Intuit Inc (INTU) — Q2 2015 Earnings Call Transcript

Thank you, sir. Good afternoon and welcome to Intuit’s second quarter fiscal 2015 conference call. I am here with Brad Smith, our President and CEO; and Neil Williams, our CFO. Before we start, I’d like to remind everyone that our remarks will include forward-looking statements. There are a number of factors that could cause Intuit’s results to differ materially from our expectations. You can learn more about these risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2014 and our other SEC filings. All of those documents are available on the Investor Relations page of Intuit’s website at intuit.com. We assume no obligation to update any forward-looking statement. Some of the numbers in this report are presented on a non-GAAP basis. We have reconciled the comparable GAAP and non-GAAP numbers in today’s press release. Unless otherwise noted, all growth rates refer to the current period versus the comparable prior year period and the business metrics and associated growth rates refer to worldwide business metrics. A copy of our prepared remarks and supplemental financial information will be available on our website after this call ends. And with that, I’ll turn the call over to Brad Smith.

All right, thank you, Matt, and thanks to all of you for joining us. It has been an eventful few weeks at Intuit and I suspect you have lots of questions. Before we get to your questions, I would like to provide as much context around the recent events as possible while keeping the bigger picture in mind. The bigger picture is straightforward. Our financial results are strong through the first half of fiscal 2015 and we are reiterating our guidance for the full fiscal year. Furthermore, our small business momentum has taken a step rate change in a positive direction. The growth in our QuickBooks Online subscribers continues to accelerate at a very healthy rate. With that said, I know tax is on everybody’s mind, given the time of year and the recent press coverage. So let me start there first. At the highest level, our tax strategy is on track. We are in the second year of a multi-year journey to achieve our product vision of taxes are done. This year’s TurboTax significantly expanded its data import capability. Nearly 75% of customers can now digitally import W2s directly into the product; that is up from less than 30% last year. This is a huge step towards our vision of taxes being done, making tax preparation easier and more accurate, which has led to several points of improvement and conversion for customers who choose to import their data. The TurboTax experience now uses more advanced data-driven insights to tailor the interview to your unique situation. We refer to this as the responsive experience, which is saving significant time and reducing questions for the average taxpayer’s preparation experience. In addition, TurboTax users can now seamlessly move across platforms, working online, on tablets or on smartphones with the ability to start, stop and continue their taxes on the device of their choice. For the first time ever, Americans with more straightforward tax needs were able to file both their Federal 1040A or 1040EZ returns as well as their state returns for free. This was a powerful offer for 60 million Americans, many of whom live paycheck-to-paycheck and count on their tax refund being the biggest paycheck that they will receive in the year. The collective impact of these innovations is showing up in the customer experience. So far this season, our ability to convert those who visit the TurboTax.com website to those who file a return is up a couple hundred basis points. This improvement is on top of a significant advance in conversion that we drove last year as well. Our net promoter scores for TurboTax Online are also up by about a half dozen points, which is encouraging. This improved product experience is helping reduce customer care calls, which were down roughly 20% year-over-year. Regarding the Affordable Care Act, we worked hard to ensure that all taxpayers could easily and accurately meet the new ACA requirements with TurboTax. Unlike some other tax services, TurboTax includes all the necessary healthcare forms at no extra cost. We don’t see any evidence that ACA is driving TurboTax customers to other tax preparation solutions. In fact, the ACA section of our product has been one of our highest converting tax topics this year, which gives us confidence that our ACA implementation is meeting our customers’ needs. Translating the sum total of these initiatives, total TurboTax units grew 11% through February 14 versus the comparable prior year period. TurboTax Online units are up 19%, while TurboTax Desktop units are down 7%, which brings me to the recent events of the past few weeks, which have not been our best in terms of customer confidence. There were no excuses when you make a mistake and we own our mistakes and have taken steps to make things right. At the same time, we’ve been at the forefront of the ongoing battle to fight fraud in the U.S. tax system, navigating a lot of misinformation along the way. Let me share some important context around both of these events. First, let me address the change to the TurboTax Desktop product lineup, which we subsequently reversed. We didn’t live up to our customer expectations and our net promoter scores are down for the TurboTax Desktop product as a result. So why did we make the change in the first place and what have we learned from the experience? I don’t need to tell anyone on this call that we are in the midst of a massive platform shift to the cloud, and every established technology company is dealing with the balance of serving customers on legacy products while advancing their efforts and serving new customers on the next-generation platform. It’s no longer a desktop software world. Our computers no longer come equipped with optical drives and shelf space allocated to software is down 50% in retail stores over the last five years. But a subset of customers simply does not want to move to the cloud. Many of these are long-term loyal customers who have used the same product for 20 years, which is why we've always been steadfast in our position that we won’t push a software delivery model on a customer. With that context, what happened? Well, last year, we had moved to a complexity baseline in our TurboTax Online portfolio, steering customers to the best offering for their particular tax situation. This included moving Schedule C, D, E, and F from the Deluxe to our Premier and our Home and Business solution. These are the schedules that enable the filing or reporting of items such as investment gains and losses and small business expenses. Our goal was simplification so customers were clear about which product was right for their particular tax needs. For over 20 million online customers last year, the implementation went smoothly. So this year, we thought to complete the alignment by making similar changes to our desktop offerings. Our goal was to streamline product development and bring any new innovations from our online product back to our desktop customers as well. For those who might eventually choose to migrate to the cloud, they would enjoy a consistent and familiar product experience. Good intentions but misinformed. These loyal long-term desktop customers simply didn’t want a different product experience. They certainly didn’t want to have to upgrade and pay a higher price for the functionality that they have always had in the Deluxe. In addition, we didn’t make the communication clear enough and we didn’t make the transition easy. For the 3% of TurboTax customers who were affected, it was simply unacceptable and they were right. So here's what we’ve done. Following a very public and heartfelt