Xero Limited (XRO) Earnings Call Transcript & Summary

Well, good morning, and thank you for joining Xero's investor briefing today. I'm David Thodey, Xero's Chair. I don't get to cover the many of these meetings, so I'm delighted to be here in Sydney with the whole Xero team. In a moment, I'm going to hand over to Steve and Kirsty for an update on Xero's half first half year results for '23. But before I do that, I want to comment on the announcement we made today that the Board has appointed Sukhinder Singh Cassidy as our new CEO from the 1st of February 2023, and we're very excited about this appointment. Sukhinder will succeed Steve, who, after serving close to 5 years as CEO, has decided to retire from this role and plans to return to his previous portfolio in business coaching and leadership development as an adviser, director and investor, which I'm sure he will continue to do incredibly well. So on behalf of the Board, I really am delighted to appoint someone of Sukhinder's caliber as CEO to really lead Xero through this next phase of growth. And I really stress that because the Board has looked at what we think are the requirements for this company as we scale it globally. It has been a rigorous global recruitment process where we considered a number of really exceptional candidates. But Sukhinder has this broad experience across different organizations, [ role ] types, geographies within the tech sector, and in particular, building product and scaling go-to-market businesses. And we think this is just a unique set of capabilities that will really be beneficial to the company as we go forward. Sukhinder is a purpose-driven and human-centered leader who is passionate about supporting our customers, which is so important to us and is committed to growing in [indiscernible] unique and very vibrant culture. So just a little bit on the timing. Sukhinder will start at Xero on the 28th of November. And she's going to work closely with Steve to manage the CEO transition, and Steve is going to remain available to advise her and the Board through to the end of May. In line to say we have Sukhinder here with us today, and she's going to say a few brief words before we hand over to Steve and Kirsty for the first half results. But just before I do that, I really do want to acknowledge Steve's enormous contribution to Xero's growth over the last 4 to 5 years. In fact, it's 7 years that he's been involved with the company, and he really has taken the company to really be on the global stage, and he's overseen significant expansion in many different respects. And of course, he is a highly respected leader both within the organization but across Australia and New Zealand and on the global stage. So at the end of the results presentation, I'll be really happy to take any questions about Sukhinder's appointment. But let's leave plenty of time for Steve and Kirsty for the questions on our results. Sukhinder won't be taking any questions today, but is looking forward to meeting with you all and engaging with you in the near future. So with that, let me just pass over to Sukhinder to make a few comments.

Thanks, David. I'm thrilled to be appointed as CEO and appreciate the Xero Board's confidence in me. What excites me about Xero is the people, the culture of the company, the passion of Xero's partners and customers clearly have for our product as well as, of course, is the large total market opportunity globally. I believe Xero is a critical business tool for small businesses and their advisers. There are huge opportunities in front of us, and I'm committed to building on the business has great momentum already in line with Xero's value. I'm looking forward to getting to know Xero people, partners, customers and shareholders, of course, around the world and leading the business through this next exciting stage of growth. I'll hand now back to David.

Well, thanks, Sukhinder. And let me just again say it's really great to have you on the team. So let me now pass over to Steve and then Kirsty for the results. Over to you, Steve.

