StoneCo Ltd. Q2 FY2022 Earnings Call

Good evening, ladies and gentlemen. Thank you for standing by. Welcome to the StoneCo Second Quarter 2022 Earnings Conference Call. By now, everyone should have access to our earnings release, and the company also posted a presentation to go along with this call. All material can be found at www.stone.com 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. Reconciliations 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. I would now like to turn the conference over to your host, Rafael Martins, VP of Finance and Investor Relations at StoneCo. Please go ahead.

Thank you, operator, and good evening, everyone. Joining us today on the call, we have our CEO, Thiago Piau; and our Chief Strategy Officer, Lia Matos. Today, we will present our second quarter 2022 results, discuss some recent trends, and provide an updated outlook for our business. I will now pass it over to Thiago, so he can share some highlights of our performance. Thiago?

Thank you, Rafa, and good evening, everyone. In the second quarter, we demonstrated consistent execution, combining strong growth with improving profitability. We produced this strong performance in both TPV and revenue growth while improving our operating margins in both of our segments. We achieved total revenue of BRL 2.3 billion, which was 5% above our guidance and up 83% year-over-year, excluding the negative revenue impact from the credit product in the second quarter '21 and pro forma for Linx. On the profitability front, our adjusted EBITDA margins increased sequentially from 4% in the first quarter to 4.6% in the second quarter, driven by improved operating efficiency in our financial services and in our software businesses. As we noted previously, following the partial sale of our stake in Banco Inter, we decided to stop adjusting the bond financial expenses in our results from the second quarter onwards. As a result, our adjusted EBITDA in the second quarter reached BRL 107 million, 19% higher than our guidance of over BRL 90 million. In our Financial Services segment, we were especially encouraged by 5 factors. First, the strong evolution of our payments client base, which crossed the 2 million mark with an acceleration of net adds in the quarter. Second, the strong MSMB TPV growth of 78% year-over-year, driven by both our active client base growth and a continued improvement in go-to-market strategy for TON and Stone products. Third, we were able to continue increasing our take rates while we increased our average TPV for both Stone and TON products sequentially. Fourth, the expansion of our banking platform, generating more engagement and increasing opportunities to monetize clients in the future. Lastly, efficiency gains in costs and expenses. As a result, the Financial Services segment revenue grew 3.4 times year-over-year and 102% excluding the effects associated with the credit product last year. At the same time, EBT margins in the segment increased from 3.8% in the first quarter to 4.3% in the second quarter. In our Software segment, revenue growth pro forma for Linx reached 23%, mostly driven by a strong performance in our core software. I'm encouraged by the margin evolution, which saw a sequential improvement of almost 300 basis points in EBITDA margin, which reached over 15% in the quarter. This improvement was the result of continued efficiency gains and back-office synergies, even though we continue to invest in our distribution, customer service, and marketing capabilities. We expect to continue ramping up our software margins in the second half of the year. I'm pleased with the consistency and direction of our results in the second quarter, and I think this is a solid step forward in producing strong results by year-end. Looking to the second half of the year, we will maintain our focus on building on these achievements. With that said, I will now pass it over to Lia, who will provide more details about our second quarter performance and strategic updates. Lia?