apology, we announced that next year, we will offer the TurboTax Deluxe Desktop software that our customers know and love, restoring all the forms that they've counted on for years. Returning Deluxe desktop customers who need to upgrade this tax season are now able to do so seamlessly within the product for free. More importantly, what lessons did we learn? First, know the customer. We're a customer-centric company, and we didn't effectively apply our own expertise in this situation. Second, ease of transition; if you're going to make product changes, make sure you have early dialogue with the customers and make the transition slowly. Finally, act quickly and decisively. When you hear noise, assume smoke means fire and jump on the situation fast. This brings me to the more recent news surrounding concerns of increasing fraudulent activity in the U.S. tax system, particularly at the state level. As we have shared on many occasions, the privacy and security of our customers’ data is our top priority. We've been working for years to apply the most advanced technologies and techniques to ensure the safety and privacy of our customers’ information, and we have been doing this in conjunction with the overall industry and with government as well. I was just in Washington three weeks ago, giving a keynote to more than 100 policy leaders on this very topic. Recently, Intuit and some states saw an increase in suspicious filings. As a result, several states communicated their intention to stop accepting TurboTax e-file. So we took the precautionary step on Thursday, February 5th, to temporarily pause the transmission of e-file state tax returns for all states. After our preliminary examination of the recent activities, with the help of a third security expert, we believe, and continue to believe, these instances of fraud did not result from a security breach of our systems. The information being used to file fraudulent returns was obtained from other sources outside the tax preparation industry. We implemented targeted security measures to combat the type of fraudulent tax activity that we were seeing. These additional steps included the implementation of more advanced multi-factor authentication, which is a proven technology for protection against identity theft. With these measures in place, we resumed e-filing with the states the next day, once we felt comfortable that our customers’ privacy and security were not at increased risk. We're continuing to work with the states as they build their own anti-fraud capabilities and we will continue to share best practices as we work towards the common best interest of the taxpayer. To summarize, the underlying health of the business and the product innovations that we're delivering are having a meaningful impact on the customer experience and on our results thus far. With that said, we suffered a self-inflicted wound on the desktop lineup situation, and we are leading the battle against an industry-wide threat of cyber fraud targeting the U.S. tax system. And all of this happened within the first few weeks of a tax season that lasts 100 days. But there is plenty of time left on the clock. If you look at IRS data through February 6th, you’ll see that self-prepared e-file growth was up 70%, contrasted with assisted e-files down 4%. This leads us to believe that the do-it-yourself software category continues to gain share. TurboTax e-file growth and other third-party data also indicate that we’re gaining a couple of points of share thus far this season. We're keeping the bigger picture in mind and we're going to emerge from both of these recent situations wiser and even more focused. This leads me to the pro-tax side of the business, where we’re seeing positive early trends and customer acquisition. In addition, we’re delivering more innovation in pro-tax than I have ever seen in my time at Intuit. We provided tools and training for our pro-customers to manage the ACA situation and to help their clients achieve the best possible outcomes. We’ve refreshed TurboTax Personal Pro, which we used to call CPA Select, and we expect the new interface and the accountant engagement tools to drive growth. We’ve launched Intuit Link, a data and document collaboration tool for accountants that saves time and simplifies the accountant-client communication, and we’ve enabled eSignature capabilities that help accountants streamline their work and securely transmit signatures on important forms. I realize that I don’t need to remind anyone that it’s early in the season for both of our tax businesses, but I will. We’re staying agile and I am very pleased with our products and our pace of innovation. We’re focused on improved execution and delivering for our customers and shareholders for the remaining season. Now, let’s talk small business. The QuickBooks Online ecosystem continues to build strong momentum. We grew total QuickBooks Online subscribers by 50% in the second quarter, up from 43% growth last quarter. We added 100,000 QBO subscribers quarter-over-quarter and now have 841,000 paying subscribers worldwide. Outside the U.S., QuickBooks Online subscribers were up more than 170% to a total of 127,000, in line with last quarter’s rapid growth. Our QuickBooks Online customers continue to adopt payroll and payment solutions at a healthy pace. In the U.S., our new customer online payroll attachment rate was 21%. This is a step down from roughly 30% last quarter, but it’s due to a change from an opt-out payroll signup to an opt-in. We expect our attachment rate to be in the low 20s over the next few quarters but anticipate improvements in retention as a result of this change. Our online payments attachment rate was 8%, which is up from 7% a year ago. To fuel our international growth, we made two acquisitions in the past quarter that will add key features and functionality to the QBO ecosystem and targeted geographies. In the UK, we acquired Acrede, a provider of payroll solutions with global compliance and data security. Their easy-to-use cloud technology can be customized to deliver payroll across multiple geographies. We also acquired ZeroPaper, a developer of fast and mobile financial management tools for entrepreneurs and micro businesses in Brazil. In addition to these acquisitions, we launched QuickBooks Self-Employed, designed specifically for the rapidly expanding population of freelancers and independent contractors. As you may recall, there are roughly 12 million of these businesses in the U.S. Our QuickBooks Self-Employed solution helps the smallest of small businesses manage their finances throughout the year and provides integration with TurboTax to simplify tax reporting. These sole proprietors generally don’t see a need for all the functionality found in traditional QuickBooks Online. They simply need to keep their personal and business expenses tracked and separated for tax time. This product is gaining real momentum and I’m excited about the partnerships we recently announced with Stripe, Uber, Lyft, TaskRabbit, and others, all centered around this particular market. We’ll continue to add partners to expand our presence in this rapidly growing on-demand services marketplace. So in total, it’s been an eventful first half of the year and it has been a strong first half as well. I’m inspired by our team’s commitment to overcome obstacles, while continuing to reimagine the tax prep experience in both our consumer and our pro-tax businesses, and you’re going to see much more innovation from these teams over the next few years. On the small business side, our small business subscriber growth is accelerating and we remain focused on global customer acquisition, all powered by cloud-based services. With that overview, I’m going to turn it over to Neil to walk you through the financial details.

