Xero Limited (XRO) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Xero Limited Half Year 2022 Results Conference Call. I am joined by Xero's Chief Executive Officer, Steve Vamos; and Chief Financial Officer, Kirsty Godfrey-Billy. [Operator Instructions] I'd now like to hand the call over to Steve Vamos, CEO of Xero, please go ahead.

[Foreign Language] from Wellington, New Zealand. Thank you for joining our investor briefing today covering Xero's financial and operating results for the 6 months ending 30 September 2021. I'm Steve Vamos, Xero's CEO; and I'm with Kirsty Godfrey-Billy, our CFO. Just before I go over today's agenda, I do want to start by acknowledging that COVID-19 does continue to create uncertainties for many people, and I hope that you and those you care about are safe and well. The first item on our agenda is a business update, including a review of Xero's performance during the half. I'll also touch on our strategy and areas of investment before I pass to Kirsty to cover our financial results in detail and Xero's FY '22 outlook. We'll then move to your questions. First and foremost, Xero delivered a strong result, reflecting the benefit of investments made over a number of years in our products, go-to-market and people capabilities. In fluctuating global operating conditions, we have continued to demonstrate our ability to execute our strategy. Adoption of digital solutions by small business continues to gather pace, driven by a number of factors, including government policy initiatives, innovation and access to financial services and new ways of working. We continue to monitor the macroeconomic environment and are positive about the critical role small business will and continues to play in the global economic recovery. These factors, the size of the opportunity and our momentum give us continued confidence in our long-term strategy. So moving to a summary of our results on Slide 5. You'll see that this is a strong result across multiple metrics. Key amongst these is operating revenue, which grew to more than $0.5 billion in the half and subscribers, which grew to more than 3 million. Both were up 23% on prior year. And in the case of revenue, 26% on a constant currency basis. Net subscriber additions totaled 560,000 over the prior year or 272,000 over the 6 months in the half. Annualized monthly recurring revenue, or AMRR, grew to exceed $1 billion, increasing 29%. This largely reflects subscriber growth of 23% and higher ARPU. ARPU increased 5% versus the prior year period, and Kirsty will talk more about our actions that contributed to this movement in her remarks. Subscriber lifetime value, or LTV, increased substantially to $9.9 billion from $6.2 billion with continued low levels of churn a factor. During the half and consistent with our outlook for the year, we increased investment spend back to pre-pandemic levels which led to reductions in our EBITDA, net profit and free cash flow when compared to the prior year period. EBITDA for the half year of $98.1 million decreased by 19%. We reported a net loss after tax of $5.9 million, down $40.4 million. Free cash flow declined by $47.9 million to $6.4 million. This increase in investment reflects our commitment to execute our strategy and pursue our long-term opportunity and aspirations. Our ability to do this is, to a large extent, a function of the strength of our business model and the sustained revenue momentum shown on the next slide. Xero delivered high sustained levels of annual top line growth over the last few years against what has been a challenging COVID backdrop. Touching on the first half of FY '22 specifically, core accounting revenues grew 18% or 20% on a constant currency basis, and this was largely in line with our subscriber growth of 23%. Price changes during the period have contributed modestly to operating revenue in the half in all regions outside of North America and rest of world, where the communicated price changes will take effect in the second half. Platform revenues grew 104% or 37% if we adjust for the inclusion of revenues from acquired businesses, as take-up and usage of financial services and adjacent products continues to grow. I'd now like to discuss the results of our operations by geography. All markets contributed positively to this group-wide outcome, although the pace of growth varied as you'd expect, given the different conditions in each market. So starting with Australia and New Zealand on Slide 7. In Australia, revenue increased by 22% to $225 million. We added 124,000 subscribers in the half, reaching 1.24 million in total. Earlier this year, we welcomed Joseph Lyons as our MD of Australia and Asia. Joe moved into the role from the role of EGM of Global Partner sales and succeeded Trent Innes, who departed Xero after 8 years of leadership and a great contribution to Xero. New Zealand's revenue increased by 13% to $72 million. We added 34,000 subscribers in the half to reach 480,000 subscribers in total. In these 2 markets where cloud adoption is relatively high, it was pleasing to see Xero delivering double-digit subscriber growth. We believe this points positively to the high potential levels of adoption in our International segment. Turning now to our International segment and starting with the U.K. Revenue increased by 24% to $133 million. Net subscriber additions of 65,000 for the period brought subscribers to a total of 785,000. Despite deadlines for the implementation of making tax digital for income tax being deferred by HMRC, we continue to invest in best-in-class cloud-based compliance as reflected by the launch of Xero's personal tax product in the half. We've also just announced Alex von Schirmeister as our incoming Managing Director of U.K. and EMEA. Alex brings more than 25 years of relevant leadership experience, having worked in e-commerce, payments and telecommunications. And from next month, Alex will succeed Gary Turner who announced in July, he would step down as MD after 12 years in the role with Xero, and I look forward to having Gary as an adviser to us beyond his tenure as MD. In North America, we added 23,000 net subscribers, more than double the additions seen in the first half of last year. Subscribers reached 308,000, which is 23% up on the prior year period. Revenue increased by 5% to $30 million. In constant currency, revenue grew 14%, with the U.S. being one of the markets most impacted by currency movements in the period. The revenue result also reflects our continued focus on serving customers through the partner channel and also a price reduction to stand-alone Hubdoc plans in the second half of FY '21. In terms of partner engagement, we signed new agreements and expanded existing partnerships with a number of accounting firms across the U.S. and Canada, such as Liberty Tax, Bernard Robinson & Co and Padgett. I'm also happy to confirm that Xerocon is returning next year. We have announced Xerocon New Orleans in May, and we're looking forward to connecting with our existing and new partners at our Xerocon events again. We continue to invest more in the localization of our product for North America. For example, we delivered enhanced provincial sales tax tools in Canada for a number of provinces and improved balance sheet and other reporting in the U.S. Our aspirations for North America are beyond what you see in our performance right now. We see a significant opportunity to bring our compliance playbook to address an estimated TAM of small businesses of more than $30 million. I'll talk more about our work here in my discussion about our investments shortly. In our Rest of World markets, revenue grew 72% or 85% in constant currency to $46 million. This includes the majority of the revenue contribution from Planday. We ended the period with 201,000 subscribers in Rest of World after adding 26,000 in the half. 6,000 Planday subscribers were added at the beginning of the period from the acquisition. We continue to deliver good progress in Singapore and South Africa. Both businesses are scaling rapidly in attractive markets. And in South Africa, we expanded our VAT filing beta, so now customers have the ability to make end-to-end VAT lodgments directly with the South African revenue service. To better meet local customer needs in Singapore, we introduced Singapore dollar billing in the half, and this has had good take-up from new and existing customers. Moving to Slide 9. Platform revenue now accounts for a double-digit portion of Xero's operating revenues. I'd like to spend some time discussing the activity indicators at the 3 largest contributors to this very important -- strategically important part of our business, Planday, Payroll and Payments. Planday has performed well in our 6 months of ownership. This has been a period characterized by some volatility within the countries and service sectors that Planday targets, but the demand for the product remains strong. We continue to work towards the launch of Planday in our other markets in the near future. On the left, we show the number of Planday employee users each quarter since September 2020, and average employee use increased by approximately 20% from the prior year period in the 3 months to end September '21. 