Thank you, David, and hi, everyone. Look, it's great to have David and Sukhinder here with me and Kirsty. And obviously, before I get into the results, I really want to extend my sincere congratulations to Sukhinder on your appointment. I absolutely know you are well placed to lead Xero through its next phase of development, and I'm really looking forward to working with you on the transition. So let's move to the business at hand, and the momentum in our business and progress on our strategic priorities is demonstrated by Xero's strong revenue growth and SaaS metrics. It shows more customers are increasingly using Xero to run their business and meet critical compliance needs. Despite its complexity and challenges for our customers, the current macro backdrop strengthens the case for small businesses to adopt cloud technology to make their business more efficient and effective. And Xero's high-value cloud accounting products and connected applications and services are needed more than ever. We remain focused on helping more small businesses use Xero given we are still early in the journey of small business cloud software adoption, and I'll talk more about that later. We appreciate the higher interest rate environment has placed greater scrutiny on the spend and returns of growth companies. This, along with inflationary pressures means cost discipline and the returns we generate from the investments we make are an important ongoing focus for us. Our disciplined approach to investment contributed to the positive free cash flow growth this half as we saw the benefits of emerging efficiencies. We'll continue to invest, focusing on growth and efficiency for both the short and long term. So with that, let's move to an overview of our results on Slide 7. We delivered 30% revenue growth on the prior year or 27% on a constant currency basis, reflecting strong growth in our portfolio across all markets. Subscriber growth remained a key driver, growing to nearly 3.5 million, up 16% on the prior year. Net subscriber additions totaled 483,000 over the year and 225,000 during the half. Subscriber additions were subdued in some markets such as the U.K., and I'll touch on that later. Annualized monthly recurring revenue, or AMRR, grew to almost $1.5 billion, increasing 31% or 23% on a constant currency basis. ARPU increased 12.7% versus the prior year or 6.3% on a constant currency basis. Subscriber lifetime value or LTV increased to $13 billion from $9.9 billion, reflecting the contribution of subscriber growth and higher ARPU. EBITDA increased 11% versus the prior year to $108.6 million, although this did include an impairment to the water business and some noncash adjustments, which Kirsty will talk to. Excluding these, EBITDA increased 28% compared to the prior period. We reported a net loss of $16.1 million, which compared to a loss of $5.9 million in the prior comparable period. Free cash flow was up $9.2 million to $15.6 million. Our ability to invest is a function of sustained revenue momentum and the SaaS unit economics we produce, and I want to touch on that on the next slide. LTV is a high-level measure of the value customers bring to zero over their lifetime, which on average, is around 9 years. The chart on the left shows the expansion in LTV we have generated in recent years with more customers doing more with us and staying with us longer. This is reflected in the key contributors of LTV being ARPU of $35.30 and churn of 0.91%. LTV to CAC of 6.9% also reflects the efficiency in the way we generate value. The unit economics we generate in New Zealand and Australia reflects the value of the Xero proposition and what it can deliver in a more developed market with LTV of $9.4 billion and an LTV to CAC ratio of 15.1%. Now while we don't expect to reach the same LTV to CAC in our International segment, we do see substantial opportunity to further grow LTV. So I'll now discuss the performance in each of our regions over the half. Slide 9 shows the continued momentum in subscribers and strong revenue growth at the Australia and New Zealand regions have delivered. Both countries contributed to this, with Australia growing revenue by 31% and adding a further 126,000 subscribers in the half. New Zealand grew revenue by 16% and added 24,000 subscribers. This resulted in 27% revenue growth across the segment, with subscribers reaching just over $2 million and ARPU expansion of 13%. Turning to the International segment. We delivered 34% revenue growth year-on-year and nearly reached 1.5 million subscribers, up 15% year-on-year. ARPU grew by 12% year-on-year to $35 or 6% on a constant currency basis. We had a busy half reconnecting face-to-face with our partners at Xerocon in London and New Orleans after almost 3 years. In the U.K., revenue increased by 32% to $175 million. On a constant currency basis, this was up 34%. Net subscriber additions of 44,000 for the period brought subscribers in total to just shy of 900,000. Revenue growth was pleasing. However, as we said at the AGM, net subscriber growth in the U.K. remained more subdued than we'd like. This U.K. performance reflects slower uptake of the final stages of MTD for BAT, a less than buoyant macro economy and changes we have implemented through our partner sales approach, which have impacted partner channel productivity. These partner sales changes will benefit us going forward, but have taken some time to bed down. We expect Xero momentum in subscriber additions in the U.K. to improve over the remainder of FY '23 with performance in H2 FY '23 expected to be similar or better than the prior comparable period. In North America, revenue increased by 44% to $44 million. In constant currency, revenue grew 30%, reflecting subscriber growth, Xerocon revenue, price changes and the contribution of the LOCATE acquisition. We've announced price rises for our U.S. and Canadian dollar business additions that will come into effect in the middle of this month. Total subscribers in North America reached 354,000, up 15% on the prior year, adding 15,000 net subscribers in North America in the period. Subscriber performance in the first half was impacted by seasonality related to the tax year-end. We expect Xero momentum in subscriber additions in North America to improve over the remainder of FY '23, with performance in H2 FY '23 expected to be similar or better than the prior comparable period. In our Rest of World markets, revenue grew 35% or 25% in constant currency with net subscriber additions of 16,000, resulting in total subscribers increasing by 20% year-on-year. You can see on Slide 11 that Xero continues to deliver a high rate of top line growth against what remains a complex backdrop. The continued momentum in revenue reflects the benefits of both subscriber growth and ARPU expansion during the period from price changes and the continued uptake of our platform products by our customers. Platform revenues grew 31% or 29% in constant currency over the prior year as further take-up and usage of our financial services offerings and adjacent products continued. Platform revenues remained at 11% of operating revenues in the first half. There remains a significant opportunity to grow the usage and associated revenue of our platform products and services as cloud accounting adoption increases further. So let's turn to some of the underlying drivers here. On the next slide are the activity indicators for the 3 largest elements of platform revenues: Planday, Payroll and Payments. Planday continues to perform well in a challenging environment in Europe. We've launched our beta for Planday Australia, and we're continuing to test and refine Planday for the Australian award system. We plan to launch Planday to Australian customers early in calendar year 2023. We -- on the left, we show a number of Planday users each quarter since September 2021. Average employee users increased by approximately 18% from the prior year period in the 3 months to 30 September 2022. The middle chart shows employees paid through Xero payroll over the same time, and this increased 21% since this time last year across Australia, New Zealand and the U.K., where we offer this product. The right-hand chart shows monthly invoice payment value has continued to show strong growth, up 40% since September 2021. So we're pleased with the operational progress and the revenue momentum we are delivering. So now over the next few slides, I'm going to update you on the execution of our 3 strategic priorities and highlight the progress we've made in the half. Our strategic priorities are to drive cloud accounting adoption, grow our small business platform and to build for global scale and innovation. These priorities guide our investment in go-to-market, product and technology during the course of the current financial year and beyond. We remain strongly focused on collaboration with our accounting and bookkeeping partners and other important stakeholders in the digitization of the small business economy. We continue to make good progress adding more than 1.4 million subscribers over the past 3 years. It is still early in the journey of cloud adoption and the opportunity is very large and untapped. We estimate the total addressable market is more than 45 million small businesses in the regions where we operate. New Zealand and Australia lead the world in the penetration of small business cloud accounting adoption. The scale of our progress with 2 million cloud accounting subscribers reflect Xero's innovation in the region, significant policy initiatives by government to encourage digitization of small business tax and payroll compliance and also collaboration with the financial services sector. To underscore the global opportunity in Canada and the U.S.A., where these conditions are at an earlier stage of development, we estimate the penetration of cloud accounting to be about 25% of that in Australia and New Zealand on a per small business capita basis. So we continue to invest in several important product initiatives to drive cloud accounting adoption for the short and long term. In H1 FY '23, we delivered what we promised in meeting needs of customers with less complex needs with our launch of Xero Go in the U.K. and deeper product localization in North America with the announcement of the Avalara partnership sales tax in the U.S. We continue to invest in practice management solutions and more efficient workflows for our accounting and bookkeeping partners. Solutions for annual tax and sales tax management and compliance and improving the quality and range of bank feeds and the seamless entry of data into our accounting platform. The shift to the cloud is inevitable as the elements of digitizing the small business economy evolved further in each market and deliver strong benefits. We are a catalyst, and we continue to invest to develop and address this opportunity. Now moving to our second strategic priority to grow our small business platform. Our vision is to be the most trusted and insightful small business platform. Growing the small business platform is a natural extension of the adoption of cloud accounting and the financial system of record to help solve more customer problems with the products we build and of equal importance through our ecosystem of more than 1,000 connected applications. We've made good progress executing our strategy over the past 3 years, more than tripling platform revenues and increasing the percentage of revenue from 6% to 11%. We are directly investing in the growth and development of applications and services that support critical business needs, including managing cash flow through payments, lending and other tools that provide insights and analytics, managing people through our payroll and workforce management products and services, managing inventory, developing our new inventory solution to small business following our acquisition of LOCATE inventory. No single vendor is likely to ever meet all the needs of accountants, bookkeepers and small businesses. This is why we are committed to being an open platform and to the continued investment in our technology to encourage and enable third-party innovation and new ways of surfacing Xero with more customers in the future. On the slide, you can see how our microbrewery business in the U.S. is leveraging our technology stack using buildup comp for payments automation and Gusto, our payroll partner. Another example is an adventure experience company in the U.K., which has utilized Rocketspark online store construction and Xero Stripe integration for payments. We are investing to grow our app ecosystem and app store to enable and facilitate access to these third-party solutions. Our app store utilizes machine learning to recommend applications to small businesses while helping our app partners scale their business and streamline billing. We're pleased with the progress we've made in our app store, where the majority of those ecosystem partners we targeted based on their fit have signed up with Xero, receiving a referral revenue share of 15% on any of the new connections through the App Store. Turning to our third priority of building for scale and innovation. This involves ongoing investment in attracting and retaining talent, evolving how we operate scale and building important capabilities for the future. We also continue to direct spend the technology investment to ensure we can capitalize on the long-term growth presented by the scale of the cloud opportunity in front of us and to add capabilities to drive revenue growth in the short and medium term. This next evolution of our product and technology investment is focused on improving efficiency, accelerating our speed to market, ensuring our people are supported to work in the best possible environment to innovate. Technology investment is also important to enable our data, AI and machine learning-driven vision of providing predictive, proactive and responsive insights for our partners and our customers in the future. As with all investment decisions, we consider the short- and longer-term benefits and returns of investment in this strategic priority, which competes for capital with other priorities and investment opportunities. All this exists within a well-considered overall product and technology investment envelope that reflects our focus on optimizing our short-term and long-term revenue opportunity. So in conclusion, we're pleased with progress in executing our strategy, evident in increasing breadth and relevance of our offering to customers and our financial results. So I'll now pass to Kirsty to cover our financial results before coming back to you to talk about Xero's FY '23 outlook.

