Earnings Call Transcript - PAGS Q1 2020

Operator, Operator

Welcome to PagSeguro's First 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. This event is also being broadcast live via webcast and may be accessed through PagSeguro’s website at investors.pagseguro.com where the presentation is also available. Participants may view the slides in any order they wish. The replay will be available shortly after the event is concluded. Those following the presentation via webcast may post their questions on PagSeguro’s website. Before proceeding, let me mention that any forward statements included in the presentation or mentioned in this conference call are based on currently available information and PagSeguro’s current assumptions, expectations and projections about future events. While PagSeguro believes that their 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’s presentation or discussed on this conference call for a variety of reasons, including those described in the forward-looking statements in the Risk Factors section of PagSeguro’s registration statement on Form 20-F and other filings with the Securities and Exchange Commission, which are available on PagSeguro’s Investor Relations website. Finally, I would like to remind you that during this conference call, the company may discuss non-GAAP measures. For more details, the foregoing non-GAAP measures and 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.

Ricardo Dutra, CEO

Hello, everyone, and thanks for joining our first quarter results conference call. Tonight, I have here with me Eduardo Alcaro, our Chief Financial Officer; and Andre Cazotto, our Head of Investor Relations. First of all, I hope you and your families are well and safe. I also would like to say thank you to all PagSeguro PagBank team, who have retained their focus and support in our businesses, our customers and partners as well as each other during the past weeks, while almost 100% of us have been working from home. Thank you very much, PagSeguro PagBank team. I will start with an overview of our results. Then I'll pass the word to Eduardo Alcaro, our CFO. And in the end, we will give you our perspective about COVID-19 and some preliminary data about Q2. Going to slide three. We compare PAGS performance with our listed peers. PAGS is in a strong momentum and is the most resilient payments company in Brazil. Despite the health crisis and higher subsidies offered to our clients through this period, PAGS was able to combine growth with profitability. Comparing Q1 2020 with Q4 2019, our revenues grew 1%, despite the strong seasonality in Q4, while our peers' revenues decreased 8% and 5%. And year-over-year, our net income grew 13%, while our peers' net income decreased 13% and 65%. These results reinforce the strength of our broad ecosystem, the resilience of our business model and the caliber of our professionals and their execution capabilities. On slide 4, we highlight the great achievements of the quarter, even with COVID-19 impact in Brazil and in our businesses. As we have seen in past years, we are proud to announce one more quarter with solid results. We delivered organic growth in topline, both revenues and TPV, with less than 3% of our TPV coming from sub-acquirers. We also delivered user growth, both merchants and consumers, and net income growth. On the left side of the slide, our total revenues and income reached close to BRL1.6 billion, growing 27% year-over-year and 1% quarter-over-quarter, despite a stronger seasonality in Q4. Our TPV reached BRL31.7 billion, up 30% year-over-year. We reached 5.5 million active merchants, up 24% year-over-year. Moving to PagBank. Our non-acquiring TPV through digital account and wallet reached BRL8.7 billion, growing 190% year-over-year. Our active users by the end of the quarter were 3.7 million, meaning we added 1 million new users only in this quarter. Now moving to our financials on the right side. Our take rate ended the quarter at 3.31%, up 19 basis points year-over-year, which is a result of adding healthy TPV in our ecosystem. Our adjusted revenue and income reached BRL1.5 billion, growing 33% year-over-year and our non-GAAP net income ended at BRL367 million, up 13% year-over-year. Now I will pass the word to Eduardo Alcaro, our CFO, who by the way, with his previous Walmart experience has been doing an amazing job in cost controlling and cash preservation, as we navigate through this unique time together. Thank you. Thank you for your work, Eduardo.

