Earnings Call Transcript - PAGS Q2 2024

Operator, Operator

Good evening. My name is Audir, and I will be your conference operator for today. Welcome to PagSeguro Digital Earnings Call for the Second Quarter of 2024. The slide presentation for today's webcast is available on PagSeguro Digital's Investor Relations website at investors.pegbank.com. Please be advised that all participants will be in listen-only mode. After the presentation, to ask a live question, please use the “raise hand” button to join the queue. Once you are announced, a request to activate your microphone will appear on your screen. Please ask all your questions at once. Alternatively, you can also write your question directly into the Q&A icon on the lower part of your screen. Today's conference is being recorded and will be available on the Company's IR website after the event is concluded. I would now like to turn the call over to your host, Eric Oliveira, Head of IR. Please go ahead, sir.

Eric Oliveira, Head of IR

Hello, everyone. Thanks for joining our second quarter 2024 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. While PagSeguro Digital believes that those are reasonable in view of currently available information, you are cautioned not to place undue reliance on these forward-looking statements as 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 section 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 non-GAAP measures. 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 EASB. 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 appendix of this webcast presentation and earnings release. With that, let me turn the call over to Ricardo. Thank you.

Ricardo Dutra, CEO

Hello, everyone, and thanks for joining our second quarter 2024 earnings call. Tonight, I have the company of Alex, our CEO, and Artur, our CFO. And I'm proud to announce the Company had a very strong quarter with all-time highs in key financial metrics, such as revenues and net income. Hence, you'll see many all-time highs at the beginning of the slides' titles throughout the presentation. On this first section, I'll share the main operational and financial highlights for the quarter. Starting with Slide 4. Total revenue grew 19% year over year, reaching BRL4.6 billion, an outcome reflecting a high quarter result with strong TPV and revenue growth in all client segments. Our gross profit margin ended the quarter close to 40%, in line with current guidance and an 86 basis point increase in comparison to Q2 2023. On a year-to-date basis, we ended the semester with a gross profit margin of 40.3%. We also reached the all-time high net income in both GAAP and non-GAAP basis, which reached BRL542 million, a 31% year-over-year growth. In the last bullet, we can see our EPS reached BRL1.68, 32% higher than Q2 2023, also a record high. Moving on to Slide 5. We reached 31.6 million clients by the end of June, adding more than 2 million clients in the last 12 months with 17.7 million active clients. We also had an all-time high deposits level reaching BRL34.2 billion, an impressive 87% increase year-over-year. This increase shows the power of our value proposition, which has been contributing to improved client engagement and to lower our cost of funding, supporting our profitability metrics. Additionally, we received a AAA rating from Moody's, now PagBank has AAA ratings from both Moody's and S&P. Furthermore, our PagBank app has an evaluation of 4.9 stars in the App Store and 4.8 in Google Play. Moving on to Slide 6. We share some highlights from the payments and banking units. In payments, we've maintained strong growth, with our TPV reaching BRL124 billion—a 34% year-over-year growth, which is three times more than the card industry growth of 11%. We experienced significant growth in MSMBs and LMEC merchants as a result of our strategy of attracting those merchants with monetization potential in financial services. Our banking cash reached BRL76.4 billion, a 52% growth year-over-year aligned with our strategy of successfully stimulating principalities for our clients. Our credit portfolio grew 11% year-over-year to BRL2.9 billion, marking the third consecutive quarter of expansion primarily driven by our credit underwriting and security products. Now I pass the word over to Alex for comments on the business unit highlights for the quarter.