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 U.K. where we offer the product. The right-hand chart shows monthly invoice payment value has grown by more than 40% since September 2020. Over the next few slides, I'm now going to update you on progress we've made on investments to support execution of our strategy. Now the main area of investment is our people where we continue to attract and retain great talent. In a competitive labor market, hiring with a focus on product and technology teams saw our FTEs grew to more than 4,000. This was a 30% increase year-on-year or 22%, excluding acquired businesses, in line with growth across our business. In August, we adjusted our flexible work policy and we introduced new permanently remote roles which seek to take advantage of an expanded potential talent pool. Now highlighting some of the product developments that our teams have delivered in the half. These include a comprehensive set of updates to bank reconciliation one of Xero's most used features. The look and feel of bank rec was refreshed as part of a broad technology initiative that's going to see similar changes across many other Xero products and features in the future. We've also leveraged machine learning to increase the accuracy of bank rec. We launched a new suite of forecasting tools called Xero Analytics and Analytics Plus. These are powered by AI, artificial intelligence, and enable more meaningful conversations between our customers and their advisers around cash flow. And looking to the small business platform, our invoice lending platform model entered an agreement with Australia's largest bank, the Commonwealth Bank of Australia, to support a new and innovative invoice financing offer. We also enhanced the Xero Me app to include the functionality of Xero Expenses. Xero Me works with our Payroll solution so that employees or our customers can access their pay slips, leave, time sheets and now make expense claims all in the one app. Moving to Slide 11. In August, we progressed our platform strategy with the introduction of the next evolution of our app marketplace, the Xero App Store. The Xero App Store lets small businesses choose their own toolkit of apps to manage their business, and there are now more than 1,000 connected apps within our ecosystem to choose from. Using machine learning, we've made it easier for small business customers to discover apps through personalized app recommendations and the search function in the App Store. Through the Xero App store, we're also providing app partners with greater support and features to scale their businesses and reach more customers. With the launch of the Xero App Store comes a shift to a more commercial model with Xero, receiving a referral revenue share of 15% of subscriptions for new customers who sign up through the App Store. Turning to the next slide. Today, we've announced we're acquiring LOCATE Inventory, a U.S.-based cloud inventory management provider. This transaction will enable us to better support the inventory needs of small businesses and enhance our e-commerce capability. Our plan is to embed LOCATE's talent and capability within Xero to enhance our inventory management solution and help meet increased demand for inventory and cash flow management tools by small businesses. Customers will be able to track and manage inventory in real time across multiple locations and channels, including a number of Xero's e-commerce partners. The new inventory solution is expected to launch to U.S. customers first before being made available in other markets. As a further step to enhance our e-commerce capability today, we've launched a new integration with Shopify available in the Xero App Store and the Shopify App Store. This will help Xero customers to simplify reconciliation, interpret sales data and use various insights within Xero to support running their business. We've also joined the Shopify Plus Certified App Program. This program is for a select group of Shopify partners to support the advanced needs of their global merchants. So I want to finish my remarks with Slide 13 and some comments on our strategy and approach to investment. Our strategic priorities are to drive cloud accounting adoption, grow the small business platform and build Xero for global scale innovation. We've made good progress on these through fluctuating global operating conditions as evidenced by our H1 FY '22 results. And progress on M&A aligned with our aspirations to provide small businesses with access to financial services and workforce management. What you see in Xero today is the result of investments made over many years. The investments we're making now are crucial to realizing the significant long-term growth opportunities we have. So with that in mind, I want to share with you some further detail about the areas of investment we're currently focused on to support these priorities. Firstly, in driving cloud adoption or cloud accounting adoption, the cloud accounting market is still young and underpenetrated. We are early in the adoption of cloud accounting and business applications by the 45 million plus small businesses, we estimate there to be across our existing markets. Three areas of focus and investment are North America. We're focused on building products and functionality to better meet the needs of our customers. Our product road map is key to our execution in North America. We're exploring how we might leverage partnerships and acquisitions alongside our product development plans in this important region. We also continue to explore products that extend our TAM towards customers with less complex needs. And for our accounting and bookkeeping partners, we're continuously working to create more modern practice and compliance tools to help them better serve their clients and run their practices. Under the small business platform, our focus areas are providing more seamless access to financial services within Xero workflows, particularly in the areas of payments and access to capital and leveraging our acquisition of Planday to bring together our capabilities in the areas of payroll and expenses to better support employing SMEs and their employees. We estimate the TAM opportunity here is more than 100 million employee users. Finally, to support our third strategic priority, building for global scale innovation. Our efforts include investing in the technology, product and business capabilities to enable a number of critical functions. These include reaching and communicating with our customers inflow and in real time through our product and digital platforms. Continuously evolving our product and technology to fully leverage AI and machine learning in order to generate data-based insights that help our customers better manage their businesses and investment in our people, capabilities and operational processes. The timing of the contribution from these investments will differ depending on a number of factors, such as macro conditions in regions, timing of government initiatives and timing of delivery. We'll provide more insight on the nature of these investments in key delivery milestones as we go forward. We remain extremely confident in the opportunity ahead of Xero to build our customer and partner base and to deliver on our purpose. Before I conclude, I want to acknowledge that this half has been challenging for many of our teams around the world as they work under varying restrictions and conditions due to COVID-19. I really want to thank them. I really want to thank them for their hard work as they continue to do all they do to support our customers and partners. So now I'll pass to Kirsty to cover our financial results and discuss Xero's FY '22 outlook.