Thanks, Steve, and good morning, everybody. I'll now provide some further detail on our financial results for the first half of FY '23, starting on Slide 19. The results Xero has delivered showed continued growth momentum across the group against what remains a complex macroeconomic backdrop. As you can see on the left, headline AMRR increased 31% to nearly $1.5 billion, driven by both subscriber growth of 16% and ARPU increases of 13%. There is some FX benefit within this metric due to recent currency movements, excluding this, AMRR increased 23%. The chart in the middle shows EBITDA of $108.6 million. This reflects the impact of a $25.9 million noncash impairment due to a change in operating conditions for the Waddle business, offset by noncash revaluation gains of $10.8 million. I'll talk through the details of these on a later slide. Excluding this, EBITDA increased 28% compared to the prior period, reflecting strong revenue growth alongside controlled operating spend against current inflationary pressures. I will point to the areas where this is evident as we discuss expenses. This demonstrates our willingness and ability to pull levers to address inflationary pressures while also delivering operating momentum. The chart on the right shows we generated free cash flow of $15.6 million. This free cash flow result shows how we continue to manage strong positive operating free cash flows generated against our investment objectives. Moving to the next slide. Steve talked to you about the importance of SaaS metrics and reflecting the value our proposition generates. I'm now going to discuss the movements in the period in a bit more detail. In the chart on the left-hand side, we show development of Xero's LTD over the half by driver. Moving left to right, subscriber growth was the largest driver of LTV uplift with an $800 million contribution. Up on constant currency basis contributed $480 million to the LTV uplift. FX contributed $760 million benefit to LTV. The contribution of gross margin and churn to LTV was unchanged with both holding broadly flat at 87% and 0.91%, respectively, which was a great outcome, and I will discuss this further on the next slide. I wanted to touch on some of the related metrics, which are highlighted in the chart on the right, LTV per subscriber, the average cost of acquiring a subscriber and LTV to CAC. You'll also find these metrics in the appendix. LTV per subscriber grew 12%, broadly in line with the increase in ARPU over the period to $3,706. Tax spend per gross net add was $540 for the period, H1 FY '22 to H1 FY '23. We -- this spend covers 3 broad areas: the cost of acquiring new subscribers, retaining our current subscribers and finally, helping subscribers uncover value and enhance the usage of our platform. A majority of acquisition costs are expensed in the period, in contrast to the revenue from subscribers added, which is earned over multiple years. This metric increased by 21% compared to H1 FY '22 due to the return of 30 cons, lower subscriber additions and also inflationary pressures. The year-on-year growth also reflects our investment ahead of Making Tax Digital for VAT and ITS in the U.K., which remain positive catalysts for adoption in this key market over the next 1 to 2 years. Tax spend per gross add is reflected in CAC months, increasing slightly from 14.2 months in H1 FY '22 to 15.3 months. Trends were broadly flat in the ANZ segment and increased in the International segment. LTV decreased to 6.9% from 7.4% in H1 FY '22. The reduction here primarily reflected in the international segment, where cat costs are higher compared to our more developed ANZ business. Now I want to come back to ARPU and churn. As we show on the left-hand side of Slide 21, ARPU has increased by 13% or close to $4 over the half. The main elements of this movement are price increases, which came into during September FY '23 across business addition plans in ANZ and the U.K. continued take-up of financial services and ecosystem products with ARPU accretive offset by product mix, which was a slight drag over the period. FX movements were a tailwind, increasing ARPU by approximately 7%. We -- to give you an idea of revenue sensitivity to FX for AMRR, we estimate that a further 1% weakening of the New Zealand dollar across all our major currencies, we would expect to see about a $12.9 million increase in AMRR. In the right-hand chart shows the decline seen in churn since cohort has been sustained and remains under 1% per month. While the trends are reassuring, given the complete macro backdrop, we're monitoring churn performance closely. We are aware of the pressure and uncertainty that small business owners are operating under. However, as we saw through COVID macroeconomic challenges and disruption can contribute to greater awareness of the value and importance of cloud accounting. Having discussed our progress on key SaaS metrics, I'll move on to gross profit and expenses on Slide 22. We Together, these 2 charts show the benefit of our continued disciplined investment. Overall, our results show healthy progress in gross profit and top line growth, which we have reinvested into the business to drive momentum this year and help build toward our longer-term objectives as Steve has highlighted. On the left-hand chart, our strong gross margin, combined with the revenue results for this year has seen gross profit increased by 30% to $573 million. Total operating expenses increased 31% from H1 FY '22 to $552 million as we show on the right-hand chart. This equates to 83.9% of operating revenue. We are focused on demonstrating cost discipline and emerging scale efficiencies. So let's take a look at the cost base in more detail on the next slide. Sales and marketing costs increased 26% compared to the prior year, comprising 36.3% of revenue in the half as we hosted 30 cons. Excluding these, cost growth was well controlled given inflationary pressures over the period, increasing 16% compared to the first half last year and only 1% against the second half. When Xerocon costs are excluded, the ratio falls to 33.7% of revenue. This proportion has fallen consistently over the past 5 years, reflecting scale benefits, particularly in our ANZ business as well as continued cost discipline in our go-to-market strategy as we build for global scale. We have made good progress when it comes to brand awareness, in particular, in our international markets. We are looking forward to the upcoming FIFA Women's World Cup, Australia and New Zealand in 2023, where our multiyear partnership with FIFA Women's Football will help build brand awareness to zero around the world. Moving to G&A. These costs are a smaller but important part of our business. We saw some scale benefit in the half in this area with expenses falling to 12.5% of revenue. This reflected the past work we did to build out important capabilities and strategy, corporate development and other support functions. Finally, on product design and development costs, these increased to 35% of revenues in the half. The growth in these costs reflected continued investment in our product road map and platform alongside the impact of new hires that joined in FY '22 and inflationary cost pressures. We continue to invest in our technologies team capability and development of the Xero product, but cost control is evident in the way we have tempered the pace of hiring against the inflationary backdrop and put a rigorous process in place to ensure we're hiring the people critical to our growth plans. Moving to Slide 24. Here, we present a summary income statement for the first half of the year showing year-on-year changes. Operating revenue increased 30% year-on-year to reach $659 million. Revenue progress was above the growth seen in subscribers of 16%, with the ARPU drivers already discussed a factor. As I've mentioned, gross margin was sustained at 87%, a pleasing outcome reflecting the benefit of scale efficiencies. Reported EBITDA was $108.6 million, 11 percentage points higher than the first half last year. This reflected strong revenue growth alongside controlled expense growth. It has also partially reflected the noncash accounting adjustments, including a $25.9 million impairment to the carrying value of Wade, reflecting the impact of the change in operating and market conditions for the water business, a $6.3 million benefit from derivative revaluations relating to our convertible notes. This is higher than in previous periods, reflecting the volatility in financial markets and benefits from a revaluation of contingent consideration and other management incentives totaling $4.5 million. Excluding these items, EBITDA was 28% higher at $123.7 million, as you can see in the table on the left. These items contributed to our reported net loss of $16 million, which compares to a net loss of $6 million in the prior half. Moving to Slide 25. Cash generation was largely offset by investing activity in the period, resulting in a $118 million increase in Xero's total cash position, including short-term deposits to just over $1.1 billion at the 30th of September. This comprises cash and cash equivalents along with short-term deposits, short-term deposits increased as a percentage of overall liquid assets, and we decided not to renew our undrawn AUD 150 million standby debt facility, which matured in August 2022 as part of our capital optimization strategy. We had another strong half of cash flow generated from operating activities reaching $160 million. We reinvested $145 million of that largely to drive growth, contributing to a free cash flow of $15.6 million. Our improved free cash flow outcomes reflect emerging efficiencies in our business as we reinvest to generate the best returns over the short and long term. Our long-term debt entirely reflects our [ zero ] coupon convertible note that matures in December 2025. The increase here reflected exchange rate impacts as the note is U.S. dollar denominated. Given the nature of our convertible note funding and another strong half of operating cash flow generation, we are comfortable with our net cash position at the end of the half at $24 million, down $101 million from the same time last year. I'll now pass back to Steve to provide some more detail on our outlook for FY '23. However, I would first reiterate that our commitment to our guidance reflects our willingness and ability to call leaders to address inflationary pressures while delivering operating momentum. Thank you.