Thanks, Brad. First, I'll start with overall company results, which all came in higher than our guidance. For the second quarter of fiscal 2015, we delivered revenue of $808 million, up 3%, a non-GAAP operating loss of $20 million, a GAAP operating loss of $98 million, a non-GAAP loss per share of $0.06, and a GAAP loss per share of $0.23. These factors reflect our strategic decision to deliver ongoing services and releases for future desktop offerings. As a result, revenue for future desktop software licenses will be recognized as services are delivered rather than up-front. As we discussed previously, approximately $400 million in revenue will move out of fiscal 2015 into later years. The impact and quarter seasonality of this shift varies by business unit. The business with a shift that is hardest to understand from an external perspective is probably professional tax. I’ll provide some data to help with modeling of the pro-tax business in a moment. Turning to the business segments. Total small business group revenue declined 1% for the second quarter, again reflecting the impact of changes to the desktop product, resulting in ratable rather than up-front revenue recognition. QuickBooks total paying customers grew 20%. Small business online ecosystem revenue grew 26% and customer acquisition in our online ecosystem continues to drive growth. QuickBooks online subscribers grew 50%, accelerating from last quarter’s growth rate. Online payroll customers grew 23%, online active payments customers grew 3%, and online payments charge volume grew 20%, driven by an increase in charge volume per customer. Payments customers attached to QuickBooks Online grew over 90%. We’re focused on growing payments in the QBO ecosystem while de-emphasizing other services such as standalone GoPayment's customers. Rounding out the online ecosystem, Demandforce customers grew 18%. Our primary goal is converting non-consumption to capture a larger share of the 29 million small businesses in the U.S. and millions more around the world. To do this, we’re leaning into QuickBooks Self-Employed, which is part of our QuickBooks Online lineup and is included on the QuickBooks Online Subscriber line on the fact sheet. We had approximately 4,000 QuickBooks Self-Employed paying subscribers at the end of the second quarter. We’ll continue to call out the growth of this subscriber base over the next few quarters. Moving to the desktop ecosystem, QuickBooks desktop units declined 26% in the second quarter as we continue to emphasize QuickBooks Online. More than 80% of our new QuickBooks Online customers are new to QuickBooks rather than migrating from desktop. Within the consumer group, consumer tax revenue was up 54% versus the second quarter last year as we benefited from an earlier start to the tax season this year. As you may recall, last year the IRS opened e-file on January 31, pushing revenue into our third fiscal quarter. So this year, we’re returning to a more normal seasonal pattern. Our strong unit growth today benefited from our Absolute Zero Promotion, and our paid mix was also a bit better than we expected. In the back half, we face a tougher compare, but we still expect units to grow faster than revenue for the season. ProTax revenue was $11 million, down 69%. As we previously discussed, we expect a revenue shift of $150 million from fiscal 2015 to fiscal 2016 due to changes in our desktop offerings. To help with your modeling, we expect ProTax revenue of about $125 million in the third quarter of 2015 and about $100 million in the fourth quarter. We continue to take a disciplined approach to capital management, investing the cash we generate in opportunities that yield an expected return on investment greater than 15%. With approximately $1.4 billion in cash and investments on our balance sheet, our first priority is investing for customer growth. We also look for inorganic opportunities, and in the second quarter, we completed two acquisitions, bringing us to a total of four transactions so far this fiscal year, totaling approximately $90 million. We’ve also repurchased $555 million of shares in the second quarter with about $1.2 billion remaining on our share repurchase authorization. We intend to be in the market consistently during the year. Our board approved a $0.25 per share dividend for our fiscal third quarter, payable on April 20th. This represents a 32% increase versus last year and reflects our large and growing cash position along with more recurring and predictable revenue streams. Looking ahead, we have reiterated our financial guidance and raised our QuickBooks Online subscriber guidance for fiscal 2015. We also provided guidance for the third and fourth quarters and you’ll find our guidance details in the press release and on our fact sheet. As a reminder, we will provide our next tax unit update in April, soon after the tax season ends. And with that, I’ll turn it back to Brad to close.