Alexandre Magnani, CRO

Thank you, Ricardo. Hello, everyone. In this section, we will break down our business unit's performance for the second quarter of 2024. Starting with Payments on Slide 8, we show that our merchant and acquiring business keeps growing faster than the industry, with strong growth registered in all segments. TPV reached BRL124 billion in Q2 2024, growing 34% year-over-year with TPV per merchant growing 42% on a yearly basis, and active merchants on a 30-day basis, excluding nano merchants, grew 4% year-over-year. These results are a consequence of our strategy to expand our payments business focused on a merchant profile with better engagement and profitability. Moving on to Slide 9. Let's look further into the MSMB segment, which gathers merchants with monthly TPV of up to BRL1 million. MSMB's TPV grew 28% year-over-year, reaching BRL83.6 billion in the second quarter of 2024. The strong cross-adds by merchants positively contributed to this performance, combined with higher productivity and expansion in our hubs. The growth in MSMB's TPV addition of BRL18.2 billion, which is five times larger than the previous year. We've been recording strong DR sales across multiple channels and geographies, which is a significant indication of how consistent and robust our current growth and performance are. These results are only possible due to the unique value proposition that our company offers MSMB clients in Brazil. Through unrivaled instant settlement solutions, we provide the cheapest working capital source, empowering businesses to thrive without financial strain. Additionally, we provide a fully integrated platform combining a complete set of payment products, a broad suite of financial services, and a comprehensive portfolio of embedded software solutions from over 350 partners. On the next Slide, moving to Slide 10, we show how our TPV from the LMEC segment has performed, which is comprised of large merchants, e-commerce, and cross-border clients. In the second quarter of 2024, this segment posted 50% TPV growth in comparison to Q2 '23, reaching BRL40.8 billion in volume, accounting for approximately one-third of our total TPV. We are increasing our share of wallet on the larger merchant segment that encompasses businesses with monthly TPV above BRL1 million, with a strong growth in card-not-present transactions that expand our market beyond POS. Furthermore, we've also seen substantial TPV growth in new growth verticals, particularly in our online segment, including e-commerce and cross-border. Our online payments platform ensures trust and reliability for online customers and provides an integrated solution under the brand PagSeguro International for the cross-border segment. Moving on to the banking business on Slide 11, our strategy to provide an exceptional experience that combines payments, value-added services, and banking through multiple interfaces for merchants and consumers continues to drive engagement. This increase in engagement resulted in over BRL76 billion realizing PagBank cash-in, which is composed of all PIX P2P, wire transfers, and deposits through boletos/invoices to PagBank accounts from other financial institutions. Our active banking client base reached 17.3 million customers, growing 5% year-over-year. As a result, Cash-in per active client, an essential indicator of our client engagement, grew 44% year-over-year, reaching BRL4,400 per client. This constant evolution of engagement is reflected in the increasing penetration of our investment and credit products, expanding at a much faster pace than our active client base. On Slide 12, we shared that deposits were up 87% compared to the second quarter of 2024, reaching a record of BRL34.2 million boosted by our AAA rating given by S&P Global, which enhanced our CDS distribution among retail and institutional investors both on and off the platform. Just last month, we received a AAA rating from Moody's as an additional sign of the financial strength of our banking platform. The balance of checking accounts, which serves as the cheapest funding source and a key performance indicator to measure client engagement, grew 39% year-over-year, reaching BRL11.5 billion. The annual percentage yield for checking accounts and total deposits remains compelling, creating a unique engine connecting pricing power without undermining profitability by lowering the average cost of funding for the Company. In light of this, as we grow deposits, we are also exploring alternatives to further reduce the current cost of funding. Moving on to the next slide, Slide 13 shows that our credit portfolio has been growing at a steady pace since resuming growth in Q3 ‘23. This quarter, it reached BRL2.9 billion with an increasing share of secured products, which currently represent 80% of our loan book that promotes financial inclusion and offers important financing lines to our clients through these products. Our NPL at 90 days has improved significantly, moving from 14.4% to 3.2% over the last 12 months. Now I turn it over to Artur for the financial highlights of the second quarter of 2024. Artur, please.