Thanks, Steve. As Steve said, I'll now take us through our financial results for H1 FY '22 in more detail, starting on Slide 15. The results show Xero has delivered consistent momentum over the first half of FY '22. As you can see on the left, AMRR grew by 29% to $1.1 billion driven by subscriber growth of 23%. We also saw ARPU increase by 5%. The charts in the middle and on the right show EBITDA of $98 million and free cash flow of $6.4 million. EBITDA fell $22.7 million and free cash flow declined $47.9 million versus the prior year period. The decline in these profitability indicators capture the increase in operating expenses anticipated by guidance provided at our FY '21 results. The expenses represent product and technology investment commitments and a return to more normal rates of sales and marketing spend. Moving to the next slide. The strength of Xero business model continues to underpin our SaaS metrics, including growth in LTV. On the left, you can see Xero's total LTV increased by $3.8 billion versus the prior year period to just under $10 billion. By segment, LTV increased by 55% in ANZ and 80% within international markets. Growth in both subscribers and LTV was subscriber -- was strong in Xero's international market, assisted in part by our Planday acquisition. Before I discuss the drivers of these outcomes, I want to touch on some of the related quality metrics. These are LTV per subscriber; CAC, or customer acquisition cost months; and LTV to CAC. These aren't on the slides, but you'll find them in the appendix. The increase in total LTV has come from the 23% increase in subscribers together with a 31% increase in LTV per subscriber to nearly $3,300. CAC months decreased from 14.8 months at the end of FY '21 to 14.2 months. This reflects consistent trends within the ANZ segment and some improvement in our international segment in H1. The LTV to CAC ratio increased to 7.4 from the 6.4 at the end of FY '21. CAC per gross subscriber addition was essentially unchanged in the period, meaning the change in this ratio was primarily from the growth in LTV per subscriber already mentioned. Now on the right-hand side, we've given you some additional disclosure around the drivers of LTV. This chart shows the development of Xero's LTV over the first 6 months of the year, broken down by driver. With the exception of FX and other movements, all of the underlying contributors have trended positively over the period. ARPU represents the monthly recurring revenue per subscriber at the end of the period. Within the first 6 months of the year, ARPU increased by 7% in constant currency to $31.32. Gross margin increased again to an 87.1%. I will discuss churn in further detail on the next slide, and the fall in churn was the largest single contributor to the uplift in LTV. New subscribers added in the half were the second largest contributor to the movement in LTV with the acquisitions of Planday and Tickstar also adding to the overall movement as shown on the slide. I now want to come back to ARPU and churn. On the left of Slide 17, we show the main contributors to the movement in ARPU over the first half. Overall, ARPU has increased by just over $2 driven by the following: price increases communicated to customers in May were effective in 3 major markets of Australia, New Zealand and the U.K. from mid-September. Collectively, these were one of the largest drivers of the ARPU increase. The acquisition of Planday also had a relatively large positive impact on ARPU. On acquisition, Planday added approximately 6,000 subscribers with a typical monthly ARPU quite a bit higher than a regular Xero subscriber. While FX movements were unfavorable in the period, product mix and other factors, including take-up of financial services and ecosystem, accounted for the remainder of the ARPU increase. The right-hand chart shows the movement in churn seen in the period relative to long-term trends. Churn fell across the group to an all-time low of 0.88%. The trend towards lower levels of churn has been visible across all of Xero's markets. We believe the disruption caused by the pandemic has enhanced awareness of the value and importance of cloud accounting to our small business customers and accountants and bookkeepers. However, we remain mindful of potential cyclical risks and the SME segment's exposure to the macro environment. Having discussed our progress on LTV, I'd now like to touch on our gross profit and expenses. On the left-hand chart, service to cost to serve efficiency gains contribute to improved gross margin. This increased 1.4 percentage points versus the prior year period to 87.1%. The improved margin profile combined with a 23% increase in operating revenues, saw gross profit increase by 25% to $440 million. It's worth noting that acquisitions completed this period have had no meaningful impact on gross margin for the group. The largest of these, Planday, has a contribution profile that is largely consistent with Xero's existing operations. Turning to the chart on the right, total operating expenses increased by 46% versus the prior year period to $422 million. This equated to 83.4% of operating revenue inclusive of integration costs incurred in the period. Looking at operating expenses by type. The way we run the business in this half versus same period last year is evident in sales and marketing costs. These increased from 32% of operating revenue in the prior year to 37%. Sales and marketing costs have proven effective at driving the strong subscriber additions achieved in the period. But we have also taken specific actions to support brand awareness campaigns