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Edited Transcript of ZML.AX earnings conference call or presentation 22-Aug-19 3:00am GMT

Full Year 2019 Zip Co Ltd Earnings Call

Aug 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Zip Co Ltd earnings conference call or presentation Thursday, August 22, 2019 at 3:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Larry Diamond

Zip Co Limited - CEO, MD & Executive Director

* Martin Brooke

Zip Co Limited - CFO

* Peter Gray

Zip Co Limited - COO & Executive Director

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Conference Call Participants

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* Ben Hughes;Epic Capital;Director

* Jonathon Higgins

Shaw and Partners Limited, Research Division - Analyst

* Justin Pezzano

Blue Ocean Equities Pty Ltd, Research Division - Investment Analyst

* Phillip Chippindale

Ord Minnett Limited, Research Division - Senior Research Analyst

* Sameer Chopra

BofA Merrill Lynch, Research Division - Head of Australian Research and Co-Head of Regional Telecom Research

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Presentation

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Operator [1]

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Thank you for standing by and welcome to the Zip Co Limited Annual Results Presentation. (Operator Instructions)

I would now like to hand the conference over to Mr. Larry Diamond, CEO. Please go ahead.

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [2]

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Thank you, and welcome to everyone to Zip Co Limited FY '19 Results Presentation. As mentioned, I'm Larry Diamond, CEO and Co-Founder. And with me today is Peter Gray, COO, Chief Operating Officer and Co-Founder and Martin Brooke, our Chief Financial Officer.

The presentation today will go through our purpose and mission, the business model and an opportunity that we see. A quick business update, followed by financials and the outlook.

Moving on to purpose and mission. So we -- as part of our brand launch last year, we also updated our purpose and mission. The Zip purpose is to give consumers the freedom to own it. And by that, we mean, Zip-enabled consumers to own the experience, own their well being, own their look and also the freedom to take back control, and particularly from the old broken credit card model and from high revolving interest debt.

As a company, the own it also represent our focus on owning our responsibility, strong focus on ensuring that those customers that get access to Zip credit can afford both products and services.

And finally, the freedom to own it is the very symbolic of what we see inside it, but we give all of our employees the freedom to grow, change and make a difference and empower them within the organization.

Our mission has also been updated, and it is now to be the first payment choice everywhere and every day. We see payments as the access point to the relationship between us and our customer. The more times that customers will use our digital wallet, the deeper the connection and the more important that we become, as that is a big focus for us and obviously an aspiration.

Moving into the vision and opportunity. Now on Slide 6. We believe the Zip is very well positioned in the current climate. Firstly, we've been able to demonstrate greater than 100% year-on-year revenue growth since inception. We are building a network-driven business connecting customers and retail partners together through a closed loop. And as a result of that network, we've seen $1 billion processed on the platform last year, 1.3 million customers transacting at 16,000 retail partners and over 30,000 -- 37,000 points of presence.

We also have built a proprietary decision technology platform, which allows us to understand customers when they sign up and when they transact, utilizing traditional and alternative data sets to deliver real-time credit decisions. And our market-leading loss rates show that we are doing well there.

The next is around the brand affinity. Unlike credit cards, which are very transactional and it's in the background, our brand lives where customers interact every day at checkout in the store. And as a result of that, we are where customers are, we believe that we're building a much deeper connection with customers, relative to other traditional credit issuers.

We're also a technology business. And in the last year, we've seen a lot of investment in products and engineering, currently around 1/3 of the workforce and anticipated to grow meaningfully over the next 12 months. We also believe that the business model has attractive unit economics. Our cash gross profit margins are well above 50%. And as volume -- increasing volumes approach on the platform, the operating leverage drives higher cash EBTDA.

We also acquired customers through our retail partners, which means that our cost of acquisition are in the single-dollar digit space relative to banks, which can spend up to a few hundred dollars to acquire credit card customers.

And then finally, we see a massive opportunity in Australia alone. We believe it's about $1 trillion payment opportunity across credit card, debit card spend and build. And obviously, there is global.

So on Slide 7, really what we're doing is bringing customers and retail partners together through a fair and valuable payment experience. We're investing in the platform. We're investing in great customer experiences and a lot of data. And we believe this interaction between customer experience, investment in platform and data enable the network to grow and the insights to allow us deliver much better products and services to our retail and customer base.

Our responsibility is also a very important part of who we are and is in our DNA, that's been baked into our DNA since we started 6 years ago, growing our responsibilities. We've tried to do a number of things. Number one, we've built our products focused on interest free in contrast to the interest-bearing credit cards. We try to be very transparent in the way that we communicate our fees to customers. We also have run ID and credit checks since inception, and we also pull bank transactional data to ensure that we understand our customers and a model that doesn't rely on customers falling into arrears.

And finally, products and services like Pocketbook, which are free, enabled customers to get on top of their financial management in a very clean and great user experience, and we're investing a lot more in that side of the business.

As we mentioned on Slide 9, the sector that we are in is undergoing enormous growth, but really only at its infancy. What we're seeing is about 7% of online spend is currently running through alternative Buy Now Pay Later rails. And the growth rate has been about 5x over the last 2 years. So based on these growth rates and the decline in credit card, you can really see that these alternative payment types are going to become a much more meaningful share of the checkout, not just online but also in-store.

The other really interesting statistic is, while it's very focused on the millennial segment, we're starting to see 1 in 5 GenXs now used Buy Now Pay Later. Again, a simple credit product, easy to understand, very simple product construct.

We're also seeing a lot of technology supporting the adoption of payments, whether it's biometrics, one-click checkout. And the sector in the last 12 months has seen open banking accelerated, comprehensive credit reporting and a positive review from the recent ASIC review. So our view is this is a very exciting sector to play in and it's really only at its infancy, and we believe we've got a very, very long way to go.

So in summary, we believe it is a massive opportunity in Australia and globally. And our intention is to build a very, very large business. Our model is very simple. Let's get more customers transacting in more places more often. On the customer side, we are very focused on Australia. We're now focused on New Zealand after our recent PartPay acquisition and moving globally into the U.K. with strategic interest in the U.S. and South Africa. We're also announcing today that we are launching interest-free installments for small business. We think that's a very large segment and one that we are uniquely placed to service more places. We are very focused on allowing our customers to transact everywhere every day. So we're going to be getting into new verticals, telco utilities every day, and also starting to form some partnerships with a lot of payment players.