Artur Schunck, CFO

Thanks, Alexandre. Hello, everyone, and thank you for joining us on the call. In this last session of our presentation, I will share our consolidated financial results for Q2 2024. Here on Slide 15, I am proud to announce once again an all-time high quarterly net income, which reached BRL542 million on a non-GAAP basis, growing 31% versus Q2 '23, with non-GAAP earnings per share reaching BRL1.68. Net income on a GAAP basis reached BRL504 million in Q2, growing above 30% year-over-year with earnings per share on a diluted basis marking BRL1.56, a 32% increase on a yearly comparison. This result was especially driven by a strong operational and financial performance, as shown in the forthcoming slides. Moving on to Slide 16. Q2 '24 total revenue and income growth accelerated to 19% on a yearly basis, positively impacted by higher volumes from acquiring and the acceleration of our banking platform. Our consolidated gross profit margin remains in line with current guidance, reaching 40.3% over total revenue on a year-to-date basis, as we have been successful in balancing growth across all segments and profitability, driven by the execution of our strategy focused on clients with better unit economics and higher engagement. Looking at our business segments in the graph on the right side, Payments Revenue reached BRL4.1 billion, a 17% year-over-year growth, with a gross profit margin marking 38%. Banking revenue grew 41% year-over-year, primarily driven by interest income from credit stemming from our cash position, combined with service fees linked to client engagement that have higher profitability. Gross profit from our Banking segment remains at 60% or higher for the third consecutive quarter. It is essential to mention that the gross profit margin in Banking is higher than in Payments based on our strategy of underwriting mostly secured credit products that inherently carry low yields while offering high yields paid on deposits to attract and engage new clients in the short term. In the next slide, we share how our discipline in capital allocation has been an important tool to balance growth and profitability, leading to higher value creation with an earnings before tax growth of almost 20% this quarter compared to the same quarter of last year. Here, let me focus on our cost breakdown and operating expenses, as well as what we can expect moving forward. I would like to start by highlighting the increasing efficiency coming from our main costs, including transaction and financial costs. Transaction costs decreased more than 11 basis points as a percentage of TPV, benefiting from the TPV mix driven by a higher share of PIX. Similar to this trend, financial costs also showed a positive performance, decreasing by 16 basis points as a percentage of TPV, primarily due to our strong deposit franchise. We anticipate maintaining this trend in the coming quarters. Operating expenses remained at 26% of our total revenue and income, the same level as last quarter. The year-over-year increase was driven mainly by marketing expenses aimed at acquiring new payment clients and distributing financial services, alongside personal expenses, reflecting the strengthening of our sales force which concluded at the end of Q1 '24. This expansion aimed to support the Company's current growth cycle, positively impacting our TPV. The quarterly increase in D&A and POS write-offs in nominal terms aligns with the current capital expenditure cycle and remains steady compared to the previous quarter. It is crucial to highlight that tax efficiency initiatives are part of our strategic plan and are running better than expectations, effectively reducing income tax charges. This quarter, we have made significant progress in optimizing our tax structure abroad and utilizing Lei do Bem benefits. Considering the volume growth level that has also exceeded expectations and efficiencies identified as mentioned before, we decided to further enhance our client experience and actively address client needs by strengthening our initiatives in customer care, product development, and service level agreements, which led to increased operating expenses. However, we remain confident that these investments will yield higher client engagement, strong cross-selling, lower churn, and larger profits to be captured in the forthcoming years as the cohorts mature, all without impacting our 2024 net income guidance. Moving on to Slide 18, we show the solid capture structure for this PAGS momentum. Our equity position expanded to BRL14.3 billion with the return on earnings accounting for 62% of the total, which demonstrates the success of our strategy of effectively balancing growth and profitability. Cash and financial investments concluded Q2 2024 with BRL6.2 billion within the 40% to 50% range of our equity balance, which we consider a good reference for a recurring level. As mentioned in the previous call, during the last week of March, we anticipated fundraising from April that increased our cash position in Q1 '24, resulting in a higher cash balance compared to the previous quarter. On the final slide, we are increasing our guidance for the year, reinforcing our sentiment that we have started the year at a very good pace. Our current performance is a pleasant surprise in terms of growth rate, particularly in larger segments and new growth avenues such as cross-border. We are also pleased with the results stemming from our banking platform. The success of our strategy to reach larger merchants to foster our deposit franchise is vital in balancing against a higher-than-expected interest rate environment. Consequently, we are taking the opportunity to revise our guidance as illustrated. We now expect total payment volume to achieve between BRL480 billion to BRL505 billion with healthy profitability. Our gross profit margin guidance remains unchanged, above 40% over total revenue and income, as we are currently delivering 40.3% in the first half of the year. Net income on a non-GAAP basis should range between BRL2.1 billion to BRL2.2 billion, considering a more efficient effective tax rate than in 2023, as we have been currently achieving. CapEx guidance remains unchanged, with higher investments in place this quarter aligning with business expansion while we increased the coverage ratio to sustain future growth. Nonetheless, current guidance remains between BRL2 billion to BRL2.2 billion. D&A plus POS write-offs are anticipated to be between BRL1.7 billion to BRL1.8 billion, benefiting from ongoing improvements in POS management. Now, let me pass the word back to the operator as we commence the Q&A session.

