Earnings Call Transcript - PAGS Q3 2023

Operator, Operator

Good evening. My name is Carolyn, and I will be your conference operator for today. Welcome to PagSeguro Digital Earnings Call for the Third Quarter 2023. This event is also being broadcast live via webcast and may be accessed through PagSeguro Digital website at investors.pagbank.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, Éric Oliveira, Head of IR. Please go ahead.

Eric Oliveira, Head of IR

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

Ricardo da Silva, CEO

Hello, everyone, and thanks for joining our third quarter 2023 earnings call. Once again, I have the company of Alex, our CEO, and Artur, our CFO. Going to Slide 3. I'm happy to announce in Q3 2023, we have reached the largest net income, both GAAP and non-GAAP in the history of the company. In the past years, we have successfully managed the impacts related to the high interest rates for a longer period while reshaping our funded structure backed by deposits. More recently, we have been seeing better operating trends in our volumes, combined with a decrease in Brazilian interest rates, which should positively contribute to our funding strategy to keep delivering growth with profitability. Our non-GAAP net income reached BRL 440 million, growing 7% year-over-year. Despite our increasing footprint to merchants, largely in the long tail, which is accretive to gross profit, alongside lower take rates, our margins continue to improve, resulting in BRL 894 million EBITDA, reaching the highest margin since Q3 2021. Total revenue was flattish year-over-year and grew 5% quarter-over-quarter, reaching BRL 4 billion. Disciplined CapEx deployment resulted in BRL 10.6 billion in net cash balance at the end of the quarter, 17% higher than the previous year, driven by 36% growth in cash earnings versus Q3 2022. Going to the Financial Services section, we have continued improving our risk management models. We have been exploring new addressable markets by offering collateralized products and despite the interchange cap's impact on our revenues from Financial Services division, revenues posted quarter-over-quarter growth, and EBITDA was positive again, reaching BRL 2 million. PagBank cash-in was BRL 56 billion, driving up deposits to the all-time high level, reaching BRL 21.6 billion, reinforcing the closed-loop advantage backed by a comprehensive set of payments beyond cards accepted while lowering the company's cost of funding. In payments, we are continuing to grow in a profitable way and our TPV reached almost BRL 100 billion, an 11% year-over-year growth. Going to Slide 4, our focus on new technologies and product developments continues in 2023. In this slide, we share the main milestones of our company. In October, our company executed its first transaction using DREX, the Brazilian digital currency through the blockchain platform, embracing the digital assets revolution. This month, we just announced the facial authentication feature for our clients aiming to use our payment link option, reinforcing our security features while improving user experience and confidence. On payments, we announced our Tap On phone solution, fully embedded in PagVendas app, our proprietary ERP software with more than 1 million users. We also launched our collection platform, a comprehensive set of payment solutions, covering card acceptance, PIX QR Code, and boleto issuance, empowering merchants to accept all payment options. On Financial Services, in addition to products launched for consumers, such as investment options, debit cards, and so on, we also launched products focused on SMBs and larger merchants. This year, we have launched our payroll solution, allowing entrepreneurs to manage their employees' paychecks seamlessly, and we also launched our PagBank business account that allows direct deposits from third-party acquirers into the PagBank account. Now I pass the word over to Alex for the commentaries on the third quarter 2023 operational highlights.

Alexandre Magnani, CEO

Thank you, Ricardo. Hello, everyone. We show on Slide 5 that our merchant acquiring business remains solid and through the combination of our superior value proposition and the broad reach of our sales channel, we have been able to accelerate TPV growth faster than the industry, driven by our merchant segments. TPV reached almost BRL 100 billion, growing 11% year-over-year. We continue to observe better TPV growth through the first weeks of the fourth quarter. MSMB TPV posted 15% growth versus the third quarter of 2022, primarily driven by SMBs, followed by micro-merchants. As Ricardo mentioned earlier, we also noted a rebound in TPV growth from large accounts, which is composed of merchants with TPV above BRL 500,000 per month. Moving on to Slide 6, the instant prepayment product, which combines payment service and financial service through PagBank account, has promoted an increasing footprint in larger merchants, resulting in a 22% year-over-year growth in TPV per merchant. Our strategy to focus on disciplined CapEx deployment did not interfere with our POS sales uptrend. In August, we presented the record POS sales level since January 2022, with the highest POS activation ratio since mid-2021. Consequently, we reached 6.7 million active merchants. At first glance, the net merchant's loss has been raising concerns about our ability to grow our business and revenues. However, when we consider active merchants with at least one transaction in the past 30 days, excluding nano-merchants, the positive trend is revealed, supported by our TPV growth rebound in all segments and the improving cash earnings generation. PagBank clients grew 16% year-over-year, surpassing 30 million clients, placing us among the most relevant Brazilian financial institutions, adding more than 4 million new clients in the past 12 months, as shown on Slide 7. Our active clients base reached 16.7 million clients, leading to BRL 56 billion in PagBank cash-in, composed of PIX and P2P wire transfers inflows into PagBank accounts from other financial institutions. Combined, TPV and PagBank cash-in led deposits up 11% compared to the third quarter of 2022 and 18% quarter-over-quarter, reaching a record of BRL 21.6 billion. This deposit level was boosted by our AAA rating attributed by S&P Global, which enhanced our CD distribution among institutional and retail investors on- and off-platform. Checking accounts balance, the cheapest funding source and a key performance indicator to measure client engagement, grew 43% year-over-year, driving down our annual percentage yields to 93% of the CDI. Slide 9 shows that our credit portfolio reached BRL 2.5 billion due to our ongoing run-off of the working capital loan portfolio, combined with the tax planning write-off of non-performing loans we started in the last quarter. Payroll loan and FGTS already account for half of the portfolio, expanding our offerings to consumers primarily through a seamless experience and a cheaper cost structure. Our go-to-marketing strategy for secured loans is based on competitive APRs and a digital end-to-end onboarding, risk assessment, underwriting, and collections. This also includes our offering of credit cards backed by investments and savings. The total credit portfolio share composed of secured products reached 60%, resulting in the ongoing downtrend in NPL 90+ to 10.7%. Now I turn over to Artur for the financial highlights of the third quarter '23. Artur, please.

