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<p>99 Xero Limited 2016 Annual Report 100 Cover image – Chow // Xero customer Inside image – Proffer Ltd // Xero customer 1 Contents Highlights Chairman and Chief Executive’s Report Management Commentary Auditor’s Report Financial Statements Notes to the Financial Statements Directors’ Responsibilities Statement Corporate Governance Disclosures Corporate Directory 2 6 10 18 19 23 43 44 49 54 $184.0 million $257.9 million $207.1 million 717,000 Cash and cash equivalents and short-term deposits at 31 March 2016 Annualised committed monthly revenue at 31 March 2016 Paying subscribers at 31 March 2016 Total operating revenue for year ended 31 March 2016: 67% growth Highlights 2 HIGHLIGHTS Regional subscribers at 31 March 2016* 2015 // 475,000 2011 // 36,000 2013 // 157,000 2009 // 5,000 2014 // 284,000 2010 // 17,000 2012 // 78,000 2016 // 717,000 paying subscribers Operating revenue growth of 67% and subscriber growth of 51% in the 2016 financial year Australia 2015 // 203,000 2014 // 109,000 312,000 New Zealand 2015 // 138,000 2014 // 102,000 186,000 2015 // 35,000 2014 // 18,000 North America 62,000 United Kingdom 2015 // 83,000 2014 // 47,000 133,000 3 (US and Canada) *Rest of World subscribers of 24,000 at 31 March 2016 4 Strong global revenue and subscriber growth Paid subscribers hits 717,000 globally, with 242,000 subscribers added in the 12 months to 31 March 2016 Annualised committed monthly revenue of $257.9 million, a year-on-year increase of 62% Operating revenues of $207.1 million, an increase of 67% on the previous year Global year-on-year revenue growth of 95% in international markets, and 57% in Australia and New Zealand Improvement in operating metrics Gross margin increased by six points to 76% year-on-year Net loss of $82.5 million for the year, an increase of $12.9 million over the previous year, as Xero continues to invest in scaling its global business EBITDA margin FY16 improved to -29% in the year from -46% in the previous year EBITDA margin (excluding share-based compensation) improved to -22% from -38% in the previous year Continuing to execute on strong global growth with improving operating metrics Highlights 5 HIGHLIGHTS Reducing cash usage1 Operating and investing cash usage for the second half of the year of $39.1 million, an improvement of $9.3 million from $48.5 million for the same period in the previous year Cash usage from operating and investing activities (including FX) was $86.1 million for FY16, lower than the cash usage of $88.2 million in the previous year Closing cash and cash equivalents and short-term deposits position of $184.0 million 1 Net movement in cash and short-term deposits excluding financing activities 6 Chairman and Chief Executive’s Report Dear shareholder, Following strong subscriber growth of 242,000 to 717,000 over the past 12 months, Xero is the market-leading small business cloud accounting software in Australia, New Zealand and the United Kingdom, based on number of subscriptions. We have made good progress in the competitive United States market where the accounting industry is at an early stage in its migration to cloud technologies. Our global experience and platform investment benefits us, as the transition to cloud-based business software continues its momentum. Our prudence in raising capital last year protected us from the correction in the global technology markets earlier this calendar year, allowing Xero to continue its global growth strategy while driving margin improvement. We have applied discipline in the deployment of capital to drive value-enhancing growth. This is most evident in the increase of $685 million in the Life-Time Value (LTV) of our subscriber base in the past year to $1.5 billion. Gross margins and EBITDA margins improved while cash usage reduced. Based on current projections and growth plans, we have sufficient capital on hand to drive the business towards cash flow break-even. Annualised committed monthly revenue surpassed quarter of a billion and our team is focused becoming a $1 billion+ revenue generating business. Performance highlights The company has continued its improvement in operating metrics. We improved cash flow performance through the 12 months ended 31 March 2016. Operating revenues increased 67% year on year to $207.1 million while annualised committed monthly revenues also grew to $257.9 million, a year-on-year increase of $98.6 million, up from the year-on-year increase of $66.3 million in the previous year. Gross margins increased six points to 76% year-on-year, while EBITDA margins improved by 17 points year on year. We achieved cost efficiencies across the company over the past 12 months and delivered on commitments to continue investing in growth, with a greater proportion funded out of revenue. Global growth The success of our global growth strategy is evidenced by our cloud accounting software market leadership in Australia, New Zealand and the United Kingdom. We will continue to build in the important market of the United States and establish ourselves in other markets including South Africa, Canada, and South East Asia where we recently opened an office in Singapore to oversee our growth in the region. “Based on current projections and growth plans, we have sufficient capital on hand to drive the business towards cash flow break-even.” 7 CHAIRMAN AND CHIEF EXECUTIVE’S REPORT Our global focus means we are pursuing a large market of tens of millions of small businesses, most of which have yet to experience the cloud and mobility revolution enjoyed by consumers and large enterprises. By focusing on small businesses around the world, Xero has the potential to grow its customer base and market share for many years to come. Being an accounting platform means that although we can replicate our core product globally, we must provide unique solutions for regions in which we, our small business customers and their accounting partners, operate. This work is a key task for our regional development teams globally. It has also led to localised innovations. Not only have we developed and rolled out more than 1,200 customer-facing features and updates, but we have also produced market-specific software that helps our customers’ businesses grow. For instance, we released Xero Tax in Australia, and more recently Xero TaxTouch in the United States – unique cloud-based tax solutions built specifically for their respective markets. Xero Tax has been embraced widely in Australia – in just 18 months, we have seen more than 1,400 firms adopt the platform and submit more than 1.4 million lodgements to the Australian Taxation Office. Xero TaxTouch has only been in the market since early March 2016, but we’ve already had positive feedback, including receiving an award at the Barlow Research’s 2016 Monarch Innovation Awards for the app. We have developed similar strategies and products in each of our core markets and will continue to do so as we build out our capabilities across the world. That’s why in the United States we are pursuing a strategy of carefully managed growth as we add critical banking integrations, expand our suite of products to include simple tax filing and payroll for more states, and attract more accountants and bookkeepers. A unique view into the small business economy In the past 12 months, the Xero platform recorded more than $1 trillion across more than 450 million incoming and outgoing transactions. The Xero platform is providing unique and real-time insights into the importance of small business in economies that has not been available before. In addition, cloud accounting is transitioning from distributing a software product to using software to rewire the small business economy. Enterprises are now automating their supply chains by connecting to Xero. Xero is connected to government agencies across our markets and connects small businesses across our platform. The initial work we did connecting banks to Xero has expanded to become a financial web. By allowing small business owners to control and connect their accounting ledger to their bank, financial institution or a financial services provider, they can access services that were once primarily only offered to large enterprises, giving small businesses the ability to potentially obtain loan approvals more quickly, benefit from accessing more competitive foreign exchange rates, and more payment options. “Our global focus means we are pursuing a large market of tens of millions of small businesses, most of which have yet to experience the cloud and mobility revolution enjoyed by consumers and large enterprises.” 