PagSeguro Digital Ltd. Q3 FY2020 Earnings Call

Hello, everyone, and thank you for waiting. Welcome to PagSeguro's Third Quarter 2020 Results Conference Call. This event is being recorded, and all participants will be in a listen-only mode during the company’s presentation. After PagSeguro's remarks, there will be a question-and-answer session. Before proceeding, let me mention that any forward statements included in the presentation or mentioned on this conference call are based on the currently available information and PagSeguro's correct assumptions, expectations and projections about future events. While PagSeguro believes that these assumptions, expectations and projections are reasonable in view of currently available information, you are cautioned not to place your reliance on these forward-looking statements. Actual results may differ materially from those included in PagSeguro's presentation or discussed on this conference call for a variety of reasons. Finally, I would like to remind you that during this conference call, the company may discuss non-GAAP measures. For more details, the reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures are presented in the last page of this webcast presentation. Now I will turn the conference over to Mr. Ricardo Dutra, CEO. Mr. Dutra, you may begin your presentation.

Good evening, everyone, and thanks for joining our third quarter results conference call. Tonight, I have here with me Eduardo Alcaro, our Chief Financial Officer; Artur Schunk, our Finance Director; and André Cazotto, our Head of Investor Relations. We hope you and your families are well and safe. Everybody knows the past few months have been challenging, and we remain focused on supporting our clients, our business partners, society, and our employees. I would like to pay tribute to our extraordinary people who work at PagBank PagSeguro and who have been supporting our business from their homes in the last eight months. Thank you very much, PagBank PagSeguro team. Even without the continued impact generated by COVID-19, we see positive trends in terms of engagement, new client additions, and electronic payment volumes we are helping enable. Our results show our business is exceptionally resilient and improving day after day. I'm glad to announce that in this quarter, we reached our all-time high absolute TPV and historical records in net new additions for both merchants and PagBank users, results of our confidence and continued investments in our business despite the challenging scenario. It is also important to mention that during these months, we have been developing features and products for both our acquiring and banking businesses, pursuing to build the most complete and unique two-sided ecosystem to explore this huge addressable market. We are just starting. Regardless of the current moment, we are confident in our strategy and the opportunities ahead of us. We will continue to manage the business for the medium and long-term while recognizing near-term realities, which means adapting our company for the opportunities accelerated by COVID-19 while we invest to grow the company. That said, Eduardo Alcaro and I will present some slides, and we will have a Q&A session at the end. On Slide 3, we highlight the achievements of the third quarter. All-time high TPV reached close to BRL45 billion, growing 53% year-over-year, or 44% year-over-year, excluding the coronavouchers impact. Our online TPV grew 121% year-over-year, showing another quarter of acceleration. A sustainable and expected trend going forward as we expect online payments to be a growth driver for our company. Active merchants reached 6.3 million, adding 1.3 million new clients in the last 12 months, with a historical record of almost 0.5 million new merchants in one single quarter. Total revenue and income reached close to BRL1.8 billion, growing 22% year-over-year, a very strong rebound when compared to the previous quarter growth, also our revenue's record. Net take rate ended the quarter at 2.35%, down 37 basis points quarter-over-quarter, or 2.58% excluding coronavoucher products, down 14 basis points quarter-over-quarter, slowing down the decrease compared to the previous quarter, but still temporarily impacted by the TPV mix, meaning more debit card transactions and fewer credit installments, directly impacting our prepayment revenues. Non-GAAP net income was BRL330 million, reaching a net margin of 18.5%, or 28%, excluding interchange, as our peers report, still impacted by the pandemic and investments in PagBank. Our adjusted net margin, excluding pandemic and PagBank investments, ended at 29.3% in the first nine months of 2020, growing 2.6 percentage points compared to the same period last year, posting continued operating leverage in the core business. Additionally, we are glad to announce that in November, PagSeguro completed the acquisition of MOIP Wirecard, which will accelerate our online strategy. Moving to PagBank, our PagBank TPV, previously known as non-acquiring TPV, through banking, digital account, and wallet services reached BRL23 billion, growing 312% year-over-year, another triple-digit growth, or 286%, excluding coronavouchers. The Q3 2020 non-acquiring TPV volume is 12% higher than the full-year 2019 volumes. PagBank clients reached 6.7 million, representing all-time high net additions of 1.8 million in one single quarter. We reached 2.2 million consumers, growing 8x year-over-year, already representing one-third of our total PagBank clients. PagBank revenues reached BRL133 million in the quarter, up 190% year-over-year, reaccelerating when compared to the previous quarter and representing 7.5% of total revenues and income. Finally, we kept increasing our cash-in process through different products, with PAGS CD's clients close to 50,000, payroll portability transfer reaching 150,000, and finally, more than 400,000 transactions to TikTok, just two months after we officially launched this service. On Slide 4, we show the main Q4 trends. Our main top-line KPIs, such as TPV for acquiring and total revenues and income continue on accelerator mode. TPV is growing above 60% in October, and in the chart below, we can see healthy TPV trends compared to the first half of March, which is pre-COVID-19 in Brazil. TPV has been improving and, in the first half of October, reached 144% of the TPV of the first half of March, with both credit and debit presenting growth, although debit is still growing faster. PagBank TPV growing close to 300% year-over-year, and total revenue and income accelerating and growing high 20s year-over-year. Although we are in the middle of Q4 and still have some impacts related to the pandemic with a continued higher mix of debit, which is historically stronger than Q4 and continued investments in PagBank, we expect to improve our results and profitability. In Q4, we expect our non-GAAP net margins to recover and to be between 20% and 21%.

