Intuit's (INTU) CEO Brad Smith on Q1 2017 Results - Earnings Call Transcript

| About: Intuit Inc. (INTU)

Intuit Inc. (NASDAQ:INTU)

Q1 2017 Results Earnings Conference Call

November 17, 2016, 4:30 pm ET

Executives

Jerry Natoli – VP, Finance and Treasurer

Brad Smith - Chairman, President and CEO

Neil Williams – EVP and CFO

Analysts

Brent Thill - UBS

Walter Pritchard - Citi

Jesse Hulsing - Goldman Sachs

Sanjit Singh - Morgan Stanley

Ross MacMillan - RBC Capital Markets

Scott Schneeberger - Oppenheimer

Michael Nemeroff - Credit Suisse

Yun Kim - Brean Capital

Kartik Mehta - Northcoast Research

Sterling Auty - JPMorgan

Jim Macdonald - First Analysis

Patrick Colville - Arete Research

Michael Millman - Millman Research Associates

Shankar Subramaniam - Bank of America Merrill Lynch

Operator

Good afternoon. My name is Lateef and I will be your conference facilitator. At this time, I would like to welcome everyone to Intuit's first quarter 2017 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. [Operator Instructions].

With that, I will now turn the call over to Jerry Natoli, Intuit's Vice President of Finance and Treasurer. Mr. Natoli?

Jerry Natoli

Thanks Lateef. Good afternoon and welcome to into its first quarter fiscal 2017 conference call. I am here with Brad Smith, our Chairman and CEO and Neil Williams, our CFO.

Before we start, I would 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 2016 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 these remarks 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.

With that, I will turn the call over to Brad.

Brad Smith

All right. Thank you, Jerry. Good afternoon everyone and thanks for joining us. Fiscal 2017 is off to a strong start and we are building on the momentum that we developed in fiscal 2016. In the first quarter, we grew revenue 9%, exceeded our QuickBooks Online subscriber guidance and we beat our overall financial target. With that backdrop, let me begin by sharing a few reflections on our business performance and I will start with small business.

QuickBooks Online continued to gain traction as we pursue a large global market opportunity. Our goal remains to be the operating system behind small business success. Helping small businesses save time and improve their cash flow so that they thrive when times are good and they remain resilient when times are tough. Total QBO subscribers grew 41% in the quarter to more than 1.6 million subs. We drove acceleration in our small business market outside the U.S. where QuickBooks Online grew 50% to 323,000 subscribers, up from 45% in fiscal 2016. The increase came in Canada, the U.K. and Australia with subscriber growth in the U.K. accelerating to 87% which was up from 78%. We continue to focus our efforts on improving the product market fit in the remaining countries which includes India, Brazil and France and we will report more on our progress with these efforts in the coming quarters.

QuickBooks Self-Employed is also contributing to the acceleration of subscribers. Roughly 110,000 of our QBO subscribers are using QuickBooks Self-Employed. This is compared to 85,000 last quarter and 35,000 year ago. We have now launched QuickBooks Self-Employed in the U.K. and in Australia as well. I am encouraged by the starts in our small business group but I also expect our momentum to continue accelerating in the second half as we draw towards our QBO subscriber target of 2 million to 2.2 million subs for the full fiscal year. I am confident in this acceleration because of the innovations that we have coming to market, including improvements in the core QBO platform that simplify the first use experience, including enabling small businesses to generate their first profit and loss statement in less than five minutes. We have also introduced a new smart invoicing capability that allows for real-time tracking of the invoice status in both QuickBooks Online and QuickBooks Self-Employed. We have also enhanced the QuickBooks Self-Employed user experience with the ability to now receive payments on mobile devices and always on mileage tracking.

And finally, our recently introduced partnership with Google enabled a seamless integration between QuickBooks Online and Google Calendar. Based on the strong product market fit that we have in Canada, the U.K. and Australia, we are leaning into greater go-to-market activities behind QBO in these countries. It's these factors that support our confidence in the continued acceleration of QBO subscribers in the back half of the fiscal year.

With that overview on small business, let's talk tax. We are gearing up for another exciting tax season in TurboTax by continuing our multi-year investments in product innovation. Those product innovations are focused on re-imagining the tax preparation process while driving customer growth and increasing market share. We also continue to promote a set of best practice and the standards within the industry that enable the IRS and the state to improve the ability to combat tax fraud.

In ProConnect we are focused on serving multiservice accountants who do both books and taxes for their customers. Our goal is to be the operating system behind these accountant's success as well. In service to this goal, we are providing one location within QuickBooks Online for accountant where the accountant can access all of their workflows. Several exciting innovations are underway to begin to leverage the capabilities that we developed in TurboTax within our accountants offering, including increasing the number of documents that can be automatically uploaded which reduces data entry. We expect these innovations to help us further strengthen our accountant relationships by helping drive QuickBooks growth over time. So across the board, we are off to a strong start in all our businesses.

And with that, let me turn it over to Neil who will walk you through the financials.