Operator, Operator

Thank you for the presentation. We'll now start the Q&A session for investors and analysts. Our first question comes from Kaio Prato from UBS. Mr. Prato, your microphone is open.

Kaio Prato, Analyst

Hi, everyone. Good evening. Thanks for the question. I would like to explore a little bit more the guidance change that you made for this quarter. We saw a significant upward adjustment in the TPV expectations, approximately a 10% increase compared to your previous guidance. However, your net income guidance increased only by 2% versus the midpoint we had previously. This seems a bit conservative, especially after the net income of the first half of the year and even lower than the expected effective tax rate. Can you provide more details on what lines of your P&L you expect to be worse than previously anticipated to offset this better TPV, D&A, and effective tax rate?

Ricardo Dutra, CEO

Hi, Kaio. Thank you for the question. You're right, when you look at the guidance, there's an increase in TPV as well as a decrease in D&A. It's important to remember that there are many moving parts in our P&L, which is very dynamic. For example, an assumption we had at the beginning of the year was that interest rates would be around 9% by the end of the year, while today, they're at 10.5%, with no visibility on a decrease. That's one factor impacting our P&L that we need to manage. We can decrease financial expenses by increasing deposits and exploring different funding sources. At the end of the day, the Company has the ability and discipline to control costs, as shown in 2022 and 2023. Even with these moving parts—some tailwinds and some headwinds—the best information we have today indicates that our net income could exceed the previous or original guidance set at the beginning of the year. We are always looking for sustainable growth to build a resilient company for the future, focusing on growing new avenues such as banking and our credit operations. The goal is to balance growth with profitability. That's the overall context regarding our current guidance.

Operator, Operator

Our next question comes from Pedro Leduc from Itau BBA. Please, Mr. Leduc, your microphone is open.

Pedro Leduc, Analyst

Thank you, guys. Congrats on the quarter. I wanted to discuss the SG&A expenses. In the prepared remarks, you mentioned a rollout of higher commercial investments. Part of it is driving revenues now, while part is expected to materialize later. Can you provide some insight into how you're assessing this reinvestment strategy and whether it may be a reason the income revision was more modest than revenue or gross margin increases? You also mentioned efficiencies expected in the second half— I'd like further clarification on that as well. Thank you.

Ricardo Dutra, CEO

Hi, Pedro. This is Ricardo. Regarding SG&A, we invested in the second quarter, and not just in the first semester, as you can see in our P&L. We increased our marketing and personnel investments. We do not expect a significant increase in these two lines in the second half. We anticipate stability in the size of our sales personnel for the second half. This expectation stems from our hiring strategy, which supported the faster growth rates reflected in our expanding banks. We also invested in customer experience, our call center, and product development. New product launches, such as multiple cards and multi-acquiring, are helping us offer a more comprehensive approach to our clients. Thus, when you review the operating expenses, the increase is clear. However, our outlook for SG&A for the second half is stable. That's why we reviewed the guidance, adjusting BRL50 million to the midpoint for net income, in light of many moving parts—including higher predicted interest rates and lower-than-expected D&A. While we are managing an evolving situation, we believe that our measures will offset the changes from raising interest rates, lowering D&A, and enhancing overall growth.