Artur Schunck, CFO

Thanks, Alexandre. Hello, everyone, and thank you for joining us in the call. This quarter, I am proud to announce all-time high net income, GAAP and non-GAAP. Total revenue and income grew 5% due to TPV growth, and gross profit grew 3% on a quarterly basis, also positively impacted by lower losses and a higher level of deposits that reduced financial expenses. Our commitment to efficiency led to another decrease in operating expenses, driving 5% EBITDA growth quarter-over-quarter, with a similar improvement in EBITDA from the payments vertical, while EBITDA from Financial Services got back to positive territory despite the effects related to the cap on interchange of prepaid cards, lowering our revenues since the second quarter. Net income on a non-GAAP basis reached BRL 440 million, growing 6% quarter-over-quarter and 7% year-over-year. Earnings per share reached BRL 1.27, BRL 0.09 better than last quarter and 10% higher than the third quarter of 2022. Cash earnings amounted to BRL 365 million, 40% higher than the second quarter of 2023 and 36% versus the same quarter of last year. On Slide 11, revenues from the Payments unit grew 5% quarter-over-quarter, while gross profit grew 4% in the same period. TPV growth and transaction cost savings due to the interchange cap positively impacted the current performance versus the third quarter of 2022. Comparing quarter-over-quarter, the increase was due to a lower take rate, partially led by client mix change towards large merchants with lower take rates but incremental gross profit contribution. Adjusted EBITDA in the Payments division reached BRL 892 million, an increase of 5% quarter-over-quarter and 7% year-over-year. On the next slide, the Financial Services vertical's total revenues reached BRL 260 million in the third quarter of 2023, 8% higher than the second quarter. On the other hand, gross profit decreased to BRL 101 million, down 9% on a quarterly basis, mainly led by an increase in provisions for losses due to a credit model update based on IFRS 9. Besides the higher provision levels, adjusted EBITDA grew BRL 64 million from the third quarter of 2022, back into positive territory. Moving to Slide 13, financial expenses closed at BRL 820 million versus BRL 921 million in the third quarter of 2022. This decrease is mainly explained by our lower average cost of funding, driven by a higher level of deposits. On a quarterly basis, financial expenses increased due to more working days in the third quarter of 2023 versus the last quarter. Total losses decreased 39% year-over-year, accounting for BRL 165 million, driven by lower provisions for expected credit losses, healthier coverage ratio, and credit underwriting mostly on secured projects. On the other hand, the increase quarter-over-quarter is mainly due to higher provisions led by modeling review for working capital and payroll loans. Operating expenses reached BRL 583 million, down 5% year-over-year and 1% quarter-over-quarter. This amount represents 14.5% of total revenue and income, lower than the level of the third quarter of 2022. Despite the lower revenue levels derived from the regulatory change and even with 5% inflation in the last 12 months, our headcount resizing and marketing and infrastructure optimization led to the leverage. In Slide 14, our cash earnings continued to gain momentum, driven by diligence in total costs and expenses, revenue growth, stable CapEx, and higher margins, reaching a positive amount of BRL 365 million, up 36% versus the same period of 2022. CapEx marked BRL 529 million, up 5% year-over-year due to inflation and the upbeat trends in merchant gross adds that require additional POS inventory levels, but lower quarter-over-quarter, driven by better merchants' cohorts and POS activation. Our discipline in capital allocation and efficiencies in IT investments remain, which we expect to result in a similar or lower capital expenditure disbursement versus last year. Depreciation and amortization, including POS write-off, totaled BRL 393 million, representing close to 10% of total revenue and income, keeping the pace to coverage of CapEx levels in the coming quarters to unlock additional profitability in the future. We expect this stabilization to happen in the second half of 2024, in line with CapEx. On the final slide, our net cash balance ended the third quarter at BRL 10.6 billion. In the past 12 months, our cash generation amounted to BRL 3.7 billion, which we invested BRL 1.8 billion in POS purchases and technology developments and BRL 330 million in buyback shares. In October, treasury holds more than 4% of total shares issued. The company bought back BRL 1 billion since 2021, representing 81% of the total program approved in 2018. Our equity position continued to increase, with 58% being composed of returning earnings, reinforcing our commitment to shareholders on capital allocation and returns. Now we have ended the presentation, and we will start the Q&A section. Operator, please.