8 We currently have relationships with more than 80 financial institutions around the world to help small businesses save time and administration in managing their finances and accessing services. In the future, intelligent data matching in Xero will automatically code banking transactions, making accounting even easier for small businesses. Pace of innovation Xero’s focus on constant product and platform innovation has been core to our growth strategy. Over the past 12 months, we have delivered significant customer-facing updates and new features to our subscribers, providing them with new tools and ways of conducting their business more beautifully and efficiently. We continued to expand our solutions ecosystem, helping small businesses connect to more than 500 solution partners who work with Xero to extend the functionality of the core accounting platform to meet customer needs and requirements. Across the year we also expanded the ecosystem to include partnerships with major global technology companies. We integrate more closely with popular devices like the iPad and iPhone, as well as widely-used tools like Google Apps for Work, Android and Microsoft Power BI, to make collaboration between small businesses and their accounting partners easier and more efficient. As we continue to grow our customer base, we are mindful of the need to scale our platform to provide customers with fast, secure and reliable access to their Xero data anytime, from any device. With that in mind, we are at the deployment stage of a two-year project to migrate our core cloud platform to Amazon Web Services (AWS). With our accounting engine largely complete and with such a large volume of transactions being processed on our global platform, AWS gives us access to new big data technologies such as machine learning and artificial intelligence. This provides the foundations for a new wave of innovation that will benefit Xero customers in the years to come and allow us to further differentiate our platform from those of legacy software providers. People Our success has been in large part thanks to the team of exceptional development, marketing, sales and support staff that contribute to Xero’s success every day. We now have more than 1,450 employees across 20 offices around the world and are continuing to grow our skills and attract top talent globally. CHAIRMAN AND CHIEF EXECUTIVE’S REPORT “In the past 12 months, the Xero platform recorded more than $1 trillion across more than 450 million incoming and outgoing transactions.” 9 Chris Liddell Chairman Rod Drury Chief Executive Our performance demonstrates the strength of our management team. Recent appointments to support our growth demonstrate our ability to attract top talent. Xero successfully transitioned the Chief Financial Officer role to Sankar Narayan, a seasoned CFO, public company executive, and technology leader. Andrew Lark assumed the role of Chief Marketing and Business Officer, responsible for all go-to-market functions. We appointed Tony Stewart as Chief Data Officer, Rachael Powell as Chief People Officer, and Kirsty Godfrey-Billy as Chief Accounting Officer to boost the Xero management team in key areas. Most recently, Chief Platform Officer Duncan Ritchie resumed responsibility of the product team now that the migration to Amazon Web Services is underway. At a local leadership level, we managed successful appointments of the Australia Managing Director, Trent Innes and New Zealand Managing Director Anna Curzon, to establish the next phase of growth in these key local markets. We also appointed Alex Campbell as Regional Managing Director to lead growth in Asia, focusing on Hong Kong, Malaysia and Singapore. While we have grown quickly, our outstanding culture, sense of purpose and urgency remains as strong as ever. Closing comments This is a long journey. Though we have reached several remarkable milestones to date, in a market of tens of millions of potential customers, we have only just begun. Xero has the resources and substantial revenues to continue focusing long-term on global growth and leadership while delivering the right financial results for our shareholders. Our strategic priorities are to: – continue to evolve our technology platform, extending our core accounting offering to meet the full needs of small businesses and provide new revenue opportunities – outpace competitors through rapid product innovation, continuous improvement, and a strong customer service model – continue the sales momentum that’s driving high revenue growth in all our core markets – grow the financial web through integrations with major banks and financial institutions – grow our ecosystem of partners, and alliances with global brands, to create new value for both Xero and its customers. Thank you to all our shareholders for your continued support. CHAIRMAN AND CHIEF EXECUTIVE’S REPORT “Xero has the resources and substantial revenues to continue focusing long-term on global growth and leadership while delivering the right financial results for our shareholders.” 10 You should read the following commentary with the consolidated financial statements and the related notes in this report. Some parts of this commentary include information regarding the plans and strategy for the business, and include forward-looking statements that involve risks and uncertainties. Actual results and the timing of certain events may differ materially from future results expressed or implied by the forward-looking statements contained in the following commentary. All numbers are presented in New Zealand dollars (NZD), except where indicated. BUSINESS RESULTS The information below compares the results for the year ended 31 March 2016 with the year end 31 March 2015. Year ended 31 March 2016 ($000s) 2015 ($000s) change Subscription revenue 201,986 121,098 67% Other operating revenue 5,074 2,922 74% Total operating revenue 207,060 124,020 67% Cost of revenue 49,881 36,708 36% Gross profit 157,179 87,312 80% Percentage of operating revenue 76% 70% 6% Total operating expenses 248,791 162,868 53% Percentage of operating revenue 120% 131% -11% Other income and foreign exchange 2,538 412 NM* Operating deficit (89,074) (75,144) 19% Percentage of operating revenue -43% -61% 18% Net interest income 8,122 7,688 6% Income tax expense (1,512) (2,078) -27% Net loss (82,464) (69,534) 19% Percentage of operating revenue -40% -56% 16% *NM stands for not meaningful. The growth in operating revenue was driven by subscriber growth in all markets. Average revenue per user (ARPU) held