PagSeguro Digital Ltd. Q2 FY2023 Earnings Call

Good evening. My name is Kyle and I'll be your conference operator today. Welcome to PagSeguro Digital Earnings Conference Call for the Second Quarter of 2023. This event is also being broadcast live via webcast and may be accessed through PagBank website at investors.pagseguro.com. Participants may view the slides in any order they wish. Today's conference is being recorded and will be available after the event is concluded. I would now like to turn the call over to your host, Eric Oliveira, Head of IR. Please go ahead.

Hello, everyone. Thanks for joining our second quarter 2023 earnings results call. After the speakers' remarks, there will be a question-and-answer session. Before proceeding, let me mention that any forward-looking statements included in the presentation or mentioned on this conference call are based on currently available information and PagSeguro Digital's current assumptions, expectations, and projections about future events. While PagSeguro Digital believes that the assumptions, expectations, and projections are reasonable in view of currently available information, you are cautioned not to place undue reliance on these forward-looking statements. Actual results may differ materially from those included in PagSeguro Digital's earnings presentation or discussed on this conference call, for a variety of reasons, including those described in the forward-looking statements and risk factor sections of PagSeguro Digital's most recent Annual Report on Form 20-F and other filings with the Securities and Exchange Commission, which are available on PagSeguro Digital's investor relations website at investors.pagbank.com. Finally, I would like to remind you that during this conference call, the company may discuss some non-GAAP measures, including those disclosed in the presentation. We present non-GAAP measures when we believe that the additional information is useful and meaningful to investors. The presentation of this non-GAAP financial information, which is not prepared under any comprehensive set of accounting rules or principles, is not intended to be considered separately from, or as a substitute for, our financial information prepared and presented in accordance with IFRS as issued by the IASB. For more details, the foregoing non-GAAP measures, and the reconciliation of these non-GAAP financial measures to the most directly comparable IFRS measures, are presented in the last page of this webcast presentation and earnings release. With that, let me turn the call over to Ricardo. Thank you.

Hello, everyone, and thanks for joining our second quarter 2023 earnings call. Tonight, I have the company of Alexandre Magnani, our CEO; Artur Schunck, our CFO; and Eric Oliveira, Head of IR. Before Alexandre and Artur share the main highlights for the quarter, I would like to share the most recent milestones in the first half of 2023. We ended June with 29.5 million clients, who have benefitted from our comprehensive set of payments and Financial Services Solutions. We enabled our clients to experience a simple, safe, seamless, and digital way to manage their financial lives. By using our POS devices, our online and cross-border payment platforms, or our proprietary set of software in our digital bank, we surpassed more than BRL2 trillion in processed volumes. It took 16 years for the company to surpass the first BRL1 trillion in volumes, and only one year to surpass the second trillion. At the same time, we maintained our consistent and disciplined approach throughout various scenarios such as the pandemic, interest rate cycles, and changes in the competitive and regulatory landscape. Our strategy to combine growth with profitability has led to our solid financial position of BRL7.6 billion in accumulated net income and over BRL10 billion in net cash balance. We kicked off August with S&P Global attributing the highest rating in the local scale brAAA to BancoSeguro, our subsidiary responsible for the issuance of PagBank certificates of deposits, one of our competitive strengths in our funding strategy. I would like to emphasize our commitment to making financial lives easier for Brazilians by offering a one-stop shop solution through one app, one internet banking platform, and one customer care center. Now I pass the word over to Alex for his commentary on the second quarter 2023 highlights. Thank you.