Operator, Operator

The first question comes from Mario Pierry with Bank of America.

Mario Pierry, Analyst

Congratulations on the quarter. I have two questions. First, regarding the take rate, it declined from 4.06% to 3.97% quarter-over-quarter. You mentioned a shift towards larger accounts. If that’s the only factor affecting the take rate, what is your perspective on the pricing and competitive environments, and how do you anticipate the take rate will perform in the future? My second question is about the BRL 10.6 billion in cash and the buyback program that has been active since 2021. You’ve executed 80% of that program so far. How do you plan to distribute excess capital in the future, whether through buybacks or dividends?

Eric Oliveira, Head of IR

This is Eric. Thanks for the question. When we think about the take rate trajectory, we always have to remind that the breakdown of take rates is based on the merchants' mix, duration mix, and also promotional prices that we make for a certain period of time. If you remember, we started doing promotional prices for our online sales channel at the beginning of the year, and necessarily as we continue to see an uptrend in gross adds, naturally, most of these gross adds come from micro-merchants, which have access to the promotional prices for the first month's transaction with us. So promotional prices for a certain period of time, merchant mix, and duration mix all play a role. We understand that the take rate trajectory in the short term should be slightly down, especially in Q4 for seasonality reasons as debit cards tend to increase their penetration in comparison to overall TPV. But moving forward, as our footprint in larger merchants stabilizes, take rates combined with the financial services revenues should also stabilize over 2024. So I think it's reasonable to expect take rates in a consolidated view to stabilize in 2024, but naturally always considering merchant mix, duration mix, and promotional pricing that we do. Now let me pass the word to Artur.

Artur Schunck, CFO

Mario, it's Artur speaking. Thank you for your question. Good to talk to you. Regarding the buyback program and the BRL 10.6 billion of net cash balance that we have, BRL 10.6 billion, it's important to mention that it's a comparison of assets and liabilities, operational assets and operational liabilities. At this point, we do not have the intention to distribute dividends. We have been buying back shares every quarter. We are expecting to continue doing that due to the current attractive valuation of the company. The buyback program launched in 2018. We executed 81%. There is BRL 200 million available at this point. And there is a new buyback program under discussion in the company, and as soon as possible, and as soon as we decide to launch this new one, we will inform the market. And so this is the thinking that we are having about the share buyback.

Mario Pierry, Analyst

Great. Let me follow up then on what Eric talked about, the promotions that you started for online at the beginning of the year. Is it fair to assume that these promotions have been ongoing since the beginning of the year or have you stopped the promotions?

Eric Oliveira, Head of IR

Yes, since the beginning of the year. But when we look at the cohort's evolution in the timeline, we see that the decisions that we made 3, 6 months ago are showing benefits, especially in the gross adds 6 months later. So the decisions we made at the beginning of the year are reflecting in a better gross adds trend now compared to the first half of '23.

Mario Pierry, Analyst

Okay. And how are you seeing the competitors behaving, Eric?

Ricardo da Silva, CEO

Mario, this is Ricardo. We don't see competitors being irrational. Of course, there are some competitors that are trying to gain some market share for a while. But once they realize that it's hard to make money, they give up, they step back. So we don't see anyone being irrational. If you look at what happened in Q3, looking at the trends more recently, we were the company that grew more quarter-over-quarter than all the market. We grew like 8% quarter-over-quarter and the market grew 4%. So we have been executing well. As Eric said, we also have this promotion that we are seeing some results at this point. But going back to your question, we don't see anyone being irrational. And we think we have a good pricing point as of now to keep growing. As you can see in our results, we had the highest net income in both GAAP and non-GAAP. So we think we are in the right lever in terms of price and growing.

Operator, Operator

The next question comes from Jorge Kuri with Morgan Stanley.

Jorge Kuri, Analyst

Everyone, congrats on the numbers. I wanted to ask you about your credit portfolio. I'm looking at Slide 8 of your presentation. We continue to see the total loan book coming down quarter-on-quarter. I'm wondering where your risk appetite is? At what point do you think this can start inflecting? Some of the smaller, more fintech-driven lenders like Banco Pan, Banco Inter, Nubank are showing significantly more growth. What do you need, either internally or externally, to start to see the portfolio of credit really taking off and making best use of your capital and your deposits?

Artur Schunck, CFO

Artur speaking. Our credit portfolio is growing when you consider where we have focused on payroll loans, FGTS, and credit cards backed by CDs. So the portfolio is growing. But at this quarter, we also had some write-offs for the working capital loans—it's part of our run-off operation. Regarding when we can return to offering credit, at this point, we consider focusing on secured rates. We still see difficulties in the market when we compare to other players and the banks reducing the limits for credit cards. We are waiting for the conditions in the market to improve to go back to offering, maybe in a different way, credit. But at this point and in the coming quarters, we will focus 100% on secured portfolio, secured originations focusing on payroll loans, FGTS, and credit cards backed by any investments we receive from the clients. We continue working on the models and all the infrastructure to offer credit at the right moment, and when we are able, we will be able to talk about it in a different way.

