Xero Limited (XRO) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Xero Limited 2024 Results Conference Call. I am joined by Xero's Chief Executive Officer Sukhinder Singh Cassidy and Chief Financial Officer, Kirsty Godfrey-Billy. [Operator Instructions]. I would now like to hand the call over to Sukhinder Singh Cassidy, Chief Executive Officer of Xero. Please go ahead.

Good morning from Sydney, Australia. Thank you for joining our investor briefing today covering Xero's financial and operating results for the full year ending March 31, 2024. I'm Sukhinder Singh Cassidy, and I'm here with Kirsty, our CFO. Moving to our results. Our first agenda item is a summary of Xero's performance during the full year. I'll then pass to Kirsty to cover our financial results in detail before I finish with strategic priorities and Xero's outlook. After that, we'll move to Q&A. So moving to a summary of our results on Slide 5. We're really proud of this result, and in particular, it shows you we are capable of executing towards our future aspirations. You'll see that Xero has continued its track record of strong revenue growth. And at the same time, we have delivered a meaningful increase in profitability, and that's led to us achieving a Rule of 40 outcome. I'm going to touch on the key metrics here, and Kirsty will discuss them in more detail later. Revenue grew 22% to $1.714 million or 21% on constant currency terms. Adjusted EBITDA of $527 million is up $225 million or 75% over last year. Together, the strong operating results and improved free cash flow generation resulted in a Rule of 40 outcome of 41%. Moving to the next slide. Xero is a macro resilient business that consistently delivers strong top line growth. This year, we saw growth balance between subscribers and ARPU with subscriber growth of 11% year-over-year and ARPU of 14%. Subscriber additions were 419,000 in the year. Price changes across both our business addition and partner addition products were a key driver of ARPU increasing 14% or 10% on a constant currency basis. I'll now spend a few minutes outlining the regional contributions to this revenue growth as well as the features we delivered on the product side to support this. Slide 7 shows the continued strong revenue growth in our ANZ segment. We delivered 22% revenue growth year-over-year. Within this, subscribers grew 11% and ARPU expanded 11% or 9% on a constant currency basis, mainly from price rises. Both countries contributed to this, with Australia growing revenue by 23% and adding a further 205,000 subscribers in the year, while New Zealand revenue grew 15% and added 38,000 subscribers. This is a great outcome in the segment with high cloud accounting penetration, reflecting our strong brand presence and product offering in these markets alongside our ability to continue to bring all businesses to the cloud and offer more spaces. Turning to the International segment. We delivered 24% revenue growth, 20% in constant currency terms and reached 1.8 million subscribers, up 11% year-on-year. ARPU grew by 17% to $41 or 11% on a constant currency basis, mainly driven by price changes. In the U.K., revenue increased 24% or 20% in constant currency. Subscribers were up 11% year-over-year with net additions of 107,000. This is a pleasing outcome in a period where there were no MCD talents. In North America, revenue increased plus 17%. However, there are some noisy items affecting the comparison. Adjusting for the revenue grew 22%. Total subscribers were up 10% year-on-year with a net addition of 38,000 for the year. Canada's nonsubscriber outcome video was subdued, largely reflecting a lack of adoption tailwinds. We've made some GTM changes, which I'll touch on later, in response to our execution there and in the cloud accounting backdrop. In our Rest of World markets, revenue grew 26% or 25% in constant currency terms. Total subscribers grew 12% year-on-year with net additions of 31,000 in the year. The largest driver of subscriber growth in the segment was South Africa, where we continue to see good momentum. So now moving to the next slide and the product investments we made in FY '24 to support this growth. The revenue growth we've delivered across our regions reflects the value of our product and the continued enhancements we've made. This slide shows our investment in completing the three most important jobs to be done, core accounting, payroll and payments in our three largest markets, Australia, U.K. and the U.S. In the core accounting, we've made great progress. In the U.S., we upgraded our coverage to spend more than 600 direct bank fees. We've also increased the number of banks that can use our bank statement extraction feature within Hubdoc, which extract data to populate into Xero. We've also made a number of improvements in several parts in the U.K. in the last year to support compliance changes. In payroll, the work we've done over the past 12 months across product and engineering is making it easier for small businesses to onboard. We've also improved functionality in our U.K. offering for nontraditional work hours and pension needs. Alongside this new functionality, we have also modernized the payroll model, breaking it down into micro services and removing 50% of unused code. This is a great achievement and highlighting our focus on delivering for customers while our modernizing. [ Payroll ] is one of our biggest opportunities and our new partnership with Bill in the U.S. will allow us to drive deeper functionality as part of our 3-by-3 strategy. We've also made more intuitive and frictionless for small businesses to find us with their own repayments. In November 2023, we began the first major small business accounting software company to launch invoicing in the U.K. We will continue to unlock opportunities in these core areas to deliver value for our customers and support revenue growth. Moving to the next slide, which shows how this translates into profitability. The chart on the left shows the meaningful change in adjusted EBITDA year-on-year, up 75%. This contributed to a strong free cash flow margin of 20%. You can see in the chart on the scfar right that adding this to revenue growth where we're using the 21% constant currency metrics resulted in our Rule of 40 outcomes of 41%. This neatly shows how we shifted to delivering profitability without moving away from adding value for customers and generating strong revenue growth. Before I hand it to Kirsty, I want to summarize the actions we've taken against the commitments we made to you. FY 2024 was a significant year of change for Xero and our team as we set the foundation for our next chapter of growth. We held out three key opportunities for hold in my first earnings call at CL roughly year ago. These were deterring more balanced, profitable growth to be more focused on how we allocate resources and to start on our journey to use new leverage, underpinning this with the commitment to build on our capabilities and evolve towards more performance-based culture. We've made a number of moves in FY '24 to deliver on what we said we do. As I talked about, we successfully balanced growth and profitability through continued our strong revenue growth while rightsizing to Xero and delivering a Rule of 40 outcome. There are a number of proof points of where we've been more focused on our allocation of capital. Key [indiscernible] were sharpened focus in the U.S. and the discontinuation of a number of noncore businesses such as Waddle and Workflow. We started on our journey to use multiple levers to growth and a focus on improving mix through onboarding enhancements and becoming more dynamic in our PAC allocation. However, what I'm most excited about is the new capabilities we've added and the steps we've taken to evolve our culture to be even higher performing and purpose driven. So as I said, it's been a big year and we're proud of what we accomplished. But it doesn't stop here. We made some moves in late FY '25, which I'll speak to later. But for now, I'll hand to Kirsty to cover the financial results in more detail before coming back to you to wrap up.