Well, thank you, Kirsty. I'll now cover the outlook. And on Slide 26, you can see the outlook statement. We provided at our FY '22 results, and there's been no change here. We continue to expect FY '23 total operating expenses, including acquisition integration costs as a percentage of operating revenue to be towards the lower end of a range of 80% to 85%. The next slide provides more color on the expected composition of this ratio as well as the longer-term evolution of Xero's financial profile. While we continue to expect a reduction in sales and marketing costs to revenue alongside flat G&A cost to revenue, we now expect the ratio for product design and development to be to increase slightly compared to FY '22. This reflects Xero's investment in global product innovation, platform delivery, the impact of new hires who joined in FY '22, while managing inflationary cost pressure. While we have tempered the pace of hiring, we continue to invest in our product road map and the technology underpinning our platform. Our commitment to our expense-to-revenue ratio outlook reflects our willingness and ability to pull levers to address inflationary pressures to deliver both efficiency and operating momentum. Noting our FY '23 guidance implies an H2 FY '23 operating expense to revenue ratio of around 80%. We Managing our investments such that we see the best returns and efficiencies possible short and long term is a key focus now and a priority for us in the next phase of our strategy from FY '24 to '26. It would be natural to expect further progress as outlined on the slide in the form of our long-term aspiration. And while we haven't put a specific time line on this, our aspiration is to see significant improvement in Xero's operating expense ratio as Xero and the global cloud accounting industry continues to mature. Having said this, it's important to highlight that from period to period, our operating expense ratio and other ratios on the slide could vary as we identified growth opportunities that are consistent with our long-term objectives and adapt to market conditions. So as I close, and given this is the last Xero results announcement that I'll present, I do want to finish my remarks by especially thanking all our people for their hard work and commitment over the last 5 years. I'm so proud of our talent and how it now extends further around the world. I also want to thank our partners and customers. Their success is at the center of our purpose and exemplifies every day the difference Xero has made. I want to thank Xero's Board, our Chair, David Thodey; and Founder, Rod Drury, for the support and opportunity to lead Xero as a company's second CEO. Thanks also to our shareholders and all who support our business, I really appreciate it. I know all Xeros really appreciate it, too. I leave this role with a very strong belief and confidence that our vision and strategy for the future is exciting, and the Sukhinder is the right person to lead Xero through its next phase of development. Congratulations again Sukhinder. As a shareholder, I'm excited about you joining Xero and look forward to watching you work with our great people, partners and customers to take Xero to the next level. So that concludes our presentation. We'll now move to Q&A, and David is happy to take a few questions at the start on Sukhinder's appointment or we can move straight to results Q&A. I'll now hand back to the moderator.

