Earnings Call Transcript - PAGS Q1 2023

Operator, Operator

Good evening. My name is Nihuge, and I will be your conference operator today. Welcome to PagBank Webcast Results for the First Quarter 2023. At this time, all lines have been placed on mute to prevent any background noise. 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, ESG and Market Intelligence. Please, go ahead.

Eric Oliveira, Head of IR, ESG and Market Intelligence

Hello everyone. Thanks for joining our first quarter 2023 earnings 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 PagBank's current assumptions, expectations, and projections about future events. While PagBank 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 PagBank's 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 PagBank's most recent Annual Report on Form 20-F and other filings with the Securities and Exchange Commission, which are available on PagBank's investor relations website. 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.

Ricardo Dutra, CEO

Good evening from Sao Paulo, everyone, and thanks for joining our first quarter 2023 results webcast. Tonight, I have the company of Alexandre Magnani, our CEO, Artur Schunck, our CFO, and Eric Oliveira, Head of Investor Relations and ESG. Before Alexandre and Artur share the main highlights for the quarter, I would like to share some achievements during the first months of 2023 and the main drivers for profits and cash flow generation, balanced with quality growth for the coming quarters. Going to slide three, on the left side, we are happy to announce the convergence of our brands PagBank and PagSeguro into one single brand: PagBank, the complete bank. We are excited about the next steps of our journey, having a unique two-sided ecosystem combining payments and financial services in one single app, one single banking platform, and one customer care. For us, PagBank brand represents our offering beyond Payments. We are also happy to announce that PAGS has joined FTSE Russell preview list, which can positively impact our average daily volumes, increase exposure to passive funds, and further improve PAGS shares awareness. Another milestone was the brokerage license granted by CVM, the Brazilian Securities Exchange Commission, an important step that enables us to provide a complete set of investment products through our proprietary and integrated platform. On the right side of the slide, we highlight our main drivers for 2023 financials. Our drivers for profitability during this year are solid and we remain committed to deliver lower losses, maintain our operating expense discipline, and further improve our structural competitive advantage by having deposits as a main source of funding and at a lower cost when compared to peers. In terms of drivers for cash flow generation, we are focused on improving our cash earnings and looking for capital expenditure efficiencies with a diligent go-to-market strategy and software development optimization. Finally, in our drivers for quality growth, we will keep fostering PagBank, secured credit portfolio products, and growing volumes in key segments. We also reaffirm our commitment to create a superior value proposition for our clients based on a transparent integration between our Payments and Financial Services platform. Now, I will pass the word to Alexandre. Thank you.

Alexandre Magnani, CEO

Thank you, Ricardo. Hello, everyone. After Dutra's initial remarks, I would like to present how the growth, profits, and cash generation drivers behaved during the first quarter of 2023. PagBank clients reached 28.7 million, accounting for more than BRL200 billion in transactions processed by us, driven by the strong customer engagement, which is a consequence of our superior product value proposition. Our EBITDA reached almost BRL800 million, and our net income was close to BRL400 million, with Q1 '23 earnings per share of BRL1.13. Our discipline in capital allocation has been driving up cash earnings momentum. Our cash earnings accounted for BRL379 million versus a cash burn of BRL17 million in Q1 '22, reaching BRL10 billion in net cash balance, while our capital expenditures marked a decrease of negative 40% year-over-year. In our Financial Services division, the main highlight was the breakeven point reached, with EBITDA close to BRL70 million, led by total banking volume growth and better spreads since deposits reached 18.6 billion with an annual percentage yield of 94% of the Brazilian interbank rate. In Payments division, our TPV grew 10%, with our key segments, micro-merchants and SMBs growing 50% faster than the industry growth, accounting for 16% year-over-year, with BRL1.2 billion in gross profit. Slide five, we are happy to announce the unification of PagBank and PagSeguro brands under PagBank only. Following our strategy to reinforce our one-stop-shop solution under the PagBank brand, we expect to have a broader reach among merchants and consumers, to simplify our communication strategy and client understanding, and increase client awareness about our services beyond Payments. Moving to slide six, we present our client base and cash-in evolution. Our number of PagBank clients almost doubled in comparison to 2021, moving up from 15 million to 28.7 million in two years. Active clients accounted for more than 16 million, where 62% of consumers and 50% of merchants consider PagBank their primary account. Our growth in cash-in reached BRL45 billion versus Q1 2022, led by total payment volume from merchant acquiring and strong growth of PIX inflow transactions. As a result, slide seven reveals deposits growth of 66% on a year-over-year basis, with nominal growth of 7.4 billion, reaching a total level of BRL18.6 billion in Q1 '23. Additionally, the respective annual percentage yields on deposits have decreased to 94% of the Brazilian interbank rate due to lower dependence on third-party platform distribution and improvement in cash flow generation. Account balance APY in Q1 '23 reached 73% of the CDI, an increase compared to the previous quarter, which was mainly related to a higher number of days our clients kept their savings in PagBank, reflecting our successful engagement strategy in SMBs and consumers with higher income. Talking about our credit portfolio, we kept our strategy of reducing credit underwriting for unsecured products while leveraging secured products origination. In comparison to Q1 '22, we reached BRL2.7 billion in outstanding credit portfolio, where secured products increased their share from 11% in Q1 '22 to 44% in Q1 '23. The diversification of our credit portfolio has played a pivotal role in our overall business strategy. It has not only expanded our market reach but has also had a positive impact on our risk management practices. This strategic approach has resulted in a significant reduction in the provision for losses, effectively lowering our exposure to high-risk clients. Furthermore, we would also like to report a substantial improvement in our credit portfolio performance. The non-performing loans (NPL) above 90 days for our outstanding credit portfolio has significantly decreased to 17.9% compared to the high level of 22.4% in Q1 '22. This reduction reflects our diligent efforts in managing credit risk assessment and enhancing asset quality. The successful diversification of our credit portfolio allows us to maintain a cautious yet proactive approach, balancing prudent risk management with the potential for long-term growth. By reducing our exposure to high-risk clients, we have enhanced the overall stability of our credit operations while optimizing our risk-return profile. These achievements underscore our commitment to prudent lending practices, rigorous risk management, long-term stability, and profitability of our credit operations. As we navigate uncertainties, we remain focused on maintaining a robust risk management framework and driving sustainable growth in the future. Before I turn over to Artur, I would like to give you more color on the growth of the Payments business on slide nine. As shown before, our TPV has grown 10% compared to Q1 '22. Our revenue growth can be attributed to a combination of factors. Diving into the specifics, our MSMB have experienced a 16% growth during the quarter. When we exclude nano-merchants, which are merchants with less than BRL1000 monthly TPV, this growth reached 17% compared to Q1 '22. When we compare the total active merchants base, we had a reduction of 10% comparing Q1 '23 versus Q1 '22. When we exclude nano-merchants, we notice a 3% growth on the active base. These figures are a direct result of our focused efforts to address MSMB needs, prioritizing the merchants with higher average TPV within the segment, which demonstrates the effectiveness of our strategy to allocate our efforts into growing on MSMB and overall TPV. Therefore, we remain confident in our decision to prioritize categories with higher profitability potential. Now I will pass the word to Artur to present our financial results.