steady despite the subscriber growth. The total operating expenses and the net loss after tax have increased as Xero continues to invest in scaling its global business and delivering significant revenue growth. As a percentage of operating revenue, the net loss and all expenses for the year ended 31 March 2016 are lower than for the previous year. Management Commentary 11 MANAGEMENT COMMENTARY EARNINGS BEFORE INTEREST, TAX, DEPRECIATION AND AMORTISATION (EBITDA) EBITDA disclosures (which are non-GAAP financial measures) have been included, as we believe they provide useful information for readers to assist in understanding Xero’s financial performance. Non-GAAP financial measures should not be viewed in isolation nor considered as substitutes for measures reported in accordance with NZ IFRS. EBITDA is calculated by adding back depreciation, amortisation, net interest income, and tax expense to net losses. Year ended 31 March 2016 ($000s) 2015 ($000s) change Net loss (82,464) (69,534) 19% Add back: net interest income (8,122) (7,688) 6% Add back: depreciation and amortisation 29,143 17,990 62% Add back: income tax expense 1,512 2,078 -27% EBITDA (59,931) (57,154) 5% Percentage of operating revenue -29% -46% 17% EBITDA, as a percentage of operating revenue, improved compared to the year ended 31 March 2015, despite being affected by the deterioration of the NZD. The primary reason for this improvement was operating efficiencies across all expense areas. EBITDA excluding the impact of non-cash share-based payments (a non-GAAP financial measure) is also provided as we believe it provides useful information to analyse trends in cash-based expenses. Year ended 31 March 2016 ($000s) 2015 ($000s) change EBITDA (59,931) (57,154) 5% Add back: non-cash share-based payments expenses 15,147 10,518 44% EBITDA excluding non-cash share-based payments (44,784) (46,636) -4% Percentage of operating revenue -22% -38% 16% EBITDA excluding non-cash share-based payments margins improved on a basis consistent to EBITDA margins. OPERATING REVENUE Subscription revenue is recurring monthly fees from customers who subscribe to Xero’s online accounting software services. Within a subscription, customers also receive support services, data backup and recovery, and system updates. Operating revenue also includes revenue from other related services such as education and the implementation of online accounting software services and conference income. However subscription revenue comprises around 98% of operating revenue. Year ended 31 March 2016 ($000s) 2015 ($000s) change Subscription revenue 201,986 121,098 67% Other operating revenue 5,074 2,922 74% Total operating revenue 207,060 124,020 67% The 67% increase in subscription revenue during the year was primarily driven by year-on-year subscriber growth of 51% from 475,000 to 717,000 at 31 March 2016. Other operating revenue increased by 74% primarily due to increased conference revenue. 12 OPERATING REVENUE – BY GEOGRAPHY Year ended 31 March 2016 ($000s) 2015 ($000s) change Australia 96,686 58,456 65% New Zealand 46,708 32,873 42% Australia and New Zealand (ANZ) total 143,394 91,329 57% United Kingdom 37,437 19,948 88% North America 16,850 7,794 116% Rest of World 9,379 4,849 93% International total 63,666 32,591 95% Corporate - 100 NM* Total operating revenue 207,060 124,020 67% Operating revenue grew in all of Xero’s geographies, with stronger growth of 95% in the earlier stage International markets compared to the more established ANZ markets. OPERATING REVENUE – CONSTANT CURRENCY As more than 77% of Xero’s operating revenue is denominated in foreign currencies, the weakened NZD during the year affected reported revenue. On a constant currency basis, subscription and operating revenue grew by 60% compared to the year ended 31 March 2015. Year ended 31 March 2016 ($000s) 2015 ($000s) change Subscription revenue – constant currency 193,393 121,098 60% Operating revenue – constant currency 198,259 124,020 60% This analysis is a non-GAAP financial measure, which has been provided to assist in understanding and assessing Xero’s financial performance during the year, excluding the impact of foreign currency fluctuations. The constant dollar revenue translates revenue for the year ended 31 March 2016 at the effective exchange rates used for the year ended 31 March 2015. SUBSCRIBER NUMBERS Subscribers means each unique subscription to a Xero offered product that is purchased by an accounting partner or an end user and which is, or is available to be, deployed. At 31 March 2016 2015 change Australia 312,000 203,000 54% New Zealand 186,000 138,000 35% Australia and New Zealand (ANZ) total 498,000 341,000 46% United Kingdom 133,000 83,000 60% North America 62,000 35,000 77% Rest of World 24,000 16,000 50% International total 219,000 134,000 63% Total paying subscribers 717,000 475,000 51% Subscribers at 31 March 2016 grew by 242,000, or 51%, to 717,000 over the 12 months from 31 March 2015. ANZ grew by 157,000 subscribers representing 46% growth in the 12 month period, evidence of strong growth in Xero’s mature markets. International subscribers grew by 85,000 or 63% from the previous period. MANAGEMENT COMMENTARY 13 MANAGEMENT COMMENTARY ANNUALISED COMMITTED MONTHLY REVENUE Annualised committed monthly revenue (ACMR) represents monthly recurring revenue at 31 March, multiplied by 12. Accordingly, it provides a twelve-month forward view of revenue, assuming any promotions have ended and other factors such as subscriber numbers, pricing and foreign exchange remain unchanged during the year. At 31 March 2016 ($000s) 2015 ($000s) change ANZ 177,863 113,754 56% International 80,062 45,584 76% Total 257,925 159,338 62% The growth in ACMR across both segments is, as previously outlined, largely driven by subscriber growth with a higher ARPU having a positive effect. ACMR at 31 March 2016 was $98.6 million or 62% higher than the prior year balance. With 76% growth in ACMR, the International markets grew faster than the more established ANZ markets. However, 56% year-on-year growth in Xero’s more mature ANZ markets represents strong growth in absolute dollars, contributing nearly two thirds of Group ACMR growth. GROSS PROFIT Gross profit represents operating revenue less cost of revenue. Cost of revenue consists of expenses directly associated with securely hosting Xero’s services, sourcing relevant customer data from banks and providing support to customers. The costs include hosting and content distribution costs, bank feed costs, personnel and related expenses (including salaries, benefits, bonuses and share-based compensation) directly associated with cloud infrastructure and customer support, contracted third-party-vendor costs, related depreciation and amortisation, and allocated overheads. Year ended 31 March 2016 ($000s) 2015 ($000s) change Operating revenue 207,060 124,020 67% Cost of revenue (49,881) (36,708) 36% Gross profit 157,179 87,312 80% Gross margin percentage 76% 70% 6% Cost of revenue for the year ended 31 March 2016 increased by $13.2 million, or 36% to $49.9 million. The primary reasons for the change were increases in hosting costs and personnel costs related to an increased headcount in Xero’s customer support teams. Operating revenue growth of 67% resulted in gross profit increasing by $69.9 million or 80%, to $157.2 million. Cost of revenue has decreased as a percentage of operating revenue compared with the previous year due to efficiencies in the hosting and customer support teams, and reductions in bank feed costs per subscriber. This drove an improved gross margin of 