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Edited Transcript of PAGS.N earnings conference call or presentation 19-Nov-19 10:00pm GMT

Q3 2019 PagSeguro Digital Ltd Earnings Call

Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of PagSeguro Digital Ltd earnings conference call or presentation Tuesday, November 19, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Eduardo Alcaro

PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director

* Ricardo Dutra da Silva

PagSeguro Digital Ltd. - Executive Officer & Director

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Conference Call Participants

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* Bryan Connell Keane

Deutsche Bank AG, Research Division - Research Analyst

* Craig Jared Maurer

Autonomous Research LLP - Partner, Payments and Financial Technology

* Daer Labarta

Goldman Sachs Group Inc., Research Division - VP

* Daniel Federle

Crédit Suisse AG, Research Division - Research Analyst

* Domingos Falavina

JP Morgan Chase & Co, Research Division - Head of Latin America Financials

* Jeffrey Brian Cantwell

Guggenheim Securities, LLC, Research Division - VP and Analyst

* Josh J. Beck

KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst

* Mario Lucio Pierry

BofA Merrill Lynch, Research Division - MD

* Rayna Kumar

Evercore ISI Institutional Equities, Research Division - MD

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Presentation

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Operator [1]

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Hello, everyone, and thank you for waiting. Welcome to PagSeguro Third Quarter 2019 Results Conference Call. This event is being recorded. (Operator Instructions) This event is also being broadcast live via webcast and may be accessed through PagSeguro's website at investors.pagseguro.com, where the presentation is also available. Participants may view the slides in any order they wish. The replay will be available shortly after the event is concluded. Those following the presentation via webcast may post their questions on PagSeguro's website.

Before proceeding, let me mention that any forward-looking statements included in the presentation or mentioned in this conference call are based on the currently available information and PagSeguro's current assumptions, expectations and projections about future events. While PagSeguro believes that their assumptions, expectations and projections are reasonable in view of currently available information, you are cautioned not to place undue reliance on these forward-looking statements. Actual results may differ materially from those included in PagSeguro's presentation or discussed on this conference call. For a variety of reasons, including those described in the forward-looking statements and risk factor section of PagSeguro's registration statements on Form F-1 and on the filings with the Securities and Exchange Commission, which are available on PagSeguro's Investor Relations website.

Finally, I would like to remind you that during this conference call, the company may discuss some non-GAAP measures. For more details, the foregoing non-GAAP measures and the reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures are presented in the last page of this webcast presentation.

Now I will turn the conference over to Mr. Ricardo Dutra, CEO. Mr. Dutra, you may begin your presentation.

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [2]

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Hello, everyone, and welcome to our third quarter results conference call. Tonight, I have here with me Eduardo Alcaro, our Chief Financial Officer, and André Cazotto, our Head of Investor Relations.

Before we get started, we would like to reiterate that we continue to focus on the long-tail market taking advantage of being the first mover, having a complete digital banking ecosystem, the most recognized brand and the UOL online distribution, which, in our view, are unique and unreplicable strengths to operate in long-tail market. Therefore, we have delivered in this quarter the same consistent performance we have been delivering since our IPO, healthy net adds growth and stable take rates, with EPS accretion. In addition, we are now seeing higher adoption of new banking products and services generating more engagement as we continue to invest in new initiatives through marketing campaigns, product development and people.

Now, we start our presentation highlighting the achievements of the quarter. Starting with our results. Non-GAAP net income to reach BRL 390 million, up 34% year-over-year, with a net margin at 27%. Our adjusted net revenue reached BRL 1.4 billion, up 42% year-over-year and our net take rate ended at 3.17%.

Moving to our operating figures, our TPV reached BRL 29.4 billion, up 45% year-over-year, closing the quarter with 5 million active merchants, adding 1.2 million when compared to the third quarter 2018 and adding 305,000 quarter-over-quarter. These figures reinforce not only that we are on the right path with a broad ecosystem but also our execution capability.

Now moving to PagBank, we ended September with 1.9 million PagBank active users, which means the use of at least, 1 additional product or feature beyond acquiring services in the last 12 months. In addition, we are seeing strong adoption of PagBank features such as mobile top-ups, an increase of 89% quarter-over-quarter, and 72% growth quarter-over-quarter in bill payments. PagBank also posted in the quarter a 53% increase in TPV from prepaid cards year-over-year, showing higher adoption of our clients in our issuance strategy. Finally, PagSeguro has proven that operating and winning the long-tail requires an online and mobile approach that is totally different from the traditional acquiring business model and new competitors that were attracted to the market after our IPO. We operate in a brand-new market that we created, and we still have a long way to go, constantly putting into practice our vision to disrupt and democratize financial services through technology and innovation.

Moving to the next slide, we show our mission. Today, almost all economic activity has been impacted by the Internet. One of the last industries to resist was banking. But now banking is changing. The Internet is finally transforming banking. To be competitive in this new banking era, companies must have a tech DNA, understand local needs and deal with local governments and local regulators. But most important, probably the unbeatable advantage, they must be the first mover. They must have the first mover scale advantage. PAGS is the most well positioned player, once PAGS is local, PAGS is tech and PAGS is the first mover.

