographies. I mean can you give us a timeline as to when you can launch your core accounting product in Europe given that you have closed the transaction for Planday? And yes, maybe perhaps just the reason why you are ramping up your investment in product development because you're entering -- because you're entering a new market?

Yes. Thanks, Roger. Well, a great -- a significant part of our investments are always about making sure that we really address the opportunities and the workflows of accounts, bookkeepers and small business in the markets we operate in. And you've seen the progress we've made in the U.K. with U.K. tax. We also have continued to evolve and develop our roadmap to North America. And right across the board, in every market, there are opportunities for us to do more. So that's definitely a key focus. We're really pleased about the fact that the acquisition of Planday gives us a much stronger understanding and presence of 5 new markets. And we'll certainly consider that and learn from that as we go forward and consider at what point in time we enter markets in addition to the ones we're currently in. Thanks, Roger.

Your next question comes from Elise Kennedy from Jarden.

I had a question around your platform revenue and in specifically, the payments opportunity. If you can talk to the role that Waddle plays in potentially driving the other income line and how and when this will be realized?

Yes, Elise, the revenues and the adjacent revenues around financial services are very much around payments and payables, so making payments and receiving payments at this particular point in time. The Waddle acquisition is really aimed at opening up a new opportunity, a new way of small businesses getting access to capital. So it's really moving the invoice financing category, which has been available to larger enterprises for some time and leveraging the data in Xero and the connections to lenders to open up that category so that invoices that are owed can be turned into a source of capital for small business. So that is a new category. It's an evolving aspect of our business, and it's an important element of our plans for connecting Xero workflows with money flows as we go forward.

Your next question comes from Bob Chen from JPMorgan.

Just a question around the ARPU and how we should sort of think about it sort of longer term. You obviously pushed through some price rises recent -- so towards the end the period. But what's the plan going forward? And how should we as investors think about your ARPU going forward with the product mix as well?

Yes. Thanks very much for the question. Yes, so I mean, as you will have noticed in FY '21, ARPU did remain pretty stable. It certainly had some substantial FX headwinds in the international sector, and that's why the difference is between 11% decrease in reported numbers, or it's only a decrease of 3% in constant currency numbers. Now this was -- this, in a way, was drawn because of the fact that we were shifting more towards the more efficient lower ARPU partner channel, which has been the way in which we've been able to really be successful in particularly H2 through the more troubled Northern Hemisphere international markets. And what we also did throughout the year was we continued with our payroll-only solution in Australia, but we also reinvigorated our revised data product because we felt that, that was really required by our customers, those that were starting out, choosing to start up businesses, for example, in a very unusual COVID time. Now they obviously have headwinds, if you like, on our ARPU. And so you have a few different mixes going on within the ARPU, where you've got the lower ARPU products being -- growing and being a more prominent percentage, if you like, about subscription mix, but then you also have the drive of the platform revenue in the adjacent products and services and financial services. And that's where it was really pleasing to be able to see in FY '21 that even though the platform revenue number excluded Hubdoc in FY '21, it still stayed consistent as a percentage of operating revenue at 7% year-on-year from FY '20. So as far as the outlook going forward, I'm obviously not going to give you guidance as to the -- as to ARPU. But certainly, in the shorter term, we'd still see those swing around about, if you like, of both the drivers, the lower products, but also the attach of the adjacent products. And I think what's important to remember is that ARPU was actually only one part of driving growth in our revenue. The other part is subscriber numbers. So you really need to ensure that you win the subscriber. And then with that subscriber, you'll be then able to, in time, also overlay the additional platform revenue. So in the shorter term, I think ARPU is going to be relatively stable. And then we'll just sort of watch the space as we drive forward.

Your next question comes from Rohan Sundram from MST Financial.

I guess for me, a question on the gross margin. And how should we think about the impacts from acquisitions on that going forward?

Yes. Thanks, Rohan. Yes, I mean, we are so thrilled that we were managing to now hit with our gross margin. I remember, over the last few years, we've been really driving towards getting to 85% and so being able to report 86% as -- is a figure really to be proud of. And as you'd be aware, as you're asking the question, that is an incredibly good gross margin percentage when you look at other technology companies that we could be acquiring. And so the chances are that acquisitions could be at a lower margin. However, depending on the size of them, even though they have a slightly maybe lower margin initially until we really embed them into our processes and increase the margin with the med acquisition, depending on the size of them, if they're not material to the size of the business, they shouldn't have too much of an impact on our margin going forward.

Your next question comes from Tom Beadle from UBS.

Just I guess a question just related a bit to Kane and Lucy's questions. I just wanted to dig into the relationship a bit more between your subscriber growth and marketing costs. So obviously, that subscriber growth is really strong in the second half. But could you talk about what it maybe looked like on a more granular, say, monthly or quarterly basis throughout the half? There was obviously that really strong half -- March, sorry. What gave you the confidence to invest in sales and marketing to drive that growth? Was there any sort of trigger or data that you saw? And I'm interested to hear about how these actions influence your subscriber growth towards the end of the half and how this all might have influenced your CAC months?

Yes. Tom, I'll kick off and then if Steve's got anything to add, he can. Yes. So I suppose, as we've talked around before, this has been a year where we have worked incredibly agilely with managing our cost base. If you think about the conversation we were having 12 months ago, we had a variety of different revenue scenarios, and we're really pivoting our cost base based on where we saw our revenue and where we saw the opportunity. And so we've been working incredibly closely with each of the different regional leaders to work with them to ensure that they are correctly receiving the right level of investment to make sure that they are taking the opportunity that they see. And so we did absolutely start to see confidence level grow in the different markets. And as our people on the ground and as the regional leaders saw that, then we were able to invest appropriately and that's what we did, and that's why we saw the growth in H2, and we also saw that uptick and spend back to more normal sort of pre-pandemic percentage levels.

