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Edited Transcript of LINX3.SA earnings conference call or presentation 15-Aug-19 6:00pm GMT

Q2 2019 Linx SA Earnings Call

Sao Paulo Sep 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Linx SA earnings conference call or presentation Thursday, August 15, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alberto Menache

Linx S.A. - CEO & Vice Chairman of the Board

* Alexandre Kelemen

Linx S.A. - IR Officer

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Conference Call Participants

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* Daniel Federle

Crédit Suisse AG, Research Division - Research Analyst

* Guilherme Haguiara

Banco Bradesco BBI S.A., Research Division - Research Analyst

* Marcelo Peev dos Santos

JP Morgan Chase & Co, Research Division - Senior Analyst

* Maria Tereza Azevedo

UBS Investment Bank, Research Division - Director and Research Analyst

* Susana Salaru

Itaú Corretora de Valores S.A., Research Division - Sector Head, Telecommunications, Media & Technology

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and thank you for waiting. Welcome to Linx Second Quarter 2019 Conference Call for the results of the second quarter 2019.

With us here today are Mr. Alberto Menache, CEO; Pedro Moreira, CFO; and Alexandre Kelemen, Chief IR Officer of the company.

We would like to inform you that this event is being recorded and simultaneously translated into English. (Operator Instructions)

This event is also being broadcast live via webcast and may be accessed through Linx' website at ri.linx.com.br, where the presentation will also be available. Participates may view the slides in any order they wish. The replay will be available shortly after the event is concluded.

Before proceeding, let me mention that forward-looking statements about future events, operating or financial results -- operating and financial results, as said, are based on the beliefs and assumptions of Linx management as well as on information currently available to the company. Future considerations are no guarantee of performance as they involve risks, uncertainties and assumptions as they refer to future events, and therefore, depend on circumstances that may or may not occur. Investors and analysts should understand that macroeconomic and industry conditions, in addition to other factors, could also cause results to differ materially from those expressed in such forward-looking statements.

Now I'll give the floor to Mr. Alexandre Kelemen, who will begin the presentation. You may proceed, sir.

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Alexandre Kelemen, Linx S.A. - IR Officer [2]

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Good afternoon, everyone. I would like to start by talking about a study recently published by IDC, as depicted on Slide 3, that shows that the Brazil's total addressable market of retail software reached BRL 10 billion in 2018, up 5.9% vis-à-vis 2017 with penetration of 1.3% in that market. In this regard, our market share in 2018 was 42.2%, up 90 points over 2017.

I think it is also important to highlight that since the beginning of the survey in 2012, to date, Linx market share grew almost 15 percentage points. In our view, the study shows that the market for retail solutions continues to present a solid base to promote a significant growth in Brazil, mostly because its strategic position to serve retailers and Linx is much better positioned to capture all the opportunities that arise as the market evolves because we focus on the development and supply of affordable software solutions that are easy to use, reliable and totally integrated through an end-to-end platform.

Now in regards to our results in the second quarter, we noticed that the main trend this quarter was the increase in retailers' willingness to become omnichannel, something that Linx can provide through our Linx Digital offering, which provides seamless integration between online and offline channels. To that end, we signed 2 other new OMS agreements with Nike and Alpargatas. In addition, our e-commerce platform reached approximately 1,000 active websites. In the same scenario, financial service offerings continue to post a robust growth mainly due to the adoption of TEF and a continuous increase in our portfolio of solutions like, for instance, the digital account and QR codes launched this quarter.

As we can see on Slide 4, recurring revenue was BRL 188 million, accounting for 86% of gross revenue, up 14% when compared to second quarter 2018 and up 4% vis-à-vis first quarter '19. I would like to highlight also that as of the second quarter, revenues from royalties are now deferred in 36 months, which led to the slowdown in the recurring revenue recognized in the quarter.