Pedro Leduc, Analyst

That's clear on SG&A. Thank you. If I may, for the second question, unrelated but also important— on the credit portfolio, particularly the working capital loans for SME clients—it appears these have been modest. How are you assessing your approach to originating additional working capital loans?

Ricardo Dutra, CEO

Well, Pedro, we do expect that segment to grow. To be honest, we're still in preliminary stages. We just launched working capital and overdraft loans by the end of Q2. These two products represent a small portion of our overall credit portfolio, but growth is significant. Our initial tests have shown promising results. Clients needing working capital have responded well, demonstrating responsible repayment habits. While I can’t provide specific guidance today, we expect these products to ramp up further in the coming quarters.

Operator, Operator

Our next question comes from Mario Pierry from Bank of America. Please, Mr. Pierry, your microphone is open.

Mario Pierry, Analyst

Hi, guys. Congratulations on the results. I wanted to inquire about the volume growth in the LMEC segment, which grew by 50%. I would like to understand the implications for take rates and profitability of this product versus the volume growth achieved in the MSMB segment. Given the increased guidance for volumes, could you explain why this isn't translating to higher net income? You indicated higher financial expenses are a factor. Yet, is the guidance for growth in the LMEC segment driven by stronger growth, even though it carries lower profitability?

Ricardo Dutra, CEO

Mario, thank you for the question. You're correct. We saw a 50% TPV increase in LMEC against 28% in MSMB. While this reflects stronger growth from larger merchants, it's essential to note that LMEC yields lower margins than MSMBs. Nevertheless, in absolute terms, this volume growth contributes positively to our bottom line. Both segments, however, continue to outperform the broader market. Specifically, with the card issuance industry in Brazil growing at merely 11%, we are achieving much healthier growth across both segments, with MSMB showing a solid 28% growth rate.

Mario Pierry, Analyst

That's clear. Can you clarify the acceleration in growth in the LMEC? You were growing around 30% previously, and now it has jumped to 50%. Are factors such as gaming and sports betting contributing to this growth?

Ricardo Dutra, CEO

Mario, multiple factors contribute to this acceleration. A significant reason is that we've completed the integration of our platforms. Since acquiring Moip in 2020, we've worked to assimilate their platform into PagSeguro's ecosystem. Now we have a singular platform to serve our online clients efficiently. Our strategy also emphasizes onboarding large merchants and integrating our banking solutions, which has enhanced our competitive edge. We have seen steady growth in clientele across both cross-border and e-commerce segments. In summary, the surge reflects a balanced and multi-faceted growth strategy embracing diverse revenue streams.

Operator, Operator

Our next question comes from Tito Labarta from Goldman Sachs. Please, Mr. Labarta, your microphone is open.

Tito Labarta, Analyst

Hi. Good evening. Thank you for the call and for taking my question. Just following up on Mario's inquiry about TPV. Is the pressure on the take rate primarily a function of the mix? You mentioned that you aren't primarily competing on price, yet you also referenced competitive dynamics specific to larger merchants. Should we anticipate continued growth in larger merchant volumes that could increase pressure on take rates moving forward?

Alexandre Magnani, CRO

Hi, Tito. Yes, the growth of our larger merchants is going to be larger than MSMBs. I want to clarify that even the MSMB growth at 28% is much more substantial than the card issuance industry in Brazil. We see strong growth across both segments. However, for the future, we believe we can sustain growth beyond the market average. Although larger merchants grow quickly, we anticipate maintaining justified pricing and margins.

Tito Labarta, Analyst

Following up on your strong deposit growth, are you seeing changes in the mix of deposits attributable to larger merchants versus MSMBs?

Alexandre Magnani, CRO

While larger merchants contribute to deposit growth, they are not the main drivers. The primary growth comes from MSMBs and consumer deposits. Larger merchants often have corporate accounts at larger banks and may only utilize us as an acquiring service. Therefore, MSMB and consumer contributions are more significant for our deposit base.

Operator, Operator

Our next question comes from Neha Agarwala from HSBC. Please, Neha, your microphone is open.