Artur Schunck, CFO

Thanks, Alexandre. Hello, everyone, and thank you for joining us tonight. As we usually do, I want to share the financial highlights for the quarter. Once again, PAGS presented another set of records for a first quarter in the company's history. TPV, gross profit, net income, and cash earnings marked all-time high figures. Adjusted EBITDA grew 18% year-over-year despite revenue growth of 9% versus Q1 '22, revealing our earnings power and cash generation that is a result of our strategy of balancing growth and profitability. From Q1 '23 onwards, we will change the managerial methodology to allocate float between Payments and PagBank, now called the Financial Services vertical. 100% of the float will be booked in the financial services vertical, similar to other financial institutions. There is no change in revenues for the Payments vertical, but an increase in financial expenses since the share of such expenses offset by the float usually booked in the Payments vertical will no longer occur. Consequently, gross profit and adjusted EBITDA will decrease. On the other hand, revenues for the financial services vertical will increase since the float will lead to a higher interest income. Consequently, gross profit and adjusted EBITDA will increase. Important to say that there is no change in PAGS consolidated basis. And for comparison reasons, we provide in the appendix the four quarters of 2022 using the same metric applied to Q1 '23 to equalize our historical results by vertical. The financial services vertical achieved a positive adjusted EBITDA of BRL69 million this quarter. Even considering the old managerial float allocation, the result closed Q1 '23 in the positive side due to better performance of the credit portfolio with secured products that demand lower levels of delinquency provisions. Net income non-GAAP achieved BRL392 million, and net income GAAP increased 6% year-over-year, totaling BRL370 million. This represents an earnings per share of BRL1.13 in the quarter, BRL0.08 or 8% better than Q1 '22. In March and April, we repurchased 2.5 million shares under our buyback program. Our strategy and focus continue to better balance growth and profitability, targeting to improve shareholders' return. On slide 11, revenues for the Payments vertical grew 10% year-over-year, due to the positive result from the massive merchant repricing done in 2022. As a result, gross profit reached BRL1.2 billion, an increase of 2% when compared to the same period of last year, with financial expenses offsetting the uptrend given the higher average interest rate versus Q1 '22. In the next slide, financial services vertical's total revenues reached BRL331 million in Q1 '23, 1% lower than Q1 '22 due to the shift to secured products underwriting, which have lower APRs and longer duration compared to unsecured products. On the other hand, gross profit reached BRL179 million, an increase of 274% year-over-year, mainly due to the secured products portfolio that naturally leads to lower provisions for losses. Based on that, we are creating a safe and solid path to restore a better mix of credit underwriting composed of secured and unsecured products in the coming quarters, reinforcing our one-stop-shop value proposition and further increasing PagBank's principal. Moving to slide 13, financial expenses closed at BRL813 million versus BRL621 million in Q1 '22. This increase is mainly explained by the higher average interest rate in the period in comparison to Q1 '22. It was partially offset by the higher share of deposits and retained earnings in the period that lowered funding spreads and led to lower financial expenses in comparison to the last quarter. Total losses decreased 50% year-over-year. This great performance comes from lower expected credit losses of the credit portfolio driven by healthier coverage ratios and credit underwriting mostly for secured products. At the same time, chargeback as a percentage of TPV decreased versus Q4 '22 and Q1 '22. Important to highlight that total losses in Q4 '22 reduced around 30% over Q3 '22, and this quarter reduced a further 34% over Q4 '22. Operating expenses reached BRL587 million in Q1 '23, up 5% year-over-year. This amount represents 15.7% of PAGS revenues versus 16.4% in the same period of last year and stable when compared to the last quarter. The improved efficiency has come from personnel and marketing expenses leverage. This quarter, we had a one-time expense related to the headcount resizing around BRL12 million. Excluding this, operating expenses in nominal terms were flattish versus Q1 '22. Jumping to slide 14, we present a summary of how PAGS results evolved during this quarter. Revenue growth, lower losses, and operating expense discipline more than offset the increase in financial expenses and D&A plus POS write-offs. In the next slide, cash earnings continued to gain momentum, reaching a positive amount of BRL379 million versus a negative amount of BRL17 million in Q1 '22. Cash earnings represented around 10% of revenues, reflecting the company's focus on maximizing LTV to CAC ratio by balancing POS subsidies, client engagement, and monetization and the dilutive process to leverage profits and cash generation. CapEx to revenue ratio reached 10.9% this quarter versus 19.9% in Q1 '22. This decrease was mainly driven by the go-to-market optimization in POS, being more selective in merchants' acquisition to leverage PagBank and sustainable growth while setting a higher bar for investments, amortization in software and engineering teams. Depreciation and amortization, including POS write-off totaled BRL365 million, representing 9.7% of PAGS revenue, keeping the ongoing convergence of CapEx and D&A to unlock additional profitability in the coming years. On slide 16, our net cash balance ended the first quarter at BRL10 billion, increasing BRL1.7 billion year-over-year. At the same time, we have been improving our capital structure and diversifying funding sources to support volume growth, with deposits now representing around 59% of our third-party funding source. Our equity position continued to increase, with 54% being composed of retained earnings, reinforcing our commitment to shareholders about capital allocation and returns. To conclude our presentation, I turn back to Alexandre for the final comments. Thank you.