Operator, Operator

The next question comes from Gabriel Gusan with Citi.

Gabriel Gusan, Analyst

Maybe to follow up on Jorge's question about the credit portfolio. Can you talk about your appetite specifically for the SMB segment? I understand, of course, in your first attempt, there was a mix of micros and SMBs, and how you continue to see the growth in SMBs outpacing micros. Is that something that you should continue to see, that we will see PAGS more active in this SMB space? And my second question is about CapEx. We see it's stubbornly high despite you reducing your exposure to micro-merchants and focusing more on SMBs. So I'd like to hear your thoughts on that. Thank you.

Ricardo da Silva, CEO

Gabriel, this is Ricardo. Regarding the SMBs, as Artur said to Jorge, we are looking at this point and focusing on secured products, which include FGTS, payroll loans, and credit cards backed by CDs. It doesn't matter to our consumers if you're an SMB business. Those are the products that we are going to focus on and accelerate in the following quarters. At some point, of course, if you want to be a bank, you've got to have unsecured products, but we just don't think that's the right time to do so. When you look at the market, we see even the incumbent banks struggling with some NPLs and delinquency rates. It seems that it's getting better, but we do not think it's worth taking the risk right now. We are going in a healthy way in these secured products, and we'll keep investing in that. If your question was about unsecured products to SMBs, we do not expect to offer that in the short term. If something changes, we will let you know, but we don't expect to have these types of products in the short term. We will keep working on secured products.

Artur Schunck, CFO

It's Artur speaking. Thanks for the question, and good to talk to you, too. Regarding CapEx, we remain disciplined in this investment. It's important to mention that CapEx is not only related to POS but also to technology developments, and we see many opportunities to develop new features and improve the features we have today to enhance our offer to our clients as much as possible. We expect to have CapEx this year slightly lower than 2022. That means the level of CapEx today is reasonable for us and is a good lever to maintain the company running and attracting new clients, increasing the gross merchants for the company. In 2024, we probably will have a similar CapEx to 2023. It's important to mention that in the second half of 2024 onwards, our CapEx levels tend to be similar to our D&A plus POS write-off. In the past years, the expenses related to D&A and write-off increased a lot and put pressure on our bottom line. We are beginning to see that in the second half; we have a better way to observe the bottom line for the company.

Operator, Operator

The next question comes from John Coffey with Barclays.

John Coffey, Analyst

Alex, I had one question for you on some of your prepared remarks. I think you said that you continue to see better TPV growth through the first weeks of the fourth quarter. Should I interpret that as meaning that you're seeing growth around 11%, more than 11%? So I'd just be interested in your thoughts on that. And then for my second question, it was really on the financing expenses that you have. And I'm just, I think, going over to Slide 13 in your deck, where one of the drivers for having the lower financing expenses year-over-year has been your deposits. Should we take this just to mean that you're becoming more and more insulated from the impacts of the Selic rate that perhaps as the Selic declines, it makes less of a difference in your financing expenses because you're almost funding most of the book or a lot of the book from your deposits?

Alexandre Magnani, CEO

Okay, John, this is Alex and I will answer the first part of your question. Actually, we are growing higher than 11% in the first weeks of the fourth quarter, and we see a very good trend in terms of growth moving forward. This is the result of this new growth cycle. We're just starting the beginning of the second semester of this year. In the first semester, we did a lot of optimization and adjustments in our operation, and we suffered in terms of TPV growth. Now we are regaining that growth momentum and we are doing better in the fourth quarter than we did in the third quarter.

Ricardo da Silva, CEO

And John, this is Ricardo, and I will start the answer to the second question regarding dependence or linkage with Selic. You're right. When you look at Slide 13, we are increasingly using deposits for funding and for all the operations that we have, meaning prepayment and also the credit that we offer to our clients. We, at the end of the day, if Selic goes down, it's good news because we're going to have lower costs. Even if you have deposits, they are linked with Selic. So look at Slide 8; we see that our deposits are paying the blended rate of 93% of Selic. If Selic goes down, we're going to benefit. As deposits grow more and more, we don't need to rely on third parties for funding, and we have a lower cost as a percentage of Selic considering the deposit. So answering that in a different way, if Selic goes down, we're going to benefit because the cost of our partnership expenses is linked to Selic, and deposits have a lower cost compared to third-party operations that we might have in the market.

Artur Schunck, CFO

Complementing the answer. When we talk about deposits, especially when we see deposits on our platform, they are much cheaper than the deposits received from outside our platform and third-party platforms. Therefore we have investments that consider deposits as capital, which is based on returning net earnings. There is no impact in the P&L, in the cost of the P&L. We mix these with other funding institutions that also help us run the business. Going forward, we expect to continue having this good performance in financial expenses because we are becoming more efficient every time. And this was the first time when we compared year-over-year that we are reducing expenses, which is good for the company. Obviously, part of that is related to the downward trend of Selic, as we are expecting more cuts in December, but also because we are becoming more efficient in the funding that we develop for the company.

Operator, Operator

The next question comes from Yuri Fernandes with JPMorgan.