[Operator Instructions] Your first question comes from Bob Chen from JPMorgan.

Question for me. Obviously, we've seen very strong ARPU growth on the back of recent price rises. How should we think about the cadence of price rises going forward and your thoughts on reinvesting this versus delivering operating leverage?

Thanks, Bob. Yes, I mean, it has really helped our ARPU and it just really shows, I think, the value of the cloud to small businesses. We don't, as some of our competitors say that we will do an annual price increase. However, we do always look at the increase in value and feel that we can put our prices up to reflect that as we invest more and more into the business.

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

A question for David. The new CEO, welcome Sukhinder. Will you permanently reside in New Zealand. And the second one for Steve on the U.K., could we maybe just get a sense on the percentage of businesses that are yet to comply with the VAT requirements in your view?

Great. Let me handle that one firstly. Look, very much the Board's thinking around here is that as the company goes global, we're less concerned about where people live. The reality is for all of us, including myself, we all are located in many different places. Sukhinder will remain where she lives now, but I'm a guy spent a lot of time in Australia and New Zealand and also in the Northern Hemisphere, where our major markets are quickly developing. So let me pass over to Kirsty and Steve for the second part of the question.

Yes. So as far as -- Garry, as far as the U.K. and making tax digital. So as I'm sure you're aware, we are at Phase 2 of making tax digital for VAT for those businesses that are under GBP 85,000. And it was -- actually, it was our expectation that we may see sub growth back and even the last financial year as we've seen in the first phase, and that didn't happen. It didn't come through our subs really for H2. And we haven't really seen it come through in H1 either. Now the government from the HMS as we've been told, are going to turn the technology off during November. And then also penalties will start to come through to small businesses if they stick with their original plan in January next year. So it's still a massive opportunity for us. And that also -- that helps give us that comfort and the statement that Steve made around really expecting our U.K. subs for H2 to be similar or better than H2 last financial year.

Your next question comes from Lucy Huang from UBS.

My question is also on U.K. I'm just wondering if you can give us some color as to whether the slowdown of Making Tax Digital or the sales restructure caused bigger, I guess, slowdown in the first half in terms of subscriber momentum. And I guess on the ground, what kind of feedback or indicators are you seeing that gives you confidence around the second half guidance on sales momentum tracking similar to the PCP?

Yes. Thanks for the question. Look, we have a very rigorous process of managing our sales teams around the world and the pipeline associated with achieving our revenue objectives. And so without sort of trying to break down factors because it's very challenging to do so, the one thing I can say, and the reason for the statement that Kirsty just repeated again is that the feedback from our sales people, the way the organization is now settled down, along with the changes we've made. It gives us a sense for the pipeline that makes it is able to make the statement we are about seeing those levels return to around or better than what we had in the similar half last year.

Your next question comes from Roger Samuel from Jefferies.

Maybe a question for David on Sukhinder. Yes, we could see the compensation structure, but can you tell us more about the LTI hurdles. And if you look in this squeeze in another one, just on the international LTV-to-CAC ratio, which has been pretty consistent around 3x for the last 4 years. And I'm just wondering when we can expect the LTV to tax ratio to improve in international markets.

Right. So let me take the first one, then I'll pass to Kirsty, I think, on LTV to CAC. Yes. Look, on the REM structure, again, the Board has taken a sort of global perspective on this and has very strongly driven it to performance outcome to align with shareholders, and that's really been part of the discussion Sukhinder wanted. And she was very much aligned with shareholders' interest. So in terms of the LTI structure, as you know, we've put in a relative TSR metric. And we will continue to have good growth metrics around revenue and I think over time EBITDA. But it's getting the balance right as the business scales, and we'll continue to work through with Sukhinder what makes the best sense for the business going forward. So you, Kirsty.