Thank you, Thiago, and good evening, everyone. As Thiago just summarized the main financial and operating highlights, I will dive a bit deeper into the drivers of our performance. Starting on Slide 7, I will focus on our client base trends. During the quarter, we reached over 2 million MSMB clients with net adds of 196,000, driven by strong commercial performance in both TON and Stone products despite some churn impact from our continuous pricing initiatives. We have continued optimizing our commercial strategy to onboard smaller clients onto our TON product, while we focus the Stone product on bigger SMBs. This approach addresses our clients' needs more effectively and provides superior unit economics for us. As you can see on Page 8, this strategy has led to better quality in our client base for Stone and TON, both of which grew average TPV over 30% year-over-year. This, combined with our client base growth, resulted in an MSMB TPV of BRL 69.9 billion, which is 3% above our guidance for the quarter and 78% higher year-over-year. At the same time, we improved our monetization with take rates increasing sequentially from 2.06% to 2.09% in the second quarter. On Slide 9, we highlight the continued expansion and engagement with our banking platform. On top of the growth in the number of clients actively using our digital banking accounts, I want to highlight the sequential improvement in ARPAC, which reached BRL 39 per month this quarter compared to BRL 33 last quarter and 3 times higher year-over-year, mostly driven by higher interest rates on average deposits from clients' bank accounts. I also want to briefly update you on the performance of our legacy portfolio. This quarter, we received BRL 134 million of cash inflows, which decreased the fair value of the credit portfolio on our balance sheet to BRL 129 million. On Slide 10, we will move on to our key accounts business. As we show on the left side of the page, TPV from key accounts had a slight decrease during the period, as we continue to deprioritize sub-acquirers. On the other hand, the TPV growth in platform services was strong at 95% year-over-year. Due to this mix shift and the increase of CDI rates, take rates have increased sequentially to 0.86%. Now let's shift to our Software segment on Slides 11 and 12. Software revenue in the second quarter of '22 reached BRL 351 million, representing a 23% year-over-year growth pro forma for Linx. At the same time, adjusted EBITDA also improved, reaching BRL 53 million with a 15.2% adjusted EBITDA margin compared to 12.3% in the first quarter and 9.2% in the second quarter of '21 pro forma for Linx. We expect profitability improvements to continue throughout the year as we capture these efficiency gains and cost synergies even while we continue to invest in several fronts. On Slide 12, I want to highlight the main drivers of this performance and the progress of our software strategy. First, software revenue growth was driven mainly by core revenue growth that was up 28% year-over-year, driven by the higher number of POS and ERP locations and average ticket as well as the consolidation of payables and receivables with our banking solutions. This result was partially offset by the digital business, which decreased revenues by 6%. In order to strengthen our strategy of helping our software clients to sell through multiple channels, we concluded the acquisition of Plugg.To, which streamlines integrations with marketplaces. We believe we have a huge opportunity here to help our clients become truly omnichannel and increase their sales. The second point I want to highlight is that we're gaining scale and improving margins. With annualized revenues of BRL 1.4 billion, we continue to generate operating leverage from our integration efforts and efficiency gains in costs and expenses, and we expect this trend to continue in the second half of this year. Finally, we see significant room to grow organically and through new investments in our core POS and ERP products, cross-sell financial services to our existing client base, and help our clients sell more through multiple channels. Now I would like to pass it over to Rafa so he can discuss in more detail some of our key financial metrics. Rafa?

Thanks, Lia. Before I go over our financial results, I would like to clarify that as anticipated in our last earnings release from the second quarter of 2022 onwards, we will no longer adjust our results for the financial expenses related to our bond. To allow for like-to-like comparison, we have included in our earnings material historical numbers in the same criteria that we are now adopting. That said, starting on Slide 13, I would like to highlight a few key points. As you can see, our results are consistently improving with revenue and margins from both our Financial Services and Software segments increasing sequentially. Our adjusted net income was BRL 76.5 million compared with BRL 51.7 million last quarter, a 48% sequential improvement. For the rest of the year, we expect profitability to keep increasing while balancing it with healthy growth levels. As we have already detailed our top-line trends, I will move directly to Slide 15 to focus on our cost and expenses pro forma for Linx. Following the trend we started seeing last quarter, we gained leverage in most of our cost and expenses lines both quarter-over-quarter and year-over-year with the cost of services and selling expenses being the highlights for the quarter. We will focus on our quarter-over-quarter evolution, which better shows our current trends. Cost of services as a percentage of revenue decreased by 540 basis points, driven mainly by lower data center costs, efficiency gains related to our registry business, and lower depreciation and amortization. In administrative expenses, we had a small gain in efficiency as a percentage of revenue. As our business kept growing, we had higher third-party services expenses, which was the main reason for the absolute growth in this line. As we continue to rationalize G&A growth, we expect to have continued leverage in this line over time. Regarding selling expenses, this line decreased nearly 400 basis points as a percentage of revenue as our marketing expenses returned to more normalized levels. We will keep investing in our growth through commercial efforts in the second half of the year. Financial expenses, with the bond included in the previous quarters for comparison purposes, presented a sequential growth of around 710 basis points as a percentage of revenue, mainly due to 3 factors: first, the further increases in CDI rates that increased, on average, 20% quarter-over-quarter; second, a larger mix of prepayment revenue; and finally, our decision to increase the duration of our funding lines. Lastly, other expenses as a percentage of revenue had an increase of almost 190 basis points, mainly explained by the write-off of assets from the discontinued Linx Pay business in the amount of BRL 16.6 million, the write-off of POS equipment, and other smaller effects. We are encouraged by the trends we are seeing, and we will keep looking for opportunities to be more efficient in the second half of the year. In addition to our P&L evolution, this quarter, we continued to generate cash and improve our liquidity. Our adjusted net cash improved by BRL 195.6 million in the quarter and BRL 455.6 million in the first half of the year, reaching BRL 2.6 billion. With that said, I will pass it back to Thiago, so he can provide you additional updates about our team and our outlook for the third quarter. Thiago?