Yuri Fernandes, Analyst

I have a question here on PIX P2M. I would like to know if you can share anything with us about how relevant it is becoming. Some competitors are starting to disclose that information, so just checking if you can help us to understand a little bit this PIX? And then I will ask a second question.

Ricardo da Silva, CEO

This is Ricardo. Thank you for the question. Well, first of all, it's important to mention that our take rates, we consider revenues, and we also consider PIX volumes in the denominator. We know some other players in the market may differ, but we use the PIX revenues to our code, and we also use the PIX TPV denominator. We don't disclose exactly the number or the volumes of PIX that we have, but they are similar to what you see in the market with other players. Yes, so as a percentage of TPV, it is very similar to what you see in other players in the market.

Yuri Fernandes, Analyst

That clearly helps a lot. And on deposits, you already discussed in the previous question, but it was not very good. Right? 20% quarter-over-quarter. This is not a seasonal quarter, right? It seems we're doing something differently. What are the drivers for this growth? Why was deposit stable for, I don't know, three quarters and now we are seeing deposits accelerating? What are you doing to bring these deposits in?

Artur Schunck, CFO

It's Artur speaking. Relating to deposits, it's not a singular action that we are doing. It's many things differently. The management is 100% focused on that because we know that it's important for us to increase the number of deposits. We are working to provide better service to the clients. The AAA rating that we received from S&P Global is also helping us to bring this money to the company in the cheapest way. TPV volume growing helped us because part of this deposit comes from merchants. So it's the result of several initiatives that we are undertaking. I can tell you that we increased the level of features that we are offering to the clients and it is much better than in the past. So many things that we are doing, it's not only one aspect that brings this result.

Operator, Operator

The next question comes from Kaio Prato with UBS.

Kaio Penso Da Prato, Analyst

Hello, everyone, and good evening. Thank you for the questions. I have two on my side, please. First, on your reported losses this quarter. So we saw that the expected credit losses increased during the quarter, and you mentioned that it was related to some change regarding IFRS 9. So I just would like to get more details here. What was the change? If this was a one-off effect or not? And also, still on losses, if you could better explain the drivers behind the sequential increase on chargebacks which surpassed the level of TPV growth. So I'd just like to understand the drivers behind that. And if this is related to the prepayment product with instant settlement or not. If you are offering these nowadays or not? And the second question is related to the expectations for 2024. If you can provide us some details and if you expect to provide any type of guidance for the year, I don't know, in the coming quarters? That's it on my side.

Artur Schunck, CFO

Artur speaking. Good to talk to you. Regarding expected credit losses, this quarter, we had the impact of payroll loan and working capital loan IFRS 9 review. That increased the provisions. This is the explanation why we increased the provisions at this point. On a yearly basis, we use it to review the models to ensure we have the right level of provisions to cover expected losses or future expected losses. But the most important point is the new credit originations are secured, which rely on a lower level of provisions going forward because we are increasing this origination related to secured products that will represent a lower provisions going forward. Regarding chargebacks, we include operational losses, we include other things related to issues of cards and chargebacks from online and POS chargebacks. If we compare the amount, okay, it’s higher. But when we compare in terms of basis points, it is lower than last year. That is most important to us because we are seeing that our fraud prevention is increasing. Regarding 2024, Kaio, we still think it is a little bit early to give some color about 2024. But I would say to you that as Alex said in his speech, we are seeing very good growth in terms of volumes, TPV growth in Q4. We expect the interest rate of the country is still expected to have another cut, maybe 25 or 50 bps at the beginning of December. So we are optimistic with Q4 to be a very good one. Usually in Q4, we have more volumes because of the holiday season with Black Friday and Christmas and so on. So we are very optimistic with Q4. From there, we can give more insight about 2024. But we are confident it's going to be a good quarter as far as we have the previous numbers. We are halfway through the quarter at this point. So we are optimistic about it.

Operator, Operator

Next question comes from James Friedman with Susquehanna.

James Friedman, Analyst

So Artur, just in response to the prior answer, because the IFRS issue came up with one of your competitors as well though it may have been for a different reason. But do you mind just elaborating on what you just said in the prior response about the impact of the working capital? And as you answer that, are there any other changes in IFRS that you're anticipating that we should also be aware of before they happen?

Artur Schunck, CFO

Thank you for the question. The most relevant impact is related to the runoff operation of working capital. So we increased a little bit the provisions at this point. It's, I would say, like a one-time impact in this quarter. We are not expecting any other change in the coming quarters.

James Friedman, Analyst

Okay. Clear. And then just a kind of a higher-level question, but I realized for a while now, you have emphasized SMB to deemphasize the less structured long tail. But I'm just wondering if you are anticipating any additional consequences of that, whether it's how you see the take rates evolving longer term or the additional opportunities that will create just as you transition the company that way for—and I know it's a very open-ended and big-picture question, but as you move the company in that direction, how do you anticipate the financial results are going to evolve?