On Slide 5 PAGS is leading the digital transformation and democratizing financial services. Brazil already has a solid infrastructure, with 3G networking covering 98% of the Brazilian population and 97% already counted with 4G coverage. The smartphone penetration in the country reached 71% of the Brazilian population. When it comes to global Internet figures, Brazil is one of the most relevant countries, being the fifth largest country in number of Internet users, fourth in time spent on Internet and second in time spent in social media. When it comes to our relevant and unique positioning to capture this digital transformation, it is worth to remind that UOL has 88% Internet audience coverage in the country, with a 108 million unique monthly users as of August 2019. Additionally, PAGS continues to have the largest brand reputation in the market, having 6x more Google searches than the second largest player.

Moving to next slide. We believe PAGS is well positioned and with a robust ecosystem that combines payments, lending, banking and software products to serve our active unique users and new customers we will acquire in the future. By upselling new products like credit, banking and software and expanding our approach to consumers, we will multiply our market. Considering the new initiatives already available for merchants and consumers, we estimate the revenue pool is almost 14x larger than payments market. According to IBGE and Brazilian Central Bank, there are 68 million unbanked people in Brazil. Additionally, 28 million of the low-income population do not have a bank account and 57% of the population are interested in adopting digital banks. Still, 40% of the paychecks are paid in cash, 65% of the bill payments are also made in cash and, finally, 51% of the new bank accounts are opened just to receive payroll checks.

On Slide 7, we show the leadership of PagBank as a digital bank in Brazil, according to Google reports. We ended the quarter with 62% of the total shares over digital banks, more than doubling our share when we started our campaigns back in May 2019, showing the importance of our marketing efforts and the strong brand reputation already [conquered] in the market. Additionally, our app was rated at 4.8 stars in iOS and 4.6 stars in Android, being the most reviewed and best rated app among digital banks and payment peers, also a consequence of our best-in-class product development and user experience-oriented strategy.

Moving to Slide 8, we provide some additional information about our lending product, PAGS Capital. We continue to scale the product to our best merchants, eligible according to their account history. Since the beginning of the operations in May 2018, we reached 60,000 lending contracts. In Q3 2019, we had 6x more contracts than what we had in Q1 2019, ending with a total credit portfolio net of losses of BRL 196 million, lowering our average ticket from BRL 5,100 in Q2 2019 to BRL 3,300 in Q3 2019, which shows our focus on the long-tail market. So far, we are being careful with credit. However, the initial results are encouraging, as we had low levels of delinquency. Credit is also an important tool to create higher engagement with our merchant base and may generate additional revenues for the company in the future.

Now, I'd like to turn the conference over to Eduardo.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [3]

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Thanks, Ricardo, and hello everyone. On the next slide, before I start, as I anticipated in the Q2 2019 earnings call, I would like to mention that, in the third quarter of 2019, we had a total of BRL 47.6 million of non-GAAP items related to our stock-based long-term incentive plan given the vesting of the fourth grant of the initial stock-based plan and consequently the market-to-market adjustment of this fourth grant. For more details, the reconciliation of these non-GAAP financial measures is presented in the last page of this webcast presentation.

On the top left of Slide 9, our adjusted net revenue, the sum of net revenues from transactions and financial income from installments, excluding BRL 16.9 million related to membership fees previously booked as sales revenues and now accounted as transaction activities, revenues reached BRL 1.4 billion in this quarter, up 42% year-over-year and 8% quarter-over-quarter.

Moving to the top right, we break down our revenue growth, with transaction activities and other services reaching BRL 862 million and growing 44% year-over-year and our financial income revenue reaching BRL 538 million and up 39% year-over-year.

On the chart below, we present our non-GAAP total costs and expenses that decreased 0.3 percentage points year-over-year, ending the second quarter at 3.1% over total TPV. Related to non-GAAP administrative expenses, over total TPV reached 0.3%, flat when compared to one year ago.

On the next slide, we show our non-GAAP net income growth. In the third quarter we reached BRL 390 million, an increase of BRL 100 million and up 34% year-over-year. The non-GAAP net margin reached 27%, up 0.8 percentage points despite higher investments on PagBank.

On Slide #11, we have mapped the current functionalities of our unique ecosystem broken down by payments, software and banking features. You can see that there are 4 new features we launched after our first quarter earnings call, and I will give you more details about them in the next slides. On the superior block, there are features oriented to merchants. Instant payments and sales app, in the software column, are the new ones. Below, you can see our robust banking ecosystem. Credit and cash cards, payroll portability and savings accounts are the new launched features. We believe these banking features will enable us to attract, engage and monetize both merchants and consumers, helping us to improve our client's loyalty and stickiness.

On Slide 12, we have the evolution of our average spending per merchant that reached BRL 6,000 in Q3, a growth of 9% year-over-year. Here it's important to recall that the nominal average spending per merchant continues to grow and even accelerated sequentially reaching BRL 179 per client versus BRL 151 per client in the second quarter. And as time goes by, we start to face harder comps, since we already reached more than 5 million active merchants and more than BRL 100 billion in TPV in the last 12 months, which makes us comfortable to keep growing TPV with EPS accretion.

In the next chart, we have our number of active merchants. We ended the third quarter reaching 5 million active merchants, adding 1.2 million new merchants in one year, representing an increase of more than 30% year-over-year. Quarter-over-quarter, we added 305,000 new merchants. In Q4, we continue to see a similar pace of net adds growth, which makes us believe that we should be ahead of our 1 million net adds expectation that we provided in the beginning of the year.

