Earnings Call Transcript - STNE Q4 2021

Operator, Operator

Good evening, ladies and gentlemen. Thank you for standing by. Welcome to the StoneCo Fourth Quarter and Fiscal Year 2021 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.co on the Investor Relations section. As a reminder, this conference is being recorded. 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 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 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 Officer at StoneCo. Please proceed.

Rafael Martins, VP of Finance and Investor Relations Officer

Thank you, operator, and good evening, everyone. Joining us here today, we have Thiago Piau, our CEO; Lia Matos, Chief Strategy Officer; and Marcelo Baldin, our CFO. Today, we will present our fourth quarter 2021 results, discuss some recent trends and provide an updated outlook for the business. I will now pass it over to Thiago so he can share some key messages and highlights of our performance. Thiago?

Thiago Piau, CEO

Thank you, Rafa, and good evening, everyone. I want to start today's call by taking a moment to reflect on our performance in 2021, the challenges we encountered, and what we learned from them. Then I want to discuss the core strengths in our business that have enabled us to continue to grow fast and take market share despite all the problems we faced last year. And finally, I will review some recent trends we are seeing in the business, why I have such confidence in our outlook, and why I think Stone is poised to benefit in 2022 and beyond. So let's start by reflecting on 2021. This past year was unsatisfying for Stone. We executed well in some areas, but we certainly made some mistakes. We took an aggressive approach. This is how we built the Company and how we help lead the fintech revolution in Brazil. But I think at the end of the day, we tried to do a lot last year, and we simply did not execute it as well as we would have liked. We ramped our credit offering quickly, but we did not manage this expansion well. Our execution challenges were magnified by the problems of the National Registry System, which we were also not well prepared to deal with. So in mid-2021, we decided to pull our credit operation, regroup, learn from our mistakes, and go back to the drawing board. In prepayment, we delayed repricing our solutions when interest rates in Brazil began to rise. We didn't want to hurt our customers with higher costs, which we felt we could absorb for a while. But in the end, the impact was too much on our bottom line, and so we began repricing in November. Despite these issues, we did not want to slow down our expansion plan. So we continued making significant investments in the business, which increased our operating costs. In the fourth quarter, we almost doubled our selling expenses, excluding Linx, and continued to invest in building our Stone products, banking ecosystem, software solutions, and enhancing our technology and customer service, which remain a key competitive advantage for Stone. In hindsight, we should have spread out some of these investments to ease the near-term pressure on our bottom line. But I think overall, it was the right strategy for Stone to lay the groundwork for strong growth and market share gains over the next few years, and I'm already encouraged by the early results. Ultimately, I think we lost some of our focus and execution precision as we managed all of these issues, while at the same time also integrating Linx, an entirely new part of our business. As a result, our performance suffered, and our profitability declined. So 2021 was not our best year. However, to be fair, we also did some pretty good things last year. We learned a lot from our mistakes, corrected our course, and despite all of our problems, we still produced very strong top-line growth. In the fourth quarter, we generated 87% revenue growth year-over-year, 60% excluding Linx, which was our best performance since the third quarter of 2019. During the quarter, we also produced a record number of new client wins, accelerated our TPV growth, executed well in the MSMB segment with a big win in the Micromerchant space, which is new for us. We continued to expand our banking ecosystem and generated double-digit organic growth in our software solutions. So the core growth engine of our business remains quite strong. We are winning clients, taking market share, and expanding our footprint to lay the foundation for future top-line and bottom-line growth. We learned a lot from last year's challenges, and we have also made some important changes in our structure and management team to strengthen our execution capabilities. We are reorganizing the Company into two operating segments: financial services and software, which we'll begin to report in 2022. The financial services segment is the Stone payments digital banking and credit business. The software segment will bring together Linx and all our other portfolio companies. We think this will provide greater transparency. As Lia will explain later, software is a strategic priority for us, and we will continue to drive growth and expansion in this area as well. Now let me shift to our outlook for this year, which is quite positive, with strong growth and improving margins. I think we are well positioned for 2022. The investments we made in our projects and operations will continue to help us drive growth on top of our strong core business, which keeps taking market share. In addition, the lessons we learned and the changes we made last year have positioned us to improve profitability this year. Looking at both top-line and bottom-line performance, I feel that 2022 will be a good year for Stone. I will discuss more of our outlook toward the end of our call. I will now pass it over to Lia, who will provide more detail about our fourth quarter performance and strategic direction.