Thank you, Ricardo. Hello, everyone. I would like to present how our growth, profits, and cash generation drivers behaved during the second quarter of 2023. Our earnings per share reached BRL1.18, 7% higher year-over-year. Our strategy to grow in selected verticals resulted in higher margins, with adjusted EBITDA reaching BRL849 million, 90 basis points higher than the second quarter of 2022, resulting in net income of BRL415 million on a non-GAAP basis. Our cash earnings grew 24% year-over-year, and our capital expenditures were 8% lower than the second quarter of 2022. Our one-stop shop solution has consistently attracted more client engagement. Total payment volume from our Payments division reached BRL92.7 billion, with PagBank cash-in of BRL50 billion driving up deposits on the platform. In the Financial Services division, we maintained a breakeven point despite the expected impact related to the regulatory change on prepaid and debit cards in Brazil. Adjusted EBITDA improved by BRL66 million compared to the second quarter of 2022. In the Payments division, we focused our strategy on key segments that kept us on track, resulting in MSMB TPV growing 10%, almost twice as much as the industry growth this quarter. Our merchant acquiring business remains solid, and through the combination of our superior value proposition and the broad reach of our sales channels, we have been able to grow above the market in the MSMB segment. During the first 45 days of Q3 '23, we noticed an uptrend in TPV growth to 8.5% year-over-year, increasing from 4% in the second quarter of '23. In MSMBs, we have improved our online sales channel, which we expect to continue contributing to TPV growth moving forward. HUBs showed further improvements in sales productivity and increased cross-selling of financial service through PagBank business accounts. This allows merchants to access our instant prepayment product while settling direct deposits from different acquirers in cases where merchants adopt more than one acquirer. This has driven up account balances and deposits while improving our understanding of merchant needs, resulting in a higher share of wallet. As a result, our consolidated TPV per merchant increased by 15% year-over-year. In large accounts, our developments in online and cross-border transactions have evolved, increasing our footprint in Latin American countries while expanding our feature set and fostering omni-channel offerings. Through our strategy of diversifying our merchant base and focusing on key segments, we expect to drive incremental volumes and gross profit contributions in the future. Our client base and cash-in evolution reflect our growth, as the number of PagBank clients reached almost 30 million, placing us among the most relevant Brazilian financial institutions. We will pivot our focus on client activation and engagement rather than merely increasing the number of clients, which will stimulate higher usage and revenue growth per client. Our BRL93 billion in TPV and BRL50 billion in PagBank cash-in have increased platform deposits by 25% compared to the second quarter of 2022, representing 86% of our total deposits and keeping our annual percentage yields at 94% of the CDI. We anticipate further growth in our deposits in the coming months, potentially boosted by our AAA rating granted by S&P Global, enhancing our CDs distribution among institutional and retail investors both on and off the platform. Our outstanding credit portfolio reached BRL2.8 billion, with 52% composed of secured products such as payroll loans and credit cards. The ongoing downtrend in NPLs over 90 days to 14.4%, combined with our tax planning, allowed us to write off BRL219 million. This amount is already fully provisioned in previous quarters, with no impact on our P&L. We continue to grow our payroll loan book, which focuses on public sector employees and retirees. This opportunity remains extremely attractive to us as our developments in providing end-to-end digital underwriting allow us to offer competitive pricing with incremental gross profit contributions, which will open new growth avenues. Now I turn it over to Artur for the financial highlights of the second quarter of 2023. Artur, please?