On the charts below, we see our TPV. Our total payment volume reached BRL 29.4 billion in the third quarter, an increase of BRL 9 billion, up 45% year-over-year and growing 10% quarter-over-quarter. This growth is the result of a higher penetration of our ecosystem in the long-tail combined with the trend of cash to plastic conversion with lots of room to grow in Brazil and having the upside of cross selling additional products and services to our clients with our PagBank initiative.

The net take rate, which is the blended take rate from transactions costs such as interchange, processing and card scheme fees, reached 3.17% which has been stable when compared to previous quarters.

On Slide 13, we present more color about our new POS membership fee model in Brazil, so called comodato, that we started in September, and it is already becoming a standard model among Brazilian payment companies. There is no change for our merchants on pricing, but moving to the new membership model, we improve our customer service by reducing some bureaucracies in the process such as issuing invoices and registration processes, helping us to deliver a better and faster experience, like reducing up to 20% the customer service time and allowing the company to deliver a faster POS activation for our new clients. We are constantly looking for changes to improve our customer service and experience.

Additionally, this model brings a different accounting treatment in our P&L, from now on, POS sales will be booked as membership fee and it will be recognized as transaction service revenue instead of revenue from sales. In this quarter and for the next 2 ones, we should have an impact in the revenue from sales line due to ICMS and PIS and COFINS taxes on the transfer of the inventory from Net+ Phone, which is a PagSeguro fully subsidiary that buys and sells POS devices to PagSeguro. The impact of ICMS, PIS and COFINS taxes in September 2019 was BRL 26.7 million.

Our cost of goods sold should also be reduced as we are now capitalizing our devices, impacting depreciation over the next few years. The result of this change was a net income positive effect of BRL 20 million in our Q3 2019.

Despite this operational change that brought a recurring positive impact in our Q3 results, it is also very important to remember that we intensified short-term investments in R&D, personnel and sales and marketing to scale new initiatives, spending an additional BRL 110 million pre-tax in the last 6 months year-over-year, aligned with our long-term strategy to offer a unique financial ecosystem for both merchants and consumers in Brazil.

Now I'd like to turn over to Ricardo, who will talk about engagement metrics and new products.

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [4]

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Thanks, Eduardo. On Slide 14, we present our next step of evolution in value generation. Since the official launch of PagBank in the second quarter, we intensified our investments in product development, people and marketing campaigns to promote this new initiative to our merchant base and consumers. We observed a huge engagement since the very beginning, and we are on the way to build our network effect as time passes by. Currently, on average, 39% of our clients use at least 3 products from our ecosystem. Our PagBank app is opened 10x a week by our active clients, which means higher engagement of our clients.

On Slide 15, we show some of the most relevant engagement trends in our ecosystem. We believe engagement is one of the most relevant metrics to follow, once it will help the company to increase the switching costs and will enable future monetization and revenue diversification.

On the top of the chart, we have the number of cards issued, especially prepaid and cash cards that increased 92% year-over-year. Our prepaid cards TPV that increased 53% year-over-year when compared to the same period in 2018. According to CardMonitor, PAGS is the largest prepaid card issuer in Brazil.

In the chart below, we see the number of bill payment transactions rose 72% quarter-over-quarter. Our mobile top-up feature is also ramping up, growing almost 90% sequentially. Moving to new payment methods, our NFC transactions grew more than 100% quarter-over-quarter, and our P2P transactions increased 45% quarter-over-quarter.

On Slide 16, we highlight our roadmap of products already delivered in this year. Being an independent company allow us to think exclusively on our clients' financial needs by delivering growth and profitability simultaneously and offering a unique ecosystem through our digital accounts. With cash and credit cards and payroll portability, we expect to diversify our addressable market and start gaining penetration with the consumer vertical, besides our higher engagement on the merchant segment.

Worth to say, we will be very cautious in the credit offer, As you know, it is important to understand credit behavior so that we can manage delinquency accordingly. In the past 2 months, we added our savings account and super app application. And for payments, we launched our low-cost smart terminal version, called Moderninha X.

On Slide 17, we present our new banking products such as savings accounts that yields more than Poupança, the most popular saving account product in Brazil, and our initial super app strategy, adding new services like Uber, Spotify and Google Play directly in app. We are just starting in our super app initiatives and we should continue to expand our products and services.

On Slide 18, we show our new devices, starting with Moderninha X, a low-cost Android-based smart terminal, with apps and software installed to help merchants to manage and grow their businesses. It also comes with PagBank digital account and an international cash card for free. Additionally, we also have Minizinha Chip 2, an upgraded version of our entry-level device, with a promotional price of 12 installments of BRL 8.90 or BRL 106.80. This device is NFC-enabled and comes with the usual sim card, a larger screen combined with a thinner hardware, and it will offer a better experience for self-employment segment.

Moving to the next slide, we present our software solutions. Through M&A transactions, we now offer a wide range of software solutions to our clients. We ended Q3 2019 with 123,000 clients using our software products, up 45% quarter-over-quarter. PAGS will continue to monitor possible M&A activities that can speed up the building of a more complete ecosystem.

Now I would like to turn the conference over to Eduardo again.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [5]

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On Slide 20, finally, this is the last slide where we have our 2019 guidance. Even accelerating investments in new initiatives, we continue to reiterate our commitment to reach close or at the top our non-GAAP net income guidance.

Now we finish our presentation and we will start the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Craig Maurer, Autonomous.

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Craig Jared Maurer, Autonomous Research LLP - Partner, Payments and Financial Technology [2]

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So first, if you could give any type of look into the trends you're seeing through mid-November in terms of fourth quarter, in terms of both TPV and if net new merchant adds are running on pace with where they’ve been?