All right, thanks Neil. I know we’ve taken some time here to cover a lot of ground, but I hope it’s been helpful context in advance of your questions. We have a lot of opportunities in front of us and at the end of the day, it all comes down to great people, and I like what I see in our company’s culture and in our employees. It is truly my privilege to serve alongside them each day. So with that, let’s open it up to you to hear what’s on your mind, Sayeed?

Good afternoon. Brad, on the tax side, you mentioned the conversion rate went up year-over-year. I’m just curious if you could give everyone a sense of what that conversion rate is today and what do you think you can do to continue to drive those conversion rates going forward?

Yes, Brent, thanks for the question. First of all, we would like to wait till the end of the season and then at Investor Day we will share with you the year-over-year comparison and conversion rates. One of the reasons we want to do that is we’re getting better every week. One of the things I mentioned in the opening remarks is the responsive experience, which is our ability to actually look at the kinds of information that we can see in your tax return and compare it to others like you to truly streamline the interview process. This enables us to get more conversion out of people who are coming in and starting to return and getting them all the way through to the end where they actually hit the send button. The other thing that we’re able to do is to look for areas where there were historical problems with entering data and then, with the electronic import capabilities that we continue to advance, we’re getting a lot of that work done for you so it reduces friction. It is a combination of those things, which we call taxes are done, and that is really improving our conversion. I will tell you the teams are truly making improvements week over week, and we will see how we finish up the season.

Great. And just real quick for Neil, given some of the renewed focus on the cyber issues that are going on in the industry, there has certainly been a lot more investments that companies have been having to make to protect themselves. I would assume given you haven’t changed the year on the bottom line that many of these increased investments around the cyber trend are included in your guidance?

Yes, Brent, clearly that is a very important issue for us, so we are providing all the funding that we need in those areas. Anything that was not included in our guidance for the full year, we expect to reallocate from other investment opportunities within the company. So we've given a lot of thought and consideration, before we reiterated guidance for the full year.

Hi, yes. Thanks for taking my question. One more on tax. I mean clearly the numbers surprised us on the upside, especially given some of the bad press that we’ve seen in the market. Can you talk about whether or not that has actually been a headwind to the business? If it has, what has more than offset that you mentioned conversion. But what are some of the other areas, or are we just assuming that the headwind from some of the bad press is just overblown? Thanks.

Well, Greg, first of all we are not Hollywood and so unlike Hollywood, all PR is not good PR. We certainly don’t like to have negative press out there about our product or have any of our customers frustrated. I think the first piece is the desktop lineup changes; we knew we made a mistake when we started hearing the feedback from customers. It is important to understand that it affected 3% of our TurboTax customers. So while the noise was out there, and the press coverage was strong, it really wasn’t a significant number of customers. We worked hard to get in touch with each and every one of them to make it right. I’d say first of all, the scope of that wasn’t as significant as the press may have portrayed it. From our perspective, we take it seriously because every customer matters. The second is on the industry-wide threat of cyber fraud attacking the U.S. tax system. This has been an industry-wide challenge; it is not a company-specific challenge. Despite some of the early press clippings, whether you look at our own competitors issuing open letters from their CEOs in major newspapers, or the IRS working with the industry since 2012 to solve this, or even the state of Montana issuing a press release last week stating that this is happening to more than one company. I think most people understand that we are processes; we are applying the most advanced techniques, and at the end of the day, they trust Intuit to process their information and protect their privacy and security. The important thing here is that the issue of cyber fraud is a threat to the tax system. We’re one of the many players that want to be a part of the solution. You have to separate the signal from the noise. The press is not representative of what we’re seeing, and as a result, I think you’re actually seeing in our business results that our customers trust our brand, and our product is even much better than it was last year, so we’re improving conversion. That plays out in the marketplace and that’s why you see stronger tax results than maybe what the press might have led you to believe.

Thanks, Brad. I’m wondering on the – you had a nice acceleration in the QuickBooks Online subscribers and you added about 100,000 in your guidance for the third quarter. Actually, your guidance assumes fewer than 100,000. If I look at prior desktop seasonality, back when it was a pure desktop business, you’d actually see a nice pickup from Q2 to Q3 in terms of subscriptions. I’m just wondering if there is any seasonality change or if there is some factor that you think drove Q2 that is repeatable as we look into Q3 for subscriber additions?

We know that each of our businesses does have cycles. In small business, we see a larger group of people buying heading into the New Year. Then it tails off a little bit into the latter half of our fiscal year, heading into the spring and summer. The desktop will throw you a little bit out of whack there. QBO is more of a real-time consideration, and you have a mix today of service-based businesses. We’re still building out advanced inventory to the mix of the kind of customer. QBO is slightly different than desktop. Right now, you’re going to see we’re still in the early learnings of just how big QBO will be in each of the quarters. This is our best forecast for the fourth quarter. It reflects the slightly nuanced differences and the service-based customers in QBO versus inventory-based in desktop. There is a seasonal pattern of when the peak periods are for QBO, just like there is in some of our other businesses.

And just Brad, a follow-up on that. Given the number you provided for fiscal 2017 of two million subscribers, you talked about about two-thirds, I’m sorry, three-quarters of those coming in as new customers. I’m wondering if what you learned in the second quarter, especially on that last part about the mix of customers coming in, new versus installed base conversion, if there is any change in your view in terms of the long-term?