Now on Slide 6, we show that adjusted EBITDA totaled BRL 48 million in the quarter, up 19% in relation to second Q '18 and plus 4% regarding 1Q '19. Adjusted EBITDA margin in the period was 24.9%, up 140 basis points in relation to Q2 '18. This was mainly due to the adoption of IFRS 16, coupled with operating leverage of investments and acquisitions in previous quarters as well as in Linx Pay Hub and Linx Digital structures, which continued to grow the addressable market into new markets and geographies.

And that -- and to conclude, I would like to remind you that this quarter, we initiated the provisioning for the long-term incentive linked to the 5-year goal of Linx Pay as approved by the general assembly this year. This provision generated a negative cash effect of 120 points in the EBITDA margin in the second quarter.

I would like to thank you all for your attention, and now we open the session for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Susana Salaru from Itaú.

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Susana Salaru, Itaú Corretora de Valores S.A., Research Division - Sector Head, Telecommunications, Media & Technology [2]

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Could you please comment on the TPV evolution? And next, if you can elaborate a little bit about the competition market, whether you feel any difference in terms of the competitive environment.

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Alberto Menache, Linx S.A. - CEO & Vice Chairman of the Board [3]

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This is Alberto. TPV, in the case of Linx Pay of our sub-acquirer, at the moment, it has superseded BRL 2 billion in annual terms. There is one important thing to mention about that, which is that it took us about 5.5 months since the launching of Linx Pay until our last call to reach BRL 1 billion. In terms of annualized TPV, I think now it's been a little over 6 months.

But now in a much lower period of time, we were able to reach the second BRL 1 billion already [and now hired]. And this shows an extensive adoption of Linx Pay in our base and also shows that our sales force has managed to show the value of the offering. And finally, I must say that we are very pleased because everything is happening according to plan.

Now in regards to the competition, Susanna, competition, we didn't see any changes in the landscape. We haven't noticed anything different in the day-to-day operations with our customers. Our renewable rate was up. It grew. Therefore, we are in a very comfortable position.

But let me just take advantage of your second question and say that it's important to highlight that Linx competition is isolated because we have one specific competitor, which is a management software for a certain vertical or sometimes we have a certain competitor linked to a financial product or even we could have a particular competitor for an online product.

But we are not aware of any other player in the market that has the same value proposition that we have, which is like an end-to-end platform, meaning that not only we can serve retailers offering all the technologies they need for today and as well for the future, but we can do that in an integrated fashion, meaning that they don't have to hire a third company to connect the services.

And in addition, there is only one point of contact and that is Linx. Therefore, any problems or any questions, they would only go to one company that can provide the same service and support. And this is something very distinctive of our value proposition.

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Susana Salaru, Itaú Corretora de Valores S.A., Research Division - Sector Head, Telecommunications, Media & Technology [4]

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Okay. Very good. Now going back to TPV and Linx Pay because you said that you just reached BRL 2 billion, and that amount was reached much faster than expected. Could you share with us what is your growth speed week-on-week? And what do you envision today?

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Unidentified Company Representative, [5]

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Well, we don't disclose this figure because this figure carries a slight volatility depending on the customer profile on a weekly basis as well. But in this last quarter, there was an increase. Every week, we were able to capture a slightly higher volume when compared to the week before. And that's why the speed was faster this time when compared to the previous period.

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Operator [6]

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Next question from Guilherme Haguiara from Bradesco BBI.

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Guilherme Haguiara, Banco Bradesco BBI S.A., Research Division - Research Analyst [7]

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My first question is about your organic revenue. We saw that your recurring revenue grew vis-à-vis the first quarter. But now considering the other factors, how do you see progress in your organic revenue in the quarter? And what is the speed of growth that you've been experiencing? And again, what are the main sources that can be further exploited?

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Unidentified Company Representative, [8]

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Guilherme, thank you for your question. Well, recurring revenue continues to grow in a very healthy way. But once -- I mean we are relying a lot of cross-selling -- relying on cross-selling from new acquisitions and also organic growth. And therefore, we haven't seen an upturn in terms of retail growth.