76% in the current period. Cost of revenue for the second half of the year was 22% of operating revenue compared to 26% in the first half of the year, demonstrating continued improvement in gross margins throughout the year. SALES AND MARKETING Sales and marketing expenses consist of personnel and related expenses (including salaries, benefits, bonuses, commissions and share-based compensation) directly associated with the sales and marketing teams, the cost of educating and onboarding both partners and small business customers, and costs in the implementation of our subscription services. Other costs included are external advertising, marketing costs and promotional events including Xerocon conferences and roadshows, as well as allocated overheads. Year ended 31 March 2016 ($000s) 2015 ($000s) change Sales and marketing 148,284 92,900 60% Percentage of operating revenue 72% 75% -3% Sales and marketing costs increased by $55.4 million or 60% to $148.3 million in the year ended 31 March 2016. The majority of sales and marketing costs are incurred in acquiring new subscribers and are expensed in the period, in contrast to the associated revenue from those subscribers that is recognised over the life of the subscriber (currently 7 years on average). As a percentage of operating revenues, sales and marketing costs decreased from 75% to 72% in the current year compared to the prior year. The second half of the year saw improvement with sales and marketing costs reducing from 76% of operating revenue in the first half of the year to 68% in the second half of the year. 14 PRODUCT DESIGN AND DEVELOPMENT Product design and development costs consist primarily of personnel and related expenses (including salaries, benefits, bonuses and share- based compensation) directly associated with our product design and development employees, as well as allocated overheads. Under New Zealand equivalents to International Financial Reporting Standards, the proportion of product design and development expenses that create a benefit in future years is capitalisable as an intangible asset and is then amortised to the Income Statement over the estimated life of the asset created. The amount amortised relating to the Xero product and platform is included as a product design and development expense. Year ended 31 March 2016 ($000s) 2015 ($000s) change Total product design and development costs (including capitalised development costs) 99,001 67,258 47% Percentage of operating revenue 48% 54% -6% Less capitalised development costs (44,948) (30,256) 49% Product design and development expense excluding amortisation of capitalised development costs 54,053 37,002 46% Less government grants (3,472) (2,946) 18% Add amortisation of capitalised development costs 19,083 11,476 66% Product design and development expense 69,664 45,532 53% Percentage of operating revenue 34% 37% -3% Total product design and development expenses were $99.0 million in the period ended 31 March 2016, $31.7 million higher than the previous year. Of this, $44.9 million was capitalised, with the balance of $54.1 million included as an expense in the Income Statement. The amortisation of capitalised product design and development expenditure of $19.1 million was also included as an expense in the Income Statement giving a total net expense (after government grants) for the year of $69.7 million. Total product design and development costs increased 47% due to increasing headcount and the associated personnel costs. Non-cash amortisation of previously capitalised development costs also increased due to comparably higher intangibles balances than in the prior year. As a proportion of operating revenue, product design and development expenses decreased to 34% in the year ended 31 March 2016 from 37% for the previous year. GENERAL AND ADMINISTRATION General and administration expenses consist of personnel and related expenses (including salaries, benefits, bonuses and share-based compensation) for our executive, finance, billing, legal, human resources and administrative employees. It also includes legal, accounting and other professional services fees, insurance premiums, other corporate expenses and allocated overheads. Year ended 31 March 2016 ($000s) 2015 ($000s) change General and administration 30,843 24,436 26% Percentage of operating revenue 15% 20% -5% General and administration costs were $30.8 million for the year ended 31 March 2016, $6.4 million or 26% higher than in the previous year. The increase is primarily due to increased personnel-related costs as a result of headcount growth to support the other business functions and higher merchant bank fees from increased subscriber numbers. General and administration costs have decreased as a proportion of operating revenue from 20% of operating revenue in the previous year to 15% in the year ended 31 March 2016. HEADCOUNT At 31 March 2016 2015 change Total group 1,454 1,161 25% Headcount increased by 293 or 25% in the year ended 31 March 2016 (taking the total headcount to 1,454) compared with a 51% increase in subscribers and 67% increase in operating revenue. The slower growth reflects the benefits of economies of scale and operating efficiencies, notwithstanding continued investment in product design and development, and the sales and marketing function. MANAGEMENT COMMENTARY 15 MANAGEMENT COMMENTARY OTHER INCOME, EXPENSES AND INTEREST Year ended 31 March 2016 ($000s) 2015 ($000s) change Foreign exchange and other income Sublease income 758 423 79% Other foreign exchange gains/(losses) 1,780 (11) NM Total foreign exchange and other income 2,538 412 NM Interest Interest income 8,177 7,713 6% Interest expense (55) (25) 120% Net interest income 8,122 7,688 6% Foreign exchange gains and losses from effective cash flow hedging relationships are now recognised in the Income Statement category being hedged (see note 2 of the financial statements for more detail). Interest income in the period ended 31 March 2016 was $8.2 million, an increase of $0.5 million or 6% on the previous year, due to higher cash and short-term deposits balances throughout the year following the $147.2 million capital raise in March 2015. This was partially offset by lower interest rates as the New Zealand official cash rate reduced over the year. CASH FLOWS Year ended 31 March 2016 ($000s) 2015 ($000s) change Net cash provided from (used in): Receipts from customers 199,737 119,566 67% Other operating cash flows (234,507) (158,189) 48% Total cash flows from operating activities (34,770) (38,623) -10% Investing activities (53,820) (49,758) 8% Total operating and investing cash flows (88,590) (88,381) 0% Currency revaluation 2,507 207 NM Subtotal (86,083) (88,174) -2% Receipts from customers increased 67% or $80.2 million to $199.7 million in line with operating revenue growth. Other net operating cash outflows increased 48% or $76.3 million, to an outflow of $234.5 million in line with increases in operating expenses. Net cash outflows from investing activities increased by $4.1 million or 8%, as a result of continued investment in product development as well as investment in a number of internal systems to drive efficiency and scalability. Operating and investing cash outflows remained relatively flat compared to the previous year, despite the deterioration of the NZD adversely impacting the current cash flows by $6.8 million compared with the previous period. After revaluation of foreign currency bank accounts, operating and investing cash flows for the year ended 31 March 2016 was an outflow of $86.1 million, or $2.1 million (2%) less than the previous year, due to receipts from customers growing faster than expenses and the benefits from the revaluation of foreign currency bank accounts. 