Secondly, more broadly, as we look forward, can you help us understand the monetization of the growth in usage of PagBank offerings? How we should think about that? I know you’ve given us the 30% of revenue in 3 to 5 years, but there's a lot of time before 3 years. So how we should think about that revenue ramp and try to translate it back to the engagement stats you're providing?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [3]

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Craig. Thank you very much for the question. Regarding net adds, as Eduardo mentioned, we are following the same path, adding 100,000 net adds per month. That's what we had in October. We don't see deceleration in November. So we are looking for close to the same 300,000 per quarter that we've seen in past quarters. Regarding TPV, we are also seeing a strong growth in terms of absolute numbers and also as a percentage. But it's also worth to say that we are comparing this quarter with also a strong quarter in 2018. So we are operating on a much larger scale. So sometimes the percentage is not as high as it used to be, but the volumes are still pretty high.

In terms of PagBank, you're right, we said about this 30% between 3 to 5 years. We are at the very beginning. It is also -- the revenues from PagBank are marginal, are very small at this point. We see some revenues coming from cards. But we still have a lot of opportunities to monetize in terms of wire transfers that people are getting to use; bill payments, people are using more; also mobile top-up. So everything has gained some traction. People are used to the account, how to use them. How to make it work. So -- but at this point, it's still very small, the revenues are very small. Once it becomes something more important, we will give more color and more information about this vertical.

I don't know, if Eduardo or Cazotto wants to add something?

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Operator [4]

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Next question comes from Bryan Keane, Deutsche Bank.

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Bryan Connell Keane, Deutsche Bank AG, Research Division - Research Analyst [5]

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I wanted to ask on the TPV. Last quarter, it grew about 59% year-over-year, and this quarter, it grew 45%. The additional net merchant adds seems to be still growing at a solid pace. So is there anything to read into the types of merchants that are staying in the portfolio that maybe they're yielding lower volumes or lower growth? Or was there something in the economy that happened that created a little bigger drop than I think most anticipated when you guys gave out your preliminary results?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [6]

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Bryan, thank you for the question. We don't see any change in terms of macroeconomics or trends that may affect our businesses. The environment in Brazil keeps the same, so we don't see any big banks coming that is changing the dynamics of the business at this point. You're right, the percentage of the growth of TPV is going down, but we are working on a much larger scale at this point, the percentage is going to be smaller. We've been adding some slightly smaller merchants in our ecosystem, which is not bad for us. It is aligned with our focus on the long-tail market. We are comfortable adding these type of merchants because we offer the most complete ecosystem and we can cross-sell additional services to these type of merchants. They are the type of merchants that are not sensitive to prices. They don't have access to financial services.

And also important to say, I know it was a question that we had a few weeks ago about the TPV per merchant. The average TPV per merchant did not grow double digits. So just to put everyone on the same page that people that are on the call, we are not talking about decreasing TPV or decreasing the spending per merchant. It grew 9%. And by the way, we don't think this is a relevant metric because, at the end of the day, it could be easy for us to increase the average of TPV per merchant if we add a large merchant that we can lose money or have a smaller margin. So we don't want to work artificially increase the TPV per merchant. We are working with the merchants that we know how to work, that are profitable and we know how to serve them. So ramping up here, we are seeing strong growth in the Q4, but the percentage is not going to be the same that it used to be in the past, 70%, 59%, or things like that because we are working on a larger base. Remember that Q3 -- Q2, we grew 10% compared with Q1. Q3, we grew the same 10%. So for us, it's -- we don't see deceleration of that because we're working in a larger base and growing the same percentage quarter-over-quarter.

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Bryan Connell Keane, Deutsche Bank AG, Research Division - Research Analyst [7]

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Got it. That's helpful. And then my second question, given the amount of investment for PagBank and new services, I think that makes sense, but what could we expect going forward as we look out into next year? I mean, should we expect an additional amount of investments as well to keep net income margin slightly growing or flat? Just trying to think about it so we can get ready for 2020.

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [8]

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Bryan, we don't expect to decelerate investment. We see a great opportunity ahead of us in terms of banking in Brazil. As we gave more information during the call, 68 million people in Brazil without a bank account. People that only open a bank account just to receive the payroll and all this stuff. So we see a lot of opportunity, a big opportunity ahead of us. So we will not decelerate in 2020. What we have in our business plan is not to hurt the margins too much in 2020. We are working the numbers. But we think that we could have an operational leverage, if we didn't have PagBank 2020, but we will use the operational leverage to invest in PagBank, invest more in marketing, products and people and to keep the growth of the company for the future.

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Bryan Connell Keane, Deutsche Bank AG, Research Division - Research Analyst [9]

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And so think about that being more flat, potentially, given the amount of investments for PagBank and other services in 2020.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [10]

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Yes. I guess, that's a good assumption.

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Operator [11]

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Next question comes from Mario Pierry, Bank of America.

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Mario Lucio Pierry, BofA Merrill Lynch, Research Division - MD [12]

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Congratulations here on the results. I have 2 questions. The first one is related to your churn rate. Can you just give us some color of your churn rates? I'm not looking for actual figures but like just the trends? And second question is related also to PagBank. If you can -- right, you talked about like how your volumes are growing 6x, I think, than what you were doing. Can you give us a little bit more like color on the average ticket size, interest rate and the NPLs that you've seen so far?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [13]

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Mario, thank you for the questions. We don't see changes in our churn. There may be some months that we have a slightly higher churn, some other months, a slightly lower churn when compared to last year. So we don't see big changes. It's -- I would say that it's stable at this time.