Lia Matos, Chief Strategy Officer

Thank you, Thiago. Good evening, everyone. I'm going to start on Slide 5 with key performance highlights. In the fourth quarter, we had very strong top-line growth with weaker profitability driven by the increase in funding costs resulting from the challenging macro scenario. On the top line, growth performance for Linx accelerated to 51% year-over-year in the quarter compared with 26% growth in the third quarter of '21. This performance was largely driven by an 87% year-over-year TPV growth in MSMB and by growth in our payments client base, which more than doubled to 1.8 million active clients compared with our previous guidance of between 1.4 million and 1.5 million clients. Pro forma for Linx, software revenue grew 15.7% driven by 26% growth in our core software business of POS and ERP solutions, offset by lower Linx of acquired revenues, a result of client migration to the Stone platform. Regarding profitability, adjusted net income was $34 million in the quarter, which, as Thiago mentioned, was negatively affected by higher financial expenses resulting from a spike in CDI rates and our delay in repricing clients, which we started in November and scaled in December and January. As we will highlight in the end of the presentation, we expect profitability to begin to recover in the first quarter. Let's now take a deeper dive into each of our two businesses. I will talk first about the financial services businesses on Page 6 to 11 and then move to software on Slide 12. In our financial services business, we serve both MSMBs, micro, small and medium businesses as well as key accounts, which we separate into sub-acquirers and platform businesses. On Slide 6, we show the evolution of our payments client base in the MSMB segment. Last year, we changed our approach to serving this segment. Previously, our sales strategy was to offer Stone products to micromerchants only and to offer Stone and Pagar.me solutions to our larger SMB clients. However, we discovered that some clients prefer a different mix of solutions or even a combination of solutions regardless of their size. So we changed our approach to better meet their needs. We now focus on the offerings sold into the client base rather than focusing on just the size of the clients' volume. During the quarter, we reached 1.7 million MSMB clients by achieving record net addition of 367,000 clients compared to 290,000 in Q3. Of these new additions, 312,000 are using Stone solutions and 56,700 are using Stone and Pagar.me products. As a result, it grew the average TPV of Stone in the quarter almost threefold versus last year, and we increased average Stone and Pagar.me TPV by 22% over the same period. We believe that this new balance between TON and Stone products yields a better value proposition for our clients and better returns for our company. On Slide 7, we show that the TPV for MSMBs has grown 87% year-on-year, reaching R$66.7 billion, accelerating over the third quarter when it grew 81%. Stone continued to accelerate growth, roughly in line with last quarter at a 21-fold year-over-year increase, while growth accelerated in Stone and Pagar.me, with TPV growing normally 72% year-over-year compared to roughly 70% in the third quarter. Although our competitors don't disclose their main growth metrics broken down by segments, we believe we had strong market share gains within the MSMB segment in the fourth quarter. On the right side of the page, we show that we have been increasing take rates in MSMBs, from 1.66% in the third quarter to 1.71% in the fourth quarter and 2.02% in January of '22. January take rate figures reflect the positive results from scaling the waves of client repricing that started in November. Combined with the repricing, MSMB TPV growth both in January and February remained very strong, above 80%. On Slide 8, we show in more detail the initial recovery from higher interest rates after we started making pricing adjustments. As you can see, the average monthly interest rate increased faster in 2021, raising our funding costs, especially in our prepayment business. As Thiago mentioned, we decided not to pass along those higher costs to clients right away and started to do so in November. With that, in the first quarter of 2022, we already see positive results and expect higher take rates combined with better margins. Given the still expected CDI increase along 2022, we will have a more dynamic pricing strategy throughout the year to achieve a healthy balance between growth and profitability. Moving to Slide 9. We have continued to drive the expansion of our banking ecosystem, which is an important part of our strategy. Banking services for small businesses in Brazil are still largely dominated by incumbent banks, and we see a huge opportunity to offer those merchants a one-stop shop solution for all their financial needs in an affordable way. The number of clients that actively use our banking solutions has increased almost threefold year-over-year to 492,000 clients, the usage of our card as well as the total outstanding deposit that clients have with us have also increased significantly, both year-over-year and sequentially from last quarter. Most importantly, we have been growing our banking client base while also increasing ARPU, which reached R$25 in the fourth quarter, growing 39% sequentially, driven by increasing outstanding volume of deposits card TPV growth and the initial scaling of our insurance solutions. Shifting to Slide 10. I want to update you on our credit business and where we are in terms of resuming disbursements to our clients. We're implementing five major fixes and improvements. First, we have completely revamped the product user experience for a more simplified experience based on monthly installments, paying through automatic retention using the Stone accounts cash-in. We believe this revamped user experience preserves the strength of our original product to auto retention but improves clients' understanding of their payment schedules, more in line with the traditional credit products. Second, to decrease the reliance on the registry system, we have added personal guarantees to enhance protection against bad borrowers with focus on maintaining a simple and frictionless onboarding process. Third, we will implement a new sales process and scoring system based on enhanced data ingestion from multiple sources, including a more rigorous assessment and detailed data input from our hub sales personnel. Fourth, so that we can improve client life cycle management and enhance recovery, we're rebuilding systems to improve client communication, have more flexible renegotiation analysis and agreements, improve the execution of warranties and better integrate with collection partners. Lastly, as