StoneCo Ltd. Q3 FY2020 Earnings Call

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the StoneCo Third Quarter 2020 Earnings Conference Call. By now, everyone should have access to our earnings release. The company also posted a presentation to go along with this call. All material can be found at www.stone.co on the Investor Relations section. Throughout this conference call, the company will be presenting non-IFRS financial information, including adjusted net income and adjusted free cash flow. These are important financial measures for the company but are not financial measures as defined by IFRS. Reconciliation of the company's non-IFRS financial information to the IFRS financial information appears in today's press release. Finally, before we begin our formal remarks, I would like to remind everyone that today's discussion might include forward-looking statements. These forward-looking statements are not guarantees of future performance, and therefore, you should not put undue reliance on them. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from the company's expectations. Please refer to the forward-looking statements disclosure in the company's earnings press release. In addition, many of the risks regarding the business are disclosed in the company's Form 20-F filed with the Securities and Exchange Commission, which is available at www.sec.gov. Please note this event is being recorded. I would now like to turn the conference over to your host, Rafael Martins, Investor Relations Executive Officer at Stone. Please proceed.

Thank you, operator, and good evening, everyone. Joining us here today, we have Thiago Piau, our CEO; Lia Matos, our COO and Chief Strategy Officer; and Marcelo Baldin, our CFO. On today's call, we will present our operational and financial results for the third quarter 2020 and will be available for Q&A after our prepared remarks. I will pass it over to Thiago, so he can share with you the main highlights of our performance and discuss the strategic direction we are heading to. Thiago?

Thank you, Rafael, and thank you all for joining us today. Let me quickly share some thoughts here before we start this presentation. First, I would like to say that I'm very proud of our team that was able to adapt quickly to this new reality brought by the COVID-19 outbreak, never losing focus on the most important thing for us: our clients, our people, and our results. This was the toughest quarter ever in terms of execution, and I think that the team should try that again. We have an amazing work, both in terms of organic execution and strategic evolution. We run our business based on our strong culture with a team of entrepreneurs who aim to change our clients' reality with better products and superior services. By having focus in a clear strategic direction, giving autonomy to this big pool of talents in whom we trust and implementing a robust management system focused on technology and execution, we were able to post a strong result in our core business, while seeing powerful traction of new initiatives, such as banking, credit, software, and phones. These areas, which are currently in different maturity stages in terms of their roadmap, enhanced their ecosystem and are already contributing to our results. In fact, in the past three months, total payment volume (TPV) growth accelerated more than 113% with strong net addition of clients and advancements on the penetration of new solutions, resulting in record TPV revenue and adjusted net income for a single quarter in our history. Even though we are happy with our growth trajectory, we think that we are still far from our potential, and therefore, we will keep investing heavily in technology, team development, and channel distribution, as we see ourselves in the early days for business. We will keep running our business with a young, fast, and small company mentality where we are passionate about customers and obsessive about details. Even though we already have some scale, we will continue bearing operational leverage. This brings capital allocation and people development. Now moving to the presentation, I would like to start on Page 3 with some highlights. As we indicated in the last earnings call, the client base had a strong bounce back, with more than 63,000 clients being added in the quarter, a number 26% higher than first quarter '20. Our strong performance across segments led to a record TPV growth in the quarter, with nearly BRL70 billion being processed by Stone, representing 114% annual growth. This includes over BRL20 billion in Coronavoucher, the government's temporary financial aid to mitigate the impact of COVID-19, which we processed mainly through our Fintech-as-a-Service strategy. When we exclude the Coronavoucher volumes, TPV growth accelerated posting 48% in the quarter and 52% in September, taking us back to the pre-COVID growth levels. This strong volume was followed by a substantial monetization; we've been increasing quarter-over-quarter take rate of 1.76%, when we exclude the direct impact of the Coronavouchers and 1.30% for the reported take rate. The combination of high volumes with healthy take rates generated a record total revenue and income of BRL934 million, representing a 46% growth when we exclude other financial income, which is mainly used on cash. Aiming to balance our long-term growth and profitability, we increased investments in the quarter while experiencing operating leverage with our adjusted net margins back to pre-COVID levels at nearly 31%, generating nearly BRL288 million in adjusted net income. Our brick-and-mortar small and medium-sized business (SMB) operation posted a sharp recovery with TPV growing 48% against the previous quarter, and a strong penetration of additional financial solutions. We are quickly advancing in creating our complete financial platform to replace our clients' traditional banking relationships. In September, we reached more than 357,000 digital accounts, a 44% growth against last quarter. We also celebrated an important milestone in our credit product, which reached more than BRL1 billion in total outstanding balance, counting on healthy return on assets (ROA) and controlled delinquency rates. As we mentioned in the first quarter '20 earnings call, we are very well positioned to help our clients with the digitization trend, which accelerated this year. Our online TPV growth jumped to 575% this quarter, with a combination of strong cohort economics from the digital SMB, and our Fintech-as-a-Service platform, which counted with a tailwind from Coronavoucher. On the software front, we reached more than 340,000 subscribed clients in the quarter with over 20% organic growth against last quarter. In addition to that, in October we invested in Questor, an ERP for accounting offices and SMBs, which brings around 6,000 clients to our base and expands our ecosystem with ERP accounting capabilities. Regarding the Linx acquisition, Linx shareholders' meeting to vote on our transaction is scheduled for November 17th, and we're very confident we have the best proposal, bringing the best outcome for Linx clients, teams, and shareholders. So, our solution for micro merchants increased its client base nearly 85% quarter-over-quarter, reaching 65,000 clients. It is important to remember here that we are reporting Stone's client base separately, and these clients are not accounted for in our active client base of 583,000 clients in acquiring. We are increasing investments in this new venture, aiming to have a complete platform to meet the needs of these specific clients. We have an outstanding service level backed by technology and self-service. With the strong growth pace in our core business and the accelerated ramp-up of our new solutions, we are continuing our higher activity in fourth quarter 2020, strengthening our team in several areas, including sales and technology. For that, we are happy to count with the best talent brought by over 100,000 applications for the Recruta program this year, our largest recruiting process, which aims to find the best talent in Brazil to work in different areas of the company. Now let's move to Page 4. We are building three highly synergistic platforms under the StoneCo umbrella. The first is a financial platform for SMBs, which we are building with the hub, our ABC platform and our incredible customer service. Here, we aim to replace merchants' existing relationships with their banks, offering a full financial services platform with local presence, the best customer service and an amazing user experience. The second is a Fintech-as-a-Service platform, where everything we offer for SMBs is a product that we offer as a service in an open platform with simple APIs to digital clients, large accounts, marketplaces, wallets, sub-acquirers, and software partners. The third is the new strategic front, where we are building a full commerce platform available to merchants of all sizes, both for traditional retailers in the offline world who want to digitize their businesses and for digital-native players who want to quickly scale their businesses based on our software platform. We believe that investment in Linx is the best foot forward in digital assets. Although we see a lot of synergy between the platforms, they will have full independence, with merchants able to use them separately, integrated with third-party partners if they want, or to choose our combined solutions with a better value proposition. As shown on Page 5, the company posted a V-shaped recovery in the third quarter, driven by continuing economic recovery and strong execution. Our overall TPV grew almost 114%, and even excluding Coronavoucher's direct impact, we had higher growth levels than in the first quarter of the year. Also when we exclude Coronavouchers' impact, we see growth accelerating every month since April from 9% to more than 52% in September. This robust growth is reflected in our record quarterly total revenue and income and adjusted net income, with margins bouncing back to the 31% level that enabled us to continue to invest heavily in growth. Now with that said, I'll pass it over to Lia, so she can discuss our strategic evolution and key priorities. Lia?

