Thank you for standing by, and welcome to the Xero Limited H1 FY 'twenty one Results Conference Call. All participants are in a listen only mode. There will be a presentation followed by a question and answer session. I would now like to hand the conference over to Mr. Steve Vermas, CEO.
Please go ahead.
Well, thank you and hello and welcome to our investor briefing covering Xero's financial and operating results for the 6 months ended 30 September 2020. I'm Steve Balos, Xero's CEO, and I'm joined by Kirsty Godfrey Bille, our CFO here at our headquarters in Wellington. Before I go over today's agenda, I really do want to start by acknowledging the continuing uncertainties and challenges that COVID-nineteen has brought upon us all in different ways. I hope you and those you care about are all safe and well. On today's agenda, I'll provide a business update, including our performance during the half before passing to Kirsty to cover our financial results in detail.
I'll then close our presentation with an update on Xero's outlook before we move to the Q and A. So, with respect to business update, let me start by giving an overview of Xero's results for the half. Business conditions during the first half of FY twenty twenty one were challenging and highly uncertain due to the health and economic impacts of COVID-nineteen. In reflecting on these operating conditions, we are pleased to report continued revenue growth of 21% and subscriber growth of 19% versus the prior year period. As Kirsty and I will discuss, the conditions in the period also saw positive movements in our profitability, which under more normal circumstances would have been offset by increased levels of spending and investment.
Xero's total subscribers grew by 396,000 year on year to reach almost 2,500,000 subscribers globally and all our geographies recorded positive net subscriber additions over the half. Operating revenue increased to just under $410,000,000 during the half. A 15% increase in annualized monthly recurring revenue or AMRR to $878,000,000 was an outcome of the 19% subscriber growth offset by a small fall in ARPU or average revenue per user of 4%. Alongside the top line growth we're reporting today, Xero delivered a strong set of profit indicators. EBITDA of $120,800,000 increased by 86% from the previous comparable half year period.
Xero also delivered a net profit after tax of $34,500,000 which was a $33,200,000 increase on the following increase following our first ever full year net profit in FY 2020. Free cash flow also improved by a similar degree, rising by $49,400,000 to $54,300,000 These profit outcomes are a reflection of top line growth combined with disciplined financial management during a highly uncertain, and I'd like to emphasize, unusual period. These results also reflect the ongoing support of our subscribers, underscore the importance of our service to them and reflect some of the benefits of scaling our business. Kirsty will further elaborate on the approach we took to spending and investing during the period. Moving to the next slide, we maintained an intense focus on our customers and partners during the half.
We prioritized and directed investment into product development and delivery across a number of areas. In September, towards the end of the half, we enhanced our small business starter plan and increased or removed the limits on planned inclusions. This allows us to better serve existing customers with less complex needs and to extend our product reach and serve more small businesses, including sole traders and new startups. We outlined our ongoing roadmap to Xero's practice management tools and delivered the first set of features in our vision of the next gen practice. For example, in Xero HQ, we rolled out the monthly revenue export to make it easier for advisors to identify clients across their practice that needed government or additional support.
We continue to build a platform experience for our partners that really streamlines their workflows from onboarding all the way to lodgments. We also announced further improvements to our existing integrations with payment service providers Stripe and GoCardless to make it even easier for small businesses to accept card and direct debit payments. At a time when sharing information and staying connected is more important than ever, we made sure to look after the well-being of Xero people as they transition to working from home and implemented a range of measures to support them in doing their best work for our customers and partners. We created our first ever digital customer and partner engagement series called 0 On Air, which covered key product announcements, shared best practices in how small businesses and accounts and bookkeepers were operating in response to COVID and insights into the current and evolving economic conditions around the world. We published Xero Small Business Insights Research Reports that showed how small business economy was faring.
These reports were based on Xero anonymized and aggregated customer data across our largest markets Australia, New Zealand and the UK. This data is being provided to governments and policymakers to help them understand the impacts of COVID on small business and plan for the future in supporting small business recovery. In navigating through COVID-nineteen, we rolled out payroll product enhancements to ensure customers could efficiently administer their access to the latest government wage subsidies or other stimulus benefits. In Australia, for example, Xero is the 1st major cloud accounting provider to become JobKeeper enabled for customers. Updates were also made to ensure other kinds of payroll changes were accommodated, such as new COVID related leave types in the UK.
We provided support to customers and partners where we could in areas including business performance, managing cash flow and helping them to apply for and access small business loans. A great example was a free business finance pack application, which we developed to help our customers in New Zealand pull together the information they needed to apply for new finance. So, moving to Slide 7, I'll now elaborate a little bit on what we've seen in our customer base as they have traversed the COVID-nineteen environment. It has been a tough time for many businesses. It's also been different in each geography.
Now, it's clear from our observations that the small business community continues to demonstrate remarkable resilience and determination to get through this. The data on this slide show 3 customer activity indicators that illustrate what's been happening. Firstly, MRR or monthly recurring revenue churn. We did see some elevation in churn over the 1st few months of the half, but it ended back towards pre COVID-nineteen levels as the half progressed. As you can see from the table on the left, MRR churn stayed flat year on year at just over 1.110.