And finally, investing in more often, which is around investing in the native app, products and features, personalization and a lot more utility, and we believe that we can focus on more customers transacting in more places more often as all tech companies do, we have aspirations to grow 10x over our future growth.

So jumping into the business update on Slide 12. Last year, we said that we were going to drive $1 billion in annualized transaction volume. We're looking to hit 1 million customer accounts and achieve tighter breakeven. So we believe we've done a really good job. We finished the year with $1.1 billion in aggregate transaction volume, and we're annualizing about $1.4 billion at the end of the year. We achieved 1.3 million customer accounts, and we've had 6 consecutive quarters of positive cash EBTDA.

And we've also been able to deliver a 4.9% rating in the App Store with the top 10 ranking. And it's been 12 months when we actually launched the app we've had about 1 million downloads, which we are really excited about.

The scorecard on Slide 13 has shown north of 100% growth in revenue year-on-year. We finished the year at $84 million. And just in the last quarter, we generated $26 million of revenue. So that implies annualizing over $100 million in revenue. Customer numbers were up 80%. Transaction volume finished at $1.1 billion, as mentioned. Our receivables were also up about 100% to $680 million. We finished the year with 16,000 retail partners, up 50%. And pleasingly, our net bad debt numbers fell by 100 basis points thereabouts, from 2.6% to 1.6% and the guys are going through that in a bit more detail.

On Slide 14, as you know, we think about the economics of the business in cash EBTDA yield as a percentage of average receivables. We've been able to show -- so if you kind of go through the figures, revenue minus cost of sales or cost of goods sold minus fixed cost gets you to cash EBTDA. You can see across all those 3 lines, revenue has pretty much been flat over the periods. We've seen a good reduction in our cash cost of sales and also the operating leverage driving down the fixed operating costs.

So 17% was the last reported revenue yield, less 8% cash cost of sales, less 7.1% fixed cost delivered a 2% cash EBTDA, which is a marked improvement over few hours ago. And we believe we have a long way to go. We've also, today, updated our medium-term targets, which is around a 2- to 3-year view. We've reduced our revenue yield target from 20% down to 18%. We've also reduced our cash cost of sales from 8% to 7% and fixed costs from 5% to 4%, which really means that we're still targeting the same 7% cash EBTDA.

If you look at the drivers going forward, on the revenue side, we believe things like every day are likely to have a reduction in the overall yield. But solutions like business installments and going global, we believe, are likely to drag that number up.

On the cash cost of sales, bad debts are currently 1.6% and we do anticipate those debts to grow over time. But equally we see huge opportunity to reduce the funding costs with the current program. So while some of the numbers above had moved, we still believe that we can achieve a 7% cash EBTDA yield. And I think most importantly, if we invest in increasing fixed costs, what we are seeing is a very attractive unit economics at the gross profit line 18%, less 7%, gets us to a gross yield of 11%. And as we mentioned, gross profit margins are above 50%.

If we kind of move over to Slide 15, a quick overview on customers and then we'll go through retail and product update. Interestingly here, what we're seeing is 1.3 million customers with an average age of 34. So what's interesting there is 55% of all customers were in the millennial bucket, but the average age is actually an older millennial. And I think that speaks to that these products are now being adopted much more mainstream. We've also seen in-store pickup, Zip now is accepted in-store at places like Bunnings and Target integrated into the point of sale, and we're driving much more transactions in-store. We believe we've got a long, long way to go, if you look at the penetration of Zip in in-store.

And interestingly on the gender split, we did see some growth. We were a lot more weighted towards female, but now 63% female, 37% male. The app has continued to feature as a cornerstone in our relationship with customers and is getting a lot of daily views. You can see here a range of screen shots. In the next quarter, we'll be introducing QR code to improve the in-store payments experience and continuing to invest in the products and features you can see here, store, navigation and search.

So the team is doing a fantastic job there and driving a lot of -- driving really high growth in monthly active users, and that's a really important metric to staying close to our customers.

On Slide 19, which I think, you can see over there, we saw a 53% growth in retail partners, and it was a really great year. We did bring on a lot of big brand names, which has continued to improve the value of the network and the pipeline is looking really, really exciting. In the last few months, we've seen the likes of Kmart, Air Asia, Bing Lee, Just Group hop on and there's many, many more due to the announced. Interestingly, we see the segment breakdown retail at about 50%, home 20%, health 6%, auto and travel and we're at about 37,000 points of presence. We're going to start referencing points of presence because we believe more places that customers can ease up is really important, so that's going to be a big focus. And interestingly, the average order value across the transaction platform is around $217, which just shows the value that the Zip transaction brings relative to traditional credit cards.

On Slide 20, we talk about one of our big missions is really to embed ourselves across the core payment ecosystem. That's with banks and acquirers, POS vendors, e-commerce platforms, card schemes and payment gateways, really important to achieve the everywhere strategy. As you know, we are in discussions with Westpac around integrating Zip into their fleet and that's currently underway. They've successfully tested a transaction and the terminal, and we'll be looking to roll that out this year. We are also in discussions with a number of other banks.

Interestingly, we also announced quite a marquee announcement with the Adyen agreement. This is the first master merchant or merchant of record relationship, which allows Adyen to wholesale Zip to its base, they have range of exciting customers such as the Uber, Ola, Groupon, et cetera. And through this integration, it will enable Zip to be turned on very, very easily. So that integration is almost complete, and we're hoping to win a lot of business through their network. And what's key here is really to expand the acceptance. It's really important that we continue to foster these channel relationships.

I'll now hand over to Peter Gray, who will take us through the exciting announcement about Zip Biz and also jump into credit and funding. Over to you, Pete.

