Earnings Call Transcript - PAGS Q1 2022

Operator, Operator

Good evening. My name is Pricilla and I'll be your conference operator today. Welcome to PagBank PagSeguro's Webcast Results for the First Quarter 2022. At this time, all lines have been placed on mute to prevent any background noise. This event is also being broadcast live via webcast and may be accessed through PagBank PagSeguro's website at investors.pagseguro.com. Participants may view the slides in any other 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, Investor Relations and ESG Director. Please, go ahead.

Éric Oliveira, Investor Relations and ESG Director

Hi everyone. Thanks for joining our first quarter 2022 earnings call. Today, we have with us Ricardo Dutra and Alexandre Magnani, our Co-CEOs; and Artur Schunck, our CFO. There will be a question-and-answer session. Before proceeding, let me mention that any forward statements included in the presentation or mentioned on this conference call are based on currently available information and PagBank PagSeguro's current assumptions expectations and projections about future events. While PagBank PagSeguro believes that the assumptions, expectations and projections are reasonable given the currently available information, you are cautioned not to place undue reliance on these forward-looking statements. Actual results may differ materially from those included in PagBank's PagSeguro's presentation or discussed on this conference call for a variety of reasons, including those described in the forward-looking statements and Risk Factor sections of PagBank PagSeguro's most recent Annual Report on Form 20-F and other filings with the Securities and Exchange Commission, which are available on PagBank PagSeguro's Investor Relations website. Finally, I would like to remind you that during the 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 on 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 our earnings release. With that, let me turn the call over to Ricardo. Thank you.

Ricardo Dutra, Co-CEO

Thank you, Éric. Hello, everyone, and thank you for joining our call. I'm pleased to announce we reached another set of record numbers this quarter, almost all of them higher than the top of the Q1 guidance and market consensus. Also, as you see in our Q2 guidance in the next slides, we have been seeing strong momentum in Q2 as well. Our performance reinforces our core strategy of delivering the best balance between growth and profitability, strengthening our lion share in Payments, while we create one of the most relevant digital banks in Latin America. Our management is extremely dedicated, committed and aligned to take decisions oriented to the business success not only in the short-term, but also in the long-term, as we see huge opportunities to be explored in Brazil. Going to Slide 4, we can see the Q1 main messages. During the first quarter of the year, our Payments Platform, also known as PagSeguro, had its first wave of repricing, which led to an increase in merchant acquiring take rate of plus 35 bps in comparison to Q4 2021. Our successful strategy to also serve small and medium businesses continues to outperform our expectations, with HUBs TPV reaching 25% of the PagSeguro volumes. The unbeatable combination of the migration from cash to plastic in Brazil, the best-in-class execution in HUBs and the lion share in longtail led us to have the largest Cards TPV market share gain during Q1 2022, increasing 70 bps vs. Q4 2021. These results reinforce our ability to increase prices and, at the same time, keep churn levels under control. In our Financial Services, also known as PagBank, our net adds marked 1.7 million, almost 19,000 new clients per day in Q1 2022, achieving 24 million clients, of which 14.3 million were active. PagBank has also been diversifying its revenue streams, mostly driven by interest income, and we also plan to launch new secured loan products to be deployed in the second half of 2022. Going to slide 5. Aligned to our mission to keep disrupting and democratizing Financial Services and Payments, primarily in Brazil, while creating value for investors and stakeholders in a sustainable and diligent way, this quarter we reached BRL 3.4 billion in total revenues and income, the highest level ever in the company, and net income of BRL 371 million. I would like to highlight the most relevant KPIs for the quarter: Beginning from the left side, our Payments Platform highlights: We reached BRL 80 billion in Total Payment Volume TPV. BRL 3.1 billion in Total Revenue and Income. More than BRL 10,000 per quarter in TPV per Merchant; and BRL 769 million in Adjusted EBITDA. On the right side, our Financial Services highlights: We reached BRL 72 billion in TPV. BRL 305 million in Total Revenue and Income. BRL 2.1 billion in Credit Portfolio; and BRL 86 million in Gross Profit. In the next two slides, we can see some Payments Platform achievements. So, beginning with Slide 6, we are happy to announce that PagSeguro was the TPV market share gain winner this quarter, growing 70 bps in Q1 2022 versus Q4 2021, while the most relevant players lagged. If we look back to 2016, we went up from 1% to 11%, which reinforces our thesis that it is much easier and profitable to move upmarket, creating the competitive advantages and scale that can be easily adapted to larger merchants. Going to the next slide, we presented important KPIs about our payments business. Creating a unique scale backed by a superior logistics infrastructure and leveraging our Marketing and Advertising through UOL. Our customer acquisition costs adjusted by inflation decreased 5% in 2021 in comparison to 2020. It's a rational pricing strategy combined with the strong migration from cash to plastic in the country our paybacks continue to be very short between four and six quarters. This 2021 cohort presented the best performance in terms of return on investment in comparison to the previous cohorts. In 2022, we expected higher take rates due to reprice focus on TPV per merchant increase, lower POS device subsidies and the efficiencies in marketing expenses to continue to support the compelling returns we have been obtaining so far. The beauty of this business is that we do not rely only on the number of merchants to keep growing differently than other businesses that rely completely on subscriptions with flat fees. We have several market growth opportunities in payments such as growing approximately 80% more than the industry on average. For example, in Q1 2022 the industry grew 36% year-over-year, while PagSeguro grew 60% year-over-year. Cards PCE in Brazil reached 50% in 2021. According to estimates, the country can reach more than 70% by 2025 increasing the share of wallet per merchant. E-commerce penetration as a percentage of total retail sales is still below the global average. And with our complete online payments offerings, we believe we can now take advantage of it. And we have been consistently gaining TPV market share, adding new merchants and volumes to the system and also attracting underserved merchant store solutions. Finally, having created the lion's share in the number of merchants with multiple times more merchants than the second player, allows us to be rational and to keep focusing our strategy to prioritize high-quality merchants in our gross adds, while cross-selling and upselling our products and services. Our execution has been very successful which is also reflected in our lion share in the profit pool of the industry. On the next two slides, I will show why we believe payments is one of the ways to build up a profitable digital bank and how the value proposition is created for merchants and consumers. On Slide 8, on the left side, we can see three charts comparing merchants that do not use PagBank with those that do. The PagBank value proposition for our longtail merchants is clear here. Merchants that use PagBank have four times more revenues, higher NPS and much lower churn when compared to those that do not use PagBank. We also aim to increase PagBank penetration in SMBs and have been launching new features to serve these clients. For instance, in this quarter we launched Corporate Accounts, Direct Deposits from other acquirers and Debit Cards. Our confidence is consolidated when we look at the market growth opportunities for banking in Brazil. Looking at the opportunities, our Cost-to-Serve clients continues to be 10 times lower than incumbent banks, in a country where the top five banks concentrated 91% of the total credit portfolio. As I mentioned before, we also see opportunities to cross-sell and up-sell financial services to our SMB clients. There is no other acquirer that serves SMBs with a complete digital account that include transactional, cards, investments, etc. Also, Brazil has a young population that is very active online which creates a perfect landscape for a digital bank like PagSeguro. On slide 9, we can see more numbers to reinforce our successful PagBank execution. In less than three years, we were able to create the second largest digital bank in Brazil, with almost 24 million clients, adding almost nine million new clients only in the last twelve months. In addition, when we go deeper in our numbers, in two years we reached 7.6 million active clients being composed by consumers, which is incredible since our credit offering is still limited for consumers and PagBank is much more a transactional account at this time. Our confidence increases when we run our internal research with our clients to know how engaged they are. Looking at the chart on the right-hand side, we see that for new cohorts, more and more consumers are using PagBank as their primary bank. Before I turn over to Alexandre, I would like to reinforce we are very encouraged by the momentum in both businesses PagSeguro and PagBank, and all the opportunities ahead. We keep working to grow our businesses and to create value in a sustainable way for investors and other stakeholders. Our controlling shareholder is convinced that PAGS will continue to consolidate Payments and Financial Services in Brazil and holds approximately 40% of the shares since 2019. Thank you very much for those who have been supporting us throughout the journey: our shareholders, suppliers, partners, other stakeholders, and our PAGS' team. Thank you very much. Alexandre, please go ahead.