across TV, online and out-of-home. We launched a number of innovative campaigns in the period including targeted sponsorship of sporting events such as the Lion's tour of South Africa and use case examples, including Channel 9's The Block. A popular reality TV show in Australia [indiscernible] and the Resident Accountant on-site use Xero for tracking their renovation budgets, sending invoices and managing receipts. We continue to see the return on investment on brand awareness spend is attractive particularly in newer markets with Xero had less presence compared to ANZ. Product design and development costs accounted for 33% of operating revenue, up from 27% in the prior year period, but in proportion to the level of spending seen in the second half of FY '21. Our investment into product remains crucial to supporting customers and delivering on our long-term product and strategic plans. G&A costs were largely consistent with levels seen in the past at 13% of operating revenue. Integration costs associated with the acquisitions of Waddle, Planday and Tickstar are included in all of these operating expense measures, but in isolation amount to just under $3 million. So to sum up, the strong gross margin and revenue progress in the period has enabled investment into CAC and product development that continues to support our long-term aspirations. Moving to Slide 19. Here, we have our summary income statement for H1 FY '22 showing year-on-year changes. Operating revenue increased 23% to just under $506 million. Revenue growth for the year was ahead of growth in subscribers, helped by the ARPU factors I've already mentioned and the contribution from the businesses acquired over the last year. Collectively, these added $19 million to operating revenue in the period. As already discussed, gross margin improved to 87.1%. To elaborate on some specific examples of operating expense movements, which you can find in Note 5 of our interim report, advertising and marketing costs have more than doubled over the prior year period and are now back to similar nominal levels to those in previous periods. Travel costs increased almost tenfold but are still at a small fraction of pre-pandemic levels due to lockdowns or continued travel restrictions, but these costs would be expected to change further as travel moves back to pre-pandemic levels. A relatively large increase in consultant and contractor costs reflects the more limited use of these resources in the prior year period. These costs support our strategic investment into product and the integration of recent acquisitions. The movement in costs has resulted in an EBITDA margin of 19.4%, a decrease of 10.1 percentage points. A net loss of just under $6 million was $40 million lower than the prior year period. This was primarily due to the operating expense envelope I discussed, but there are some other items to flag. These are impairment charges totaling just under $3 million related to the software and other intangibles and finance costs include a noncash charge of $3 million related to the unwind of the discount applied to acquisition earnout. Prior to payment of these earnouts, the related amounts are recognized as the contingent consideration liability on the balance sheet and are subject to discounting that amortizes through the income statement as a noncash interest charge. Adjusting for this charge, underlying finance costs were consistent with the prior period. Moving to Slide 20. Cash generation and other movements in the period brought Xero's overall liquid resource to almost $1.2 billion at the 30th of September. This comprises cash and cash equivalents, short-term deposits and undrawn committed debt facilities of $150 million. Deducting our total debt term liability of $883 million, our net cash position at the end of first half was $125 million, down $132 million from the end of FY '21. The main movement in our cash position over the period came from $136 million in acquisition payments. These mostly comprised initial cash considerations for the acquisitions of Planday and Tickstar, which were completed at the start of the period. Before I move on to the outlook, I wanted to recap our approach to capital allocation. We continue to prioritize reinvestment of 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 complete to complement our strategy. Now to our outlook on the last slide. You can read our full outlook statement here, but I'll point out a couple of key elements. You remember the last 18 months have seen us shift from an initial rapid response to the uncertainties of pandemic progressively back towards a long-term focused growth setting. Our guidance on operating expenses for FY '22 continues to reflect this and remains unchanged, except for the acquisition we have announced today. We expect total operating expenses, excluding acquisition integration costs as a percentage of operating revenue, to be in the range of 80% to 85%. In addition, we expect integration costs associated with all the acquisitions announced since the start of FY '21 to increase total operating expenses as a percentage of operating revenue by up to 2% for FY '22. Given our performance in the first 6 months of the year, it is worth emphasizing that both elements of the operating expense guidance relate to Xero's full year performance for FY '22. And lastly, as previously stated, Planday is expected to contribute approximately 3 percentage points of additional operating revenue growth in FY '22. That concludes our presentation. Thanks to everyone for joining us online and by phone today. I'll now pass over to the moderator for your questions.