Thank you, Rafa. Before we move to our outlook for the third quarter, I would like to give you an update on some additional changes to our executive team. Marcelo Baldin, our Chief Financial Officer, is departing from the company after 5 years of service, building out our finance functions and helping the company execute on its IPO. Baldin will be replaced by Silvio Morais, who was named as our interim CFO. Silvio, who has extensive experience in finance, including serving over 20 years as controller at Ambev, will temporarily step down from our Board to assume his new duties. Additionally, Tatiana Malamud was appointed our Chief Legal Officer, a new role that will be part of the Executive Committee. Tatiana has 30 years of experience as in-house counsel and Head of the Legal department for different financial institutions as well as deep experience in capital markets. We would like to thank Baldin for his valuable contributions to Stone over the past 5 years and wish him success in his new endeavors. I'm excited to have Silvio join the management team and benefit from his significant experience in finance. I would also like to welcome Tatiana to our team and look forward to her developing this critical new role for the company. Finally, let's move to Slide 16, where we will share with you our third quarter outlook for the business. We expect total revenue and income above BRL 2.4 billion, representing a year-over-year growth above 63.3%. For MSMB TPV, we expect volumes between BRL 73 billion and BRL 74 billion, with year-over-year growth between 41.4% and 43.3%. Lastly, regarding adjusted EBT, we expect more than BRL 125 million without adjusting for the bond financial expenses compared to BRL 106.7 million for the second quarter. We still have a long path ahead of us, but we believe the consistent results achieved in the first half of the year demonstrate we are on the right track with an encouraging outlook for the second half of 2022, in which we continue to expand margins while keeping strong growth levels. With that said, operator, can you please open the call up to questions.

And our first question today will come from Tito Labarta with Goldman Sachs.

I have a couple of questions. First, regarding the take rate on MSMB, there was some expansion this quarter. Can you help us understand if you're finished with repricing? Is there potential for further repricing? Should we expect this take rate moving forward? Additionally, we noticed that net margin adds have accelerated. Could you explain how repricing interacts with merchant additions and your capacity to add more merchants in the current competitive environment? My second question is about your management of costs and expenses. There have been noticeable improvements, but is there still more that can be done? How do you envision cost savings and expense control evolving from this point to enhance margins?