At this time, Walter, we’re not changing that long-term view. That two million subscribers aspiration is not only to meet that but to exceed it. We’re continuing to see strength in new-to-the-franchise customers. This particular quarter, 80% of QBO customers were new to the franchise; about 20% were migrators from desktop. We’re doing everything we can to get desktop customers comfortable. We’re adding that advanced inventory capability, we’re continuing to finish off things like job costing, and we’re running promotions. But as you learned from the TurboTax desktop experience I just walked through, some of these customers aren’t going to be moving in anytime soon, and we’re fine with that. What we really like to see is that we’re expanding the category and getting new people into accounting software that have never even used our product before. So right now, we are locked in on that two million number. We just raised our forecast for subscribers this year. So we are not moving that two million yet, but if we continue to close in the way we are, we’ll talk to you about that in the future.

Yes, thanks. Hi Brad, you mentioned the ACA was not causing TurboTax users to leave for tax prep. I think the bigger concern that I hear from investors is whether you are seeing any shift in DIY. Given your prepared remarks, it sounds like that is not the case. I’m kind of curious if that just where we are in this part of the tax season and maybe that changes, or is there something that you’re seeing that the ACA just isn’t having any impact on that kind of category shift?

Sterling, it’s a fair question, and I think it’s still out there for many to think through. Our assertion from early on is if you look at what happened in Massachusetts back when Romney was governor, there was no shift between tax prep methods when a light program was introduced at the state level. So our hypothesis was if we do our job, and we take the complexity and make it simple, this should not act as a catalyst for the assisted category. We've worked hard to do that. I think the second thing is we do know that as we move further into the season, you will see the assisted tax prep methods start to pickup a little bit as more complex returns get processed. But right now, this is about where we were this time last year with the assisted category growth through February 6 reported by the IRS, and also where the DIY category was. At the end of the season, the DIY category picked up a little bit of share. I believe we are going to see the same thing happen this year. If there was going to be a big impact, we anticipated that if ACA was going to have one, it would impact earlier in the season, because families without health insurance often need to file early to get their refund. The fact we haven’t seen a significant shift leads us to believe our original hypothesis looks like it’s going to play out. We don’t expect this to be a catalyst. But we are prepared to respond if anything changes based on the rest of the season.

Okay. And then just one follow-up, and you touched upon it in your answer there. Can you help us understand, given the timing differences on when returns are starting to be accepted, we end up with a lot of numbers over different periods of time. A lot of apples and oranges. Can you reiterate for us what you think the tax season growth will be for the tax business? And kind of what the results that you just reported mean in terms of hitting those goals?

Yes, Sterling. So two things here: IRS data through February 6 reported the self-prepped DIY category with that of 7%, and assisted is down 4%. If I take our numbers and right now we reported February 14, if I move them back and make them apples-to-apples, the number of e-filed returns we submitted through the same date the IRS put their data out, we’re up 13%. So right after that, you can just do the math and say, okay, we’re growing 13% while the category is growing 7%. It looks like TurboTax is picking up some share; that’s kind of where we were last year, too. Our assumptions for the full season are that the IRS total returns will grow about 1%, and right now, that’s what they’ve reported through February 6. The second is that we anticipated the DIY category would pick up about a point of share out of the total returns filed. Right now, through the results of February 6, it’s up almost 3 points, so it’s a little bit higher than that. But we know it works through the balance of the season, and it does start to shift a little more to assisted, so that'll come down a little bit if history plays out. The third lever is that we expect we will pick up share, and so far the data suggests that we have picked up several points of share. But we also know we came off of a very exciting program called Absolute Zero. We’re going to say if we can hold our ground for the balance of the season, and the last piece is revenue per return. We fully expect customer growth will outpace revenues. We don’t expect that to be a big catalyst, and that adds up to the 5% to 7% total guidance we gave for consumer tax. I know there is a lot in there, but I hope that parses the numbers out and gives you apples-to-apples of us versus the IRS and then what our assumptions were.

Thanks a lot. I have two, so first on consumer tax, a lot of price changes this year across the portfolio and Brad, you’ve said a couple of times you expect units to grow faster than price. But by my math so far this season, it looks like revenue per unit is a bit higher than last year and I’m a little surprised at that. Just because you’ve obviously got the Absolute Zero program going on. Any comments on that? Is my math right and any thoughts around that so far?

Ross, your math is right. As Neil was going through his opening comments, he said not only do we have an exciting program with Absolute Zero, but our actual paid mix is higher than we had forecasted. Part of that is driven by the complexity base lineup we moved to last year, where we were trying to help customers get into the right product. As a result, TurboTax Online has actually helped us to get customers to the right product. As a result, our paid mix is healthier. People are getting to the Deluxe and the Premier versions of the product, which is where they should have been all along. Another factor is simply conversion and attach; as we continue to make it more seamless for you and you’re able to find services that are important to you, we’re able to make that mix healthier as well. Those two things are adding to slightly higher revenue per return at this point in the season. But as you know, we still have about 60% of the season left to go. So we’re going to see how the ultimate assumptions play out when we’re done on April 15.

That’s helpful. And then just a quick follow-up on the small business side; obviously with the introduction of self-employed and as you are pushing into international markets, there are going to be quite different dynamics around ARPU or revenue per subscriber. Just from a big picture standpoint, how would you have us think about that as we progress through this transition? Because I think right now, you've still got that ARR number on small business online ecosystem growing at a pretty nice clip.

Yes, Ross, I want to let Neil take that. I tend to monopolize the airwaves, so we’ll turn it to Neil on this one.