16 SEGMENT INFORMATION ANZ ($000s) International ($000s) Total ($000s) Year ended 31 March 2016 Operating revenue 143,394 63,666 207,060 Expenses (93,982) (104,183) (198,165) Other income – 758 758 Segment contribution 49,412 (39,759) 9,653 Year ended 31 March 2015 Operating revenue 91,329 32,591 123,920 Expenses (68,328) (61,280) (129,608) Other income – 423 423 Segment contribution 23,001 (28,266) (5,265) Operating revenue is allocated to a segment depending on where the subscriber resides. Expenses include cost of revenue, sales and marketing costs incurred directly in-region, and an allocation of centrally-managed costs and overheads, such as hosting and customer support costs. ANZ – Operating revenue for the year ended 31 March 2016 grew by 57% compared to the previous period as subscribers increased by 46%. This, along with cost efficiencies, resulted in the contribution improving as a percentage of operating revenue from 25% to 34% for the year ended 31 March 2016. The improvement was largely due to the performance in Australia, which added 109,000 subscribers in the year to finish with 312,000 paying subscribers, and revenue growth for the year of 65% to $96.7 million. International – Operating revenue grew by 95% based on subscriber growth of 63% and a weaker NZD. Although the contribution margin improved, it reflects the investment to accelerate growth in both the United Kingdom as Xero builds brand recognition and in North America given the stage of Xero’s entry into this market. KEY SAAS METRICS ARPU is calculated as annualised committed monthly revenue (ACMR) at 31 March divided by subscribers at that time (and divided by 12 to get a monthly view). CAC months or months of ARPU to recover CAC (cost of acquiring subscribers) represent the number of months of revenue required to recover the cost of acquiring each new subscriber. The calculation is sales and marketing costs for the year less conference revenue (such as Xerocon) divided by new subscribers added (gross) during the same period, divided by monthly ARPU. CMR churn is the value of committed monthly revenue (CMR) from subscribers who leave Xero in a month as a percentage of the total CMR at the start of that month. The percentage provided is the average of the monthly churn for the year. The calculation for calculating churn has been changed from subscriber churn reported previously to CMR churn, as management believes this better reflects the impact of churn on the customer base. Lifetime value (LTV) is the gross margin expected from a subscriber over the lifetime of that subscriber. This is calculated by taking the average subscriber lifetime (1 divided by CMR churn) multiplied by ARPU multiplied by the gross margin percentage. Group LTV is calculated as the sum of the individual segments LTV multiplied by segment subscribers, divided by total Group subscribers. MANAGEMENT COMMENTARY 17 MANAGEMENT COMMENTARY Lifetime value/CAC is the ratio between the lifetime value (described above) and the cost to acquire that subscriber, e.g. the gross margin derived from a subscriber in ANZ is currently on average 9.1 times the cost of acquiring that subscriber. The table below outlines key metrics across Xero’s segments: 31 March 2016 ANZ International Total ARPU ($) 29.8 30.5 30.0 CAC months 9.1 23.5 14.5 CMR churn 0.9% 1.8% 1.2% Lifetime value per subscriber ($) 2,454 1,305 2,103 Lifetime value/CAC 9.1 1.8 4.8 31 March 2015 ARPU ($) 27.8 28.3 28.0 CAC months 8.7 22.9 13.5 CMR churn 1.0% 2.0% 1.2% Lifetime value per subscriber ($) 2,001 1,051 1,733 Lifetime value/CAC 8.3 1.6 4.6 ANZ – ARPU increased by 7% due to a higher portion of new and existing subscribers in New Zealand adding higher ARPU products, and due to the weakened NZD against the Australian dollar. This along with an improved gross margin led to a higher LTV. International – ARPU increased by 8% due to a shift to higher ARPU products in the United Kingdom and due to the weakened NZD against the United States dollar and British pound. The increase in ARPU and improvement in churn led to a higher LTV in the current year. 18 REPORT ON THE FINANCIAL STATEMENTS We have audited the group financial statements of Xero Limited and its subsidiaries (“the Group”) on pages 19 to 42, which comprise the statement of financial position of the Group as at 31 March 2016, and the statement of comprehensive income, income statement, statement of changes in equity and statement of cash flows for the year then ended of the Group, and a summary of significant accounting policies and other explanatory information. This report is made solely to the company’s shareholders, as a body. Our audit has been undertaken so that we might state to the company’s shareholders those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s shareholders as a body, for our audit work, for this report, or for the opinions we have formed. DIRECTORS’ RESPONSIBILITY FOR THE FINANCIAL STATEMENTS The directors are responsible on behalf of the company for the preparation and fair presentation of the financial statements in accordance with New Zealand Equivalents to International Financial Reporting Standards and International Financial Reporting Standards, and for such internal control as the directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. AUDITOR’S RESPONSIBILITY Our responsibility is to express an opinion on the financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing (New Zealand). These auditing standards require that we comply with relevant ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on our judgement, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, we have considered the internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates, as well as evaluating the overall presentation of the financial statements. We believe we have obtained sufficient and appropriate audit evidence to provide a basis for our audit opinion. Other than in our capacity as auditor and providing remuneration market benchmark data and tax compliance services we have no relationship with, or interest in, the Group. Ernst & Young, its Partners and employees may deal with the Group on normal terms within the ordinary course of trading activities of the business of the Group. OPINION In our opinion, the financial statements on pages 19 to 42 present fairly, in all material respects, the financial position of the Group as at 31 March 2016 and the financial performance and cash flows of the Group for the year then ended in accordance with New Zealand Equivalents to International Financial Reporting Standards and International Financial Reporting Standards. ERNST & YOUNG 12 May 2016 Wellington Independent Auditor’s Report to the Shareholders of Xero Limited 19 Financial Statements Income statement Year ended 31 March Notes 2016 ($000s) 2015 ($000s) Subscription revenue 201,986 121,098 Other operating revenue 5,074 2,922 Total operating revenue 4 207,060 124,020 Cost of revenue 6 49,881 36,708 Gross profit 157,179 87,312 Operating expenses Sales and marketing 148,284 92,900 Product design and development 69,664 45,532 General and administration 30,843 24,436 Total operating expenses 6 248,791 162,868 Foreign exchange gains/(losses) 1,780 (11) Other income 758 423 Operating deficit (89,074) (75,144) Net interest income 5 8,122 7,688 Net loss before tax (80,952) (67,456) Income tax expense 7 (1,512) (2,078) Net loss (82,464) (69,534) Earnings per share Basic and diluted loss