Yes. I think it's spot on. I think one thing I would add is that the marketing investments we make aren't necessarily about the in-month sales. So there's also an element to this of continuing to drive growth longer term, building brand, building awareness and driving growth in the pipeline. So that was another reason. It was not just our increasing sense of positivity through the half, but also our view that, that was going to continue through '22.

You now have a follow-up question from Garry Sherriff from Royal Bank of Canada.

North America. Just trying to get a sense. Is the subs growth you're seeing there, is that driven more out of Canada? I just know that you've alluded to traction in the U.S. being hard. I'm just trying to get a sense out of the growth rates between the U.S. and Canada.

Thanks, Garry. Look, both contributed in a very positive way. We're executing the playbook when it comes to engaging with accounts and bookkeepers in both markets. Really pleased with the teams we have on the ground in both countries now. And we've also really got our product teams much more strongly connected to the needs of our customers in North America. So we've got a roadmap there that we're progressively working on. So yes, contribution from both markets.

I suppose just to add to that, Garry. There was certainly a higher proportion based on the larger size of the opportunity that we've got in the U.S. market for that FY '21 result.

Your next question comes from Paul Mason from E&P.

It is sort of a related question to Garry's. Seeing in the accounts that you guys have mentioned that you've signed BDO as a global partner. So I just wanted to get some color on sort of how that came about and sort of whether that's something that is like a key part of your strategy now, or whether the sort of partner strategy is still largely more driven at the sort of country-by-country individual level?

Yes. Thanks, Paul. A lot of the work we're doing is around our -- continue to develop and grow our go-to-market capabilities. So if you look at what that means, it means that we're getting much more focused on looking at industry segments and verticals, but we're also looking at the larger firms and the opportunity to partner with them. We have got good relationship with a number of the large firms. BDO, in particular, has been a very strong partner to Xero for many years. The idea here is that whilst we still execute very much locally in terms of the partners of these firms and the small business clients they have. The reason for doing this is that there's real value in bringing some consistency to the relationship at a global level and making sure we're very aligned, not just in the way we execute in market, but also explore opportunities to collaborate a little bit of joint innovation around how we help them continue to digitize their practice, at the same time, provide differentiation to their clients that is, in a sense, combined with what Xero offers. So it really is -- it's something that we are open to doing with others and -- but it's a really good step in terms of moving our focus to enterprise-level engagement more so than that very local engagement that's typically characterized our work in the past. It's pretty natural part of growth -- have continued to grow and let's call it, increase the sophistication of our go-to-market capabilities. Thanks, Paul.

Your next question comes from Kane Hannan from Goldman Sachs.

Just on the M&A strategy and the productive period you've obviously had. Is this a sort of run rate of acquisitions we should be thinking about for Xero? Or is this a bit of an anomaly and things might slow down from here?

Yes. Look, I think the way that I would look at it is to say that it's not M&A for M&A's sake. We've got a strategy to execute, and that driving our strategic initiatives is really a combination of what we do organically and where acquisitions and also partnerships can help us, we consider them. So I would just say that we'll continue to assess opportunities in M&A. We'll also continue to explore partnerships as well as execute organically across our strategic priorities, and we'll be able to talk about the flow and the key steps there as they come.

Your next question comes from Gareth James from Morningstar.

Yes. Just on the North America segment. I just noticed that between the first and the second half, you had 14% subscriber growth, but I think reported revenue fell by 3%. So I was just hoping to get a bit of explanation behind that. And also if you could give some guidance on the ARPU outlook for North America also, please?

Yes. So we -- I'll start with the first thing. So there was -- there was definitely difference between our subscriber growth and also our revenue growth in North America, and that was really linked to Hubdoc and also looking at our -- the lower ARPU partner channel. And so really, if you normalize that, the numbers do get far back -- closer -- far back to being sort of equal in those cases. We also, of course, didn't have Xerocon coming through for the FY '21 year, which we've had previously as well within the revenue numbers.

Could you -- you had a second part to the question as well. Could you repeat that?

Yes. Sorry, it was just on the ARPU outlook for North America.

Yes. So we don't drive down, Gareth, into ARPU per particular countries. But as I said -- as I mentioned before, we have had relatively stable ARPU for the year. And constant currency, international did fall by a small amount because of the difference in product net going through the partners. Our partner strategy is certainly a very important part of us, of the North American strategy. And so therefore, that will be reflected in the ARPU going forward, but also the expectation that we'll be able to drive platform revenue across those subscribers as well.

Your next question comes from Lucy Huang from Bank of America.

Just a follow-up question. So are you able to talk through the competitive dynamics that come from other key markets, whether you've seen any change or whether the dynamics have remained relatively stable?

Yes, Lucy, I think describing it as relatively stable is not far off the mark. I think I always -- I always -- I need to say and do say that across our markets, there's still tremendous opportunity given the relatively lower rates of penetration of cloud accounting around the world relative to Australia and New Zealand. So again, the competition is something that we obviously keep an eye on. But in a developing market, it's a good thing to have others also promoting the benefits of small businesses operating their business in the cloud. Thanks, Lucy.

Thank you There are no further questions at this time. I'll now hand back to Mr. Vamos for closing remarks.

Okay. Well, look, thanks, everyone. I really appreciate you taking the time and joining the call and for your support. So thanks, everyone. All the best, and I'm sure we'll be talking.

Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.