The second chart shows weekly usage levels by our subscribers based on average weekly log ins per subscriber from January to September. These have remained steady overall, trending at levels similar to those before and during the onset of COVID-nineteen. The 3rd chart shows monthly invoice payment activity measured in total payment value where subscribers have attached a payment service such as Stripe or GoCardless. Invoice payment value for the Q2 of the financial year was up 33%. In the month of September, invoice payment value increased by 44% from the lows seen in April.
Overall, we're seeing that customers continue to make extensive use of Xero during challenging times and the business critical tools for managing and administering small business finances have increased in relevance during COVID-nineteen. While these metrics on the slide show that our customers have remained engaged over the 6 months to September, considerable uncertainty does remain, we'll continue to monitor conditions closely and respond to the operating environment with agility. So now moving to Slide 8 and framing the remainder of my presentation are Xero's 3 strategic priorities. These are to drive cloud accounting, which is about increasing the penetration of small business cloud accounting software. Secondly, to grow the small business platform, which is about extending and enriching Xero as a platform to help small businesses run their business and then third, to build for global scale and innovation, which is about preparing Xero for realizing our aspirations to become the most insightful and trusted small business platform.
So, first of all, to drive cloud accounting on Slide 9, we're focused on executing our strategy to address the very significant long term opportunity for Xero. We estimate that global rates of cloud accounting adoption still sit at less than 20% and that we are early in our journey. On this slide, you can see that the progress made in subscriber growth reflects a relatively less disruption from COVID-nineteen in the Australia and New Zealand segment when compared to the international segment. Let me cover each segment in more detail in the next two slides. Australia became Xero's 1st geography to pass through 1,000,000 subscribers, growing 21% to reach 1,010,000 subscribers.
Revenue in Australia grew 18 percent to $184,000,000 or 17% on a constant currency basis. We were able to deliver this outcome with the support from a further push in the Australian government's Single Touch Payroll or STP initiative for the smallest of employee businesses sorry, employing businesses. Many small businesses also sought to become STP compliant in order to electronically apply for and access the Australian government's JobKeeper wage subsidy payments. New Zealand also delivered a pleasing result with net adds in the half reaccelerating for the first time since the second half of FY twenty seventeen. Subscribers increased by 22,000 in the half, bringing total subscribers to 414,000, an increase of 13% year on year.
Operating revenue also grew by 13% in New Zealand, which demonstrates ongoing opportunity for Xero in the market where we were founded. In New Zealand, we have seen an increased interest in partner migration to the cloud by those who have not yet adopted. We believe this is linked to the impact that COVID-nineteen has had on their practices. This dynamic is also interesting because it could be an early indication of a potential for increased migration by later adopters as markets become more penetrated. Moving on to our international segment.
The international segment broke through 1,000,000 subscribers, another milestone that signpost the increasing scale of our global operations. This also came despite major markets in the international segment being more impacted by COVID-nineteen disruptions over the last 6 months. To break it down by region, in the UK, we continue to make progress in the half, growing subscribers by 19% to 638,000. However, in making comparisons to the prior year, keep in mind the net additions were boosted last year by the first phase of making tax digital or MTD for VAT. Revenue in the UK increased by 33% to 107,000,000 During the half, the UK government revised its compliance deadlines for the next phases of MTD.
These are now coming up in April 2022 for the 2nd wave of VAT and April 2023 for income tax. We expect this to be a further catalyst for small business digitization cloud adoption and continue to prepare for the upcoming phases of MTD with further development of our 0 tax product in the UK. In North America, we also saw continued growth and progress. Our North American business passed a quarter of a 1000000 subscribers in the half, growing by 17%. Revenue grew to $29,000,000 an increase of 4% on the prior year.
As hub dock subscriptions were most concentrated in North America, there was a more pronounced impact to revenue from the bundling of hub dock into core subscriptions near the end of FY 2020. The absence of any North American ZeroCon revenues also reflected in this revenue outcome. Without the impact of these factors, revenue growth in North America would have been in line with the growth seen in subscribers. Beyond the wider disruption from COVID-nineteen, North America was also impacted by a prolonged tax season in the U. S.
The end of the U. S. Tax season is usually a catalyst for new subscriptions. However, this year's deadline was extended from April to July due to COVID-nineteen, which meant partners had less time than usual to migrate or onboard clients. We also signed a bank feed agreement with Bank of America, which completes our coverage of all top tier banks in the U.
S. We continue to focus on growing subscribers through our partner network in the U. S. And Canada, and partner channel capacity continued to expand to over 1,500,000 estimated small businesses in the half. Before I move on from North America, I also wanted to flag that we recently launched Canadian dollar billing for our Canadian customers as part of our local product market fit playbook.
In the rest of the world markets, South Africa, Singapore, 2 of our newer geographies contribute to total subscribers across rest of world, growing 37% to 136,000 and revenue growing 38% to $27,000,000 Government initiatives continue to drive the digitization of small business compliance in Singapore, including incentives related to the adoption of e invoicing under the e invoicing registration grant and other software solutions under the digital resilience bonus, which was introduced during COVID-nineteen. And in South Africa, we've signed a bank feed agreement with a major South African bank Nedbank and released improvements to our VAT solution, enhancing our local market product fit in South Africa. Now moving to the next slide. Our second strategic priority is to grow the small business platform. And platform revenues comprise 6% of total group revenues, which is the same percentage as a year ago.