Alexandre Magnani, Co-CEO

Thank you, Ricardo. Hello everyone. Moving to slide 11, I'll start the segment highlights with PagSeguro's overview during the quarter. PagSeguro's Total Revenue and Income grew 63% year-over-year, reaching R$3.1 billion and reflecting the TPV growth of 60% year-over-year, totaling R$80 billion. I would also like to remember that this growth happens even after a quarter of strong volumes due to holiday seasonality. As a result, PagSeguro was the TPV market share winner, as Dutra mentioned, reaching almost 11% of the Brazilian Acquiring Industry Market Share. In the next slide, we show PagSeguro's net take rate evolution since October 2021, when we started the repricing process, following the Interbank Rate hikes. We were able to increase our net take rate by 34 basis points since October, maintaining stable levels of churn on our client base. This stable churn, even with a higher pricing policy, shows the importance of our superior value proposition which consists in a complete banking offer through PagBank, Instant settlement offering with same day prepayment and our best-in-class SLAs with robust logistic distribution. We ended this first repricing cycle in April and will follow closely Selic's behavior in order to determine if others repricing rounds will be needed. I would also like to highlight the successful execution on HUBs operation that was even better than our own expectations. HUBs reached 25% of PagSeguro's TPV in Q1-22, showing the results of our accretive sales strategy for the SMB segment. Slide 13. I want to share some updates about PagBank operation. Total revenue grew 95% year-over-year ending the quarter at R$305 million approximately 9% of total revenue and income of tax. Total payment volume reached R$72 billion, up 129% year-over-year with engagement TPV gaining traction driven by cashing, bill payments, card spending among others. Up right we show our net interest income, which grew 164%, totaling R$142 million in Q1 2022 and gross profit including revenue from service, minding provision for losses, grew 83% year-over-year accounting for R$86 million. PagBank metric rate reached 1.54%, an increase of 61 basis points reflecting the increase of monetizable TPV and higher float revenues due to the increase of deposits and the higher Brazilian interest rate. Moving to slide 14. I would like to recap our milestones in credit on the right. Since 2018 we have launched several products such as credit cards, working capital loans, supply chain finance, payroll allowance and overdraft credit line within PagBank accounts. Given the challenging scenario that Brazil has been facing now, we have focused our development into collateralized products such as credit cards backed by CDs and FTTS early prepayment. On the first quarter, our credit portfolio surpassed R$2 billion with working capital and credit cards, representing around 90%. And other initiatives such as payroll loans and FTTS, so the prepayment reached 10%. We are very focused on the consolidation of our credit offerings since we know that this is a fundamental piece to become the customer primary bank choice. We have been executing this in a very consistent way, making sure that our underwriting, credit policies, and provisions are under control and well-priced, guaranteeing that any major change in asset quality in the near term will be adequately provisioned. We are highly confident that PAGS will consolidate the credit business in Brazil through PagBank by cross-selling and up-selling strategies for existing clients. Moving to slide 15. I won't share some facts regarding peak impacts on our operations. As we can see on the left chart, peaks have been promoting the PagBank cash in growth in 250% year-over-year, totaling R$24 billion in the first Q 2022. PagBank accounted for almost 10% of peaks transactions market share on this quarter. Peak has been key to boost the opening of new accounts since we offer an easy and simple boarding process for the population to have access to this instant transfer network. Another positive effect of Peak is the increase in the average balance of new accounts. Consequently, this is leveraging a cheaper funding source for prepayment operation and promoting the growth of monetizable cash out throughout card spending through payments and top-ups. Furthermore, this is an important tool to collect additional client behavior data to improve customer knowledge and ascertain new offerings and products. Finally, before I turn over to Artur, I would like to review our guidance for Q1 2022 and establish a ballpark for the Q2 2022. Total revenue in first Q 2022 was BRL 3.42 billion higher than consensus. For the second quarter 2022, we expect a ballpark between BRL 3.5 billion and BRL 3.6 billion. PagSeguro TPV grew 60% year-over-year in First Q 2022 reaching the top range of the guidance. For the Q2, we expect something around BRL 84 billion to BRL 85 billion. Net income non-GAAP will be higher than Q1 around BRL 370 million to BRL 380 million. Having said that, I pass the word to Artur, our CFO. Thank you.