Neha Agarwala, Analyst

Hi, thank you for taking my question. My first question is about your guidance. What is the implied average selling that you have incorporated in both the old and the new guidance? Secondly, regarding the LMEC segment, is it comparable to the IBEX TPV that we observe? I believe e-commerce and cross-border volumes included are not part of the IBEX system, which distorts comparisons. Can you break it down for us to represent a clearer sense of the market share?

Ricardo Dutra, CEO

Thank you, Neha. To clarify, the TPV we report here does not wholly align with IBEX metrics. While the cards in Brazil show 11% growth, RTPV includes PIX as well. Even if you disregard PIX's participation, our TPV growth far outpaces competitors and IBEX comparisons. Regarding guidance, we consider interest rates above our original business plan, which was 10.5% without considering any reduction moving forward.

Artur Schunck, CFO

Neha, in terms of guidance, our interest rate considerations are above our original 2023 expectations—today, 10.5%—while also being circumspect about any reductions going forward.

Ricardo Dutra, CEO

Furthermore, we continuously assess various scenarios for interest rates and manage our company effectively to fulfill our guidance provided during the presentation.

Neha Agarwala, Analyst

Great, that’s helpful. Finally, in the MSMB segment, we notice an overall reduction in take rates. Most of this can be attributed to the strong growth from LMEC. Specifically within the core MSMB segment, what is the take rate, and how has it evolved in the last year?

Ricardo Dutra, CEO

We do not precisely disclose these take rates, but they have slightly decreased year over year—though not by significant margins. Overall, we maintain health in this segment, as evidenced by a healthy growth trajectory of 28% despite remaining competitive in the market.

Operator, Operator

Our next question comes from Jorge Kuri from Morgan Stanley. Please, Mr. Kuri, your microphone is open.

Jorge Kuri, Analyst

Hi, everyone. Thanks for the opportunity to ask questions. I wanted to revisit marketing and selling expenses. In the first half of the year, selling expenses were up 42% year-on-year and significantly outpaced revenue growth. Given that many of your peers experienced similar dynamics, what gives you comfort that this will translate into accelerated revenue growth? Many companies, such as Stone and Cielo, are adding resources, making competition even tougher. What makes you confident that you will outperform your peers in this case?

Ricardo Dutra, CEO

Hi, Jorge. Thank you for your question. We recently achieved impressive figures this quarter, with TPV growing 34%, revenue rising 19%, and deposits increasing by 87%. Our banking revenues grew by 41%, and new records were set for both TPV and cash inflows, suggesting that we are growing sustainably. Strong investments are essential for our continued growth. We could have opted for short-term profit over long-term growth; however, the substantial demand we see gives us optimism about our returns on these investments. Our unique offering combines acquiring and banking, providing us with an edge. While competitors may excel in specific areas, few offer a comprehensive blend of services like we do.

Artur Schunck, CFO

To build on what Ricardo said, we're seeing considerable benefits from strategic investments made through 2024. Therefore, it’s essential to view our spending as part of a larger plan—a calculated strategy focused on achieving sustainable growth instead of reacting impulsively to competitive pressures.

Jorge Kuri, Analyst

Thank you for that. If I may ask a second question regarding payroll loans, can you clarify the nature of these loans—who they are for, sizes, and how big this business could potentially grow? Are there metrics on how many clients currently use such loans?

Ricardo Dutra, CEO

At this point, our payroll loans primarily target retirees and government employees. The average ticket size aligns with industry standards, and while this segment is growing, it still represents a mere 3% of a larger BRL600 billion total addressable market. We aim to digitize the process to improve client interactions. As of now, no private employee loans are being offered, but we are keen on developing this segment in the future. Regarding the digitalization of our loans, we aim for 100% origination through our platform. Some segments utilize an intermediary, but we strive to reduce this dependency. Currently, the loan initiative has focused on providing convenient, frictionless access for clients.

Operator, Operator

Our next question comes from John Coffey from Barclays. Please, Mr. Coffey, your microphone is open.