Yes, so you’re right, Ross. I mean as you look at the self-employed product rolling out and products growing globally, where we have less attach opportunities, you’re going to see the ASP be slightly pressured for QuickBooks Online ecosystem overall. We modeled all that into the lifetime value equation we shared back at Investor Day, and we’ll update as we move through the end of this year. We’re closely monitoring how different dynamics are impacting that as you heard us talk about on the call today. We like what’s happening with tax, particularly in the U.S. We made some acquisitions that will help us get to payroll faster outside the U.S., which will help those assumptions. We’re waiting to see how well we do with the self-employed product, which we’re excited about at this point, but it’s still very early days. So the short answer to your question is that the lifetime value equation that we gave you back in Investor Day last year is still good at this point, and we’re assessing as we go through each quarter the puts and takes. We’ll update that for you at the end of the year and kind of show you how it migrates from one to the other. But look for higher attach rates in the U.S. and improved retention to mitigate some of the downward pressure you would see outside the U.S., where you don’t have the same attach opportunities. Our product, like QuickBooks Self-Employed, clearly has a lower ASP and lower attach opportunity than the traditional QBO product.

Hi, Brad and Neil. Brad, you talked about your desktop customers affecting about 3%. Do you think the decline you saw in desktop at 7% is the majority just people transitioning to online? Or I guess how would you parse out kind of the changes and then clients impacted versus transitioning to online?

You know, Kartik, if you look at the last five years of TurboTax desktop, the average has been a 3% decline, but two of those five years, the desktop was actually down about 6%. So it happens to be during the two years where there’s been a delayed opening to tax season, so it ramps up a little bit later. I would tell you our 7% decline season to date is reflective of an ongoing secular trend of people moving from desktop to the cloud. It’s probably in that 3% to 4% range. The rest of it, honestly, I think was just the result of us having made a bad decision on a desktop lineup, and we’re going to have to work hard to earn those customers back. So that’s the truth of it: about half of it is a secular shift to the cloud, and the other half is a self-inflicted wound that we're going to fight for and try to get those customers back.

And Brad, on the QBO side you said – I believe you said 80% are new to the system. As you look at those customers, are they new businesses, or are they existing businesses that are now switching over to QBO?

It’s a combination of both. New-to-the-world businesses are finding it a lot easier to come in now and get up and running from any device they want to use, including tablets or a phone. The others are existing businesses that have historically been using Excel spreadsheets. So it’s really a mix of completely new to the world and then those who are new to the category.

And just one last question, Brad. Have you seen a change at all in your cost to acquire QBO clients based on the type of customers you’re getting and maybe if you see competition out there?

We continue to see an improvement in our cost to acquire customers. As accountants are getting more comfortable with QBO, the new re-imagined version, they’re recommending it. That recommendation leads to a faster response from the small business side. We’re also getting better SEO and SEM. Ultimately, our direct channels are more efficient and our account referrals are building. Outside of the U.S., as we enter each of the countries, we are in brand-building mode, so the cost of acquisition is more expensive in those countries. But on a quarter-by-quarter basis, we’re seeing the efficiency improve there as well. So you put it all together, and our cost to acquire is getting more efficient regardless of the competitive dynamics in any of those countries.

Hi, thanks for taking my question. I wanted to stay on QBO. You have seen an acceleration of subscribers ever since you launched your harmony of product. How do you think about where that is going to max out? What are the puts and takes to say like okay, 50% of something we think is good or can it go to 60% or 70%? I mean, just you know at some point, we’re going to hit kind of a number where you won’t accelerate, and I just want to be ready for that. Also, can you talk a little bit about the international business in terms of what are the stronger countries that you like and where the performance could have been better? Thank you.

You’re welcome. I wish that I had an answer for your first question. I’d like to know when that’s going to max out too, not because I’m anxious to get there, but I just want to see if we can blow past. You touched on it: we’ve had half a dozen quarters now we’re continuing to accelerate quarter-over-quarter, and we’re feeling very good about the trajectory. I can’t tell you that we’ve drawn out a flat line with any certainty because we think we’ve got a lot of opportunity ahead of us as we’re expanding the category. I wish that could be more helpful on that one. Regarding global markets, with the acquisition we just made of ZeroPaper in Brazil, that takes us into a new country. Right now, we have Canada, the UK, Australia, and India. We mentioned at Investor Day we were doing a Greenfield launch in France, and now with the acquisition of ZeroPaper in Brazil. Each of these countries has had different characteristics. The Canada business is strong; it continues to grow and be profitable. The UK is a very competitive market right now with many established players. We continue to accelerate our performance quarter-over-quarter, but we still have work ahead of us to get to the number one position in that market. In Australia, that is a very contested battlefield. We’re aggressive in showing our capabilities there. India is Greenfield. We’re creating the cloud category there, as most products have a DOS-like feel to them. We’re trying to create that category and get people comfortable with the cloud in India. France and Brazil are our newest entries, and right now we’re in the early learning phases there. In Brazil, we’re taking QBO and localizing it, then rolling out in the market. ZeroPaper is a Brazil-specific product but it’s a rapidly growing economy with a lot of opportunities; we’re going to put it on our platforms. You can unlock and grow into QBO over time. As a whole, we’re growing 170% and feeling very good about our global trajectory and the fact that we’re getting more efficient regarding our customer acquisition every quarter.