Thanks, Sukhinder, and good morning, everyone. I'll now provide some further detail on our financial results for FY '24, starting on Slide 13. Before turning to the details, I want to echo to Sukhinder's commentary on our FY '24 financial performance. We have delivered strong financial results with a pleasing Rule of 40 outcome. This slide highlights the key internal metrics we use to monitor our success as we identified at our Investor Day. There are three key things you will notice about our financial performance this year. Our continued growth momentum, the value that customers [ pay to Xero ], both of which are reflected in our ARPU growth and also net subscriber additions. And finally, our focus on balancing growth and profitability shown in our OpEx ratio and significant revenue per [indiscernible] improvement. [indiscernible] at topline growth. This slide shows [indiscernible] revenue between our core accounting revenues and [indiscernible] ad-ons. Core accounting revenue growth of 24% or 23% in constant currency was driven by our subscriber growth and ARPU expansion with benefit of price changes. Platform revenues grew 22% to 18% in constant currency and remained at 11% of operating revenues. There was some [indiscernible] in performance from the [indiscernible]. The decrease in other revenues largely reflects reduction in [indiscernible] revenue as we only had one [indiscernible] in FY '24 versus 3 in FY '23. [indiscernible] the underlying same metrics that show how we generate revenues. This slide shows our continued strong ARR performance alongside of [indiscernible], subscriber growth and ARPU expansion. On the left-hand side, you can see the change in mix between the two without the contribution expanding to reach 10.8% in constant currency this year, while subscriber growth was 11.2%. This shows a continued focus on ARPU expansion. But both drive AMRR, which as you can see on the right, translates into continued strong momentum with growth in FY '24 of 26% or 22% in constant currency. This resulted in AMRR ending the year at more than $1.9 million. Just as a reminder, this metric reflects the annualized benefit of our subscriber base and ARPU as end of 31st of March and indicates a revenue exit rate in absolute terms for our business moving into FY '25. Now it's worth noting that price rises announced in Australia, which take effect in July and not included in this number. Turning to more detail on ARPU and churn. As we show on the left-hand side of Slide 16, price changes were the largest driver of the 14% increase in ARPU followed by FX [ expenses ] primarily from the pound and U.S. dollar. It's worth noting the FX impact included in these metrics are on a spot basis at the 31st of March rather than an average rate over the period. We saw limited benefits from a shift in our product mix, which we are moving more actively turning our focus to, but it is early days. The improvements we have made to our Australian product letter demonstrate the work we do to build and support this muscle. [indiscernible] was flat over the period were key drivers outlined on the next slide. However, I want to touch on churn first. In terms of the key outcome we consider when looking at levers to drive ARPU expansion, we have seen an uptick in partner product churn over the year as AB is managed undeployed inventory. This was largely in response to patent addition price rises for 2023. This translated to only a slight uptick in MRR churn from the all-time line we reached post-COVID with churn up 9 basis points over the year and 5 basis points in the second half. [indiscernible] reflect the volatile price point of these products, which definitely [indiscernible] in oyou're churn. As you can see in the chart, despite the uptick, we remain the low long-term average with [indiscernible] the value to customers continue to [indiscernible] to run the business. Now turning to the drivers of platform revenue on Slide 17. We saw good growth in payments offset by slower growth in payroll and Planday. On this slide are the activity indicators for each of these. While there were different factors across each, we see significant opportunity in developing this leader in line with our strategy to win the 3x3. This includes pricing and packaging work to support adoption and increased usage across our markets, targeted investment and product functionality to improve the customer experience and changes to sales promotions to better align our go-to-market priorities.Lastly on the list, we show that monthly invoice payment value has grown strongly in the year to March have increased 18%. Now this was impacted by the timing of Easter, with the underlying trend better seen in the April data, where we delivered 30% growth. Revenue growth in the year to March was 36% [ constant ] currency. In addition to the increase in volume, this reflected the unit economics margin expansion with our partners improving as we reach key growth and product development milestones. We see payments for the core opportunity, which is reflected in this inclusion in the 3x3. We are focused on improving the user experience to increase customer uptake for example, continuing to streamline their onboarding and workflow experience by working closely with our partners. The middle chart shows employees paid through Xero payroll. This increased 7% since this time last year across Australia, New Zealand and the U.K. where we offer this product. There is an element of normalization and growth in Australia, where we have seen very high adoption following STP tailwinds in prior years. There's more work to be done to enable our product to better deliver for customers in the U.K. and New Zealand market, and this is a focus for product delivery at the FY '25. We're also reviewing our approach to product packaging and bundling across markets, learning from experience in Australia. The right-hand chart shows the number of planned a users at the end of each quarter since March '22 which increased by approximately 8% from the prior year. As we said previously, Planday has recovered through a period of transition to a smaller segment than in the European home market. This has indicated the growth rate in the number of employees [indiscernible] in FY '24. One of the decisions made in this transition was to exit the Australian market as we announced in April. The final consideration for top line dynamics is our plan to address line of subscriptions. As we mentioned in the first half, we define long idle subscriptions as those that have been undeployed for more than 24 months and are not expected to be deployed in a reasonable time frame. As you will see on Slide 18, the range has shifted down to 125,000 to 175,000. This can be due to partners either deleting early or indicating their plans to deploy. We've also provided a more granular disclosure of the regions we expect to be impacted by the removal of the subscriptions. The majority of these subscriptions are located in the international segment across North America and the U.K. As we said before, we plan to [ approve ] subscriptions during the coming half and we'll update you on the outcome of [ conversations ] at our first half '25 results. This is what we [indiscernible] subscriber growth [indiscernible] in that period. Based on the midpoint of the updated range we provided [indiscernible] '24, and these subscriptions were removed, the group market with increased by 34%. The low ARPU nature of these subscribers means that removing is expected to have minimal on FY '25 revenue. Moving to the next slide. Here, we highlight how the set metrics are discussed reflect the value Xero generates. LTV is a high-level measure the value customers bring to Xero over their lifetime which, on average, globally is around 9 years. The chart on the left shows continued expansion in [ LTV ] that Xero has delivered. This is reflected on the key contributors of LTV, which you can see on the right, ARPU of $39.29 and churn of 0.99%. We measure our efficiency of acquiring new subscribers through the value of the subscriber or LTV to the average customer