effective risk monitoring is one of the cornerstones of the successful credit business, we're implementing an improved risk monitoring system to effectively resume disbursement with a more robust risk management. We will begin testing these improvements with clients in the second quarter of 2022. We will take a conservative approach to scale in order to observe client behavior in more detail. In addition, we also expect to launch a business credit card for SMBs in the second half of 2022. Despite the initial challenges we faced with the legacy credit portfolio in operation, we're committed to resuming credit offerings to our best SMB clients as this is such an important solution for them. The opportunity is huge, and we're confident we will be better prepared to have a compelling offer that is great for our clients and, at the same time, profitable for us. Updating you on our legacy credit portfolio, it is performing in line with our expectations. This quarter, we had a cash inflow of R$430 million from clients paying us back. And we're close to receiving all the amounts we have disbursed since inception, de-risking principal capital. Given this performance and collections, the portfolio decreased to R$1.2 billion by December from roughly R$1.6 billion at the end of the third quarter and is recognized at a fair value of R$511 million in our balance sheet. Our coverage ratio decreased slightly to 98% in December, which is a natural evolution of a portfolio being phased out. In January, we sold a distressed portion of the portfolio to a third party for R$12 million above its fair value. We continue to collect payments on the remaining portfolio and have reduced its size to R$850 million at the end of January 2022. Finally, moving to Slide 11. We show some KPIs for our key accounts business within financial services. TPV, excluding Coronavoucher, was roughly stable in the quarter compared to last year at R$22 billion. There are two different dynamics in our key accounts business. We continue to deprioritize sub-acquirers in which we had a volume decline of 28% year-over-year, while our platform services business continues to grow fast, up 93% year-over-year. Our sub-acquirer volumes should continue to decline significantly in 2022 with a very limited impact on our bottom line. As we penetrate the pool TPV within the Linx client base, we expect this to drive overall TPV growth in key accounts. Take rate for key accounts was 0.82% in the quarter, higher than third quarter levels, mainly as a result of higher prepayment rates and a mix shift towards platform services, which have higher take rates as compared to sub-acquirers. On Slide 12, I would like to recap important advancements we made on the software front. Since the closing of the Linx acquisition, we have taken an important step to integrate Linx and the portfolio of Stone software investments into a unified software division. We will focus execution of our enhanced software strategy along three main fronts. The first one is core software, which is the driving force of our software strategy. Our core software business comprises POS and ERP solutions for multiple retail and service verticals. Our TEF and QR Code gateways that enable payments and fixed integration to the POS and ERP, our reconciliation solution, which enables reconciliation of all payment methods within the POS and ERP, and our CRM solutions. Our focus in the core will be on driving organic growth through new locations and cross-sell as well as inorganic growth through selected strategic acquisitions. In 2022, this segment should represent approximately 85% of software revenues and should grow approximately 20%. We expect this part of the business to have a 20% plus EBITDA margin level. The second front is digital solutions where we will focus on enabling our core clients to digitize. Digital comprises the OMS, our omnichannel solution for physical stores, our e-commerce platform, engagement tools that help retailers to better reach consumers online, our marketplace hub that helps merchants sell in multiple marketplaces through a single integration and/or ad solution. This part of the business should represent 15% of software revenues in 2022 and grow approximately 20%. We still expect negative margins in digital in 2022 as the business continues to mature. The third front is the integration and cross-sell of financial services. This used to be the lengths of acquiring business, which is nearly shut down because we have migrated the majority of clients to the Stone platform. We will focus the strategy on cross-selling Stone financial services to our software client base. In 2022, we expect to have positive contribution margins from this part of the business as we execute our cross-selling strategy. Now let's talk a little bit about software performance in the fourth quarter of '21. Our revenue from software solutions reached R$328 million in the quarter, up eightfold compared to last year or 15.7% pro forma for Linx. When we look more closely at the growth trends across the different software fronts, we see very different growth dynamics. Core software had a strong growth of 26% year-over-year. As we show in more detail in our earnings release, the number of locations using Linx POS and ERP solutions increased 11.7% year-over-year, reaching 109,000 locations. Linx digital solutions grew revenue by 20% year-over-year, and Linx of acquiring business had a revenue decline of 53% as we discontinue this operation and transition it to the Stone payments platform, as I just described. Overall, given the early stage of many of the software solutions and the work we still have to do in cost management, integration of companies, and synergies with our financial services business, software is still dilutive to margins. However, in 2022, we expect margins to improve as our business scales and we advance in these fronts. Finally, on Slide 14, we show some encouraging initial results of penetration of Stone financial services into the Linx client base. TPV from Linx clients processed by Stone has increased 116% year-over-year in the fourth quarter of 2021 to R$5.9 billion. This was largely driven by the migration of Linx Pay volumes, but also by the cross-sell of Stone solutions to Linx client base as well as a natural overlap as Stone continues to grow organically. Compared to the second quarter, which was the latest quarter before the closing of the deal with Linx, volumes grew 47%. In the fourth quarter, we estimate that our TPV represents approximately 13% of the overall TPV of the Linx client base, up from 8% in the fourth quarter of 2020 with a still huge opportunity ahead. Now I will pass it over to Rafael so he can discuss in more detail some of our key financial metrics. Rafa?