Neil Williams

Thanks Brad and good afternoon everyone. For the first quarter of fiscal 2017, we delivered revenue of $778 million, up 9%, GAAP operating loss of $61 million, non-GAAP operating income of $32 million, a GAAP loss per share of $0.12 and non-GAAP diluted earnings per share of $0.06. Note that our GAAP earnings per share includes the impact of the early adoption of the new accounting standard update for share based compensation. This update requires excess tax benefits realized upon the settlement of a share based compensation award that flows through the earnings statement instead of the balance sheet. We expect this accounting change to reduce our GAAP tax rate from approximately 34% to approximately 32% for full fiscal 2017. The impact on GAAP earnings per share is an increase of approximately $0.07 in the first quarter and $0.12 for the full year.

Turning to the business segments. Total small business revenue grew 11% for the quarter. As Brad mentioned, QuickBooks Online subscriber growth remained strong and we exceeded our guidance for the quarter reaching 1,638,000 subs, up 41% year-over-year. Small business online ecosystem revenue grew 26% for the quarter. As we discussed at Investor Day, we are focused on driving customer growth first followed by online ecosystem revenue. We expect online ecosystem revenue to grow 25% to 30% this year, accelerating as the year progresses.

QuickBooks Desktop remains a resilient and important part of our business. The first quarter was exceptionally strong for desktop units, up 23% as unusually high renewals from existing desktop customers were driven by operating system upgrades. Our plan does not assume this growth continuous throughout the year. Desktop ecosystem revenue grew 6% in the quarter.

Moving to tax. Consumer tax revenue for Q1 was $60 million and ProConnect revenue was $112 million. This was in line with our expectations in a seasonally light quarter. To help with your modeling, we expect second quarter consumer tax revenue to grow about a point faster than last year, given the way the calendar falls in January 2017. And as a reminder, we expect to provide a tax unit update in late February concurrent with our second quarter earnings release. We will also provide a final unit update in late April after the tax season ends.

We continue to take a disciplined approach to capital management, investing the cash we generate in opportunities that yield a return on investment greater than 15% over five years. We ended the quarter with approximately $600 million in cash and investments on our balance sheet. Our first priority for the use of that cash is investing for customer growth. One of the best use of cash, we will return cash to shareholders via share repurchase and dividends. We repurchased 1.8 million shares in the first quarter for $192 million and $2.2 billion remains on our authorization. The Board also approved a dividend of $0.34 per share payable January 18, 2017.

You can find our fiscal 2017 Q2 guidance details in our press release and on our fact sheet. We reaffirmed our full year guidance with the one exception being higher GAAP earnings per share guidance due to the early adoption of the accounting standards update mentioned earlier.

And with that, I will turn it back to Brad to close.

Brad Smith

All right. Thank you Neil. I have to say I am pleased with the strong start to the fiscal year and I remain optimistic about the path we are on to grow our QuickBooks Online franchise here in the U.S. as well as in our prioritized markets around the globe. We are building on our QBO momentum in Canada, the U.K. and Australia and we further expanded the category with relevant offerings like QuickBooks Self-Employed.

Our third annual QuickBooks Connect conference in late October was a great success with attendance up year-over-year which reinforce the power of the ecosystem that is creating these dispensable connections between small businesses, accountants and developers. So on a headline, we like how we have come out of the gates in Q1 and we remain focused on delivering another great year.

So with that, Lateef, let's open it up and hear what's on everyone's mind.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Brent Thill of UBS. Your line is open.

Brent Thill

Thanks. Good afternoon. Brad, on the small business segment, the operating margin was flat year-over-year. You obviously grew it in 2015 to 2016 pretty nice margin improvement. I know you don't give a lot of guidance specifically to that business, but there's been some concern as you go international that you can’t maintain that operating margin expansion. Can you just walk through how you think about the segment business first for small business on margins for the rest of the year?

Brad Smith

Yes. Brent, sure can. First of all, as we look at the company overall, you know, our financial principles are to grow the topline double digits, to grow revenue faster than expense, which gives us operating margin expansion and that produces strong cash flow and then we invest that cash flow to grow the franchise, either through internal investments, it's acquisitions or it's returning cash to shareholders. And ultimately, as we look at the businesses, both tax businesses, we like to see those business margins north of 60% and in small business given we are in an expansion mode, investing in growing category, expanding into new geographies, we like to have that in the neighborhood of 40%. I wouldn't get too caught up in the first quarter. We had some things that we have moved around last year. We had our QuickBooks Connect conference that fell in the second quarter last year. This year it fell in the first quarter. So that brought a little bit of the marketing spend forward. So right now we actually feel good about the overall investments that we are making and in our ability to deliver the kinds of margins that we typically talk you to about.

Brent Thill

Thank you.

Brad Smith

Thank you.

Operator

Thank you. Our next question comes from Walter Pritchard of Citi. Your line is open.

Walter Pritchard

Hi. Thanks. I am wondering if, Brad, you could help us understand on the international side. I have to say, a little bit of a turnaround or an improvement in your tone there relative to even the Analyst Day you had back in September. It sounds like some of those countries you are seeing stronger trends there and I am just wondering, obviously you talked about product market fit. But any more detail you could give us about why you think that's ticked up a bit in some of those countries?