Tito, Thiago here. I will start with the first part of your question. Thank you for all the questions. If I miss something, please remind me here of all the points. So first, regarding take rates, we have continued to reprice clients according to CDI. In the second quarter, repricing efforts were a little bit smaller than what we did in the first quarter. But now in the third quarter, we have intensified these repricing efforts. So far, we are doing very well. We expect that in the third quarter, the improvement in take rates will be greater than the improvements that we had in the second quarter. I think that we had the time to adjust our pricing policy to the value proposition of both TON and Stone products. I think that we are performing well; the client base is performing well, and the net adds we have shown this quarter prove our ability to navigate this environment. We are seeing a better performance in terms of commercial activities than we were expecting. So we expect better net adds for the third quarter too. Regarding competition, what I can say here is that in payments, it has been the same dynamics as always. We see the 6 main players in the market being rational regarding prices, which is good. In banking credit, we continue to build capabilities to allow us to compete head-to-head with the incumbent banks. Therefore, we still have a lot of room in these additional financial services for our clients. And in software, competition tends to be more vertical-specific and very fragmented. We continue to consolidate the industry given the strength of our solution and the strength of the team. There are no big news in competition, but I think that the 6 main players in the market that dominate the majority of the market share are being rational in terms of pricing, and I think that this is positive for everyone. In terms of cost and expenses, we are improving discipline in the way we manage capital allocation in OpEx in our business. So we expect to continue to gain leverage in our lines. We expect a better second half of the year in terms of discipline in managing OpEx.

Great. That's very clear. Maybe just one quick follow-up on the competitive environment. You mentioned that everybody is being more rational now. How long does that rationality last? I mean, do you think once rates come down, do people start to get more aggressive again? Is everybody just kind of normalizing for the higher interest rates? Just help us think kind of long-term how competition can evolve given how competitive it's been in the past.

All players were impacted by the CDI almost in the same way. There are some differences in terms of capital structure between players. But at the end of the day, I think that when interest rates were moving up very quickly, the competitors were trying to see what each other were doing, leading to some delays in the pricing strategies of all the players. However, I think that now this is behind us; we are not pricing our products based on competition. We are pricing our products based on the relationship we have with our clients and the evolution of our solutions for them. We have been stable regarding price and strategy. I think that these dynamics we have today will continue. If the interest rate goes down, of course, some of that will be moved to clients. However, I think that the industry will maintain margins when interest rates ease. That’s what I expect.

And our next question will come from Josh Siegler with Cantor Fitzgerald.

So the average revenue per active client in banking continues to trend higher. Do you believe there's more room for it to expand in the back half of 2022 as interest rates remain elevated?

Josh, this is Lia. Thank you for the question. I think the short answer is yes. As we continue to see our clients engage further with our banking solution, I think there are a few drivers there. Number one is average deposits are, of course, a big impact on the ARPAC, as I just mentioned, the evolution in the quarter. This is correlated with interest rates. Therefore, as long as interest rates go up, that monetization will improve, and also average deposits are trending upwards. Additionally, as we deploy more features and help our clients with new banking solutions, that will also contribute positively to monetization. So I think the trend in monetization in banking as we see it is very positive going forward.

Great. And then if I could just have a follow-up. MSMB TPV came in above your expectations this quarter. Was that largely driven by higher TON adds? Or did average spending per merchant also surpass your original outlook?

Josh, Thiago here. I think that the positive surprise was the average TPV on both products. We were already expecting these improvements in net adds and we are adding net adds in all client tiers, from the micro merchant space to SMBs and medium clients. For all tiers of clients, we have a positive net add. However, the average spending per merchant on both Stone and TON products came a little bit above our expectations, and this was a positive. I think that the client base has a better quality now. Let’s see how this movement will continue in the second half of the year. As I said, we expect to continue improving our net addition of clients because we are managing the client base and the new sales more effectively now. So let’s see how the average spending will behave, but I think that this trend will continue.

And our next question will come from Mario Pierry with Bank of America.

Congratulations on the results. Let me ask you two questions. One is on the efficiency gains that you talked about. I would assume a lot of this gain is coming from the incorporation of Linx, right? Can you talk about how much of Linx's cost base has been reduced or how much do you expect to reduce? Just trying to get a better feel here for how much more cost savings we can see. The second question is related to financial expenses. They are running close to BRL 1 billion per quarter now. But it seems to us that interest rates in Brazil are close to a peak. So just can you give us some type of sensitivity of your financial expenses to movements in interest rates in Brazil? That will be very helpful.