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Peter Gray, Zip Co Limited - COO & Executive Director [3]

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Thanks, Larry. Look, really pleased to be able to talk to you guys today about a new product opportunity for the business. So Zip Biz is coming. I guess, by way of background, the small-to-medium business market is extremely large and underserviced by the banks on any sort of construct. They're the backbone of the economy, 2.3 million SME businesses, representing 99% of all businesses registered in Australia. The segment actually contributes about 57% of Australia's GDP. So not an insignificant amount.

The sector creates 7 million jobs. So a large contributor to the employment market is housed in this sector. So essentially, Zip wants to be able to help these small businesses grow and scale. We're going to level the playing field, give them access to better financial services and products and experience and services, a system to manage their cash flows, and we would also like to play bigger role in the community.

So what is Zip Biz? So essentially Zip Biz is an interest-free line of credit with an installment option product for the small business community. So very similarly to the consumer side of the business. It's a fair, transparent and inflexible product up with decisions about -- up to $25,000 in terms of the available line. We really believe we're uniquely placed to offer this product throughout our network. So essentially, we have 16,000 points of presence in market already. So we have a very strong distribution network to acquire small business customers to transact in our closed-loop environment. So many of the customers transacting on our platform with the likes of Officeworks and Bunnings are small businesses.

So we're sort of uniquely placed to sort of capture that traffic onboard and in real-time using our core capability of micro credit decision, which is really, really exciting. So we hear from our retail network anecdotally that tens of thousands of old school trade credit accounts being carried on balance sheet by a large number of our retail partners. We have the ability to offer those customers a Zip Biz account and immediately have them transacting throughout the Zip network. Further, similar to PayPal credit, in America, we have a large network of small business customers using the Zip platform to offer to their consumer partners who are expressing a need for small business credit.

In terms of a quick update on Pocketbook. So Pocketbook currently has over 700,000 bank users, have in excess of visibility over 500 million transactions on a yearly basis. We have the first open banking integration with Macquarie Bank. Obviously, open banking legislation has now centered. So we'll see more of these sort of the integrations.

The Pocketbook business continue to provide the categorization engine or the Zip underwriting platform, which is a key component or a key pillar of our market-leading underwriting platform. We'll be investing significant amounts in the Pocketbook business over the next -- the course of the next 12 months, and we have some very exciting development to share in the short term.

In terms of the brilliant basics and some of the things that we sort of are addressing as we continue to scale, we remain a technology-led business. We continue to invest to maintain our path to sort of world-class products and services. We have touched on a core competency in our credit and decision platform. It is already delivering world-class results. We're very well capitalized in terms of equity and credit facilities, and we have maintained a very strong focus on our people with north of 230 staff now, not an insignificant number. Company incentive programs have been launched, and as Larry touched on earlier, we really have updated our purpose and mission and have a very loyal staff.

So moving on to the financial results in Slide 26, by way of reference, look, another real highlight of our financial performance is the continued performance of the credit in terms of the performance of the receivables. So as Larry highlighted, net bad debts of 1.63%, which is down from 2.61% at June 2018. Now that really is a market-leading sort of performance when compared to any of our peers. Arguably, marginally low for business of our size and we really have the ability to sort of tweak our scorecard to maximize our revenue appetite at the front end without compromising the back end and bad debts. The arrears performance has remained largely steady throughout the previous 12-month period, obviously heavily predicated by seasonality, but very similar in terms of performance. And the repayment profile remains sort of really healthy 13% to 14%. So effectively, the capital or the receivables are recycling once every 7 or 8 months gets to really well placed sort of platform should there any changes to an economic environment, any changes that we make to our scorecard, to decrease or increase risk are very swiftly felt through the performance of the receivables, given that fast repayback period.

Turning to Slide 27 in the credit underwriting. To highlight, we ID and credit check every single customer, significant differentiator from our peers and other Buy Now Pay Later providers. We consume more data at the point of application than any other financial services provider in Australia. This data allows us to provide great consumer experiences, real-time compliance decision and significantly better performance in terms of the output of the receivables. We're just sort of highlighting some of the data points that we're consuming at that point of application, very strong use of banking transactional data, which we see is underpinning unsecured consumer credit decisions.

In terms of the funding update, moving through the deck, we currently have 2 funding programs in place. The NAB Bank Trust or the 2017-1 Trust, that facility is available in the financial year totaling $560 million. We've recently increased that to capacity of $660 million in July. We've also extended the term until 2021. As at the end of June, $530 million had been drawn.

We also have the 2017-2 Trust, a more expensive but very flexible trust available to fund receivables in junior notes. This facility is currently available until December 2020. Of the available $71.5 million facility, $57.5 million had been drawn on the 30th of June. We retained an equity position of $72.5 million in the trust structure.

Important to call out that currently our weighted average interest on loan outstanding is approximately 4.65%, this is down from 5.19% at the end of the previous financial year. So a good result. We're currently in the process of launching the Zip Master Trust. This is a structure that's very similar to the Latitude Master Trust, which is a very robust and scalable sort of vehicle or structure designed to meet our funding needs over the medium to long term. This week we launched our initial issuance of rated notes into the structure, and to be fair, the level of interest has been exceptionally high. This will be one of the largest Fintech deals of its type globally. We went to market with an initial issuance of $400 million with the potential to upside that to $500 million. The transaction is proceeding very smoothly, as I touched on, interest has been exceptionally high. We expect to close that transaction and settle on the 5th of September.

While we expect to realize a material interest reduction in the future issuance, the initial issuance has been subject to a rating cap and enhance subordination requirements to basically due to Zip's Limited trading history. While we've been demonstrating great results for 5 years in terms of credit performance, that is not a long period of time for a rated issuance. Accordingly, in the short term, we do not expect a significant sort of variation to the interest rate level. But over time, we expect to get material benefits and scale from this structure. Slide 29 provides an overview of the structure that is being implemented in the Zip Master Trust.

Over to Martin to provide some further financial update.

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Martin Brooke, Zip Co Limited - CFO [4]

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Okay. Thanks, Pete. So we're now on Slide 30. As covered before, portfolio income hit records level at $83 million, 111% increase on the previous year. As a reminder, our revenues generated from both merchant and consumers, approximately 40% from merchant and 60% from consumers with less than 1% coming from bank fees.