acquiring a subscriber or LTV [ UK ]. The unit economics we generated in New Zealand and Australia reflects the value that Xero can deliver in a more developed market with an LTV to CAC ratio of 14.3. On the next slide, we break down how these metrics have evolved over the year. Starting on the left of the slide, we show how the drivers of LTV have moved. From left to right, subscriber growth contributed $1.3 billion to LTV uplift. ARPU expansion was the largest driver of the LTV output and contributed approximately $2 billion. The uptick and churn partially offset this increase, reducing LTV by $1.7 billion and FX and gross margin with slight benefits. I wanted to touch on some of the related metrics highlighted in the chart on the right, LTV per subscriber CAC and LTV to CAC. You'll also find these metrics in the appendix. LTV growth subscriber grew 4% over the year to $3,732. CAC has been covered three broad areas. The cost of acquiring new subscribers and investing in our brands for future subscribers, initiatives to educate existing customers to encourage [ retention ] and costs associated with [ up selling ] and cross-selling to existing customers. The majority of acquisition costs are expensed in the period, in contrast to the revenues from subscribers added, which is earned over multiple years. Expense increased 15% as we increased investment and brand recognition and performance marketing, particularly in the U.K. and North America. This included our partnership organizations with FIFA Women's Football, which came through in the first half. This resulted in CAC per gross add metric increasing by 9% over the year. The increase in tax spend per gross add was more than offset by ARPU expansion. This resulted in CAC [ funds ] falling to 15.2% from 15.9% with similar trends in both ANZ and International segments. While we [indiscernible] in International segment, over the long term, we expect to see an improved albeit the time it may move around as we become more dynamic in our CAC allocation as we see specific opportunities to invest. [indiscernible] sounds like a 6.2% compared with 6.5% in March '23. The reduction here was due to the higher CAC per gross add. Turning to Slide 21 and our cost base. Our high gross margin, combined with the strong revenue result has been gross profit increased by 24% year-on-year. The chart on the left shows this trend with gross profit of $1.5 billion for the full year. We have remained disciplined in how we serve our customers and this is reflected in an improved gross margin up nearly a percentage point compared to last year. This cycle [indiscernible] efficiency, and we continue to [indiscernible]. A great example of this is how we have experimented with generative AI and Xero Central, our customer support and learning site as well as other AI experiments throughout the onboarding process which aims to reduce the need for human [indiscernible]. Now moving to operating expenses. We delivered our guidance that operating expenses to revenue would be around 75% with our revenue for the year sitting at 73.3%. This significant improvement in efficiency reflects our commitment to balancing growth with profitability. The key driver of this improvement was embedding the changes post the step change in our cost structure following our 15% head count reduction. We also benefited from greater clarity, speed and effectiveness across our organization. It's also worth highlighting the half-on-half seasonality we saw in this number with the first half higher reflecting timing of tax spend, the flow-through of our restructuring and the timing of price rises. In line with our commitment to balancing growth and profitability, we will [ embed ] to drive growth across our business in FY '25. As such, we expect our OpEx ratio in FY '25 to be around 73%. Sukhinder will talk about this later. To show you how we deliver operational leverage while continuing to grow revenue, I'll take you through the individual function areas in our cost base. Starting on the list, sales and marketing costs increased 15% against revenue growth of 22%, which resulted in the [indiscernible] 31.7% of revenue. [indiscernible] during the period and included increased brands at performance marketing investments, including our partnership with FIFA. The benefit of this brand amusement will roll through over time brand winners and recognition develops, particularly in our international markets. Moving to product design and development costs. These fell to 30.7% of revenue. At this area, we see majority of FTE reductions occurred as part of our restructure and a significant decrease in spent years due to these changes. Total or gross product and development costs, including capitalized cost occupancy, excluding D&A, was 33.6% of revenues, down from 42.7% in FY '23. For the moment, our total product fee is largely reflection on our restructure, which was partially offset by a planned reinvestment. All the [indiscernible] extend and expected due to [indiscernible]. We expect to continue this business in FY '24 as we build on momentum we've seen in our prior velocity. Finally, on G&A expenses, these fell to 10.8% of revenue, reflecting robust cost control. These efficiency improvements reflect our commitment to balance and growth profitability. [indiscernible] adjusted EBITDA margin showed on Slide 24. As a reminder, adjusted EBITDA, end-to-end share-based payments and focuses on providing a view of underlying business performance. Adjusted margins expanded over 9 percentage points in FY '24, reflecting the benefits and efficiency across all functions in the business. There were limited nonoperating impacts to EBITDA this period with the largest item being the noncash impairment of Xero Go as we retired that product. The improvement in margins translated to a significant improvement in free cash flow generation. Slide 25 breaks down the $240 million increase in free cash into its constituent components clearly highlighting both our strong growth and improved profitability. Taking a look at the key components of operating cash flow, starting with customer receipts, where we continue to see strong growth. This is mainly from subscribers and trends closely follow the growth of our reported revenue. Moving across the charter payments to suppliers and employees, we you can clearly see the benefits of our restructuring and subsequent margin expansion. This included $34 million of redundancy payments from our restructure. Excluding this, growth year was only $85 million. We continue to generate net cash interest receipts during FY '24. The improvement here reflects higher earnings on our cash and term deposit balances given the current rate environment. I'd remind you that almost all of the interest expense we incur is noncash amortization of our convertible notes, which does not impact free cash. Income tax payments had a small impact on our cash flows in the period. We are monitoring our tax payments carefully as we utilize our accumulated New Zealand tax losses, which you can see in our disclosures and through the deferred tax asset movement on the balance sheet. Finally, capitalized costs mainly reflect product development as well as a small amount of investment in physical assets. Turning to Slide 26. The increase in cash generation was a key contributor to the $268 million increase in Xero's total cash position, including short-term deposits of $1.5 billion at the 31st of March. Our term debt liability entirely reflects the Xero coupon convertible notes that mature in December 25. This note has offered us optionality for inorganic investment and a lower cost than bank debt was a mechanism that provides us flexibility in managing the dilution through our core spread and the choice to [indiscernible] cash or shares. Given the flexibility that our convertible notes funding provider, the significant improvement in our cash generation and the growth we are delivering, we have a strong balance sheet with our net cash position increasing more than $320 million from this time last year. Thank you, and I'll now pass back to Sukhinder.