Thanks, Thiago, and good evening, everyone. Thanks for joining us today. Let me start with the evolution of our financial platform for SMBs on Page 6. Our client base is back to a healthy growth level, even excluding TON, with 26% more net adds when compared to the first quarter of 2020. Looking at TPV, our growth was not only higher than in the first quarter, but also accelerated every month from April to September when it reached 52%. As Thiago mentioned, we continue to foster a long-term relationship with our brick and mortar SMB clients, helping them to manage their business and sell more. For that, we recently began to scale our new financial solutions. The graph on the right side of the page shows that the percentage of clients using more than payments jumped from 12% in January to 27% in September, either by taking credit, being inactive users of our digital banking account, or both. The successful penetration of new solutions is driving a positive impact on monetization. And despite the COVID effects, we are seeing take rates in the hubs going up again. We see plenty of opportunities to upsell our new solutions to SMB clients by offering the best customer service and simple intuitive product at fair prices. As we show on Page 7, a huge step forward in this direction will be the full launch of our ABC platform in the fourth quarter, when we expect to migrate all our SMB clients to the platform. With this, our clients will have access to a comprehensive set of financial services through a single integrated experience, including all payment methods, prepayments, credit, wire transfers, boleto issuance and bill payments, pre-paid cards, payment links and a virtual shop. We will also enable our clients to accept fixed transactions directly on the POS, using a dynamic QR code, bringing more security and convenience to retailers. Moving to Page 8, we show our banking platform's fast ramp-up with the number of digital accounts jumping to 367,000 clients, nearly three times more than in the first quarter, including over 88,000 merchants receiving their sales directly into a Stone digital account. In addition, due to a combination of the high engagement of digital banking clients and the initial strong traction of our Fintech-as-a-Service platform, the number of transactions increased eight-fold, with revenues jumping approximately 370% in the quarter when compared to the second quarter. Slide 9 shows the evolution of our credit solution, which achieved a significant milestone last quarter, surpassing over BRL1 billion in total outstanding volume. More than 73,000 merchants now use these working capital loans, which they seamlessly pay by deducting a small percentage of their sales every day. Our product remains fairly conservative with a small duration of seven months and an average ticket for new loans of BRL19,000, the equivalent of roughly a month of their TPV. We remain very focused on balancing risk and profitability, which is reflected in our relatively stable ROA and lower expected losses despite the COVID impact. We see a huge opportunity ahead of us, and we will leverage our distribution and proprietary credit scoring model to continue to serve merchants with our working capital solutions. Also, as we have already indicated, in the coming months, this operation will start to be funded with third-party capital through FIDC structure, which will allow us to limit our credit exposure while maintaining good economics. Moving on to Page 10, we show the traction of our TON initiative, our new venture to serve micro merchants and autonomous workers. In the third quarter, we re-accelerated investments in marketing campaigns for the product and we saw the client base grow nearly 85% quarter-over-quarter, reaching 65,000 clients at the end of September. The compound monthly growth rate for TPV from April to September was 40%, which shows the product's strong initial traction. Now I want to talk a little bit about the evolution of our Fintech-as-a-Service. In Page 11, we illustrate the current and future capabilities of our platform and how we serve different types of clients offering financial services according to their business model needs. First, let's talk about the digital SMB. Here, we enable payments as a feature embedded in commerce platform. With a very easy setup, clients can start selling with complete abstraction of the complexity of managing online payments. Secondly, we serve more digitally mature merchants that look for increased conversion rates through direct integration with our platform and need the ability to customize the functionalities according to their needs. Through our APIs, it is easy for them to connect and access the features of our platform such as authorization retrial, split payments, pre-payments, chargeback disputes, reconciliations, anti-fraud, and analytics. The combination of the capabilities of our platform enables such large clients to greatly streamline the way they manage their financial service operations, improving their productivity. Lastly, we enable tech companies such as marketplaces, sub-acquirers, wallets, and Fintechs in general, to provide financial services to their own clients as part of their product offerings in a white label manner, such as branded POS devices, or white label digital account prepayment services to their clients, among other services, which can all be achieved through simple API integration. The capabilities of our platform result in improved conversion rates, high availability, and a complete suite of services which simply lead to an increase in our client sales and success. We continue to work hard evolving our platform to serve the evolving needs of our clients. On Page 12, we show some highlights of the results of our Fintech-as-a-Service business. Our online TPV jumped nearly 575% in the quarter, growing four times more than the previous quarter. There was a powerful contribution from Coronavoucher volumes processed through a platform for different integrated partners, such as wallets and sub-acquirers. However, even excluding the government programs' impact, volumes grew about 76% in the quarter, four times more than the growth experienced in the first quarter of 2020. As we have just indicated, our digital solutions are not exclusive for large or more digitally mature players. Our platform also offers simple features to connect small e-commerce, social sellers, and brick-and-mortar SMB clients to the digital world. As a graph on the right side of the page shows, our digital SMB cohorts represent high revenue retention, which speaks to the power of our business model, allowing us to grow as our clients grow and mature. On Page 13, we show our evolution in software. As you can see, in the third quarter we had strong fully organic growth in our software client base, which we increased more than 20% when compared to the previous quarter, reaching over 340,000 subscribed clients. We remain focused on helping our merchants digitalize their business. For instance, the number of posts in our social media management solution and labs grew more than 160% in just one year, reaching over 50 billion post impressions on the platform per month. Lastly, on top of the organic growth, we're happy to welcome a new company to our ecosystem, bringing new solutions and more entrepreneurs. Questor is an ERP for accounting offices in SMBs. Their accounting clients serve more than 450,000 businesses across the whole country and process 1.5 million individual paychecks monthly. With this strategic update, I will pass it over to Rafael, who will discuss our financial results in detail. Rafa?