John Coffey, Analyst

Thank you for taking my questions, which I have regarding some financial details. With Slide 6, could you elaborate on the potential for early payments and receivables from other acquirers? Additionally, on Slide 9 regarding geographic expansion, can you share if there are areas in Brazil where you're still looking to increase penetration?

Ricardo Dutra, CEO

For geographic expansion, we have a digital presence serving clients across Brazil, but we are focusing on areas where we can establish hyper-local sales forces, which supports specific regional needs. This local approach contributes to our sales strategy and is a key factor driving our operating expenses. Regarding early payments, this product utilizes our receivables system, allowing clients using PagSeguro and other acquirers the opportunity for early prepayments through our app. Our total addressable market consists of two-thirds TPV in Brazil. This initiative is complex but offers a competitive advantage given our ability to finance receivables based on our deposit base. We expect to provide more details in the upcoming quarters as we fine-tune this product.

Operator, Operator

Our next question comes from Yuri Fernandes from JPMorgan. Please, Mr. Fernandes, your microphone is open.

Yuri Fernandes, Analyst

Thank you, and congratulations on the strong growth. I'm curious about the weeks showing a substantial decrease in securitization costs—around 40% quarter-over-quarter. Is this primarily due to your growing deposit franchise? Furthermore, I am interested to know how you plan to use your increasing cash reserves in a context where you have substantial net cash generated each quarter?

Ricardo Dutra, CEO

Yuri, yes, the financial model of our deposit franchise is supporting these trends. Our financial costs through time deposits average around BRL96. However, this is a blended rate—some deposits yield higher, while others drive lower costs. We're balancing funding sources effectively to support our growth. Regarding our cash position, we have BRL12 billion in net cash. At the moment, we aim to invest in business growth rather than relying heavily on external financing. Strategic acquisitions and diversified investments in credit, banking, transferring clients seamlessly into our ecosystem are part of our ongoing strategy, ultimately maximizing shareholder returns.

Yuri Fernandes, Analyst

Could you look at the interplay of these factors on your net cash position? Are you planning any M&A, dividends, share buybacks, or perhaps increased investment in expanding your deposit base?

Ricardo Dutra, CEO

It's challenging to forecast the state of M&A activity five years from now because the industry is continually evolving. However, we are always looking for effective opportunities to create shareholder value. While I can't predict consolidation today, we are actively assessing various market opportunities.

Operator, Operator

Our next question comes from Bryan Keane from Deutsche Bank. Please, Mr. Keane, your microphone is open.

Bryan Keane, Analyst

Hi, congratulations on the impressive results. I wanted to dive deeper into the acquiring TPV, which continues to surpass market growth. With prospects for future growth in both MSMB and LMEC segments, how sustainable do you believe these changes are in outpacing market growth in both these segments?

Ricardo Dutra, CEO

We've been gaining market share consistently, and as we exceed growth rates, our processes, training, and investments ensure sustainable advancement. The financial health of our company allows us to pursue new avenues for growth, especially as we continue to enhance our product offerings.

Bryan Keane, Analyst

Could you share insights on potential acquisition targets or internal projects you are considering that could enhance your portfolio and cross-selling opportunities?

Ricardo Dutra, CEO

We continuously evaluate ways to acquire companies that could synergize with us or talent pools that enable us to enhance our capabilities. While we have a proprietary M&A team processing ideas, nothing is set in stone at this time.

Operator, Operator

Our next question comes from Gustavo Schroden from Bradesco BBI. Please, Mr. Schroden, your microphone is open.

Gustavo Schroden, Analyst

Thank you, everyone, and congratulations on your results. Regarding LMEC, is it reasonable to assume that the marginal TPV you are including isn't yet breakeven? Despite positive news on TPV growth, pre-tax earnings remained stable. Was this quarter a non-recurring event for LMEC? How do you expect future performance?

Ricardo Dutra, CEO

LMEC remains profitable, and while their margins vary compared to MSMBs, the increase in TPV is accretive. Although margins are tighter, we ensure a blend across revenue streams that remains beneficial overall. It's crucial we maintain focus on high-volume growth and sound financial practices.