However, reflecting the inclusion of Hubdoc in our core business edition products now. Looking beyond this one time revenue movement related to Hubdoc, the actual growth of the other 2 contributors to platform revenues was more than 50%. Our ambition remains to grow the small business platform and drive growth through additional revenue streams, including adjacent products such as payroll expenses and projects and financial services related revenues such as payments and bill payables. Also with our physical events like ZeroCon and Roadshows, which we typically hold in the period, non recurring revenues fell by 87 percent when compared to the prior year. Now with this in mind, I'd like to touch on our recent acquisition of Waddell.
We announced this acquisition back in August and completed it in October, after the end of our half year balance date and as such, there is no Waddell related contribution to our H1 results. Waddell is a cloud based lending platform that helps small businesses access capital through invoice financing by addressing pain points in the traditional invoice lending process. For a small business, this means they're able to unlock capital that's otherwise tied up in their invoices to get access to finance and often this means they can source working capital for their business without having to put up their own home as security for loan. One lines to streamline the flow of information interaction between the small business customer and the lender, automating many of the manual processes involved in assessing credit, underwriting and monitoring. The access to a small business customer's accounting data that a lender gets through a connection to a platform like Xero is at the core of the proposition with Waddell.
Currently with a presence in Australia and the UK, we are excited about the potential benefits that Waddell can bring over time to our customers and banking partners around the world. We're keen to have a range of lenders participate on the platform, greater choices benefits for our small business customers. We're excited about this acquisition. We'll continue to grow the smallzero small business platform to help solve the customer financial needs, like managing cash flow and accessing capital. So I'll now close my presentation by outlining some of the progress we've made against our 3rd strategic priority, which is to build 0 for global scale and innovation.
As I outlined at our FY 2020 results, 0 to scale and innovate effectively and at speed, we need to really focus on the strategic investments we need to make to drive this outcome. We made good progress during the half in a number of investment areas that support this priority. When it comes to attracting, inspiring and retaining all of us talent, despite COVID-nineteen, we continue to build and enhance our people capabilities by acquiring new talent and developing our teams. In particular, we focused on hiring people in our technology, data and product teams. Optimizing Xero's operational financial structure is effectively a continuous improvement project that alongside our work on talent considers how the right people are doing the right things in the right way within our business.
Our previously detailed changes we made to the operation of our global sales and custom functions under Xero's Chief Customer Officer, Rachel Powell. In the half, Rachel and her team have continued to ensure that there's alignment of global and regional sales and customer teams as Xero's customer base grows globally. As Kirsty will outline shortly, when it comes to our financial structure, we ended the half in a strong financial position. Our need to assess the capital requirements to execute our strategy remains an ongoing area of focus. I also wanted to highlight the progress we've made in integrating and aligning our social and environmental impact activities with our wider business functions.
Our efforts in this area are an important element of pursuing Xero's purpose, which is to make life better for people in small business, their advisors and communities around the world. This is a purpose we believe in deeply and drives us to do what we do. Our approach is outlined by the framework shown on the slide and I wanted to elaborate briefly on 3 elements. When it comes to the environment, we remain committed to maintaining a net zero carbon footprint through our carbon offset program, net 0. In terms of our communities, in July, we launched the Zero Community Appeal that supports multiple charities across our regions around the world.
And in the center of our framework are our people. During the half, we appointed a global head of well-being, who's dedicated to developing and leading programs that provide our people with the support they need. With that, I'll now hand over to Kirsty, who is going to take you through the financial results.
Thanks, Steve. Hi, everyone. I'm Kirsty Godfrey Bille, Xero's CFO, and I'll now take us through Xero's financial results for H1 in further detail. As we outlined at the FY 'twenty results back in May, in the uncertain COVID-nineteen environment, we have taken a somewhat different approach when it comes to running the business. To recap, at the start of this financial year and just after COVID-nineteen was declared a pandemic, we implemented a scenario based spending and investment plan.
This approach looked to manage the business for a range of potential revenue scenarios while continuing to drive progress on our strategic priorities. I'm really pleased to report today that this approach has had a positive impact on performance over the last 6 months with Xero reporting strong EBITDA, net profit and free cash flow results. However, it's important to consider that should we see a return towards more normal operating conditions, we would expect to see an increase in our spending and investment levels as we look to address the opportunity. In particular, this would result in higher sales and marketing costs with the resultant shift in our profitability indicators. In terms of the headline financial measures, the top line results we are reporting today reflect the resilience of Xero's business model and that of our customers and partners.
Annualized monthly recurring revenue or AMRR increased by 15 percent versus H1 FY 2020 to $878,000,000 The growth seen in AMRR reflects the 19% growth in subscribers, offset by a 4% drop in ARPU versus the prior year period. The year on year movement in ARPU was driven in part by the previously communicated decision to bundle HubDock into all business addition plans and to defer a related price rise in the majority of regions from March 2020. This change was undertaken prior to the end of FY 2020. And so when compared to the end of FY 2020, H1 ARPU was effectively unchanged at the group level. When it comes to profitability indicators, EBITDA for the half almost doubled to 121,000,000 dollars This was a record result for a 6 month period, but as I've mentioned and will discuss further, specific factors have contributed to this outcome.