Also just to remind you, our portfolio income includes revenue on accrual basis using the effective interest method. Merchant fees, establishment fees and monthly fees being recognized as the expected repayment profile, which is 6 and 12 months, respectively, for Zip Pay and Zip Money. Fees that are added to customer accounts but not recognized under this method are reported as unearned future income and shown in the balance sheet as a reduction of cash receivables.

Following the review of their repayment profile, the Zip Money customers in the second half of the financial year, the expected repayment profile for Zip Money customers has reduced from 14 months to 12 months, which will -- you'll see noted in an annual report without any material impact on the -- on income.

Cash cost of sales which comprised the interest bank fees, data costs and net bad debts written off, increased 56% year-on-year and cash gross profit increased 208% to $43.7 million. Cash operating costs increased 49% and the group reported positive cash earnings before tax depreciation and amortization for the first time of $9.3 million, up from a negative $8.8 million in the previous year.

As discussed before, the group continuing to demonstrate operating leverage in the cost base and the increase in revenue obviously far exceeds the increase in costs. The movement in bad debt provision reflects the increase in receivables balance and the impact of AASB 9, whereby we are provisioning for expected credit losses at a rate of 3.75% as compared to 3.3% previous year. We'll look at the impact of AASB 9 in a bit more detail in the later slide.

Amortized finance costs include the costs associated with entering the group funding programs amortized over the term of those facilities, and it obviously includes the costs associated with the lieu in the 2017-1 facility for an additional 2 years in May.

Depreciation and amortization increased largely due to increased amortization of the group's IT development and software, and depreciation on the new currency has been straight.

Earnings before taxes improved significantly from a loss of 22.5% to a loss of 11.1%, a 50% reduction. For the first time, the group recorded a taxable profit, and we grow unrecognized tax losses to account to extinguish the tax liability.

Turning to the next page and looking into our costs as a percentage of average quarterly receivables in a little more detail. Our cash cost of sales have dropped from 11.1% to 8.2%. Interest cost has dropped from 5.7% to 4.8%. We exited the expensive legacy funding program in November 2017 and are currently using the funds from the capital raise to support the acquisition receivable.

Bank fees and data costs had dropped from 1.7% to 1.1%, as we renegotiated the unit rates on the back of increasing volumes for both expense items and will continue to do so. Net bad debts written off better consider as a percentage of closing receivables, but for the year we rose our net amount of $10.8 million compared to $8.2 million in the prior year, which is very pleasing results given the growth in receivables.

Bad debt recovery is running at approximately 12% of the amount written off. We retained ownership of all debts that we write-off and we used the services of the third-party to help us recover the debts written off. We paid them a percentage of the amount they collect.

Headcount is the largest component of our operating cost base comprising 50%, 7% of cash operating cost. Permanent headcount totaled 185 at the end of June, up from 138 at the end of the previous year and 155 at December. We also have a temporary workforce of approximately 50, which brings us up to peak number of 230.

The group has invested and will continue to invest further in the product and technology team and add to the operations team to support the growth in volumes. The group increased its spend on Google and Facebook ads in the second half to help drive consumer acquisition, and we continue to use these sourcing channels extensively. This is sliding further into the increasing marketing cost.

We also had increased marketing activity year-on-year with initiatives including joint campaigns with merchants, largely spent on point-of-sale marketing, online marketing as well as attendance at the great number of retailers. Other operating costs or increase in occupancy as the group moves office and also an increase in IT cost to support these growth. I'll now move into the balance sheet, the group reported cash of $12.6 million on the balance sheet, of which $6.4 million is held in the accounts of trust and is reported as restricted cash and is not available to the credit of the company. Also should be noted that much of the balance of the $6.2 million rate the cash that returns to the trust the following day.

The group does not retain cash on the balance sheet, rather investing notes in the trust to reduce the need to grow expenses funding. Rather than sit with money on the balance sheet, a 12% for cost of funding in some of the trust, we actually use it. Due to the timing of the June '18 year-end, we reported $4.9 million in customer payments and other receivables and $8.8 million in payment to partners and other payables. These amounts represent timing differences in both the receipt in payments, whereby the amounts have been recorded in the customer receivable, but the funds are not received or payment made until the next working day. These timing differences occurred at higher level of June '19 as month end fell on a Sunday compared to a Saturday of the previous year.

Growth in receivables as we reported net of earned earnings and allowances bad debt reflects the increase in borrowings and the use of funds on the capital raise on receivables. Group had equity of $72.5 million at the end of June '19, which is significantly above the levels of the subordination required in the trust on an ongoing basis, and the excess can be withdrawn and use to fund the group growth plans as required.

Gross receivables increased by $366 million, excluding the impact of bad debt write-offs over the year to $683 million. Of the increase, approximately 95% is going to principal equating to $348 million as borrowings increased by $298 million, a balance of approximately $50 million being funded by the capital raise. Goodwill rates, the Pocketbook acquisition in previous balance of year, other intangibles includes the group's investments in its proprietary software, identifiable intangible assets arising with the Pocketbook acquisition.

As we reported previously, Pocketbook will hit all the milestones set at the time it was acquired and according to the first consideration has been settled in shares are no longer sitting as liability on the balance sheet.

Moving on to the cash flow on Page 33. Generated a positive cash flow from operations of $22.6 million compared to $1.4 million in the prior year. Of the 22.6%, an enormous 15.1% was generated in the second half. Payments for property plant and equipment were insignificant for the year, payment in the previous year reflecting the fit out of new office. We invested a further $3.6 billion in proprietary software systems in the year and moving into movement in receivables is obviously supported by the movement in borrowings and proceeds from the capital raise.

We raised $56.8 million from a capital raise and $1 million from the conversion options. Equity raise was significantly oversubscribed and comprised $48 million to -- $42.8 million from new and existing institutional sophisticated and professional investors, a $5 million under share purchase plan and pleasingly Westpac exercised (inaudible) right granted at the time of the original investment raising $8.9 million. Capital raise incurred cost of some $2.3 million and borrowing cost rates -- the cost of extending the group 2017-1 facility, as mentioned previously.