Thanks, Ricardo, and hello, everyone. It's great to be here today, and I hope you all are safe and healthy. In the next slide, we present our revenue figures. Total revenue and income grew 22% year-over-year, reaching almost BRL1.8 billion in the quarter, showing a strong rebound sequentially. Breaking down our operating revenues, transaction activities and other services grew 38% year-over-year also showing a very strong recovery compared to 4% in the second quarter. Our financial income revenue also improved when compared to the 8% decrease observed in the past quarter and flat on a year-over-year basis as a consequence of the consumer behavior during the pandemic, leading to fewer credit card transactions in installments in our transaction mix. Important to remember that our prepayment model is automatic, meaning that every credit card installment transaction is automatically prepaid instantly in D+14 or D+30 to our clients. In the charts below, we present the recent TPV market data provided by the Brazilian card association as of Q3 2020. The market is growing at 17% year-over-year or 10% excluding coronavouchers, with debit cards growing 41% year-over-year or 22% ex-coronavouchers on a year-over-year basis, while credit cards are only growing 1% showing how the mix changed across the board as a consequence of the consumer behavior during the pandemic. Based on those numbers, PAGS is gaining market share in both products, and our total volumes grew 4.5x faster than the market, excluding coronavouchers. In the next chart, we present our net take rate, which is the blended take rate net from transaction costs such as interchange, processing, and card scheme fees, that reached 2.35%, down 37 basis points quarter-over-quarter. Excluding the coronavouchers impact, our take rate reached 2.58%, or 14 bps down, already easing the pace of decline sequentially as a consequence of the temporary mix effect already discussed earlier. In the next slide, we present our cost and expenses structure and net income performance. Our non-GAAP total costs and expenses ended the quarter totaling BRL1.3 billion, growing 44% year-over-year. Breaking down categories, our sales and services costs grew 58%, driven by higher interchange costs, up 37% year-over-year, as we grew our TPV by more than 50%. Our personnel expenses grew 63% year-over-year as a consequence of the expansion of our PagBank teams hiring more tech developers, cards, credit, investments, sales and insurance professionals. Our D&A has also increased 200% year-over-year as a consequence of unprecedented merchant addition expansion during the quarter, boosting POS acquisition depreciation and higher amortization of product development and tech teams. Marketing allocated in sales and services also increased by 42% year-over-year with higher investments to promote digital wallet, PagBank products and engagement. Moving to selling expenses, we highlight costs related to chargebacks, declining as a percentage of the TPV from 0.21% to 0.18% year-over-year, even with higher exposure to online sales and a credit portfolio twice larger than in Q3 2019, driving to a healthy CAC. Non-GAAP net income reached BRL330 million, a decrease of 15% year-over-year, but 8% higher when compared to Q2 2020. It's important to remember that in every Q3, we have the stock-based long-term incentive plan grants, leading to a larger non-GAAP market-to-market adjustment. For more details, the reconciliation of these non-GAAP financial measures is presented in the last page of this webcast presentation. Bottom right, non-GAAP net income margin reached 18.5% in the quarter, stable compared to Q2 2020. We expect to expand net income margins in Q4 compared to Q3.