Free cash flow for the half increased markedly rising from $5,000,000 to $54,000,000 over the prior year period. This is equivalent to 13% of Xero's first half operating revenues and reflects the top line progress made combined with the dynamic and relatively conservative spending and investment plan the business has operated under. It remains our priority at 0 to reinvest significant majority of capital generated by the business to drive long term growth. The additional funds generated during the half combined with our existing liquid resources represent significant optionality as we drive the business forward. On Slide 16, 0 SaaS metrics continue to show the strength of the business model despite the difficulties of the COVID-nineteen environment.
I'll discuss each of the customer level metrics on the left hand side before moving to the group level segment and total lifetime value or LTV. ARPU of nearly $30 was flat against the prior half with a 4% year on year decline as already discussed. As Steve has already mentioned, churn varied in the half, but in aggregate was consistent with the first half of FY 'twenty at 1.1%. Gross margin increased slightly to 86%. In aggregate, these changes brought about a 3.9% reduction in LTV per subscriber versus the same period last year to just over $2,500 Total life zone value increased by 15% over the last 12 months to reach $6,200,000,000 adding almost 800,000,000 When it comes to CAC or customer acquisition cost, our reported efficiency metric were as follows.
CAC months increased from 40 months at the end of FY 2020 to 14.9 months and LTV to CAC decreased slightly from 5.7 to 5.7 from 5.8. Most of the softness in our CAC efficiency measures came in our international segment where the business was more impacted by COVID-nineteen disruption when compared to the Australia and New Zealand segment where our CAC efficiency measures actually improved. It's important to note that CAC spending in any period targets by future growth as well as the subscribers added in that period. Against a tough backdrop, reported SaaS metrics continue to demonstrate the resilience of Xero's business model. Gross margin improved slightly versus the prior year period driven by continuing efficiencies in Xero's customer support team and minor improvements in security and bank feed costs.
The second chart shows a marked shift in cap trends that reflects the settings under which we have run the business and also the slower rate of subscriber growth seen over the first half of the year. CAC as a percentage of revenue reduced by more than 11 percentage points to an all time low of 32%, down from 43% in the prior year period. As I've already mentioned, this trend is largely a function of the current circumstances as a percentage of revenue product costs including both OpEx and CapEx increased to 34%. This was a 2 percentage point increase on the prior year period and reflects our unwavering prioritization of investment and product development and commitment to support customer needs as signaled at the end of FY 2020. Turning Slide 18, H1 segment contributions from both our Australia and New Zealand and international segments increased markedly.
This was primarily due to the responsive spending and investment management approach we have taken in the period. The Australia and New Zealand market segment contribution grew by $38,000,000 or 29% year on year to $169,000,000 dollars Revenue growth for this segment of 17% was achieved alongside a conscious focus on cost, particularly in the 1st few months. This resulted in an absolute fall in sales and marketing costs, but the segment still added 122,000 subscribers similar to the level of additions achieved in H1 FY20. This demonstrates the benefits of our focus on pack efficiency in our most developed markets and the opportunity which still exists within these markets. In our international segment, there was also a significant improvement in contribution.
This was again due to a fall in sales and marketing spend that would otherwise be expected to rebound under more normal operating conditions. The decline in CAC spend combined with the 28% increase in revenues saw international contribution improved by 40,000,000 to 51,000,000 over the prior year period. Echoing my earlier comments, I also wanted to briefly mention how we might expect contribution margins to evolve going forward. Contribution margins incorporate the cost to serve customers in each segment and the cost of growing the subscriber base through sales and marketing or CAC. All else being equal, we would expect to return to higher rates of subscriber growth in both the current and future periods to be driven by a necessary increase in sales and marketing expenditure.
This in turn would moderate any improvement contribution results over the short to medium term. Moving to Slide 19. Here we have a summary income statement for H1 showing year on year changes from H1 FY20. There are some different outcomes this half year that I'd like to highlight. Operating revenue increased 21% to just over $410,000,000 This result connects relatively closely to the 19% growth seen in subscribers across all markets.
Revenues were impacted by the absence of non recurring revenues, which declined to almost nil, primarily due to cancellation of planned in person events such as 0 Con Sydney in the first half. 0 Con revenues are typically offset by costs within the sales and marketing line. In addition, our Xerocon UK event originally planned for later this month has also been canceled. As I've already called out, gross margin improved the prior year period by 0.5% to 85.7%. Moving to expenses, I want to mention a couple of specific examples of variable expense management that contributed to that performance.
Advertising and marketing costs declined by 46 percent from $50,000,000 to $27,000,000 and travel related costs fell by 99% from $8,000,000 in H1 FY20. Further detail of our expenses can be found in note 5 on Page 27 of the interim report. EBITDA for the first half was $121,000,000 which is a $56,000,000 improvement year on year. The EBITDA margin of 29.5 percent improved by 10 percentage points year on year. The significant margin improvement has slowed down to the bottom line with our 4th consecutive net profit for a 6 month period of 34,500,000 dollars Moving to Slide 20, cash generation and other movements in the period brought total liquid resources to $723,000,000 These consist of cash and cash equivalents, short term deposits including proceeds from convertible notes and also the undrawn committed debt facilities.