Thanks, Kirsty. Now moving to strategic themes. Having recently spoken with you at our Investor Day, I'll briefly revisit our strategy. I also want to update you on a few recent moves we've made. As we said on Investor Day back in February of this year, the next 3 years are seemed winning on purpose. For us, this means providing winning solutions for our customers, living our purpose consistently in what we do and how we do it as a company and being purposeful and focused in what we choose to do and what we choose not to do. Moving to the next slide. As you know, our vision and purposes are constant at Xero. Successfully delivering our needs is key to achieving our aspirations, which I'll cover in a few moments. Our how-to-win strategy, which you saw us layout at Investor Day, had four key pillars: [winning 3x3], Total Winning, GTM playbook for Xero Next Chapter, Win the Future, which is really about focus best and innovation and continue to grow our medium to small market. And lastly, I'm reaching Xero and Xeros to win. On this slide, as you will remember, there were 12 key tactics, 3 under each stage. Now I won't go through these again, but we'll be making moves against all of these, and we are doing them already, which I'll discuss on the next slide. We've made a number of moves in recent months as we execute against our strategic priorities. To support winning the 3x3, we recently established a partnership with Deputy to embed time and scheduling into our core product in Australia. As part of this, we are exiting Plant A in Australia, and we'll focus the Plant A team and business in Europe and the U.K. We've launched simplified product packages in Australia. This supports our GTM playbook to make it easier for customers to choose the right plan for them in a level of complexity. Part of our focus bets for the future and grow other markets efficiently, we've restructured our Canadian sales team. This reflects us rightsizing for the current cloud accounting backdrop. We also returned Xero Go in the U.K. as we evolve our mobile efforts and focus on our primary segments. Finally, as partners continuing to unleash Xero to win, we promoted [indiscernible] to Chief Product and Technology Officer. Her leadership across these teams is improving the team's way of working together, particularly how our engineering and product functions operate seamlessly as we continue to evolve our capabilities and improved product delivery and velocity. You will notice many of these news are about purposefully allocating capital towards our 3x3. This leads us to the next slide, where I'll touch on our priority areas for product investment in FY '25. For accounting, we want to continue to add value for our customers by deepening and localizing local core accounting capabilities. We'll continue to support the evolving accounting and tax laws in Australia and deepen our U.K. tax offering. In the U.S., we will continue to localize key book keeping and compliance features such as safety, bank reconciliation, sales tax and reporting. Further, across all of our regions, we will empower [indiscernible] and book keepers to [indiscernible] sites. Here is multiyear modernization program in payroll has boosted momentum. Automation will be leveraged, especially in the U.K. to simplify payroll across SMBs along side their compliance. Reduced payment and tax rates will continue to focus on reducing friction for small businesses on boarding to Xero. We're also going to provide more ways to pay for customers receiving a Xero generated invoice. We will enhance the U.K. bill pay experience and introduce our Bill.com embedded solution in the U.S. This is a lot here and you should take from this that product investment across our 3x3 is a priority as we add value for customers and support revenue growth. And this brings me to our FY '25 outlook, which reflects the impact that we're making. Total operating expenses as a percentage of revenue is expected to be around 73% in FY '25. And compared to FY '24, product design and development cost as a percentage of revenue is expected to be higher. Of course, in addition to this, we continue to pursue our aspirations. These are to be a world-class global SaaS business from a very strong position today. We have the opportunity to double the size of this business and deliver Rule of 40 or greater performance. And we will focus on high-quality growth, which is the balance between subscriber growth and ARPU expansion. As I said before, these operations are powerful and purposeful, so we will continue to pursue them aggressively over the short, medium and long term. To wrap up, there were four key themes that you will pick up from today's presentation. Our results show we are capable of executing towards our future aspirations. It shows that we are delivering on our commitments. They sell as we are progressing our strategic priorities and purposefully allocating capital. We've given you some improved points [indiscernible]. And finally, the big share as we're well positioned to win on purpose as we move through the FY '25, '27 strategic period. Before I conclude, I want acknowledge our teams around the world and I really want to thank again for their hard work as we continue to do all we can to support our customers and our partners. That concludes our presentation. I'll now pass over to the moderator for your questions.