Mario, Rafael here. Thank you for the question. Regarding your first question about efficiency, it's important to highlight that we are gaining efficiency not only in Linx and the Software business but also in the Financial Services front. In both segments, we are achieving operational efficiency. We do have an improvement in margins in software, right? The EBITDA margin increased from 12% to 15% this quarter. So yes, we are capturing cost savings in the software front. However, we achieved some of the cost efficiencies in our banking business as well. For example, we had lower data center costs and operational efficiencies. So we do have cost efficiencies related to the entire business. As Thiago mentioned, this aligns with the overall goals of Stone. When we think about financial expenses, as you said, our financial expenses tend to increase both with the average interest rates in Brazil and also the growth of our business. If you look at our TPV, the consolidated TPV grew 9% quarter-over-quarter. The CDI increased on average by 20% quarter-over-quarter. Adding those two changes, you'll see that it's pretty much what our financial expenses increased. As the CDI rate tends to flatten, of course, it will benefit financial expenses. And as Thiago said, we do adjust pricing policies accordingly. So over time, you should see financial expenses stop increasing as a percentage of revenue, as we have seen over the last year when the CDI flattens.

Rafa, can I add some comments here? Mario, Thiago here speaking, just to clarify. When the interest rate goes down, assuming it happens, we expect direct contributions to our margins. If the trend in interest rates changes and they go down, we expect to capture this as benefits in our margins in our results.

Okay. That's clear. Just a follow-up then. On your headcount, can you talk about your total headcount today versus two quarters ago or versus one year ago when you integrated Linx?

Mario, Rafael here. Yes. So the headcount today is a little over 14,000 people. It's pretty much flattish over the last half year. This is a result of the OpEx discipline we commented on. Overall, the increase in personnel expenses that you see in our results is primarily due to adjustments we have to make, both legally and in bringing in new talents and more senior people. However, the headcount is pretty much stable.

Do you see, sorry, Thiago, go ahead.

Thiago here. Just a comment. As I told you last quarter, I think we already have the necessary infrastructure in terms of personnel, both in distribution, logistics, and customer service to meet our client base and accommodate the growth we have projected for the medium short term. We are improving our productivity in the way we design our processes. Now we have a new wave of growth, adding more products to our clients without needing to increase our workforce. Therefore, we expect to continue gaining leverage in the personnel expense line.

And our next question will come from Kaio Prato with UBS.

So I have two here on my side, please. I think you completed a new partial sale of your stake in Banco Inter this quarter. The first one is, can you please confirm this to us? What was the impact on our earnings and cash? And what is your current stake in Banco Inter today? And what is your strategy on this going forward? The second, we see that your cash generation was negative in this quarter again, and it's close to BRL 700 million cash burn year-to-date. So just wondering if you can please share with us what's your view about that. When do you expect to return to positive cash generation? and what should be the main drivers for this going forward, please?

Kaio, thank you for your question. Regarding the partial sale of the stake in Banco Inter, you're right. We had a little under 5% stake in Banco Inter. We currently hold around 4%. Essentially, we sold that 1% stake that we had before. We received those proceeds at the end of June, so there is a very small effect in terms of those proceeds. When you look at the mark-to-market that we have, the mark-to-market refers to the stake we have remaining. As we mentioned in the past, this is an investment we made back then, and it is not the core of our strategy right now. We have admiration for the Inter team, but this is not a big focus for us at the moment. We continue to hold the stake we have in Banco Inter. Regarding the second part of your question, we have actually generated cash and improved liquidity this year, almost BRL 0.5 billion. So our adjusted net cash position has improved to BRL 2.6 billion. We expect to continue generating cash with lower CapEx in the second half of this year compared to the first half, and we anticipate that our business will continue to generate cash.

Kaio, Thiago here. Just an additional note. We made only one partial sale of Banco Inter when we chose to receive the cash option during their migration to NASDAQ. There are no updates on our investment in Banco Inter; we remain at the same position we discussed in the last earnings call. There was only one sale when we chose the cash option in their migration to NASDAQ, and no further updates on that.

And our next question will come from Geoffrey Elliott with Autonomous.