Alexandre Magnani, CEO

Before ending our presentation, we would like to delve into a key point regarding the prepaid cards interchange fee cap impact on our business. First and foremost, it's important to recognize that PAGS ecosystem is a robust and adaptable platform that leverages our complementary businesses, namely acquiring and card issuance. This combination creates a natural hedge for the company, allowing us to mitigate risks and capitalize on opportunities in the market. By observing the impacts in the month of April and looking ahead to 2023, we anticipate that the net income will remain relatively stable since the impacts on net income due to prepaid cards new interchange regulation are relatively negligible. Before jumping to the Q&A session, I would like to emphasize our focus for 2023: Grow with profitability, combining optimization and expansion cycles. Consolidate PagBank penetration, customer engagement, and revenue diversification. Develop an integrated, unique, and superior value proposition under a single brand. Foster security at all operating levels to reduce losses and improve customer experience. Invest in our human resources to keep building a pleasant and highly productive work environment. Now, we have ended our presentation, and we will open the Q&A session. Operator, please.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from John Coffey, Barclays.

John Coffey, Analyst

Great. Thank you very much for taking my question. My question was really on TPV growth, particularly some of the numbers you mentioned on slide nine of the deck. I see that I know you reported 10% TPV growth, but if you were to exclude the large accounts in several quarters, you'd be at 16%. So I guess I was wondering what is happening with the large accounts and some acquirers given that six PPT magnitude between those growth rates? Are these just certain accounts moving off-platform? Or does it speak to any kind of underlying factors that you're seeing in Brazil?

Ricardo Dutra, CEO

Hi, John. Thank you for the question. Yes, you're right, on slide nine, if you exclude the nano-merchants and the large accounts and sub-acquirers, the growth is 16%, which is higher than the industry at 10.7%. What happened is that, of course, with the high interest rates in the economy, some sub-acquirers are decreasing their volumes. That's part of that. But the majority of the movements here are the moving parts because we are looking for profitable accounts with positive net take rates. As we always say, we are not looking for market share as the main driver for the company. Market share is a consequence of what we're doing, looking for positive accounts with positive net take rates. Eventually, some large accounts and sub-acquirers may migrate to other players that are looking for market share, and that's fine. We are fine with that decision. We are looking for profitability in a sustainable way. We are looking for clients that could also use PagBank so that we can cross-sell, gather data, and eventually offer credit to them in the near future. But that's the explanation. Some clients are moving to someone else, and also some sub-acquirers have been decreasing in volumes because they are struggling with the high interest rates. In a situation like that, it is important to have scale as we have here in PAGS.

John Coffey, Analyst

Right. Thank you. And I just have one quick follow-up just related to that. When does the impact of the nano-merchants essentially go away? Like when do all the ones who are going to leave your platform leave so that all the numbers start moving, and the growth rates start moving in the same direction again?

Ricardo Dutra, CEO

Well, we are seeing some mortality. As you may know, last year we did not focus on nano-merchants because we had subsidized the POS more than what you think is healthy and sustainable for the company. So that's why we see the churn is stable, but the gross additions are lower because we took this conscious decision not to accelerate nano-merchants anymore. But importantly, a portion of the nano-merchants that are not using or acquiring still keep working with us, using PagBank. The main focus is really the micro-merchants and the SMBs.

Operator, Operator

Our next question comes from Mario Pierry, Bank of America.

Mario Pierry, Analyst

Hey, guys, congratulations on the results. Let me ask you two questions. First one, the market is starting to price in lower rates in Brazil later this year. Can you remind us of your sensitivity to a lower rate environment? Also, how would that impact your strategy, especially on pricing? Would you be willing to pass on that improvement to your clients, especially because we're seeing some of these non-listed companies becoming more aggressive in market share? So just wanted to hear your thoughts on how a low-rate environment would impact your business. And the second question, I thought it was interesting that you're choosing the name PagBank. The bank today represents about 10% of your revenue. So when we look, you know, over a five-year period, do you think that the bank will clearly become a bigger part of your business? Just wondering how you see that evolving. Is banking revenue going to be 30%, 40%, 50% of your revenues? How do you look at that? Thank you.

Ricardo Dutra, CEO

Hi, Mario. Thank you for the questions. Regarding interest rates, you're right that some people are saying that interest rates could go down in Brazil this year. Of course, that's something very dynamic. No one knows what exactly is going to be the interest rates in the near future. As you mentioned in your question, as we have many moving parts here, we have some part of our clients that are long-tail, and once the interest rates go down, we can recover margins in the next business day because we charge these clients a fixed rate regardless of the SELIC. There are some other clients that may eventually call us to negotiate because they probably have some information about the interest rates and may call us to negotiate, but that's not going to happen immediately. So we will also take advantage of that. We have some small part of our TPV that is already linked with SELIC. So if SELIC goes down, the MBRs and the prepayments for these clients may decrease with SELIC. So we have many moving parts here. In addition to that, we have competition, as you mentioned. We'd rather not give you an exact number. But I would say that if or when the interest rates go down, we'll be the company that benefits the most with that because of the long tail that we have, because of the service that we offer for our clients, and the stickiness that they have in our base. But we'd rather not give an exact number here because, as you mentioned in your question, there are many moving parts here. That's the first part. The second one regarding PagBank, at the end of the day, we are a technology company offering financial services and payments. That's what we have been building over the years, and we think PagBank represents more of what we already have today, regardless of the revenues that you mentioned, which is 10%. PagBank represents what we now have in terms of products, terms of stickiness, and even the number of clients. We have more clients in PagBank than in PagSeguro, and that's the future of the company, that's for sure. We are going to offer more and more financial services, and we think that's the right time to do that. In addition, we also believe we can optimize our marketing investments by having only one brand. When you're a multi-brand company, there are inefficiencies when you advertise, and it may generate some confusion among some of our clients. So we took the decision at this point to move to PagBank, invest in this brand, and, of course, in the future, we're going to have more and more revenues coming from the financial services and related to that.