Artur Schunck, CFO

Thanks Alexandre and hello everyone. I will continue the presentation with our Q1 2022 financial results. On the top left of Slide 18, our consolidated net take rate reached 2.60% representing an increase of 21 basis points year-over-year even with changes in the client mix due to HUB’s operation growth. The increase reflects the company ongoing pricing process for all segments, whose second round was fully implemented in April. In the table on the right side, we present our P&L for the first quarter of 2022. Our total revenue and income reached a record of BRL 3.4 billion, growing 66% year-over-year. Excluding transaction costs related mainly to interchange and card scheme fees, financial expenses related to cost of funding to prepayment receivables, exchange expenses and other financial income related to financial investments, our gross profit grew 28% year-over-year. Adjusted EBITDA closed at BRL 665 million, up 16% in comparison to Q1 2021. Net income non-GAAP achieved a record of BRL 371 million for all first quarters in our history. Net income GAAP increased 29% reaching BRL 350 million versus the same period last year, despite the hike in Brazilian interest rate. Backing to the left side in the graphic below, as a result of our TPV market share gain, revenue growth and expenses leverage, we delivered an earnings per share of BRL 1.05 in the first quarter of 2022. It is BRL 0.23 or 29% better than the same period of last year, on our shareholders' return. Moving to Slide 19. In the top left side, operational expenses and other costs excluding chargebacks reached BRL 560 million in Q1 2022. This amount represents 16% of PAGS total revenue and income versus 20% in the same period of last year. The improvement of 400 basis points reflects operating leverage, mainly from personnel and marketing expenses, and on top of that HUBs and PagBank revenue growth helped to dilute our OpEx. In the bottom left, financial expenses reached BRL 621 million versus BRL 44 million in Q1 2021. 50% of this increase is explained by the hike of SELIC from 2.1% per year in 1Q 2021 to 10.4% per year in this quarter. The other 50% was related to higher TPV volume, prepayment of receivables to merchants, and credit card mix. These effects were partially offset by ongoing repricing in acquiring, APRs increase on credit underwriting, and lower cost of funding through deposits growth. In the next slide, CapEx per sales reached 20% this quarter versus 17% in 2021. This increase reflects an additional POS purchase to recover the inventory's coverage ratio and to prevent a potential new lack of semiconductors due to lockdowns in some geographies. For 2022, we are focused on reducing POS subsidies, keeping healthier LTV to CAC, and maintaining our best-in-class SLAs on PagSeguro operation. In the graphic below, depreciation and amortization are under control and totaled BRL 244 million in Q1 2022, representing 7.1% of PAGS total revenue and income with slightly improvement versus full year of 2021. The next and final slide shows our cash position which ended the first quarter at BRL 8.3 billion, improving BRL 400 million year-over-year. This was driven by TPV growth, higher share of credit cards with larger penetration of same-day prepayment to merchants. At the same time, we have been improving our capital structure, ending this quarter with 68% of our financing position funded by third-party capital. Our full banking license is key to diversify funding sources and extend average terms. On top of that, the company is focusing on increasing deposits from merchants and consumers to keep lower financial costs. Our PagInvest platform is also an important tool to distribute PagBank CDs to our clients or bring new clients to PAGS. Now, we ended our presentation, and we will open to the Q&A session. Operator, please.

Operator, Operator

Thank you. The floor is now open for questions. And our first question comes from Mario Pierry, Bank of America.

Mario Pierry, Analyst

Hi everybody. Good afternoon. Congratulations on the results. I have two questions. Can you discuss the changes in your take rate? You provided the monthly figures up to the end of the quarter, but I’m curious if you plan to adjust prices in the second quarter. Also, regarding your net income guidance for the second quarter, if I assume the midpoint, you'll approximately reach BRL 750 million for the first half, which annualizes to BRL 1.5 billion, similar to the net income from 2021. Should we interpret the full year this way, or do you anticipate growth in the second half that exceeds the first half? Thank you.

Ricardo Dutra, Co-CEO

Hi, Mario, this is Ricardo. Thank you for taking the time to speak with us and for your questions. Regarding the take rate, we did see an increase in price in April. In Q2, we are noticing that take rates are rising. It's important to mention that even when considering the take rate and factoring in financial expenses, this metric is still increasing. The price hikes we implemented are yielding positive results. As mentioned during the presentation, there is no impact on churn. Therefore, we anticipate a better take rate in Q2 compared to Q1. Concerning the net income guidance, you're correct. If you take the midpoint of Q2, it will be around 750 million, which annualizes to about 1.5 billion BRL. I want to emphasize that this is the best information available at the moment, but we are continually aiming to exceed our guidance. Regarding TPV, we expect it to continue growing in the coming quarters. While I can't provide a firm guidance, with increased volumes, we aim to see improved net income in the future. However, we can't guarantee that right now. We are dedicated to surpassing our guidance and enhancing net income in the upcoming quarters.

Mario Pierry, Analyst

That's clear. Just a follow-up then on the take rate. Just so that we have a better understanding like what percentage of your clients have already been repriced? And if you're repricing both the MDRs and the prepayment product?

Ricardo Dutra, Co-CEO

Mario, we are repricing the MDRs and also the prepayment. Usually, we repriced MDRs more for credit because that's why we had the impact with the cost of funding, right? Because the debit transaction is settling in the next business day and in credit cards in 30 business days. So, but we are increasing both MDRs and prepayments. We don't give the details about the percentage of clients or the percent of TPV that we are increasing. First because of strategic reasons; and second because it's a very let's say live situation here that we keep following different clients with different industries which are retail or fast food and depending on what went on we keep increasing adjusting. And even for some clients we did some pricing that fluctuates a little bit with SELIC. So we are, kind of, protected for large clients that will not have any impact and we don't need to keep going back to them to increase prices very often. So unfortunately, we cannot give the details about the number of clients in TPV, but we are increasing the price for both MDRs and prepayments.

