Earnings Call Transcript - STNE Q1 2023

Operator, Operator

Good evening, ladies and gentlemen, thank you for standing by. Welcome to the StoneCo First Quarter 2023 Earnings Conference Call. By now, everyone should have access to our earnings release. The company also posted a presentation to go along with its call. All material can be found at www.stone.com.br on the Investor Relations section. Throughout this conference call, the company will be presenting non-IFRS financial information, including adjusted net income and adjusted net cash. 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 appear 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 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. 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 Officer at StoneCo. Please proceed.

Rafael Martins, VP of Finance and Investor Relations Officer

Thank you, operator, and good evening, everyone. Joining us today on the call, we have our CEO, Pedro Zinner; and our Chief Strategy Officer, Lia Matos. Today, we will present our first-quarter 2023 results, discuss some recent trends, and provide an updated outlook for our business. I will now pass it over to Pedro so he can share some highlights of our performance. Pedro?

Pedro Zinner, CEO

Thank you, Rafael, and good evening, everyone. First, I'd like to say that I'm honored and excited to join the Stone team. I would also like to thank Thiago for all that he has done for the company and for easing my transition into the CEO role. I'm confident that Thiago will continue to contribute to our success in his new role as a board member. I'm pleased to report that Stone has continued to build on its solid performance from 2022, delivering stronger than expected top line and bottom line results in the first quarter of 2023. Let me provide some quick comments on our strong quarterly results and share some initial impressions on the company so far. In our last earnings call, the team outlined our priorities for 2023. I'm quite happy with the results achieved so far, which you can follow on Slide 5. Our first priority was to grow with efficiency. I'm pleased to report that we have exceeded our expectations on both fronts. We grew our revenues by 31% year-over-year and delivered strong profitability with adjusted EBT of BRL324 million in the quarter, 22% above our guidance. As a result, we were able to deliver adjusted net income of BRL237 million, which represents our best Q1 performance in our company's history. Our second priority was to generate cash. In Q1, we had strong cash flows from operations and we were able to increase our adjusted net cash by approximately BRL500 million to reach BRL4 billion. Our third priority was to keep expanding our financial services business. As you can see, we have delivered a very strong performance in our MSMB segment. We grew MSMB TPV two times above the industry, accelerated the net addition of clients in both payments and banking, and are in line with our plans to resume our credit business. We have taken significant steps on the credit side, having dispersed to a small number of clients but, most importantly, we have improved many aspects of the product and operation that will enable us to grow our portfolio sustainably. I want to take a conservative approach towards the expansion of the solution and grow the portfolio depending on market conditions and the completion of the tests we're doing. Finally, we were able to achieve this growth and evolution with a significant increase in monetization, with take rates reaching 2.39%, an 18 basis point improvement over the last quarter. The fourth priority was to evolve our software business. On this front, results were below my expectations. The team is working hard to build the foundations that will enable us to deliver a unified experience to our clients. Integrating software and financial services and becoming the all-in-one solution for small and medium Brazilian retailers. We're making progress integrating and building those capabilities, but we are not there yet. In our software sales, our revenue growth was hurt mainly by a reduction in ad spending by some of our enterprise accounts, and our EBITDA margin was also impacted by an increase in selling expenses. Throughout the rest of this year, I want to put a strong focus on our team integration, cost discipline, and streamlining of our software portfolio. Finally, our fifth goal is to build a fit-for-purpose organization that will enable us to deliver on our long term priorities. We have to make sure our organization is properly equipped to withstand the additional pressures that come with high-speed growth. I don't think this guarantees success, but I believe that not having the right resources in place is a leading indicator of failure. As part of this process, I want to welcome Luiz Andre Barroso as our new board member. His experience as a Google fellow and a seasoned professional in the tech industry will help us on our path to differentiate ourselves and lead through innovation. Now, I want to share some additional thoughts on the company and my experience in the role so far. The first thing I'd like to highlight is the inspiring and fantastic people I have met over the last couple of months. Whether I've been spending time with teams at our hubs, at our distribution centers, or within our offices, the great ideas, positivity, and enthusiasm for the work we do is truly inspiring. I believe the superior talent in this company will continue to be a great driver for our long-term success. The second is that we have significantly improved the company's governance structure and management systems over the past year. I see the company doing a better job offsetting more clearly defined goals, cascading this to different layers within the organization more effectively, and linking compensation more closely to our performance. This is improving decision-making and I see that we now have a better understanding of the key value drivers affecting our business. This is certainly a continuous process, but I believe we now have a better structure to maximize value and returns over the long term. The third is the strong foundation of our client-centric culture. I think a key driver of Stone's success during its journey has been its ability to identify and ease the points of friction that MSMB clients have with traditional financial institutions. This combined with the last-mile distribution capabilities that Stone has built over the past few years has become a significant competitive advantage and enabled Stone to disrupt the market. I think the same attributes can also extend our value proposition into banking and credit and, over the long term, extend our competitive advantage in our software business by solving the vertically specific complexities of our clients and creating a more cohesive ecosystem of integrated software, hardware, and financial services. For the short term, I believe that focusing on excelling at the basics will allow us to emerge stronger and more resilient. For example, our cost management initiatives are already improving our operating leverage and our pricing discipline is positively impacting our profit margins. Long-term, I am working with our team to design our strategy through 2030, setting clear goals and execution paths ahead. We will provide you with more details on this new long-term plan at an upcoming Investor Day that we're working towards, and we will share more details of the event a little later this year. And now, I'm going to pass it over to Lia, who will discuss our first-quarter 2023 performance and strategic updates. Lia?