Eduardo Alcaro, CFO

Thanks, Ricardo, and hello, everyone. On the next slide we show our total revenue and income that reached almost BRL1.6 billion, up 27% year-over-year. This means an acceleration of our total revenue and income growth of 260 basis points, which grew 24% from the fourth quarter of 2018 to fourth quarter 2019, proving that we are on the right track as far as investments in PagBank. On the top right, we show the total net revenue and income growth compared to Q4, up almost 1%. Let me just pause here for a second. This is a remarkable achievement. Despite the COVID-19 pandemic and a strong seasonality in Q4, PAGS was able to grow total revenue and income quarter-over-quarter. Moving to the chart below, our operational revenue and income that reached BRL1.5 billion, grew 33% year-over-year. Talking about net income, PAGS delivered growth year-over-year. Our non-GAAP net income in the first quarter reached BRL367 million, an increase of BRL42 million and up 13% year-over-year, despite the COVID-19 pandemic and investments in PagBank. Moving to slide 6, we present here our operating figures. Our TPV reached BRL31.7 billion, growing BRL7.2 billion, or 30% when compared to the first quarter of last year. As we show in the next graph, our TPV grew high 30s in January and February, and low 40s in the first half of March, better than our expectations for the year shared with you during our fourth quarter 2019 earnings call, but decelerating sharply in the second half of March. This occurred given social distancing measures implemented in several Brazilian cities, resulting in partial shutdowns as a consequence of the pandemic. We estimate an approximate miss of BRL2 billion in TPV for the quarter due to the COVID-19 outbreak, which means a miss of approximately BRL40 million in the bottom line for the full quarter. On the chart below, our net take rate, which is the blended take rate net from transaction costs, such as interchange, processing and card scheme fees reached 3.31%, 19 basis points year-on-year and 34 basis points quarter-over-quarter increase. This increase is explained by a better mix of credit versus debit, higher contribution of PagBank revenues and the resilience of MDRs in the long tail. About transaction costs, we had a positive impact in scheme fee rebates of nine basis points in Q1. Active merchants reached almost 5.5 million, growing 1.1 million year-over-year and 227,000 sequentially. Also important to say that the pandemic impacted 25,000 to 30,000 net adds in the second half of March. Moving to slide number 7, we highlight our strong balance sheet and cash generation despite the pandemic. On the top left chart, we present our solid balance sheet, ending the quarter with BRL8.1 billion in cash, plus our net position between accounts receivable from card issuers less payables to merchants. Moving to the top right, we ended the quarter with BRL3.5 billion in cash, growing more than BRL1 billion when compared to one year ago. This is explained by higher cash generation, higher PagSeguro clients' deposits, as well as higher receivables discounting in volume and duration, resulting in BRL22 million of additional interest expenses when compared to the fourth quarter of 2019. From a cash management perspective, preserving capital and liquidity are the top priorities for now. On the chart below, we present our non-GAAP total costs and expenses that increased 0.2 percentage points year-over-year, and the fourth quarter, that 3.4% over total TPV and down 0.7 percentage points when compared to the previous quarter. Related to non-GAAP admin expenses over total TPV reached 0.2%, down 0.1 percentage points when compared to one-year ago and stable quarter-over-quarter. Important to highlight that approximately 70% of our costs and expenses are variable, meaning that the company has the flexibility to do the necessary expense adjustments to deliver healthy margins and solid bottom line growth. Since April, we are revisiting our expense structure, which should allow the company to maintain the same level of net income margins in Q2 2020, observed in Q1 2020. Now, I'd like to turn the conference over to Ricardo, who will talk about engagement metrics and new products. Stay all healthy and safe. Thank you.

