StoneCo Ltd (STNE) 2018 Q3 法說會逐字稿

Good evening, ladies and gentlemen. Thank you for standing by. Welcome to the Stone Company third-quarter 2018 earnings conference call. (Operator Instructions). This conference is being recorded today, Monday, November 26, 2018. By now everyone should have access to our earnings release. It can be found at www.stone.co on the Investor Relations section.

Throughout this conference call the Company will be presenting non-IFRS financial information including adjusted net income. These are important financial measures for the Company, but are not financial measures as defined by IFRS. Reconciliations of our non-IFRS financial information to the IFRS financial information appear in today's press release.

Finally, before we begin our formal remarks, I would like to remind everyone that today's discussion will include forward-looking statements. These forward-looking statements are not guarantees of future performance and therefore you should not put undue reliance on them. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from our expectations. Please refer to the forward-looking statements disclosure in the Company's earnings press release.

In addition, many of the risks regarding our business are disclosed in the Company's final prospect for our initial public offering filed on Form 424-B4 with the Securities and Exchange Commission, which is available at www.SEC.gov. I would now like to turn the conference over to your host, Rafael Martins, Investor Relations Executive Officer at Stone. Please proceed.

Good evening, everyone, and thank you for joining us today. Today I have here with me Thiago Piau, our CEO; Marcelo Baldin, VP of Finance; and Lia Matos, Chief Strategy Officer. Before I comment on the third-quarter 2018 results I would like to turn the call over to Thiago. Thiago?

Thank you, Rafael, and good evening, everyone. Thanks for joining us for the third-quarter earnings call and our first call as a public company. We look forward to getting to know all of you. I also want to thank our clients for their support, the entire Stone team for their tremendous work throughout the years, and now investors who have backed us throughout this journey that led us to a new chapter as a publicly traded company.

We are clearly excited about the opportunities available to us to continue to expand our business, offer more solutions to merchants and give long-term shareholder value. We are pleased to report strong third-quarter 2018 financial and operating results which reflect our commitment on executing our growth strategy and our 100% focus on our clients' needs.

Our active client base reached over 230,000 in the quarter, representing a 127% growth year-over-year. Also we generated total revenue and income of BRL440 million in the third quarter, up 121% year-over-year. We achieved adjusted net income of BRL89.3 million that represents a 21.6% adjusted net margin, almost 19 percentage point improvement versus the third quarter of 2017.

Since this is our first call, I thought it would be helpful to reinforce some of our key business points. We empower merchants to conduct electronic commerce seamlessly across multiple channels and help them grow their business over time through technology. Our mission has and will always be to help our clients grow providing superior value proposition and the best customer experience.

In order to do that we have developed a deep client centric culture and an end-to-end proprietary technology platform that enables us to offer great solutions, offer superior value proposition and the best experience to our clients has brought the Company where it is today and this is reflected in our best-in-class Net Promoter Score.

We've created a disruptive go-to-market approach [business strategy] that has enabled us to rapidly grow our client base in only four years since the launch of our services. We plan to grow our business by leveraging our culture of technology and innovation, to create new solutions that empower our clients to grow and manage their business more effectively.

Our main target are the 8 million plus SMBs in Brazil and, with over 230,000 active clients in the quarter, we have a few growth opportunities. We will continue to strengthen our relationship with our clients through our local operations being at the doorsteps whenever they need.

Now I would like to provide you with some other more recent updates, including the competitive environment. In a dynamic industry like ours the ability to recruit, develop and retain talented people is critical to our success and growth. We are currently running our semiannual recruitment campaign called Recruta Stone.

For those of you who are not familiar with this campaign, it's one of the biggest recruitment processes in the country and also one of the main [country] events at the Company. The three main goals of the programs are: first, hire motivated and talented entrepreneurs with high potential; second, train our leaders in our culture and high practices; and finally, improve our brand as an employer. We have had nearly 30,000 applicants for the process this semester.

Regarding our commitment of providing new solutions to our clients, we have to continue positive traction on our reconciliation platform, Equals, as well as our foodservice ERP and POS software, Linked Gourmet, both of which are still in the early beginnings.

Also, we have seen discussions in the market regarding the competitive environment and we believe it is important to share some thoughts with you regarding how we frame this topic. The Company will always have a humble approach to listen to different opinions and ideas in order to learn as much as we can about the competitive landscape.

The SMB market in Brazil is very competitive and it has been facing competition with incumbents since day one. We were born in a constantly changing environment and we have a very dynamic organization. We believe we have the right team, culture, technology and innovation capability not only to adapt to market changes but to drive those changes ourselves as we have been doing since our foundation.

We believe competition is positive for the market, especially for those who matter the most, the merchants. The Brazilian regulators and antitrust authority have been successfully fostering competition and innovation in the country. This has allowed the influx in the market of players like ourselves that are setting higher standards and better prices for the merchants.