Mario Pierry, Analyst

And I'm very clear. Let me just follow up then. If you can be a little bit more specific about competition in the SMB segment. I think that's where we're seeing the bulk of competition today. I'm hearing a few players say they will increase their sales force. Are you also considering increasing your sales force to face competition?

Ricardo Dutra, CEO

Mario, we have two parts here, and thank you for the follow-up. First, when you have these headcount resizing, we did not affect our sales force. Of course, if there are some salespeople that are not performing, but that's different. When you have this headcount resize, we try to preserve our sales force because we believe it's one of the strengths we have in the company. We are executing very well. The results speak for themselves, and regardless of growth of this team, we are always evaluating. There is no fixed decision here that we will not increase. Once we see there is an opportunity for growth with decent net take rates, we will invest. But I would say to you that just to give a quick number here, our productivity per salespeople doubled in the last year because we are being more assertive in how we make the routes. They get more training over time and have a better sales pitch. So, going back to your question, we are evaluating that very carefully. We are not concerned about competition; we keep doing our job. Look at what we are doing with our productivity, and if we think there is an opportunity to increase our sales force, we will.

Operator, Operator

Thank you. Our next question comes from Craig Maurer, FT Partners. Please proceed.

Craig Maurer, Analyst

Yeah. Good afternoon. Thanks for taking the question. Just one question on the take rate in the acquiring business. Could you give us some thoughts on how that should trend over the coming quarters, considering it sounds like there will be a slowing of attrition in the nano-merchant business? And you also made a statement that you're shifting the focus in large merchants from share gains to profitability in terms of large merchants that you'll be taking on the platform. Plus, you also talked about some attrition in sub-acquirers' volume. So the take rate, it would just be great to get some thoughts on the directionality.

Ricardo Dutra, CEO

Hi, Craig. Going straight to the answer, we expect the take rates from the acquiring business to be stable in the following quarters. Of course, remember that in Q4 we have seasonality with more debit card transactions, and it may go down eventually, but not because of our pricing, but because of the mix with more debit card transactions. We expect stability because we also have some moving parts here. At the same time that we are increasing our SMB efforts and also micro-merchant efforts, as you said, we lost part of our nano-merchants, but it's only 2% of TPV. On the other hand, when you have these sub-acquirers and large accounts moving out, it also helps our net take rate because they have a lower net take rate, as you may know. So with all these moving parts and all the execution we are doing, we expect the net take rate in the following quarters to be stable.

Operator, Operator

Our next question comes from Bryan Keane, Deutsche Bank.

Bryan Keane, Analyst

Hi, guys. Just wanted to figure out if we could get the percentage of TPV that comes from large accounts and also sub-acquirers?

Ricardo Dutra, CEO

Hi, Bryan. Thank you for the question. But to be honest, unfortunately, we don't give this disclosure because of competitive reasons. But I would say that MSMB is the largest portion of our TPV already, but we don't give the disclosure or the breakdown between the other parts of the TPV. I'm sorry.

Bryan Keane, Analyst

Okay. And then just on the bigger picture question, most of your investors and analysts on the call are primarily from the tech side of things. When you say you want to grow into financial services, how much credit risk are you guys willing to take to look like a traditional bank? Because that's a totally different investor base and a completely different kind of company.

Ricardo Dutra, CEO

Yes, Bryan, you're right. That's eventually a different dynamic. As I answered the question from Mario, we are a tech company that offers financial services and also payments. But of course, it's unavoidable that we, at some point, are going to take some credit risk. At this point, we don't have this appetite. We stopped giving credit without collateral in the first quarter of 2022. Since then, 100% of the new underwriting is 100% secured. As you can see in our deck of slides today, 44% of our credit portfolio is 100% secured. We don't think that's going to change in the following quarters. But at some time in the future, we will start to give unsecured credit, of course, starting with clients we already have in the base. But right now, the macroeconomic scenario doesn't help us to have this appetite. We can see even the big banks in Brazil struggling to charge some of their clients seeing higher NPLs, not to mention the macroeconomic environment worldwide. So here we are accelerating in the 100% secured. We found a way to grow PagBank sustainably with a path to profitability through secured products, and we don't think that's going to change in the future. That's the big picture of the company. In terms of the investor base and the point that you brought, I don't think that should change much because, at the end of the day, we are a tech company with a diversified product offering here. So we will not rely on credit in the near future.

Operator, Operator

Our next question comes from Pedro Leduc, Itau BBA.

Pedro Leduc, Analyst

Thank you guys so much. A little bit on the losses and operating expenses lines that are a little more on your control. First, on losses, very good delivery here on reducing chargebacks. We want to understand if you think this is just a path that started or if it's got to do with the clean-up of the base if there is more to go. Also, on the credit losses on the portfolio as you've been adjusting, is this maybe a new run rate here in terms of cost of risk, this 40 million? And then later I'll jump on the OpEx side. But first on the losses, chargebacks and credit, please.