Thanks, Alexandre. Hello, everyone, and thank you for joining us tonight. Once again, PagSeguro presented another record-setting quarter in the company's history. TPV, gross profit, net income, and cash earnings all reached all-time high figures. Total revenue and income grew by 2% quarter-over-quarter, positively impacted by TPV growth and financial income, partially offsetting the effects on the top line related to the regulatory change in the interchange cap on prepaid and debit cards that came into effect on April 1. Our winning funding strategy has led to a decrease in financial expenses for the third consecutive quarter, despite no change in the Brazilian interest rate in the second quarter of 2023. Our additional leverage from lower losses and reduced operating expenses led to EBITDA growth of 8% quarter-over-quarter, significantly improving EBITDA from payment units, which grew by 18% versus the first quarter, driven by lower transactional costs and related to the regulatory changes on prepaid and debit cards that neutralized potential effects on the bottom line from decreased revenues. Earnings before tax also demonstrated strong growth of 13% quarter-over-quarter and 7% year-over-year, thanks to the sustained adjusted EBITDA breakeven in the Financial Services division. Better-than-expected results in Financial Services led to a higher tax income rate, which did not create headwinds for profitability. The net margin on a non-GAAP basis improved by 60 basis points compared to the second quarter of 2022, resulting in a net income of BRL415 million. Earnings per share increased again, reaching BRL1.18 in the quarter, 5% better than Q1 '23. Regarding revenue performance, several factors impacted this quarter. In Financial Services, we experienced a loss of BRL74 million compared to the second quarter of '22 due to the interchange cap on prepaid and debit cards. However, this had a negligible impact on the bottom line, given the natural offsets in transaction costs and financial expenses. The shift towards secured credit products, which have lower yields and longer durations, resulted in short-term negative effects, but we expect these to mitigate as the portfolio grows. In Payments, TPV growth contributed an incremental revenue of BRL141 million, offset by a lower gross take rate primarily driven by shorter durations on TPV for credit card installments and accelerated growth in SMBs compared to other segments. In other financial income, we had a positive contribution from the higher average interest rate compared to the same period last year. Revenues from the Payments unit grew by 4% quarter-over-quarter due to the carry effect from the significant merchants repricing conducted last year, partially offset by a client mix shift toward larger merchants with lower take rates but incremental gross profit contributions. As a result, gross profit reached BRL1.3 billion, reflecting an 11% increase when compared to the same period last year, with transaction costs and financial expenses performance being the main drivers of operational leverage. Revenues from the Financial Services vertical totaled BRL242 million in the second quarter of 2023, a 27% decrease from the first quarter, impacted by the regulatory change in prepaid and debit card interchange fees and higher shares of secured credit products with lower APYs but longer duration, such as payroll loans. Conversely, gross profit reached BRL111 million, up 57% year-over-year, driven by improved asset quality in the credit portfolio requiring lower provisions for expected credit losses. Financial expenses were BRL796 million compared to BRL756 million in the second quarter of 2022. This year-over-year increase is mainly explained by the higher average Brazilian interest rate in the period and TPV growth. Conversely, financial expenses decreased compared to the first quarter of 2023 due to our unique funding mix strategy backed by deposits and retained earnings exceeding 70% of our working capital needs at a lower cost than the market average. Total losses decreased by 55% year-over-year, accounting for BRL122 million, driven by lower provisions for expected credit losses in the credit portfolio, healthier coverage ratios, and most of the credit underwriting being on secured products. Operating expenses amounted to BRL589 million, a decrease of 5% year-over-year and flat quarter-over-quarter, representing 15.4% of total revenue, similar to the level of the second quarter of 2022 despite lower revenue levels from the regulatory changes. Headcount resizing and market optimization led to this leverage. Our cash earnings continued to gain momentum, reaching a positive amount of BRL319 million, up 24% compared to the second quarter of 2022. CapEx amounted to BRL530 million, down 8% year-over-year but increased quarter-over-quarter due to positive trends in merchants gross additions requiring additional POS inventory levels. However, our discipline in capital allocation and efficiency in IT investments remains intact, anticipating similar or lower capital expenditure disbursement compared to last year. Depreciation and amortization, including POS write-offs, totaled BRL374 million, representing close to 10% of total revenue and income, maintaining our pace of conversion to capital expenditure levels in the upcoming quarters to unlock further profitability. On the final slide, our net cash balance exceeded BRL10 billion in the second quarter, up from BRL8.6 billion compared to the same quarter last year. In the past 12 months, our cash generation totaled BRL3.5 billion, of which BRL1.8 billion was allocated to investments and BRL200 million to our share buyback program. Our equity position continues to strengthen, with 56% comprising retained earnings, reinforcing our commitment to shareholders regarding capital allocation and returns. Now, we have concluded the presentation, and we will open the Q&A section. Operator, please.

Our first question comes from Mario Pierry with Bank of America. Please go ahead.