[Operator Instructions]. Your first question comes from Eric Choi from Barrenjoey.

My question is just on FY '25 investment and the return on that investment. I think you're guiding to a nominal increasing cost of $200 million or more in FY '25. And I know there's extra Xero cons and wage inflation and maybe some revenue shares. But to get to that cost guidance, I think you're also implying over a continuation or acceleration in that FTE growth that you did in second half '24. So I'm just wondering if you can talk to where that head count is going how it differs from the original 400 R&D roles that were originally cut and Sukhinder is sort of razor focused on ROE. So how do we think about the long-term returns on that investment?

Thanks, Eric. I'll start and then if Sukhinder wants to add anything she can afterwards. So I mean the cost -- the way in which we're looking at cost allocation as I had sort of went through on the Investor Day is that we start very much with our strategy. And then from there, we look at -- we look at what we should be deploying into care and into products and technology. Now we talk through around the way in which we look at allocating out the CAC, and Mike is doing some investments in experimentation around ensuring that we are getting the best use and return out of our CAC. And in there also went through and has a very detailed product road map, which links into that strategy. Now as far as the increase between '24 and '25, as I sort of alluded to within my script, there was a bit of timing difference between particularly in the product and technology space around bringing in and recruiting some key sort of domain expertise that we need and is required within Xero to really ensure that we are continuing to do that growth. And so just due to the timing of nature, we did recruit some people, some of them, hopefully, those that were at our Investor Day, we were able to meet them over the lunch breakout session. We now have the annualized cost of the cost throughout the whole of '25 plus also in the additional capability that we bring in. We also are really focused with our purpose and performance culture about ensuring that we are really paying people the right amount for high performance. And so that plays a part of it as well. And then as with all years, there is also a bit of wage inflation there. So we're certainly not saying that you should see a massive uptick in head count per se. It's more about ensuring that we're bringing in the right people with the right expertise and then ensuring that we're paying them the right amount.

Yes. I don't have anything to add, Eric, other than to say, I think Kirsty's point is important. We're pretty focused in making sure our headcounts are in areas that are aligned to our strategy that give us velocity in the area we need, that we are competitively paying the team we have. We think we have a great team at Xero, and we want to make sure that we are both disciplined but also have an acquisition and retention strategy for our people that's important. So I don't think it implies that we kind of want to go wild on headcount. I think we want to be pretty focused. But investing because that supports our revenue growth and our velocity in the right areas.

Your next question come from Garry Sherriff from RBC.

Just a quick question on the Australian plan overhaul. How do you think that affects churn versus the price and mix benefits. We're just trying to think from a holistic net revenue retention perspective, should we continue to see the type of ARPU growth in Australia in your eyes, given those changes to plans and pricing?

Sure. Well, why don't I start, Gary. Thanks for the question. So first of all, I think that the plan changes we announced recently are really in line with our long-term strategy of simplifying our product plans, so people get on to the right plan giving them more value. In fact, the majority of users who are being migrated to new plants will get more features and functionality for a given level than previously and driving long-term adoption of features they might enjoy. So I think it's really setting ourselves up for the future while simplifying the amount of clients we have in the market, which is in line with what we said at Investor Day. Now how should you think about all of this? Well, I think that as we talked about at Investor Day, I think there are numerous levers within pricing and packaging, price increases, simplicity of offering, what gets bundled, what doesn't, and then, of course, our sales teams are thinking about mix, i.e., what's the mix of penetration of these different products and do we have the right customer on the right product. So we believe between all those levers, there is opportunity to consistently demonstrate our ARPU yield. And of course, the most important thing is making sure our customers utilize all the benefits and features that we continue to add to our plans. So we think there are kind of multiple levers within there, and you kind of want to feel like you have at your disposal, getting the right people on the right plan and then deepening utilization.

Your next question comes from Tom Beadle from Jarden.

I just wanted to ask if the numbers based questions around product design and development. Can you just talk to the capitalization rate you're using in FY '25? Because I'm obviously just trying to work out that you did that 68% OpEx ratio in the second half, which is obviously outstanding, but you're guiding to that stepping up to 73% in FY '25. So I'm just trying to work out, is there any sort of issue around capitalization rate and just trying to work out what that -- I guess, the step up as a percentage of sales, that product design and development costs actually is.

Thanks, Tom. I mean, if we -- if you sort of look back over the years and have a think about how the capitalization rate has been. It's always been in around that sort of low 40s, and it has come down a bit for this year. We've been consistent for the full year pretty much where we were at the first half. And the main difference in that is around the use of our own internal resources rather than contracting out P&T. So as we bring in new capabilities, specialist services, we are using our own resource. And from a capitalization perspective, when you capitalize a contractor, it is at a far higher capitalization rate than an FTE. And so that has been the big swing to just under 41%. So you're obviously not giving guidance around '25. But I suppose from your perspective in your modeling, there's probably no reason to believe that it should be anything that is too different from where it sort of sitting at the moment.

Your next question comes from Lucy Huang from UBS.

I have a question around the U.K. I mean, I think pretty decent set of numbers, given there's been no making tax tailwinds for this year. I guess, what have your thoughts on the level of subscriber momentum coming into FY '25 given, I guess, macro is still slightly more challenging. We still are waiting for Phase III to kick in? How should we be thinking about subscriber growth in the U.K. next year?