Just looking at the impact on AASB 9, obviously as required, we applied for the first year of this financial year. The impact is to require the group to recognize bad debt on an expected basis rather than an incurred basis. To do this, we take account of undrawn credit limits when calculating the provision on performing facilities, undrawn facilities for those in arrears. We also adjust for recoveries and take out the macroeconomic factors and modeling risk (inaudible) provision.

Our modeling at July '18 require us to increase the provision at that date to $14.5 million or $4.05 of receivables, compared to $9.5 million or 3% receivables at 30 June paid the day before. The adjustment to $5 million is reported in adjustments to the opening balance as required under AASB 9. At 30 June, 2019, we reported a provision of $25.6 million or 3.75% of closing receivables. This reflects both an improvement in the roll rates of June and a reduction in the period over which we provide against definitely nonperforming receivables as a consequence of the 2-month reduction in the payment profile.

The impact of this reduced repayment profile was to reduce the level of provisioning by approximately 0.2%. So pretty much immaterial. Importantly, the adoption of AASB 9 has no cash impact on the group.

On that note, I'll hand back over to Larry.

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [5]

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Thank you, Martin. So we've gone through in about 35 minutes the year that was, which is all old news. And here we are 6 years into the business, and it genuinely feels like we're only getting started. So we want to talk to you about what's next. So we are a growth business, and there are really 3 pillars to our growth story. Number one is focus on core. We believe there's a long, long way to go there. Number two is around product and segment expansion, and number three, which is a really exciting announcement, in just this last week, is around global expansion.

So moving on to Slide 37. The core for us is still a huge, huge focus. If you look at Zip, we represent under 1% or about 0.2% of the Australian retail market. So just bear with us, if we've used retail dollars rather than total payment for the purpose of telling the story, but in our view it's not just retail. I think Zip has proven our ability to work in bills, utility and across many other categories. So step -- firstly and foremost, we really need to continue to increase the places of acceptance. We're only at 37,000 places and many times, the customer doesn't use us because we aren't available over there. So we need to make sure that we can deliver everywhere, and we've got a strong pipeline of retail partnerships, but also strategic partnerships to help us accelerate.

Number two is around customers using us every day. Big focus for us internally is around not the total number of the customers, which we have about 1.3 million, but how many of those customers are transacting every day, every week, every month. If just those -- that segment achieved all of that, the volume would be multiples and that's before any further customer acquisition. So let's continue to drive engagement, investment in the native app, invest in personalization and our feature set.

And then thirdly, drivers in the core are really our people, who we call Zipsters. And we genuinely believe this is one of our secret weapons. We like to hire people that have a growth mindset, are evangelical about what we are doing, are customer fit and passionate about the product. And we certainly would not be here today without the team that we have built. They've done a great job, but we all need to continue to grow to achieve our goals over the next few years.

In the product and segment expansion, we're looking to move into other verticals, utilities, telco, every day. We believe we can prove to be a true credit card disruptor. We're seeing initial learnings from a lot of the work that we're doing, and we believe we can move into anywhere payments accepted. And then as Pete touched on earlier, very exciting today to announce that we're launching in the coming months Zip Biz, interest-free installment for small business. It's really a natural extension of what we're doing anyway. We have lots of traders and micro proprietors. This is an extension of that and really allows us to accelerate the customer size.

And finally, we're looking to launch the next version of Pocketbook, which is very exciting in a market where a lot of investment is going into digital banking. Pocketbook has a 700,000 user base and a really great opportunity. So focus on the other side of the ledger customers, who are looking to say don't want credit, who aren't eligible for credit, we believe we can have a really strong relationship with them.

So while we are focused on Australia, what's become clearer to us is that the global opportunity really dwarfs the local region. $320 billion in Australia, it's around 1% of the global retail spend of $22 trillion. And if you look globally, while we're hearing a lot of noise, if you look at the share of Buy Now Pay Later and alternative payments, it is absolutely minuscule, and we believe it's still very much in its infancy and really important for us to really for us to start to have a conversation.

And so as a Board, we decided that global is really important. It's been a discussion for quite a while, but we have to wait for the capital raise to be in a position to actually achieve our mandate. So global is now an important part of our growth story, and we're very excited to have brought the PartPay business into the Zip fold, which we announced earlier this week. This provides us a platform to accelerate growth globally, but still remain very focused on the Australia and New Zealand market. And as a result of the transaction that we announced, we acquired 100% of the New Zealand business, of the U.K. business and the strategic interest in South Africa and America.

PartPay is a leader in the New Zealand market, they've managed to bring on some of the largest retail groups in that region, recently just announced The Warehouse Group and currently rolling out across their business. Spark, which is a large telco. The U.K. business only launched earlier this year. There's a small team on the ground. It's very, very early stage, but it provides us a big chance to roll out there.

QuadPay in America is a very exciting interest-free installment solution. It's a couple of years old. It was actually founded in 2018 on the PartPay code base and which was one of the attractions to us. And they're growing very, very strongly over in the U.S. and similarly Payflex was also built on the PartPay technology stack.

So the rationale for the acquisition, I'm sure we'll get a few questions later. So we acquired PartPay for NZD 50 million upfront, and there is a $15 million earnout over the next few years based on transaction performance milestone. At the same time, we also increased our shareholding in QuadPay to 15%. Now the reason that we've gone down this path is for a few reasons. Number one, we found the PartPay team to be incredibly culturally aligned with Zip, buying businesses, merging the businesses is not just about the strategic alignment, it's about the culture alignment, and we found Simon and the team to be absolutely fantastic and the same mission and the DNA as us. Pleasingly, they also have a very strong focus on responsibility. Their platform in New Zealand already does credit checks, already does ID check and they've built a lot of techniques into the products to ensure suitability first and foremost.

Secondly, it's a separate technology stack. Has been proven in many, many markets, it's portable and can be set up very quickly, and this allows us to very quickly move global. If we try to do it with our current road map in Australia, we're probably a year away, and we believe it's a great timing opportunity. We can enter the New Zealand quickly, we can enter the U.K. quickly, and increasingly we believe that payments is going global. There's more importance to be global, a lot of payment partners that we deal with are global and this is the next phase. And really technology is enabling this. Many, many years ago, would've been much more challenging. Nowadays if you plug into Magento or in Australia, you can plug into Magento in the U.K.