Moving to Slide 10. I want to share how we are positioning our ecosystem and strategy. PagSeguro was born online in 2006 starting as an e-wallet, PayPal-like model, from millions of Brazilians to pay online in a safe and easy way and, over time, became the largest payment provider for micro, small and individual professionals through a very complete omnichannel offering that goes from very basic entry-level mPOS devices to cross-border and online checkouts, not forgetting about self-service software features to engage and help our clients sell more and better. The payments market continues to be our core business, a market of BRL27 billion opportunity, mainly the long tail, that is still low penetrated with higher margins, few well-succeeded competitors and higher barriers to enter. Since the beginning of our banking journey in early 2019, we have been investing in new products, software, people, and marketing to position our company to enter into a much larger market. We believe PagBank is well positioned and developing a robust and unique two-sided ecosystem that combines payments, banking, digital wallet, investment and insurance to serve and cross-sell products and services to our active unique users and new customers, both sellers and consumers. All this, combined with a very strong brand and a unique scale due to a massive online distribution backed by UOL. In 1.5 years, we reached almost 7 million PagBank active users, probably the largest growth of additional banking in Brazil in a very short period of time. By launching and upselling new products such as banking, including cards and credit, investments, and insurance and expanding our approach to consumers, we estimate the market pool is almost 17x larger than payments. The pandemic accelerated this digital-first mindset for payments and banking, including millions of Brazilians for the first time. Combined with new initiatives such as PIX and open banking, we are ready to lead this digital transformation in Brazil. According to IBGE and Brazilian Central Bank, there are 68 million unbanked people in Brazil. Additionally, 28 million of the low-income population do not have a bank account, and 57% of the population are interested in adopting digital banks. Still today, 40% of the paychecks are paid in cash. 65% of the bill payments are also made in cash. And finally, 51% of the new bank accounts are opened just to receive the payroll.

In the first chart, PagBank TPV, previously known as non-acquiring TPV, reached BRL23 billion, growing 312% year-over-year or 286%, excluding the BRL1.5 billion volumes related to coronavouchers top-up. Moving to PagBank clients, we ended the quarter reaching 6.7 million users, growing 257% year-over-year and adding 1.8 million new users in one single quarter. In the chart below, we present the evolution of our consumer base. Consumers reached 2.2 million users in Q3, growing 8x year-over-year and already representing 1/3 of the total PagBank base, showing our ability to expand our addressable market, as we become a full complete financial digital ecosystem.

Thank you, Eduardo. Moving to Slide 14. I would like to comment about the existing opportunities in Brazil and how PIX could unlock massive financial volumes to be captured and incorporated into the financial system, consequently boosting the usage of PagBank. To start, we are happy to say that according to Central Bank's initial figures, PAGS was the third largest player in PIX key registration to be the account destination of PIX cash-in. This figure shows a very strong acceptance and engagement of our client base and reinforces our view that PagBank is becoming the final money destination for our clients, both sellers and consumers. We believe PIX will be complementary to card payments, mainly because the dynamics of the payments transaction is very different from a wire transfer. And also because of the maturity of card payments in Brazil, already established in our consumption culture with roughly two debit cards and one credit card per adult, representing 41% of our total private consumption expenditure. PIX presents the opportunity to boost electronic transactions and leverage financial inclusion to millions of unbanked and underserved Brazilians. PAGS also has the largest installed POS base in the country, which allows our sellers to offer PIX transactions through QR code, fully integrating our platform, bringing convenience, robustness, and security for transactions.