Thanks, Lucy, for the question. Well, I think as you pointed out, absent regulatory tailwinds, which do provide sort of temporal velocity, we really just think about where are we in the U.K. with regard to overall cloud penetration, and there's still plenty of opportunity. So what's in our control, of course, is the levers in our own GTM playbook. I think you might have noticed that in the second half of this year, we also promoted Kate Hayward to be our new head or MD, under Alex [indiscernible] in the U.K., which speaks to sort of both our opportunities to investing and to bring great talent there alongside increased product velocity. So I'd say, overall, we continue to feel good about the U.K. and our opportunity there, and we continue to invest in a targeted way to go after both subscribers and more features and functionality.

Your next question comes from Kane Hannan from Goldman Sachs.

Just the international ARPU trends were very, very strong in that second half. And I appreciate some of that's pricing. Can you just talk a little bit more about the other moving parts in there, mix things that impacted. And you're seeing some of the early benefits of that U.K. plan suggests that you highlighted at the Investor Day, for example.

I'll take that one, if you like Sukhinder. So when we look at ARPU, so I suppose the first comment is that the first comment is that international has a bit of a mix of different markets within it. You've got the U.K., you've got North America, but then you've also got Rest of World. And so in Rest of World outside of those areas that we have a physical presence, the only plan we can buy as a BE, which has which has a very good ARPU associated with it and usually in USD. So I think that's the first point. There is just a bit of a bit of mix in there. As far as where the growth has come from. So we have seen some good upside from price increases across the International segment. We have also benefited from FX. And then there has also been pleasing and not matter, but definitely working in the right direction, seeing that change in product mix. which is not only just within the Rest of World, but also is within other markets within the International segment. And then also, we are seeing some increase in other areas, so attach to payments, for example. So there's been -- we basically, we're checking every box of moving in the right direction in ARPU on and that -- particularly in that International segment.

Your next question comes from Siraj Ahmed from Citigroup.

Just maybe a multipart question. Just on the pricing packaging changes you've just announced. What's the feedback that you've had so far? I know, online some of the feedback is a bit negative. But just keen to hear what you're seeing based on the feedback so far? And just secondly, on the same pricing and packaging, if you look at the ARPU drivers this year or in the last few years, it's been mainly price, right? Do you expect that packaging changes that you've announced in Australia to be more of a driver of ARPU in '25? Or is it more '26?

Siraj, it's Sukhinder. Well, first of all, yes, we monitor all the communications around any changes and so, of course, we are monitoring the feedback on the pricing and product plan changes we just announced. I think there's a couple of important context pieces. Really, this was about a set of plan changes, but we know from our customers that they always ask us to give them a heads-up on extras pricing changes early because of when the fiscal year starts for accounts and bookkeepers and their clients in Australia. So please note that we made the decision to put those together largely in response to customers wanting to know early what the pricing will be for the following year before they sign their contracts with customers. But there were two changes in there, and you noted that. The first change, obviously, was about simplifying the product packaging because we believe we have too many plans in Australia, and we want to make sure that we simplify the amount of offerings you have take away a pretty long list of add-ons and start to bundle more capacity and capabilities that you can utilize and should discover. And we think that's the right thing for Xero long-term end customers. Having said that, the changes we announced were, first and foremost, for new plans, people coming into Xero for the first time, and we said we will work with customers on their specific migration path with the game plan or intention to be done by March of next year. So we'll continue to monitor the feedback, work with our customers, our existing customers while setting ourselves up for the future to have a simplified product ladder that should benefit everyone longer term and discovering our features and functionality.

And then just a second part of your question around ARPU, the majority of the changes within the packaging actually don't increase the underlying costs. They improve the amount of value that a subscriber is giving. Now that's the majority. So therefore, there are a small number that are seeing a bit of a price rise, but they are not going to be, as Sukhinder was saying, there's going to be a lot of communication working out which bundle -- new bundle was going to be the best for them. And so therefore, we really expect that ARPU -- any the ARPU change to be really towards the back end of the year. So it wouldn't really have a massive impact on '25. It's more likely, as Sukhinder said, it will be the new subscribers coming in that will be directed to the right bundle, so it would be more of a '26 story.

Can I ask [ that ]. So what you're saying is that payroll change is not only in the middle, if forget which plan it is, but that's not a big number as such. It's still a new driver, new business that comes in, that's right?

Yes.

Your next question comes from Roger Samuel from Jefferies.

Just on your Rule of 40, do you think you can deliver the Rule of 40 every year. Obviously, this year, you benefited from the high interest rate, but I'm conscious that you may need to retire your compatible bond at some point next year. And then you also get some benefit from the New Zealand tax losses as well.

Yes. So I'll take this one, if you'd like. So thanks, Roger. I mean, it was -- we were really thrilled that we hit the Rule of 40, to hit 41 has been a bit of an ambition that we've had. And certainly, we continue to have that. Now what we -- the first point is, we've shown that we can do it, but what we want to do is be able to have the optionality to continue it if we like, but if we see an opportunity in the short term to invest and something that we see will drive growth, then we want to be able to have that flexibility, hence, why we're not giving us this guidance that every year now, we will be 40 as the Rule of 40 or greater. Now as far as those sort of one-off items that you talked around, it is pleasing to be able to see that the funds that are effectively free because of the Xero coupon are also now attracting cash and interest income. And so we have -- we certainly have had a bit of upside from that. We've also, though, we have, for example, paid the restructuring within this year where we expensed it in the previous year. So there are some puts and takes on both sides that need to be considered. You've also mentioned the New Zealand tax payment. We are suddenly looking -- well, we are utilizing the tax losses -- accumulated tax losses. But we did also, in recognition to the fact that we are becoming in time, a tax payer within New Zealand, we did also, as you'll note in Note, '22 note that we did make a payment of $30 million in preparation for that tax payable that we will have in New Zealand. So as I said, there's puts and takes to both sides of the one-offs of the Rule of 40 cash, our free cash flow implications this year.