Thank you, Lia. Starting with Slide 14, we present our topline evolution in the quarter. We reached 583,000 clients excluding TON, mainly due to the strong performance in the hubs. With our bricks-and-mortar SMB operations showing promising trends and additional investments to grow, we do expect to keep a strong net addition of clients at the end of the year, despite the seasonal effects accelerating into 2021. Our TPV grew 114% in the third quarter of 2020 compared to last year, reaching BRL69.7 billion. There is a significant contribution of BRL21.6 billion here from Coronavoucher volumes. Coronavoucher is a government financial aid program targeting the most vulnerable part of the population, such as autonomous and informal workers and people without income. Those individuals receive the amounts in a prepaid card, and many of them use the cards to transfer money to different digital wallets and to buy goods. When those digital wallets use Stone's Fintech-as-a-Service platform to process the cash in transactions, we capture the related TPV. If we consider only volumes apart from Coronavoucher, TPV was BRL48.1 billion in the quarter, nearly 20% higher than our highest historical quarterly TPV, which had been reached in the fourth quarter of 2019, a seasonally stronger quarter. Total Revenue and income was BRL934 million in the third quarter, a 39% increase year-on-year. Excluding other financial income, which mainly comprises interest on cash, total revenue and income grew 45.5% year-over-year. As shown in Slide 16, the massive TPV brought by the Coronavouchers led to a reported take rate of 1.3% in the quarter. However, the take rate in the hubs continued to increase, contributing an additional 4 basis points in the take rate this quarter, resulting in a 1.76% take rate excluding the effect of Coronavoucher volumes, a 2 basis points increase from last quarter's comparable metric. Moving to Slide 16, we show our consolidated P&L and on Slide 17, the evolution of our operating leverage and profitability. This quarter we experienced a significant increase in operating leverage, reaching record adjusted net income of BRL287.9 million. In addition to the usual adjustments in net income related mainly to the share-based compensation program launched at the IPO, this quarter we included a BRL13.5 million effect related to Linx M&A expenses and present value adjustments related to the earn-out of companies we have invested in. Our operating costs and expenses decreased by nearly 12 percentage points from last quarter, representing 48.6% of our total revenue and income. Financial expenses declined from 9.4% to 6.9% of the revenue and income, mainly as a result of the lower base interest rate and higher efficiency. This combination resulted in a sharp increase in our adjusted net margin, which went from 22.5% last quarter to 30.8% this quarter, and our adjusted pre-tax margin, which recovered from 29.9% in the previous quarter to 45.2% this quarter. Now going over in more detail to each P&L item, our cost of services reached BRL208.1 million or 22.3% of total revenue and income in the quarter, increasing 5.5 percentage points when compared to last year. The increase was mainly due to higher provisions in losses, which do not include provisions for delinquency related to our credit product, significant investments in technology and customer service, higher card-bearing fees, and variable compensation. Compared to the previous quarter, cost of services as a percentage of revenue decreased 7.5 percentage points, primarily because of lower depreciation expenses due to a change in the POS depreciation period from three years with a residual value of 30% to five years with no residual value, lower provisions and losses, gains of scale in transaction costs and lower brand fee. Administrative expenses were BRL106.2 million or 11.4% of total revenue and income, 0.8 percentage points higher than the prior year period, mostly due to higher third-party services and higher personnel expenses. Selling expenses were BRL139.5 million in the quarter, an increase of 37.3% versus last year, mainly due to higher investments in TON and variable compensation. Compared to last quarter, the line showed 2.2 percentage points of operating leverage, mostly explained by a lower average number of salespeople and severance costs accounted for in the second quarter of 2020, which were partially compensated by higher marketing investments. Financial expenses were BRL64.7 million, a decrease of 36.1% compared to the third quarter of 2019, mainly due to the lower CDI rate, which more than compensated for the significantly higher volumes in the quarter. Finally, on Slide 18, we show our adjusted free cash flow, which was BRL288.6 million in the third quarter, or 7 times our third quarter '19 figure, mainly driven by a higher adjusted net income and better working capital. With that said, operator, please open the call for questions.

At this time, we're going to open it up for questions. Our first question comes from Tito Labarta with Goldman Sachs. Please go ahead.

Hi, good evening. Thank you for the call. A couple of questions. I guess first on the Linx just to get the latest update. And I heard this morning that you eliminated the breakup fee and you increased the bid a little bit. If you can just tell us the kind of the rationale for that and kind of what's the latest that you're hearing from CADE? Do you still expect to hear from them in November? And then on the second question, very strong growth on the TPV, obviously. But how do we think about that TPV, I guess once the Coronavoucher goes away? So should we think of it sort of excluding that, like when does that go away? Do you think that after 4Q then TPV should decline back to ex-Coronavoucher levels? And following up on that, if we think about the margin expansion we saw this quarter, like how much of that was related to the Coronavoucher linkage? Without the Coronavoucher, what would your net margin have been like? Thank you.