Artur Schunck, CFO

Hi, Pedro. It's Artur speaking. So related to total losses, the reductions we're having right now are 50% in comparison to Q1 '22, and 30% in comparison to Q4. That was 30% better than Q3 '22, all as a result of the shift of our credit portfolio from unsecured products to secured products. We expect to continue to have good results in terms of losses. As Dutra mentioned, that's the right path to move PagBank toward profitability.

Pedro Leduc, Analyst

Okay. And on the chargebacks side of the losses?

Artur Schunck, CFO

I'm sorry, inside the total losses, we have the chargebacks that also improved in comparison to 2022. So we did a great job here, in my opinion, in terms of fraud prevention and all the systems, teams, and processes that we developed during 2022, which helped our acquiring business perform well in controlling chargebacks.

Eric Oliveira, Head of IR, ESG and Market Intelligence

And importantly, Pedro, our unique value proposition offered to merchants is instant settlement, which does not necessarily increase chargebacks. This is something we've been improving on, including our KYC processes in order to further decrease chargebacks as a percentage of TPV.

Pedro Leduc, Analyst

Okay. Thank you, Eric. If I may on the second question and on the operating expenses. First, if you could help us on the personnel side, there's an 11% increase year-over-year. You mentioned there's a one-off impact related to the downsizing. If you can just help us understand how these 11% would look like without this one-off impact. And then the second there on the marketing advertising run rate for the remainder of the year, if you think this lower level here is something that is more reasonable for this environment. Thank you.

Ricardo Dutra, CEO

Okay. Regarding personnel expenses, you are right. We have this headcount resizing in the beginning of this year in January, and the severance cost was around BRL11 million, BRL12 million. That was a non-recurring item for Q1. As for marketing expenses, we are expecting to spend a little bit more than Q1 in Q2 because of this, I would say, rebranding of PagBank from PagSeguro. But we will continue to apply our disciplined cost control, not only for OpEx but CapEx. The best we can do right now is control costs as much as possible to keep our company healthy.

Operator, Operator

Thank you. Our next question comes from Neha Agarwala, HSBC.

Neha Agarwala, Analyst

Hi. Thank you for taking my question, and apologies if there's any disturbance. My first question is on choosing the brand PagBank. I believe PagSeguro created a very strong brand name in the acquiring business, especially in the long tail. And I'm sure you've done studies to understand what would be the impact of moving from PagSeguro brand to PagBank brand. How seamless do you think it will be for your customers? So if you can comment on that. And my next question is, I understand you do not break down your TPV by how much is large accounts, how much is in SMB? But could you give us some sense of what the take rates are in the large accounts and sub-acquirer segments? Because from what we understand, looking at your peers, the take rates are much lower for that part of the business, which probably is about 30%, 40% of your business by now. So if you could give us some sense of where the take rates are, what kind of proportions do you see, and where is it headed? Do you plan to increase your share in the large accounts and the sub-acquirers, or are you planning to reduce your share there? Some color on how the TPV mix should evolve. That would be very helpful. Thank you so much.

Ricardo Dutra, CEO

Hi, Neha. Regarding the brand, you're right. We have a strong brand with PagSeguro, but we also have a strong brand with PagBank. I know we started PagSeguro before PagBank, and that was the beginning of the company offering POSs. However, we launched PagBank in 2019, so we are completing now four years, and it also has a very strong brand already in Brazil. Many of our merchants use both brands. They sell through the POS and make transactions, and they use the app. In the app, they use their PagBank already since the beginning. And of course, we won't make the migration from one day to the other. That's something we will gradually start to use more PagBank, but the POS they still use PagSeguro. So while making this transition, there is this communication project so that we can communicate to our base that PagSeguro is now PagBank and so on. Therefore, we don't expect friction there. Mainly, because many of our clients already use the PagBank app when they wish to cash out or use our cards and so on. Regarding the second question.

Alexandre Magnani, CEO

And Neha, this is Alexandre. Just to give you more color on that question regarding the brand. Today, 60% of our active customer base use only PagBank and have a relationship only with financial services. Out of the 40% remaining, which is the merchant base that primarily uses the acquiring service, 90% of them also use PagBank. Our POS terminals have been PagBank branded only since 2019, and all of our cards issued since then are also PagBank branded.

Ricardo Dutra, CEO

So the second question about take rates and the moving parts, Neha. As you know, we don't give this disclosure about the percent of TPV coming from large accounts and sub-acquirers. I would say that if you look at the market, the other players that are more focused on large accounts and sub-acquirers, our net take rate is similar to them. It's not that different, similar to what other players in the market that operate in this type of client have. Our net take rate is significantly lower than what we have in SMBs and also in micro-merchants. We will look for accounts that have positive net take rates that provide some returns that we think is feasible for the capital of the company. Again, we are not concerned about the market share of total TPV. We will focus on the key segments we decided to prioritize last year, which are micro-merchants and SMBs. Even with all the moving parts and even some large accounts that we will get — because, of course, we may lose some large accounts, but some clients come to us because they want to work with us, and even sub-acquirers. With all these moving parts, that's why I mentioned earlier that we expect the net take rate to remain stable through the year, except in Q4 due to the seasonality of debit card transactions.

Neha Agarwala, Analyst

We have not talked much about exposure to large accounts or sub-acquirers in the previous quarters. This is something that we're discussing in this particular quarter. So what led to this kind of pivot to having exposure to large accounts? Because you started from the bottom of the pyramid, you moved up to SMB, but we never really talked about gaining exposure to the large accounts. Has this been something that you've been planning for the past couple of quarters? Or do you see opportunities coming your way, which makes sense economically? And that's why in the last one or two quarters, you're gaining more share in large accounts? How has that come through? Thank you so much, and that's my last question.