The main reason for growth is related to cross-selling, is related to new initiatives and the new acquisitions. Our organic growth was 9% this period vis-à-vis the same period of last year. There is the small effect due to the new accounting standards that reduced that growth a bit. The revenue is now being deferred in 36 months rather than deferring it in a much shorter period. So this is a small margin [over the fact] that brought growth down a bit.

And in terms of new initiatives, Hiper is moving quite well. The Hiper recurring revenue growth is very much in keeping with our expectations. We were able to integrate TEF at Hiper's product right at the base, and we initiated TEF's sale to that client as well. Therefore, despite the fact that growth hasn't picked up yet, it has been consistent.

Just to clarify one aspect. With the new accounting standards from this last period -- yes, I'll better refer to IFRS 15 related to royalty revenues that is now being deferred in 36 months. Yes, we used to defer in a year's time. And as royalty and other service revenues, it's recognized -- used to be recognized as soon as the service was rendered.

And that's why as we have -- we had an increase in deferred revenue and a reduction in royalty revenues. So due to the accounting effect, this impacted the growth of revenue and also impacted organic growth on the negative side. But this is purely an accounting effect rather than related to the performance of the company.

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Guilherme Haguiara, Banco Bradesco BBI S.A., Research Division - Research Analyst [9]

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Okay. I just have a second question, if you allow me, in regards to your cash position, which is quite considerable after the June offering. What could you share with us in terms of pipeline in general? What would be the main possible targets? And once we look at organic investments, what's in your pipeline in terms of opportunities that will demand higher investment so that you could put that cash to work?

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Unidentified Company Representative, [10]

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Guilherme, we usually say that it would take us between 2 to 3 years to use the proceeds or the cash just like in previous rounds of IPO and follow on. Usually, this is the period of time that we estimate for the use of the proceeds. But it's also important to say that this outlook still remains. We acquire Hiper and Millennium in the first half of the year and we had to -- well, we used, I would say, approximately BRL 160 million in a single half year.

But this is totally online with the amount of proceeds and the time that we allot for the use of the proceeds. So we'd like to see -- to look at new things, to look at new technologies. We've seen technologies that can help shape the future. So these are the things that we favor the most.

There may be some other things related to portfolio additions, et cetera, but what we are looking the most are new technologies. And our main M&A focus -- or almost 100% of our M&A focus is in Brazil. We are looking at one or other things outside, but that's not a short-term priority, therefore, our main focus, 100% of it is currently in Brazil. And in different verticals, like technologies -- different technologies and different geographies as well. So do you have any more questions about that?

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Guilherme Haguiara, Banco Bradesco BBI S.A., Research Division - Research Analyst [11]

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No. That's perfect. It's very clear.

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Operator [12]

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Next question from Marcelo Santos from JPMorgan.

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Marcelo Peev dos Santos, JP Morgan Chase & Co, Research Division - Senior Analyst [13]

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My first question. Could you elaborate a bit more on TPV monetization? I think it's early maybe, but I think you already have a considerable amount of TPV. I mean what could we envision? I mean how do you think this will evolve? It will start lower and then will -- it will grow? I mean -- whether you can tell me anything.

The second question relates to the Omnichannel conversion of the projects into revenue? I mean your service revenue was quite strong related to the deployment of Omnichannel. Therefore, I -- this seems to be a leading indicator that this will be converted into recurring revenue because at a given moment, these projects do generate more revenue. And so what could we expect looking forward?

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Unidentified Company Representative, [14]

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Well, first of all, about TPV's monetization, today, as we are a sub-acquirer, we leave an important toll in the hands of the acquirer. Our price is put on top of the acquirer's price. And in the future, if it makes sense for us to become a full acquirer, then we will monetize the difference.

But today, we are putting more volume in-house. We are showing what we can do in terms of service, and we are more concerned in creating something different and also to show that, that's a good solution that we can provide an outstanding service level rather than being concerned with last-minute details related to the bottom line because this is something that will come naturally with time.

And we also believe that the business will be quite profitable, not just profitable through MDR because the trend of MDR is downwards. But there are things that will be monetized, starting with prepayment of receivables, the digital account, the issuance of the Linx card, where the -- we will collect from the interchange revenue, and the interchange revenue is the best revenue from the entire card business. This is a revenue that is not coming down, but on the contrary, is growing.