Brad Smith

Yes. Walter, sure can. You are right. At Investor Day, we were pretty candid and [inaudible] about seeing the opportunity outside the U.S. being much larger with the potential to grow faster than we were able to produce in fiscal year 2016. Our teams are already on that. I am simply the radio man and the good news is that we are working on closing out that last mile of getting the product compliant and at the levels that these countries expect. We got there for Canada, the U.K. and Australia and as a result of that, net promoter scores are going up, so we have leaned in the go-to-market activities in those countries.

The team also has and we have seen by the way the corresponding increase in growth from 45% up to 50% and I called out the U.K. specifically which exited last year at 78%, now it's at 87% and this continues to build momentum. These other remaining countries have their own timeline to get that last mile completed for product market fit and they are very near term. We expect to see those coming online as well. So I am optimistic that we are on it. We know what the right levers are and the first quarter shows that if we focus on it we can actually get the numbers moving in the direction we want. So you should hear some more optimism in my tone now because I am starting to see the proof points pay off.

Walter Pritchard

Okay. And then just relative to desktop, I heard the comment on the operating system upgrades driving some of that. How much of that would you say was people who maybe re-committing more than you expected to the desktop? And obviously the online subscribers overall this quarter were quite strong, but as we look out a couple quarters, how does potentially more of your customers re-committing to desktop impact what you might be looking for in terms of online subs as we get out a year or more as maybe some of those were to move over?

Brad Smith

Yes. Walter, we actually feel like we are expanding the category by having both offerings in the market. So, primarily the desktop business was the result of the operating system upgrade. Windows 10 drove an upgrade cycle and then the operating system upgrades, then Mac. And it was about 60/40 Windows and Mac. If you pull those out, it was basically flat to down 1% without the upgraders. And so I would say that kind of normalizes things out for us.

If you look at the total customer base and you counted the way we used to, which we no longer put out on the fact sheet, those are people using at least the last three years version of desktop or they are buying a subscription, the total base grew in the neighborhood of 5% and that's up from where it was when we exited last year. And then if you break that down, you mention QBO subs are strong 41%, the desktop got a boost through this upgrade cycle, which pushed it up to 23% and you put it all together and the total paying customers in this last period was up a total of 33%.

So I do not see cannibalization happening. I do think we were the beneficiary of these operating system upgrades. We are going to continue to have a good quality desktop offering but we are leaning into the cloud and the customers are choosing the cloud. So I would say that net net, we are growing the category.

Walter Pritchard

Great. Thank you

Brad Smith

You are welcome.

Operator

Thank you. Our next question comes from Jesse Hulsing of Goldman Sachs. Your question, please.

Jesse Hulsing

Yes. Thanks for taking my question guys. I wanted to drill in to your expectations for payroll and payments moving forward a little bit more. The payroll subscribers accelerated. I am curious what your thought is on whether that acceleration is sustainable? And I am wondering on the payment side when you will start to see the impact of the invoicing product starts to hit the model? Thank you.

Brad Smith

We do see opportunity to continue to strengthen our performance in payroll and payments and the team is focused on that, just like we are with our international expansion in QBO. I feel good that the team knows the right levers and we are continuing to optimize and improve. Currently right now, if you look at the penetration rates into the customer base, payroll is at 15% in QBO and that compares to roughly 32% in desktops. So we have got a lot of headroom there. And payments right now is in the neighborhood of 6% in penetration and that's a little ahead of desktop and we think that opportunity just has more headroom as well.

So our outlook is that we are going to continue to focus on this and we are going to continue to have you focus on the penetration numbers because that's the ultimate size, but the payoff for us is we have been guiding subscriber growth of QBO greater than 40% and we saw that tick to 41% and we have been guiding QBO ecosystem revenue of between 25% and 30% and we saw it tick up to 26% in this quarter and that's the proof of the opportunity we have if we just stay focused on those two numbers. We are going to see strong payroll and payments growth and strong overall SBG growth.

Operator

Thank you. Our next question comes from Keith Weiss of Morgan Stanley. Your line is open.

Sanjit Singh

Hi. This is Sanjit Singh for Keith. I wanted to toggle back to some of the dynamics behind subscriber guidance or the subscriber performance this quarter. So if I recall last year, I think you had some challenges in India and there was sort of a reset in terms of strategy there. I think in Canada also there was a change in go-to-market. So I guess my question is, is how much of this quarter's performance in terms of the year-over-year growth is coming off of the easier comps? And then going into the second half, is it just a function of better feature functionality driving that international growth going forward? Is that the right way to think about it?

Brad Smith

Okay. Great question. You are correct. Last year, as we had a period where we didn't feel like our non-U.S. growth was reflecting the kind of opportunities we see ahead of us. We did have two countries that were in a pivot, Canada and India. Canada was actually because we had tried to test to selling a QBO subscription in a retail box in retail stores. And what we found was, we were getting units, but then they were attriting, they were dropping off after a 90-day period and so we literally didn't like the quality of the sub and we pulled that out and we had a grow-over.