So in terms of next steps on this transaction, on Slide 41, we're aiming to complete in October post a shareholder vote. We'll then integrate PartPay in the coming months which will rebrand in New Zealand, rebrand in the U.K., integrate product technology and people also allow us to have a distributed workforce, which we're really excited about with great tech talent in places like New Zealand.

There's many Australian retailers that we can take across Tasman and we'll be looking to do that. And we plan to come back in a few months at our November AGM to update the market on the U.K. rollout. We also have the right to board seat in QuadPay, and as a strategic investor, we'll stay very, very close to share learnings and continue to explore opportunities in the Americas. And we'll continue to monitor markets of interest. Now that we have a great platform, we will look -- we are looking actively at strategic partnerships that allow us entrance into various markets, and we can be flexible in how we deliver on that mandate.

So before we talk about the outlook, I think just a quick update on the conditions that we're seeing and how that informs how we think about next year. So number one, we're seeing strong demand from retailers for alternative payments and Buy Now Pay Later at the checkout, more and more businesses are looking to offer alternative payments. That's really a positive dynamic.

And the general decline of credit card, which, if you speak to most banks, is meaning that there's a lot of adoption coming for the Buy Now Pay Later type product, which is a simple, easy to use, easy to understand credit product, where customers feel like they have control, and we're seeing that adoption across all 8 segments. And we spoke about overseas, still very, very early, and we believe the timing is now. Interestingly as well, we're seeing upgrades across most of our business partners, whether it's at the point of sale, ERP, terminal and this technology revolution is allowing integration to happen quicker, faster and smarter. We are seeing heightened competition in the local market, more players entering and more players starting up. This will result in pay to play, a lot of retail -- a lot of players are paying to get into retailer checkout. We have seen margin compressions and increased marketing spend.

And on the debt side, we've seen falling interest rate environment, which is improving our servicing costs. And Pete and Martin were out on the debt roadshow and the great demand there is showing the chase for yield and high-quality credit.

So as you think about FY '20, we are extremely excited. We are cash flow breakeven. As Martin mentioned, we have $70 million sitting in the trust, the large chunk of that has come from our recent capital raise. We believe we are well-funded to achieve our road map here. Target for next year, 2.5 million customers by June and $2.2 billion in annualized transaction volume. Locally, we're going to be pushing hard in installments for business and strike a couple of deals with some smart partners to accelerate acceptance and revamp Pocketbook.

More investment is going into technology. We're lifting availability, lifting SLAs, lifting performance, which is really exciting for us and important for us in order to continue to foster deep strategic relationships with different counterparties. And we're investing -- we're going to be investing more in brand, brand awareness, customer acquisition and partner marketing. The Zip brand is in many windows, but we need to get it out there and start to have more conversations with our customers.

And then finally, international. We will integrate PartPay. We will grow the New Zealand market share and launch in the U.K., whilst exploring other opportunities. So that brings to an end the formal presentation, and we're happy to open it up to Q&A. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first questioner is Jonathon Higgins from Shaw and Partners.

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Jonathon Higgins, Shaw and Partners Limited, Research Division - Analyst [2]

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Just a couple from me quickly. Just firstly, just around this business loans product. We're seeing sort of rates in market from anywhere sort of ranging from 30% to upwards of 40-sort-of percent and you've talked towards in one of your slides, sort of seeing a little bit of a benefit, I think, towards increasing above 17%, back up to 18%. Are you able to give us any early thoughts on sort of duration? Or how that product is going to be geared at this stage?

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Martin Brooke, Zip Co Limited - CFO [3]

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Okay. Thanks, Jon. So the product construct is fundamentally different to some of the other small business lending products in markets. So it essentially will be an interest-free line of credit, disrupting old-school trade credit-style account. So very short duration in terms of the payback. So the customers will have the ability to make multiple transactions under their line and structure the repayments to pay back in a very short period of time. So we anticipate it will be strong on the yield side. I guess, we -- that will be the balance of maximizing yield and how aggressively we want to push into market, but we are anticipating very strong uptake from products.

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [4]

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I think, Jon, I would also just add that this is an interest-free product. It's not interest-bearing product. So very much similar to the Zip Pay construct, where customers will enjoy into interest-free terms and be able to use the account to pay Bunnings and the like on interest-free installment.

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Jonathon Higgins, Shaw and Partners Limited, Research Division - Analyst [5]

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Just a couple others for me. Just in regards to just your slide around your outlook, you're sort of talking towards 2.5 million customers end of the year. And if I'm reading that right sort of $2.2 billion of annualized sort of transaction volume, which it could be 1 month by 12 sort of end next financial year or quarter by 4, whatever it may be. If you sort of check 2.5 million customers by sort of your average spend that you've been doing this year throughout the period, you get sort of a materially higher number than that sort of $2.2 billion of annualized volume. Is that being driven by sort of expansion into overseas markets so we will potentially see the averages per customer coming down a little bit this financial year? Or how should we think about that?

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [6]

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Yes. So -- look, I think we were targeting 2.5 million customers, $2.2 billion in -- if you look last year, we did $1.1 billion, and we believe that we can double that next year, so ...

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Martin Brooke, Zip Co Limited - CFO [7]

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Yes, I think -- and also, Jon, the end number is the target by the end of year, which would reflect the run rate in transaction volume to get the annualized transaction. So I'm not sure the equation you're using is exactly precise to get that number.

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Jonathon Higgins, Shaw and Partners Limited, Research Division - Analyst [8]

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Yes. Okay. No worries. And just in regards just to -- you've sort of revised some medium-term targets -- and last one from me, sorry. But you've revised the medium-term targets. You're sort of talking towards 2 to 3 years out. You've still got the 7% cash EBTDA margin. You've made a few changes just around that. Do we -- should we still expect cash EBTDA to scale as a percentage of receivables during this financial year? Or should we expect that you're obviously making some large investments that probably come within the second half of '20 to perhaps, say, just that margin sort of flatline a little bit while you do that? What can you tell us around that?