Hi guys, good afternoon. Congratulations on the results. Let me ask you a question focused on your headcount reduction. You've talked about operating expenses declining year-over-year due to some changes in headcount that you made. However, we're hearing some of your competitors talking about expanding headcount going forward, especially in salesforce. So can you give us an idea of where your headcount reductions impacted and how do you think about headcount going forward? Thank you.

Hi, Mario, it's Artur speaking. Thank you for your question. Regarding the headcount reduction, there is only one department where we didn't make any changes, which is related to the commercial team. We have a little over 300 HUBs and 3,000 people in the field, and there is no intention to increase any personnel in the salesforce at this point. What we did was relocate some HUBs from one area to another where we identified many opportunities that we didn't have HUBs. The reduction was related to other departments, including IT. Looking ahead, we do not see the need to hire more people for the commercial team. So the headcount reduction we made this year is sufficient for our intention to continue growing the company.

Okay, that's clear. And then if I may ask a second question related to volume growth, TPV growth of 4% year-on-year. We see that the industry is decelerating, but can you give us a little more color on why we're observing the slowdown in growth overall? Is it because card penetration in Brazil is reaching a mature level, or is PIX disrupting the growth? How should we think about volume growth going forward?

Hi, Mario. Thank you for your question. Q2 saw some decrease in overall card volumes in the economy, which appears to be more related to macroeconomic variables than to card penetration. If you look at the figures, you will see that debit is not growing year-on-year. However, seeing increases in debit and prepaid suggests some disruption from PIX. We don't see a cannibalization effect on credit cards. In our numbers, the first 45 days of Q3 showed an 8.5% growth in TPV. Thus, we see an acceleration in TPV during the first portion of the quarter, showing that the worst may be in Q2 2023 for the industry overall. In summary, it seems more closely tied to macroeconomic scenarios, such as customers being without credit card limits rather than saturation or other factors.

And going forward, how should we expect to see double-digit growth in volumes?

We've already seen 8.5% growth in the first 45 days. I believe that Q3 will be approximately that. As for Q4, there is anticipation in the industry for a more optimistic outlook in the second half. So we may see an acceleration again, though it's early to assert. However, the signs from Q3 are encouraging, with an 8.5% year-on-year growth in the first 45 days of Q3.

Okay, guys, thank you very much.

Thank you.

Our next question comes from Pedro Leduc with Itau BBA. Please go ahead.

Thank you, guys, so much. Good evening. I have questions on the expenses or losses front. You anticipated no expected credit losses, and I understand you have shrunk your loan book, but would you clarify the underlying driver for these nil credit losses? Also, regarding chargebacks, we noted that they rose this quarter after what seemed to be more stable in Q1. Thank you.

It's Artur speaking. Thank you, Pedro, for your question. Regarding provisions for credit losses, as you may know, last year we decided to shift our originations and the portfolio to secured products. Additionally, last year, we significantly increased provisions to cover deteriorating performance of legacy accounts, and all legacy accounts are 100% provisioned. Thus, the new underwriting focused on secured products requires fewer provisions than unsecured products, which explains our almost zero impact from provisions. As for chargebacks, while there’s been a slight increase from Q2 compared to Q1, we believe this is not a sustained event but rather a natural fluctuation over time. We expect overall chargebacks to remain around 10–11 basis points this year, with potential small variations across quarters due to the nature of chargebacks.

Thank you, Artur.

Our next question comes from Jorge Kuri with Morgan Stanley. Please go ahead.

Hi, good evening, everyone. Thanks for taking my question. I wanted to ask about the take rate contraction during the quarter. Could you walk us through the drivers? How is Q3 trending compared to the contraction in Q2? And what are you observing in terms of prepayment rates now that the Central Bank has started easing?