Ricardo da Silva, CEO

James, this is Ricardo. Just to be clear, we are not emphasizing the long tail. We're just saying that we're seeing a significant opportunity in SMBs. As you can see, we are growing SMBs at 18% and the long tail is growing 9%, as indicated in Slide #5. So we are growing, and even when we consider the long tail, we are growing 9%, which is the same growth as the industry. And remember, some of our long-tail clients become SMBs over time. They keep working with us, and at some point their businesses grow, and then they become an SMB. So if you look at the composite of these two parts, both SMB and long tail are growing at 15%, which is like 60% more than what the industry grew in Q3. So, it doesn't mean that we are deemphasizing, but we are seeing a very good opportunity in SMBs as well, not only in acquiring but also in banking services. We have a robust value proposition for this type of clients that includes instant settlement, banking, and proprietary software. So that's why we see opportunities coming from there. In terms of financial results, as we tried to explain before, our take rates might go down as a percentage, but in absolute terms, it makes total sense because SMBs have much more volume when compared to long tails—sometimes 10x bigger. So as a percentage, the net rate is lower, but as absolute terms, it makes total sense. So that's why we keep growing. In Q3, we had the highest net income of the company ever.

Artur Schunck, CFO

Also, I would just like to complement that in this quarter, we had a record of POS sales since January 2022, with the highest POS activation since mid-2021.

Operator, Operator

The next question comes from Neha Agarwala with HSBC.

Neha Agarwala, Analyst

A few observations from your comments so far. It seems like on credit, you are not even testing or piloting the unsecured loan product at the moment because you are fully concentrated on the secured lending side. But first, is that right? Or is it something different? And I do not understand correctly. Because when we talk to most of the other players in the market, while they had been restricting originations so far, even the larger banks are now talking about the potential acceleration in growth. So I just want to understand that if you're not testing, if you're not open to lending in the unsecured market, then your competitors will be ahead of you when the market conditions improve. So what are your thoughts on that? And did I understand correctly that lending to the less structured long tail is not your priority because I would assume that the SMBs are probably less risky than the long tail when it comes to unsecured lending products, so clarification there. And this goes to my next question, which is on the take rate. The take rate has been coming down given the change in mix. And next year, you see more stability in terms of mix. So take rates should stabilize. But what about '25, '26? Do you see take rates continue to come down due to competition? Or do you think new products like banking or credit would be able to offset any pressure on take rates from competition or lower rates? So some clarification on the trends there.

Ricardo da Silva, CEO

This is Ricardo. I'll try to address your questions. If not clear, let me know. But we are testing unsecured credit for small volumes for some clients. We have some credit pilots, and we are doing small tests for different clusters of clients. So we do have processes in place; we have the models, the billing process in place, and so on. So we are testing that. But the point is, even when you look at the credit cycle, as I said before, it’s still the time to wait it out. It seems to be getting better. Many of the big banks or the incumbent banks in Brazil have struggled with NPLs in the previous quarters. Now, in Q3, things are looking a little better for some of them, but that doesn't indicate it is time to jump in. We are prepared to do that when we determine it is the right time, and the risks and returns make sense. To be honest, we find a way with secured products that we are comfortable with, and we'll accelerate that as much as we can. It doesn't mean that we can’t offer unsecured products in the near future; it’s just not our focus at the moment. However, we do test when the right opportunity arises. In terms of SMBs, we believe that we have a strong value proposition that doesn’t require us to offer credit to these clients to grow our base. Of course, there could be some SMBs that may only seek an acquiring company and not a lending offer. But we don’t see that as a barrier to our growth. In Slide 5, we are growing at 18% year-over-year in SMBs.

Artur Schunck, CFO

Also, it's worth mentioning that the market dynamics, last year we have been focused on secured lending because the risk is more manageable, and we believe it's the right strategy for the present circumstances. We will continue to analyze the market conditions, and if we feel that unsecured lending presents a suitable opportunity, we will act accordingly.

Operator, Operator

The next question comes from Joshua Siegler with Cantor Fitzgerald.

Joshua Siegler, Analyst

Nice print today. First of all, I was wondering if you could comment on how you're thinking about the longer-term capital allocation of the business given the cash generation you have going?

Artur Schunck, CFO

Well, Josh, it's Artur speaking. Thank you for the question. Regarding long-term capital allocation, what I can tell you is we are 100% focused on continuing to deliver the results that we are delivering, growing quarter-over-quarter, and using part of these results to reinvest in the company to reduce the dependency on other financial institutions to fund part of our operations. We have very good margins on advancing receivables to merchants, and we will continue doing that. On top of that, we have this buyback program that we expect to approve a new program in the coming months, and we will inform the market about this new program and its rules. At this point, we are not discussing dividends, so we're going to focus on delivering results, investing part of this money to buy back shares, and investing part of this money in operations.

Joshua Siegler, Analyst

Great. That's helpful. And I just wanted to dive a little bit deeper into 2024, potential stabilization of take rates. Can you give us some more KPIs that would be integral to seeing that take rate really start to stabilize?

Eric Oliveira, Head of IR

When we see, again, take rates, we have not stopped moving up-market only to post higher take rates because, by the end of the day, I think we have shown quarter after quarter that as the company continues its strategy to extend the services beyond long tail, this business looks accretive to EPS. What are the drivers for that? Primarily better spreads, given the deposit base by lowering our cost of funding structurally. Also, the financial services uptrend in terms of revenues can contribute positively to the take rate evolution moving forward. Naturally, we expect at some point to have a much more stabilized TPV mix broken down by merchant size than we have today, which should bring more stable take rates moving forward. But again, we are not looking only at take rates; we are looking at merchant growth and how they contribute to the bottom line. If we look only at take rates, we are losing the focus, which is necessarily to grow with profitability by delivering EPS growth quarter-over-quarter and year-over-year.