You mentioned being 5% ahead of the outlook you provided. But in the sense, you were kind of further ahead really in June because the outlook was given at the start of June, and I guess, at that point, you had pretty good visibility into the April and May numbers. So can you help us understand where did you perform better than expected? Was it a particularly strong June? And then is there anything we can read into that as we look out into the third quarter?

Geoffrey, Rafael here. Thank you for the question. So I think, yes, along the lines of what Thiago mentioned regarding the TPV, we saw a better performance than expected. I think we did see a strong June, as you mentioned. That's the primary reason why we delivered a number that is higher than the previous guidance. Yes, when we look at the top line, both TPV and revenue came above what we initially expected.

And given the strength in June, is there anything we can extrapolate from that? I guess, were you performing better than you expected in June? And can we kind of read through from that into July, August, September?

Yes, I think the guidance we have provided for the third quarter already incorporates some of those improvements versus the initial expectations. As Thiago mentioned, when we look, for example, at the take rate evolution, we see a bigger evolution in the third quarter compared to the second versus the evolution we had from the second versus the first. We have also incorporated those effects already in our guidance, and we are very committed to that guidance.

Can I add a comment here? Geoffrey, Thiago here speaking. That’s a great question. In our outlook for the third quarter, we assure that although we are comparing our growth against tougher comps, as each quarter becomes harder to continue to grow at the same pace, we are saying that at the top of the range, we will be growing 3% on MSMB TPV, but total revenue would be growing at 63.3% at the top of the guidance. I think here, we show our ability to improve take rates through this guidance, and we are committed to the top of the range of the guidance.

And our next question will come from Neha Agarwala with HSBC.

Could you provide us with an update on your software business? How are you integrating the Linx products into your SMB client base? Have you begun cross-selling products to your clients, and how is that process progressing? Additionally, regarding your credit business, you mentioned that you are working on designing a product and conducting a pilot. How is that coming along?

Neha, Lia here. I understand you made two questions, one regarding software and one regarding credit, right?

Yes, Lia. Perfect.

Good. Good. Good. Okay. Let me start first with software and how we see penetration of financial services evolving into our software client base. The penetration of financial services into our software client base has evolved sequentially, and this had a positive impact on the growth of platform services TPV, which saw a 95% growth year-on-year, because that is where we account for the TPV within our software client base. To be clear, we still see a lot of opportunities not only in acquiring but in integrating banking into the ERP and, when the time is right, in credit. A few updates on the product side, Neha. We have made good recent advancements in product integration. Regarding fixed integration to the POS, which is when PIX is integrated as a payment method and can be reconciled as a payment method, we have a substantial coverage of Linx POS with PIX enabled. The second point is a native integration of Stone banking into the ERP. This is a recent advancement that we have made. In the majority of the verticals, we have integrated the ERP with our strong banking, which greatly facilitates clients' cash management workflows. We have also integrated our reconciliation platform to most of the vertical ERPs. Additionally, we have made advancements in integrating mobile POS in some verticals, which improves productivity in stores by streamlining the checkout process. These are examples of recent advancements we've made in integrations, and we expect this will help strengthen our software value proposition in the verticals where we offer them. Regarding credit within the software base, we believe this is an opportunity that we will address a bit longer-term because our priority in credit right now is focused on SMB clients within the Stone product. However, there is a significant fraction of clients within the Linx client base that are in the middle of the pyramid in the SMB space, and we think there is an opportunity to leverage software data to be more precise in giving credit to those clients. Regarding where we are on credit itself, the message is the same as we gave last quarter. For our working capital product, we have started testing on a very small scale, examining the product and the system improvements we have made. We are in test mode right now to assess systems, collateral, user experience, and some features and enhancements we've done in the product. We aim to continue these tests and complete a full cycle before we decide to scale. We are also on track to start a pilot very soon with our credit card products, which will continue throughout the second half of the year. I think those are the main messages regarding software and credit, Neha.

Could you also update us if the registered receivables—which had some operational problems—are working better now? Are you keeping an eye on to see how that is improving?