Regarding PAGS Capital, that is your question about the number of contracts. The average ticket that we have -- that we had in Q2 was BRL 5,100. Now, the average ticket is BRL 3,300. So it's a very small ticket. Again, we are looking for long-tail. We are focused on these type of merchants. These guys that do not have access to financial services. And that's the type of merchant that we like to work and we know how to work with them, and that's what we've been doing in the past years.

The interest rate, it varies, depends on the account history they have with us. We don't do anything lower than our prepayment interest rate, which is 2.99%. But some of the merchants will have different rates depending on the risk that we think the merchant could pose to us.

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Mario Lucio Pierry, BofA Merrill Lynch, Research Division - MD [14]

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And then on the NPLs, I know it's a recent portfolio, but have you seen -- what kind of NPLs are you seeing on the portfolio?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [15]

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We are working here to have the best NPLs in the market. And the reason why is because we also want to have the lowest interest rate in the market. Our idea is to help our customers to increase their business with us, and we don't believe in high interest rates. So I mean, this is a complementary product to help our customers to grow their business with us. We are still not disclosing specific metrics on NPLs, because it is still something that is under construction. It's a -- our portfolio is still really small if you compare it to our total receivables. And we ended with like BRL 190 million. If you compare that to our total receivables, I mean, it's roughly, I mean, around 2% of our total receivables. So I mean, it's a product that is encouraging. It's getting a great acceptance. We are lowering our average ticket by continuing to focus on the long-tail market. And all that we can tell you right now is that we are very, very pleased with the results that we are having so far. I think that's all the way we can say at this stage.

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Operator [16]

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Next question comes from Josh Beck, KeyBanc.

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Josh J. Beck, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [17]

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I wanted to ask about PagBank, and you had mentioned in one of the charts that it basically was 63% of Google searches in September. So that was the biggest of all of the challenger banks, if you will. So I'm just wondering, do you think that it has really moved into a position where it's being viewed as a true consumer product? And consumers are really what are going to drive the growth versus your historical focus on merchants?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [18]

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Josh, thank you for the question. We -- at this point, we are serving both merchants and consumers. It is clear for us that the merchants that we already have in the base, they are the, let's say, the low-hanging fruit. Those are the type of merchants and type of PagBank clients that we are having adopting PagBank as a financial service option more rapidly and more quickly than the consumers. But we already have thousands of consumers using our products. We've been collecting feedback since May. We've made improvements in the products. And yes, you're right. We are going to the consumers pretty fast, so that's why we are building this brand. We are having adoption of the consumers at this point, but to be sincere with you, right now, we have much more merchants than consumers in the base because the merchants are already working with us, and the consumers are at this point, knowing our services, trying, seeing what we offer, how it works and so on. But we believe, in the future, we're going to have millions of consumers using PagBank as well.

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Josh J. Beck, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [19]

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Okay. And I also wanted to ask about the software subscribers, that seems to have moved up nice sequentially. Is this a big investment area for you in 2020? I'm imagining that is going to take you up-market to slightly larger merchants. Just trying to understand strategically how important that opportunity is for you?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [20]

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Well, the investment in this area is not that big. We acquired these 4 companies. What we do is to maintain the software and make some upgrades and some improvements in software because it needs to evolve as time passes by. But it's not a huge investment in this vertical. It's just to keep it working and make it better as time passes by, collecting feedbacks from merchants and so on.

Regarding your question, if we are moving up in the pyramid. If you look at these 4 softwares, only 1 of them is for larger merchants, which is the conciliation R2TECH. The other 3 software solutions, 2 of them are for small merchants. And TILIX, the bill payments is focused much more on consumers. So by investing in these software initiatives, it doesn't mean that we are going up in the pyramid, that's not the case.

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Operator [21]

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Next question comes from Tito Labarta, Goldman Sachs.

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Daer Labarta, Goldman Sachs Group Inc., Research Division - VP [22]

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Also a couple of questions. I guess, following up just on the growth, I understand you expect it to decelerate from the growth rates you were posting in the past. But in terms of going forward, I mean, is like the 45% growth, does it decelerate further from there? Or should we think about like 10% growth per quarter that you mentioned? Is that sort of reasonable? Could maybe fourth quarter even be a bit higher just because it's seasonally stronger than the 10%? Just want to understand in terms of how much it could decelerate potentially. And then a second question, in terms of the competitive environment. The take rate, you fell a little bit, still relatively stable. But just that anything you're seeing in terms of competition increasing or coming in that could potentially add some more pressures to the take rates going forward?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [23]

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Tito, this is Alcaro speaking. About the TPV, just to reinforce what Ricardo just said. When we talk about absolute TPV figures, we operate today in a much larger scale. Our TPV has overpassed BRL 105 billion in the last 12 months. The additional absolute TPV figure in Q3 '19 compared to Q2 '19 has increased BRL 222 million. So our growth quarter-over-quarter remaining stable in 10%. So there is no absolute TPV deceleration. About Q4, of course, we should expect a higher -- a number that is higher than 10%, because we have the holiday season in Q4. So I think that's the first point.