Lia Matos, Chief Strategy Officer

Thank you, Pedro, and good evening, everyone. I would like to begin by briefly going over our consolidated results on Slide 6. As Pedro mentioned, this was a strong quarter with growth and profitability above our expectations. Total revenue reached BRL2.7 billion, growing 31% year-over-year, and our adjusted EBT increased to BRL324 million, above our guidance of BRL265 million. As a result, our adjusted net income increased almost 6 times year-over-year to reach BRL237 million with a margin of 8.7%. Now from Slide 7 to 12, I will delve into the performance of our Financial Services segment, which continues to produce strong growth with consistent profitability improvements. Revenue in this segment increased by 36% year-over-year and was flat sequentially despite the typical weaker seasonality in the first quarter. This was driven by good performance in our MSMB client base, which demonstrated strong TPV and client base growth, produced higher take rates, and generated more revenue from our banking solutions and PIX. In addition to this top line improvement, incremental cost efficiency gains generated higher profitability with adjusted EBT reaching BRL306 million in the segment and a 13.1% margin. Moving to Slide 8. I want to talk about some highlights in our MSMB performance. MSMB active payments clients reached 2.8 million in the quarter with an acceleration in net adds to 232,000. This good performance resulted from successful marketing campaigns, driven in part by our lead sponsorship of Brazil's most popular reality show, which increased our brand awareness of both Ton and Stone, and from a significantly lower churn in all client tiers. By optimizing our commercial strategy of Ton and Stone offerings across our multiple sales channels, we were able to drive client base growth in all client tiers this quarter. This approach continues to produce good levels of profitable TPV growth, as I will show on the next page. As seen on Slide 9, we grew TPV in MSMB clients by 25% year-over-year, over 2 times the industry growth to reach BRL79 billion. We generated this growth while also increasing our take rates on a year-over-year and quarter-over-quarter basis. Our MSMB take rate reached 2.39% this quarter, up from 2.21% in the fourth quarter of 2022 and 2.06% in the first quarter of 2022. Our take rate improvement is a result of higher monetization of prepayments, stronger growth in our Ton brand, higher contribution from banking revenues, and a higher credit TPV mix compared to the fourth quarter. We continue to execute pricing discipline across our initiatives. On Slide 10, we will move to the performance of our key account segments. Given that sub-acquire volumes have become immaterial to our TPV, we have decided to stop disclosing the breakdown of our key account volumes this quarter to simplify our disclosure. Overall, key accounts TPV decreased by 26% year-over-year to reach BRL15 billion in the quarter as we continue to shift our priority from sub-acquiring business to platform services within the segment. However, as a result of our priority shift, our take rates in key accounts increased by 31 basis points year-over-year. On a quarter-over-quarter basis, TPV declined, especially due to first quarter seasonality and continued deprioritization of sub-acquires. Take rate remained flattish sequentially, mainly due to lower prepayment penetration. Now I will give some highlights of our banking performance on Slide 11. As we mentioned in our last earnings call, this quarter we launched Super Conta Ton, our full banking solution for micro clients. As a result of this launch, we saw significant growth in our banking active client base to BRL1.3 million in the first quarter of 2023, 2.5 times higher year-over-year and a growth of 81% quarter-on-quarter. This has also led to a quarter-on-quarter decrease in ARPAC from BRL45 in the fourth quarter of 2022 to BRL37 in the first quarter of 2023, as micro clients generate lower revenue contributions compared to SMB clients. We have also started piloting debit cards in Stone, which is an important step in evolving our banking solution for