Canada has since been picking up momentum and growing, but the real upside here was not just Canada, in the U.K. where we went from a 78% growth rate in Q4 to an 87% in Q1 shows that it's picking up momentum as is Australia. So I would tell you, this is less about a year over year easy comp and this is more about that product market fit and leaning in the go-to-market and that's the kind of feedback we are hearing from customers.

And of course we have the other three countries that we are getting to the last stage of product market fit as well and then we will start to lean into those in the back half and that's why we feel like our 2 million to 2.2 million target is absolutely the right target to be given.

Sanjit Singh

Understood. Thank you for that. And just a quick follow-up and an update on maybe some of the unit economic metrics. So if there is any comments you have on renewal rates in terms of QBO and maybe by segment? And then also with respect to ASPs, I noticed on the Analyst Day that the ASPs for QuickBooks Self-Employed were up pretty nicely versus fiscal year 2015. So could you give us any sense of how ASPs by QBO segment looks like this quarter? Are those trending up?

Brad Smith

Do you want to take this one, Neil?

Neil Williams

Sure can. I would give this a shot. It's Neil. If you go back to the guidance we gave in the conversation we had at Analyst Day, there are a number of moving parts in this. Clearly, QuickBooks Self-Employed, as Brad mentioned, is growing quite nicely and which is overall providing some downward pressure on our overall ASPs. We did implement a price change in QBO in the U.S. midway through the first quarter this year, which had a little bit of a impact. It will impact for the balance of the year. It's a very modest price increase, but it's on a fairly large base. And as we have already talked about, we are probably focused more on retention and driving the value of the accounting product outside the U.S. where you know, we don't have the same potential for payroll and payments with that as we do in the U.S. but first quarter was good. It actually looks like we are very much on track with our expectations. You saw the acceleration in the online ecosystem revenue by a point. So early in year but so far I think the plans we made are playing out exactly as we expected.

Sanjit Singh

Any early indication on renewal rates in Q1?

Neil Williams

Nothing. No substantial change from what you saw at the end of last year.

Sanjit Singh

Perfect. Thank you so much.

Brad Smith

Okay.

Operator

Thank you. Our next question comes from Ross MacMillan of RBC Capital Markets. Your question, please.

Ross MacMillan

Thanks for taking my question. Brad, a couple. Maybe the first one is just on online payroll adds. I think the online payroll adds were 40,000. That's up lot relative to the run rate you have been doing. What actually happened there? Was there some international payroll markets that opened up? Or is there any other high level driver for that this quarter?

Brad Smith

Yes. So first of all, one of the things we are continuing to do is improve the online payroll first use experience. So one of the areas that the team has leaned into is make it easy for you to come in and then contextually find additional services like payroll and payment. We did have a reclassification which may give you a little bit of a pop in the fact sheet of about 7,000 units that have been attributed to the -- it's in the Mac product. It had been attributed to desktop. It's now being attributed to online. That's where it should have been classified along the way. So it's giving you a little bit of an additional bump. But underneath that is really strong growth with the tens of thousands, you talked about roughly 40,000, the bulk of those are just continuing to improve the user experience and then there was a 7,000 subscriber pop as a result of a re-class.

Ross MacMillan

Okay. That's helpful. But no other, it wasn't like you opened up an international market to payroll for the first time. There was nothing like that.

Neil Williams

No.

Brad Smith

No. There wasn't.

Ross MacMillan

Okay. That's helpful. And then just I am curious now that you have opened up Self-Employed, I think you said to U.K. and Australia. Any sense for, when I look at the overall international adds, any sense for how material the Self-Employed addition was within the international adds?

Brad Smith

Well, I put it in total aggregate and if you look at it in aggregate, we added 20,000 Self-Employed subs in the first quarter and that compares to 60,000 in the full 12 months of last year. We weren't in the market for the full first quarter in the U.K. and Australia. That's been in more recent weeks. But the early results have been very positive. And so I would say, overall most of that acceleration continue to be in the U.S., but we are getting some upside with the new country expansion.

Ross MacMillan

Okay. That's helpful. And great to hear the active base growing up 5%. That's a very good number. So congrats from me.

Brad Smith

Thank you Ross. I appreciate it.

Operator

Thank you. Our next question comes from Scott Schneeberger of Oppenheimer. Your line is open.

Scott Schneeberger

Thanks. Good afternoon. Guys, I am going to switch it up and go over to tax. Brad, I am curious, with the PATH Act coming up in this upcoming tax season, just curious how you think that's going to shape early season filing behavior? And it looks like the storefront guys are going to have some new refund advance products. Just your thoughts on how you might compete with that? Thanks.

Brad Smith

Sure Scott. Every year is an exciting year in tax. Our team is geared up. We have got some really cool product innovations and go-to-market campaigns and the team's itching for the season to start for that first whistle to blow. Obviously we do have the PATH Act this year. Those are people who have earned income tax credit or for those who actually have a child credit, the IRS is working with the rest of the industry has decided to hold those refunds until February 15 which helps us increase W-2 verification and prevent fraud. We have been very supportive of that. We believe fundamentally though that IRS and the industry is still leaning in towards nine out of 10 returns, who will actually get the refund back in 21 days. So we don't see a material change in the seasonality, but we are fully prepared to help those people get their money.