Hi Tito. Thiago here. Thank you very much for your question. So I will start here with the Linx update. So as you said, with the two updates this morning, working together with the board of Linx and independent board members of Linx, we decided to waive the breakup fee in the shareholder meeting that will take place on November 17th, and increase the deal by $0.50. The main reason here is that, although we know that the breakup fees are valid in legal instruments, and we have discussed proactively with CADE about this. We saw the opinions of P3, which is the regulator of the Brazilian market, about the CADE rules. We respect the opinion of P3 and decided to waive all the fines related to the shareholder meeting of November 17th. We think that this will be very well received from Linx shareholders. And regarding the bids, we think that we already had many discussions about the process. Now we would like to turn our focus into clients, the team, and the roadmap of technology and projects that we have to create. In that sense, we decided to give an incentive for the meeting to take place on November 17th. We want to ensure that we have the best proposal on the table for both clients and shareholders. So we are very confident to conclude the process and focus on product, technology, and team. Regarding growth, it's difficult to talk about COVID volume, Tito, because mainly here we're dependent on the government's ability to provide Coronavoucher for the population. We noticed that the volumes of Coronavoucher will decrease from BRL600 to BRL300 for the fourth quarter. We still depend on the share of wallet of our integrated partners inside the Coronavoucher volume. It's very difficult to state what the volumes will be, but we still expect growth in TPV excluding Coronavoucher volumes for the fourth quarter. We're very happy with the growth levers that we have. We will continue to invest heavily on growth in the hubs and in the Fintech-as-a-Service platform that we have built. I think that regarding margin expansion, I will pass it over to Rafael.

Hi, Tito, Rafael here. Thank you for the question. So when we look at the Coronavoucher volumes that we had in the third quarter, it’s accretive for our revenue and it's positive for our P&L. It's not a big amount. When we look to the fourth quarter, you'll have an effect of - in the third quarter, we still have some effect of COVID because some lower sales were accompanying the hubs versus what they could be. In the fourth quarter, you should have less of the Coronavoucher volumes but also more recovery from COVID. So we don’t see our margins being impacted because of lower Coronavoucher volumes. In the short term, they shouldn’t change much. That’s what we're seeing here in internal margins.

Thanks, Thiago and Rafael. I have two quick follow-ups. Regarding the Linx matter and the ruling from CADE, do you anticipate that happening in November? Also, about the margin, should we consider your net margin as a recurring margin moving forward, with potential for upside as you continue to grow?

Hey, Tito, Thiago here back again. I think regarding Linx, we have to wait for the analysis of CADE. We are not worried about the analysis of CADE because we think that we have a complementary solution with financial products and software that will increase the value proposition for clients. As we said, our platform will always operate independently, and the client has the ability to choose which partners they want to use integrated. We do not expect an impact from the CADE analysis of the deal. I think that the deal is accretive for clients and will be very well received for everyone. I think that this process should take around three to four months. That's the timeline that we are working with here. During this period, we will be planning the integration and all the projects that we can create together, respecting the rules and guidance of CADE. Regarding margins, Tito, we like this level of margins that we have. But we are always pursuing better avenues of growth in which we can deploy our capital in terms of OpEx and CapEx. If we see a way to increase growth and if we have to give away some margins to increase growth, we will certainly do it. We have our minds focused on growth. We think that our opportunities ahead are very big, both in terms of the whole financial platform and the Fintech-as-a-Service in the software one. We think that we have healthy levels of margins. We always talked about around 30% margins. But once we have a new avenue of growth that we can deploy more energy, we will gladly do it.

All right. Perfect. Thank you, Thiago. Very helpful.

Our next question comes from Craig Maurer with Autonomous Research. Please go ahead.

Yes. Thanks for taking the questions. First, could you repeat quickly the number that you gave regarding Coronavoucher expectations for the fourth quarter in terms of TPV? Secondly, I assume you're wrapping up the work on your FIDC funding structure for credit. And we know that the credit opportunity is more than Forex than in terms of revenue of the acquiring business. So how quickly do you think you can attack the SMB market, displacing the bank creditors that are already in place with those merchants? Thanks.

Hi, Craig. Thiago here. Thank you for the great questions. About the Coronavoucher number that I just said. In the third quarter, the amount that the government gives to the population was BRL600 per elected person, and now, this amount is BRL300. So that's the change that happened in the government's financial aid. About the public structure and how fast we can grow in credit, you are looking in the right direction. The reason why we are accelerating our process of selling the credit outstanding balance to third-party capital is to increase the speed in which we penetrate credit in the SMB operation. We are in the final stages of this process here, both with our own outstanding credit balance and the process of raising capital with the BNDES as we talked about. We seek to raise around BRL900 million in the next month to give additional volume to credit that we will deploy over time. We will be very aggressive and fast in scaling the credit product because this creates a lot of value for our clients. The feedback that we are receiving from the clients is very good. We will increase the speed in which we can penetrate credit in our client base.

Thank you.

Our next question comes from Mariana Taddeo with UBS. Please go ahead.

Hello, good evening, everyone. Congrats on the results. My question is on the pace of net adds that was quite strong this quarter. Could you share with us the main reasons for that? Have you resumed the hub opening? Or has it been a reflection of increased productivity with salespeople returning to the hubs? How is the competitive pressure in the SME segment? Can we expect you to keep the same pace in the coming quarters? Thank you.

Hello, Mariana. Thiago here. Thank you for the question. Regarding the pace of net adds, there are two factors here. One is that we are improving productivity in the hubs as we said. During the COVID outbreak, we learned how to improve productivity by changing processes and investing more in our technology operations. Now we have a better team and a better operation, allowing for better productivity levels in our sales force. We are back at the hiring process, so we are hiring our team as we can. We are now further penetrating people in the hubs that we already have. We have more operational leverage in terms of our growth. The big surprise was the control in terms of churn that we have this quarter, with decreased churn levels considerably when we compare this quarter against the last quarter. These two combined effects give us the strong net adds. We expect net adds to work as you can see in last year; in the third and fourth quarters, we have kind of the same level of net adds. So we expect to keep this trend because of the seasonality that happens in the fourth quarter. But we will grow aggressively the net add space throughout 2021 as was the plan for 2020. So we still have a lot of room to grow net adds. We think that next year, we will be able to increase our sales force around 60% or more. So we are deploying capital and energy to grow our hub operation as much as we can. Brazil still has a lot of room to grow in our own distribution. So in 2021, I think that we will have great results in terms of increasing the pace of net adds.

That's clear. Thank you.