Hi, Jorge, thank you for the question. I'll start with your second question. We haven't observed any pressure on prepayment rates thus far. We have a small part of our TPV that is related to the basic interest rate of the economy, which is tied to CDI. As CDI decreases, so do rates for these clients, but that comprises a very small share of TPV. For other parts, we have not changed our pricing, nor have we seen competitors lowering prices. Remember we saw a reduction from 13.75% to 13.25%. While 50 basis points isn't monumental, we don't believe this will trigger a price war. We intend to maintain our pricing longer, assessing our competitors' decisions. If rates decline, some competitors might reduce their prices, but we plan to be cautious. Many companies are focusing on rational growth rather than rapid expansion, prioritizing profitability. I don’t foresee irrational moves in price adjustments, but we will be vigilant. For your first question, Artur will explain take rate dynamics further.

Yes, Jorge, thank you for your question. The take rates involve multiple moving parts. On Slide 9, we've outlined these elements. In the Financial Services division, the interchange cap on prepaid and debit cards affected revenues. We also shifted our underwriting towards secured products that yield lower returns, but provide better client engagement. In Payments, we benefitted from 4% year-over-year TPV growth, yielding BRL141 million in revenues, but we've also faced a lower gross take rate due to shorter credit card installment durations. Furthermore, we have continued to shift client composition toward SMBs that entail lower take rates but offer strong gross profit and EBITDA contributions. Additionally, we saw BRL22 million in interest income, which also contributed positively to our results.

Thank you for that explanation. Can you provide insight into how take rates are progressing into the third quarter relative to the second quarter?

We expect our take rates to decrease slightly, though not significantly, primarily due to the shift in client mix.

Got it. Thank you for the detail, Artur and Ricardo.

Thank you.

Thank you.

Our next question comes from John Coffey with Barclays. Please go ahead.

Great, thank you for taking my call. I had two questions. The first was about the slide pointing out the BRL74 million loss attributed to the prepaid interchange caps. Can you estimate how long that might persist? As for the BRL171 figure related to shorter TPV duration, should we expect that to continue or have we already seen the worst of that subtotal?

Hi, John. Thank you for the question. On the SELIC dynamics, for every 100 basis points decrease without price adjustments, we anticipate roughly BRL1,200 million EBT benefits annually, maintaining our current capital structure. For the BRL171 figure, while it's challenging to predict, the duration dropped slightly this quarter. Q4 typically brings different consumer behavior and might yield varying outcomes, so we should be cautious moving forward. Overall, we should monitor both financial income and expenses, since the net outcome is what truly affects our profit and loss.

That was helpful. Thank you.

Thank you.

Our next question comes from Gabriel Gusan with Citi. Please go ahead.

Hi, good evening. A couple of questions regarding broader competition dynamics and CapEx trends. Are there signs that competition or broader financial factors could impede PagSeguro from fully benefitting from falling SELIC rates? Then on CapEx, we saw an increase quarter-over-quarter. Can you explain the reasons behind this, given the lower client additions?

Hi, Gabriel. To answer your first question, we are not observing significant changes in competition across the segments we operate in, particularly MSMB. While key accounts may face more competition, we are focused on MSMBs, where the competitive environment remains stable. Most entities seem to prioritize profitability, and we expect that to continue to mitigate negative impacts. Regarding our CapEx, Artur can provide insight into how we are strategizing this aspect.

Gabriel, regarding CapEx, indeed it was higher than Q1 '23 but lower than Q2 '22. The increase this quarter corresponds to the heightened POS inventory levels due to stronger merchant additions. Looking forward, we aim to maintain or reduce CapEx relative to 2022 levels.

Perfect. Thanks a lot.

Thank you, Gabriel.

Thank you, Gabriel.

Our next question comes from Neha Agarwala with HSBC. Please go ahead.

Hi, thank you for taking my question. Can we discuss the dynamics within the SMB segment? You posted stronger growth at around 10% for the SMB segment compared to overall TPV. Should we expect intensified growth for the SMB segment going forward? Additionally, regarding the long tail segment, we're seeing a decline in active merchants due to a more selective focus on profitability. When do you think we could see stabilization? Also, have any newly licensed players impacted competition among lower tier merchants, resulting in price subsidies for POS or other notable changes?