Joshua Siegler, Analyst

Okay. That's very helpful, Eric. And congrats again on the quarter.

Operator, Operator

The next question comes from Soomit Datta with New Street Research.

Soomit Datta, Analyst

And great, great numbers. Just on that point, it seems like the momentum in the business in Q3 and in early Q4 is really strong. You talked about some initiatives in the first half of the year really coming through. I mean just to dig into that in a bit more detail, you talked about some promotional pricing being part of that. Maybe just help us understand what else you've done and what else is happening to continue that TPV momentum would be helpful. And then I have a quick follow-up, please.

Ricardo da Silva, CEO

Thank you for the question. Good to hear. It's Ricardo. The promotions that we have, we always have promotions depending on the seasonality, whether it’s a holiday, if it's Black Friday; we always have promotional prices. At the end of the day, the idea is to have a driver for new clients that are looking for specific promotions, specific features, or a specific pricing structure. But to be honest, these promotions don't move the needle because they are very small in terms of the TPV that they have today. So we have BRL 100 billion in TPV in Q3. So imagine we are getting new clients, but they are a small portion of the total. So I don't think, to be honest, these promotions will impact the take rates negative significantly because they are very small compared to the whole volumes. We do have promotions depending on the type of clients and some periods that we have, sometimes limited to volumes; sometimes the promotion is only debit, other times in credit. So we have promotions all the time. It's not an issue, and it’s not something new. What it seems is we are getting more clients, more SMBs, and they are getting mature. Some of them may start using other services now that they are using us more and more. But we are having a good momentum from our view and growing more in the market quarter-over-quarter with strong TPV growth in Q4 as well.

Soomit Datta, Analyst

Okay. That's clear. And quick follow-up, if possible, please. Again, just referring back to Slide 5, when there's a bit of granularity on the different segments. Can you just maybe help us understand how much of the volume is SMB today? And can you remind us of what the cutoff is, what the definition is of SMB versus long tail is? And then just finally, the chart on the right-hand side showing the relative growth rates, is that broadly how you'd expect to see the relative segments going forward?

Ricardo da Silva, CEO

We do expect SMBs to grow more in TPV because, again, they have more absolute TPV than other clients in the long tail. We are seeing good momentum in the SMBs. And as I said before, some of their clients become SMBs. So that's why once they reach some level of TPV, they go to the SMB niche. But yes, we do expect SMBs to grow more than long tail. But we don’t disclose exactly the level of each one. However, you may expect that in long tail you have more clients, and in SMBs, you have small businesses with a few employees and so on. So we don’t disclose exact numbers, but it’s similar to what some other players in the market disclose. Usually, the TPV from SMBs is 5 to 10 times larger than long tail.

Operator, Operator

The next question comes from Pedro Leduc with Itau BBA.

Pedro Leduc, Analyst

So congrats on the quarter and good disclosure. Question quickly on the selling expenses that have been quite controlled year-to-date, but they seem to have moved up in 3Q and looking at almost 20% Q-on-Q jump. I'm wondering if it's related to that heavy activation of POS that you mentioned more recently or if it has to do with the greater SMB profile, again, essentially trying to get to the total cost and expenses, but this line, in particular, everything else was quite controlled. This one caught our attention. Just wondering if there's any specifics here you want to share with us?

Artur Schunck, CFO

Well, Pedro, thank you for your question. It's Artur speaking. There's a mix of things in this line moving up and down. We have a little bit of an increase in the sales force in the last months of the quarter. That is pushing a little bit this line up. But we also increased the level of chargebacks and provisions for credit, and so the most relevant impact is coming from total losses.

Eric Oliveira, Head of IR

Exactly, Pedro, because at the end of the day, even though chargebacks as a percentage of total payments have decreased 1 basis point in comparison to Q3 ’22, naturally, it grows with TPV, but also the higher level of expected credit losses given the credit model update according to IFRS 9 made us to additionally increase our provisions in the short term. We also had an increase in the sales force, reinforcing some geographies or operations slightly—so when we combine all of these deployments, we necessarily had this kind of trend in Q3.

Operator, Operator

The next question comes from Alexander Markgraff with KeyBanc.

Alexander Markgraff, Analyst

Just one for me. I was wondering if you all could comment on a metric that you disclosed in the past, the clients using PagBank as a primary bank. I don't think you've shared it for a couple of quarters. Just wanted to get your observations around that metric, both for consumers and merchants?

Ricardo da Silva, CEO

Alex, this is Ricardo. You're right, we don't have the information here, but we used to have around 60% using that in consumers and 50% in merchants. That didn't change too much. It might have grown a little bit, but you can consider it at the same level—60% for consumers and 50% for merchants using PagBank as the primary bank.

Alexander Markgraff, Analyst

Okay. And is that true as well for the newer cohorts that have onboarded?

Ricardo da Silva, CEO

Yes, that is true for the newer cohorts. To be honest, for some of them, it's even higher, but you can consider it very similar to what we had.