[Operator Instructions] Our first question comes from Rohan Sundram of MST Financial.

Just the one from me. Trying to understand from your perspective how the acquisitions over the last 12 months have been performing. I take on board the Slide 9 detail in the commentary. But just overall, how do you feel about them now that most of them have bedded down, all of them?

Yes. Look, thanks, Rohan. Good question. Look, we're very pleased with the progress. It still is early days. I mean we completed Planday and Tickstar at the very beginning of the half. So -- but look, everything about the strategic rationale for the acquisitions, very pleasingly, the people in the organizations we've acquired and the alignment in purpose, but also the way they've engaged has been really positive. And we've continued to evolve and work on our plans and programs going forward. So very pleased with the progress overall.

Our next question is from Garry Sherriff of RBC.

I'd just like to ask around the price changes. You did obviously put through for some of the bigger markets recently. Can you maybe just talk to us around the planned price changes over the next 6 to 12 months in those other markets and/or if there's more potentially coming for your core big ANZ U.K. markets?

Yes. Thanks, Garry. So yes, as we announced in August, there is going to be a price change that goes through North America and Rest of World in the middle of November. Now this is for only the business addition customers. And so that's out there in market. As far as what we can tell you about further pricing in the future, there's nothing to be seen here at this stage. However, as we've stated before, we very much look at increasing our prices based on the level of value we are providing to the small business and accountant and bookkeeper channel. And so as we put more into product development and as that value increases, then we believe that gives us the ability to be able to increase the prices at that time.

Our next question is from Stephen Ridgewell of Craigs Investment Partners.

Can you talk a little bit more to the improvement in international churn from sort of 1.5% a month last year to 1.2% a month? Just interested in your thoughts to what extent does the improvement reflect the increasing average age of the customer base, maybe a little bit from acquisitions more cyclical drivers or other things? And then just also understand your thoughts as to whether you're expecting to see that churn rate continue to kind of trend downwards in those international markets?

I'll take this one, Steve. And so Stephen, yes. I mean the -- we're very, very pleased with the churn result. It's continued to lower. We were pleased with how it was in March and it's full into, as I said, 0.88% for September. And this was both across the ANZ and the international segments. Obviously, more of an impact across the international group. I mean in ANZ, we're now at 0.67%, which means that if you look at the lifetime of a customer, it's now over 12 years. And so there's probably -- we are very, very thrilled with our ANZ number at the moment. International down at 1.2 has also been an improvement, and it has been improved across all of our regions within the international segment. We still -- as a sort of known most small businesses, about 50% of small businesses go out of business in the first 5 years. And even in international now, we've got almost 7-year lifetime of a subscriber, which is better than the average small business. And so we've seen that come down. We've seen it as we have improved the quality of our subscribers that have come through. Also, as we have looked at moving our go to market and building up that centralized resource, it's really increased the focus on global sales and marketing disciplines and processes. And of course, externally, things that we can't necessarily have that much impact on we have seen an increase of cloud adoption. COVID has certainly been a good factor that has helped us with that, along with government digitization as well across the region. So who knows what will happen with churn in the future, but we are certainly pleased with where it sits today.

Okay. And then just maybe pivoting to North America. With the 14% constant currency revenue growth in that market in the first half, can you able to give us a little more color on the relative performance of the U.S. and Canada, obviously, a newer market entry for you?

Yes, Stephen, I think also we did touch on the fact that repricing stand-alone Hubdoc subscriptions also played a part there and that if you factor that in, you get a revenue growth figure that is closer to the subscriber growth. And we do continue to execute across both Canada and the U.S. with a focus on the partner channel. I won't -- we don't break that out. But I think that essentially, what I would say is that the markets are very different in terms of the way we go about them. However, there are a lot of consistency at this stage, really, the consistency is about the way that we approach our customers in those markets and go to market. So the progress we're making is consistent across both the U.S. and Canada.

Our next question is from Lucy Huang from Bank of America.

I'd just like to ask around Planday and Tickstar. So given -- have you had any early thoughts into the strategy of the integration moving forward? Are we likely to see these products being bundled into the core Xero plans or still monetized separately? Just wondering if there's been any early thinking around that.

Yes. Look, Planday and Tickstar a little bit different. I think your question is spot on in the context of Planday, where essentially, there's a great opportunity for us to bring the functionality of Planday to many, many, many small businesses, and that is the objective of the collaborations we have in terms of reaching that small, small business segment that we can really serve well. So that's a big focus for us. Whilst Planday does continue to serve and support small business and medium businesses that have larger employee bases than a typical Xero subscribers. So that's a great opportunity for us. We're working on that and obviously keen to see Planday in the markets where Xero has presence. Tickstar is a little bit different because Tickstar is about a capability around the invoicing. And so that's kind of distributed more equally across all markets by virtue of the capability we have as we develop our e-invoicing offerings and continue to do that in each of the markets around the world. So look at Tickstar more as a capability and Planday as an application suite that can really help any small employing business.