Gustavo Schroden, Analyst

On the lending side, despite strong growth in deposits, your loan-to-deposit ratio is around 8%. What is a target ratio for this metric, given that elevating profitability is crucial?

Ricardo Dutra, CEO

We don't have a specific ratio guidance for the loan-to-deposit structure at this time. Our deposits' growth trajectory allows us to fund various avenues, including credit operations and prepayments. Ultimately, this flexibility is beneficial for our overarching strategy.

Operator, Operator

Our next question comes from Daniel Vaz from Safra. Please, Mr. Vaz, your microphone is open.

Daniel Vaz, Analyst

Thank you, and once again, congratulations on the results. I wanted to revisit the credit portfolio's strategy as you move towards SMBs and larger merchants. As your growth shifts, can we anticipate a reduction in retail loans and resultant pressure on your approach to wholesale?

Ricardo Dutra, CEO

We aim to strike a balance within our credit portfolio. Currently, much of our focus revolves around payroll and credit cards, but we're now launching new offerings like working capital and overdraft loans. Our goal is to widen our range, serving both consumer and merchant segments effectively.

Daniel Vaz, Analyst

When do you anticipate LMEC growth to align more closely with MSMB rates?

Alexandre Magnani, CRO

We foresee continued growth in LMEC, particularly in card-not-present transactions, where our market share still lags significantly. There remains an extensive runway for growth, which will help drive both segments toward a convergence in performance metrics.

Operator, Operator

Our next question comes from Gabriel Gusan from Citi. Please, Mr. Gusan, your microphone is open.

Gabriel Gusan, Analyst

Hi, good evening. I would like to discuss CapEx as it is presently running above the higher end of your guidance. Should we expect this trend to persist going forward since there is a transferral of investments towards LMEC?

Artur Schunck, CFO

Thank you for your question. CapEx has been hovering around BRL2 billion annually, with over half designated for technology enhancements rather than for point-of-sale devices. We anticipate adjustments as investments stabilize post the ongoing initiatives while maintaining strategic growth objectives.

Operator, Operator

Our next question comes from Renato Meloni from Autonomous Research. Please, Mr. Meloni, your microphone is open.

Renato Meloni, Analyst

Thank you, and I appreciate your response. I would like to delve into profitability. Observing gross profit as a percentage of TPV, it seems stable but did decline slightly this quarter by 11 basis points. Could this decrease be linked to LMEC performance, and do you expect any further compression in the second half? Additionally, regarding funding costs, could you discuss your initiatives to lower these costs?

Alexandre Magnani, CRO

LMEC performance does exert some downward pressure on gross profit margins. However, this isn't solely attributable to this segment. A broad mix of product performance, especially in rapidly growing ones such as PIX, also influences this. We anticipate similar patterns in the second half.

Artur Schunck, CFO

Regarding funding costs, we continuously seek avenues to optimize and enhance competitiveness. While we do not have a specific target for costs predefined, we are focused on maintaining flexibility with a diversified funding base.

Operator, Operator

Thank you. That's all the questions we have for today. I will now pass the line back to Arthur for his closing remarks. Please, Mr. Arthur, you may proceed.

Artur Schunck, CFO

Before we end the call, I want to address a recent change within our Investor Relations team. Eric Oliveira has accepted a new role in the company, where he will lead a team focused on banking growth initiatives—an integral part of our strategy. We extend our gratitude to Eric for his invaluable contributions during his tenure in IR, marked by enhanced communication and engagement with our investor community. In this light, I am pleased to announce that Gustavo Sechin joins our team on Aug 26th as the new Head of Investor Relations, ESG, Market Intelligence, and Economy. Gustavo brings extensive experience related to finance and investor relations. I have confidence in Gustavo's capacity to uphold our commitment to transparency and effective communication. Eric and Gustavo will work hand-in-hand to ensure a smooth transition. We appreciate everyone’s participation in our second quarter 2024 earnings call and look forward to connecting in our next call.

Operator, Operator

This concludes PagSeguro Digital’s conference call. We thank you for your participation, and wish you a very good evening.