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [24]

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Regarding competition and the competitive environment, we didn't see any change in these past quarters. As you can see in our numbers, we've been adding the same 100,000 per month. October, we had the same figure. So same competition that we used to have in the past is that what we are seeing at this point. No big changes, no news. By the way, if some of the incumbents, when they talk about long-tail, they just copy our prices, which is good. So they are more rational, it's about pricing, and they know that we are the best player in terms of serving long-tail, and they just copy what we are doing in terms of devices and also in terms of MDR. So we see a few players doing some irrational prices. But when they discover that by lowering the price of the devices too much, the activation goes down. The long-tail is not sensitive to prices. They start having the irrational prices again. So summarizing, we don't see big changes in the competitive environment so far.

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Operator [25]

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Next question comes from Daniel Federle, Crédit Suisse.

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Daniel Federle, Crédit Suisse AG, Research Division - Research Analyst [26]

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My first question is to understand how should we see the credit initiative, if it's still up in a pilot stage. And if that's the case, what is the company waiting to scale up this more fast? And the second question regarding the remuneration of the accounts. If 100% of the accounts were already remunerated in the third quarter, and if you have any estimates about the impact of that in net income?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [27]

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Daniel. In terms of PAGS Capital, the lending business, it's still at the very beginning. We are growing gradually. We know that it's a different business than the acquiring. The risk is different. The way we should work, it's also different. It's -- people don't think too much when they decide to take credit, but the collection is sometimes maybe a challenge. So that's why we are very careful about this credit and how we're going to make it bigger. We are growing gradually, step-by-step, taking care of the risk, and we -- once it becomes a very important business line, we will give more information about it.

Regarding the savings account, the -- just to remember that we remunerate the accounts only for the balance that stays with us for 30 days, and we know the long-tail people, they have the cash in and cash out very often in their account because they need to work, they need to use the balance to buy products to resell, and then they receive the money and cash out again to work and so on. So we have this remuneration only for the balance that stays with us for 30 days. And so far, the amount is small as well. It's not a big amount that could hurt our P&L or net income or things like that.

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Operator [28]

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You next question from Domingos Falavina, JP Morgan.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [29]

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I confess I'm a little lost. Actually, I have 2 questions. The first one is basically on accounting moving parts. Reading your press release and your transcript remarks, I think you had 2 effects. One, you moved all your POS from the subsidiary, which impacted, according to your press release, BRL 27 million in revenues or 30% in taxes would be about BRL 20 million positive impact on earnings. And the second whole change between sale to lease, which you claim as negatively BRL 20 million to earnings. My question is, should I read this -- how should I read this basically? Is this like net-net everything else? If you haven't changed POS parking days, if you have not changed the lease to -- the sale to lease or anything like that? How much would the earnings impact? There would be close to 0 impact. Or should I read that the BRL 20 million is net negative considering everything already? And then I'll move to the second question.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [30]

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Okay. Domingos, this is Alcaro. Let me reconcile this for you. So first, you have approximately BRL 17 million of subscription revenues because, remember, we started with the comodato beginning on September 1. So we have just 1 month of membership fee. So we have BRL 17 million of membership fees. If you deduct the 34% income tax, you get roughly to BRL 11 million of a positive effect. So that's effect number one.

The second effect that makes up to the BRL 20 million positive is the Q3 negative margin. If you look at previous quarters, we had, on average, BRL 88 million of negative margin on POS subsidies. We had BRL 74 million this quarter. And what is the headwind and the tailwind here? The headwind is really the taxes on the transfer on the inventories that we had. And the tailwinds are the market-to-market provisions that we had to make in our inventories, such as the market values. So if you compare the BRL 88 million negative to the BRL 74 million negative that we posted this quarter, it's roughly BRL 14 million of negative margin and after tax is BRL 9 million. So if you add the tailwinds that we had in the negative margin plus the tailwinds that we had in the membership line, those 2 things combined, it's a total of BRL 20 million, that we should have the same amount in Q4 as well. So that impact of BRL 20 million was just in September. So if you consider, for example, Q4, it's around between EUR 50 million and BRL 60 million of positive impact in Q4.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [31]

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Just one thing. When you say negative margin, I mean, that depends on your commercial decision, right?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [32]

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Right.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [33]

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I guess my question is more tilted to the accounting, not that like, well, we decided to lower the prices. If you had not changed the accounting or the lease to rent, what would be -- have been the impact on the net income this quarter?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [34]

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BRL 20 million.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [35]

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Positive?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [36]

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Yes. The membership is helping the P&L in BRL 20 million this quarter.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [37]

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If you have not done anything, neither relocated the lease nor change the -- relocated the POS from the subsidiary.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [38]

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Right, right, right, right.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [39]

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Okay, perfect. The second question is, what is your legal understanding as far as 2 options. If you have a terminal sold to a merchant, can he or can he not hypothetically connect to another acquired provider, hypothetically, GetNet or anybody? And if you lease this equipment to the merchant, can he or can he not? Is there a change in understanding as far as the ability of these merchants to use this terminal for other providers?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [40]

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Well, Domingos, first of all, it's also worth to say that, what some people say portability, in our view, is more like piracy or things like that. It doesn't work for 100% of transactions. So if some merchants decide to use one device from a company they bought using another app from another company, it will not work for 100% of the transactions. That's the first thing to say. So that's why people don't stick with this type of, let's say, [sell do] solution. If we sell or if we lease, in the contract, we have the right or we ask the merchants that they cannot use the device with other companies. So it doesn't matter if you are leasing or selling the device. The contract says that they cannot use it in other companies. Some of them, they may try, they see that doesn't work, and they will come back to us. But going back to your question, it doesn't change.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [41]

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Okay. Super clear. And just out of curiosity, like the recognition of the sale of the terminal under lease is upfront, but the cost that you bought that terminal is deferred over time. Is that the reason why you have this positive impact? Or something different?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [42]

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Yes. That's the reason. That's the reason, you've got it.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [43]

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All right. Perfect. And you defer the acquisition cost over 12 months, I'm assuming.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [44]

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Over 3 to 5 years. It will depend of the average life of each device.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [45]

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Understood.