Mario Pierry, Analyst

Okay. That’s great. Thank you very much, guys.

Ricardo Dutra, Co-CEO

Thank you very much, Mario.

Bryan Keane, Analyst

Hi, guys. Congrats on the results from me as well. I guess two questions. Is the idea that you guys will continue to raise prices in order to cover the cost of the rise in the Selic rates. So, if Selic rates stop rising and just let's stay flat, it might take I don't know another 12 months to 18 months to catch up to the full amount. But at some point, I guess, the plan is still to catch up and pass through the entire higher rate. I just want to make sure the higher interest rates will get passed through the Selic rate? And then secondly, on merchant accounts it sounds like more of the strategic focus now is to expand and grow within the higher TPV per merchant and create higher revenue per merchant than it is maybe to land a micro merchant that might not be as profitable. Just obviously you guys had a slide on that. I just want to make sure I understand that strategy. Thanks.

Ricardo Dutra, Co-CEO

Hi, Bryan, thank you for the question. It's Ricardo here again. Regarding the prices, just remember that the base interest rate in Brazil went from 2% to 12.75% at this point. And there's going to be another meeting of the Central Bank on June 14 or 15. So we are following the probable increase in base interest rates, and if necessary we can increase our price. But I would say to you that the largest part of the price increase we already did because that's the high impact from 2% to almost 13%. If necessary, we will increase the price, but it will be more customized according to some clients and some adjustments that we need to do, but I don't think that there's going to be a massive price increase looking forward. That's one thing. But it's important to say that Brazil started increasing prices much earlier than other countries. And we had hyperinflation periods in Brazil, inflation 90. So the Central Bank acted very quickly here to increase prices to increase base interest rates. And we expect that at some point, this interest rate could go down maybe next year or 18 months from now as you mentioned. So when that happens, we will not decrease our prices proactively. So the same situation that we took a while to increase prices as Selic rises, we will also take advantage. We will not decrease the prices immediately, if Selic goes down. So what is today a headwind, it could be a tailwind two quarters from now. But going back to your question, the majority of the price increase is already done. And regarding net adds – you're right. We are looking for clients. We are not looking for big clients, but we are kind of not focused too much on the nano-merchants, the smaller ones. We follow what happened with the previous cohorts, the payback that we had, and we evaluated here and concluded that the best decision right now is to increase POS prices, decrease POS subsidies, improve the LTV versus CAC ratio, and look for clients that use not only PagSeguro but also PagBank. So that's why we are focusing a little bit higher merchants. And I'll take advantage of your question just to complement that, different than other companies where the number of subscribers is key to model revenue and so on. When you have five seats, it's very different here because we have many growth drivers. The clients that work with us usually, they grow their TPV. We can cross-sell products, so the idea is to also bring this client and increase the revenue promotion that we have today. So that's what we have in mind. That's what we are looking for.

Éric Oliveira, Investor Relations and ESG Director

Bryan, this is Éric. Just to add my sense here related to the spreads, when we think about spreads, remember that as we move up market, larger merchants, they have slightly lower spreads in comparison to micro merchants. And this is okay for us because it is EPS accretive, so not necessarily will spreads be fully recovered even though EPS will continue to grow, okay, while due to the client mix change towards larger merchants that have much higher TPV per merchant in comparison to long tail. So the summary here is consolidating long-tail, increasing share of wallet and also moving up market with clients with larger volumes and slightly lower take rates but still very profitable for us.

Bryan Keane, Analyst

Got it. Thanks for taking the questions.

Éric Oliveira, Investor Relations and ESG Director

Thank you, Bryan.

Pedro Leduc, Analyst

Good evening everybody. Thank you so much for taking the question. I have two please. First, if I think about your net margin evolution for the coming quarters, of course, you're working on the top line on the repricing. OpEx seems to be getting diluted. I'd like to get your views on that as well for the coming quarters. But also on the funding cost side, especially in the light of the strong deposit figure, what can you expect from the funding side as a help to net margins in the coming quarters? Is this something that you can do not to offset a little bit the Selic pressure that is still lingering? So that will be the first. Thank you.

Ricardo Dutra, Co-CEO

Hi Pedro, this is Ricardo again. I will start and Artur can complement if he wants to. Just before answering you about the margin, just pretty quick math here. Our financial expenses in Q1 2021 were R$44 million and in Q1 2022 were R$621 million. So it's a difference of around R$580 million in financial expenses. Of course, that happened because of the increase in base interest rates. If you analyze that, this R$600 million times four, we are talking about R$2.4 billion increase in financial expense, a big headwind. And even with that, we are growing our net income in absolute terms, which for us is a huge, huge achievement because you can imagine R$2.4 billion before taxes is a big headwind and we're still delivering a net income higher than last year of 29% when looking at GAAP measures. So with all the scenarios that we have looking forward, we will focus to remain and to increase our EPS. We always look for growth and profitability. So, we have this volatility, not only in Brazil but around the world and residential access in Brazil and so on. So to be sincere, we are trying to seek some operational leverage as we had in personnel and marketing for instance. But we're not yet looking for margins as a percent of revenues in the following quarters due to the volatility that we may have and the headwind in financial expenses. But I don’t know if Artur would like to complement. And regarding funding costs, we of course are following that very closely. And we also have the advantage of having the bank with BRL 11.2 billion in the products which helps to decrease the average cost we have in funding. And it's going very fast mainly because of the deposit growth on the balance account and also the CDs that we've been launching since last year.

Éric Oliveira, Investor Relations and ESG Director

And just to add my two cents here Pedro. This is Éric. When we combine the full banking license and all the products that we have been rolling out, remember that the deposits that we are capturing here is a winning go-to-market strategy to keep attracting new clients with high APYs, at the same time that we foster cheaper balancing accounts to help to diversify the cost of funding. The heat that we have been seeing in our profits in the short-term related to the interest rate hikes will not be as high as it was right now because in the next interest rate hike cycle, we expect to have a larger deposit base which will be a natural hedge for the company to deliver much higher profits in the future since we have the full banking license and PagBank.

Pedro Leduc, Analyst

That's very clear Éric, especially sort of getting to know the deposit was an impressive figure. Congrats. And I'll go back in line for a second question. Thank you.