In terms of some of the stores leaning in with these refund anticipation loans, we pulled out of that business, as you know, more than a decade ago. And you can go back and track our results while they have had refund anticipation loans and we have not. We have been able to manage to grow the do-it-yourself category and to gain market share over that period of time. So we fundamentally don't see a shift in any sort of method behavior based upon history and we are fully prepared to help those people with earned income tax credit get their refunds.

Scott Schneeberger

Great. Thanks Brad. And just on a follow-up, what are you expecting for industry growth this year in tax with the IRS? And just your thoughts on potential influence this year or looking out a few years, given the results of the election? Thanks.

Brad Smith

All right. Well, our assumptions right now are in the neighborhood of 1% to 2%. We typically are in the zero to 1% range. Right now, everyone in our business as well as some in the industry suggest that it might be a little more robust this year. So we will have to say somewhere in that zip code of 1% to 2%.

In terms of what's happened with the election, you know as well as we do, we have been in this business now for over three decades and we hear a lot of really good intent and then ultimately what happens when the new President and Congress get in is what we actually turn that into. And so I would tell you that we remain dedicated and supportive of things like tax simplification. We have been big supporters of that. I am very vocal about it. We are very supportive and vocal about voluntary compliance and we are also big fans of putting more money in the pockets of small businesses and consumers paying less tax.

So, so far that's sort of what we are hearing, but we haven't got to January yet. We don't have the new President elect in office and the new Congress. So right now we are just prepared to do what we always do is have the best product in the market and try to win the customer one customer at a time.

Scott Schneeberger

Great. Thanks.

Brad Smith

All right.

Operator

Thank you. Our next question comes from Michael Nemeroff of Credit Suisse. Your line is open.

Michael Nemeroff

Thanks for taking my questions. Brad, do you have maybe any early data points regarding the subscriber contributions from some of the new ecosystem partners, namely G Suite and AmEx? And what your expectations for subscriber contributions towards that 2 million to 2.2 million subs in the year? And then for Neil on tax, now that you are selling the SE product bundle with tax, I am curious how you are going to recognize tax revenue coming from SE? Is it going to be on a subscription? And if so, do you expect any impact in Q3 from that SE product with tax?

Brad Smith

Okay. Michael, I will take the first one and give Neil the second one, as you had asked. In terms of an individual partners subscriber contribution, we haven't provided any of those breakdowns, but I can bring it up to an overall impact. We know where one of our small business customers attach as a third-party product. That increases the retention of QBO 10 points. And so we are big fans of these partnerships that we are announcing because we think it improves not only the customer experience because they can solve additional problems but also it helps build more retention into QBO which is one of the biggest levers we have in terms of recurring revenue. So that's sort of how we would look at it at an aggregate level.

You want to talk about the bundle?

Neil Williams

Sure. We are excited about the TurboTax online and QuickBooks Self-Employed bundle and we will see how that plays out. The way we are going to treat that, Michael, is that we are watching carefully to see how those customers engage with QuickBooks Self-Employed after tax season is over. And so for those customers who are active and who use the QuickBooks product, we will defer and allocate part of that revenue over the 12 month subscription period that they are entitled to use QuickBooks SE. We have some assumptions around what those utilization rates are that are baked into our guidance for the year, both for units and for revenue. Certainly, if we see that play out differently and we see the guidance change, either by quarter or for the full year, we will let you know. But for those customers who do activate and use the self-employed component of the bundle after tax season is over, we will be allocating a portion of what they paid over the 12-month period that the subscription covers. But that's reflected in the guidance for the full year and we come back and give you guidance for Q3 and Q4, we will have those assumptions baked in.

Michael Nemeroff

Okay. Thanks very much guys.

Brad Smith

All right. Thanks Michael.

Operator

Thank you. Our next question comes from Yun Kim from Brean Capital. Your question, please.

Yun Kim

Thank you. Congrats on a solid QBO sub number. But I guess I will ask on the overall strong QBO Self-Employed performance, is that your core U.S. QBO subs, when you exclude the self-employed version actually grew strong in the quarter for the first time in a while especially off the somewhat of a slowdown last year. I know it's just one quarter but do you expect that part of the core traditional QBO subs to rebound this year? Does the traditional QBO sub adds, is that heavily influenced by what you are doing currently with focusing on the accountant programs and whatnot?