Therefore, I don't have any more details to give you at the moment. But what I can say is that, today, profitability is low in terms of cost of goods sold, but it will increase with time.

Now in relation to Omni, our first project was with Centauro. And I think it's about 2 years old or -- give or take, about 2 years. When we started, there was a large service revenue, but after the rollout, we start getting recurring revenue. Therefore, at the moment, the trend is that service revenue would slow down and recurring revenue would grow faster. That's the trend.

But now when we look at Linx' recurring revenue as a whole, one of the lines that is growing the most is Omni's recurring revenue. But we still have a large backlog of stores that are yet to be activated. There are new customers that joined in, and this activation will occur.

Now based on the customer space (inaudible) just released their results last night. And if I'm not mistaken, they just said that they concluded the rollout of OMS, the omnichannel. So this is something that will come with time. And we have to keep up with the customer. There is a limit to how far we can go because it depends on a lot of internal processes, a cultural change. Therefore, we have to mind what is happening on the side of the customer.

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Marcelo Peev dos Santos, JP Morgan Chase & Co, Research Division - Senior Analyst [15]

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Alberto, I just have a quick follow-up. In relation to the inventory of stores, how much of the rollout has been done? And just give me an update now considering the new customers.

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Alberto Menache, Linx S.A. - CEO & Vice Chairman of the Board [16]

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We don't have this number right now, Marcelo. I think we're talking about 8,000 stores to be rolled out between the half to the end of next year.

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Operator [17]

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Next question from Daniel Federle from Crédit Suisse.

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Daniel Federle, Crédit Suisse AG, Research Division - Research Analyst [18]

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My first question relates to the capitalized [P&D]. I would just like to know whether this is a one-off situation or the level of Q2 is recurring and it should be [solved] for quite some time. And the second question is about TPV from Linx Pay. I think you signaled that by the end of the year, on an annual basis, it could reach something close to BRL 10 billion. But the things we saw on Q2, does it still suggest that, that figure is feasible or you are revisiting that number?

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Unidentified Company Representative, [19]

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Federle, I don't recall giving any other different number other than the number that we have as our target for the next 5 years. What I can say is that things are moving as planned. But more than that, I cannot disclose at the moment.

In terms of capitalized R&D, and this is something that was mentioned during our road show, we raised funds mostly to M&A but not solely to M&A. Therefore, we understand that we can still promote a lot of organic innovation, particularly in regards to financial services and means of payments, et cetera. And this is a development that takes place relatively quickly. And it's not very costly, especially when we compare to a possible M&A.

There are many fintechs that have been knocking at our doors, they are either for sale or they are looking for investors. So when we look at this trade-off between acquiring something in the market that relates to technology or maybe develop it internally, and when we look at the return on investment, or ROI, we are choosing to do it internally because it's better. Therefore, we will maintain investments at high levels. And so this level should not be reduced anytime soon.

Just as a reminder, for the first time, we released part of our capitalized investments. And I would like to say that they are earmarked for the future. As Alberto said in one of the answers to a previous question, the trend towards net MDR is that it will be close to 0. So we want to be successful.

And if we want to link our goals to Linx Pay financial services, we have to continue launching disruptive products, just as disruptive as the products that we have launched in the past, and I'm referring to the digital account that we will monetize it through the floating end use of -- and the QR codes.

And as we repeatedly said during the road show, we believe that this is the future of credit card use, reminding us well that for -- many times we said that we intend to launch more products in the next 5 years that will compensate for the drop in net MDR.

So in order for us to maintain that launching level, not only for financial services, but also for Linx Digital and at a lower extent, to other existing products of Linx Core, this requires major effort to send most of our on-premise products into the cloud. And to do that, we have to keep up with our level of investments and innovation, which is translated into capitalized investment.

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Operator [20]

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Next question from Maria Tereza Azevedo from UBS.