Operating cash flows increased by 77% over the period year prior period year to $127,000,000 ahead of the EBITDA results and indicative of 0 strong monetization profile. Investing cash flows increased by 9% to $72,000,000 Spending on fixtures and fittings was an example of spend that has been largely paused. Cash flows relating to the acquisition of Waddell will be presented in our FY 'twenty one accounts as the transaction closed in October after the period end. Total cash and short term deposits at September 2020 were $573,000,000 Deducting our term debt liability of $395,000,000 associated with the US300 million convertible notes we issued in 2018, our net cash position at the end of the half was $178,000,000 up from $101,000,000 at the end of H1 FY 'twenty. The uplift in our cash position has strengthened our liquid resources.
However, as Steve has already mentioned, we remain focused on optimizing Xero's financial structure. This is to ensure we have the right settings to power growth and deliver on our strategic priorities. We continue to prioritize reinvestment of capital generated and we don't believe this position will change for some time. This is driven by the potential we have to create significant long term value through successful execution of our strategy. When it comes to organic growth, most of our investment will focus on the areas of go to market and product development.
We also continue to evaluate potential investment opportunities that can extend and enhance our small business platform and broader ecosystem. I'll now hand back to Steve to take you through our outlook before we move on to Q and A. Thank you.
Well, thanks a lot, Kirsty. Moving to Xero's updated outlook, Xero is a long term oriented business with ambitions for high growth. We continue to operate with disciplined cost management, targeted allocation of capital. This allows us to remain agile so we can continue to innovate, invest in new products and customer growth and respond to opportunities and changes in our operating environment. The continued uncertainty created by COVID-nineteen means it remains speculative to provide further commentary on our expected FY 2021 performance at this time.
And before I conclude, I really want to acknowledge and thank the entire team across Xero for all their hard work during what has been a challenging time for all. I'd also like to thank all of you on the webcast and the phone for joining and listening in today. I'll now hand back to the moderator for your questions.
Thank Your first question comes from Suraj Ahmed from Citi. Please go ahead.
Thank you. Steve, just to touch on trends in subscriber growth, if you could. Just in Australia, in the first half, how should the benefit how much of the subscriber additions actually came from just the payroll only plan, because you have flagged that as one of the reasons for ARPU to decline?
Yes. Hi, Suraj. Look, we don't break out the details. I think we're pretty clear that STP has been a driver, but now at this stage we don't break out specifics of the subscriber, the subscription mix.
Yes, maybe see another way is, I mean, because that would have been in Q1 and maybe through June, just keen to understand overall, I guess maybe Kirsty did mention that you expect subscriber growth to accelerate. I'm just keen to understand if that's the expectations overall in second half given you have seen an increase in COVID cases in U. K. And U. S.
So just how you can came with the near term on subscriber growth that would be helpful?
Suraj, I'll take that and Steve can add a few more. Yes, so what we were discussing earlier was, I suppose, just mentioning in Australia, I think, we have, as the results show, we have had an incredibly strong half. This has been the 2nd best half in Australia ever. And so that was obviously a consistent story through the half and incredibly pleasing based on the COVID backgrounds that Australia was dealing with. If you look more towards the Northern Hemisphere, that has been hit as we're all aware, far harder than ANZ.
And so therefore, we did really see a very difficult Q1 and this was at the time when we were ensuring that we were able to pivot our cost base to match into the opportunity that we've seen. I think it is questionable as to what's going to happen with COVID-nineteen in the Northern Hemisphere through H2. I suppose we have seen resilience, we've seen growth in all of our regions throughout the hubs. And I think looking forward, we still all very much see the opportunity of further cloud penetration across particularly that Northern Hemisphere, which has such low cloud adoption and conversations around vaccines can only help with that.
Thanks. And just moving on to ARPU and price increases, you've announced price increases in the U. S. Just keen to understand how you're thinking about other markets, if you could?
So with price increases, we announced that we were going to put a pause on the price increase back in the middle of March when COVID-nineteen was sitting around the globe and still very much believe in the increase in value that we have provided our small businesses and accountants and bookkeepers through not only the bundling of Hubdoc, but also through the additional products that Steve mentioned throughout his presentation, both helping in COVID, but also just increasing the value of the product. And so therefore, we as we always do continually look to see when is the right time to put appropriate pricing through. And so very carefully watching each region on a region by region basis at the moment and we'll give notice to our small businesses, accountants and bookkeepers when we believe it's the right time.
And just last one, just on the same topic about attach rates. Just on Slide 7, where you show the payment or the invoices activity for your attach Stripe and GoCardless, Just keen to understand, I mean, there will be some seasonality compared given it's indexed to Jan compared to September. Just keen if you can just talk to penetration versus just seasonality, you are just how is adoption increasing in the payment space because that's a key driver for your growth going forward?
Yes, look, I think that that graph, the way that's presented actually reflects a couple of things. It does obviously reflect seasonality because that will flow through to usage, but it also does also reflect increased usage of the service. So it does reflect penetration and underlying growth as well as an individual customer's seasonality of use.
All right. Thanks Steve. Thanks Kirsty.