per share 8 ($0.60) ($0.55) Statement of comprehensive income Year ended 31 March Note 2016 ($000s) 2015 ($000s) Net loss (82,464) (69,534) Other comprehensive income* Movement in cash flow hedges (net of tax) 18 (5,800) 2,175 Translation of international subsidiaries 2,079 (646) Total other comprehensive income/(loss) for the year (3,721) 1,529 Total comprehensive loss for the year (86,185) (68,005) * Items of other comprehensive income may be reclassified to the Income Statement The accompanying notes form an integral part of these financial statements 20 Statement of changes in equity Notes Share capital ($000s) Treasury shares ($000s) Share- based payment reserve ($000s) Accumulated losses ($000s) Foreign currency translation reserve ($000s) Cash flow hedge reserve ($000s) Total equity ($000s) Balance at 1 April 2015 504,570 (12,565) 7,705 (155,474) (758) 2,175 345,653 Net loss – – – (82,464) – – (82,464) Other comprehensive loss – – – – 2,079 (5,800) (3,721) Total comprehensive loss – – – (82,464) 2,079 (5,800) (86,185) Transactions with owners: Share-based payments – employee restricted share plan 20 9,443 (254) 620 – – – 9,809 Share-based payments – restricted stock units 20 1,242 – 5,434 – – – 6,676 Share-based director fees and options 20 70 – 844 – – – 914 Share-based payments – employee share options 20 – – 548 – – – 548 Exercising of director share options 14 209 – (43) – – – 166 Exercising of employee share options 14 631 – (96) – – – 535 Share-based payments – employee schemes arising on acquisition – – 973 – – – 973 Balance at 31 March 2016 516,165 (12,819) 15,985 (237,938) 1,321 (3,625) 279,089 Balance at 1 April 2014 341,436 (5,128) 4,682 (85,940) (112) – 254,938 Net loss – – – (69,534) – – (69,534) Other comprehensive income – – – – (646) 2,175 1,529 Total comprehensive loss – – – (69,534) (646) 2,175 (68,005) Transactions with owners: Issue of shares (net of issue costs) 144,275 – – – – – 144,275 Share-based payments – employee restricted share plan 20 13,033 (7,208) 1,650 – – – 7,475 Share-based payments – restricted stock units 20 885 – 652 – – – 1,537 Share-based director fees and options 20 35 – 1,346 – – – 1,381 Share-based payments – employee share options 20 – – 475 – – – 475 Exercising of director share options 14 443 – (112) – – – 331 Exercising of employee share options 14 476 – (99) – – – 377 Issue of shares – purchase of Monchilla, Inc. 3,987 (1,993) – – – – 1,994 Share-based payments – employee schemes arising on acquisition – 1,764 (889) – – – 875 Balance at 31 March 2015 504,570 (12,565) 7,705 (155,474) (758) 2,175 345,653 The accompanying notes form an integral part of these financial statements FINANCIAL STATEMENTS 21 FINANCIAL STATEMENTS Statement of financial position At 31 March Notes 2016 ($000s) 2015 ($000s) Assets Current assets Cash and cash equivalents 39,024 58,866 Short-term deposits 145,000 210,000 Trade and other receivables 9 27,098 21,499 Short-term derivative assets 18 358 3,151 Total current assets 211,480 293,516 Non-current assets Property, plant and equipment 10 15,462 16,631 Intangible assets 11 97,779 65,112 Deferred tax asset 7 1,376 1,427 Other receivables 2,004 1,712 Total non-current assets 116,621 84,882 Total assets 328,101 378,398 Liabilities Current liabilities Trade and other payables 12 21,634 13,937 Employee entitlements 20,783 14,040 Income tax payable 7 311 2,218 Short-term provisions 13 63 26 Short-term derivative liabilities 18 3,983 130 Total current liabilities 46,774 30,351 Non-current liabilities Deferred tax liability 7 755 1,453 Long-term provisions 13 972 828 Other long-term liabilities 511 113 Total non-current liabilities 2,238 2,394 Total liabilities 49,012 32,745 Equity Share capital 14 503,346 492,005 Share-based payment reserve 20 15,985 7,705 Accumulated losses (237,938) (155,474) Foreign currency translation reserve 1,321 (758) Cash flow hedge reserve 18 (3,625) 2,175 Total equity 279,089 345,653 Total liabilities and shareholders’ equity 328,101 378,398 The accompanying notes form an integral part of these financial statements 22 Statement of cash flows Year ended 31 March Note 2016 ($000s) 2015 ($000s) Operating activities Receipts from customers 199,737 119,566 Other income 4,144 2,580 Interest received 9,852 7,950 Payments to suppliers and employees (245,288) (166,724) Income tax paid (3,215) (1,995) Net cash flows from operating activities 15 (34,770) (38,623) Investing activities Purchase of property, plant and equipment (4,749) (10,315) Capitalised development costs (47,749) (32,994) Business acquisitions - (5,349) Other intangible assets (1,192) (174) Rental bonds (130) (926) Net cash flows from investing activities (53,820) (49,758) Financing activities Exercising of share options 701 709 Share issue – 147,200 Repayment of management loan 540 2,090 Cost of share issue – (2,845) Payments for short-term deposits (145,000) (418,000) Proceeds from short-term deposits 210,000 403,000 Net cash flows from financing activities 66,241 132,154 Net increase/(decrease) in cash and cash equivalents (22,349) 43,773 Foreign currency translation adjustment 2,507 207 Cash and cash equivalents at the beginning of the year 58,866 14,886 Cash and cash equivalents at the end of the year 39,024 58,866 The accompanying notes form an integral part of these financial statements FINANCIAL STATEMENTS 23 1. REPORTING ENTITY AND STATUTORY BASE Xero Limited is a company registered under the Companies Act 1993 and is listed on the New Zealand Stock Exchange (NZX) and the Australian Securities Exchange (ASX). The Company is an FMC reporting entity under Part 7 of the Financial Markets Conduct Act 2013. The financial statements of the Group have been prepared in accordance with the requirements of Part 7 of the Financial Markets Conduct Act 2013 and the NZX Main Board Listing Rules. In accordance with the Financial Markets Conduct Act 2013, because Group financial statements are prepared and presented for Xero Limited and its subsidiaries, separate financial statements for Xero Limited are not required and therefore have not been presented. The consolidated financial statements of the Group for the year ended 31 March 2016 were authorised for issue in accordance with a resolution of the Directors on 12 May 2016. The Group’s principal activity is the provision of a platform for online accounting and business services to small businesses and their advisors. 2. BASIS OF ACCOUNTING (a) Basis of preparation The consolidated financial statements of the Group have been prepared in accordance with Generally Accepted Accounting Practice in New Zealand (NZ GAAP). The Group is a for-profit entity for the purposes of complying with NZ GAAP. The consolidated financial statements comply with New Zealand equivalents to International Financial Reporting Standards (NZ IFRS), other New Zealand accounting standards and relevant authoritative notices that are applicable to entities that apply NZ IFRS. The consolidated financial statements also comply with International Financial Reporting Standards. Other than where described below or in the notes, the consolidated financial statements have been prepared using the historical cost convention. The consolidated financial statements are presented in New Zealand dollars ($) (NZD) (the ‘presentation currency’). Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). (b) Changes in accounting policies and disclosures Apart from the changes noted below, the accounting policies adopted are consistent with those of the previous year. During the year, the Group’s operating segments were redefined based on the way in which the Global Executive Team reviews performance. The change results in two reportable segments, namely Australia and New Zealand (ANZ) and International. Grant income previously recorded in other income is now recognised contra product design and development expenses in order to more appropriately reflect the nature of the grant income. Comparative amounts in the consolidated Income Statement were reclassified for consistency, which resulted in $2.9 million being reclassified from other income to product design and development expenses for the year ended 31 March 2015. Hedging gains and losses previously recorded as part of other income is now allocated and recognised within the operating revenue or expense line item to which the underlying hedged item relates. Comparative amounts in the consolidated Income Statement were reclassified for consistency, which resulted in an increase to subscription revenue of $170,000, and decreases to cost of revenue, sales and marketing, product design and development, and general and administration expense categories of $695,000, $578,000, $481,000 and $112,000 respectively. Certain other comparative information has also been reclassified to conform with the current period’s presentation. (c) Standards or interpretations issued but not yet effective and relevant to the Group The International Accounting Standards Board has issued a number of standards, amendments and interpretations which are not yet effective and which may have an impact on the Group’s financial statements. These are detailed below. The Group has not applied these in preparing these financial statements and will apply each standard in the period in which it becomes mandatory: – (a) NZ IFRS 9 – Financial Instruments – Classification and Measurement This standard addresses the classification, measurement and de-recognition of financial assets, financial liabilities, impairment of financial assets and hedge accounting, and will be effective for the year ended 31 March 2019. – (b) NZ IFRS 15 – Revenue from Contracts with Customers This standard establishes the framework for revenue recognition, and will be effective for the year ended 31 March 2019. – (c) NZ IFRS 16 – Leases This standard requires a lessee to recognise a lease liability reflecting the future lease payments and a ‘right-of-use asset’ for substantively all lease contracts, and will be effective for the year ended 31 March 2020. The Group has not yet assessed the potential impact of the above standards. (d) Critical accounting estimates In applying the Group’s accounting policies, management continually evaluates judgements, estimates and assumptions based on experience and other factors, including expectations of future events that may have an impact on the Group. All judgements, estimates and assumptions made are believed to be reasonable based on the most current set of circumstances available to the Group. Actual results may differ from the judgements, estimates and assumptions. The significant judgements, estimates and assumptions made by management in the preparation of these financial statements are outlined below. Deferred tax assets The Group recognises a deferred tax asset in relation to tax losses, only to the extent of the Group’s deferred tax liabilities. The Group has not recognised a deferred tax asset in respect of additional losses or other temporary differences given the uncertainty of the timing of profitability and the requirement for ownership continuity. Deferred tax assets and deferred tax liabilities are recognised in the subsidiaries in respect of temporary differences; assets are only recognised to the extent that it is probable the assets will be utilised. NOTES TO THE FINANCIAL STATEMENTS Notes to the financial statements 24 Capitalised development costs The Group capitalises a proportion of employee costs related to software development. The Group regularly reviews the carrying value of capitalised development costs to ensure they are not impaired. The development costs are amortised over three to five years, the expected useful life of the assets, with limited exceptions to this for assets specifically identified as having shorter useful lives. At 31 March 2016, if capitalisation rates had been 10% higher/lower with all other variables held constant, the impact on operational expenses would have been $9.9 million lower/higher. 3. SEGMENT INFORMATION The Group operates in one business segment, providing online solutions for small businesses and their advisors. Xero has two operating segments. These segments have been determined based on reports reviewed by the Global Executive Team (the chief operating decision-maker). Segment operating expenses represent sales and marketing costs and service delivery costs, including both in-country costs and an allocation of centrally managed costs. Segment contribution ANZ ($000s) International ($000s) Total ($000s) Year ended 31 March 2016 Operating revenue 143,394 63,666 207,060 Expenses (93,982) (104,183) (198,165) Other income – 758 758 Segment contribution 49,412 (39,759) 9,653 Year ended 31 March 2015 Operating revenue 91,329 32,591 123,920 Expenses (68,328) (61,280) (129,608) Other income – 423 423 Segment contribution 23,001 (28,266) (5,265) Reconciliation from segment result to consolidated operating revenue Year ended 31 March 2016 2016 ($000s) 2015 ($000s) Segment revenue 207,060 123,920 Corporate revenue – 100 Total operating revenue 207,060 124,020 Reconciliation from segment result to consolidated net loss before income tax Year ended 31 March 2016 2016 ($000s) 2015 ($000s) Segment contribution 9,653 (5,265) Corporate revenue – 100 Product design and development (69,664) (45,532) General and administration (30,843) (24,436) Foreign exchange gains/(losses) 1,780 (11) Net interest income 8,122 7,688 Net loss before tax (80,952) (67,456) NOTES TO THE FINANCIAL STATEMENTS 25 NOTES TO THE FINANCIAL STATEMENTS At 31 March 2016 $104.0 million, or 92%, of the Group’s property, plant and equipment and intangible assets were domiciled in New Zealand (2015: $71.7 million). Depreciation and amortisation by segment Year ended 31 March 2016 ($000s) 2015 ($000s) ANZ 1,984 1,667 International 3,263 1,136 Corporate (not allocated to a segment) 23,896 15,187 Total 29,143 17,990 Employee entitlements: share-based payments by segment Year ended 31 March 2016 ($000s) 2015 ($000s) ANZ 3,666 2,404 International 4,380 1,538 Corporate (not allocated to a segment) 6,691 5,230 Total 14,737 9,172 4. REVENUE Subscription revenue Subscription revenue comprises the recurring monthly fees from subscribers to Xero’s online accounting software services. Subscribers are invoiced monthly in arrears, with no set contractual term. Revenue is recognised as the services are provided to the subscribers. Unbilled revenue at year end is recognised in the Statement of Financial Position as accrued income and included within trade and other receivables. Other operating revenue Other operating revenue comprises revenue from related services such as education and implementation of the online accounting software services, along with conference income. Revenue is recognised as the services are provided to customers. Revenue by geographic region Year ended 31 March 2016 ($000s) 2015 ($000s) Australia 96,686 58,456 New Zealand 46,708 32,873 United Kingdom 37,437 19,948 North America 16,850 7,794 Rest of World 9,379 4,849 Corporate – 100 Total 207,060 124,020 5. NET INTEREST INCOME Interest income is recognised as it is accrued using the effective interest method. The effective interest method calculates the