MSMB. Client deposits reached BRL3.9 billion, which was roughly stable quarter-over-quarter despite a seasonal decrease in TPV, an important driver of deposits as it is the main cash in method for clients using the complete acquiring and banking solution. With the ramp-up of new clients and the launch of new features, we expect deposits to continue to grow over time. On Slide 12, I want to give a quick update on the credit front and on the results we have achieved so far with our pilots. We enhanced our working capital loan product by combining a flexible daily settlement mechanism with minimum monthly down payments, increasing predictability for both our clients and us. We're in advanced stages of improving our system automation and credit life cycle monitoring and making our decision models more sophisticated through enhancements of data. We have also fully integrated our systems with the register of receivables and formalized personal guarantees as a form of collateral, which has already been executed as expected. We're currently working to rebuild our recovery and renegotiation process to give our clients the option to renegotiate directly through the Stone app if they wish to do so. Until the end of April, we have disbursed around BRL6 million to approximately 200 clients with key credit performance indicators in line with our business model and our credit underwriting standards. We're aligned with our plans to test our credit card solution in the second half of this year. As Pedro said previously, we will take a conservative approach towards the expansion of this solution and grow the portfolio depending on market conditions and the completion of the tests we're conducting. Now I'm going to shift to the discussion of the performance and strategic updates of our software business in Slides 13 and 14. In the first quarter of 2023, software revenue increased to BRL358 million, with a 10% year-over-year growth, representing a deceleration from past quarters, given some weakness in our ads business from large enterprise accounts that reduced spending this quarter. Adjusted EBITDA for software was BRL40 million in the first quarter, with a margin of 11.1%, a 120 basis point decrease compared to the first quarter of 2022, primarily driven by the software revenue growth in the quarter and an increase in selling expenses as we invested in our sales team. On Slide 14, I want to highlight our performance and priorities. Software revenues this quarter were positively affected by a higher number of POS and ERP locations in smaller client tiers as well as inorganic expansion. The growth in the number of locations focused on lower-tier clients was in line with our strategy to increase our presence in medium and small clients with our software solutions. This shift towards smaller client tiers is also expected to drive average tickets down while opening up a broader TAM opportunity ahead. Looking ahead, I would like to share our priorities for software this year, emphasizing our long-term view. We have five key priorities this year: a strong focus on cost discipline; integrating teams and functions across StoneCo; increasing operational leverage; continuing to expand our presence by scaling our distribution channels; driving growth within medium and small client segments; and continuing efforts to build an end-to-end value proposition of software and integrated financial services in select verticals and segments. We believe this is key for us to strengthen our differentiation in some client segments where we have a relevant opportunity to address. Streamlining software assets to increase strategic focus and expand our addressable market by entering new retail verticals through M&A. In the long term, our goal is to build a unified commerce solution for our clients, and our software business is an integral part of the strategic vision. We believe we have a lot of work ahead of us, but we're on an exciting path to become the only end-to-end integrated software and financial services provider for Brazilian merchants. Now, I want to pass it over to Rafael so he can discuss in more detail some of our key financial metrics. Rafael?