Great, thanks for taking my question. Brad, turning back the clock to February 6th on tax, it’s nice to see you’re taking share based on that 30% growth in returns that you have shared. Do you have any insight or thoughts on where that share is coming from, even just broadly whether from the larger or smaller competitors?

You know, Brad, we really don’t at this point. None of our competitors as well as TaxAct reported as a part of Blucora, but there wasn’t a lot of data that was shared. They kind of reiterated their guidance for the season. The other major competitor is not going to be reporting until March. Once they get their data out there and then we have the numbers from them, we’ll be able to triangulate more accurately. But right now, I’d just be speculating.

Okay, that’s fair enough. If I could follow-up with one more on the change in new QBO payroll attachment, going from an opt-out to an opt-in model. Could you maybe just give us a little more color on why the change and talk about the impact of the bigger picture?

Yes, sure. What we try to do is make it very seamless for you to come in and sign up for QBO with payroll included. What ended up happening is that a portion of customers would come in and found in their first bill that they were paying for payroll; in many cases, they didn’t need payroll if they didn’t have employees or were using another service. It created frustration, leading to customer care calls or cancellations. So what we realized was we weren’t clear enough, and it was confusing. Instead, we’ve moved to an opt-in model based on certain moments of need during the process. We’re actually seeing an improvement in our retention, a couple of hundred basis points. The biggest leverage you have in a subscription business is improving retention. While we’re taking a step back because we had a false positive at about 30% attach rate, we’re now in the lower 20s. We’re actually improving retention, and we think that will lead to a much healthier franchise over the long term.

Yes, thank you. I wanted to ask about the impact of the True Zero promotion. Have you seen a higher percentage of your online TurboTax filers in the promotion versus last year? If I’m not mistaken, the promotion lasted a couple of weeks longer this year and obviously went down from $15 to True Zero. Of the $15.2 million TurboTax Online users this year, was a higher proportion within the promotion versus $13.6 million from last year?

Gil, the answer is more than last year. The paid mix is healthier than we had forecasted. I was looking at the analysis—Neil and I sat down with the tax team regularly as you might imagine before tax season. They are showing us the source of the new customers. The two biggest groups year-over-year, which are really encouraging, are first-time filers (people who have never filed tax returns before) and then first-time movers into the category. We’re expanding the DIY category with this kind of offering. I think this is exciting for us because we know we can get a customer into the franchise and we can monetize them and grow their lifetime value if their tax situation becomes more complex. We’re not only seeing better conversion than last year with the promotion but our paid mix is healthier than we thought as well.

Got it. And then in regard to the fraud situation, did you find that those customers affected by fraud—someone filed under their information—have higher attrition than the rest of the population? Was that a significant factor?

It wasn’t, and I’ll tell you why. First, I want to be clear in my opening comments that the headline here is our customers know they can trust Intuit. We take the privacy and security of their data very seriously. Two things are fact today: one, we are up and running and processing returns in all states; and two, there is no breach of Intuit systems. That is not only the result of our own analysis, but outside third-parties have come in and run diagnostics with us. We’ve reached that conclusion with customers who appreciate that. If they’ve been victims of ID theft from other high-profile sources we’re reading about in the news, the point is they understand that this is broader. We’re helping them navigate the process, providing agents who can assist them with their filing. As a result, we have not seen an increase in attrition caused by that issue.

Hi, thanks for my question. Brad, with respect to the new user attach rates, I know you mentioned that due to a different methodology, the numbers are looking a little different. But can you talk to how this trajectory should continue so as to enable you to hit or exceed your goals for the long-term? Are we looking at a hockey stick-type trajectory or do you think that the trends so far are a more normal progression towards the attach of payroll and payment?

Yes, Kash, we do see a continuation of a normalized attach rate. We put in our prepared remarks that our payroll and QuickBooks Online attach rates would be in the low 20s in the next few quarters. We see that moving up into a healthier mid-20s and beyond as we get past the next few quarters. But we also see a corresponding offset which is an improvement in retention. As a combination of those things, that will drive lifetime value when we step back and look at the payroll and the payment attach rates for new users in QBO. Then, you look at the penetration opportunity against the base. We see opportunity ahead of us and continue to see that increasing and improving quarter-over-quarter. So aside from these next few quarters of payroll as we have to grow over this opt-in, opt-out situation, we do see a continuation of strengthening attach rates for payroll and payments products which lead to the lifetime value assumptions we'll share with you at Investor Day.

Got it. With respect to the desktop QuickBooks product, are there any plans to at least curtail development or, if not, curtail selling of it completely and go into a maintenance mode at this point, to get the customer base to slowly shift to the online?

I was born at night, but not last night. Coming off of the TurboTax desktop challenge we just had, I’ve learned a pretty important lesson that these customers are happy with their product. We have committed to making sure that if they want to stay on desktop, we’re going to support them for as long as they want to use that product. But we’re going to make it really enticing for them to get into the cloud, and we have zero plans to sunset the product or to do anything that will upset them and make them decide to shop someplace else. I didn’t mean to be flip; I meant to be self-critical. We’ve made a lot of mistakes, and it’s okay to make two mistakes—someone ought to slam my hand in a door.

I appreciate the candor. Finally, maybe I missed this about six months back. Did you share an ARR goal for the online business longer-term for fiscal 2017 or 2018? If you did, I looked at it, but if you didn’t, I would love to hear your thoughts on that. Thank you.