Éric Oliveira, Investor Relations and ESG Director

Thank you.

Jeff Cantwell, Analyst

Hey, great. Thanks for taking my question. I wanted to follow up on the PagBank commentary that you were highlighting earlier and more specifically, on Slide 9 of your presentation. I was hoping you could talk a bit more about the active client base of the growth that you're seeing in active clients right now. One of the things we're trying to unpack is just sort of the marginal profitability of the consumers that you're bringing on board. I was hoping you could kind of give us a little bit of a sense of what you're seeing in some of your more recent adds and how you think about profitability going forward. Thanks a lot.

Ricardo Dutra, Co-CEO

Hi, Jeff. On Slide 9, you can see that we experienced significant growth in our consumer base. Increasingly, our clients are using PagBank as their primary banking option. We have been careful in extending credit to consumers, yet over 50% of our clients consider us their main bank, which benefits us when launching new products or offering better pricing. Regarding your question on monetizing merchants, we earn revenue from various transactions they conduct, such as making payments or topping up prepaid mobile phones. Additionally, we have two main product lines. The first is deposits, which are crucial for our funding. As our client base and deposits grow, this helps manage funding costs, particularly in an environment with a 13% base interest rate. We are also introducing new products that provide credit to consumers with collateral. For example, we offer CDs, allowing us to issue credit cards to consumers, generating revenue through interchange fees while maintaining minimal credit risk. We remain cautious about extending credit. Although we saw an increase in deposits from Q4 to Q1, growing by around BRL 200 million from BRL 1.9 billion to BRL 2.1 billion, this growth primarily came from collateralized products based on government employee deposits. If a consumer defaults, we have government backing to recover the funds, which has driven most of our growth in Q1.

Jeff Cantwell, Analyst

Thank you very much. That's great color. I will jump back in the queue. I appreciate it.

Ricardo Dutra, Co-CEO

Thank you, Jeff.

Pedro Leduc, Analyst

Thank you guys for taking the follow-up. I would like to switch subjects quickly for credit it's small and I appreciate you guys have been prudent on it. Portfolio is growing steadily, now down BRL 2.1 billion. Can you discuss a bit how we should expect it evolving in the coming quarters, especially between the secured lines, which seem to be growing faster? And then other than growth, a second question is now related to credit risk. How you're seeing that on the ground? How was the ex-provision expense figure for this quarter? And how should we think about that one evolving in the coming quarters? It seems like you've adjusted some standards etc. May it have peaked or stabilized? Thank you.

Ricardo Dutra, Co-CEO

Hi, Pedro. What I've seen so far will start from backwards and then again Artur can help me here. But I've seen so far in the market, in the Brazilian market and we've been hearing from big banks that know how to give credit in the market. There was a little bit of deterioration of NPLs. And of course, because of that is the macro scenario. We've been seeing here with the inflation employment and so on. So, and here the sales was not different. We had a little bit deterioration in NPLs nothing to be concerned. But we also expect that we've been seeing the cohorts. And that's what is going on with us and Artur can give more color. But looking forward, I would say that we do not expect to grow our current portfolio too much. If you grow slower or just a little bit. But there will be a transition from quarterized products non-quarterized products to quarterizing profit. So we are already doing that. We did that in Q1 with this FGTS product that you know very well in Brazil what I'm talking about. So we have this government guarantee. So that's very important and secure and safe collateral. So what we probably will have, what we see in the future is more and more collateralizing products taking share from other products with more credit risk. Of course, our goal here is to have a balanced portfolio with products with higher risk, but of course with higher returns and a huge part of the portfolio with collaterals that we can also navigate to different times depending on what's going on in the macroeconomic scenario. But at this point, the majority of our credit portfolio is still without collateral, the working capital for the merchants. What you see is going to see this migration from non-collateral to collateralized products.

Éric Oliveira, Investor Relations and ESG Director

And Pedro just to complement, we are seeing difficulty in the economy, difficulty in the market. All the incumbents said that the portfolio deteriorated a little bit and happy to hear too, but remember that our net income non-GAAP for this quarter was R$371 million. Imagine if the asset quality was better; we could have better results too. And this is the reason that we are observing the market, trying to understand when will be the right moment to accelerate again. At this moment we are, as Dutra said, we are working to provide credit for merchants and consumers that could provide collateral to us.

Pedro Leduc, Analyst

That's perfect, very full. Regarding the provision expense line, you mentioned that net income this quarter could have been even higher. Do you think that the provision expense line has plateaued, or will it continue to increase as the portfolio grows?

Ricardo Dutra, Co-CEO

I can say that it could be stable. The most important thing to us is that we are using the most advanced accounting process for the credit portfolio. We do not anticipate a significant impact in the future because our provisions are based on IFRS 9 expected losses looking at the next 12 months. Therefore, we are positioning ourselves accordingly, and there are no concerns for the future.

Éric Oliveira, Investor Relations and ESG Director

But Pedro, this is Éric. More importantly to ask about provisions, and you're completely right to make this question, is the APRs that we charge, okay? In light of this challenging environment, we also increased the APRs potentially or expecting to see deterioration in asset quality to keep these spreads, okay? So this is the main message here. The APR has increased to cover the higher provision for losses. And remember that IFRS 9 makes the company to make the upfront provision for losses and capturing higher margins over time as we book as interest income, okay? Thank you.

Pedro Leduc, Analyst

Super useful guys. Thank you so much.

Éric Oliveira, Investor Relations and ESG Director

Thank you, Pedro.

Neha Agarwala, Analyst

Hi. Congratulations on the results, and thank you for all the comments. I just have one quick question. You mentioned that the earnings in the coming quarter should continue to improve with the pricing mostly done, and I believe the funding costs will continue to go up because as you do more of repayment and the volumes grow. So that should put some pressure on the funding cost in the coming quarters as well. So what would be the main drivers for the expansion in earnings in the coming quarters? Also, the monetization at PagBank has been a bit weak. And I understand that's mostly because you're not being very aggressive on credit and that perfectly makes sense. So how do you think that contribution will look like by next year for PagBank? Thank you so much.