Rafael Martins, VP of Finance and Investor Relations Officer

Thanks, Lia. Starting on Slide 16, I will highlight some aspects of our 2021 performance. While our adjusted net income decreased to R$203 million, our adjusted cash flow from operations increased by 40% compared with 2020, reaching R$1.1 billion. That increase is mainly because some of the factors that affected our P&L in 2021 are noncash items such as the fair value adjustments related to our credit business. Cash net income, which grew 20% year-over-year, was the main growth driver in our cash flow from operations. Our adjusted free cash flow for the year was negative R$214 million, impacted by two decisions we made that, although very accretive to the business, generated additional cash outflows in the year. First, we decided to significantly increase our CapEx in the fourth quarter to R$548 million compared with R$50 million last year to make advanced purchases of POS terminals, de-risking 2022 growth amidst supply chain uncertainty and microchip shortages. This proactive investment resulted in significant reductions in our POS lead time. Second, we prepaid R$230 million of marketing expenses in the first quarter of 2021, which was fully funded by cash received from Grupo Globo and is still mostly available for us to use. We believe that those two measures were appropriate and necessary decisions for our business, strengthening our value proposition and our ability to grow at a strong pace. And of course, when we look at CapEx for the coming quarters, it should decrease substantially compared to the fourth quarter. Excluding the cash outflow from those two preemptive investments, full-year adjusted free cash flow would have been positive and at a similar level as full-year 2020 despite the negative headwinds and challenges we have highlighted throughout 2021. Excluding these investments, we are continuing to generate solid adjusted free cash flow while driving strong growth and investing in existing and new solutions. In the following slides, I will provide more detail about costs and expenses that drove our bottom line results. On Slide 17 and 18, we show our P&L for the quarter as reported on Page 17 and pro forma for Linx on Page 18. In order to provide more transparency and help investors better understand our results, we have included this quarter our adjusted P&L where we allocate the same adjustments we do for our adjusted net income metric into each line item in our P&L. As we provide a detailed analysis of each line item in our earnings release, including a discussion of the item, excluding Linx, and have already talked extensively about top-line, I will move directly to Slide 19 to focus on our cost and expenses pro forma for Linx. Although we continue to increase investments in our business, we are implementing and will continue to implement in 2022 more measures to better rationalize costs and expenses. We believe this is healthy for the business and for our culture of ownership. Compared with last quarter, we realized operating leverage in cost of services, administrative, and selling expenses, which were all lower as a percentage of revenue compared to the third quarter. Financial expenses as a percentage of revenue continued to increase this quarter as a direct result of the substantial increase in CDI, while we only started our waves of repricing in November. Starting with cost of services, we saw a 96% year-over-year increase in the fourth quarter, growing from R$329 million to R$646 million. As a percentage of revenue, cost of services increased from 26.4% in the fourth quarter of 2020 to 34.5% in the fourth quarter of 2021, an 8.1 percentage point increase. Within that increase, 3.7 percentage points was a result of the lack of credit revenue and 2.7 percentage points increase was driven by costs related to our registry business, which is a very early-stage business. It started operating in June 2021, and therefore, to negatively impact our margins. We also increased investments in technology, customer service, and logistics. Most of our costs tend to increase with the growth in our client base. We expect that as our registry business matures in the coming quarters, it should break even and start contributing positively to our pretax earnings. Also, we believe we can improve efficiency in costs related to data center, cloud costs, and other overall costs. Looking at administrative expenses, we have gained operational leverage both year-on-year and on a quarter-over-quarter basis. Administrative expenses grew 41.7% year-over-year to R$230.5 million, decreasing from 13.1% of revenue in the fourth quarter of 2020 to 12.3% of revenue this quarter. Main drivers of growth in this line are personnel expenses and third-party services. Although we are already seeing operational leverage here, we will seek additional efficiency as the business scales and we rationalize back-office expenses both in financial services and software. Our selling expenses increased 73.4% to R$318.4 million going from 14.8% of revenue in the fourth quarter of 2020 to 17% this quarter. This increase was mainly due to higher marketing expenses and investments in salespeople. We have been expanding our sales team in the hubs with a focus on increasing coverage density in existing regions. Compared with last quarter, selling expenses as a percentage of revenue decreased 4 percentage points, mainly due to operational leverage and slightly lower marketing expenses. We are constantly measuring the unit economics and payback of our CAC, and selling expenses are an important part of the calculation. Following the November and December repricing waves, our CAC payback of 8 to 13 months remains highly accretive and the reason why we continue to increase our selling investments compared to last year. Financial expenses were R$610.6 million in the quarter, roughly eight times last year's levels. This increase was mainly led by higher funding costs combined with the strong growth of our prepayment operations. Higher cost of funds is the result of a combination of several factors: first, a higher base CDI rate in the country, which increased from 1.9% at the start of the year to over 9% by year-end; also, there was some change in our capital structure with a higher percentage of third-party capital being used to fund our prepayment business; and finally, we had approximately R$90 million of financial expenses in the quarter arising from the sale of receivables to our new FDIC. As we have signed longer-duration receivables to this fund, the result was a higher-than-usual impact in the quarter. As we started to reprice our clients in mid-November, we are already seeing a recovery in profitability. And in the first quarter of 2022, that will be translated into higher overall margins for the business when compared with the fourth quarter. Now I would like to pass it back to Thiago so he can close the presentation with our 2022 priorities and outlook. Thiago, back to you.

Thiago Piau, CEO

Thank you, Rafa. As I mentioned earlier, and we announced today in a separate press release, we have taken important steps to reorganize the business and bring in new seasoned and talented people to strengthen our team. We believe this change will help us simplify the management of our operations, enable our team to focus and manage our bigger and evolving mission more effectively, and create greater strength and depth of expertise across our management structure. To highlight a few of these new appointments, Caio Fiuza, who is the Head of our Micro-Merchant business, TON, was appointed COO of our Financial Platform division. Gilsinei Hansen, previously the Head of Linx Core, was appointed COO of our software division, which encompasses our Linx business and Stone's portfolio of software solutions. João Bernartt, a former Board member of several retail companies in Brazil and Founder of Chaordic, has joined the Company as Chief Information Officer, leading our efforts in product, technology, and data with greater focus in the financial platform division. Sandro Bassili, former VP of People of Anheuser-Busch Inbev, is our Chief People and Management Officer, leading a big part of our organizational and management system changes as well as maintaining a focus on talent attraction, development, and retention, a hallmark of the Stone culture. Diego Salgado, former Executive Director in the LATAM debt capital markets team at JPMorgan, has joined our team in 2021 as Head of Treasury. In terms of the business reorganization, from the first quarter of 2022 onwards, we will report our financial results in three reportable segments: financial services, software, and other segments. We believe this will also provide more transparency to the market, helping investors to better understand the drivers behind our performance. Our 2022 priorities for each business are presented on Slide 20. In financial services, given the expected ongoing increases in the CDI in 2022, a key priority will be balancing profitability and growth through a more dynamic repricing strategy. We will continue to execute on our product road map to become the one-stop shop financial services solution for our MSMB clients. And in this rising interest rate environment, the banking strategy becomes even more compelling, as shown in our recent ARPU evolution. For this business, evolving our banking offering will also be a key focus this year. On top of this, we are, of course, focused on relaunching our credit offering in 2022. We are certain that credit is one of the most pressing needs of our clients and a huge opportunity for us. We also believe that we are well positioned to win in this segment given the proximity with clients built into our business model and the expertise we have through our over 100,000 clients to whom we have previously extended credit. In addition to relaunching our working capital solution in the second half of 2022, we're also building a business credit card and overdraft product for SMB. In software, most efforts will be concentrated on driving organic growth and margin improvement in the core, and we will continue to pursue selected strategic inorganic opportunities, an important part of our software growth playbook. We'll also focus on digitizing the core client base. As Lia discussed, we see an attractive opportunity to increase penetration of financial services across our software client base, with our initial focus being on payments and banking. We'll also begin to explore different models by which to leverage our distribution to scale our software solutions to SMBs. Finally, three elements will be key to a successful execution of these priorities; first, the evolution of our management structure and a strong team, which is underway, as I have mentioned; second, our continued investments in technology to advance our multiproduct strategy; and lastly, the discipline to maintain a strong balance sheet and liquidity levels. I would like to close with some specifics on our first quarter 2022 outlook for the business. We expect revenue growth to accelerate in the first quarter of 2022 with total revenue and income between R$1.85 billion and R$1.9 billion, representing year-over-year growth of between 113% and 119% or 67% and 72% pro forma for Linx. We expect revenue growth to be driven substantially by the growth of our MSMB business, projected to reach TPV between R$58.5 billion and R$60 billion, representing year-over-year growth between 79% and 83%. A net effect of the repricing waves initiated in the fourth quarter is expected to be a lower pace of net client additions in the first quarter. We expect to see an improvement in profitability with adjusted pretax earnings above R$140 million in the first quarter, coupled with ongoing heavy investments in our business. In summary, for 2022, we will continue to invest in our growth avenues and strategic priorities while improving our margins. With that said, operator, can you please open the call up to questions?