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [46]

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Domingos, just to reinforce here that, regardless of the accounting impacts that could be positive, negative or whatever, the main driver for us to change the model is to have a better experience for our merchants. Because of the bureaucracy in Brazil and all the paperwork that you need to do when they buy the device versus when they lease, so that's what drives us to -- what drove us to make this change. We're going to have a much better experience, faster activation. We will improve our SLA. So it's going to be, at the end of the day, a better service for the merchants, that's what matters for us.

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Domingos Falavina, JP Morgan Chase & Co, Research Division - Head of Latin America Financials [47]

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No. Super clear. Just wondering if you had as an additional benefit a higher entry barrier, but super clear.

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Operator [48]

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Next question comes from Jeff Cantwell, Guggenheim.

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Jeffrey Brian Cantwell, Guggenheim Securities, LLC, Research Division - VP and Analyst [49]

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Most of my questions have already been asked, but I did have a question which relates to your earlier commentary on your software strategy. I guess, what I heard was, you framed software as a smaller piece of the overall company strategy. But I do want to ask if you can drill down for us a little bit and just explain why pursue that strategy? For example, are you seeing higher revenue per merchant from those software customers? And if so, can you quantify that for us? Maybe it's a specific vertical strategy where you're trying to get that market share or gain market share. Just we see the increase you have in your subscribers added with software. I just wondered how you're putting that type of growth up? And so I'd like to know more about it and where it's going in the future?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [50]

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Jeff, just to be clear for everyone on the call that, when I talk that we do not invest in software or that is a small piece of our investment, we are talking about these 4 softwares that we presented in the deck of the slide -- in the Slide #19. Of course, we do invest a lot in software, in the platform and in our app. And a lot of initiatives that we have in PagSeguro. So just to be clear for everyone that we were talking about only these 4 softwares that we described in Slide 19.

Our merchants, as we are focused on long-tail, sometimes they don't have the -- I would not say the capability, but they don't have the -- it's missing the word, yes, sophistication here to have a software solution to you. They just want to make the transaction, that's all. But some of the merchants, they do use additional softwares when we offer, like, a small CRM, that you can have the number -- the name of our clients, the mobile phone, the date of birth and things like that. So the idea here is not to make a lot of money from software. At this point, most of the software that we offer are for free for our merchant clients. So the idea is to increase the stickiness, give them better services, make them more loyal to our solutions and increase the switching costs. Some of the merchants, yes, they do pay, but some of the merchants, they just use as part of our offering in the acquiring services and in the payment solutions that we have.

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Jeffrey Brian Cantwell, Guggenheim Securities, LLC, Research Division - VP and Analyst [51]

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Great. If I could just ask one on the take rate. We heard your earlier commentary on the margin outlook for next year. But what were you saying currently would be -- the 2 or 3 factors that would swing the take rate up from where it currently is or down? And sort of how should we think about the trajectory and the take rate going forward from here?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [52]

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So talk about net take rate. We -- if you look at our take rate compared to last year, there is a slightly decline in the take rate as a result of mix because we are not taking prices down. Our prices are public, and they remain untouched in the last 12, 18 or 24 months. Going to Q4, obviously, as we had last year, you may remember, Q4, we have a higher percentage of debits because people receive their 13th salary, and they go out and spend that through debit. So we should expect in Q4 a decline in the take rate as a result of our mix not because we are taking prices down. Overall, if you look, this year is a slightly decline compared to last year as a result of mix. And in Q4, it should follow basically the same trend.

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Operator [53]

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Next question comes from [Karina Martín] Citibank.

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Unidentified Analyst, [54]

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So first thing that I wanted to ask is, as you shift to this membership model, how should we look at the cost of goods sold? Because as you're actually going to lease the terminals and not sell them, they're going to stay on your balance sheet. So cost of goods sold should actually be lower. And we should expect that to go through CapEx, which could actually increase operational leverage. So first, is that -- am I correct to assume that?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [55]

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That's correct. We recognize the membership model as revenue in the transaction line. And the cost of goods sold, instead of flowing through the P&L, I mean, will flow through the P&L, but through depreciation of the assets. If you look at our fixed assets, you could see a material increase in Q3 because now we are booking the hardware, the devices as fixed assets instead of cost of goods sold.