Ricardo Dutra, Co-CEO

Thank you, Neha, for your questions and for taking the time to connect with us. Regarding unit pricing, it's an ongoing discussion. I want to clarify that the majority of the price increase was due to interest rates rising from 2% to nearly 13%. If there are any further increases, we expect them to be minimal in the upcoming central bank meetings. That's why I mentioned there may be some adjustments, but the bulk of adjustments have already been made. We believe we are in a good position with our spreads when we compare the financial income we generate against our financial costs. While prepayment volumes are increasing due to our company's strong performance—growing 60% year-over-year—the growth in financial income is keeping pace or even outpacing those volumes. We think our financial income and expenses are balanced at good levels, with room for slight improvement. However, I don’t want to commit to raising prices for everyone, nor can I guarantee that there won't be any price increases for some clients. The major price adjustments have already occurred, which is the key takeaway. Looking ahead to next year, as I stated before, the Central Bank in Brazil has been quick to raise rates despite the interest spike, so we expect inflation to be managed in the coming quarters. If interest rates fall, we won’t necessarily lower prices for our clients, as we aim to maintain our pricing strategy for a while and leverage that to our advantage. Therefore, it's difficult to predict whether margins will improve and by how much due to the macroeconomic environment. However, within our control, we are actively managing operational expenses, personnel, and marketing costs, increasing prices for some clients, and making smarter client acquisitions. Although we acknowledge that revenue may be slightly lower than we anticipated, our decision to hold back on credit, given the macroeconomic context, does impact PagBank’s revenue. While it could be higher, we believe now is not the right time to take on that risk. Nevertheless, with 23 million accounts open in PagBank and 14 million active clients, we see a significant opportunity. When we decide to expand our credit offerings, we expect to capture some of the revenue that we are currently missing due to our cautious approach in this macroeconomic environment.

Éric Oliveira, Investor Relations and ESG Director

Two points, Neha. First, keep in mind that spreads for larger merchants are somewhat lower than those for micro merchants, and we are no longer solely dependent on micro merchants. In Q1, 25% of our volumes came from hubs, small, and medium merchants. Secondly, our revenues increased by 66% year-over-year, while our combined personnel and marketing expenses grew at half that rate. The investments we've made in new ventures like PagBank and hubs are beginning to pay off by providing operating leverage to our bottom line. The main challenge we face is financial expenses. Nevertheless, we are striving to achieve a higher net income in 2022 compared to 2021.

Neha Agarwala, Analyst

Could you provide your thoughts on the competition, particularly in the long tail? Do you perceive the competition becoming more rational? I believe all players are now aligning on pricing, which should lead to greater rationality, but has there been any change or is anyone behaving aggressively or irrationally in the market?

Alexandre Magnani, Co-CEO

Hi Neha, this is Alexandre. What we have observed in the market is that all the value players have been more rational in their pricing strategies in the long-tail segment. We have the lion's share in terms of the number of merchants. And through our experience of having the largest merchant network in Brazil for all these years, we learned how to manage properly how these retail customers and we have a very good value proposition for this segment. We have superior logistics. We deliver our terminals in the same day between one to two days mostly. We also have a value proposition between the banking and acquiring business that no one else has in the market. We provide this service with a single app and with a single customer care contact for our merchants. So we believe that our value proposition and our assets make us the strongest competitor in this area while being more rational about terminal subsidies and promotional offerings is making us capture more value out of these clients. We are raising the average TPV of our merchants. And we are also able to capture merchants that have a higher propensity to use financial services, and this is helping us to boost PagBank.

Artur Schunck, CFO

Just complementing the initiatives from other incumbent companies, acquiring companies such as CLO and credit cards apart from they kind of decided not to continue serving the inactive anymore. So, it seems that there were more competitors in the past than there are today in the long tail. So that's the situation. If you look at one year, 1.5 years ago there were many, many more players trying to enter the long tail. And just to give an idea, these two companies decided not to serve them the same way anymore because of the reasons that Alexandre just mentioned, the logistics that we have at PagBank and so on. So we're seeing more rationality and fewer players serving the long tail at this point.

Neha Agarwala, Analyst

Perfect. That’s very helpful. Thank you so much.

Artur Schunck, CFO

Thank you Neha.

Kaio Prato, Analyst

Hello, everyone good evening. Thanks for the opportunity for asking a question. I have two here on my side please. The first one is on PagBank revenues. So in the last quarter, you mentioned a guidance for PagBank revenue of R$240 million to R$260 million, and the date that you disclosed the results were really close to the end of the first quarter, but you delivered more than R$300 million this quarter, while the NII remained flat quarter-over-quarter. So I just would like to have a sense on what happened if this is indeed an impact of fees, and in which line of fees we saw the inquiry. And also, what can we expect in terms of revenue growth from PagBank going forward? And if I may just to add my second question here is related to the tax rate. If you could first give more details about the impact on effective tax rate this quarter? And what can we expect going forward? And, of course, I'm trying to better understand what could we expect in terms of earnings before taxes if we could see this expanding over the next quarters? That’s it. Thanks a lot.

Ricardo Dutra, Co-CEO

Hi, Kaio. This is Ricardo. I will start backwards here and then Artur can complement and also talk to you about the PagBank revenue guidance. When you look at the tax rate this quarter if you look at the specific line, you see a lower effective tax rate, right? But the point is in other lines of our P&L, we had a negative revenue tax impact in the line of other financial income. We have a headwind in the other financial income. And then we could offset that in our tax rate for income, income tax rate. So if you make the sum of the parts and the puts and takes, there is no real benefit in the bottom line. It's just a trade-off in tax collection between different lines. So for this reason, I will reinforce here that net income impact was negligible here in the situation. There's just a trade-off between these two different lines. Artur?

Artur Schunck, CFO

Kaio discussed the effective tax rate moving forward, which will be around 16% to 20%. To provide some clarity, in Q1 2022, we were somewhat cautious with our revenue forecasts for PagBank, but we ended up exceeding our expectations in areas like credit, cards, and various services.

Kaio Prato, Analyst

Okay. Thank you.

Ricardo Dutra, Co-CEO

Thank you, Kyle.