Operator, Operator

Thank you. At this time, we're going to open it up for questions and answers. Our first question comes from Jorge Kuri with Morgan Stanley. Please go ahead.

Jorge Kuri, Analyst

Congratulations on the quarterly results. There has been a nice improvement across the board. I have two questions, if that's alright. The first one is about the lending business. I remember discussions from last August and September where Andre Street and the management team mentioned transitioning the lending business to a distribution model that would rely on partners for the balance sheet and risk assessment, with your company handling the distribution exclusively. However, from what I gathered during today's call, it seems like that is not the direction and that you prefer to operate independently with your own risk and balance sheet. I want to confirm if my understanding is correct. If it is not, could you clarify how this will work? My second question is regarding your guidance for the first quarter, specifically concerning pretax income, which is projected to exceed R$140 million. Considering the typical seasonality, that figure would approximate around R$600 million, which is significantly higher than consensus expectations. As you assess the consensus for 2022, where do you believe the market is underestimating your potential for the year? What do you consider the primary areas of your business that the market might be overlooking?

Thiago Piau, CEO

Hello, Jorge, Thiago here speaking. Thank you very much for your questions. So regarding the credit operation, actually, we want to implement both models, Jorge, but we have to start in a model in which we have the origination in-house, we assess the credit risk, and then we sell to partners. So that's the first model because we want to make sure that in terms of the credit risk assessment, the way that we handle clients, the full life cycle of the clients we are executing within our plans, and then we have the ability to sell the client portfolio to partners that can bear the risks afterwards. So in both models, we have to make sure that the risk assessment is on the right track, but we will move to a model in which we distribute credit from third parties too. So we intend to execute both. But to make sure that the operation is working well, it's important to start originating in our own balance sheet and then selling the outstanding balance to third-party partners. I think that’s the best way to begin. Regarding the guidance, I will pass it over to Rafa. I think that Rafa can be helpful here.

Rafael Martins, VP of Finance and Investor Relations Officer

Hi, Jorge. Rafael here. Thank you for the question. The feedback we've received from investors over the past few months highlights two main concerns: the increase in CDI and our ability to reprice. This is a significant factor. Additionally, in the last quarter, investors lacked clarity on our costs and expenses, which is one of the reasons we provided more details in this call. Many of these expenses and costs are linked to our ongoing investments. Once these investments yield results, we anticipate increased profitability. I believe these were the two primary concerns. Furthermore, if you examine our guidance and revenue expectations, despite the weak seasonality in the first quarter, you won't see a substantial change compared to fourth quarter revenue. We've also shared details regarding our take rate, which may have alleviated some of those concerns reflected in our guidance. Those are our impressions.

Tito Labarta, Analyst

I have one follow-up on the margin guidance. And any color on how do you think that evolves from here as you continue to reprice merchants? And can you talk a little bit about the competitive environment to reprice those merchants? I mean you mentioned a little bit net adds should be a bit weaker next quarter perhaps because of that. And are you seeing a big difference between repricing SMBs and micromerchants? And then I have a second question on Linx, but maybe you can start with that one.

Thiago Piau, CEO

Thank you for your questions. We are currently focused on providing guidance for the quarter, and I can share that we expect our margins to continue to increase throughout the year, leading to improved bottom-line results. We are implementing a more disciplined approach to managing costs and expenses while heavily investing in our growth. We will allocate significant resources to our banking platform, credit platform, and the software unit we are developing, but with a more careful strategy regarding capital allocation and cost management. I anticipate this trend will persist throughout 2022. It's important to note that we are striving to balance profitability with growth. Beyond the guidance for our bottom line, we decided to showcase the results from the MSMB in January and February. According to Slide 7 in the presentation, we've already seen TPV growth in the MSMB of over 80% in those months. I'm quite confident in our guidance and in the team's ability to deliver the results we expect.

Tito Labarta, Analyst

That's helpful. Perhaps a follow-up on that. Regarding the take rate, which you mentioned in January is already above 2%. As you continue to reprice, how high do you think it can go? Yes, I mean, that's the main question. How much more can it increase as you continue to reprice?

Thiago Piau, CEO

Tito, we are seeing two things here. One is that we see competitors talking more about repricing in their own strategy. So I think that this is a trend in the market, and it's a positive trend. The second thing is that we are focused to use not only the repricing but the offering itself. So we created an offering. In TON, we adjust automatically with the SELIC improvements here in Brazil once we scale banking and have a more expansive balance for our clients, that money receives interest rates because we put that capital in investments in the Central Bank, and we receive interest rates on that outstanding balance. So, I think that more than just repricing the existing offerings, we think more offerings to our clients better align what we are doing with what is best for them. So we expect that we will continue to drive more profitability for the business, but with a mindset of aligning the strategy of the Company with what is best for our clients. And regarding competition, as you said, I think that everybody is being more rational in this challenging environment regarding interest rates. So I think that, that’s what we are seeing.