Ricardo Dutra, CEO

Thanks, Eduardo. On slide 8, we present our highlights in terms of online distribution, Google searches and our app rating. Starting with Google searches for digital banks, PagBank continues to lead in gaining share over its peers, with 72% of the total share over digital banks, a consequence of our marketing strategy and product rollout. On average, 53% of our clients use at least three products of our ecosystem. And PagBank App is opened 11 times a week. Our PagBank app was rated at 4.8 stars in iOS and 4.5 stars in Android, being the most reviewed and best rated app among digital banks and payment peers, also a consequence of our best-in-class product development and user experience oriented strategy. Finally, with UOL, that in the quarter broke new audience records in Brazil, reaching 1.8 billion accesses, ending with 113 million unique monthly users and reaching 94% of the Brazilian Internet audience, just behind Google and Facebook. On slide 9, we show some of the most relevant engagement trends in our ecosystem. We believe engagement is a relevant metric to follow this stage, once it will help the company to increase the switching cost of our clients, their stickiness and loyalty, which will enable future monetization and revenue diversification. On the top of the chart, we reached BRL8.7 billion in non-acquiring TPV through our digital account, including prepaid card top-ups, cash card spending, credit cards, mobile top-ups, wire transfers to third parties, cash-in through bank slip, bill payments, tax collections, P2P, QR code and other Super App transactions, growing 190% year-over-year. In the chart below, we see the number of new payment transactions that increased 25% quarter-over-quarter. Our payroll portability feature is also ramping up, growing almost 37% sequentially. Moving to alternative payment methods. Our QR code transactions grew more than 30% quarter-over-quarter, and links of payments increased 53% year-over-year, both boosted by COVID-19. Finally, on PAGS Capital, we continue to offer the product only to our best merchants, eligible according to their account history, TPV behavior and payment frequency. Since the beginning of the operations in October 2018, we have done 150,000 lending contracts. We ended the quarter with a total credit portfolio of BRL338 million. Additionally, we ended the quarter with BRL156 million in our credit card portfolio. Our credit card strategy is also targeted to our best merchants. So far, we continue to be careful with credit disbursements. However, the preliminary results are encouraging as we still face controlled levels of NPLs. To keep our operations under control, helping our merchants, particularly in the COVID-19 crisis and following the Central Bank's instructions, we are offering 90-day grace periods on a case-by-case basis. Finally, it is important to highlight that during the first and second quarter of 2020 we are not showing significant deteriorations. On top of that, to manage our price-to-risk exposure in the middle of the global pandemic, we have significantly reduced disbursing for now. Credit is an important tool to create higher engagement with our merchant base and will continue to generate additional revenues for the company in the future. On slide 10, we highlight our roadmap of products already delivered in the past two years. Being tech and independent allows us to think exclusively on our clients' financial needs and consequently combine growth with profitability. Since May 2018, we have delivered almost 40 new products, including hardware, software, banking and services in our Super App. In May, we launched our services offers and Discounts Map feature, where our clients can find in-app through geolocation closest ATMs and also merchants in different categories, such as restaurants, pharmacies, gas stations and general services to have discounts or cash back when they purchase through QR code or by using our cards. Additionally, we also launched two new CDBs paying 115% and 120% over CDI. PagBank CDBs with remunerations 30% above the traditional savings account is part of our strategy to expand our investment product offer as well to acquire new PagBank clients. Despite the current health crisis, we decided to keep investing in product development and keep committed with our roadmap agenda. We should continue to deploy new products and services on payments, banking and software fronts. Our ecosystem and its development are key to our core strategy. On the next slide, we present some of the new products or initiatives launched in the quarter. First, we officially started our partnership with Shell, one of the largest gas station companies in Brazil. Additionally, we announced a partnership with the most relevant drug and retail pharmacies, offering incentives, discounts and cashbacks with purchases done with PagBank cashcard. This partnership reinforces PagBank card usage. Given the health crisis, we also decided to accelerate some new initiatives such as PagPerto, our new virtual shopping to support merchants and individual entrepreneurs to sell online. On the social side, we announced a partnership with the State of Minas Gerais, and PagBank became the exclusive digital bank to distribute the social aid paid by the government for more than 380,000 public school students. Additionally, PagBank is also supporting the most vulnerable families by offering to the Minas Gerais bank users that are transferring the aid paid by the government to PagBank account. Citizens could withdraw the money or select a bank to have their vouchers deposited. And PagBank was eighth in the ranking in terms of deposits received. On slide 12, we present PagBank Health, officially launched in late April. PagBank Health works in a mostly subscription model with prices between BRL9.90 and BRL14.90 per month, and offers a diversified number of medical and dental appointments, including remote appointments during the COVID crisis, exams and pharmacy discounts in the whole country at low cost, everything in-app. We work in a third-party partnership model with different health care companies. On the next slide, we introduce PagPro Pequeno, in English, Pag for small companies. Our website was launched during the COVID-19 pandemic with PagSeguro solutions to help our clients to keep selling remotely even with their doors closing. Some of the solutions are: link of payments, a non-card-present transaction that can be shared via social media, email or SMS; PedeFácil, a delivery app, PedeFácil is a complete omnichannel that combines payment with software and online menu and online ordering. We also offer Envio Fácil, a partnership that is set with the post office, with promotional price to our clients, less bureaucracy and faster shipments. In QR code, we are offering 0% MDR fees to our merchants and 10% cash back for all buyers. Additionally, we are offering from now on unlimited wire transfers at no cost to our PagBank clients, both merchants and consumers. Now I would like to share the management perspectives due to the outbreak of COVID-19, including our initiatives with our clients, employees, community and investors. I would like to reinforce PAGS has a highly variable cost structure, mainly interchange and card scheme fees, combined with a scalable platform. So that we are able to manage cost and expenses accordingly to sustain net income margin levels observed in Q1 2020 during Q2 2020. And to describe to lead the new financial inclusion and electronic payment adoption with 5.5 million active merchants and 3.7 million PagBank users. Our employees are our first and main priority. In a few days, we were able to set home office for almost 100% of our team, and we continue to hire people for positions in our product development and software engineer departments. Important to mention there were impacts in our systems operations as we transitioned our team to work from home status. To our investment community, we recognize you would appreciate as much information on our performance as possible. And to that end, we will disclose some second quarter preliminary numbers in the next slide. However, due to obvious reasons such as poor visibility and high uncertainty levels around the duration of lockdown measures and the near-term economic effects of COVID-19, we have decided to withdraw our full year 2020 soft guidance for absolute TPV growth, take rate and net margin shared in the previous conference call. For our clients, as we saw in previous slides, we launched many services, such as PagPro Pequeno and also helped with government distribution in financial aid to the population. Community matters for us. PagSeguro donated thousands of masks to public hospitals, donated more than 200,000 food baskets and promoted online concerts with donations of cash, food and health items to UNICEF Brasil. All the initiatives to our clients and communities will reach BRL30 million. Finally, on slide 15, we can see some Q2 preliminary data. We saw a stronger impact in the second half of March, with a sharp decline in sales for two consecutive weeks due to initial shutdowns in Brazilian retail. However, since April, we started to see recovery in sales posting a small decline of only 3% year-over-year when compared to almost 37% decline in retail sales in Brazil in the same period. Also, important to say, we are observing growth in a year-over-year basis since the second half of April. Adjusted by calendar effect, meaning fewer working days due to a national holiday in 2020, our TPV in April would have been up 2% year-over-year. In May, we are seeing until last week, growth of 11% year-over-year or 18% up, adjusted by calendar effect. Once in May, we also observed one less working day due to a national holiday in beginning of the month. This trend shows the resilience of our diversified merchant base, comprised by micro, small and medium merchants and also by individual entrepreneurs that were less impacted by the crisis. Important to mention, some states in Brazil are reducing social isolation and retail volumes are gradually improving. Important to mention our lack of concentration in segmental geography, a 100% coverage of Brazilian cities, and a little over one-third of our TPV coming from large capitals. In our efforts to rapidly adapt and deploy omnichannel products are a key to our TPV recovery. On the right side of the slide, as of May 23 active merchants reached 5.7 million, backed by a healthy trend of 167,000 net adds in April and May. Meanwhile, PagBank reached 4.6 million active users, maintaining the accelerated pace of net additions of 826,000 in the same period. In summary, we are prepared to increase our leadership in the long tail market, which is still huge, due to large number of micro merchants and informal employees and it will grow due to acceleration of shift from cash to plastic. Important to mention, some of our peers decided to reduce the investment in long tail segment. Having said that, we reinforced our plan to have 30% of our revenues coming from PagBank, meaning services beyond acquiring in up to five years, with acquiring still growing at a healthy pace. Although, we are pragmatic in understanding and managing short-term impact of COVID-19, we are confident about the strong fundamentals of our businesses and the strength of our brand that they constantly have built so far. We will keep investing in our long-term strategy in people, products and growth. We believe PagSeguro is uniquely positioned to lead the digital transformation of financial services in Brazil. Having said that, we finish our presentation. We will start the Q&A session. Operator, please?