Sheriq Sumar, Analyst

Hey everyone. Thank you for taking my question. I have a two-part question regarding churn. I understand you started increasing rates in January, and that trend continued through April. How much more room do you think there is for churn to increase? Is all the churn fully reflected in the price increases or in your estimates? Additionally, I know that the actual churn will not be apparent until about 12 months from now. By the end of the year, where do you expect the number of active merchants in your PAGS business to be, and will your focus on high-impact lines lead to an increase in churn among your merchants? In summary, how should we think about the number of active merchants for the full year?

Ricardo Dutra, Co-CEO

Thank you for the question. As we discuss this quarter and look towards future quarters, we still have some legacy clients from MOIP who are showing churn. However, as you pointed out, these clients have not made any transactions with us in the past 12 months. If we exclude MOIP, we have achieved decent growth. While it’s not the same 250 new merchants every quarter that we used to see, this was a deliberate decision. We opted to increase prices to attract better merchants rather than focus on smaller ones. Consequently, our gross additions have been somewhat lower than in previous periods, and we are experiencing churn from a year ago. What we are closely monitoring is the activity level of these merchants, the total payment volume (TPV) per merchant, and our growth, which was 60% year-over-year with revenues rising 66%, reflecting more than just volume from TPVs. Even though we are observing churn, it's not affecting our TPV significantly, as it primarily involves the small merchants we are losing. Regarding the price increases, we have not seen any spike in churn as a result, because the entire market is experiencing price hikes. The churn will only escalate if merchants stop processing card transactions, which is not the case. We increased our prices, mirroring the broader market trend, and consequently did not notice an increase in churn linked to these price adjustments. Looking ahead, I can estimate that having the same 250 new merchants per quarter as before is unlikely. Nevertheless, we are prioritizing merchants with higher TPV, and the impact of the current churn will reflect 12 months from now. The churn behavior we observe in our current base does not appear to be deteriorating due to the price increases. In summary, our gross additions are lower because we've chosen to pursue fewer merchants with greater TPV, and the churn from our previous base of smaller merchants is affecting our overall net additions. It’s important to focus on total TPV, TPV per merchant, and revenue per merchant. It is difficult to predict our trajectory for the upcoming quarters, but this is the best information I can provide at the moment.

Sheriq Sumar, Analyst

Sorry. Thank you so much.

Ricardo Dutra, Co-CEO

Thank you.

Unidentified Analyst, Analyst

Hi, guys. This is from Cantor on for Josh today. I was hoping you could share a little more color about the diversified revenue streams around PagBank. What services are clients specifically engaging with? And is that going to be a trend that continues into the future? Thank you.

Ricardo Dutra, Co-CEO

Thank you for the question. When you mentioned diversification, it is because in the past, most of our revenue came from interchange fees related to card transactions, where customers spent money using their cards for purchases, online shopping, or withdrawing cash from ATMs. We are noticing an increase in engagement from our 14 million clients, which is contributing to our revenue alongside the growth in our credit portfolio. As we indicated in our Q1 May message slides, we are witnessing revenue growth from interest as our share in PagBank increases. We anticipate this trend will continue in the upcoming quarters, even though we do not plan to significantly expand our credit portfolio. It appears that it will remain stable, focusing on more collateralized products. Looking ahead, we also discussed growth drivers related to digital accounts for small and medium-sized businesses (SMBs). During the quarter, we launched several new products, and I want to highlight three of them that are included in these slides. One is the debit card for SMBs that have requested it. We also enabled direct deposits from other acquirers to PagBank, and we are introducing certificates of deposit (CDs) with credit cards for SMBs, which were previously only available for consumers and not formalized companies. These initiatives are expected to drive our revenue growth as we recognize a significant opportunity within the SMB sector. As I mentioned earlier, we are the only acquirer providing SMBs with payment solutions and digital accounts. Other acquirers that aim to serve SMBs either lack access to their own bank accounts or are subsidiaries of banks that have fallen behind us by at least three years in this regard. Therefore, we plan to further penetrate the SMB market, increasing both our client base and engagement, which in turn will enhance our revenue.

Unidentified Analyst, Analyst

Okay. That’s really helpful. Thanks for taking our question.

Ricardo Dutra, Co-CEO

Thank you.

Tito Labarta, Analyst

Hi, good evening. Thank you for taking my question. I have a follow-up I guess on the guidance a bit and on the margins that are implied, right? I mean at the midpoint of the guidance, it implies that the margins fall a little bit from this quarter. I mean you mentioned most of the repricing is done, where do you think that we can begin to see some operating leverage in the business and the margins begin to go up? I mean is it – do you need to wait for interest rates to come down? Is it PagBank and the hub decline profitable? Just to get a better sense of when we can begin to see an inflection point there. And then maybe a follow-up to that. I mean you mentioned you would have proactively reduced rates when rates come down. But what if your competitors start to lower rates when interest rates decline would you be forced to follow, willing to follow? And – or do you think you could then be able to maintain prices in a lower interest rate environment as well? Just to get a sense also on some of the potential operating leverage there if and when rates eventually may be coming down. Thank you.