Tito Labarta, Analyst

Okay. Great. And then my question on Linx. You gave some good color there. I think you have about $5.9 billion in TPV from their clients. You continue to highlight around $200 billion addressable market. How much of that Linx TPV of the client base do you think you could potentially penetrate? Any color on the take rate you get on Linx' clients? And any update on when you think it becomes accretive since you had believed that last time?

Thiago Piau, CEO

Yes, Tito. Regarding Linx, I believe we are just starting to explore financial services within that client base. We have decided to share some numbers from our initial efforts. The take rate aligns more closely with the key accounts take rates presented separately. These larger clients are more aligned with that segment and the platform service compared to the sub-acquiring ones, which is why the take rate is more in line with key accounts. Beyond just entering the payments space, our initial steps have provided the payment solution from clients who have already used the test gateway within Linx. We are focusing on additional services leveraging the banking platform. PIX represents a significant opportunity for Linx. The combination of PIX, our bank accounts, and the Linx checkout process in stores could be a major opportunity for us. We are dedicated to developing projects and integrating the checkouts and point of sale at Linx with our banking and financial platform appropriately. We are seeing encouraging initial results, and we anticipate this growth to continue. We will share more information with you and investors as we progress. We expect this business to be accretive, as previously mentioned, although we still have investments to make. We are finalizing the shutdown process of the sub-acquiring platform, and I believe we are making good progress.

Tito Labarta, Analyst

That's great. And sorry for a follow-up question. Just one quick follow-up on the margin. Just to understand that, that would be the pretax margin that you guided for in 1Q, you think that continues to increase throughout the year?

Thiago Piau, CEO

Yes. That's what we are aiming here.

Sheriq Sumar, Analyst

I have a question on the financial expenses. We just wanted to get a sense as to how to think about for 2022; would 4Q '21 be a good jumping-off point, like assuming the rates kind of continue to grind higher, like, to say, around like 12-plus percent or something? And I do have a follow-up after that.

Rafael Martins, VP of Finance and Investor Relations Officer

Thank you for your question. The financial expenses are influenced mainly by two factors: the evolution of CDI and the growth of our prepayment business. Looking at our total payment volume for 2022, we expect it to continue growing, and in terms of CDI, the fourth quarter serves as a good reference point, with one notable exception mentioned in our earnings release. In the fourth quarter, we incurred about R$90 million in financial expenses due to the sale of receivables to our FDIC, with approximately R$60 million linked to longer-duration receivables. This particular element should not be factored into your full-year calculations. Beyond that, you can use the fourth quarter figures along with the CDI increase and our TPV growth for your projections.

Sheriq Sumar, Analyst

That's super helpful. My second question is on the loan origination. I just wanted to get a sense on the timing and the magnitude of how you would want to ramp up in 2022. And how much of that is incorporated in your 1Q 2022 guidance? What would be the revenue contribution if there's anything that's going to be in the first quarter?

Thiago Piau, CEO

Thiago here. Thank you very much for the question. First, I want to clarify that there is no credit origination included in our first quarter guidance. We anticipate beginning to test the product between the second and third quarters. As we assess the life cycle of our clients and the performance of the risk, we will adapt our approach. Therefore, we plan to take a more cautious stance. By the second and third quarters, we expect to have much more data to share with you regarding the tests conducted with our clients, but we will remain conservative in scaling the business. It's important to note that once we begin disbursing credit to our clients, we will apply a new methodology and will no longer rely on fair value. We will implement the accrual methodology for new credit disbursements, as previously mentioned. Consequently, we do not anticipate any disbursements in the first quarter, and this has not been factored into our guidance.

Sheriq Sumar, Analyst

Got it. I'm sorry, I just want to squeeze in one more. Can you give a sense of how the attrition has tracked so far in this quarter given all the price increases that you have done? And also like I know you kind of talked about the incentives of your banking products, but is there any kind of incremental cost that you would have to generate because of maintaining those clients on your platform while you increase your prices?

Lia Matos, Chief Strategy Officer

Thank you, Shariq, for your question. It's Lia here. Regarding attrition, we provided some insights on net additions and trends for the first quarter. As we implemented several price adjustments between November and January, we anticipated a slightly higher level of churn during this period, which is a normal consequence of these pricing changes. The majority of these adjustments occurred during this time, so we expect a one-time increase in churn impact in the first quarter. That's the overall picture concerning churn trends.

Thiago Piau, CEO

Yes. May I add?

Lia Matos, Chief Strategy Officer

Follow-up. Yes, yes. Go ahead.

Thiago Piau, CEO

Hi, Shariq, this is Thiago. I’d like to share some thoughts on that. When we talk about repricing, it consists of two parts: adjusting prices for new sales and re-evaluating our existing client base. We’ve noticed that while we are implementing higher pricing, our capacity to sell our products and the interest from our clients remains strong. We continue to add clients at a steady pace, and our investment strategies in our channels are performing well. We do anticipate some additional churn among our clients, but I’m feeling optimistic because the total payment volume from our MSMB clients in January and February is above 80%. This supports our confidence in the guidance we are providing and the trends we are observing. We are retaining the most valuable segments of our client base, and while we might lose a small part due to our pricing decisions, we’re comfortable with that. The overall impact on the company has been minimal. The services and products we provide to our clients justify this pricing move. I'm pleased to see the company effectively balancing repricing with our client relationships. We’re maintaining our strongest clients, which is reflected in the increase in total payment volume in the first quarter, and we remain confident in our guidance for this quarter. I’m satisfied with our performance in both new sales and our management of the client base.

Operator, Operator

Next question comes from Jason Mollin with Scotiabank. Please go ahead.