And the aspiration remains solid. Like we put that aspiration at Investor Day. We think we can do both double the size of this business and be a Rule of 40 or greater company. And so we take that aspiration seriously. Even though it's not guidance.

Your next question comes from Rohan Sundram from MST.

Just one for me regarding the stronger rate of net adds in subscribers in international, maybe if you can just talk through any improvements that help drive that, whether it be operational or market. I take on all your comments earlier Sukhinder on U.K., but any commentary on that would be great.

On what's driving -- sorry, Rohan, I just want to make sure I get the question, on what's driving strong performance in the International segment?

Well, yes, I just noticed a better rate of net add in subscribers in the second half versus the first half? And is there anything you'd like to attribute that to?

Yes. I mean I'll jump in on this one. So different markets have had different halves, which is stronger. So for example, Australia with year-end and at the end of June, generally has a stronger net adds in H1. We then have the U.K., New Zealand and many in the Rest of World, which has the year-end fitting in H2, which therefore, does drive an increase in net subs in that sort of second half to March. But then I think if we just sort of look across the different regions. It was really pleasing to see the U.K. results, particularly without that sort of making tax digital tailwinds that we've seen. But we also have -- we've seen it really pending up [indiscernible] in rest of world, which is which is great. Colin is doing an amazing job in South Africa. There were huge numbers of attendees and the road shows that were practically the size of Xero towns across the two different locations in South Africa just over the last month. So it's great to be able to see those newer smaller markets starting to really sort of gain a bit of traction, still small numbers, but those are the sort of the -- those regions that will become more major over time.

Your next question comes from Stephen Ridgewell from Craigs IP.

Just a question on the sort of revenue outlook. Clearly, no going to spend provided today. If we look back to this time last year, AMRR was around $1.55 billion and it ultimately delivered $1.7 billion in revenue for FY '24, around about 10% growth relative to where AMRR started the year. And looking at the disclosure this morning, I see AMRR is up to $1.96 billion. It's on the 31st of March. So if we add 10% to that, it sort of implies revenue around $2.15 billion for FY '25. And even if we take away $20 million for WorkflowMax and $10 million for the inactive subs, does suggest revenue coming in around about $2.1 billion, consensus is currently $2.02 billion. So I'm just -- it is quite a big gap. I'm just interested if you're able to make any comments around the revenue momentum you're seeing in the business and whether there would be some other considerations to suggest that the historic relationship between AMRR and revenue growth won't hold in FY '25, please?

Thanks, Stephen. Good to hear our New Zealand accent on the call. So I suppose what I -- and I really appreciate it actually that you sort of spelled out really clearly for everyone on the call, just that connection between AMRR, exit run rate and in the revenue for the next year. I think the only thing that you need to just watch out for when you are thinking around that is just the timing of things like price rises because depending on what months they happen, that will always be included in the AMRR at the end of the year at 31st of March. But depending on when it went through, if it went through later in the year, it means that you haven't had so much revenue in the previous year. So then the revenue growth looks higher. So when you're doing that 10%, you just got to be a bit mindful of that. You've also, as you mentioned, there are a few different nuances, particularly for the for the 25 year, you've mentioned WorkflowMax. We've also got -- although it's not hugely material, we do have the headwind of the removal of the long line of subscribers. But on the whole, I like your thinking around looking at the AMRR, the growth rate of 22% and then thinking about how that could impact the next financial year.

Your next question comes from Roy Van Keulen from Morningstar.

My question is on the receivables. [indiscernible] I think faster than '24 revenue growth. It looks like it's accelerating in H2. Could you talk about what's driving that and whether that should be perhaps [indiscernible] return?

I think I got your question. It was a bit hard to hear you, but I think you were asking around the increase in the accounts receivable. And so there were a couple of items that meant that there was an increase in that as at the 31st of March. The first thing is around the timing of Easter. So Easter happened to fall right [indiscernible] on balance date. And so therefore, we hadn't -- we hadn't received the cash of the sales because it was during Easter. And so therefore, those sales are accounts receivable. We also did have some prepayments. We had, particularly in the sales and marketing. And so that can be to do with the lead up to Xero Cons, also just looking at sort of timing of longer-term licenses that we've got with Salesforce. So there are sort of a few different things to look through in the accounts receivable. But I suppose what you can hear from that is that it's business as usual type activities and the timing of Easter does make a bit of a difference to whether or not we receive the cash or whether or not it hits the balance sheet and accounts receivable.

Your next question comes from Andrew Gillies from Macquarie.

Most of my questions have been answered, but I'll just ask a quick one on that AI opportunity. It sounds like it's kind of expanded a little bit beyond Jacks, which you flagged at the Investor Day. You talked about potentially removing the need for human intervention in the sales cycle. I don't want to read into it too much. But is this something that impacted margins in FY '24? And is it a potential sort of structural tailwind over the next few years?

Got it. Thank you for the question. I think that was Andrew, right? Andrew, thanks for the question. So a couple of things. I think that we discussed it in '24, we used AI in Xero Central to take a bunch of queries that would otherwise go to search and is a conversational interface. And we saw some nice just early productivity wins in the number of people using that feature. I don't think -- so I think it was a minor support. I would say we have, as you know, already a pretty healthy gross margin. in our customer service team, but they're also in the teams who really are great adopters of technology to keep staying efficient while providing very high trust pilot scores and I appreciate that about the team. So some minor support but already a very strong margin. Do I think structurally, there's an AI tailwind to our cost base? Well, I think like every company that has the same problem we do, which is too many things to do for our employees and they're looking to get more productive with their time. We think there will be maybe more productivity yield for every Xero, and that's great. But I don't think we think about sort of that hitting our OpEx necessarily. It's just about how much time they spend on the business versus on administrative tasks. So I think we'll stay measured regardless. I think the biggest structural talent is for our customers and our partners because AI will fundamentally give them back time and allow them to spend more time on value-added services. So if you're addict to media, value-added service is running your business. If you're an AB, the value-added services advisory work and we think we can power that. So I think we see the biggest structural tailwind probably in providing great software that increasingly gives you back time and insight that help you create more value through your business, that's the biggest one, by far, given that we're a software company, it deals in the delivery of data.