Operator, Operator

The next question comes from Sheriq Sumar with Evercore ISI.

Sheriq Sumar, Analyst

It's nice to see the trajectory on the margins. I just wanted to get a sense as to how should we think about for next year in terms of the margin trajectory as to how focused is PAGS on driving margin expansion? And also on the operating expense side, we saw a nice decline as a percentage of top line to like 14.5%. I mean I know you kind of also answered that. But is there like a target on that as to what's the baseline for that, which we could see for 2024 and even for the fourth quarter as well?

Ricardo da Silva, CEO

Thank you for the question. I will let Artur go in a few minutes to complement in that. But in terms of margins, it's worth mentioning that we are the most profitable company in this market considering TPV for every real or dollar you have in volumes transaction in our POS devices or online solutions. We are the one that translates that into profits more than any other player. So in comparison to our competitors, we are the most profitable company in this market. Therefore, margin is a consequence of what we're doing and growing in terms of clients. As we mentioned before, as we have this mix shifting from less to long tail and more to SMBs, we may see the net take rate lower but in absolute terms, it's higher. In absolute dollars, it is higher. So we don't view margins as the main driver for the company because at the end of the day, our goal is EPS accretion. In this quarter, we achieved 7% EPS accretion quarter-over-quarter and 10% year-over-year. That is the main driver we seek to generate value for our shareholders—EPS accretion.

Artur Schunck, CFO

As Ricardo mentioned, we will keep growing our business in payments, in financial services, and all of the segments are contributing to the bottom line. We had all-time high net income GAAP and non-GAAP this quarter that we are proud to announce. We are not putting a lot of focus on margins, but in nominal growth, yes, we are focused on that. It's true that going forward, lower interest rates and better performance in financial services can help us to increase margins. We are not providing any guidance for the future, but it's true that those two things and the focus on reducing expenses while continuing to grow in both business lines can help us to deliver that.

Operator, Operator

The next question comes from Tito Labarta with Goldman Sachs.

Tito Labarta, Analyst

Just a follow-up on Slide 5. Thanks for the disclosure on the growth side, the different segments. I know you mentioned that SMB probably still grows faster. But should we expect some type of conversions between SMB and long tail, just in the sense for the take rate to stabilize, they probably have to begin to stabilize? So there could be some deceleration in SMB and maybe some acceleration in long tail. And maybe not a completely fair question, but one of your competitors gave some long-term guidance on 30% CAGR and SMB TPV growth. Just you're growing 15%. But how do you think about the sustainability of the micro and SMB TPV over time? Do you think you should be able to gain share, growing at a mid-teens type TPV growth sustainable over the coming years?

Ricardo da Silva, CEO

I will start backwards, and then Eric or Artur can elaborate further. We always say that we try to grow more than the industry in a profitable way, and we aim to achieve that in the following years. We kind of decelerated a little bit our TPV in Q1 this year and in Q2. However, in Q3, we saw this rebound again. In Q4, we have had fair numbers in the first 45 days, and we're going to try to keep growing faster than the industry in a profitable way in the niches we decide to target, which are SMBs, long tail, and SMBs. Of course, if you look at TPV, we have relatively more penetration in long tail than SMBs related to the market. Therefore, that's why SMBs TPV grows more when compared to long tail. We continue working in these different niches, but we do not have as much exposure to SMBs at this point and that's why we are growing. We see good service out there, and we need to grow there and decrease prices as required—we can offer our value proposition. We are aiming to progress in a healthy way.

Eric Oliveira, Head of IR

And one of the things, Tito, is that if the CAGR is a reality, I think this is positive news, especially for players like us, right? Because, at the end of the day, when we look at small and medium businesses—despite hearing more companies discussing this existing opportunity, we have the merchant acquiring and digital bank fully integrated. We have been growing nearly 20% year-over-year. There is still room to keep growing. If feasible, that’s great, as it implies an economic outlook and industry trend improving as seen in Q3 compared to Q2. This is interpreted as better card penetration necessary for our market share gains in all segments, enhancing our overall market share.

Ricardo da Silva, CEO

It seems that it’s a good message when we hear that the outlook for the next few years is competitive because the opportunity primarily lies with new players like us. Secondly, we have the advantage of having a lower average cost of funding, similar to bank acquirers, while offering a value proposition that's competitive with or better than new players. This vast combination leads us to believe we’re well-positioned for future growth and sustainability.

Tito Labarta, Analyst

Great. That's helpful. Appreciate it. And just one follow-up kind of on the first point. But is it fair to say that for the take rate to stabilize, you do need to see a little bit of a conversion between the SMB and the long tail on the growth, just given the different dynamics there?

Eric Oliveira, Head of IR

It depends on how both segments work. It's early to say anything about conversions right now.

Operator, Operator

Thank you all very much. This concludes our Q&A section of the call. I'd like to turn the conference over back to management for your closing remarks. Please go ahead.

Ricardo da Silva, CEO

Thank you very much for your participation in the call. Thank you for investing the time. Talk to you on the next call. Thank you very much.

Operator, Operator

This concludes today's conference. Thank you for attending today's presentation. You may now disconnect.