Operator, Operator

Thank you. Our first question comes from Craig Maurer, Autonomous Research. You may proceed.

Craig Maurer, Analyst

Hi. And thanks for all the good detail tonight. Two questions for you. First, from our own perspective we're trying to pay attention to the competition from what we can see. It looks like competition has pulled back significantly through the early part of the pandemic. And is that creating an opportunity for you? Second, should we expect financial expenses to normalize in second quarter, following the need or perceived need for short-term liquidity in late March? Thanks.

Ricardo Dutra, CEO

Hi, Craig. Thank you very much for the question. Regarding competition, we have seen some competitors reducing terminal subsidies, reducing smart investments, and at some point, even reducing headcount. Some of them are increasing the price of the terminal, decreasing advertising, taking out some promotions. So we see that some of the players are pulling back. They are trying to focus on large accounts and SMEs. So you're right, we have seen less competition from some of the players. We always said that to operate in long tail, it requires a part of front investment in the platform, the branding, user experience and payback will come later. So we started doing that in 2006. We had a very broad ecosystem, very complete. So that's why we are able to scale our platform and bring, as you could see, 80-plus-thousand new merchants per month and we got that at the same time. So, going back to your question, you're right, some competitors decided not to invest in retail as they used to do in the past. Regarding the financial expenses, Eduardo will take that.

Eduardo Alcaro, CFO

Hi Craig. Obviously, we expect financial expenses in Q2 to be lower than Q1. Obviously, because in Q1, we had to build this liquidity reserve. But going straight to your question, we should expect lower interest expenses, financial expenses in Q2 compared to Q1.

Craig Maurer, Analyst

And if I could just ask one follow-up. Could you discuss your e-commerce business? Because I know you do have a significant or meaningful e-commerce business. And can you discuss where that's focused and how it's been performing?

Ricardo Dutra, CEO

So, we are observing faster adoption of e-commerce for some of our base, mainly post-COVID. Online transactions have been growing 50% year-over-year in May. That's the number of transactions, not TPV, because the average ticket sometimes is lower. We are taking advantage, so to say, because of COVID and all the interest from the clients or merchants to sell online, to leverage our online or e-commerce platform. So, it's been growing at a healthy pace faster than POS, of course, and we see opportunities in the future to even take market share from POS to e-commerce.

Eduardo Alcaro, CFO

Just one follow-up here, Craig. As we said in the presentation, we decided to accelerate some new initiatives like virtual shopping, PedeFácil that's our omnichannel full delivery application. So, some new initiatives that should help the company to capture more internal transactions through all channels going forward.

Craig Maurer, Analyst

Thank you.

Operator, Operator

Our next question comes from Bryan Keane, Deutsche Bank. You may proceed.

Bryan Keane, Analyst

Hi guys. Two questions. First on the PagBank user growth, it continues to be solid and impressive. Can you just talk a little bit about these new users? Any change in under-banked or are they coming from other competitors, both, I guess, in the physical branches or even the digital competitors, and what engagement you're seeing out of these new users to start? And then secondly, the take rate was also impressive in the quarter. Can you quantify the impact that PagBank might have had there and what take rate might look like as we go into the second quarter? Thanks.

Ricardo Dutra, CEO

Hi Bryan, good to hear. Thank you for the question. Regarding PagBank, as we can see in the presentation, we grew 1 million new users during this quarter. The majority of this growth is still coming from merchants. But a large part is coming from consumers increasingly adopting the account. We already have hundreds of thousands of consumers with PagBank and it's growing fast. Part of that we saw in Q1 as people digitalized more because they do not want to go to the streets or they can't go. So, they signed up for these digital accounts. Second, we benefited from government distributions. We are talking about 200,000 that started in April. They are not in the March numbers yet, but we started in April. Also the brand awareness campaign is making our brand more known in Brazil. Also, we have been launching new products, such as CDBs, and we see some interest coming to us because of these new products. So, I think the answer to your question is we have seen more interest from consumers in the past months and it is growing faster than the merchants. Regarding take rate, Eduardo can take that.

Eduardo Alcaro, CFO

Yes, hi Bryan. Take rate is a combination of things. First, we had lower transaction costs. We also expected a higher net take rate, because of seasonality. Remember that in Q4, usually, we have a higher mix of debit because of the holiday season and the 13th salary compared to Q1. And obviously, we do have a higher engagement of our users in our banking strategy, which is already showing some monetization in our take rates.

Bryan Keane, Analyst

Got it. Thanks so much and stay safe.

Operator, Operator

Next question comes from Jorge Kuri, Morgan Stanley.