Our next question is from Roger Samuel of Jefferies.

My question is around the TAM. You mentioned that TAM is about 45 million small businesses and also 100 million employee users. I just want to clarify a few things. Firstly, do you include Europe in that number? And secondly, do you discount the number to account for small businesses and casual employees for Planday? And yes, thirdly, just wondering with the acquisition of LOCATE in the U.S., are you able to able to address probably businesses that are goods based?

Yes. So, Roger, on the first one, the numbers we published are about the English-speaking markets that we are in, just to be clear. And on your second question is very spot on. We see great opportunity to support goods selling businesses, small businesses, and in fact, the significant growth in e-commerce and the fragmentation between different systems that small businesses use some -- in terms of operating their business, once they enter into the e-commerce world is something that we can really address by having a strong inventory offering that connects their sales activities through their e-commerce channels and many of them will have more than one to their accounting and financial systems, that means they can get a much, much clearer and cleaner insight to how their business is performing and also a really good insight into the quality of their inventory and the way that they're moving stock through the different channels. So that's absolutely a big motivator to what we're doing.

Yes. And just to follow up, is it fair to say that your current customer base is mainly service-based businesses as opposed to yes, selling goods?

No, no. We do have plenty of retail customers, and we participate across both sectors, both the services sector and the goods selling sector, if we call it that. It's really about everything we're about, which is there's a long way to go before all small businesses are getting the value out of cloud-based accounting and cloud-based software. And when we look at our growth opportunities, we look at the segments of small business and the applications that small businesses can most get benefit from. And e-commerce and inventory is obviously a significant one and an important one for us.

Our next question is from Elise Kennedy of Jarden.

Kirsty and Steve, great to get some more disclosure around the growing platform revenues and the role of acquisitions. I just wanted to tap further into App Store. I know it's early days since you've changed that revenue model, but I'm curious to know if you're willing to share of those 100,000 customers you have on there, how -- what percentage are on that revenue share today? And do you know if your peers are also taking a fee or a revenue share from the customers and if that's become a friction point to adding them at all?

So Elise, I just missed that last part of your question about the second part. I think it was about who's taking revenue share. Can you just say that again?

Just wondering if any of your peers are following a similar revenue share model or if they've kept it free and if that's become a friction point at all.

Look, it is, as you said, Elise, it is early days, and it really is too early to start sharing the progress. We've literally launched within the last 8 weeks. So it's a little bit early to say so. Certainly, we've got a great -- a very positive reception to the commercial terms that we put out at 15% because when you do look across the industry at similar organizations where they're app stores, the 15% that we the share that we're receiving is very competitive and seem to be very fair in the context of what we're doing.

Our next question is from Siraj Ahmed of Citi.

Steve, it seems like there's a bit more increased enthusiasm or confidence in North America. Just keen to hear your thoughts on how you're placed on that? And secondly, what do you see as the big gap that you need to address to grow the U.S. business and the $30 million TAM that you have for that market?

Yes. Look, as you say, it's a big opportunity, and it's still a market where -- most small businesses are not supported or served by cloud accounting and cloud-based business applications. We're really pleased with the 23% subscriber growth that we had. Interestingly, in that, we are getting -- we're getting endorsements from customers and partners on the value of Xero and their desire to do business with Xero. And it's called out some of the successes we've had with some significant partners. The focus in North America is actually it is different, but follows the same fundamental elements that led to our success -- have led to our success in Australia and New Zealand, in particular, which is really to make sure that our product road map supports a greater degree of seamlessness and integration of workflows. And if you can wire compliance, payroll and accounting together along with a strong ecosystem and applications, that is the future opportunity we have in all markets to get all small businesses to really benefit from that. We also get a lot of encouragement from partners in the North American market, and we've got a good partnership with Gusto in payroll and many other partners. And it's a very fertile area of opportunity. And then acquisitions, such as the one we announced today, also give us an opportunity to further fill out our product road map for North America. So we know there's a big opportunity. We have big aspirations beyond where we are today. And at the end of the day, it comes down executing on the fundamentals, and that's what we intend to do.

On that, do you reckon you need to increase your product for the U.S. market or the current levels for that?

Sorry, do we need to increase -- I didn't quite get the question.

The product development as a percentage of revenue, the investment development in R&D. Do you reckon you need to increase that? Or do you think current levels will suffice?

Yes. Look, I think that there's 2 questions in the question around the overall and then specifically to North America. Maybe I'm not going to -- I won't answer on the overall, but I will in terms of North America, it's a priority for us. So we'll continue to invest commensurate with the opportunity and also the return we see long term for the North American market.

Our next question is from Paul Mason of E&P.

I might jump back in the queue for a second one as well. But in terms of your addressable market discussion that you've had today, one of the things that seems to be jumping out is around Australia, in particular, where I think you guys have communicated about $2 million addressable market in the past there. But if I add up your number, insurance numbers and MYB's last disclosed numbers as well, so it looks like it's gone past that and you're still around 20-plus percent. So maybe could you give us a bit of color in terms of like sort of how you're thinking about where penetration rates are out there? And sort of what other forces might be driving growth rates if it's not just that we're still right in the middle of the adoption curve?