Thank you.
Your next question comes from Paul Mason from E&P. Please go ahead.
Hey, guys. Just a couple from me. So the first one, I just wondered on payroll in regions where you sort of build that separately instead of having it bundled. It sort of looks like you basically didn't take any really material impact. I'm just wondering if you could provide some color there on whether you've seen payroll related revenues decline and then return back up or what the pattern is then?
So we I mean, Paul, we don't, as you're aware, go down into that level of detail. But I think I can certainly say that we haven't seen where it's that variable payroll revenue. We certainly haven't seen that drop and I think a note that can be made is that ancillary revenue has actually seen a slight increase from the half definitely between H1 last year and H1 this year and the variable component of payroll was part of that.
Great. And just the second one for me relates to reinstatement of your sales and marketing costs. And so I was just wondering if you could talk through some color on sort of how you're going to assess, say, relaunching 0 Con in Australia, for example? And then more broadly, what the sort of trigger points that you're thinking about are for lifting your sales and marketing back up towards sort of 40% of sales, maybe region by region, obviously, given Australia and New Zealand are in a very different position to Northern Hemisphere?
Yes, look, great question, Paul. And essentially, it's an ongoing watch and brief in terms of the overall environment around the health and the health of community in each region, also the economics and the economic impact going forward. So it's really an ongoing process. It's a very active process between our finance organization, all our go to market and our customer team. So we are I think that as you can kind of assume that as the environment improves, so will our level of investment.
And we did see a pickup, as you know, in the second half of the half. And essentially we'll just keep a watch on that and as Kirsty said, you'll see those levels return to more normal levels as we go forward.
Okay, great. Thanks.
Thank you. Your next question comes from Craig Wong Pan from CLSA. Please go ahead.
Good morning. My first question just on sales and marketing costs. Could you just give some examples of areas that you've pulled back in? So I guess 0 Con is 1, but could you give any other examples of what's being pulled back? And then also just related to that, the different regions, like it looks like your CAC months declined in ANZ but increased in international.
So is that right to say the international sort of market still had increased spending around sort of on sales and marketing?
So, yes, just to give you some examples of sales and marketing costs, as you rightly referred to the in person events, now there are also other in person events. So we have ZeroCon, which is the large event, but then we also do run WIGO roadshows. And so then there's travel associated with that as well. And then obviously from a straight marketing perspective, we also as we do always really look to make sure that we are going to be driving benefit out of any marketing campaign that we do. And so we run the same level of rigor over that now as we have done in the past.
So I think that's from a sales and marketing perspective, it's really just looking at that variable cost base and Xerocon was a major factor for the first half on that.
I think also it's fair to add that early in the half, tempering our advertising investment felt totally appropriate given our focus is really on supporting our customers and the environment was very, very challenged. So that's just another area where we tempered relative to what we do normally.
Okay. Thanks for that. And then my next question, just around the North American markets, could you make any comments about how the U. S. Compares to Canada?
U. S. A. And Canada, we have separate subsidiary leaders now and operations are very different markets. U.
S. Clearly is multiple regions in one region when you look at compliance being payroll and tax and other forms of interaction between business and government, whereas Canada is very much more like what you find in the Commonwealth countries, more consolidated banking sectors and governments that are very focused on advancing digitization. So penetration rate in Canada are a lot lower than they are in Australia, New Zealand, the UK, so very good opportunity there. But clearly, our strategy and approach to both markets needs careful thought in terms of making sure we leverage where it is the same as where we've done before and also making sure that we are in tune with and adjusting to and really responding to the differences in
both markets. Sorry, I kind of meant more in terms of the kind of sort of dynamics there like and I guess impacts from COVID, are they sort of being impacted similarly or are you seeing kind of much change in the different dynamics there between both markets?
Look, I don't know. I think there's 2 things you're talking about. 1 is the impact of COVID, which both have been impacted more than Australia and New Zealand. There's no question about that. But U.
S. Has been tough as you know in that respect. In terms of the market dynamics, we don't really see that as we said as a different thing and that's why we're really focused on each market individually, having teams focused in executing go to market and product plans that really reflect the differences between the 2.
Okay. Thank you.
Thanks.
Thank you. Your next question comes from Quinn Pearson from Credit Suisse. Please go ahead.
Hi, good morning. Thanks for the time and the questions. You touched on this in the prepared remarks, but I hoping you could maybe elaborate on to what degree you think there might be a COVID boost that you're benefiting from and things would be helping customers access various government support, whether it's wage assistance or PPV loans and the like, or supporting cloud adoption to help accounting customers work remotely. I was just hoping you could talk us through how you're seeing that from a kind of a structural impact both on this half and how that plays through from here? Thanks.
Yes. Look, I think it's very clear in the context of New Zealand that there is something happening across the accounting and bookkeeping community where those who have been slow to adopt are now really engaging and keen to adopt given what they've growth for us and adoption, we do think that the experiences at large of what's happened to all of us through this have heightened, as we can see in many contexts, the importance of digital platforms and employing digital technology. So, in fact, even with our 0 small business index report, we were able to show the correlation between multiple app usage and lower impact of COVID on business performance and jobs. So they're important. So that's an example of that.