Jorge Kuri, Analyst

Hi, everyone and congrats on the numbers. Two questions, if I may. Can you maybe talk through what's driving that resilience in Brazilians among your micro merchants? I think it's pretty impressive that you’re at 86% of pre-COVID levels in terms of TPV. Can you just help us understand that is it geographical presence? Is it industry verticals? Is it the ability of micro merchants to pivot to do different things? Is it that they simply didn't lock down? Any color that you can provide would be helpful. And then the second question is could you — I mean, you continue to talk about 30% of your revenues not coming from acquiring, so I'm assuming that's PagBank really. Where are we in that path? Clearly, with PagBank now at almost 5 million clients, I'm assuming it’s already bringing in some percentage of the top line at least. Could you tell us where we are in that pathway to getting there? Are revenues already a meaningful portion from PagBank, say 5%, 10%? Any quantification around that would be very useful. Thank you.

Ricardo Dutra, CEO

Hi, Jorge. This is Ricardo. Good to hear you. So I'll take the question about the resilience of our total payment volume. I agree with you, it's really impressive that we already have 86% of our TPV in the first half of May compared to the first half of March. Part of that, I would say, first of all, we don't have exposure to industries that were very, very affected by COVID-19, such as airlines, rental cars and things like that. So as we don't have this exposure, we didn't serve them just like other players in the market. We have clients in every city in Brazil. It's more than 5,500 cities in Brazil. Our TPV comes from a wide geographic spread. A little over one-third of our TPV coming from capitals and the other two-thirds from small cities and the countryside. We don't have dependence in a specific industry. The largest industry that we have is bars and restaurants, close to 15%. So it's very spread out. Also worth saying that all this TPV is organic, right? Only 3% of our TPV comes from sub-acquirers. So we are not leveraging TPV from other companies. So it's organic, all directly connected to us. What happened due to COVID is that we saw some changes as weeks passed by. In the first week, we saw a lot of TPV coming from supermarkets and also from pharmacies. Gas stations went down a lot and then came back. Restaurants are also coming back. Beauty salons and hair salons are up a little bit. But as we don't have too much concentration, we could see TPV come back to 86%. The other advantage is that many micro entrepreneurs need to work. So if they cannot sell coconut at the beach, they will work as a plumber. They will paint houses. They may do something, because they need to survive. So that's part of the answer to why our TPV has been resilient in this period. Also, we observed faster adoption by micro entrepreneurs on PagSeguro channels, such as link of payments and QR code and delivery services. Link of payments in our presentation grew more than 50% year-over-year, QR code more than 30%. So also reinforcing the good work that we did internally to offer new channels for our clients, even working remotely in this environment.

Eduardo Alcaro, CFO

Hi, Jorge. This is Eduardo speaking. In terms of the additional revenues in this quarter, what we can say is that they grew almost three times when we compare year-over-year. So when we compare Q1 2019 to Q1 2020, those additional revenues grew three times year-over-year. And we expect this trend to continue in 2020. I think despite the potential impact of COVID, which really has been an upside to the larger adoption of electronic payments by their resilience, PagBank is really helping our clients during these tough times. We are offering, for example, free wire transfers, 10% cash back through QR codes, cash backs for people who choose PagBank as their bank to receive the government aid or even incentives in the state of Minas Gerais. So we are really confident that we can reach the 30% of our total revenues and income in five years.

Jorge Kuri, Analyst

Thank you and congrats again.

Operator, Operator

Next question comes from Mario Pierry, Bank of America.

Mario Pierry, Analyst

Hi, everybody. Congratulations on the results. Let me ask you also two questions. First one is related to PagBank. When we see here that you added 1 million clients, and you brought your base up to 3.7 million. So this is a significant growth in your client base, PagBank in one quarter. If you can be a little bit more specific? Then about your acquisition costs, your client acquisition costs at PagBank, do you think also that PagBank has benefited from the disruption that we have had and people then are moving more into the digital banks? Also, when you mentioned in the prior question that your revenues are up from non-acquiring business, that your revenues are up three times year-over-year. Can you be a little bit more specific about what product is driving this growth? Is it related to your credit book? What is really driving this big increase in revenues year-over-year? Thank you.

Ricardo Dutra, CEO

Hi, Mario. Thank you, good to hear you. Regarding PagBank, we monitor the acquisition pace almost daily, sometimes intra-day. We have a very efficient funnel for PagBank and we leverage the PagSeguro brand and UOL. The customer acquisition cost for PagBank has been relatively low because we leverage the ecosystem. The majority of new PagBank users are consumers, accelerated by COVID-19 as they sought digital alternatives. We made changes in the last months that also help PagBank: free wire transfers, attractive CDB yields, virtual cards available immediately after account opening. These product rollouts drove traction. The majority of revenues at this point are related to interchange. As I said before, interchange is a strong part of our business in Brazil. So most revenues are driven by transaction and some nascent credit revenue, but credit is still a small portion at this point.

Mario Pierry, Analyst

Okay. Thank you for that. Let me ask then a follow-up related to the mortality of your clients. Can you give us some color on the mortality that you see both at PagBank and PagSeguro?