Yes. I think -- I mean we I suppose when we first go into the market, the only way that we can really get the number of -- the total number of TAM is by looking at, say, for example, companies registered and information that we can get from tax authorities. And many times, the data that we get doesn't include the level of, I suppose, structure that small businesses can have within their business. So for example, you could have -- you could be trading under a company, you might have your assets secured in a trust. You may be doing some form of partnership with a friend or a family member. In that example, you have 3 subscriptions, even though if you looked at the company's information, it would only show us one. And so it's something that we've seen both in Australia and New Zealand as we get more penetrated in the market, actually, the TAM grows because we start to be able to look through and see those additional entities that do become part of the TAM. So we see that the cloud penetration in Australia at the moment is probably around that sort of 60%, 65%. So still a long way to go. And if you look at what's happening in the New Zealand market, where we have higher cloud penetration, New Zealand had its largest ever half ever last -- in this half. And so it certainly isn't slowing down, much like Australia, had its best behalf too. So it's going to be really interesting to see where that lands in the future.

Our next question is from Tom Beadle of UBS.

Just I had a question on the international subscriber growth. Obviously, it's a pretty solid number. It was probably a little bit below expectations, though. So I'm just wondering, is there anything to talk to sort of any drags to talk to from a macro perspective. So I mean, for example, what can you see in your own data on your SME customers in the U.K. and U.S.? And how does that compare to Australia and New Zealand?

So something that we always need to consider looking at comparing H1 and H2 is that different countries, different regions do have seasonality. So effectively, you end up in a situation where normally H2 is the stronger half for most regions, apart from Australia, which has majority of the taxes at the end of June. So there is certainly seasonality behind it. And also, this has been a market which has had a fluctuation in variability. And so we're pleased with how we've gone in the international segment. We have seen good growth, 23% subscriber growth, both in the U.K. and North America at good solid numbers. And as I say, we've had -- we've also continued to have really strong growth across the ANZ segment.

I think, Tom, I'd add also because you can get access to the Xero small business insight data that we published that takes anonymized aggregated data across several hundred thousand small businesses in Australia and New Zealand and the U.K. and sort of draw some conclusions around what's happening with revenue and job sales and jobs growth in those markets. And we talk about fluctuating conditions, well, that is the case. That's what we're seeing. And when lockdowns occur, that has an impact. And then when the lockdowns end, that also leads to a positive outcome. But overall, it is still, I think, best described outside -- in the broader context is fluctuating times and conditions.

Our next question is from Quinn Pierson of Credit Suisse.

So as I think about your revenue growth outlook from here, ARPU is increasingly featuring. And a lot of these ARPU drivers are at far higher contribution margins than the group, some at 100% contribution margins, things like price rises. So look, you've been clear on your FY '22 cost guide. I just wonder if looking past FY '22, we're finally at a stage where we can be thinking about reinvestment and still being able to handle some margin accretion. I'd love to know your thoughts kind of on FY '23 and onwards, how to be thinking about the ability to reinvest and still bank some margin expansion?

Thanks, Quinn. Yes, I mean, we are very much talking around the first half of FY '22 today. So I can't really give you any kind of commentary on FY '23. I think within that question, you did include a fair number of different things. We talked around -- you talked around ARPU and we were really pleased to see the ARPU uplift of 5%. And as I went through in my script, there are a number of different factors which have driven the increase in that ARPU. The price change that we put through definitely helped and was very successfully managed across each of our regions that have impacted. We've also seen changes in the product mix, the acquisitions, particularly Planday also helped the attach of different ecosystems. But then, of course, we have FX being a bit of headwind. So overall, ARPU does sort of bounce around at the moment. It's a little bit volatile depending on what's happening within the half. But obviously, longer term, with the product set that we have today, ARPU should be on the upward direction as long as, for example, we don't suddenly get a massive hit on the payroll only solution or that our -- that this data -- the reinvigorated data product from last year, those sorts of new products would also have a drag on our ARPU. As far as whether or not you can expect margin expansion in the future, I think we've been pretty clear around the fact that we see huge opportunity out there globally. We have a strategy that wants to take as much of that opportunity as we possibly can. And so we very much at the moment are focused on reinvesting that contribution back into the business to take hold of the opportunity that we see ahead of us.

Our next question is from Bob Chen of JPMorgan.

Just a question around the broader M&A strategy going forward. Obviously another small pickup today with LOCATE. I mean, what does that pipeline look like going forward? And how does that tie in with some of the gaps across your current product offering? And maybe even some color on what scale of acquisitions would you be willing to take on as well?

Yes. Well, thanks for the question, Bob. Look, again, it's grounded in strategy. And our strategy really does have 2 dimensions. One, in terms of executing M&A -- well, actually 3. There's driving cloud accounting adoption, there's a building of the platform, in other words, applications and services that extend the usage of Xero platform by our customers. And then obviously, capabilities that we're building for continued growth. And those 3 things play into the way we think about this. We have a really good idea in the context of our strategy about the application areas, the markets, the needs that are really worthy of consideration and participation. And what I would say is there's no fixed formula for what an acquisition might look like other than its suitability to help us in that execution of our strategy. So alignment with our strategy is what we look for, the value it's going to deliver to customer is what we look for. The actual size scale is not, in a sense, the driver here. So we're very open-minded around that.

Our next question is from Garry Sherriff of RBC.

Just a quick follow-up on ARPU. Are you able to just remind us on the ARPU contribution versus the Planday, I should say, relative to the core. Can we just get a sense of what the ARPU is from Planday, if possible?