Thank you, Mariana. I'll just take the second question actually that you made about the competitive pressure. We are not seeing competitive pressure being harder than it was before. I think that now the market is much more stable in terms of competition and prices. We are not facing the level of competitive pressure that we had in the fourth quarter of last year and the first part of this year. The market is much more rational and stable, so we are not seeing any additional pressure in terms of competition.

Our next question comes from Rayna Kumar with Evercore ISI. Please go ahead.

Hi, this is Josh Siegler calling on behalf of Rayna Kumar. Thanks for taking my call. So I know you guys have talked in the past about the synergy possibilities with Linx. Are there any immediate or near-term synergies you hope to generate? And if so, can you provide some color on these opportunities?

Hi, Josh. Lia here. Thank you for the question. As we've mentioned before, this is really a scope transaction. So we see a lot of strategic complementarity in this acquisition. We see three value generation avenues. The first one is our ability to penetrate the base of Linx clients with financial services, mainly acquiring and transaction banking services by integrating with our Fintech-as-a-Service platform. The second is really to combine Linx's powerful set of digital assets with our Fintech-as-a-Service platform to offer the ability of Linx clients to go digital and have this real omnichannel experience by being able to sell not only in the physical store but also in digital channels, such as marketplaces, their own commerce websites, or social commerce. The third value generation avenue is what we think is a bit more long-term, which is our ability to streamline and simplify the solutions that Linx has developed for different verticals and bring those down to SMBs. We aim to develop this powerful distribution model for SMBs in software, built upon the same concepts that we did with hub distribution. So I think those are the three value creation avenues. Of course, the first one is more of a shorter-term time horizon. The second and third are more medium to long-term time horizons.

Great. Thank you very much. And can you help us quantify the negative impact on take rate in 4Q from Coronavoucher and the seasonally debit-heavy mix?

Hi, Josh. Rafael here. Yes, we have shown in our presentation, the effect on Slide 16. It was around 46 basis points of negative impact from Coronavoucher volumes. You had a smaller debit mix effect when you look at a debit mix, which is 2 basis points. And we have a 4 basis points positive impact from the increase in take rates from the hubs. So that's the effect we aimed to break down because of the magnitude of it; so analysts and investors can understand the logic between the two volumes.

Great, thank you. And finally, given that your marketing has become more efficient over time, do you plan on expanding that marketing in 4Q?

Yes. So, what we did is we started investing in marketing again after we launched the solution on March 1st, and then we had to step back a little bit because of COVID impacts. We resumed those investments in marketing. We are doing this very carefully in different phases. But we are increasing slightly the marketing investments as we have the unit economics improving, and we learn the customer acquisition cost (CAC) equation of that market. As you can see, the solution is gaining more and more traction. And as it gains more traction and we see the unit economics working well, we will invest more in marketing expenses.

Great. Thank you very much.

Thank you.

Our next question comes from Jamie Friedman with Susquehanna. Please go ahead.

Hi, thank you. Congratulations on the results. I just want to ask my two upfront, they're both in reference to the slide deck. So Lia, on Slide 7, you had discussed the broader rollout of the dashboard and platform. I'm just wondering, what do you anticipate is the potential penetration for that? You used to give a metric about I think the number of cross-sells or the number of products that each client took. So, is this part of that? That's the first one that's Slide 7? And then on Slide 15, I can't - so maybe for Rafael, why is it that the Coronavoucher is diluted to the margin? Is that just a zero take rate, like a gateway type product? So, the first on Slide 7, the second on Slide 15. Thank you.

Sure. Hi, Jamie, let me take the ABC question, and then Rafael will take the next one. So, regarding the launch of our ABC platform, as we've said before, we started this year piloting this integrated solution. The way to think about this is the following: once a client is onboarded onto the platform, there is a whole set of features and functionalities that the clients can choose to use. We have worked very hard to ensure that the solution is well-fit for the clients and that they like it and use it. The onboarding and operational process is seamless, and we are ready for that rollout. Which is why we are on track to fully deploy the ABC platform to all clients in the fourth quarter. What this means is we will migrate all of our clients in the hubs to this platform. All new clients that we onboard into Stone will already be onboarded onto the platform. We have disclosed this number of the penetration, where those clients use a combination of those solutions within the ABC platform. Of course, once a client is onboarded, they can choose if they want to use just banking, acquiring, or both banking and acquiring with credits. Over time, we work hard to also upsell solutions to the same client. So, that's kind of how to think about penetration. Over time, we will penetrate the number of features that clients use within the platform. We will make sure that 100% of our clients are onboarded onto that platform.

Lia, just to complement on that, there's great bridge information here that we are already seeing in the clients that are using our payment solution and then settling transactions into their Stone bank accounts. They use the prepaid card as a cash-out method; they pay some bills and do some wire transfers through the platform. When they use the whole cycle or the product for the payments, the bank account, to the credit card, and paying some bills, we now see a little bit more than two times take rates on those clients when you compare to clients that use only the regular payment solutions. It’s incredible to see how they become stickier as the churn decreases on the use of all the solutions and the credit solution too. We also see the NPS going up and take rates a little bit more than double on those clients versus only on the banking platform. So that’s a big win-win for us, and we are very happy to see these dynamics.

Hi, Jamie, Rafael here. Regarding the second part of your question on Slide 16. So the Coronavoucher volumes resemble more of debit volumes. The take rate here is lower than debit because most of those volumes come through partners in our Fintech-as-a-Service platform. Since they are larger partners, usually the take rate is lower. But those volumes are accretive for us in both our bottom and top line. That’s an interesting demonstration of how our Fintech-as-a-Service platform can work and deal with big volumes but, despite lower take rates, it's accretive in dollar amounts for the company.

Just to complement. So Coronavoucher is not a gateway type of transaction—it's an acquiring type of transaction. The economics are comparable to the debit economic, which is why it dilutes a little bit on the take rate. But it's very accretive for us. It's important to highlight that we only disclose TPV of the acquiring product. We have more TPV because we have the gateways, but all TPV that we are seeing here is all acquiring TPV.

Got it. Thank you all.

Thank you, Jamie.

Our next question comes from Jeff Cantwell with Guggenheim Securities, please go ahead.