Ricardo Dutra, CEO

Yes. PagBank is growing fast, and because we don't charge for core services many users keep using the account. So PagBank churn is very low. In terms of PagSeguro merchant base, it's early to talk about churn rates after these two months of the health crisis, but we saw a slight increase in the absolute number of merchants that stopped making transactions. We survey these merchants and the answer is they stopped because their business is closed or they temporarily paused. We expect these to be temporary churn. We don't see a structural acceleration in merchant attrition. Many merchants are micro entrepreneurs who need to return to work and we are seeing recovery. The worst numbers were in April, but in May we have seen some recovery as you can see in TPV. So I don't see that churn will be an issue; it's temporary.

Eduardo Alcaro, CFO

Mario, just one add-on here. We do believe that the addressable market could increase especially after the crisis. Similar to the 2015 crisis, many new individual professionals and informal entrepreneurs could be created due to rising unemployment. We expect to be able to capture a meaningful portion of this incremental addressable market.

Mario Pierry, Analyst

That's very clear. Thank you very much.

Operator, Operator

Next question comes from Eduardo Rosman from BTG Pactual.

Eduardo Rosman, Analyst

Hi, everyone. Two questions here. First on the TPV, I just want to understand if you have seen in the last two months clients who were only using the machines as a part-time job increasing the usage right now? My question here is trying to understand if maybe people lost their job and income right now and so they need to use it a lot more as a full-time job when compared to before? So this is the first question. If you're seeing something like that, a lot more usage on machines. And the second question is on PagBank. We can see here that the bank has been a very clear beneficiary of the corona voucher. One of the challenges that you have is to educate clients on how to use the functionalities of the bank, which probably is much tougher than to understand a POS machine for merchant acquiring. Right? Do you think this crisis will force the lower-income part of the population to learn how to use the app and this could be very good news for you? Thanks.

Ricardo Dutra, CEO

Hi, Eduardo. Good to hear. Regarding TPV, we did not see material evidence that people who lost jobs have dramatically increased device usage to full-time levels across the base. There must be some cases, but given the millions of devices it's a small effect so far. In terms of government aid, the government is giving BRL600 for close to 50-60 million people in Brazil for three months and people can receive through the government bank or select a bank to have the money deposited. PagSeguro was eighth in terms of deposits received. We are proud to help distribute those payments. The PagBank sign-up process is simple and intuitive; users can sign up in two minutes. There are segments of the population that have some difficulties with technology, but many of those are being forced to try digital banking and are finding it useful. We design the app with clear fonts and intuitive flows to make adoption easier. So we see this as an opportunity to onboard users that were previously resistant.

Eduardo Rosman, Analyst

Okay. Thank you very much.

Operator, Operator

Our next question comes from Mariana Taddeo, UBS.

Mariana Taddeo, Analyst

Hi, there. Good evening everyone. I have some questions related to credit. During the presentation, you mentioned that you reduced your credit origination. What level is it today compared to the level before the COVID-19 outbreak? And what can I expect in terms of credit portfolio at the end of the year? Also, how is NPL trending in the current scenario and how are incremental provisions facing more challenging scenarios? Thank you.

Ricardo Dutra, CEO

Mariana, I'll talk about the growth of the portfolio and Eduardo can comment on details. We closed Q4 with BRL286 million in total portfolio. In Q1 we closed BRL338 million, so we grew BRL52 million. If you look at the pace in previous quarters it was close to BRL90 million per quarter, so in Q1 it slowed to BRL52 million. In Q2 it will be less than that. We are being very careful about credit origination given the COVID situation. It's hard to give a full-year forecast because it depends on when lockdowns end and the rebound of the economy. But right now we are cautious and in Q2 we'll originate less than Q1.

Eduardo Alcaro, CFO

The variability of our ratios has not shown relevant deterioration yet. We are offering repayment schemes on a case-by-case basis depending on the client. As Ricardo said, we are managing our exposure and slowed down credit originations so far. Credit is still a new business for us and very small as you can see in the presentation. Before the health crisis, we were rescaling the product to our best merchants, cherry-picking according to TPV, account history and repayment frequency. That's where we are on NPLs right now.

Mariana Taddeo, Analyst

Thank you. That's clear. And if I may ask another question related to your net adds. Net adds remained strong in the first quarter and based on data you provided quarter-to-date it's similar or even higher in Q2. Could you share a bit on the profile of these new merchants? Are they individuals that did not accept card before or retailers increasing their POS base for deliveries for instance? Is this incremental margin coming with lower average spending than the ones you have in your base? Thanks.

Ricardo Dutra, CEO

Yes, Mariana. We had close to 170,000 net adds in April and part of May. The majority of net adds are similar in profile to previous quarters. Some merchants are buying additional devices for delivery but that's the minority. The majority of new merchants still did not accept cards before joining us—around 80% per our surveys. In terms of TPV and margin, it's similar to historical levels; any lower spending is more due to the economic situation than profile changes.

Eduardo Alcaro, CFO

Mariana, just one additional commentary here. We are keeping the same subsidies for clients. Some peers and competitors reduced marketing campaigns and subsidies; some increased hardware prices. When peers reduce subsidies or marketing, it will likely help PagSeguro to keep increasing market share in the long tail.

Mariana Taddeo, Analyst

That's clear. Thank you.

Operator, Operator

Next question comes from Jamie Friedman, Susquehanna.