Ricardo Dutra, CEO

Neha, we may not say that in terms of exposure, but we always said that we have large accounts. Remember, we started e-commerce back then. And e-commerce at the beginning, we had large accounts. We also bought another company acquired in 2020 and brought in some large accounts in e-commerce. So we've always had some large accounts and even sub-acquirers. We're not saying that we will not focus on this type of client anymore. We're just saying that we will not compete with price against players looking for market share. We'll continue to work with this type of client as long as they meet the returns that we think are feasible and sustainable for the company. Just to clarify, we've always had this type of client. We worked with them. Some of them come to us because they wanted to work with us. Sub-acquirers chose to work with us because they like our POS. So this type of client has always been in our base, and it was not the primary focus of the company, and it won't be the primary focus of the company. I guess what you're seeing here in this slide, when you say the growth of TPV of 16%, is that we did not make significant efforts to keep accounts with net take rates that are unsustainable or not at the level the company expects.

Operator, Operator

Thank you. Our next question comes from Soomit Datta, New Street Research.

Soomit Datta, Analyst

Hi there. Yeah, thanks very much. A couple of questions, please. First of all, on the PagBank merchant base versus the acquiring merchant base. The two are kind of moving in sync, or alternatively put, the PagBank merchants as a percent of acquiring merchants is pretty stable at around 90%. Given you're losing nano-merchants, or you're willing to lose nano-merchants, I would have thought your kind of percent of acquiring merchants, which are PagBank, would be going up, but it seems to be stable. So I'm just curious why that percentage isn't increasing as you kind of move up the pyramid. That's the first question, please. And then second, if I could hold it there and then if we could go with that one first, please.

Eric Oliveira, Head of IR, ESG and Market Intelligence

Soomit, this is Eric. Just to recap here, you're asking about the merchants engaged in PagBank, and we've basically had a slight decrease in this number. Am I right?

Soomit Datta, Analyst

Yes, exactly. Exactly. So as you lose your acquiring merchant, that typically is the low TPV nano-merchants, I would have thought that your percentage of acquiring merchants, which are PagBank, would be going up and up, but it seems to be stable.

Eric Oliveira, Head of IR, ESG and Market Intelligence

Perfect. Thank you. Thank you. So just to answer your question, I think it's important to highlight that, for the long-tail clients base, which is composed of nano-merchants and micro-merchants, I would say to you that probably 100% of them are engaged in PagBank. As we run off and de-prioritize nano-merchants, which are barely profitable, we tend to lose these clients at first glance in PagBank. However, if you look closer at the PagBank clients of merchants, this decrease is lower than the decrease in the active merchants because we have several nano-merchants that, for example, got back to the formal economy and still work with us, but they receive a monthly paycheck and use PagBank as their primary bank. This doesn't concern us. In fact, we see an opportunity to cross-sell other products for them. As we continue to move that market, our concern here is not anymore growing very rapidly our number of clients because we already have 13% of the Brazilian population having a relationship with us. Our focus is to increase the cross-sell of financial services, increase deposits per client, and necessarily increase profitability per client. This is our goal.

Soomit Datta, Analyst

Okay. That's clear. Thank you. And maybe a quick follow-up, if that's okay, just on financial services profitability. Either on the old or the new EBITDA basis, if we could pro forma that EBITDA for the interchange cap, is it fair to say that financial services is now EBITDA positive, and there’s no reason to think it won't stay that way going forward? Thank you.

Eric Oliveira, Head of IR, ESG and Market Intelligence

Thanks for the question, Soomit. This is Eric again. Naturally, as the interchange cap came into force since April 1st of this year, as we disclosed previously in our material facts, we expect a negligible impact on our bottom line. In the financial services vertical, revenues should decrease, but the gross profit and EBITDA evolution should decrease not in the same magnitude. So investors should expect a lower revenue in 2023 versus 2022 in the financial services vertical, but completely offset by the savings in the merchant acquiring division.

Soomit Datta, Analyst

And is it possible to say in absolute BRL terms what the run rate is on a quarterly basis for that impact? I take your point, it's neutral to the group, but just in terms of modeling out the splits between the two parts of the business.

Eric Oliveira, Head of IR, ESG and Market Intelligence

At this time, we are not providing any ballpark of these impacts. We can evaluate here. But I think the main message is it's a negligible impact for the bottom line. So any potential revenue and gross profit reduction in the financial services vertical that analysts can assume should be completely offset by the savings in the merger and acquiring vertical.

Operator, Operator

Thank you. Our next question comes from Josh Siegler, Cantor Fitzgerald.

Josh Siegler, Analyst

Yeah, hi, guys. Good evening. Thanks for taking my question. To start with, can you discuss how competition has trended specifically in the payment space? Are you still seeing rational pricing from some of your peers?

Ricardo Dutra, CEO

Hi, Josh, thank you for the question. Yes, we are seeing rational pricing from the peers that we compete with, mainly in the micro-merchants and SMBs. We cannot say about the companies that are looking for larger clients because we see some changes in market share in Q1 between the big acquirers. But in the markets that we are competing, which are micro-merchants and SMBs, we are seeing very rational prices. Everyone is looking for profitability, as you could see in the quarter-call results from us and from other players. So yes, that rational pricing is present at this point, and we don't think it's going to change because interest rates are high in Brazil. Everyone is looking for profitability, not only in Brazil but around the world, and not only in the payments industry but also in all industries.

Josh Siegler, Analyst

Okay, great. I appreciate that. And then you guys have been repurchasing some shares recently. I'm curious about how you're thinking about your capital allocation strategy moving forward. Thanks.

Artur Schunck, CFO

Yes, it's Arthur speaking again. The capital allocation strategy we have today is based on the results we have. We are reinvesting in the business, using the results we achieve now, or even using the good results we are achieving to repay the expensive debts we have and also reducing the CDs we are issuing to fund operations. At this point, with around 14% interest rates in the country, it doesn't make sense to distribute dividends. We can reconsider that going forward, depending on the interest rate level. The strategy we are using to repurchase shares is based on the share price; if it's a good opportunity for the company or not. The shares we have in treasury are used to distribute for the long-term incentive plan for employees. Currently, we are thinking that we need to use the money to fund the operation.