In terms of really getting into the details specifically, it's very hard to say in a quantitative way what we expect, but we do think that certainly new business is being formed. We've seen an increase there and highly likely those businesses will be created and built with digital platforms in mind. So I think overall, whilst there's no question it's created significant challenges for all, there is some elements here to driving the adoption of digital technologies faster in the future.
Helpful, thanks. And maybe if I could just confirm how to be thinking about the margin profile of the business. It sounds like once you're comfortable of, I guess, a normalization of conditions, if you will, that the CAC spend will then return. I mean, do we think of that spend returning to similar levels as a percentage sales and therefore should think about the free cash flow margin kind of reducing back into that single digit level?
So yes, so as we have been clear about in the past, we certainly see plenty of opportunity for reinvestment back into the business and that is primarily looking at CAC and product and technology spend. As far as whether or not CAC will return back to that 43% that it was H1 last year, It is the expectation is that it will return to a similar ish number. The number that we look very closely at is our LTV to CAC to ensure that we're getting the right level of efficiency out of our CAC dollars. And so I'd focus more on that rather than the percentage of revenue. But then also I think so as far as the free cash going forward, we then would be looking at opportunities to either grow our top line by investing in CAC or by as we have through the COVID period putting more investment levels into product and technology for future growth.
That's helpful. Thank you.
Thank you. Your next question comes from Tom Beadle from UBS. Please go ahead.
Hi, guys. Thanks for the questions and good result. Just the first one, I mean, the trends obviously appear to have improved towards the end of the half. Just wondering, everything is obviously fairly fluid at the moment. So just wondering, could you maybe give some observations as to what you've seen in the 1st 5 or 6 weeks of the second half?
Obviously, there's lockdowns in the UK. You've had the U. S. Election. Is there anything worth highlighting there?
Tom, clearly at this point, no. It's too early in the half and you'll be hearing more from us, I guess, full year results. So, no, nothing to comment on that at this point.
Okay. No problems. And maybe just the second question, I mean, I know while you plan to reinvest, there's obviously going to be some temporary reductions in your costs until COVID finishes. So if I put all that together, with your AMR growing, should we expect to maybe see some degree of free cash flow that's higher than it otherwise would be in the short term? And sort of following on from that, just given the strong position of your balance sheet, your liquidity is strong.
So then obviously, can you talk about like your views on M and A and even things like how would you approach capital management given that you're continuing to generate capital?
Yes. So I suppose just from looking at sort of what you can expect in the future, we certainly the plan wasn't for H1 to look like this pre COVID. We certainly see so much opportunity both within CAC and also within products and technology to really be able to drive the future growth of 0. And that's not just within the current year, but in future years to come. And so therefore, through H2, we will certainly be looking at ways in which we can deploy the capital for future revenue growth.
Now we will still apply the same level of agility within the cost base. But certainly, with talk of vaccine and the hope around COVID being able to improve in the Northern Hemisphere after they pass through winter, we certainly want to make sure that we are ready and available to capture the opportunity that we see as they've been talking around that cloud penetration and further enhancement into digitization of small business. So I think we are definitely not looking at running our business as it has been over the first half. We've done a good job of managing through a very, very difficult and unusual time. But we'd love to be able to get back to what we previously were doing, which was really driving investment to be able to really take opportunity of the future growth.
Okay, great.
Thanks. Sorry,
just on
the balance sheet. So we do, as you pointed out, we do have reasonably strong liquidity. It includes that undrawn standby facility, the 723,000,000 dollars But we're also constantly looking at the way in which we should look at our balance sheet and maximize the value within the balance sheet. And we see, as we've seen for and been focusing on now for a while, looking at different M and A opportunities to really ensure that we are able to enhance the service offerings out to our accountants and bookkeepers and small businesses. And so very much looking at a pipeline of M and A opportunities at the moment.
Obviously, nothing to announce today, but really, really driving hard in that area as well.
Okay, great. Thank you.
Thank you. Your next question is from Roger Samuel from Jefferies. Please go ahead.
Hi, good morning all. Thanks for
the question. My first question is on the subscriber growth in North America and the U. K. So you've added about 36,000 subs over the last 12 months in North America. And when I look at the numbers from QuickBooks Online, they added about 360,000 over the last 12 months ending in July.
And I know that you were not comparing like for like periods here. But I'm just wondering how can you accelerate your growth in North America? And the second part of my question is, do you think that you have gained or lost any market share in UK?
So do you want to take that, Steve?
Yes, yes. Look, well, thanks, Roger. Look, I think with both markets we see tremendous opportunity. And so I think you have to, in a sense, reflect beyond the impacts of COVID-nineteen to what we are doing and the way that we see that opportunity. Certainly in the UK, we think we've performed strongly in those difficult circumstances relative to the opportunity.
And similarly in North America, we are continuing to evolve our business. We are really happy with the progress our go to market teams are making and also certainly as we go forward and we really connect more and more with customers and understand the differences in each market, we've also got product roadmaps that we're investing in that evolve very much with a focus on each. So our position with tax in the UK is a very strong position. We're looking at other markets in a similar way to make sure that from a compliance and a core accounting application perspective, we're really delivering the value customers want. So we're still very positive about the progress we're making.