Jamie Friedman, Analyst

Hi. Thank you and congratulations on the numbers. I'll just ask my two upfront. Eduardo, I realize with the Q2 margin you're guiding the net margin to be flat sequentially. I'm just wondering are you comfortable? Do you think that it will be at those levels for the remainder of the year? And then you also mentioned in your prepared remarks 70% of the costs are variable. So what would it take — since the cost structure is so variable, I mean what would it take to see a significant deterioration in the margin? Thank you.

Eduardo Alcaro, CFO

Hi. Thanks for the question. As you can see our cost structure is about 70% variable: transaction costs, interchange, card scheme fees, marketing, advertising and chargebacks. We are also a company that's not very people intensive. We have visibility on Q2 and that's why we're guiding to maintain the net margin at Q1 levels in Q2. We continue to hire engineers to invest in the platform. We are reviewing every single line of expense during Q2, and slowing down investments that do not make sense at this stage. Looking at Q3 and Q4, we prefer to have more visibility. But for Q2, we can say it's going to be at the same level as Q1.

Jamie Friedman, Analyst

Great. Thank you very much. Be well.

Operator, Operator

Next question comes from Tito Labarta, Goldman Sachs.

Tito Labarta, Analyst

Hi, good evening. Thank you for the call. A couple of questions also. Following up, going back on your take rates. I understand the seasonality in the quarter compared to last quarter. So it's an increase. But it was higher than every single quarter last year. With PagBank and everything else going on, is this a new level for the take rates? Do you think it can increase higher over time particularly as you do more with PagBank? Just want to get a sense of the long-term outlook for take rates. And then my second question on marketing expenses. You mentioned you spent around BRL67 million in marketing for PagBank. Did you reduce that a lot in the second quarter? Given the lockdown and potential revenue impacts, would that have any impact on future growth of PagBank? If you can give color on that it would be helpful. Thank you.

Eduardo Alcaro, CFO

Hi, Tito. The take rate level in this quarter is a combination of a better mix in Q1 compared to Q4, lower transaction costs, and more additional revenues compared to Q1 2019. We grew those additional revenues three times compared to last year. We believe that going forward, additional revenues and PagBank should contribute to higher take rates over time.

Ricardo Dutra, CEO

Regarding marketing expenses, this is Ricardo. We decreased marketing investment in Q2, but we manage acquisition costs carefully to ensure they make sense. We closed some partnerships that helped PagBank new users. Investment in March and Q2 decreased. We are focused on performance and keeping margins at Q1 levels. Even with lower marketing we added 826,000 new PagBank users in these two months. For Q3 and Q4 we kept the same budget planned for the year, but we will adjust depending on how the situation evolves. We always look for growth with profitability. We will control marketing spend so it is accretive to our P&L.

Tito Labarta, Analyst

Okay. Thank you, Alcaro and Ricardo. And just to go back on the take rate. Once you get the 30% of additional revenues related to PagBank, would it be fair to assume the take rate should eventually be higher because of the contribution from PagBank? Is that a fair assumption?

Ricardo Dutra, CEO

Yes, Tito. It's expected to go up, but we are talking about 30% in five years, so many things could change until then. But of course we expect PagBank to help the take rate. There are assumptions in a five-year plan and results may vary, but directionally yes, PagBank should help increase the take rate.

Tito Labarta, Analyst

All right. Perfect. Thank you very much.

Operator, Operator

Next question comes from Victor Schabbel, Bradesco BBI.

Victor Schabbel, Analyst

Good evening everyone. Thanks for taking the questions. First, congratulations on all the initiatives that the company has carried out on the social side. I think it's worth highlighting that. Second, I would like to hear from you about the strategy going forward regarding instant payments. What do you guys see as an opportunity coming from the new infrastructure that the Central Bank is developing? Is it more of an opportunity for PagBank? Is it a threat for PagSeguro acquiring business? How do you see that evolving?

Ricardo Dutra, CEO

Hi, Victor. Thank you for the questions. Regarding instant payments such as PIX developed by the Central Bank, currently Brazilian buyers don't pay to make a debit transaction and it is part of our culture. For PIX adoption, consumer behavior will be key. In other countries it took time for instant payments to gain traction. We think PIX will likely cannibalize cash, checks and wire transfers more than card transactions in the near term. One-third of the Brazilian labor force is paid in cash today, so shifting cash to electronic payments is a big opportunity. We see instant payments more as an opportunity than a threat. Anything that shifts cash to electronic payments and increases financial inclusion is beneficial for us.

Victor Schabbel, Analyst

Perfect. Thank you.

Operator, Operator

Next question comes from Felipe Salomao, Citibank.

Felipe Salomao, Analyst

Hi, Dutra, Alcaro. Thanks and hope you all are well. I have two questions. The first one is regarding the take rate. You reported a 3.31% net take rate. But I think there was an adjustment of BRL88 million in transaction costs. Can you please explain why this was adjusted? Also should we expect similar adjustments in upcoming quarters or was this a one-off? My second question is related to the marketing budget for 2020. I remember roughly we could expect BRL600 million to BRL700 million in marketing for the full year. Do those numbers still make sense or should we expect a bit lower? Thank you.

Eduardo Alcaro, CFO

Felipe, I'll take the first question. The BRL88 million relates to an intercompany tax transaction with the company that applies terminals and sells terminals to PagSeguro. The transaction is structured due to tax incentives and lower taxes on the cost of terminals that we acquire. It is a tax accounting adjustment related to intercompany transfers and incentives. Regarding whether similar adjustments will occur, these are driven by tax and accounting specifics and may not repeat identically every quarter.