Jason Mollin, Analyst

My first questions are on the credit side. I mean I guess I understood the answer to the question that we should be waiting to the second or third quarter to get more of a sense of the timing and magnitude of the disbursements, but maybe you could give us some color on the sale of the distressed portfolio that was sold. I guess the data shows or what you released was that the price was over 2.5x the fair value. If you can give some comments on that, is that reflective of the portfolio payer pricing in general? And my second question would be a general question on the software business, particularly the core business that you talked about growing 20%. If you can talk about where you think you are in the market share there and where you think you're going with that 20% expected growth profile for 2022.

Rafael Martins, VP of Finance and Investor Relations Officer

Thank you, Jason. Rafael here. I will get your first question, and then I'll pass it over to Lia. Regarding the legacy credit, I think the legacy credit is performing as we expected. As we mentioned, we did that sale of that distressed portion of the portfolio to a collection company here in Brazil. It was above fair value. I don't think that if we look to the ratio, we should apply the same ratio to the whole portfolio. So the fair value that we have there in our balance sheet is a little over R$500 million. But what I can tell you is that the legacy portfolio is performing as expected. As we mentioned in our call, we are almost having a cash flow payback of all the disbursed amounts we had since inception. So, I think that what you'll see over time is that the legacy portfolio will continue to go down in terms of outstanding balance and as we collect the cash inflows from clients. So in the fourth quarter, it was a little over R$400 million, and we expect this to phase out over this year.

Lia Matos, Chief Strategy Officer

Great. Jason, taking the question on software. So we tried to provide a little bit more color disaggregating the software business and showing the core digital and the financial services part separately. And regarding your question on market share and how we see growth in the core, I think there's two big messages here. So our software position right now is very strong in the mid- to large clients. So we do have relevant market share in many different verticals in retail and services. We do see opportunity to continue to gain market share within the mid- to large client base, both organically and also inorganically either within the verticals that we are or in new verticals that are strategic for us. But there's also a second part of this, which is the big opportunity we see to grow software within the SMB, and that's where we believe a lot in leveraging our business model and our distribution capabilities because we think that the software market overall in the SMB space in Brazil is still very fragmented and underpenetrated, and there's a big opportunity there. So those are the two areas where we really see opportunity to grow and gain market share in 2022 and beyond. So we gave color on how we see growth ahead. We will focus a lot on those two movements this year. And we do see a lot of opportunities to continue to gain market share both in mid- to large clients and also SMBs.

Thiago Piau, CEO

Can I add comments? Jason, this is Thiago speaking. When we consider Linx's position within its client base, it holds a strong market share. In major Brazilian cities, Linx's presence is significant. Moreover, as Lia mentioned, there's a substantial opportunity in the SMB sector here in Brazil. I firmly believe that every merchant should leverage software to enhance productivity, manage their performance better, and optimize sales channels. This is a necessity in Brazil. Currently, there isn't a dominant player in this space, but Linx has established itself as a leader in the retail segment. Therefore, there is a considerable untapped market for providing merchants with straightforward solutions to boost productivity, which is our aim. We are dedicated to investing in our distribution, project implementation, and capabilities. I believe the opportunity in Brazil remains vast, and we will actively pursue this in the long term.

Antonio Ruette, Analyst

Can you hear me well?

Thiago Piau, CEO

Yes.

Lia Matos, Chief Strategy Officer

Yes.

Antonio Ruette, Analyst

I have a follow-up question regarding the churn rate in relation to the prepayment and the repricing of the premium product. Could you provide a breakdown of how different segments have responded to this repricing?

Thiago Piau, CEO

Antonio, Thiago here. So as we said, we saw churn a little bit higher, not something that we are too much worried about. The segment that we saw the churn increasing a little bit was the clients with TPV from zero to R$5,000 a month. So that was the segment that we experienced, a little bit bigger increase in churn, but it's not something that we are really worried about. I think it happens when you do this type of repricing in the client base. However, we do not expect the change will be on high levels. And actually, what we are seeing now in February, March, the churn already got back to the levels we were used to. So there is a big movement now as pricing is a much more dynamic component in our operations. With pricing and repricing, I think that this will not be something that will impact too much our ability to grow.

Antonio Ruette, Analyst

All right. Super clear. Now on a broader question. Well, you have a very tough year. So you had impact from your credit product, the pandemic, the rest of receivables. I would ask you, what were your main learnings from this year? What do you believe it is wrong? What it is right? And after all this, what are the main issues do you think should still be addressed in 2022?

Thiago Piau, CEO

Great question, Antonio. I tried to talk about this at the beginning of the call, and I wrote about this in the letter, myself, with the team. But I think that we tried to do too much last year. We took an aggressive approach towards the growth of the business and the many initiatives that we had at the same time. And in the end of the day, I think that we lost a little bit of focus in our execution. So we regrouped with the team. We brought more experienced people close to us where we can learn from. We are very focused on the core strength of our business. And I really believe in what we are executing here. And I think that the team is focused on a very different year in 2022. This type of year that companies pass, and we had our in 2021, which is difficult, I think that it changes the way you see the business, and you learn a lot from them. So in one way, I'm happy that we learned. It was a good experience. Now we have to move on, execute what we believe, and build this business, which is an amazing business that we love and we are putting all of our efforts here. So we learned. We changed, and let's move forward for 2022.

Antonio Ruette, Analyst

Yes. Just a follow-up on this. Do you believe there are structural issues that still need to be addressed? Are the foundational elements for your credit product, other financial products, and our software products in place, and is it now just a matter of execution?

Thiago Piau, CEO

The only structural part we are seeing is the macro environment. So we know that the environment in Brazil and actually across the globe is not a very easy environment. We are seeing interest rates moving up faster than we were expecting. We are not expecting this new impact that we are seeing, but we learned to be more dynamic in the way that we see the environment and the way that we act on the environment we have in front of us. So I think that we are much stronger structured regarding the macro environment and interest rates. The other part, I think that we have the execution now on track, good leaders in place. We have the assets and the team we wanted to have. Now it's a matter to execute and deliver on our results.