Brad Smith

Yes. Thanks Yun Kim. First of all, I really appreciate that you called out the U.S. QBO subs number. We are also very pleased with those results and we think there is more in the barrel for us to get there. In fact we talked about these innovations that will really kick in for the second half. I was talking about that first use experience, the ability for a first-time user to come in and get to their P&L less than five minutes, we think will be really cool for final conversion. The other thing is, if invoicing tracking capability, think about that like an ability to have Uber or FedEx tracking for your invoice where you literally can go in on your phone, you send the invoice that will let you know if it's been opened, then it will let you know if it's been paid and then it will send you an alert when it's actually in your account. And that's getting small businesses paid 15 days faster, over two weeks faster. And then we have other components we are adding as well as like Google Calendar. The ability for someone to have their appointment in Google Calendar and then click on it and send an invoice and have a flow right into QuickBooks and get paid, those are all elements that not only help QBO outside the U.S. but it will help accelerate our growth rate in the U.S. So we think there is fundamental strength in the United States while also looking at these non-U.S. markets and we think these innovations will only add some fuel to that fire.

Yun Kim

Okay. Great. Thank you.

Brad Smith

Thank you

Operator

Thank you. Our next question comes from Kartik Mehta of Northcoast Research. Your question, please.

Kartik Mehta

Okay. Thank you. Brad, I wanted to ask you a little bit about tax and the success you have had with Absolute Zero. As you see more competition in the marketplace, whether it's this RAL funding or your competitors kind of going to an Absolute Zero, do you think you have to expand that program to even include more forms to attract customers? or do you think where you are and the strategy you are taking doesn't have to change?

Brad Smith

Kartik, thank you for the question. We have been on a multi-year journey to re-imagine the tax preparation process and our goal is to eliminate six billion hours of tax prep drudgeries. You don't even have to answer questions. And last year we knocked off 40% of the time it takes to file an average tax return in TurboTax and we leaned into a leading mobile offering that no one else has. And I think that is the source of our advantage and our market share gains.

Just to give you a case in point, last year we had a competitor who matched Absolute Zero, not only matched it in terms of the product line but they even kept it out in the market longer than we did. We ended the program March 31. They you carried through the end of tax season. And we still took share. So my fundamental belief is that price is not a durable competitive advantage, neither are promotions. It is the product and the experience you create for the customer and we have got a three or four year head start on the players in the market by basically re-imagining this next chapter.

The second piece on RAL, as I mentioned a few minutes ago. We pulled out of that business more than a decade ago and you can go back and look and I know you have, you and I have spent time talking about this. You can look at do-it-yourself category growth. You can also look at our market share gains within that category despite not having a refund anticipation loans. So we don't believe we are dealing with anything differently this year in terms of a RAL than we have for the last 10 to 12 years and we are fundamentally leaning into the product experience and we think it's going to be another competitive season, but I like what our team has in the pipe and looking forward to the January 1 kick off.

Kartik Mehta

And then Brad, I just want to go back to what you were saying about the PATH Act and make sure I understood, were you saying that even with the PATH Act, you anticipate that most refunds will be around the same time that customers got it last year? Or was the point that the timing of the difference, whenever the IRS starts processing, it will be the same?

Brad Smith

Well, the overall, if you put all 150 million returns that the IRS will process roughly in the year, nine out of 10 of those will actually get a refund back in 21 days or less. The PATH Act does actually know when on those who do earned income tax credit and those who have a child credit and they are going to have that refund held back until February 15. So for those who come in early, have those qualifications and are hoping to get the refund sooner, they are going to be held back for a week or two here until February 15. So that will be an impact to Group.

But our goal is to help those individuals understand the status of their refund, keep them apprised and make sure they have a great experience. But fundamentally, I don't think they are going to shape or shift the overall tax season. And that's our philosophy going in and we just want to make sure we are there for these customers. And I don't think the refund anticipation loan, honestly, is going to shape the overall season. I think it's basically going to be a period of time and then we are going to get past that.

Kartik Mehta

Thanks Brad. I appreciate it.

Brad Smith

All right. Thank you.

Operator

Thank you. Our next question comes from Sterling Auty of JPMorgan. Your question, please.

Sterling Auty

Yes. Excuse me. Thanks. Hi guys. You talked about the strength in the QBO subs internationally, but I am just kind of curious what your thoughts were around the additions here in the U.S. in the quarter relative to your expectation?

Brad Smith

Yes. Sterling, as I shared a few minutes ago, when Yun Kim asked about the United States QBO subs, we felt good with the strength in QBO in the United States. So we feel even more optimistic as we look at the balance of the year because the new innovations that are hitting, we think, are going to add more fuel to the fire. And so I think if you look at QBO core in the United States, it's continuing to produce strong results with some cool innovations coming.

The second piece is, we have QuickBooks Self-Employed that's going to add more fuel to the fire in the United States. And of course we do have desktop migrators. In the first quarter, we got a little bit of a bump there with these operating system upgrades. The migrators were up about 50% year-over-year. Last year they were up 25% overall. So that's always a little bit of tailwind as well, but we feel good about the United States and the QBO sub outlook as we look for the balance of the fiscal year.

Sterling Auty

And then just one follow-up. In terms of some of the new functionality that you are bringing into QBO, do you expect any of that will actually have a material positive impact on the renewal rates as well?

