Xero Limited (XRO) Earnings Call Transcript & Summary

Good morning, and thank you for joining us. For many of you who I haven't met, I'm Sukhinder, the new CEO of Xero. Since joining Xero, I've worked with our team to better understand how we work and what we work on. I spent the last 90 days meeting and learning from our people and customers around the world. As part of this, I have received a lot of feedback, including from investors directly. I know many of you will be on this call. Through this process, I have learned that Xero has many strengths, including how resilient our business has been over the last few challenging years for our small business customers, as well as the strength and opportunity we have to still capture the very large and growing cloud accounting market where we are still early in our evolution. But we also have some challenges, and we must evolve. The organizational changes and decision to exit the Waddle business announced today reflect a reshaping of our business so we can simplify focus, strengthen our efficiency and execution, and balance growth with profitability. As a result, we have made the difficult decision to remove 700 to 800 roles across Xero, representing approximately 15% of our employee base globally. Kirsty will talk about the financial impacts of these decisions shortly. Let me add while I know these decisions are the right decisions for us financially, I will note that today is a very hard day for Xero. We are letting go people who have contributed so much to where we are today. In fact, these decisions will be acutely felt, and impact many talented friends and colleagues we have around the world. We take our purpose and values very seriously and remain committed to working closely with everyone affected and providing them with the right level of support. We have made strong progress in executing our strategy. However, as we aspire to build an even higher-performing global SaaS company and to enable Xero's next phase of growth, as well as drive better customer outcomes, it's clear we need to streamline and simplify our organization. These changes will adjust our operating cost base as we balance growth and profitability. We will continue to reinvest in strategic priorities while taking a robust approach to capital allocation that supports longer-term value creation. Looking ahead to the fiscal year 2024, these headcount reductions will improve our operating profitability as our operating expense to revenue ratio is expected to reduce significantly in full year '24. Along with the reinvestment into our strategic priorities, we are targeting an operating expense to revenue ratio in full year '24 of around 75%. The focus for Xero's next phase is to drive disciplined growth as we capture the large opportunity ahead of us. I'll now pass to Kirsty, our CFO, to take you through the financial details.

Thank you. As Sukhinder said, we will target an operating expense to revenue ratio of around 75% in FY '24. Today's announcement will also impact our financial performance in the current year. We expect to incur $25 million to $35 million of restructuring charges and related costs in the current period. These costs will be recognized in operating expenses, and we will provide more detail on this and where it's been allocated at our full year results in May. The costs will have minimal impact on cash flow for the current period with restructuring provisions flowing through cash in FY '24. We remain committed to our FY '23 guidance that total operating expenses, including acquisition and integration costs as a percentage of operating revenues, are expected to be towards the lower end of the range of 80% to 85%. This will exclude the restructuring charges I outlined. Additionally, we expect to book a $30 million to $40 million write-down associated with our decision to exit the Waddle business. This reflects all of the remaining goodwill and residual asset value of that business. I'll now hand back over to the operator to move to Q&A. Just as a reminder, we will only be taking questions on today's announcement.

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

I just wanted to understand where exactly those cost cuts are coming from. Like is there a specific part of the business or region, or is it across the sales and marketing team or product development side? Just a bit of color on that would be great.

Thanks for the question, Bob, this is Sukhinder. We took cuts across all functions in all regions, so this was across Xero. I will note, of course, that proportionally, we have some higher headcount in some regions and in some areas, so you can expect some proportionality there. And of course, we took care to try and protect our go-to-market functions as we remain excited about our growth opportunity.

Your next question comes from Lucy Huang with UBS.

Sukhinder and Kirsty, I got 1 question. So just wondering if you can give us some color into maybe where some incremental reinvestments would occur. You talked about strategic kind of priority. Any color that you can shed on that would be wonderful.

Lucy, this is Sukhinder, thank you for the question. We're not here to talk specifically about our growth strategy today, but as you might expect, growth areas for reinvestment could be short, medium or longer term in your opportunities to obviously meet or forecast and our expected plans for the year, raising to longer-term opportunities. But I don't think we're going to go into detail today about our growth strategy.

Your next question comes from Kane Hannan with Goldman Sachs.

Maybe just the timing of the headcount reductions, Sukhinder, do we think there will be a full run rate in that '24 number, or could there be some carryover benefits for '25 in terms of the reductions?

Why don't I let Kirsty take that question. Kirsty?

Thanks, Sukhinder, I was going to jump in. So thanks very much, Kane, for the question. We do expect that the majority of the savings will flow through in H1 next year. And so therefore, there will be shaping based on that. However, as you're aware, we do have some seasonality within our business. So you need to be able to take that into consideration. But as you'd expect, going into '25, we are, as Sukhinder has outlined, you know we are very focused on growth and also ensuring that we are improving our profitability.

Your next question comes from Roger Samuel with Jefferies.

Do you think that the job cuts is a response to a slowing top line growth? Or perhaps another way I'll ask you the question is do you think that the job cuts will have any impact on your future growth in FY '24, '25?

Roger, thank you for the questions. First of all, I think what you can take from our announcement today is our desire to balance growth with profitability, and to really kind of enter the next stage and chapter for Xero which is about more disciplined growth. I'll note that we were pretty pleased with our half year results, so I would look at today's announcement more as an opportunity for us to increase our efficiency.

Our next question comes from Eric Choi with Barrenjoey.