Neha Agarwala, Analyst

Congratulations on these results. The first question is on the repricing effort. It's really good to see the numbers above 2% for January, very encouraging. Have you been able to reprice and pass on all of the higher cost of the customers or maybe only a part of it, which we're seeing in the higher take rate? And which segment has been easier to reprice, the micromarket or the core SMB market? And then I'll ask my second question.

Lia Matos, Chief Strategy Officer

Thank you for the question, Neha. Regarding repricing, we conduct our processes in waves and do not follow a standard approach across all clients. We select different groups of clients and determine the appropriate level of repricing based on each specific group. There is extensive testing before we implement any pricing changes on a large scale. Therefore, there isn't a simple answer about which clients are easier or harder to reprice. We aim to be methodical rather than do everything at once, which is why we began in November and completed the necessary repricing waves by January. As Thiago mentioned, it's a very dynamic process. Most of the repricing waves occurred during this period, but we anticipate a more dynamic process going forward as the interest rate environment remains consistent throughout 2022.

Neha Agarwala, Analyst

And when you reprice, on average, how much of the higher funding costs have you been able to pass on to the customer? And how much are you observing? I understand maybe from a margin perspective, it doesn't have a similar impact. But just trying to understand how much of the higher prices you still maybe have to bet on average.

Rafael Martins, VP of Finance and Investor Relations Officer

Neha, Rafael here. So we are now passing along the CDI increase to clients. And I think one important element is what we focus and what we look at when we do repricing is we look at the unit economics of clients, and we try to balance this with a healthy level of growth. So in some cases, when we look at payback returns, sometimes it doesn't mean necessarily that passing along 100% is the best outcome. So in many clients, we are doing that. But what I can tell you is we are balancing the unit economics to have a healthy payback level, but also a healthy level of growth. So I think this is the way we think internally and how we are dealing with that dynamic environment, as Lia mentioned.

Thiago Piau, CEO

Rafa, Thiago here. Can I add something? I want to make one more point about pricing at a high level. The Company should not only focus on pricing or payment solutions. Once we enhance client engagement with our banking platform and increase outstanding balances, they will utilize our cash-out methods and use our cards for purchases. We are currently working on developing credit cards for small and medium-sized businesses. As we improve software distribution to these businesses, the conversation with clients shifts significantly. You're not just repricing an existing product; you're offering them a more attractive deal. This is where our long-term focus lies, aiming to establish a fundamentally different relationship with clients beyond just prepayment solutions. In the short term, we are adjusting prices and passing along the CDI, but we are doing so in a way that maintains a strong relationship with our clients.

Neha Agarwala, Analyst

Understood. My next question is on the margin improvement that we should expect during the year. And not 100% clear. Could you give us some numbers or some sort of range to understand how much of a margin expansion are we talking about over here? And if you're looking at an adjusted pretax margin level or an adjusted net income margin level because if I look at the adjusted net income margin for the year, it was 4%? So what range should we look at for 2022? If you can just clarify that, that would be very helpful. And then lastly, any update on TAG. I understand you might want to do a partnership or share some stake in TAG. So any update on that would be very helpful.

Rafael Martins, VP of Finance and Investor Relations Officer

Hi, Neha, thank you for your question. To clarify, the guidance we provided for the first quarter was based on pretax earnings. This is in contrast to the R$17 million of adjusted pretax earnings from the fourth quarter, which had a margin of 0.9%. When considering the R$140 million top line guidance we shared, you will notice that it represents approximately a 7% margin. This is the guidance for the first quarter. We believe that focusing on pretax earnings offers a clearer perspective on operations, which is why we did not present adjusted net income, as that includes a tax rate. I just wanted to clarify what that figure truly signifies.

Neha Agarwala, Analyst

So, around a pretax margin of around 7% for the year and maybe gradually improving in the remaining quarters?

Rafael Martins, VP of Finance and Investor Relations Officer

So as Thiago mentioned, we are not providing guidance for the full year at this moment. What Thiago mentioned is that we expect to continue improving our margins over time, right? So this is sort of the message we are conveying at this moment.

Thiago Piau, CEO

Neha, Thiago here speaking. So just a comment on that. I think that the margins we are guiding for the first quarter, they are far away from the stabilized margins that we expect to have in the business. So this margin should improve by the way that we execute and as the business matures. So we continue to invest heavily in our growth in a strategy that we believe. But now you will see those margins increasing. So we decided to give the guidance for the first quarter. I think that that's the first step. And then we will help you to frame better. Once in the first quarter we provide more numbers on the two business segments we have, the two business units, I think that the levers will be much more clear. And we are planning a session to be helpful to the market to frame the levers and forecast the business better on your end. Regarding TAG, what I believe is that the infrastructure of the registry system is really important for credit for SMBs. We are a little bit frustrated that, that didn't evolve well nationally in Brazil last year, but we still believe that this can be a big change in the way that SMBs can access credit in Brazil, and they really need that. But in order to decrease the risk, the system has to be working well. So I think that there's a good value in what the team builds. I think that the technology that we built is a very good technology. We still see problems in terms of governance between the registries and how the environment is working. So we're assessing the strategic options here we have. And regarding the financial impact, we expect the target achieved breakeven this year. So I think that from 2022 onwards, the financial impact in TAG will not be a burden, but we will continue to provide our efforts to make the National Registry System work. And I believe that the team is doing a pretty good job in terms of technology. So we will keep improving our work on the registry front.

Operator, Operator

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

Thiago Piau, CEO

Hello, everyone. Thiago here. Just final comments here. We are now in a high energy momentum with the changes that we are doing in the business and we're doing it with the learnings. We had from last year really focused on the front line of the business, our clients, our product road map. We're really passionate about what we are building our mission. And thank you very much for your time to follow our call and see you next quarter. Bye-bye.

Operator, Operator

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