Brad Smith

We hope so. One of things we do know is that there is an important problem that customer has and it's one of the top things they have requested and then we solve that problem well with a new feature, it improves retention. And we fundamentally believe that the things we have narrowed in on are some of the most important and frequently asked feature requests. And so I feel good that the team not only has narrowed in on the right problems, but I also like the early results we are getting back in terms of customer feedback on those new features. So our goal is to continue to push retention up and I think it will continue to help us do that.

Sterling Auty

Thank you.

Brad Smith

All right.

Operator

Thank you. Our next question comes from Jim Macdonald of First Analysis. Your line is open.

Jim Macdonald

Yes. Thanks guys. Could you give us a little more on the quarterly shift? You said one point of tax into the January quarter. And could you talk about what the -- is that just taken out of the next quarter? I mean 1% of what?

Neil Williams

Yes. Hi Jim, this is Neil. The way the calendar falls in 2017, January 31 is actually on a Tuesday. In 2016 it fell on a Saturday. And we know a lot of people do their tax returns over the weekend and actually file them on Mondays. So when we factor in 2017, getting the full 31 days of January into our first quarter, it would make our growth rate, the way we look at it for TurboTax revenue in Q2 about a point or so higher than the growth rate we posted for last year. So I know getting seasonality right consumer tax is always a challenge for you guys and so just to let you know the way we see it playing out, is we would see our second quarter growth in consumer tax about a point or so better than the growth rate we posted last year, just because there are a couple of extra days customers can actually file their returns taking into the weekend into account and getting them into our Q2, it's a total shift from Q3 to Q2. It doesn't change the full-year outlook. It doesn't mean any more taxpayers or anything like that. It's just an anomaly with the way the calendar falls and the way consumers have time to work on their returns.

Jim Macdonald

But just to clarify, so last year there was a shift and a big shift. So you had a big growth of consumer tax due to the shift back. So you are saying, it's going to be 1% more than the 30% last year?

Neil Williams

Yes. Last year was actually a return to more normalized trends after the year before that having a delay with the IRS opening to receive return. So we kind of use 2016 as being a more normalized Q2 for us in terms of consumer tax revenue. And so yes, so a point or so above that.

Jim Macdonald

Okay. Thanks.

Operator

Thank you. Our next question comes from Patrick Colville of Arete Research. Your line is open.

Patrick Colville

Hi guys. Great quarter. Thank you so much for taking my question. Can we just go back on the desktop unit growth and why the drivers that we saw this quarter wouldn't persist through the fiscal year?

Brad Smith

Okay. Patrick, I am going to ask you repeat the first part again because you cut in and out a little bit and I couldn't hear what the particular product line you are asking about was, please?

Patrick Colville

Sure. On the desktop unit growth, why the drivers that we saw this quarter wouldn't persist through the fiscal year?

Brad Smith

Got it. Okay. Well, we fundamentally believe that a lot of the goodness we saw was the result of the operating system changes from both Windows and Apple. We saw Windows 10 upgrades and we saw the Mac OS upgrades driving a lot of this early strength. And so we think that a lot of that, if you just look at the natural upgrade cycle that's probably occurred, there will be a little bit of strength potentially here in Q2, but as we look at it for the balance of the year, we don't think it's going to persist through all four quarters. So that's really the hypothesis we have at this point.

Patrick Colville

Got it. And can I just ask a quick follow-up on the tax business, just to help non-U.S. based analysts. So tax simplification, if that were to happen, I probably see that driving share shift to the DIY category, but probably also driving ASPs a little bit lower. I mean, is that right?

Brad Smith

Well, first of all we do agree with you. We think tax simplification would drive more people to basically do the taxes themselves. In terms of whether it would ASP lower, there are other value-added services that we provide that basically help consumers say, I am willing to pay for that particular service. And so we don't fundamentally believe that ultimately lead to a lower ASP. It basically puts more energy into what are the other services you can offer a tax filer that they are willing to pay more for and those are the things that our team has been leaning into over the last couple of years. So I would agree with the first concept, we don't believe it naturally suppresses ASP on the second concept. It just puts more innovation into areas beyond the actual tax filing itself.

Patrick Colville

Awesome. Thank you very much.

Brad Smith

You are welcome. Thank you Patrick.

Operator

Thank you. Our next question comes from Michael Millman of Millman Research Associates. Your question, please.

Michael Millman

Some more tax. I guess the PATH is a concern at all. It's basically, word gets out on the street and people delay, but no big swing in terms of the full year. Would you agree with that? Well, at least you certainly would agree with second part.

Brad Smith

Yes. Michael, we agree with the second part. I do know there are family that are hoping to get their money as soon as they can and that's important. So we don't take that lightly, neither does the IRS or the rest of industries. So we want try to help them get that, but I think to your second point, it doesn't change the outcome of the full year. And that's what we are looking at.

Michael Millman

Okay. So some other questions then. I guess, version and retention time type of questions. I was wondering if you would give us some feel and maybe more than a feel on what you are seeing in conversion from people going to the website or are you in fact seeing more people go into the driving to the website? To what extent are you seeing conversion changes in free to priced? And then I have a couple retention questions, but we will start there.

Brad Smith

Okay. Michael, first of all, I want to make sure, are we still on the tax topic here?