Yes. So I mean, within that ARPU, it had slightly less than $1 impact on the ARPU.

And the last question just in relation to legislative tailwinds or headwinds. I mean you did refer to making tax digital being deferred. I mean are there other material developments in the U.K. or other major markets on the horizon that you can fill us in on from a timing perspective?

Yes, probably nothing specifically in terms of a deadline or a date, but more to do with -- certainly, the governments continue to encourage in every market digital connections to business. And you've got also trends like open banking, which are significant in several markets. You've got invoicing, which is another area that's being promoted. So I think that there is definitely potential for more government-related support for the digitization of small business as we go forward.

Our next question is from Roger Samuel of Jefferies.

Just a follow-up question from me. You mentioned that North America is a key focus for you right now. I'm just wondering why this time different for you? Why are you confident about your future success in the U.S.? Is it the market structure is different? Is it the competition has sort of backed away from small business segment? Just curious why is it a priority for you.

Yes. Look, it's I think a bunch of reasons, Roger. I mean it is a big market, a big opportunity. It is underserved at this particular point in time and will be for a while to come yet. We get a lot of encouragement out of being able to add subscribers and also engage and build great relationships with accounting and bookkeeping partners. We know our customers and credit to Tony and the team that have been leading our go-to-market focus and efforts over the last couple of years. We've got a really good sense now and our product teams are engaged very closely to understand the specific needs of accountants and bookkeepers and small business customers in North America. And we're at a point in our journey now where the progress we've made elsewhere, we've learned a lot, and we can -- we also have capabilities now that give us the opportunity to put a road map in place and also to partner and look at acquisitions that can really help us. So I would say it's just a function of the ongoing growth and the maturity of Xero today versus where we were 3 years ago, which is half what we are today. So it's all part of what we've been building for, and there's still a lot of work to do. The job is not done, but we really believe that where the offerings are in the market today, they're either not being used or there's plenty of room for us to differentiate and provide a different value proposition as we go forward.

Our next question is from Siraj Ahmed of Citi.

Steve, can I just touch on Slide 9, we show the activity levels. It seems like there's a bit of softness in the September quarter for Payroll and also for Planday. Can you just touch on -- is that, first of all, on Payroll and Payments, is that just sort of lockdown in ANZ and...

Yes. That's right. Yes. Yes, it's definitely -- sorry, I'm cutting you -- I'll let you finish. Sorry about that. Go ahead.

You finish, Steve, sorry.

Yes, I think you've got it right in terms of Payroll. I mean the Payroll business is growing. But when we have lockdowns, it does have an impact on, obviously, what we're reporting there. And Planday, look, we're, again, very, very pleased with the progress they're making and the growth in employee users is a real positive there for us. So still a lot of market available to them, both in the markets they're in, the European markets are in, but also in the Xero markets that we plan to bring them to.

But at -- Steve, is that lockdown later as well? Because again, the step-up is slightly slower than the June quarter?

Yes. Sorry, this is -- you're talking about which one in that context?

The third chart on Slide 9, if you look at payment volume, it's increased on June quarter, but actually, the delta is a bit slower than March to June. So just wondering whether lockdowns had an impact in payment value as well.

Look, certainly, in the last few months of the half, there was a lot of lockdown activity in New Zealand and Australia that would have had some effect. But again, even in that context, it's still good to see that overall, there's growth. But this -- the conditions have been fluctuating. I mean when I said that the last -- the half was challenging for our people, it's because they're experiencing the changing conditions, lockdowns and then opening up again because we're going back and forward between different environments as well. And so are our customers and our partners.

Our next question is from Paul Mason of E&P.

Sorry, this is going to end up being a 2-part question, but -- so because there's been a comment about making tax digital being deferred. So my understanding is that the next phase of VAT requirements is still coming in, in April '22 and the thing that's being deferred incrementally is income tax from '23 to '24. Maybe you can correct me if I'm wrong on that. But presumably, I'm right, the second part is maybe if you could give some comments on sort of how the trajectory of this year is sort of feeling in the U.K. with the regulatory trigger at the end of the year coming versus what the last time felt like in 2019.

So yes, thanks for the question. You are correct. Certainly, that's sort of second phase of VAT for businesses that are under the 85,000 threshold hasn't being postponed as the next part, the next phase of making tax digital. I mean there is a large opportunity for us as there was with the first phase. They are smaller businesses. So therefore, it will be interesting to see how much of that really fits in with the Xero solutions that we have today. But there certainly is a large opportunity there. I think information from the HMRC was that in total, there was going to be about $1.1 million opportunity there of businesses who fit within that criteria and probably sort of close to 400,000, 500,000 of those only have making tax digital solution at the moment, which does leave there are few that need to work out how they are going to solve for that connection within the next sort of half.

If you have any further questions, please contact the Xero Investor Relations team. If you're a media representative, please reach out to Xero's Corporate Communications team. Mr. Vamos back to you for closing comments.

Thank you very much, Ari, our moderator, and thank you to all of you for taking the time to join us today for your questions and for your ongoing interest in Xero. We really, really appreciate it, and our team are ready to connect when that suits you. So thank you very much. And appreciate you all. Look after yourselves, and thanks for attending.

Thank you. That concludes today's call. Thank you for joining. You may now disconnect your lines.