amortised cost of the financial asset and allocates the interest income over its expected life. Year ended 31 March 2016 ($000s) 2015 ($000s) Interest income – cash and short-term deposits 8,172 7,616 Interest income – loans to key management personnel 5 97 Interest expense (55) (25) Total net interest income 8,122 7,688 26 6. EXPENSES Sales tax The Income Statement and the Statement of Cash Flows have been prepared so that all components are stated exclusive of sales tax, except where sales tax is not recoverable. All items in the Statement of Financial Position are stated net of sales tax with the exception of receivables and payables, which include the sales tax invoiced. Sales tax includes Goods and Services Tax, and Value Added Tax, where applicable. Overhead allocation The presentation of the Income Statement by function requires certain overhead costs to be allocated to functions. These allocations require management to apply judgement. Facilities, internal information technology costs, and depreciation and amortisation not relating to product software development have been allocated to each function on a headcount basis. Recruitment costs have been allocated according to the number of employees hired in each function during the period. The amortisation of product-related software development is included in product design and development. Year ended 31 March 2016 ($000s) 2015 ($000s) Cost of revenue and operating expenses Employee entitlements 159,210 106,153 Employee entitlements – share-based payments 18,563 15,263 Employee entitlements capitalised (42,690) (28,504) IT infrastructure costs 18,277 10,909 Advertising and marketing 53,781 29,683 Consulting and subcontracting 13,082 7,138 Rental costs 9,909 7,425 Travel-related costs 6,453 5,609 Communication and office administration 4,123 3,589 Staff recruitment 2,064 2,565 Superannuation costs 5,085 3,803 Computer equipment and software 4,547 2,970 Directors' fees 796 515 Auditors remuneration 460 627 Other operating expenses 15,869 13,841 Total cost of revenue and operating expenses excl. depreciation and amortisation* 269,529 181,586 * Includes grant income of $3.5 million (2015: $2.9 million) Depreciation and amortisation Relating to: Amortisation of development costs 22,019 12,947 Amortisation of other intangible assets 698 346 Depreciation of property, plant and equipment 6,426 4,697 Total depreciation and amortisation 29,143 17,990 Total cost of revenue and operating expenses 298,672 199,576 Depreciation and amortisation included in function expenses as follows: Cost of revenue 2,348 1,279 Sales and marketing 2,898 1,982 Product design and development 23,145 14,284 General and administration 752 445 Total depreciation and amortisation 29,143 17,990 NOTES TO THE FINANCIAL STATEMENTS 27 NOTES TO THE FINANCIAL STATEMENTS Year ended 31 March 2016 ($000s) 2015 ($000s) Audit and review of financial statements – EY 205 – Taxation services – EY 42 – Other services* – EY 15 – Audit and review of financial statements – PwC – 205 Other assurance services** – PwC 198 354 Taxation services – PwC – 27 Other services*** – PwC – 41 Total fees paid to auditors 460 627 * Services relate to provision of remuneration market data ** Services relate to assurance services in relation to the preparation of US GAAP-compliant financial statements, audit of the Company’s share register and compliance engagement in respect of a grant application *** Services relating to global mobility, and other services in respect of IT change management and disaster recovery advice 7. CURRENT AND DEFERRED INCOME TAX Tax expense comprises current and deferred tax. Income tax is recognised in the Income Statement except when it relates to items recognised directly in other comprehensive income, (in which case the income tax is recognised in other comprehensive income). Income tax is based on tax rates and regulations enacted, or substantially enacted, in the jurisdictions in which the entity operates. Deferred tax is recognised in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The amount of deferred tax is based on the expected manner of realisation of the carrying amount of assets and liabilities, using tax rates enacted or substantially enacted at the end of the reporting period. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Current income tax The tax on the Group’s loss before tax differs from the theoretical amount that would arise using the weighted average tax rate applicable to the profits or loss of the consolidated entities as follows: Year ended 31 March 2016 ($000s) 2015 ($000s) Accounting loss before income tax (80,952) (67,456) At the statutory income tax rate of 28% (22,667) (18,888) Non-deductible expenditure 1,317 723 Prior period adjustment (490) 467 Impact of R&D credit claims made in current year (510) – Tax rate variance of subsidiaries 166 416 Total tax losses not recognised 23,696 19,360 Income tax expense 1,512 2,078 Comprising: Income tax payable 2,788 3,589 Prior period adjustment (490) 467 Impact of R&D credit claims made in current year (510) – Deferred tax (1,228) (1,132) Tax losses utilised 846 (846) Effect of changes in foreign currency 106 – Income tax expense 1,512 2,078 Auditor’s remuneration 28 Income tax payable At 31 March 2016 ($000s) 2015 ($000s) Opening balance 2,218 732 Prior period adjustment (1,165) (209) Impact of R&D credit claims processed in current year (510) – Income tax liability for the year 2,788 3,589 Income tax paid (3,215) (1,995) Effects of changes in foreign currency 195 101 Current tax payable 311 2,218 Deferred income tax The analysis of deferred tax assets and deferred tax liabilities is as follows: Derivatives ($000s) Provisions & employee benefits ($000s) Tax depreciation ($000s) Tax losses ($000s) Total ($000s) Year ended 31 March 2016 Deferred tax asset balances: At 1 April 2015 – 1,247 180 – 1,427 Prior period adjustment – (882) (191) – (1,073) Charged to Income Statement – 1,231 (302) – 929 Foreign currency adjustment – 93 – – 93 At 31 March 2016 – 1,689 (313) – 1,376 Deferred tax liability balances: At 1 April 2015 (846) 1,691 (4,650) 2,352 (1,453) Prior period adjustment – 99 77 223 399 Charged to Income Statement – 438 (2,419) 2,280 299 Charged to other comprehensive income 1,861 – – (1,015) 846 Tax losses utilised – – – (846) (846) At 31 March 2016 1,015 2,228 (6,992) 2,994 (755) Year ended 31 March 2015 Deferred tax asset balances: At 1 April 2014 – 1,089 (1,497) 894 486 Prior period adjustment – (301) (98) (217) (616) Charged to Income Statement – 460 1,774 (677) 1,557 Foreign currency adjustment – (1) 1 – – At 31 March 2015 ��� 1,247 180 – 1,427 Deferred tax liability balances: At 1 April 2014 – – – – – Charged to Income Statement – 1,514 (3,445) 1,506 (425) Charged to other comprehensive income (846) – – – (846) Tax losses utilised – – – 846 846 Acquisition of Monchilla. Inc – – (1,056) – (1,056) Foreign currency adjustment – 177 (149) – 28 At 31 March 2015 (846) 1,691 (4,650) 2,352 (1,453) NOTES TO THE FINANCIAL STATEMENTS 29 NOTES TO THE FINANCIAL STATEMENTS The Group’s deferred tax asset and deferred tax liability are expected to be recovered by $0.3 million and $0.3 million respectively within the next 12 months. Deferred tax assets and liabilities have been offset where the balances are due to/receivable from the same counterparties. Deferred income tax assets are recognised for carried forward tax losses to the extent of the Company’s deferred tax liabilities. The Company has unrecognised New Zealand tax losses available to carry forward of $241,082,000 (2015: $144,945,000) subject to sha</p>