Michael Millman

Yes. On tax.

Brad Smith

Okay. Got you. I anticipated that, but obviously we don't have any real conversion and retention numbers to talk about at this moment, because we haven't kicked off the new-season. But if you go back to our Investor Day deck that we shared in the fall, we laid out some pretty good detail on the funnel and it's actually on page 63 of our Investor Day deck, just to let you know the specifics. And it talked about the fact, we had roughly 92 million people who came in and visited turbotax.com through tax season. And then it talked about how many of those converted into logins, then actually filed a return and then the net net on that.

And you will see that we laid in there basically the improvements, the conversion at every step along the way and then the ultimate impact in retention. And I feel good about that and then the following page talks to your free to paid. Obviously, we introduced free back in 2004, 2005 and we were getting about $29 a return and making about 60% margin back then. Last year, even with the very aggressive Absolute Zero, we made $49 a return and margins were around 65%.

And our free to pay continues to be muscle we have refined and developed. We haven't broken down the actual percent of how many of them we convert, but you can look at the aggregate number and see that not only we are driving the revenue per return, but we are also improving the margin. So that data is in that Investor Day material and hopefully you will get the chance to take a look at that and it will give you a little more specifics on each of the key areas.

Michael Millman

Thank you.

Operator

Thank you. Our next question comes from Shankar Subramaniam of Bank of America Merrill Lynch. Your line is open

Shankar Subramaniam

Hi. Thanks for taking my question. I am asking the question on behalf of Kash. Just on online payment and online payroll, can you talk about the attach rates that you are seeing right now relative to fiscal year 2016? And where do you see that going, especially given the growth in SE? Do you see an inflection point where you can actually see the attach rate growing from here?

Brad Smith

Sure Shankar. First of all, let me start with the reason why we try to talk about penetration rates is because we think that's the ultimate payoff and that leads to ecosystem revenue growth. And so right now, there is two big numbers that we look at.

One is what's the QBO ecosystem revenue growth? And it's 26%, which is up a little from last quarter.

And then the second piece is, what are the penetration rate of payroll and payment into the QuickBooks Online base? And those are currently 15% for payroll and 6% for payments. Lots of upside opportunity but good strength.

Now one of the leading indicators is an attach rate. We are trying to pull back on that because attach rates get muddied. They get muddy because QuickBooks Self-Employed, by definition, does not have a payroll. They don't have any employees, but they go into the QuickBooks Online base and if you start doing the math, you will say, looks like we have got a problem here, attach is going down, but it's not. It's QuickBooks Self-Employed becoming a bigger part of the mix.

The other thing that throws you off, if you talk about attach rates is, we will do promotions at times, whether it's a buy now without a bundle or it might even be something with accountants who in turn then get the customers start to think about payroll and payments down the road. And those can muddy the water.

But I will answer the question on what are the attach rates right now. It was 15% in the quarter for payroll and it was 9% for payment. But you have to put that caveat next to it which is, we had a big mix of QuickBooks Self-Employed and we also had some growth outside the United States where we don't yet offer payroll and payments and those numbers are going to make the attach rate look a little bit distorted. So [indiscernible] 26% ecosystem growth, which is up from 25%, that's the real health indicator.

Shankar Subramaniam

Got it. There as one more question on the QBO sub growth for fiscal 2017. Given that the Q1 was above your expectation and all the other international growth in SE seeing strong traction, what's the put and take about exceeding your expectations for the fiscal 2017? Do you see more optimism that that's probably a conservative estimate and you can actually exceed it? Or is that more realistic target even with your new data?

Brad Smith

Well, if you go back and look at what it would take for us to deliver the 2 million to 2.2 million subs, it would subscriber growth between 32% to 40%. And right now we just clocked 41% in Q1, which is an uptick from last quarter. And then we did walk through some of these innovations we have in the market now that we have introduced that we think gives us confidence that we are going to be able to deliver that 2 million to 2.2 million. It's still too early in the game for us to say hey, our confidence is now that we are going to go past the 2 million to 2.2 million, but hopefully it gives you enough assurance to say, you can see momentum in the base growing and you can hear the innovations coming. And honestly, it gives me a little bit of confidence to hear that the question is now, are you going to hit the number and now, it's actually are you actually going to exceed the number? We feel good about the things in the pipeline, but it's too early for us to say that we are going to be looking at raising guidance.

Shankar Subramaniam

Got it. Thanks.

Brad Smith

Okay.

Operator

Ladies and gentlemen, I am not showing any further questions. Would you like to close with any additional remarks?

Brad Smith

Yes. Thanks Lateef. I will tell you, we are encouraged with the strong start to the fiscal year and we really do feel like we have some momentum building with some new innovations in the market. But that said, you all know as well, our biggest quarters are still ahead of us. But we are looking forward to that whistle blowing and getting into peak season. I want to thank everybody for your questions today. And for those who are in the United States and celebrating Thanksgiving next week, we want to wish you a happy holiday. For everyone else, take care and we will speak with you soon. Thank you.

Operator

Ladies and gentlemen, thank you for participating. This concludes today's conference call.

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