Ricardo Dutra, CEO

Felipe, on marketing, as we said before, we decreased marketing expenses in Q2. We are focused on performance and controlling acquisition costs. For Q3 and Q4, we kept in our budget the same marketing investments planned for the year, but we will adjust as necessary. If economic activity and reopening accelerate, we may increase marketing. But we will always look for performance-based investments that are accretive. In Q2 we've taken steps to preserve margins and liquidity while keeping growth where accretive.

Felipe Salomao, Analyst

Okay. Thank you.

Operator, Operator

Next question comes from Jeff Cantwell, Guggenheim Securities.

Jeff Cantwell, Analyst

Hi guys. Thanks for taking my question. On PagBank, we saw the May update in the slide deck and you have 4.6 million active users for PagBank which is very impressive. That number of users still seems like early days if we think about the size of the addressable market PagBank has. Why couldn't PagBank's market share double over the next year or two? It seems like that's the pace PagBank is on. Could you talk about your level of confidence for PagBank growing its user base from here over one to two years? Thanks.

Ricardo Dutra, CEO

Hi Jeff. Thank you. PagBank is in a strong momentum. It's easy to open an account and start using it which helps adoption. We launched PagBank in May 2019 as a basic account and then rapidly added features: paying bills, cash backs, offers, CDBs, virtual cards. These rollouts increase stickiness. Growth is aggressive and we believe it's realistic to expect significant expansion of the user base from here. Some users treat PagBank as a main bank; adoption is growing. We are investing in products and partnerships to drive further adoption. So yes, it's realistic for the base to expand materially in the next one to two years, though exact multiples depend on execution and market dynamics.

Jeff Cantwell, Analyst

Okay. Thanks very much. Stay safe.

Operator, Operator

Next question comes from Marco Calvi, Itaú BBA.

Marco Calvi, Analyst

Hi, good evening. Can you share your view on the profitability of your online clients? How different is that from the rest of your active client base? And second question, can you confirm how much of your first-half TPV came from online clients? Thank you.

Ricardo Dutra, CEO

Hi Marco, thank you. We are not disclosing the TPV split between online and offline in detail. The distinction between online and offline is getting blurred—for example, ordering food online and paying on delivery can be classified differently. In terms of profitability, online and offline long-tail merchants are pretty similar. Long-tail rates are structured to be profitable for us and merchants are less sensitive to small basis-point differences. Online tends to have more credit and higher mix of card payments, but overall profitability is similar.

Marco Calvi, Analyst

Thank you. Very clear.

Operator, Operator

Next question comes from Neha Agarwala, HSBC.

Neha Agarwala, Analyst

Hi. Good to hear from all of you, and thank you for the detailed presentation and congratulations on the results. My question is more on PAGS Capital. Should we expect that in the second and third quarter you wouldn't be making more provisions on the loans that you've already given out as the 90-day grace period ends? And could you give any indication on the profitability of the loans that you are giving out right now on PAGS Capital? Thank you so much.

Eduardo Alcaro, CFO

Hi Neha. Regarding NPLs, it's hard to say how long closures and social distancing measures will last. If they last longer, we should expect higher NPLs in Q3 and Q4, but there's a lot of uncertainty. We have provided visibility that we're evaluating on a case-by-case basis and helping clients as needed. NPLs did not materially affect our take rates in Q2 so far.

Ricardo Dutra, CEO

Neha, regarding the type of credit we offer: currently we offer loans primarily to merchants, not to consumers (except a small pilot). We offer credit only to our best merchants using their account history, TPV behavior and payment frequency. This is lower-risk merchant credit because it's targeted and backed by transaction history. We have information proprietary to PagSeguro which allows better underwriting. So these loans are designed to be profitable and lower risk.

Neha Agarwala, Analyst

Great. Thank you so much.

Operator, Operator

Next question comes from Josh Beck, KeyBanc.

Josh Beck, Analyst

Thank you so much for the color and information, it's very helpful. I wanted to ask about PagBank engagement. You mentioned the app is opened 11 times a week, which is quite high. Are there some existing PagBank clients that are effectively completely replacing traditional banking relationships and just using the PagBank app?

Ricardo Dutra, CEO

Hi Josh. People use PagBank not only for basic transactions such as transfers or bill payments but also for offers and cash backs. We have partnerships with large pharmacy chains and other merchants where PagBank users get discounts and cash back, so people open the app frequently to find offers. We have seen people start to use PagBank as their main bank and that trend is growing, though not yet the majority. Adoption is increasing and COVID-19 accelerated digital adoption.

Josh Beck, Analyst

Thanks so much. Stay well everybody.

Operator, Operator

Thank you. That concludes the question-and-answer session. Now I'd like to turn the floor over to Mr. Ricardo Dutra for his closing statements.

Ricardo Dutra, CEO

Hi, everyone. Thank you very much for your time, and for your questions, and for your support during this time. I hope to meet you all very soon or as soon as possible, and talk to you next quarter in the conference call. Thank you very much.

Operator, Operator

That concludes PagSeguro's conference call. Thank you. Have a nice night. Stay well and safe.