Thanks for taking my question. This is a very thorough presentation. It also gave us a lot of detail on your prepared remarks today. So thank you for that as well. Just want to circle back. Can you tell us about what you saw in terms of your net adds this quarter? It seems like the pace of recovery has stopped very quickly for you. Maybe could you comment a little more on that? And tell us about what's driving that? Maybe which industry those adds are coming from? Is it specific to an industry or is it more broad-based across many industry verticals? And then also, can you help us think about how sustainable net adds are going forward? Any color there would be great. It seems like you have 60% of your hubs personnel back right now. So just curious about the timing, when you think that can get back to 100%? And thinking about how that might impact the number of net add comparisons? So appreciate any comments there. Thanks so much.

Hello, Jeff, Thiago here. So regarding net adds, we have really two effects here that are driving this pace of net adds; increasing productivity and decreasing churn levels. That’s why we have this level. We now have 60%, as we said, of the hub personnel back on the streets around Brazil. We are not concentrated in any specific industry with net adds coming from the whole regions we are present across Brazil. We expect that by the end of this year, specifically in the fourth quarter, we will be back at the peak in terms of the number of people in our sales force that we had prior to the COVID effect. We will grow our hub team throughout 2021 rapidly. I said we expect at least a 60% increase in personnel compared to the current number, with the same powerful economics that we have. It’s interesting to see that as we deploy more energy and capital in growing the hubs, we maintain the same level of cost of acquisition and lifetime value for the clients. We seek to drive lifetime value up once we penetrate credit, banking, prepaid cards, and the whole solution of the ABC platform that we are now rolling out. We expect to have 100% of our clients rolled out to this new solution by the end of the fourth quarter. Therefore, we expect to increase considerably the pace of net adds throughout 2021. That's where we are directing the company and putting the energy here.

Okay, great. I appreciate all the color there. I appreciate all your disclosures on Fintech-as-a-Service. Can you maybe help us understand how to start a new merchant platform and help us understand what those economics look like? Perhaps there are more durable customers adding here. What types of products are they interested in? Meaning, are those ABC customers? I just wanted to understand how that piece of the strategy is enhancing the mix or enhancing the revenue opportunity that you have as a company? Thanks very much.

So, Jeff, I'm going to start here by talking a little bit about how we see the Fintech-as-a-Service strategy. First, as we disclosed a little bit in the presentation, we explained how we serve clients. The behavior of those clients on the platform is that when we talk about the SMB, they need a very streamlined way to accept payments in their e-commerce operations. And our platform provides that. When you saw the cohorts that we displayed, as we onboard clients and they mature in their digital operations, we grow as our clients grow. That’s why we see such powerful cohort economics. When we talk about larger clients, we're speaking more about the capabilities of the platform to serve their business model needs. We see two main ways to address this opportunity. First, is that digitization trend, which was greatly accelerated due to COVID. We don't think it's a COVID specific effect. We think COVID actually accelerated a trend that was already happening in Brazil. More consumers are looking to buy online, and as consumers are looking to buy online, more different players will want to establish their own operations. Merchants will want to sell not only in the physical store but also in online channels including marketplaces and social commerce as well. This trend will continue strongly. Secondly, beyond retail itself, we see the trend of many different business models embedding the Fintech strategy into their strategy as a strong opportunity ahead of us. Not only retailers looking to go beyond the physical store, but digitally native retailers establishing their digital operations. There are many different business models wanting to embed financial services into their offerings, and we see these two strong trends continuing, for which we're very excited. When you think about the economics, overall take rates for SMB clients are generally higher because you see a greater relevance of credit volumes and also installments and higher duration.

Lia, can I give my two cents here?

Sure.

Regarding the SMBs, in terms of distribution channels, we have three avenues here. We have our lead generation that brings clients to our inbound team who close the sale by phone. It's a direct distribution. We have a self-service site that goes to our website because the brand is recognized in Brazil, and they can take the product and a service mentality. We also have partnerships with e-commerce platforms that help us distribute our financial solutions to their client base. We have several partnerships with e-commerce platforms in Brazil. In the SMB market, what's interesting is that this online SMB sector is growing a lot. More digital-native clients are starting here. Those clients show powerful unit economics because, as time goes by, they generate more revenue per client as they grow, and we grow alongside with them. The take rates in the digital space are bigger than those in the hubs, so that creates a very promising future. We’re even starting to offer credit products to the SMB clients in the digital space right now, so we are piloting that. We observe the economics of credit among our digital SMB clients, and we expect to roll out the credit solution for them soon. As for the larger integrated partners and wallets and marketplaces, there remains a very big potential because we built a solution based on modules. They have many types of features that they use to increase conversion rates, manage charge back disputes, offer anti-fraud solutions, and so on. I think by the credibility we have built with our partners, they now trust us to use our banking as a service. So we can help them with white label accounts to allow them to offer wire payments and transactions to their clients in a white label fashion. I believe we will soon be able to offer credit as a service to them, including credit scoring and collections among other functionalities that helped us achieve strong tech economics in the hub. We really believe in the growth avenue of the Fintech as a service strategy. We decided to integrate our gateway PSP and core platforms into one single team, making our solution even stronger, and the market is growing very fast because of the COVID trend and digitalization in Brazil. We’re very excited about this opportunity.

Okay, that's great. Thanks very much. And congrats on the results.

Thank you, Jeff.

Our next question comes from Mario Pierry with Bank of America. Please go ahead.

Hello, everybody. Congratulations on your results. I have two questions. The first one is on TON. You're showing very strong growth, but I was wondering if you are planning on providing financials for us on TON anytime soon? When do you expect TON to breakeven, just so that we can monitor how the performance has been going right? Because the growth seems very good, but I was just wondering how TON is performing based on your expectations? My second question is related to all the regulatory changes taking place in Brazil. States become operational now in November. We have the receivables platform as well. Can you just remind us of your expectations from all these regulatory changes and how they should be impacting your business? Thank you.

Hi, Mario, Rafael here. Thank you for the question. Yes, as I mentioned, TON is getting more traction now. I think it’s still very small compared to the overall size of the company. When it gets more representative, we will provide more details or breakdown. Just a reminder here that TON is contributing negatively to the bottom line at this moment; we do have investments in that solution in our P&L. Still very small; we have 65,000 active clients in the third quarter. Of course, the average TPV here is much smaller than the SMB space, as you can see from other players in the market. So, as it gets more relevant, we will provide more detail. Regarding your second question, Lia will take it. So Lia, thank you.