No, we did not, Kash. We shared an outlook for company revenue, which fairly is the QuickBooks Online revenue as a portion of that. We did not provide more specificity around the overall revenue guidance number.

Hi, good afternoon, guys.

Hi, Jim.

Hey, looking at the February 14th tax data at that point, do you think the impact of a delayed filing last year versus this year is washed out? Moreover, I don’t know if you can quantify the effect of your Absolute Zero program—do you think that is reflected in that data?

Yes, Jim, our assumption is that the effect of that delayed filing last year is pretty much washed out at this point. We’ll have to see full season how everything shakes out, but that’s what we’re operating from in terms of the Absolute Zero promotion. We like the results so far. We want to wait until the end of the tax season and look back and see if it achieved everything we thought it would. So far, the early data is suggesting very positive results. We like the impact of new franchise, new-to-the-world filers coming in; we also like the fact that the categories expanded. It looks like we picked up a couple of points of share and all of that is still improving our paid mix. So far, so good, but we want to wait for the full season effect to ultimately determine what the impact was.

Great. And then in Brazil, on ZeroPaper, what are your plans about using their product versus will their product become effectively QuickBooks Online down there? What are your thoughts on how that will work in Brazil?

Yes, Jim, Brazil is a unique market. They have this notion of something called [indiscernible], which is like an invoice; the payment methodology, and then you can convert that invoice into cash. That’s what ZeroPaper has done. It’s really valuable; it helps micro businesses do their thing. So we’re taking the product and importing it over into the QBO platform and think of it as becoming entry-level for QuickBooks Online. Eventually, it will grow out to our more mainstream QuickBooks Online product. So it will remain in market; it is a Brazil-specific product, but that’s a rapidly growing economy with a lot of opportunity. We’re going to put it on our platforms so you can unlock and grow into QBO over time.

Thanks, Steve and Brad. Just curious on the desktop—the pricing change obviously didn’t go as you had planned, and that was probably one of the things that was going to subsidize Absolute Zero. I’m curious how confident you are at this juncture of the year. We know it affected 3% of TurboTax customers, and we saw a volume impact. But just on revenue per return, obviously, you have a lot of moving pieces. Was that a headwind? Did you mention some positives on revenue per return? Could you compare and contrast those at this juncture? Thanks.

Yes, Scott, we’ve seen some puts and takes so far in the season. The take is we reversed our decision, and we’ve given customers the upgrade for free. That accounts for some revenue that we would have originally had in our forecast. The flip side of that is, as Neil said, even with Absolute Zero, we’ve had a healthier paid mix than we had forecasted. So when you blend it, it gives us the confidence to sit with you today and, based on what we see, reiterate our guidance for the full year. I think it’s really just a combination of all these things.

Great, thanks. And then following up regarding strategy—just an open-ended question. Going to free state with free federal—do you feel that you can reverse out in the future? Or now that you’re there, is it something you think is permanent?

Well, we’ll take a look at how the program played out at the end of the season, and if it’s an effective program, then you will see us continuing to do things that we think make sense for customers and for our strategic goals, which are growing the category and our share. If it’s not a successful program, we found that you can make these kinds of changes and those kinds of promotions year-over-year, and customers understand. It’s pretty premature for us to speculate what’s going to happen with Absolute Zero next year, but so far we like the results given where we are in the season.

Great, thank you. Brad, I wanted to touch on some of the longer-term targets around QuickBooks Online subscribers, specifically the increased guidance for this year and then the targets for 2017. I’m curious how you think about those in terms of where the business is today, with 80% coming in as new to the QuickBooks franchise, versus what your expectations within those projections are around desktop conversions or potentially future contributions from the self-employed product?

Yes, so Jennifer, as we’re sitting here and speaking, we’re looking at the assumptions we had and then what’s playing out in the market. There hasn’t been anything that’s fundamentally different. I’ll give you a couple of tweaks. One is the product is continuing to perform in a way that we’re delighted by; it’s expanding the category and getting first-time small businesses, as well as people who are new to the accounting software category in. We originally assumed a slightly larger portion of desktop moderators would migrate to the cloud; that number is nice at the level we thought, but we're getting more new-to-the-franchise customers. The other thing is QBO SE, QuickBooks Self-Employed, is new for us, and we’re looking to make it a global product. Right now, we don’t count those customers in QBO if they aren’t paid subscribers. We do have deals with Lyft and Uber and others that we mentioned. They are free QuickBooks Self-Employed customers, and then ultimately, the way we monetize, if you want to send that into TurboTax, we have an attach rate that shows up in a different business unit called TurboTax. It’s a nice little one Intuit ecosystem at play. We’ll see how QBSE growth becomes more meaningful over time as part of the paid subscribers; we’ll break that out so you can see it, but right now it’s only about 4,000 of the total number of subscribers, so it’s pretty immaterial. You put that all together, we’re hoping to get more desktop customers excited about the cloud; if not, we still feel good about our two million subscribers because we’re getting more people into the franchise than we anticipated with the new QuickBooks Online. Thank you all for your patience today. I know our opening remarks were longer than usual, but we wanted to give you as much context as possible around the two recent events. If you take anything away from this call, I hope you heard confidence in where we are in the first half of the year. We’re excited about the momentum we’re building in the back half. Thank you for your questions, and we’ll look forward to catching up with you on the aftercall. Take care, everybody.