Thanks David. Roger, so yes, I mean, as we've spoken about before, Xero is a portfolio of different regions, which are all at different stages along the time line of cloud penetration. And so that's where you see the ANZ segment increasing up to 15.1% LTV to CAC, which is just phenomenal and shows the growth that we're seeing in subscribers with Australia having the best subscriber half ever. And so then we've got the portfolio of the regions where we still see masses of opportunity. And with the balanced portfolio, I suppose, coming up the 6.9% is actually incredibly high LTV to CAC. And if you remember, a few years ago, we were -- we were down at the 6% mark. So it is showing that over time, we are improving it. But with ANZ being up at 15.1%, it does give us the ability to be able to really invest in those in those newer markets. We've got the opportunity in the U.K. at the moment with Making Tax Digital, which we definitely want to ensure that we're spending the right amount of cash to make sure that we get our first year of that. And then also ensuring that we're putting the right level of investment into our new markets of North America and rest of world. So we as we always see Xero as a portfolio of regions. And so as we've got that, we're able to invest into international. Remembering, of course, in international, there are businesses within that, that are higher than the 3 and those are the more newer businesses that are slightly under that 3% to give us the average.

Your next question comes from Kane Hannan from Goldman Sachs.

Just that second half OpEx comment around 80%. I mean, if I run that through my model, I guess thing around 82% for the full year. First question is, is there a risk that we're more -- I suppose the midpoint of that 80% to 85% range? Or are there still scenarios where you could be 81% for the full year? And then just a sort of quick second line, just the U.K. business. I mean, what was the difference in the revenue growth for sort of subscriber trajectory versus your initial expectations to the -- I mean, clearly, it's a very strong revenue outcome but with the weaker subs. I mean, is that all ARPU? Is that Planday? Just trying to understand what was different in your expectations, is.

Kane, I'll start off and then if Steve wants to add anything he can at the end. So from an operating expense perspective, we do say lower ends. And so therefore, that means the lower end of 80% to 85%. I'm not going to tell you exactly with that is, but it's obviously a range that's not met but lower. So -- and that's where we're not saying definitely -- as ether. It's ATS, and we'll continue to work within those guidelines and ensure that we work to that lower end of 80% to 85%. From a difference in the U.K. between revenue and subscribers, that is -- the thing that comes -- that drives revenue is subscribers and also ARPU. And so therefore, you can see really strong ARPU growth going through the U.K., which has helped us. And coming back to the pricing question earlier on in the call, we do feel, particularly with the amount of investment that we put into Xero in the core that we are increasing the value of our core product, and that gives us the ability to be able to pull the pricing lever. ARPU also obviously reflects the where subscribers are on the product tec and also additions of platform revenue, too. So that's all in the mix in the U.K.

Perfect. So it was a better quality mix of subscribers and more transaction revenues than you were potentially thinking initially.

Well, I don't know quality is -- I think all of our subscribers are quality subscribers, but certainly higher ARPU, which is a higher dollar value.

Your next question comes from Siraj Ahmed from Citi.

Just a quick clarification maybe, Steve, on your comment on the U.K. subs. You mentioned that you're expecting improvement, but just clarifying whether you've seen an improvement to date in the second half? And I guess my key question just on the -- there's quite a mention about efficiency in the presentation. So the exit run rate of 80%, should we be thinking it's lower next year or just cognizant that you still need to invest in Xero Go. And on that, David, just on the LTI structure, surprised that EBITDA is not there, if you're seeing the next phase has efficiency as a metric.

I can give the last part. What was the...

So I think the first part was around whether or not we could continue to see the operating efficiency run through the business into future years. I mean I suppose if I refer you to the slide and the Investor deck, Slide 27. Our long-term exploration as cloud adoption does increase, is that absolutely, we should see efficiencies coming through all of our cost lines. I mean the amount of positive operating cash that we generate shows us that if we chose to stop investing, we would be an incredibly profitable business. However, we do see huge amounts of opportunity. And so therefore, do want to ensure that while we're able to show that definitely, the scale efficiencies coming through, we also do want to ensure that we are investing the appropriate amounts to be able to take hold of that take hold of that opportunity.

Siraj, can you just repeat the question regarding the U.K. subs. Sorry, mate, I didn't hear it...

Yes. Yes. Just have you seen an improvement because in November was the deadline for the old system to be stopped. So have you seen an improvement in the cadence for the ads in the U.K.? Was that yet to come?

Well, look, I can't comment on that, but the statement that I have made is a bit of a pointer. I mean I can't -- clearly, it's all about the forecast and execution of our sales teams during the half that we have confidence in. And I won't say anymore, but it's -- that is a pointer.

Right. And then I think at the last part of the question. I think the last comment was around with the efficiency focus, where's EBITDA in the LT. But just remember that what we put out there is the current LTI and we review LTI every year. So -- and as I mentioned, the Board will work with Sukhinder what looks like the best metrics going forward. So that's all we can really say at the moment.

Your next question comes from Eric Choi from Barrenjoey.

Maybe a high-level one for you, David. Just I guess you've appointed both Sukhinder and Kirsty both of which have -- both of whom have a Canadian background. So just wondering if there's got any extra perspective on what hasn't worked with the U.S. strategy and how that might shape the go-to-market strategy in Canada going forward? And if that all possible to stick in a second one. I was just wondering, I mean, with that international churn, it's still really low, but it's ticked up ever so slightly. And I'm just wondering if that's correlating to a higher uptick in business insolvencies at all. And therefore, if that's the top-down metric, we should start to be more mindful of.

Yes. I think I'll get Steve to answer some of that. But let me quickly say I think 2 Canadians wasn't our plan. So we quite like Canadians to be quite honest. But there's nothing you can read it there. But Steve, let me...