Hi, Mario. Starting with the registered receivables and then I'll talk a little bit about Pics. As we've said before, we see this regulatory evolution as a vast opportunity for us in terms of addressable markets for prepayment and credit. We will be able to offer our clients prepayment and credit based on their full receivables agenda. In terms of our business model and how we plan to capture this opportunity, I think there are two things. First, we believe that owning distribution will be a significant differentiating factor because once we obtain our clients' consent, be it through our customer relationship team, our distribution team, or even digitally through the platform, we can offer them these products in the same way that we do today but with a much higher addressable market. Our product is ready for that, our business model is really fit for this opportunity. Operationally speaking, we don't know yet, but the expectation is that it will go live soon on November 3. We will be ready once it goes live on that date. Our team is working very hard and we are fully ready for that go live. Talking a little bit about Pics, I think we see three main use cases. The first is to substitute wire transfers. The second is as an alternative to debit transaction. The third is as an alternative to collateral. When Pics goes live, it's more likely to substitute use cases regarding wire transfers and debit transactions. We see this opportunity in two main ways. When you look at our SMB clients, we will enable our clients to accept Pics as a payment method directly on their POS machines through our dynamic QR code, which greatly improves transaction security. This will be a very simple and streamlined process: with a simple setup, within minutes in the POS machine, clients can be ready to accept payments. Pics will be reconciled as a payment method just like we do with credit, debit, and all of the other payment methods. On the other hand, we see an opportunity in the context of our Fintech-as-a-Service strategy to offer fixed transactional services for indirect players in the market, given that we are a direct player integrated with the central bank's infrastructure. Regarding the economics, we will apply market rates, but we believe that the economics in these transactions will be preserved according to whatever the use case is. So, we believe that the economics will be preserved, and we will apply exactly whatever the market rates turn out to be.

Mario, can I add some topics here very quickly? Regarding the registered receivable, the central bank directed that everyone should be ready on November 3, right? So we're ready; we will be 100% ready for what the central bank has asked from everyone. We will see that some players may not be ready, and there is some discussion about a potential delay. Let's see. I think the registered receivable is a good opportunity for the whole society, both clients, new players, and everyone, because, at the end of the day, it makes the whole process more efficient. By having the registered receivable, we will have a better avenue for growth to provide credit for clients that still don't use our payment solution with the same level of security and non-performing loans (NPLs) that we have today. So, we’re very excited about this, and we can’t wait to see the registered receivable happening. We've made all our product offerings and our operations ready to take advantage of that. We think this is a big evolution of the industry, a big improvement in terms of how we deal with collaterals and credit based on collaterals. Regarding Pics, I think there was a question about the take rate of Pics and pricing of it. What we have in mind now is that we will simply follow the market. We will see the market price and we will use it. We will simply follow the market, but as Lia said, we have three written applications here; so, for each application of Pics, we expect zero take rates like a debit transaction. For that type of economic model, most of the margin in acquiring should be maintained with the same margin as we have had. So we will see what the average standards for pricing of the market should be. You have features for wire transfers that should be cheaper, as the SPI infrastructure provides better resources and cheaper transactions. The pricing of wire transfers should decrease. I think that you have a third application where it should closely resemble a boleto and can have a future due date, but we still have to see how it will deal with interest rates and fines that you can put as delays in payments and things like that. But this should be a boleto-like transaction. For every company that will try to work with the Central Bank, we expect the economic model to align with the industry standard; we will simply follow the pricing.

Very clear. Thank you very much.

Thank you very much.

Our next question comes from Neha Agarwala with HSBC. Please go ahead.

Hi. Congratulations on the result, and thank you for taking my question. My first question is on Linx. Today you revised some of the agreements, but the breakup fee, if the transaction does not go through as the shareholders' meeting is, is still there. Some market participants have been saying that this is somewhat high; it's about 7% of the main value. So why not reduce or completely do away with this breakup fee and make the transaction even more lucrative for the Linx shareholders, which will probably make it more difficult for them to reject your offer. Your thoughts on that would be appreciated. My second question is on revenues. Could you give us some sense of how much of your total revenue is generated from non-acquiring business? Last quarter, you gave us a sense of how much you earn from your software in terms of revenue. Any color on the non-acquiring share in your total revenue would be helpful? And last question is on churn. You mentioned that churn has reduced dramatically versus last quarter. But how is churn behaving versus last year? What is the reason for an increase or decrease in churn versus last year? Thank you so much.

Thank you, Neha. Rafael here. Regarding your first question on Linx, what we announced today is that we are waiving the breakup fee of BRL112 million in the Linx shareholders' meeting. If they do not approve the Stone transaction, Linx shareholders will have no breakup fee on that. What we’ve kept is that if there is a concurrent offer approved after that, the breakup fee is maintained. Just to remember that we believe the breakup fee that was there and is there, and the one that remains is valid and legal. We expect to spend over BRL270 million on the transaction overall, including follow-on expenses. We decided to go, as Thiago mentioned, to have the discussion on the 17th, so that Linx shareholders will have no breakup fee if they vote against our transaction. Regarding the second part of your question on revenue, we see increasing trends in terms of the penetration of new solutions, as we've shown you in the SMB, with 27% of clients using financial solutions. If we look at software, for example, we mentioned in the previous quarter that we had over BRL100 million of pro forma revenue. This means pro forma as if we owned 100% of the companies in which we invest. We don’t necessarily consolidate those, as we sometimes invest 20% to 30% stakes in those companies. If we look at financial solutions, we see increasing penetration there. We expect over the coming years that to be more and more relevant, and as it gets more relevant, we might discuss additional disclosures for you guys. Regarding your third question on churn, we saw decreasing churn both on a quarter-over-quarter and also on a year-over-year basis. Some reasons that we believe could have contributed are new solutions that have contributed to the reduction of churn, along with statistical analysis showing that this trend reduces in all the solutions, especially when they are combined. Customer service and SMB relationships remain crucial to us.

Thank you so much, Rafael. That's very helpful.