Your next question comes from Paul Mason from Evans & Partners.

Just one on Making Tax Digital in the U.K. and your strategy around the next date that's sort of -- some of the accounts are starting to gear up for right now. You've obviously retired Xero go and the next stage is sort of anticipated to be a lot of lower end smaller revenue bases like sole traders and landlords and things like that. So could you tell us like have you got like another product that you're planning to bring out for that to hit those target subscribers really well? Or are they sort of like deprioritized now that you're like focusing on like SMEs with more jobs to be done. What's sort of the general view of the world there?

Paul, it's Sukhinder. Good to hear from you. I think, first of all, we do think Making Tax Digital Phase III is very relevant to us in the U.K. because we have accountants and bookkeepers who, a, first and foremost, service customers of all sizes. And b, even though our primary segment is employing SMBs so many sole traders use our products. So to order -- in order to have a full offering in the U.K., we anticipate that we will need to satisfy, Making Tax Digital Phase III. Having said that, I don't think we believe that Xero Go has to be the way to satisfy it. One of the reasons we retired it, it was great loading for us is we want to make sure our mobile strategy is, I would say, more cohesive and not on it, its own code base. So think of that as more a technical decision than anything else. But we do anticipate that we will need to make sure we're ready for ITSA Phase III, ITSA or MTD Phase II and our teams anticipate that. We have to be a full-service provider in the market.

We have a follow-up question from Siraj Ahmed from Citigroup.

Sukhinder just a question on capital allocation. Just in terms of the investment in Deputy, can you just touch on why you actually made that investment given it sounds like it's a pretty small stake and what that would imply in terms of just M&A in terms of capital allocation as well.

Sure. Sure. Siraj. So first of all, we partnered with Deputy because we want to make sure that we have a great time and attendance solution for customers in Australia. As you know, this is one of our largest markets in terms of the subscribers we support and their needs. And we wanted a free Planday up to really focus on the markets where it can provide an even more robust experience like the U.K. and the Nordics. And so first and foremost, it was a decision to purposefully, I'd say allocate capital at Planday in the best possible way and then also to satisfy Xero's requirements for a really strong solution in a timely manner in Australia. Now why did we do the investment? As you noted, it's a minority investment, we could easily have not done it. We did it just to strengthen our partnership. I mean, it's really just to support our partnership, we think we're adding value to Deputy as a strategic partner to them. And so we want to have some small participation in the company, but it's very small. It doesn't imply anything more than it's just. I mean we're not on their board. We have no observer rights. It made [ benefits ] of things that come with more active participation in the company's strategy. We are just happy to be a strategic partner and cemented that with a small investment. In terms of larger M&A, I think you know independent of Deputy, we do believe that systemic M&A will be warranted in our build buyer partner strategy in the 3x3. There are -- those are super jobs, and there's a lot to do within them, and we'll continue to look at systemic M&A to fill meaningful gaps or accelerate product development in our core strategy.

We have a follow-up question from Roger Samuel from Jefferies.

I just got a follow-up on your product development cost. It looks like you're putting more money into the U.S. to localize the product. And just wondering what sort of gut rails are you going to put in place to make sure that you're not over investing in the U.S. like before? And maybe a second part of the question is, in the longer term, do you expect that the product development cost as a percentage of revenue to decline in the long term.

Okay. How about I take the first part, and I'll give Kirsty the second part. With regard to U.S. strategy, I'm sure, Roger, you recall our first half business review of the U.K. -- the U.K. -- sorry the U.S. And we also disclosed our historic investment rate. We -- I think we disclosed at around $30 million historically over the last 10 years, and we said we will keep our investment rate. We will not be profitable. We would keep our investment rate reasonable relative to our top line expectations. So while we do think one of the reasons we've improved our velocity of execution in the U.S. is the formation of an onshore team in the U.S. in engineering and product, and that's great. We do intend to keep it reasonable in the guardrails we provided at the half are the same ones we would look to today. Kirsty?

As far as the percentage of P&T of revenue going forward, I mean, we're not giving forward guidance today apart from saying that for FY '25, it is expected to be greater than it is in FY '24 for the reasons that I've gone through. And we will continue to invest across the strategic period of '25 to '27 with the product road map to ensure that we are maximizing the opportunity in the markets that we're in.

Okay. Okay. I mean the reason why I'm asking is because in the previous results presentation, you show the percentage there's an error going down for the long term, not for any particular year, but yes, I'm just wondering if the trend is going to be down over the long term.

Yes. Well, I think -- I mean, definitely in the long term. I mean, if you think about what Xero could look like in steady state, for example, it would be a different sort of business than it is today because we wouldn't be growing. We wouldn't see the same level of opportunity because we had so much more cloud penetration around the globe. So definitely, at that stage, we would still absolutely expect P&T to be to be down in the long term.

That is all the time we have for questions today. I'll now hand back to Ms. Singh Cassidy for closing remarks.

Well, we want to thank you again for joining us today. We appreciate your time. We appreciate your support. We appreciate the continued curiosity an investment in our business and, of course, all of our shareholders as well. So thank you so much for your time. And of course, always shout out to Xero employees and the Xero team around the world for all they do to make this possible. Thank you.

Thank you for joining the Xero Limited 2024 Results Conference Call. 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.