Yes. Look, look, we're really fortunate to attract the caliber of talent we have at Xero. And Kirsty's contribution has been really valuable in understanding where our business is at in North America. And I think that we'll benefit from that and are benefiting from that. So when we talk about the North American business, we talk about the amazing opportunity. We talk about the fact that the functions that really drive small business cloud adoption are still developing, things like bank feeds, things like government initiatives to encourage digitization. And then there's the work we have to do to fill out our product portfolio to really meet the needs of accountants bookkeepers and our small business customers. In Canada, we've got provincial sales tax now. We've got annual tax with TaxCycle. U.S. We've announced the Avalara partnership with sales tax, the acquisition of LOCATE for inventory. So all those fundamentals that really define the success we've had in Australia and New Zealand apply to those other markets around the world, and we're investing to really be that catalyst for accelerating growth. And I have to admit, I can't remember the second part of your question. So if you don't mind repeating, that would be great.

Sorry to sneak a second one maybe more for Kirsty anyway. Just looking at the international churn, it's ticking up ever so slightly. So I'm just wondering if like a rising U.K. business insolvencies is driving that at all?

Yes. I mean it hasn't really gone up too much from March. It was -- at March, it was 1.23%. It's now 1.26%, which is -- has gone up very, very slightly. But I think the thing to really remember is that, that is still rate that are far better than we were at pre-COVID. And so a very tiny uplift. I don't think we need to read too much into it at this stage, keeping an eye on it, but still incredibly pleased with the churn rate. I mean, it's Steve said it in the script. At the moment, with June at 0.91%, it means that Xero subscriber hangs around with us for about 9 years, which is pretty amazing, way, way longer than a normal small business sort of life.

Your next question comes from ZheWei from Macquarie.

Slide 14, the TAM. I was wondering if you could give us some background as to -- or the assumptions behind our TAM. That's the first one. And the second one, very quickly is just LOCATE inventory, if you might be able to give us an update as to the status of that business?

Yes. Thanks. Well, look, the -- I think on the slide, it actually does point to the fact that the TAM as described there is based on the best reporting of the number of small businesses that are registered in each market. which is quite interesting because it doesn't necessarily describe the potential of what a subscriber is because we have subscribers who are not just registered small businesses. They're just using Xero for their own personal use. So -- but that's the background to that particular aspect way. The LOCATE -- look, the LOCATE team have settled very, very well into the Xero business. They were very visible at Xerocon in New Orleans. The project is well underway, and we're really looking forward to making sure our U.S. customers benefit from that product first up, and then we'll take it further after that.

Thank you. Your next question comes from Matt Ingram from Bloomberg Intelligence.

Thanks for the very detailed pack and presentation. Sorry to bang on about the cost theme, I just wondered your CAC months in international are obviously substantially higher than in ANZ. I just wondered if you could give us some more color on the U.S. versus the rest of the international business? And I guess, how are you going to overcome that being a blend problem to the group margins as the U.S. presumably gets much bigger as you focus in that market increases.

Yes. So thanks, Matt, for the question. As I was talking about before, ANZ LTACs is far better as is our CAC months. And that gives us the view that once a market becomes more mature, if you like, when we have more relationships with the counter bookkeeper, when our brand has more of a presence there. We can work towards very, very efficient tax spend. Now within the International segment, and I'm not going to split out each of the regions individually. But there is a portfolio, the U.K. has got higher cloud adoption. And so therefore, we are more efficient. The U.S. that you specifically mentioned has huge amounts of TAM. And so therefore, we want to ensure that we have that those relationships with the accountants and bookkeepers there, the brand recognition to really be able to take our first year of that market. And I think we are seeing indicators that that is happening. The Xerocon that we had in New Orleans was incredibly well received by the accountants and bookkeepers that attended it. And so we absolutely -- we make sure that we spend the right amount of money based on the traction that we're getting in each of the markets. But longer term, we absolutely feel that the U.S. is with all of the different regions within the International segment, well with the level of investment that we're making at the moment.

[Operator Instructions] Your next question comes from Elise Kennedy from Jarden Limited.

Thanks, Steve, for your time over the years and all the best in your future endeavor. I have 2 questions. One, I wanted to ask on the Planday rollout and monetization that was previously announced across U.S. and U.K. just where that sits at the moment? And then the second question is just on ANZ. It seems to continually surprised on the number of subscribers that come through that market, particularly in relation to the number of SMEs is. I'm wondering how that can pan out in a more mature market than it is with a softer backdrop? Is the extra subscribers coming from competitors? Or is it more business creation?

Well, Elise, thank you for your comments. I appreciate it. I'm going to -- I'm having a little bit of trouble tracking questions. So I'm going to do the second one first. So the opportunity in Australia is to continue to grow subscribers is one that Joe and Will and the team are really focused on because we do see opportunity to continue to do that. And part of that is around winning the customers of other suppliers, but it's also about continuing to extend the benefits of the Xero platform beyond that TAM of small business customers because as I said earlier, the benefit of Xero can apply to many other structures and individuals beyond the registered number of small businesses. So there's still very much a growth mindset in the Australia business as there is in New Zealand. On Planday, we have released a beta, and we are learning a lot from obviously putting the product in the hands of the customers who are testing the product. We're continuing to refine it and looking forward to announcing it or making it more broadly available in the early part of next year.

Your next question comes from Nicholas Basile from CLSA.

2 questions, if I can. First one for David. Can you give us some more detail on the aspects of Sukhinder's experience that you think fit the Board and the management team's future vision for the growth of the company. I guess that question really comes from me thinking that I imagine part of it may be related to growing the Xero app ecosystem for SMEs or scaling in North America. But yes, just interested any feedback or thoughts you had in terms of the StubHub or Google experience and how that's going to drive the business going forward.