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Maria Tereza Azevedo, UBS Investment Bank, Research Division - Director and Research Analyst [21]

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I just have a follow-up question related to Marcelo's question. It's about the Omnichannel project and how do you intend to monetize them in recurring revenues in the future, but not only in revenues, but in of -- in EBITDA. Do you see that these -- do you think that these projects will have similar margins when compared to what you have in your core business and the same thing will go for the Linx Pay services?

Today, the margin levels you have, not only in terms of CapEx, but also related to other financial service revenues, do you think that this will have a positive impact on the margins of the company in the mid to long range? Or this strategy would be to use the excess margin generated from these services to invest in research and development? So how should we look at margins going forward in different types of growth opportunities?

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Unidentified Company Representative, [22]

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Maria Tereza, thank you for your question. First of all, both Linx Pay in the case of TEF and gateway and OMS, in -- have to consider the softer dynamics, which is highly scalable because once the product is developed, whatever I get in terms of recurring revenue will be all -- be turned into margin. Therefore, once I overcome the barrier of fixed cost, particularly regarding OMS, which is a newer product, everything else that I scale up, it's turned into margin. In the case of TEF, which is already a very profitable product and the other one was launched more recently, so it still needs to go through the maturity curve.

But looking at the margin of the company as a whole, I will just tag along your question. Our culture to invest the excess margin into new initiatives that can generate new avenues of growth. So even if in theory, we could increase the overall margin of the company, our trend is to use this excess to continue growing and to expedite our growth as well.

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Operator [23]

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(Operator Instructions) Our next question comes from Guilherme Haguiara from Bradesco BBI.

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Guilherme Haguiara, Banco Bradesco BBI S.A., Research Division - Research Analyst [24]

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Now my new question is related to EBITDA. We notice a faster growth of your sales expenses or G&A considering IFRS 16, and you even talked about investments in your sales teams and your compensation -- or long-term compensation plan. But I just want to get a bit more color. How much longer should we expect this pressure to last? And in relation to investments in your sales teams, how would these lines behave looking -- going forward, they may be also going into next year. What would have happened if you -- if we were to disregard the adoption of IFRS 16 this quarter?

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Alexandre Kelemen, Linx S.A. - IR Officer [25]

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Guilherme, this is Alex. Well, first, G&A, as I said before, this quarter, we started to include long-term EBITDA that was approved in our April General Assembly in line with that TPV target of BRL 100 million. And as this was only approved in our General Assembly of last April and even though we already started working on it in January, we posted the entire first quarter into the second quarter.

In terms of long-term incentives in the calculation with no cash effect in long-term incentive had an impact of 120 points in the EBITDA margin. And this decrease our possibility of operate -- of having another impact in the margin. So that's why the revenue was a bit lower.

In terms of sales expenses, you are right when you talked about a slowdown year-on-year, and this is very much related to Linx Pay and Linx Digital because they were both launched in the second half of

(technical difficulty)

And therefore, this required more investments during the second half because when Denis took over the TEF area, he started with 5 employees. But today, there are a little bit over 200. This entire team came from acquirers and also from banks. So this is the team that is the core of our platform of financial services, and they are the ones that are supporting the launching of new products and also, the sale of products going forward. But then if you look on a quarter-on-quarter basis, we see a slight operating leverage, which demonstrates the success of both initiatives, both Linx Digital and Linx Pay.

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Operator [26]

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(Operator Instructions) We now conclude the Q&A session. I turn the floor back to Mr. Alberto Menache, CEO of Linx, for his final remarks.

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Alberto Menache, Linx S.A. - CEO & Vice Chairman of the Board [27]

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I would like to thank all of you for joining us and also, I would like to thank you for all the attention you gave us during our road show in the U.S. and also in the follow-on in Brazil. And the outcome of that was a very successful offer with important primary funding for the company. And Linx, therefore, became the first software company from Brazil listed in the U.S. Therefore, thank you all very much and have a very nice afternoon.

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Operator [28]

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Linx conference call is now concluded. Thank you very much for participating and have a pleasant afternoon.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]