Thank you again, Ricardo. Just before we start our Q&A session, I would like to make an important announcement about the expansion of our senior management team. I'm glad to announce the promotion of Artur Schunck as our new CFO. Artur is a great talent developed internally that has done a fantastic job for PagSeguro over the last seven years, being responsible for accounting, FP&A, and the logistics teams, a top-notch professional with a strong background in finance at companies like Walmart and UOL. I'm not going anywhere, and I will take a new role in the company as the new Chief Business Development Officer, remaining as a PagSeguro Board member. The transition will be gradual and expected to occur within the next six months.

Hello, everybody, and thanks for the opportunity. I just want to say that I am very excited about the new challenge. After almost seven years as Head of FP&A, treasury, accounting, logistics and leading many relevant projects at PagSeguro PagBank. I am taking the role of CFO, willing to keep the great work done by Eduardo. Thanks to Eduardo and all of the team for supporting my journey until now. I am looking forward to enhancing our relationship in the coming quarters, and I hope we can talk soon. Having said that, we finish our presentation, and we will start the Q&A section.

Thank you. We will now begin the question-and-answer session. Our first question comes from Mario Pierry, Bank of America. Please proceed.

Hi, everybody. Thank you for taking my questions and congratulations on the quarter. I have two quick questions. The first one — and thank you for providing more color, especially on Page 13, this detailed breakdown of your — what you consider to be investments and impact on your margins. What I was trying to get when you say 3% impact from PagBank, is this a number that we should continue to see increasing over the next years? Or is this a number that we are peaking, and this number should eventually go to zero? Just wanted to make sure also that this number is just like one-time investments. They do not include recurring expenses. And then my second question is related to your credit portfolio. You mentioned you have been very cautious the last two quarters in originating new credits and you're ready to start lending more. But when you became cautious, what drove you to become cautious? Did you see a pickup in provisions? Did you see a pickup in delinquencies, and that's starting to normalize now? Was it really you were expecting, given the uncertain environment that things were going to get worse? If you can give us any color on the profitability of this portfolio, any — if you can share with us any ROA metrics, that would be very helpful?

Hi, Mario, this is Ricardo. First of all, good to hear you, and thank you for the question. Well, talking about the investment in PagBank that you asked, the 3%. I don't have here the exact percentage for the next year. But for sure, we will keep investing in PagBank. I don't think in 2021 or even 2022 we're going to see that going to zero because, as you can see, we are growing triple digits in terms of revenues, growing a lot in terms of users. So we have a lot of opportunities that we cannot decelerate at this point and save, I don't know, BRL15 million or BRL20 million in the bottom line instead of growing faster. So we will explore the opportunities that we have, all the opportunities that even COVID accelerated, more people getting digitalized and doing things online, buying online for the first time. So we will keep investing in PagBank. We gave some information about the next features we will launch in the investment side and in the insurance side, we just launched the marketplace today in the morning. So there is a long road map of features that we will launch. So that's why it won't go to zero for sure in 2021 and probably not even 2022, because there are a lot of opportunities that we have to explore. Regarding the credit, when the pandemic started in the second half of March, we kept evaluating our TPV, seeing the behavior of our merchants. And, of course, we saw a decrease. Some restaurants being closed. People not selling anymore. So, we decided to stop. We didn't see delinquency going up. But it's important to remember that we had to renegotiate some contracts because the merchants were not working and stores were closing. We started giving some credit again in July, because the economic activity in Brazil was coming back.