Operator, Operator

Thank you. Our next question comes from Kaio Prato, UBS.

Kaio Prato, Analyst

Hi. Thanks for the opportunity to ask questions. I have two on my side, please. First, on the costs of PagBank. We saw a quarter-over-quarter drop; it decreased by 10% quarter-over-quarter. I understand that the TPV went down, but the drop in deposits was actually higher. So just wondering if you can provide us some details behind that, please? Moreover, what do you expect in terms of deposit growth going forward? And my second question is related to CapEx. Just wonder if you could help us understand the moving parts on CapEx this quarter, both related to PP&E and intangibles? And what can we expect going forward in terms of growth for these two lines and on a consolidated basis as well? Thank you very much.

Ricardo Dutra, CEO

Thank you, Kaio, for your question. Regarding the first point related to deposits, it's true that it reduced from Q4. The main impact comes from seasonality. As you may know, in Brazil, there are a lot of bills to pay in the beginning of the year. People use the funds to pay those bills. One point we are paying attention to closely is changing the deposits we are issuing with third-party platforms and trying to originate internally in our platform. The second point is related to CapEx. We achieved this quarter, BRL408 million, which is much lower than Q1 '22. That positively impacted our cash earnings. Last year, our cash earnings were BRL17 million negative. This year, they closed to BRL400 million positive. In terms of CapEx going forward, we expect to have a lower CapEx per revenue compared to 2022, and more related to technology investments with around 60% for technology and 40% for POS acquisition. We'll continue investing in CapEx for POSs in the same strategy we launched last year, focusing on client selection with high engagement and companion paybacks, combined with eventual promotions we can offer to clients.

Kaio Prato, Analyst

Okay. This is clear. Thank you very much. Just a quick follow-up on the deposits question. I'm wondering if you have any target in terms of deposit growth for this year that you could share with us?

Ricardo Dutra, CEO

What I can say about deposits related to this question is that all of our management is focused on increasing deposits. Deposits, as you know, is the cheapest funding source that we have after return on earnings. We have all of the management focused on increasing those deposits.

Operator, Operator

Our next question comes from Eduardo Rosman, BTG Pactual.

Eduardo Rosman, Analyst

Hi, everyone. Good evening. I have a question here regarding all this noise related to the revolving credit card theme. I think the sector as a whole has been a little bit more under pressure recently, on concerns that something might happen with the parcelados with no interest, right? So which, in theory, if that happens, that would be potentially bad for the prepayment business. So can you share your thoughts on what's being discussed? Are you being part of the working group? What’s your belief here? I think, Alexandre, I saw, I don't know, some comments to broadcast. So I just want to make sure everybody is on the same page here. Thanks a lot.

Alexandre Magnani, CEO

So Eduardo, thank you for the question. We know there have been some discussions with Brazilian authorities about possibly implementing a cap on interest rates for revolving credit cards. As you may know, this discussion is not new and is being carefully evaluated by regulators. And of course, regulators talk to everyone. What we may say from the government or from the regulators in the past years is that they have been playing a very relevant role to promote competition and financial inclusion in Brazil. They listen to everyone. Just before I go straight to your question, some players link this cap in interest rates with changes in installments. As you may know, interchange in Brazil is one of the highest in the world. The credit card business in Brazil is very profitable. As I said, some players try to link this discussion with changes in installments, which, in our view, is very unlikely to happen for many reasons. But the main two I would mention are that a change in installment is not the way to decrease the high interest rates in revolving credit lines. By changing installments, revolving lines will not decrease. The second reason is that installments are very important for the Brazilian economy. They account for 50% of total credit card transaction volume in Brazil; in 2022, that number was BRL1 trillion, which represents 10% of Brazilian GDP. It's largely accepted by merchants of any size, providing power for consumption, especially for low-income consumers who cannot afford to make purchases without installments. It is also the cheapest working capital for merchants. We believe that any change in installments is very unlikely to happen because it doesn't address the concerns of the ongoing discussion and is essential for the economy. So that's our view at this point.

Eduardo Rosman, Analyst

Great. Super clear. Thanks a lot.

Operator, Operator

Our next question comes from Geoffrey Elliott, Autonomous. Please proceed.

Geoffrey Elliott, Analyst

Hello. Thanks very much for taking the question. I know you've introduced some new offers on the website, Vista, Multi, and Maximize, which look quite a bit more competitive in terms of pricing than what you're advertising previously. Who are you marketing those at? And what are you doing to mitigate the risk of cannibalization of clients on the older offers with higher pricing, trying to move on to the newer cheaper ones? Thank you.

Ricardo Dutra, CEO

Hi, Geoffrey. Thank you for the question. We always make promotions. Some of the promotions we do through online, targeting some types of merchants. Some of the promotions target particular consumers. We also make some tests on our website. Of course, a large part of our demand comes from paid media and media that we buy from third parties. Part of the demand comes from the website. The promotions we are making require the merchants to have a minimum TPV of BRL3,000 per month, so it's not for everyone. Of course, we are always monitoring in terms of attrition with our existing clients; however, that's not an issue at this point. Such promotions are common for companies like us with millions of clients. It's very common when you have a telecom company and see a promotion from them, and then you experience a better condition for a new client than for the current one. But that's part of the business dynamic. We try to control that in a more reactive way in the call center. But I don't think it’s a concern currently because we require a minimum TPV, and there are some other requirements as well. It's part of the promotion dynamic; it's not a significant change in company operations.

Geoffrey Elliott, Analyst

Thank you. And then maybe just to clarify on some of the comments from earlier. You talked about the prepaid interchange cap and then you talked about adjusted net income being similar to what you delivered in the first quarter. Was that just a statement saying the interchange cap is not going to have a significant bottom line impact? Or was that more an all-encompassing statement saying you think 2Q net income plus or minus is going to look similar to the first quarter? Thank you.