Hi, Neha. I'll address your inquiries in two parts. Regarding SMBs, we expect to maintain the growth trajectory observed in recent quarters. We have a strong value proposition, combining payments and digital banking, and several SMB clients appreciate our instant settlement feature. Many still opt for the banks they already know, but we anticipate continued growth. For long tail clients, some churn is noticeable, primarily from a year ago, so we won't account for those who remain inactive. We're balancing subsidies against acquisition costs, aiming to invest wisely towards future growth. In Q3, we're seeing an uptick in gross additions and stronger performance overall with 8.5% growth through the early days of Q3. No new entrants have disrupted our market significantly; existing dynamics remain relatively steady.

Thank you very much, Ricardo.

Our next question comes from Kaio Prato with UBS. Please go ahead.

Hi, everyone. Good evening, and thanks for the opportunity. My question relates to your payments strategy and how your mix shift might be affecting TPV growth. While EBITDA has shown improvement, there appears to be a discrepancy in TPV growth slightly lagging behind the industry, along with declining revenues excluding transaction costs. Can you clarify this dynamic and your strategy moving forward to reinvigorate both revenue and transaction costs?

Hi, Kaio. Thank you for your question. We're in an optimization cycle that began in the second half of last year, implementing important repricing measures and strict risk management policies to reduce chargeback losses. This adjustment reduced our growth in acquiring business overall, mainly affecting long-tail and large accounts. However, as these risk management strategies and repricing cycles take effect, we foresee opportunities for growth moving forward. We have not lost sight of long-tail growth, nor do we overlook the necessity of increasing TPV and revenues moving ahead.

Thank you very much.

Thank you, Kaio.

Our final question comes from Josh Siegler with Cantor Fitzgerald. Please go ahead.

Yes, hi, guys. Thanks for taking my question today. I wanted to discuss the long-term growth potential surrounding payroll loans. How do you evaluate the total growth opportunity?

Hi, Josh. The payroll loan market is significant, and our existing market share is minimal. We are continually shifting our portfolio towards secured credit, moving approximately 8 percentage points from unsecured to secured products each quarter. This transition enables us to pursue a substantial market opportunity in payroll loans, and we believe our client onboarding through digital means enhances our position in the market in the future.

Understood, and how do you plan capital allocation for the remainder of 2023? Will the pace of buybacks continue or possibly increase?

Hi, Josh, it's Artur. Regarding our capital allocation, we see three directions guided by our positive cash flow: first, reinvesting in the company, which means we aren't planning for dividends. Second, we'll shift to more cost-effective funding lines to maximize funds while reducing financial expenses. Lastly, we're conducting quarterly buybacks—we've accumulated 7.5 million shares in treasury and intend to continue, given the low share price relative to company expectations. We are committed to growing in the long run, not just for one quarter.

Thanks for your insights.

Thank you.

Our next question comes from Tito Labarta with Goldman Sachs. Please go ahead.

Hi, good evening. For 2024, what are your high-level expectations regarding revenue growth? With TPV trends indicating a possible acceleration, prepayment contributions from PagBank could also enhance results, particularly post-impacts from prepaid interchange caps. Your thoughts on revenue growth for 2024?

Hi, Tito. To begin, as we see TPV growth acceleration in the second half of '23, we anticipate revenue increases. For Financial Services, the interchange cap effect will linger until Q1 '24, but that will provide easier comparisons from Q2 '24 onwards. We expect compounding impacts from our payroll lending activity, alongside growth in deposit bases contributing significantly to our financial revenues. In the medium term, we are aimed at enhancing onboarding processes, credit underwriting, risk assessment, and collection strategies, which will help restore and accelerate unsecured product underwriting.

Thanks for the clarity.

Thank you.

Ladies and gentlemen, that concludes our question-and-answer session. I would now like to turn the floor over to Mr. Ricardo Dutra for closing remarks. Please, sir, go ahead.

Thank you everyone for taking the time to participate in our call. See you next quarter. Thank you very much. Good evening.

The conference has now concluded. Thanks, everyone, for participating. You may now disconnect.