Ricardo Dutra, Co-CEO

Hi, Tito, this is Ricardo. Well, definitely we will have some – we expect to have better margins when the interest rate goes down because of this mismatch of timing between the decrease of course versus the level of revenues that we have at this point. So increasing the spreads because of interest rates going down, then you keep the price at the same levels. Regarding your question on whether competition decreased prices, I don't think it's let's say a simple answer like we're going to follow or will not follow. We have 7.7 million merchants, almost eight million merchants. So you can imagine you have every type of merchant in all the cities in Brazil, more than 5,500 cities. Many of our clients use us, not because of the prices. We have the highest net rate in the market, but the users because of the ecosystem, because they have PagBank, because we are the first mover and so on. So part of our clients are not that price sensitive. So I don't think that there's going to be a move to other players because we did not decrease the price. So we don't need to follow immediately, if some competitors decided to decrease the price. And many of our competitors don't have a strong presence in long tail for instance. So we think that we will take advantage of that. Of course, if we think about large clients that they have all the financial manager, or things like that, there could be some competition there. But again, we try to differentiate PagSeguro from other service providers by offering better services and better logistics and so on to try to sustain higher prices compared to competition. And if you look at the industry, we have the highest rustic rate and also net take rate. Regarding margins in the short term, you were looking at our guidance, depending on whether you're looking at the bottom or the midpoint and so on, but it seems to be stable in Q2. Of course, we still have some days to finish Q2. But it seems to be stable. Operational leverage we do expect to happen because we already invested in hubs in the past two years with our 300 hubs. And we are not let's say opening new hubs at the same pace that you used to have in the past, only small hubs here and there. So all the base that these hubs that we invested in the past creates the base of merchants TPV that we are having right now. Of course, we can take some – we can get some leverage there. But again, I just don't want to promise here better margins, because we don't even know how it's going to be the next interest rate increase, if we have by June. And then, of course, we had this interest rate increase, we increased the price as much as we can and we have the ability to pass the price as we could see in Q1. For me, we had a very successful price strategy here. We were able to increase the price, increase take rates, and keep churn levels under control. And that's why our revenues grew more than our volumes, 66% versus 60%. And in Q2, we are seeing better take rates when compared to Q1. So – it's a matter of time for this operational leverage to happen, but I just don't want to promise you when will happen, but I guess, the best answer here at this point is just to say some of the headwinds that you have today could be tailwinds in the future. So let's see, when they will become some tailwinds, and we can take advantage of that.

Tito Labarta, Analyst

Great. Thanks, Ricardo. That's helpful. Maybe just one follow-up then on that. In terms of PagBank, I think you had initially said breakeven maybe at the end of this year. I think last conference call you said maybe that gets delayed a quarter or something because of slower credit origination. Is that still the case? Do you think PagBank turn to profit next year? And then also a similar question on the hubs, would you say how long does it take for the hubs to become profitable? Is that this year, next year? Any color on the profitability of the hubs?

Ricardo Dutra, Co-CEO

Regarding PagBank, what we're seeing in Brazil is that, despite last year's access to capital, the funding environment has changed significantly. This presents an opportunity to grow our client base, even among smaller players who received venture capital funding. We are committed to accelerating our acquisition of PagBank clients, and the numbers indicate that we're performing well. While monetization isn't progressing at the speed we anticipated, we’ve already become the second largest regional bank in Brazil, so maintaining profitability will follow naturally. Specifically, if we don’t reach breakeven in Q4 this year, it will likely occur in the next quarter. However, this does not alter our profitability needs. We're constructing the second largest digital bank with R$14 million, and we're seeing increased engagement and deposits, which are aiding our funding efforts. We're on track for breakeven, but I can't guarantee it will happen this year, though it won't be too far off. We are genuinely leveraging the current market conditions to grow PagBank as swiftly as possible. As for the hubs, I believe Artur can provide additional insights on that.

Alexandre Magnani, Co-CEO

Yes. Tito, this is Alexandre. Regarding the hubs, hubs represent today 25% of our TPV. We have around 300 hubs spread all over the country covering around 80% of the Brazilian GDP geography locations. We have very compelling paybacks in our hubs operations between four to six quarters. What we see is that through our superior logistics infrastructure same-day prepayment and PagBank offering, we have been growing much faster than the competition in our hub strategy, exploring and gaining share in the SMB segment. And we see that we are gaining that traction and that market much faster than we originally would think about.

Tito Labarta, Analyst

Okay. Yes. Thank you. That's helpful.

Alexandre Magnani, Co-CEO

Thank you, Tito.

Soomit Datta, Analyst

Hi there. Thanks for taking the question. Just a quick one at this point please. You've given some data on the hubs contribution to TPV over the course of the last few quarters. I'm trying to kind of plot that progress over time, i.e., how much is hubs contributing over time, it's a bit hard to get to the exact numbers. I'm curious to what degree is, is the long tail still growing TPV relative to hubs? I think, for example, you said hub TPV is up to 25% of total. Now I think it was 20% at the end of the year. So when I look at the TPV progress through Q1, it was flat. Does that mean long-tail TPV is down, and hub TPV is up? And when you're guiding for TPV into the next quarter are you assuming long tail is still growing, or is it really coming from the hubs at this point? Thanks very much.

Ricardo Dutra, Co-CEO

Hi. Thank you for the question. Long-tail TPV is growing. We were the first to enter this space and have built a very loyal base of long-tail and small merchants. This segment is experiencing growth, but the hubs are expanding at a faster rate because they are generally five to six times larger than long-tail merchants. The TPV share of the hubs has increased to 25%, which is positive since we are also growing TPV at 60% and revenues at 66%. We anticipate that hubs will continue to gain market share due to their strong performance, which has exceeded our expectations. While the long-tail segment is indeed growing, it is not doing so at the same pace as the hubs, primarily due to the maturity differences between the two. We are seeing much faster growth in hubs compared to long-tail, although both are increasing. It's important to note that while hubs have lower net take rates as a percentage, their absolute profit remains substantial due to their larger size. It’s uncertain what the future size of hubs will be, but we expect them to continue gaining market share, which is a positive outcome as they are growing quicker than long-tail. Additionally, we will be cross-selling our PagBank solutions for hubs. So, Éric?

Éric Oliveira, Investor Relations and ESG Director

It doesn't matter the size of the merchant we are serving, whether it's long tail or SMB. This might be a tricky and misleading question. We selectively choose the best merchants, which is why we have the highest take rate in the market and are the most profitable acquiring company, building a banking relationship with 23 million clients and capturing over 40% of the net profit in the sector. We are not concerned about long-tail or SMB; we focus on selecting the best merchants, aiming for those with higher transaction per volume and healthy take rates.

Soomit Datta, Analyst

Okay, got it. Thanks.

Ricardo Dutra, Co-CEO

Thank you.

Operator, Operator

This concludes the question-and-answer session. At this time, I would like to turn the floor back to Ricardo Dutra and Alexandre Magnani for any closing remarks. Please go ahead.

Ricardo Dutra, Co-CEO

Hi everyone. Thank you very much for investing the time to talk to us. Thank you very much for those who asked us some questions as well, and hope to see many of you in person in the following weeks. Thank you very much.

Operator, Operator

This concludes today's PagBank PagSeguro conference call. Thank you for attending today's presentation.