Xero blows out H1 FY2020 - tips over 2 million active subscribers

Xero just turned in some extraordinary numbers for the first half of FY2020. Let's get to it. From the blurbs - all figures are in NZ$

Operating revenue was up 32% to $338.7 million (33% in constant currency (CC
30% growth in annualized monthly recurring revenue (AMRR) to $764.1 million
30% growth in total subscribers to 2.057 million
Total subscriber lifetime value grew by 37% (38% in CC) to $5.4 billion, with more than $1 billion added in the half
Free cash flow was $4.8 million, compared to free cash outflow of $9.8 million in H1 FY19
Net profit after tax increased by $29.9 million to $1.3 million
EBITDA excluding impairments of $65.9 million almost doubled from $34.5 million in H1 FY19

Gross margin was up to 85.2% fro 82.8% a significant expansion, and the company is now throwing off free cashflow at a decent clip and a turnaround of NZ$14.6 mill YoY.

To indicate momentum, it took Xero a decade to get past its first million users and less than three years to double up to 2.057 million. Assuming the same or similar growth rates, then in another three years, Xero will be comfortably north of 4 million users and a revenue run rate of just over US$1bn pa. Significantly, Xero reports that total lifetime customer value stands at NZ$5.4bn. In other words, each customer is sticking with Xero for about seven years.

In the regions, Xero reported growth as follows:

Australia +28%
New Zealand +13%
UK +51%
US +21%
ROW +52%

The net was +30%.

None of these figures surprises me.

For example, in the UK, the exit of FreeAgent to RBS and the earlier sale of Kashflow to Iris coupled with relatively weak offerings from Sage and an underwhelming commitment from Intuit to the UK gave Xero a clear run at bearing down on its channel strategy. Talking recently with accountants, it's surprising just how much of a preference professional accountants have for Xero compared with the competition. The conversation usually goes something like: 'We'll support you if using Sage or Intuit, but we prefer Xero.' Is it any surprise then that the UK subscriber number tipped over half a million for the first time?

The US has always been a tight market to crack, mainly because Intuit is such a dominant player, and Xero has really struggled there, with a leadership team that has rotated more times than a championship figure skater. Even so, lifting the subscriber count to 215,000 is hardly shabby, and there is plenty of runway for Xero to end up a credible number two.

My understanding is that a recent roadshow in South Africa was very well received and so it should not surprise that Xero expects great things from that emerging economy.

My take

I've followed Xero since its earliest days in the UK. At one time I was an advisor to the company, I spoke at the first London Xerocon in 2012, and remember the night Gary Turner celebrated his appointment as UK MD.

I've always liked Xero's go to market strategy because I see how it plays to the emerging role of the SMB accountant as 21st-century advisor in an always-on, services-driven world.

It helps that the software mainly does what it says on the tin, even if we do have to buy additional services to get decent expense handling, reporting, and forecasting. Ironically, that pushes our complete accounting services costs up significantly, but the value derived is obvious. And that's what counts.

This year, Xero announced a price hike of about 10%. If that seems counterintuitive for a service-based business where the marginal cost of servicing an additional customer is close to zero, then you'd be forgetting that there have been hundreds of enhancements to the solution over the years which were offered at zero cost increment.

I suspect the days of making consumer-like offers - you know the thing, get three months for bugger all, then get whacked with the full price - are over. Try before you buy is here to stay, but the value Xero demonstrates speaks for itself, and I'm not convinced it has to compete on price in the same way it did when scrambling for market share.

I hope that Xero doesn't fall foul of the temptation to nickel and dime customers as we've seen with others. My sense is there is too much runway in the addressable markets for that to make any sense. And, to be fair, the current leadership has carefully chosen its price points and the solutions that carry those increments.

In full disclosure, I am a 3x Xero user, and while this quarter's VAT returns for two of my firms was bedeviled by painfully slow access to MTD for last-minute filers (like me), it got the job done in time to hit the filing deadline. Phew! And in that regard, I can see some needed improvements in customer service. More on that another day.

In the meantime, this half demonstrated excellent performance and bodes well for the future of both the company and its customers.