Ricardo Dutra, CEO

Hi, Geoffrey, thank you for the question as it's an opportunity to clarify that. What we are saying is that with the change in the cap and interchange for prepaid cards that started on April 1st, it didn't change the net income of the company as a whole. The benefit we had in the acquiring business by having a lower interchange is very similar, in absolute terms, to the losses we experienced with the revenues from PagBank as a card issuer. We're just saying that the change in the cap and interchange for prepaid cards is neutral to the company as a whole. We do not state that the net income is going to look the same in Q2 compared to Q1 or anything like that. We're just indicating that this cap in interchange did not impact the expected net income of the company because the effects of these variable factors are neutral.

Juan Recalde, Analyst

Hello. Thank you for the opportunity to ask questions. My question is related to the NPL ratio. I noticed a decline from around 30% or more than 30% in the fourth quarter to 18% this quarter. Can you talk about what drove this improvement, whether there were some sales of loans or write-offs? And also, can you comment on how you see asset quality evolving? How do you think the credit portfolio can grow in the rest of 2023? Thank you.

Artur Schunck, CFO

Okay, Juan. It's Artur speaking. Thank you for your question. It's important to clarify that the numbers you have in the income statement are related to the past due. All the calculations regarding the percentage of our portfolio are based on past due when an installment is unpaid, which gives you this past due status. This quarter, we decided to give this information more clearly in slide 8 of the webcast presentation. The NPL for 90 days in Q1 '22 reached 22.4%, the worst moment was in Q2 '22. You will see what we have for the coming quarters. We now have 17.9%. Since June, we have seen a reduction in this NPL within 90 days. Additionally, it's important to mention that our secured credit portfolio presented 1% of NPL. Our whole portfolio has been moving down pretty fast quarter-over-quarter. The main impact related to this is because our credit underwriting now focuses 100% on secured products. You can also see in our slides today that our total portfolio is split into 44% secured products and 56% unsecured products. Going forward, our strategy will remain focused on underwriting secured products related to payroll loans and also credit cards backed by CDs or balance account reserves.

Alexandre Magnani, CEO

And Juan, it's essential to mention that most financial institutions write down their non-performing loans after 360 days. We have not done so yet for exclusively tax planning reasons. For the coming quarters, we do expect to begin writing down these NPLs over 360 days, creating a mismatch between the NPLs at 90 days that we provide in our presentation compared to the financial statements that disclose full non-performing loans over 90 days, considering the NPLs over 360 days. We are very comfortable about the provision levels, meaning a downtrend in NPLs is something natural moving forward.

William (ph), Analyst

Hi, guys. Thanks for taking my question here. I wanted to ask about NPLs as well. I noticed on slide eight that your 90-day plus NPL ratio has been going down. Can you say a few words about the status of the Brazilian consumer credit quality? I imagine some of that decrease that you see is perhaps due to the shift towards more secured lending, but any commentary on consumer credit quality would be helpful. Thank you.

Eric Oliveira, Head of IR, ESG and Market Intelligence

I will. This is Eric. I think since we made some changes in our management team in terms of risk management, we have been delivering lots of improvements in the credit risk assessment processes and KYC. So this necessarily implies that as we keep underwriting secured products in the short-term and continue to prove our risk assessment models, as the economy improves, there’s a natural path to restore unsecured credit products in the future. The main concern for the credit industry in Brazil is when the asset quality will improve. In our case, it's the opposite because we decided in early '22 to focus exclusively on secured products, so our NPLs peaked in June '22, and they have been trending down since then. The asset quality concerns that surround the Brazilian credit industry do not affect us because we already altered our credit underwriting to focus on secured products in early '22.

Soomit Datta, Analyst

Got it. That's super helpful. That's clear. And I guess one quick follow-up I'll have is, can you talk briefly about Carnival and how the timing of the holiday may impact year-over-year comparables in the second quarter?

Eric Oliveira, Head of IR, ESG and Market Intelligence

You're right. This is Eric again. Last year, we had a very strong first half, driven by the reopening of the economy and a higher number of workdays. This year, we have many holidays in Brazil, resulting in TPV behavior similar to weekends, especially Sundays, which tend to have lower TPVs compared to workdays. This means that the first half of '23 might be impacted compared to the first half of 2022 due to these holidays.

Operator, Operator

Thank you. Our next question comes from Alex Markgraff, KeyBanc Capital Markets.

Alexander Markgraff, Analyst

Hey, guys. Thanks for taking the question. I just wanted to pile on the credit questions, asking about secured credit mix. I think last quarter you mentioned a 60% mix target in the near term. So just first question is whether or not that's kind of still in the plan for the year, that 60% mix? And then secondarily, just pairing that with what you just mentioned regarding an eventual restoration of unsecured credit, what do you think is the right long-term mix between secured and unsecured? Is it above, below that 60% level?

Ricardo Dutra, CEO

Hi, Alex. We plan to keep growing secured products, which is on track. We have been increasing the participation of secured products in the total mix quarter after quarter, and we'll keep growing in the following quarters. If we don't reach that 60% this year, it’ll be close to that, but in the short term, we will keep offering just secured products, so it will be close to that. When you ask about credit without collateral in the future, I would say we don't have the exact number here to give you because there are many products. When you think about unsecured products, there are overdrafts, there are credit cards, and there are working capital for merchants. So there are many products here. I would say we will continue to look at the risk and return to have a balanced portfolio so we can navigate in times of expansion and contraction. So honestly, I don’t have a target here, like 50-50 or anything like that. But it's going to be something we build as we go, watching the risk and demand for the products because you must price the product, and you may or may not have demand. So the best way to answer is we will continue building these unsecured products while controlling the risk and return on a quarter-by-quarter basis. But in the short term, we will keep offering secured products, and this 44% will keep growing in the following quarters. Thank you.

Operator, Operator

The PagBank conference call is now concluded. We wish you a very good night. Thank you.