Our next question comes from Domingos Falavina with JPMorgan. Please go ahead.

Thank you. Good evening, everyone. Congratulations on the high-quality result. I had a question, I think I guess is worth counting-wise. You guys had very strong financial income results for BRL460 million booked as financial income. I haven't had the time to go through the full release in detail, so I apologize if there's data on that. But you had BRL460 million and BRL27 million in financial income. You have two operations that I'm aware of: one is the prepayment of performed sales, which there is no credit risk; and the other is the credit operation, which does vary in credit risk. I would like the breakdown of this financial income regarding how much stems from traditional prepayment and how much stems from credit related operations? If you could also explain how you manage this credit. For example, do you originate using 30% a year and set aside 5% to 7% in provisions? I'm having a hard time here looking at the asset quality of that. The last one, I'm sorry for running a little long. You mentioned you plan to securitize the loan book in a few months. How do you plan to manage credit risk? Will it be within the security? So, let’s assume you package the entire BRL1 billion. How do you plan on taking on 20% of that with 80% being the barrier for first losses? Will you have a senior bond and a junior bond to cover proportional losses? Just to understand a bit better, given the obvious concerns around asset quality nowadays.

Hi, Domingos. Rafael here. Thank you for the question. If we look at the financial income revenue line, we do have the prepayment operation and the credit revenue there. The BRL27 million you mentioned in other financial income is mainly derived from interest on cash. So, basically, the BRL460 million is those two line items contributing to the increasing credit revenue. The majority of the business is prepayment, and the prepayment is much more relevant. The credit is also helping us in the hubs to gain traction in that line. If you look at interest rates in Brazil going down year-over-year by two-thirds, we're still able to grow the financial income line. We do intend to fund credit in the future, mostly with third-party funding, as I mentioned. We have the FIDC in place that now today Stone is the only investor there. It will be a structure similar to the one we did for prepayment back in the past; Stone keeps investing in the FIDC, allowing senior quota holders to have senior quotas of that fund. We started that process just before COVID and held it back, and we believe that soon we'll have more of the third 2020 there, as Thiago mentioned. Regarding your question on credit risk, when we account for credit revenue, the revenue has already netted the expected delinquency. We factor in the credit risk of clients already, which is also reflected in our balance sheet for the credit we have booked at fair value. This already includes risks in that portfolio.

Perfect. Thank you for that. You mentioned that I didn't want to go that deep, but if I look at September, the FIDC looks like the book value at BRL4.555 billion with a fair value of BRL4.479 billion. As you're short on carrying in the other loss, is the difference between providing the credit the provision or expected loss because of the crisis? Why is the difference?

Yes. This is the liability part. The FIDC this is the part of the senior product, which we have in the balance sheet. This is like a debit-like FIDC. It's not related to the credit portfolio. So this is not related to delinquency or anything like that; this is basically the senior quota holders' part of our FIDC that we recognize as a liability in our balance sheet, just like a debt.

Just let me help you with some information here. We have two separate FIDC structures. One is the FIDC in terms of accounts receivables that we sell; we take their money and do prepayments. When you're talking about the numbers you provided about BRL4 billion, you're talking about the FIDC made for prepayments. What Rafael was saying before is regarding the FDIC structure to fund the credit, so it's a whole different FIDC. But we intend to use the same mentality in which we generate the outstanding balance, and then sell it to the market. We can’t talk too much about this, unfortunately, because we’re in a quiet period moment about this structure. Once we conclude the capital raising process, we can provide much more detail about risk profiling, a whole disruption, and everything that goes on. The main data we’ve disclosed to you regarding this is the outstanding balance, which is around BRL1 billion or BRL1.1 billion. We have the other way, which is basically the rates at losses on a monthly basis, and you have the duration which we’ve disclosed to you. Those are the main lines. As Rafael said, when we book the revenue, we book it at fair value and take into account the expected rate. We don’t expect to have any impact on our revenue in the way we account for that; this will happen in the coming months, shortly.

Perfect. Thank you. Congrats again on the quarter. It's just gaining a bit of share, and it's a big upside. And then disclosure is a bit different from what we’re used to, and given the COVID situation, more transparency about provisions on tracker would help us. Again, congrats.

Thank you very much, Domingos.

The next question comes from Victor Schabbel with Bradesco BBI. Please go ahead.

Thanks for the opportunity, guys. Congratulations on changing the terms for the transaction with Linx. I think it's improved the level of corporate governance related to that transaction. So this is pretty welcome from our side. I have just a couple of follow-ups, if I may. One, on Domingos' questions. Would you guys come out and obviously, you probably will, but with more information about the risk taken on credit transactions, not for the receivables for the credit itself. For example, the minimum level of the donations right. When do you guys think you could come up with this type of information for us to get a sense of how you’re viewing structure to leave investors comfortable at fixed income? This is my first question. The second question, I would say positively surprised by the fact that you guys captured a lot in terms of Coronavoucher volumes required, right, way ahead of some other peers. I'd like to understand whether these came from entirely from you guys, directly from your POS, or is there a big chunk? If you can just give some color—not a lot, just a bit—to get a sense of where it came from; if it was strong, capturing a big chunk of the Coronavoucher payment in the period? Or if there is some greater capillarity due to the sub-acquirers you guys work with? Thanks.

Hi, Schabbel. Rafael here. Thank you for the question. Regarding your first question on the FDIC subordination, we can't talk much about that. As Thiago said, the subordination should be very low. As soon as we can provide more details on that, we will definitely do it, and we can follow up with you in more detail. Regarding your second part of the question, the Coronavoucher, the biggest part of the Coronavoucher volume we have in our TPV comes from our Fintech-as-a-Service platform through partners. We have a small volume in the hubs, but the biggest part is through our Fintech-as-a-Service platform. It’s also important to clarify that when there is cash in a partner or in a wallet and the digital account with prepaid cards, that's where we transact and we capture that part of the TPV. We have the data to separate it and disclose it to you guys.

Perfect. Very precise. Thanks for the answer.

Thank you.

There are no further questions at this time. This concludes the question-and-answer session. I will now turn it over to your hosts for final considerations.

Hi, everyone. Thank you all for the great questions this quarter. We're very happy to see the level of engagement of our team, the energy here, and see you next quarter. Bye-bye. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.