Rafael Martins, VP of Finance and Investor Relations Officer

Thank you, Lia. I would like to begin on Slide 15, where we discuss the evolution of our costs and expenses. As we have mentioned in the past, 2023 should be a year with more cost discipline and OpEx control. In the first quarter, we have started to see initial results of that approach, especially in administrative expenses, as I will detail shortly. Cost of services increased by 7% year-over-year to BRL721 million. As a percentage of revenue, it was 26.6% in the quarter, 600 basis points lower than last year. Compared to the previous quarter, it grew 3%, mainly driven by higher investments in technology. As we said in our last earnings call, we expected administrative expenses to reduce on an absolute basis and to increase below inflation for the year. In the first quarter, administrative expenses decreased by 11.5% sequentially, mainly explained by lower third-party advisory expenses and more normalized levels of personnel expenses that were seasonally higher in the fourth quarter. As a percentage of revenue, administrative expenses improved 70 basis points year-over-year and 130 basis points quarter-over-quarter to reach 9.7% of revenue. Selling expenses grew by 1.6% year-over-year and decreased by 4% sequentially, with operational leverage gains in both comparisons. The main reason for the quarter-over-quarter improvement was lower personnel expenses, partially compensated by higher marketing and sales commissions. Financial expenses increased by 10 basis points as a percentage of revenue to reach 33.5%. Due to market dynamics this quarter, we conservatively decided to hold a higher average cash position during part of the quarter, which indirectly impacted our financial expenses. Lastly, other expenses decreased by 17.5% sequentially and 90 basis points as a percentage of revenue as our fourth quarter results were affected due to the impairment of proprietary software and the write-off of some non-core assets. Moving to Slide 16. I would like to talk about our cash generation. This quarter, we have increased our adjusted net cash position by almost BRL500 million to reach BRL4 billion. The main driver for this was the strong cash flow from our operations as well as the sale of our stake in Banco Inter for net proceeds of BRL218 million. Compared to the first quarter of last year, adjusted net cash increased by BRL1.5 billion. Now moving to our second-quarter 2023 outlook on Page 17. We expect total revenue and income above BRL2.875 billion in the second quarter, representing a year-over-year growth above 24.8%. For MSMB TPV, we expect volumes between BRL83 billion and BRL84 billion in the second quarter compared with BRL69.9 billion in the second quarter of 2022, representing a year-over-year growth between 18.8% and 20.2%. Finally, we expect adjusted EBT of more than BRL375 million compared to BRL324 million for the first quarter. This number is not adjusted for any share-based compensation expenses. With that said, operator, can you please open the call up to questions?

Operator, Operator

Thank you. We will now begin our question-and-answer session. The first question will come from Sheriq Sumar from Evercore ISI. Please go ahead.

Sheriq Sumar, Analyst

Hey, thanks a lot for taking my question. On the take rate front, can you provide us with some color regarding how we should think about 2Q, 3Q, and even 4Q? In terms of how much more pricing upside can we see and I think the current economic state, the average is expecting a decline in the rates going forward. So can you remind us as to how should take rates evolve if interest rates are going to go down in the back half of the year and in 2024 as well?

Lia Matos, Chief Strategy Officer

Hi, Sheriq. This is Lia. Thank you for your question. Regarding take rates, the first message is, we continue to see positive take rate trends going forward. I think regarding repricing, as we've said many times before, this is a dynamic and continuous process. So we always take into account where we are and the opportunities we have to reprice the base based on our return hurdles. So I think that's the message and that we can expect to continue to see a positive trend going forward.

Rafael Martins, VP of Finance and Investor Relations Officer

Sheriq, Rafael here. Just to add to Lia's answer. Over time, over the coming years, what we do expect is that new revenue streams like banking and credit should also contribute more and more to take rates over time. So not only the pricing in acquiring alone, but also the monetization on other fronts.

Sheriq Sumar, Analyst

Got it. And just one more follow-up. On the banking front, this new macro-led product or offering for the micro clients. Can you talk about what's the cost of acquisition for these clients and the profitability of that going forward? The main reason I ask is, is there a way in which you could increase your ARPA from these accounts to drive better margins for the overall business?

Lia Matos, Chief Strategy Officer

Thank you for the question, Sheriq. I think regarding trends and talking a little bit about Super Conta Ton, so the full banking solution for micro clients. This is a solution that is completely bundled with the acquiring solution. So there's no incremental tax when we sell the banking solutions to micro clients. It's one comprehensive offering. Regarding ARPAC trends, as we have been saying for a couple of quarters already, ARPAC will trend downwards basically due to a mix effect, right? Because the economics of the micro clients are naturally smaller than the economics of SMB clients. So as we grow faster in the micro segment, this will contribute to ARPAC overall trending downwards due to a mix effect. But the important message is that overall, because this is incremental to our banking business in Stone, overall deposits will also increase as we grow banking clients both in Stone and Ton products, but also as we advance on the banking portfolio, we expect to increase engagement of our clients with banking. So I think those are the trends that you can expect.