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Unidentified Analyst, [56]

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Okay, good. And as you guys -- you commented earlier in the call that you're going to assume flat -- like flat margins in 2020 because the operational leverage, you're actually going to like use that benefit to further invest in marketing, first of all, and the expansion of PagBank. So that actual increases -- this change in accounting actually increases your operational leverage. So should we expect even further increases in marketing? Because if your margins are going to stay flat, you would actually have a benefit from having COGS go through CapEx and not the P&L.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [57]

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Actually, this is already happening. If you see our margins, the nice thing about our business is the operational leverage. I mean, we have -- we closed the last 12 months with more than BRL 105 billion, and we do have operational leverage. And we are reinvesting this operational leverage in new initiatives. Basically, that's what's happening. Because if you look to our net income margin, it's pretty much flat when compared to last year. It would be very easy for us, for example, to cut marketing expenses by half and having a great EPS or a great net income. But we are building this company for the future. We are investing in this company for the long term. So it wouldn't make any sense, for example, to slow down our marketing investments or slow down investment in people or in sales in exchange of short-term results. So we are looking here -- for the long term, you are looking to the growth of this company. By the way, nobody has, at least in the long-tail market, the ecosystem that we offer plus the online distribution, the brand recognition and all the benefits of being a first mover. And our idea here is to build this company for the future. It's not -- we are not concerned about short-term results.

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Unidentified Analyst, [58]

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Just one last thing on this. The positive impact in net income that you have from this change in accounting, that wasn't accounted for in the guidance for the year, right? That's like a plus.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [59]

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Well, it is accounted, actually, mean -- because this brings a -- I mean, in Brazil, the process of issuing invoices is very bureaucratic. When you need to replace a terminal, I mean, it's cumbersome, the process that we need to go through. So we really wanted to have to -- to implement this change before September. I mean, it's because, I mean, it requires some system changes. I mean, it requires some time to make that happen. But there is a small benefit in September. But on the other hand, we invested, the last 6 months, BRL 110 million more in new initiatives, for example. So it was in the guidance. And as well as -- I mean, we had more investments in the new initiatives, we are accelerating the PagBank initiative. So at the end of the day, I mean, pluses and minuses. As I said before, the beauty of this company is the operational leverage, and we are reinvesting this operational leverage in new initiatives here.

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Operator [60]

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Next question comes from Rayna Kumar, Evercore.

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Rayna Kumar, Evercore ISI Institutional Equities, Research Division - MD [61]

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Can you provide your initial thoughts into 2020 net adds and TPV growth? You mentioned 300,000 net adds in fourth quarter, would you expect that to continue into 2020?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [62]

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Rayna, we are not giving this type of information at this point. We've been discussing a lot about guidance and about 2020 and the plans for the future. But we -- I don't even have the official number even if we decided to give some number for you right now. So we don't have this net adds and TPV for 2020 at this point. Just remember, this year, we had a guidance of 1 million net adds, we're going to surpass that. We already had 1 million until the end of October. So we still have 2 months ahead. November, which is a strong month with Black Friday and holiday season in Brazil and December. So -- but going back to your question, we don't have this type of figures at this point.

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Rayna Kumar, Evercore ISI Institutional Equities, Research Division - MD [63]

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Understood. You spoke about adding smaller merchants in 3Q. Do you expect that move down market to continue? And if so, would you anticipate the increase in net adds and growth in PagBank to offset any lower volume per merchant that we might see?

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [64]

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Just to make it clear for everyone, we added slightly smaller merchants, and we're not adding smaller, smaller, smaller merchants on a comparative basis. So it's slightly smaller when we see the way they are working with us in the first months when compared with the cohort of the legacy that we have, they are slightly smaller than what we had. We are not changing our strategy in terms of marketing. We are not using different channels. We are just bringing these type of merchants for us, which, at the end of the day, is good news for us because those are the type of merchants that they are not price sensitive, they are not in certain the financial system in Brazil. They require a lot of financial services they don't have access to. They -- sometimes, they don't even have an access to a bank account. So that's the type of merchants that we like to work, we know how to work, and we may how to make profits from them. So we didn't change that merchant, it's slightly smaller than already had in the base.

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Rayna Kumar, Evercore ISI Institutional Equities, Research Division - MD [65]

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Got it. So how much of that average spending per merchant deceleration from 2Q to 3Q was from just going to smaller merchants versus other factors?

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [66]

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Rayna, I think the information that we provided is what we will all provide. So at the end of the day, those are the metrics that we have just released in our Q3 numbers.

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Rayna Kumar, Evercore ISI Institutional Equities, Research Division - MD [67]

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Okay. I guess I'm asking about the driver, though, to that metric. Just that deceleration, if we can get a better understanding of why there was that sharp deceleration? I think that would be very helpful.

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Eduardo Alcaro, PagSeguro Digital Ltd. - Chief Financial & IR Officer, CAO and Director [68]

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Well, let me repeat that again. First of all, talking about TPV figures. I mean, we operate in much larger scale. We grew TPV from Q2 compared to Q1 at 10%, and Q3 compared to Q2 in 10%. So we really -- we don't see here a deceleration. And again, as Ricardo said, we do not consider TPV per merchant as a relevant metric because it's very easy to fabricate and to get a bunch of high-volume merchants and post a very nice TPV per merchant. So again, we are not seeing any deceleration. The TPV growth in the last 2 quarters, quarter-over-quarter, was 10% on each product. So and that's, I mean, how we are seeing TPV here in the company. We continue to deliver healthy take rates. Our take rates have been stable, and we continue to deliver stable net income margins.

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Operator [69]

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This concludes today's question-and-answer session. I would like to invite Mr. Ricardo Dutra to proceed with his closing statements. Please go ahead, sir.

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Ricardo Dutra da Silva, PagSeguro Digital Ltd. - Executive Officer & Director [70]

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Hi, everyone. Thank you very much for your time and for the questions. We'll see you next conference call. Thank you very much.

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Operator [71]

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That does conclude the PagSeguro audio conference for today. Thank you very much for your participation.