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Martin Brooke, Zip Co Limited - CFO [9]

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I think, you should expect me to flatline off the middle as we're investing in the initiatives that could be entered for this year.

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [10]

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Yes. I think what we're calling out is a lot more investment in technology, a lot more in people. Some of that does go to CapEx and lot is going into the actual intangible capital expenditure as well, but more in marketing and more in other parts of the business. So Pocketbook as a separate line we'll get more and we'll probably report that separately, similarly in the other markets. But I think what we're seeing is there is a huge opportunity now. It's really important for us to continue to spend in building the technology platform, making sure that we can connect into a lot of our strategic partners, hit those SLAs, invest in DevOps, infrastructure ops, cloud engineering, security. We also need to invest in brand awareness and product feature set. So we are turning the dial up a little bit as a result of that spending will go up, but what we will continue to see is strong economics at the economics level, which will then maybe push out the bottom line number a little bit. But when it does start to come through, it should come through at an accelerated rate.

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Operator [11]

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Your next question comes from Phillip Chippindale from Ord Minnett.

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Phillip Chippindale, Ord Minnett Limited, Research Division - Senior Research Analyst [12]

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It's Phil Chippindale, just to avoid any confusion there, guys. And I've just got a few questions. Firstly, just on the FY '20 target of 2.5 million customers, I assume that's across the entire Zip platform. And so that we should think about PartPay being included within those numbers, is that right?

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [13]

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Yes, that's right.

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Phillip Chippindale, Ord Minnett Limited, Research Division - Senior Research Analyst [14]

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And just to clarify on...

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [15]

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That also doesn't include -- that's not Pocketbook for 700,000. That's just the Zip wallet.

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Phillip Chippindale, Ord Minnett Limited, Research Division - Senior Research Analyst [16]

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Understand. You have referenced the PartPay customers of a bit over 110,000, I think. Can you give us a bit of a sense of what the split is between the geographies? Just so we understand how much exposure that business has to the U.K. currently versus, obviously, it's home markets like New Zealand and obviously Australia?

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [17]

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Yes, sure. I mean, most of it is definitely in New Zealand market. The U.K. market is only been up and running for a few months, that's still very, very early stage, which -- and we'll needing to invest in that go-to-market over there, but it's basically New Zealand.

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Phillip Chippindale, Ord Minnett Limited, Research Division - Senior Research Analyst [18]

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Okay. Just turning over to the Zip Biz proposal. Yes. I'd just be intrigued to get a little bit more details on that. I think Peter mentioned earlier, it will be short duration. What sort of duration you're talking about? Is it sort of 90-day product, being possibly less? And then the second question, just following from that is, obviously with individual consumers you do a credit check, that's one of the Zip offering is that every customer who joins on, does undergo a credit check. And I think in some instances, you'll actually review customers' bank accounts, et cetera, for transaction history. So just transferring that to a business, how do you propose to establish the credit worthiness of the business? Yes, I'd be interested to hear your approach on that.

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Peter Gray, Zip Co Limited - COO & Executive Director [19]

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Yes. Thanks, Phil. So the underwriting model would sort of -- and will be very similar to the consumer side. So obviously, we've build up a core competency and significant IP consuming all this data at the point of application. So similarly on the business side, it'll be heavily relying on bank transactional information and the ability to sort of model cash flows from that banking transactional data. So very strong -- sort of strong reliance on that. It also applied to usual credit bureaus to solve other risks sort of indicated there, but very similar to the consumer side. Yes, in terms of the product construct, so up to 60-day terms with the ability to flex the repayments to a 3-month installment products off the back of that. It's a very sort of fast duration. So enable customers to continually sort of make purchases for their business needs and manage their cash flows.

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Operator [20]

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(Operator Instructions) Your next questioner is Sameer Chopra from Bank of America.

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Sameer Chopra, BofA Merrill Lynch, Research Division - Head of Australian Research and Co-Head of Regional Telecom Research [21]

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Congratulations, very good set of numbers. I had 2 questions. Larry, one for you just on -- could you talk a little bit about cohort analysis? I'm just trying to figure out, if you look at people who were using Zip, say, year ago, how frequently were they using it compared with people that you've onboarded in the last 3 to 6 months? If you can give us a flavor around that, it will help us better estimate transaction volumes and how it is? And then, Martin, I'll have a question for you on provisioning shortly.

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Martin Brooke, Zip Co Limited - CFO [22]

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I might talk to that one, if that's okay. So I think we look at cohort analysis in a number of ways. One is obviously performance of the receivables further to sort of look at the underwriting models and sort of model how we're performing. The performance over time is getting significantly better, cohort by cohort, which is very pleasing that we're continuing to learn and we continuing to plug in additional data point. Similarly, in terms of transaction and sort of monthly transacting users and number of transactions, we're doing better and better and better over time with regards to that metric as well. One of the tools that sort of significantly assisted us there is the implementation of the app. So obviously we only brought the app to market in August last year, we have almost 900,000 users using the native app. So what we can see from those numbers is that these customers are more engaged. So they are using the product more. They're logging in more. They're transacting more. And lastly and not to be underestimated is, they're actually repaying better, so they're structuring the repayment more frequently to suit their budget and their lifestyle. So the output from the app is significant in terms -- of the original question in terms of transaction usage, but also in terms of credit quality.

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Sameer Chopra, BofA Merrill Lynch, Research Division - Head of Australian Research and Co-Head of Regional Telecom Research [23]

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When you look at the people, who are using the app, were you saying they are, say, 2x more frequent users, 3x, 5x? Just trying to get a sense of the order of magnitude as people get on to an app or have been on the platform for north of kind of 12 months, are they two, three, fivefold more intense users than the ones that have -- that are more recent? That just helps us dimension the business.

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [24]

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Yes. I mean, we can probably sit down and chat about it in more detail, but I think it's fair to say that the 2 metrics for engagement are retransaction and repayment, and then loss rates. So we're seeing across all 3 very, very different, much, much better to web is probably how we'd characterize it.