Neha, Thiago here. Can I go on Lia?

Go ahead.

Okay. Neha, regarding the registry of receivables, I think there are no big updates here. We continue to follow the evolution of the three main players closely. We are integrated with all three of them, both in terms of our credit products, and we are now starting to pay closer attention to using the registry of receivables to create projects to prepay receivables for our clients with acquirers. However, we don’t feel that we have the system that is stable enough to incur the risk if we only look at those receivables being processed by the registry. We are still being careful on that. I believe that in the second half of the year, the industry will evolve and open significant opportunities for us, both in terms of prepaying receivables that clients have with other acquirers and this is a very big opportunity for Linx, for example, and to enhance our collaterals in the credit project. Let’s see what the second half of the year will bring.

And our next question will come from Pedro Leduc with Itau BBA.

Two for me, please. One, just seeing your guidance figure for 3Q revenues, BRL 2.4 billion. It's almost flat compared to 3Q, mid-single, low single-digit expansion at most, which maybe is just you guys being conservative because of what we just heard—net add strong, further repricing business evolving. It seems like this deceleration, I can't really reconcile them unless there's a big drop in the key accounts to come. So I'd like to pick your brains around this; is maybe it's just conservatism or what you're seeing so far in the quarter? That's that.

Pedro, Rafael here. Thank you for the question. So I think that we—as you said, it’s an important point—when we look at our revenue, we do have MSMB revenues and key account revenue in the financial services. Of course, key account revenue can be more volatile, and we are discontinuing some sub-acquiring business, which can make them harder to forecast. We want to ensure that we reach the guidance we give, and of course, the guidance is above 2.4%. However, the number we have is the best number we have right now, and we are very confident that we will reach it. Overall, when we look at the growth that this guidance implies, it’s still a very strong growth year-over-year, over 60% growth in revenue, which we think is a healthy pace given the improvement in profitability we aim to achieve. This is sort of the net effect of all those elements in our business.

Super clear. And the other question is a little more on the strategic business side. You recently saw— you guys bring in Rodrigo Cury, former BTG banking, digital banking lead. I've seen you mention banking services a couple of times in this call. I can't help but think that you have all this budget to spend globally, maybe to boost that avenue as well. Am I correct in thinking that this should be a significant attention point for you all in the near future?

Thiago here. Yes, you are right in your thinking. We want to be a leading player in financial services for merchants in Brazil. We are creating substantial efforts to enhance our client base with the main projects. On top of that, we aim to transform the company into being perceived by our clients as the primary financial provider for all their needs. A significant step we are taking is improving our team and our ability to create new products that are integrated in a straightforward manner for our clients. I believe we have the capability, distribution, culture, and team to execute this plan. Let’s see how we will evolve over the next six months and a year. However, I am confident that the new addition of Rodrigo, combined with our existing talent, will significantly strengthen our strategy and evolution. So yes, that’s the direction we are heading.

And our next question will come from Domingos Falavina with JPMorgan.

My question is just trying to get your perspectives on pricing and what you take into consideration. When we look at your MDR revenues, it basically grew about 9% quarter-on-quarter, which is good and is in line with what we saw TPV growth. However, when we add financial expenses, it basically shrank 1% quarter-on-quarter. I struggle a little because you mention that you're pricing is not based on competition, which has contributed to margin improvement, but rather on the relationship with your existing clients. I guess my question is, when you're pricing—is this pricing based inclusive of financial expenses, which can be tricky to allocate managerially—where you're booking prepayment versus debentures or other weighted average cost of funding? This is a challenging detail to assess. If you're not really pushing hard on this price adjustment, are you happy with the price all inclusive of costs? If that is a number you're satisfied with, considering we noticed good compression Quarter-over-Quarter. Lastly, what exactly are your senior management's main goals or remuneration tied to? Is it tied to TPV growth or profit? Because obviously, we're seeing a big shift in investor sentiment around that position.