Right. Well, I think it's a little bit of all of the above, really. So -- but let me try to give you some color. Look, this has actually been the product of over 12 months' work about looking at where we think the future of Xero will be. And there is a really important strategic imperative about us really being a global company. As Steve mentioned, where the total market opportunity is, we realize that we need to keep scaling. And so when we were looking for the next CEO, that was the criteria we actually applied. I mean, very gratefully, Sukhinder's background fits that profile incredibly well. it's not just experiences at StubHub, it's not just the experiences at Yodlee. It was also the experiences as President of Google and growing the business throughout Asia Pacific and South America. She is truly a global executive. And as I stressed before, that was our criteria. So as we look to the market opportunity, you know we have a strong position here in Australia, New Zealand that will always be part of who we are, but it must be in the northern MS markets where we really focus. Now we continue to work in Canada and the U.S. and the U.K. and in time, that will be Europe, and that's where we need to be. So they were the criteria, but also it was the type of leader that we wanted to recruit Sukhinder actually came down to Australia at 100 in here in Sydney. She got to see our partners to get a feel for the type of company we are. And I can vouch for you that it left an indelible sort of, I think, impact on it, she mentioned that before. So that was what we look for because we need to get that balance right. But unquestionably, our future must be looking to the Northern Hemisphere, while we retained very strong presence here in Australia and New Zealand. So I hope that gives you a bit of color.

Yes. One more, if I can squeeze it in for the rest of the team, Steve or Kirsty perhaps. What are you seeing in terms of competition in the offshore markets? I think your own data suggest macro conditions are tougher in the U.K. and the U.S. than they are here in -- so just interested on any color on market positioning and related to that, how do you think that impacts the way you're thinking about price increases on the core software going forward?

Yes. Well, look, I'd say that the competitive environment hasn't changed significantly since we last had a conversation. It is competitive. The U.K. environment is competitive. North America is competitive. And I've always said that in the state of these markets, which are still early and underpenetrated relative to where we are in Australia and New Zealand, there is benefit having others also promoting the benefits of cloud software, cloud accounting, engagement by other stakeholders in the whole process and the whole benefit between economy of having a digitized small business sector. So I'd just say we've -- my belief is always that if you do a great job of serving your customers showing up and being able to articulate our proposition clearly in a growing environment, a growing market and underpenetrated market, you generally will win. So competition is a really important reference point, sometimes friends, sometimes not. But overall, it comes down to how well do you execute, how clear are you about who you want to serve and making sure you're exercising all those elements effectively.

Your next question comes from Rohan Sundram from MST Financial.

Best wishes, Steve, and congratulations, Sukhinder. One question for me. Just around the rest of world's first half net adds a little bit below recent history. Can you just maybe talk through the headwinds you are seeing there? And are you able to say whether you do expect a better second half from rest of world?

Yes. So we don't give any guidance about Rest of World separately. I suppose if you look at the components and think about the key countries that we have within Rest of World, we still have challenges within the Hong Kong market. And then across Singapore and South Africa, too, they were also seeing the economic challenges across those areas. It is a portfolio that, as I said before, rest of world is a small component, small and important for our future, but there's certainly on that very small end. And so we continue to invest appropriately in those areas and manage our different regions as a portfolio.

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

So I wanted to ask about sort of North American tax in general. I was hoping you could give a bit of extra detail on the extent of the integration with Avalara and also the nature of the go-to-market partnership. And then maybe also a little bit of color on the progress integrating TaxCycle in Canada.

Well, Paul, they're all obviously work in progress. In terms of the Avalara relationship, the idea there is that we integrate their functionality into the customer experience and flow within the product. So that will surface in the product ultimately. So -- and then obviously, the go-to-market related to that is the channels that we have and the work we do to connect with accounts and bookkeepers. TaxCycle, early days, but we're definitely seeing benefit there in the TaxCycle acquisition, helping us win new accounting and bookkeeping practices. And we have a nice integration between TaxCycle and Xero that addresses the workflows at our cat bookkeepers for annual tax are looking for at this point. So that sort of also shows up in TaxCycle's go-to-market work and our go-to-market work at Xero. So -- and the 2 teams are collaborating really well.

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

One more on the U.S. post Paul's question. The U.S. performance and the obstacles around them. Could you maybe just give us a view on what critical elements you think might be missing from a product perspective that may be hindering that adoption curve in the U.S.

Look, we had -- actually, David also attended a meeting that we had in October in Denver, where we had a panel of accountant simpler customers who've been actually on the journey, one of the fellows in fact was recounted the days when Rod turned up in the U.S. And look, I think the thing I would say is our focus is on accounts and bookkeepers and really helping them with their workflow. So the work we're doing in tax and also the work we've done to improve the customer experience around our reporting products has been really well received. We've got really positive feedback at Xerocon around that. The located inventory is really important because in a sense, it just broadens our appeal to small businesses that go beyond the services sector into the goods selling sector. So they're the main -- what you see are the main areas, we believe, because many of the other elements are things we can accommodate through really good partnerships like payroll and Gusto and others. So I think we've been pretty open about the areas that are important to us when it comes to U.S. product going forward.

Thanks for your stewardship, Steve.

Thanks, Garry.

That is all the time we have for questions. If you have any further questions, please contact the Investor Relations team. If you are a media representative, please reach out to Xero's corporate communications team. I'll now hand back for closing remarks.

Well, thank you, everyone. This is Steve. Really, really appreciate your interest and your engagement. And I wish you all the best, and thank you for your support of Xero. We appreciate it a lot. All the best.

And I should close recognizing Steve, I mean there has been a wonderful close to 5 years and we're very grateful to work with them. It's been a lot of fun. And it's just exciting now as we look to the future and Sukhinder now will be in the chair -- well, not the Chair role, the CEO, she could take that as well as the way in Feb. And I just think we're -- the companies are really well placed to continue to grow and do well. So thanks for your time, and I'm sure that there'll be a lot of briefings in the next week.