So Sukhinder, clearly a bit more of a shift to profitability. Can we assume this feeds into your FY '24 KPIs as well? Obviously, there was some reference to your '23 KPIs being mainly revenue focused. And if there is that shift, I'm just wondering if there's any reference to free cash flow because you haven't mentioned anything about capitalization rates. But can we just assume like the capitalization rate, nothing really changes with that new OpEx guidance?

Thanks, Eric, for the question. I think there are 2 in there, so I'm going to take the first and have Kirsty speak to free cash flow. I think your first question is like can we assume that today's announcement is related to KPIs for '24. I think what you can assume, as I noted earlier, is we really do see the opportunity to become a more disciplined growth company while still focused on obviously being a high-performance company. But we look at that in 2 buckets going forward, both growth and the efficiency of our OpEx. So I think you can take this as a nod to the importance we place on both going forward. Kirsty, do you want to take the question on free cash flow?

Yes. So just referring to capitalization rates, there will likely be a little bit of noise as we go through and bid down the structure. But ultimately, we don't see that the capitalization rates will materially change. So therefore, you can assume that savings that we are making and profit that we're making within the business will also have an improvement on our free cash going forward.

Your next question comes from Rohan Sundram with MST Financial.

Sukhinder and Kirsty, just the 1 for me, more of a modeling question. Will Xero continue to expense these items that you called out around restructuring and Waddle above the line? Or going forward, will you make it a clear distinction between what is the underlying earnings of the business versus what is the statutory and good business and treat these as significant items?

Kirsty?

Yes, so I'll take that, Sukhinder. So from a financial reporting perspective, we do need to include those restructuring items as part of operating expenses within our profit and loss. However, as we pull together our more -- our section of the annual report, we can certainly look to see how we can ensure that you can really get a clear indication of the true business operation of the performance at the year. So take that into account, that feedback into account and let's have a look at what we can do in the annual report.

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

Just maybe on the structure of the guidance, I was just wondering if you could make some comments on the level to which the cost savings are in the CapEx program versus OpEx. Because just at a basic level, I'm looking at the 700 to 800 employees, and that looks like it's something like 14% to 16% of your employee base. And so I think that should translate to sort of somewhere in the range of 7% to 8% cost savings. But the main trajectory is sort of only shifting by sort of like 5% or 6% or so. And so that sort of implies not that much top line unless there's a big chunk of that that's coming out of the CapEx program instead of OpEx. So I was just hoping if you could give us a little bit of color that would like sort of clarify the trajectory there.

Sukhinder, I'll grab this one and feel free to jump in if you want. So from a cost perspective, as Sukhinder said, we really are wanting to try and protect the top line growth. And so therefore, when you look at what we expense versus what we capitalize onto the balance sheet, generally, what is going on to the balance sheet is around those growth aspects of going forward. So as I see it, you shouldn't really expect the capitalization rate in the longer term to change that much. You do have to also take into account that amount of reinvestment that Sukhinder also spoke about. So you do have the cost coming out, but then we do also have that reinvestment back into the business to ensure that we are taking hold of the opportunity that we've got and continuing to grow.

[Operator Instructions] Your next question comes from Roger Samuel with Jefferies.

Just a follow-up, so the 700 to 800 headcount, that will only bring you back to where you were in September 2021. Because over the last 12 months, we added about 724 people. Do you think this is the end of it, or do you think that there's more that you can do in terms of head count reduction?

So Roger, this is Sukhinder, I'll take the question. So first and foremost, our cuts were carefully considered. And as I noted earlier, while they looked at across all functions, you can expect that we were deliberate in looking at where there were opportunities to save. We're trying to both do 2 things, number one streamline our operations, but also continue to grow. So as I said, I think we felt like this was a pretty good measure of where we're headed in our -- we released a blog post today which you can take a look at. We announced to our employees that in the next 3 months, we are looking at org redesign work and a deeper evaluation of our tech function, and so there might be smaller magnitude of impacts there that were not announced today. But we expect those to be smaller in magnitude than what we announced today and to complete by July.

And just to add to that, Roger. So I suppose what you've also got to consider is that our revenue has continued to grow in that period as well. And so therefore, we are looking at driving a greater level of efficiency based on if you compare the business back to what it was like back in the middle of '21.

Your next question comes from Bob Chen with JPMorgan.

Just a quick follow-up. I mean in terms of that balance of reinvestment going forward, are you thinking about potentially slowing hiring or will you sort of implement any hiring freezes off the back of this as well?

Hey, Bob, it's Sukhinder. First of all, as I noted in the employee letter we put out, we actually did substantively slow the rate of hiring in fiscal '23. And I think that was noted publicly. I think we think about it as we described which is a balance between growth and profitability. So what we're looking to do as we become more disciplined in our growth is, of course, be more measured in the returns we're looking at, or when we make increases in hiring and so on. So I don't think you should anticipate that this means no hiring. What it means is being very, I'd say, thoughtful in our hiring and the returns we seek from different areas of the business as we grow head count.

There are no further questions at this time. I'll now hand back to Ms. Sukhinder Cassidy for closing remarks.

Thank you so much for joining us today. And of course, I look forward to connecting with many of you as we announce and publish our full year results. I also just want to say while today's decision was a very hard one, I remain very optimistic about the opportunity for Xero as it enters this next chapter, and there's still so much room globally for us to drive adoption of cloud accounting among small businesses. So I look forward to speaking with you all more as the year unfolds and certainly in May.