Domingos, Rafael here. Very good question regarding financial expenses. When we look at the second quarter, we saw less contribution. If you observe the change in our pretax profits, we saw less contribution from revenue net of financial expenses, and the improvement in profitability was mainly from OpEx discipline. In the third quarter, I believe that these dynamics will change a little, as we expect a better dynamic of revenue net of the financial expenses. There is always some lag effect between how the CDI evolves, which brings financial expenses versus our pricing. What we try to do is always look at the unit economics of our clients and the returns we achieve from investing in our platform. We have some hurdles that we look at. After the CDI increases, we adjust prices accordingly. So I think there is a lagging effect here. Further, one other effect you have in financial expenses this quarter is that we opted to extend our funding lines a bit longer, which also negatively affected our financial costs. This aspect is not purely reflective of the funding cost we have with our clients. It indeed has influenced our expenses. I think Thiago would like to add to that answer.

Yes, Domingos, it’s Thiago here. Let me add to that. Regarding the cadence of repricing, we executed a significant improvement in the first quarter, and we don’t want to create too much stress on both our client base and our team. Therefore, the improvements we did in the second quarter were smaller because it’s challenging to keep adjusting prices frequently without straining relationships. That’s why we spaced the adjustments between the two significant movements. Now in July and August, we made another substantial movement already, and I think we executed it well. We are now creating more predictability in our pricing strategy. With a large client base, that predictability is essential. So we executed a significant pricing jump in the first quarter, a smaller adjustment in the second quarter, and have improved the pace again in the third quarter. I believe this strategy is performing well in both the base and in commercial activity. You are correct when you see that revenue—less funding cost has been basically in line with the last quarter. As Rafa just mentioned, the increased duration of our funding lines also factored into this. So there are several elements in play. You will notice in the third quarter that revenues are growing more rapidly than funding costs. We are managing this appropriately. Regarding your last inquiry, if you ask whether management is focused on TPV growth or profitability, we place emphasis on the quality of client retention and profitability. We will continue to grow rapidly; you can see our commitment to this in net additions. However, our priority right now is to enhance profitability and create a better balance between growth and profitability. We are delivering on that commitment through direct engagements.

And the next question will come from Jeff Cantwell with Wells Fargo.

I wanted to ask you about your software revenue and really about your software EBITDA, which looks like it’s up about 300 basis points sequentially to 15%. Could you sort of provide us with a little more insight into what's driving that expansion in margins? Any color you can offer on the ongoing margin perspective for the software piece would be great.

Jeff, Thiago here. There are two main drivers: One, we are integrating our portfolio of companies into the Linx management system, creating one large business unit that combines all of our software businesses. This offers us the ability to continue growing at our current pace. In the medium term, we expect to maintain this growth pace while improving margins. We achieved a 15% EBITDA margin, and I believe we can approach 20% quickly. I expect to have positive news about margins close to 20% by year-end. The discipline that the team is showing in providing efficiency across all our software products while continuing to invest in growth and improving customer service is working well. As we keep up this growth rate, I believe we will see margins advance close to 20% in the final quarter and beyond. In the new year, we will continue focusing on enhancing efficiency and increasing our cross-sales within our existing base. Those are the key drivers.

Okay, great. And just a follow-up on that. Could you prioritize or explain what the biggest drivers are to get from 15% to 20%? Is that dependent on top-line growth or efficiency? I’d like to delve deeper on that area, as much as we can.

Jeff, Rafael here. I think it will be a combination of those elements. The strong organic growth will help dilute G&A expenses, which is number one. We have seen improvements in negotiations on cloud costs that contribute to services. Additionally, as some software solutions we have continue maturing and gaining traction, we will be able to reach a higher margin. Remember that we have invested in software solutions previously that operated with essentially zero margins. As we advance those solutions and increase traction, we expect to evolve and improve margins. Those are the key elements that should help us here.

And this will conclude our question-and-answer session. I'd like to turn the conference back over to Thiago for any closing remarks.

I would just like to say a big thank you to our team for the amazing work in the quarter and for the support of our shareholders. We expect a very good second half. We are very excited about our business and see you next quarter. Thank you very much. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.