Certainly, the environment was tough through the last 6 months and it's one again that is not about changing our strategy. Our strategy is very clear and we're executing it. It's really just about making sure we're adapting in the shorter term to the realities that our people and our customers are facing.
Thank you. Your next question is from Lucy Huang from Bank of America. Please go ahead.
Hi, Steve. Hi, Christy. Thanks for taking questions. I just have 3. So firstly, you mentioned you're starting to see new business formation.
I'm just wondering if you can give us some early insight into whether you're seeing a similar rate of new businesses being formed versus other years in a more normal environment. Just wanted to see what the cadence of that is like at the moment. And then just secondly, you've launched the new starter pack in Australia. Just wondering if you've seen much take up of that since the launch in around September and whether you've seen any existing customers migrate down given that we are still in quite a challenging COVID period at the moment? And then just my last one, sorry, to touch on free cash flow again, assuming that things do improve in the second half or whenever it does improve, where will most of the free cash be deployed?
Is the focus going to be on new market entries? Or do you think it
will be more geared towards platform products or
kind of just penetrating the existing markets? Thanks.
Yes. Hi, Lucy. On new business formation, there are data sources that you can access through government around the world that do indicate there is an increase in new business formations. Where that flows in terms of how those businesses actually operate and what they acquire is still to be seen. We do certainly track our the interest that we get through our direct digital funnel in terms of trial volumes and those trial volumes have held up.
So there's definitely interest there in adoption of cloud accounting. So that's encouraging, but too early to be drawing any specific conclusions from. On the starter, I'm really pleased with the progress there. In our decision to progress with that, we were aware that there was going to be some aspect of potential downgrade, but you look at that in the holistic sense of what additional customers are going to bring to the Xero platform by virtue of having that offering and really pleased with the performance to this point and the business case that we made has held up very nicely. So we're pleased that we did that.
And I'll let Kirsty handle question 3 on free cash flow.
Thanks, Lucy. So as far as when we're looking at what's going to happen with free cash flow going forward, I suppose if you think around what we've done within our cost base for H1, we have brought in really pleasingly, we've been able to actually hire new people through this process and most of those have been within the product and technology area. And so you will see an annualized impact of those even just in H2. And then as far as where we are likely to put the to put the remainder of the cash that we generate in H2, we will continue to focus on increasing also our products and technology spend through drawing different strategic initiatives. And that is to not only just improve the core product that we've got, but also as you mentioned to enhance the adjacencies and the connections that we've got with our ecosystem partners.
We will also see an uptick, all things going well on the CAC side as well. We're not announcing any new markets that we're entering today. We still very much see there's a lot of opportunity within the markets that we're in at the moment. So, opportunities that sit within the markets that we're in taking all opportunity that sit within the markets that we're in currently and ensuring from a product and technology perspective, we're in the best shape to take the opportunity that comes out the back end of COVID.
Thank you. Your next question comes from Roland Sundram from MST Financial. Please go ahead, Roland.
Hi, Steve and Kirsty. Just one question for me. Just on the capital management side of things, a follow-up there. Can I ask about dividends? And granted that you're still in a growth phase and best spend at present is to reinvest into the business.
But is the commencement of dividend payments at all the discussion point in internally? And if not or if so, what are some of the key considerations that you have to think about in turning before and determining when that is the right time to commence payments?
Yes. So Rowan, as we have as we've been quite clear about, we certainly still consider that the best place for us to be allocating capital is back into the business because we are a long term orientated business with ambitions for high growth now and into the future. And so therefore, we do not discuss dividend policy at this stage.
Thank you. Your next question comes from Weiwei Chen from JPMorgan. Please go ahead.
Hi, guys. Just a question from me about, I guess, is the feeling right now from 0 that we're past the worst of the pandemic in terms of impact on your business or are you concerned about sort of an increase in business failures as we sort of see the gradual lifting of government support initiatives? Hi, Weiwei. Thanks for the question. Look, I think at this stage, we'd say it's too uncertain to say.
The uncertainty remains. I mean, we don't have a different view into the future than others. It's really too hard to say.
Thank you. Your next question comes from Andrey Mironenko from Alfiniti Investment Management. Please go
ahead. Thank you. Just to understand, so your operating revenue has increased by 21%, while your subs have increased by 19%, yet your AMRR by only 15% driven by ARPU reduction. So given this strength in operating revenue per sub but weakness in ARPU, does it mean that operating revenue per sub kind of kept declining throughout the half? And what does it mean for the next half?
Yes. So I think thanks for your question, Andre. If you look at constant currency, our operating revenue grew by 19%. So we did have some upside there on the FX, which then is consistent with the subscriber growth. I think we've talked around the we've talked around the variances within our ARPU and that has held at a constant currency perspective held around flat over the 6 months as well, which has been really pleasing.
And I think opportunity for us to really drive further platform attach, further growth in our platform side, as we've been driving towards over the last few halves as well, will then flow through into ARPU.
Thank you. That does conclude the question and answer session for today. I will now hand back for closing remarks.
Well, look, thanks everyone for listening today, for your time, your questions. Really appreciate it. Appreciate your support. And thank you very much from everyone at Xero for being here today. Thanks very much.
Thank you. That does conclude the conference for today. Thank you for participating. You may now disconnect.