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Martin Brooke, Zip Co Limited - CFO [25]

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We'd have to take it on notice to provide you with a more accurate sort of number, but it's significantly higher usage.

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Sameer Chopra, BofA Merrill Lynch, Research Division - Head of Australian Research and Co-Head of Regional Telecom Research [26]

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Okay. My second question was just on provisioning. So the provisioning came down significantly to 3.75% versus 4.57% like-for-like kind of I think. Could you walk us through what's driving that down sort of thing? And why it's not static?

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Martin Brooke, Zip Co Limited - CFO [27]

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Yes. I mean, that's largely due to an improvement in roll rates from last year to this year. So when we get -- when we went through the model, the roll rates are factual, you take those roll rates and then, I guess, predict, expect or generate expected credit losses and the roll rates improved year-on-year.

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Sameer Chopra, BofA Merrill Lynch, Research Division - Head of Australian Research and Co-Head of Regional Telecom Research [28]

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Okay. And, Larry, probably one for you just on -- one of the slides mentioned the capital structure. I was just wondering, do you think you have enough equity on the book for the receivable balance that you have once the master trust its rate? Or do you think you need maybe a little bit more equity kind of thing because the equity position has been relatively static and the receivable balance has doubled and will grow again sizably as you expand out?

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [29]

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Yes, I might take that one. The way we kind of look at it is we have a combination of junior notes and equity that we can use to fund positions of about $130 million. If, for example, we were funding a book of $1 billion, then we will have a requirement to have 60% at the bottom of the debt stack, which would be $60 million. So that gives us sort of $65 million of space, I guess to invest and drive the initiatives that we're looking at. I mean, at the moment we, as I mentioned previously, we are significantly over subordinated. So we have a lot of money sitting in the debt warehouses, but we don't need to have that place to put funds at this point in time.

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Martin Brooke, Zip Co Limited - CFO [30]

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Yes. And I think the large chunk of that is the $55 million that we raised a few months ago, and we had a growth net, right. So we are cash flow breakeven. We're going to remain cash flow breakeven. So that's really around growth funding, and we see it adequate for our current road map.

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Operator [31]

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Your next question comes from Ben Hughes from EPIC Capital.

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Ben Hughes;Epic Capital;Director, [32]

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You've already confirmed the first question which is on the excess subordination in the structures, which are you saying just to confirm that the 6% will translate to Master Trust as a minimum level of subordination? And second to that, maybe I'll just give you the second question for Larry or Peter. Just on channel deals, such as Adyen or similar, on merchant sign up, are you able to do that electronically now? And is it opt-in opt-out electronic agreement, et cetera? Just trying to get a feel for that.

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [33]

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Yes, Ben, I'll take the first one. So subordination -- the 6% translates to master trust.

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Peter Gray, Zip Co Limited - COO & Executive Director [34]

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If you look at the master trust, the bottom note or F note are the notes that we have to hold. That's required to be 5%. And then you'll see there is also a seller interest, which is 1%, so we have to hold that.

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Martin Brooke, Zip Co Limited - CFO [35]

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Just on Slide 29, Ben, the Class F notes which is debt would be 6% in that structure. In terms of the second question, so it does depend integration by integration, to be honest. So some will be opt-in and some will be opt-out, but they can all effectively sign on automatically with something like Adyen sets as an example, effectively the option is enabled and the retailer basically would just need to turn -- go and activate it and then sort of -- we would work with them in terms of getting the collateral throughout the customer journey to ensure that that's set up to make them succeed. But in terms of the actual integration piece that's not required by that integration. And with the likes of Tyro, obviously, we're striving very hard to make that an opt-out sort of structure once it goes to market so they're able to sort of maximize the full extent of that reach.

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Ben Hughes;Epic Capital;Director, [36]

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And just to clarify, would you expect Westpac to be opt out?

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Peter Gray, Zip Co Limited - COO & Executive Director [37]

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We're working through that. First definitely is the technology integration, which has been green lighted. But absolutely we'd much prefer to have a model that scales far, far quicker than the one that scales slowly.

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Operator [38]

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Your next question comes from Justin Pezzano from Blue Ocean Equities.

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Justin Pezzano, Blue Ocean Equities Pty Ltd, Research Division - Investment Analyst [39]

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Congratulations on your result. My question is around the customer profile and the evolution of the profiles into the mainstream. I'm wondering if the change is really being driven by marketing or the type of merchants that you have? Or whether it's just a natural evolution? And what option or opportunity is there to accelerate that?

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Larry Diamond, Zip Co Limited - CEO, MD & Executive Director [40]

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Yes. So look, it's definitely reflective of both, because ultimately if you start out in a fashion segment focused of the young 20s, you're going to end up with polarizing towards that side. So certainly, the likes of Bunnings and other retailers will have a very different footprint. But I think if you -- we had a conversation with the bank the other day, the average age on the credit card portfolio I heard, was 52, right. So we shouldn't be surprised to see the GenXs using these products and services. So we are seeing this widen out. We have also seen the GenX segment use products, such as interest-free consumer finance, which still is predicated on the old credit card model and seeing them shift towards more leading-edge digital products.

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Justin Pezzano, Blue Ocean Equities Pty Ltd, Research Division - Investment Analyst [41]

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And just another question. In terms of the new markets, New Zealand and U.K., do you think they're going to pressure or make easier the medium-term target for revenue yield, cash costs and operating costs? How do you think that will evolve?

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Martin Brooke, Zip Co Limited - CFO [42]

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Yes. So I think I would say, given the profile of the product and payback being slightly quicker, I think that will have a positive uptick on revenue yield. I think our business can help also reduce the COGS there around credit losses and acquiring and collection costs as well as, obviously, funding. But I do think there will need to be investments in New Zealand to go a bit faster, rollout. That we would like to roll out more features. It's certainly involve using some of the work that we've done in Australia to bring that across. And so I think there'll be more investment in the fixed cost base to really drive accelerated volume as we bring on more and more partners.

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Operator [43]

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Thank you. We unfortunately do not have any more time for any further questions. That does conclude our conference for today. Thank you for participating. You may now disconnect.