We are very happy to have contributed to market changes that have improved the ability of our clients to grow and manage their business more effectively over time. We will always monitor competition very closely. However, our commitment towards the client, our actions as driven by client needs and our priorities will be to keep listening to them so we can provide them with a superior value proposition.

Having that said, I would like to say a few words on price. Our clients get superior products and service for a competitive price as we look at prices on a takeaway basis because it reflects the monetization of additional products and services we offer to them. Also, because we may have different combination of rate for each of our products depending on the client needs and competitive dynamic in each region.

Regarding competitors trying to take our clients by pricing the lowest, we have already been seeing this with more emphasis since the beginning of the year. However, we have been able to show our clients that the difference in dollar amount is not worth the much poorer customer experience and support the incumbents offer.

We know for a long time how to react to players who rely on price to compete. Also important to note that we manage our pricing strategy in terms of lifetime value of the client. So whatever we believe our price is not optimal either up or down, we may adjust in order to increase lifetime value.

Our performance so far in the fourth quarter 2018 in terms of growth, operational leverage, profitability, take rate, churn rate and productivity KPI has been very strong and on track. The Company's strategy of having the best customer experience is disciplined execution and indeed very close to the client has been paying off.

Looking to the balance of 2018 and beyond, we are excited about the opportunities available to us to continue to expand our business, offer more solutions to merchants and build long-term shareholder value.

Now I will turn the call back to Rafael so he can provide a high-level overview of our financial results for the quarter. Rafael?

Thank you, Thiago. As Thiago said, our third-quarter was a great quarter for the Company and the results are indicative of our commitment and focus on creating long-term value for all stakeholders.

Total revenue and income increased by 121% to BRL440 million in the third quarter of 2018 compared to BRL187 million in the third quarter of 2017. This was mainly driven by a year-over-year increase of 187% growth in net revenue from transaction activities and other services, a 124% increase in net revenue from subscription services and equipment rental, and a 108% increase year-over-year in financial income.

Cost of services was BRL81 million for the third quarter 2018, an increase of BRL27 million or 50% from BRL54 million in the third quarter of 2017. Cost of services as a percentage of total revenue and income was 19.5% in the third quarter of 2018, an efficiency gain of 9.2 percentage points from 28.7% in the third quarter of 2017.

This efficiency gain was primarily due to a reduction of transaction and client service costs as a percentage of total revenue and income by 6.3 percentage points from 16% in the third quarter of 2017 to 9.7% in the third quarter of 2018, and a reduction in other services costs such as personnel costs and depreciation and amortization as a percentage of total revenue and income by 2.9 percentage points from 12.7% in the third quarter of 2017 to 9.8% in the third quarter of 2018.

The reduction of transaction costs as a percentage of total revenue and income was primarily driven by dilution the fixed costs of our proprietary processing, migration of clients from Elavon Inc. platform and efficiency gains.

Administrative expenses increased 45% year-over-year for the third quarter of 2018 to BRL62 million. The increase in administrative expenses is primarily attributed to growth in headcount, third-party services and facilities costs to support our growth and preparation to become a public company in addition to higher depreciation expenses.

Selling expenses increased by 104% reaching BRL50 million in the third quarter of 2018. This increase was primarily due to an increase of BRL21 million from additional headcount in our sales team in line with our strategy to grow through the development of Hubs.

Financial expenses were BRL83 million, an increase of BRL27 million from BRL57 million in the third quarter of 2017. This was mainly driven by an increase in cost of funding of BRL31 million due to higher prepayment volumes, partially offset by a decrease in Brazilian interest rates and better funding cost efficiency.

Net income was BRL90.4 million for the third quarter of 2018 compared to a net loss of BRL14.8 million for the third quarter of 2017. In connection with our earnings release we are disclosing adjusted net income, a non-IFRS measure, which we believe is an important metric to evaluate the operating performance of the Company.

Adjusted net income was BRL89.3 million in the third quarter 2018 compared to BRL5.7 million in the third quarter of 2017. The main factors that contributed to the growth in adjusted net income were: increase of our total revenue and income primarily due to higher TPV and our focus on growing our base of SMB merchants; improvement in financial efficiency reflected by the reduction in financial expenses as a percentage of financial income; and operational leverage which resulted in a reduction in cost of services, administrative and selling expenses as a percentage of total revenue and income.

Besides the results of the third quarter I would like to update you on some recent developments. On September 4, 2018, the Company exercised an option to purchase the control of equals and upon consummation of our initial public offering, in October the Company acquired the remaining 44% stake it did not own, resulting in 100% ownership of the Company.

On October 24, 2018 we priced our initial public offering of 50.7 million Class A shares at a public offering price of $24 per share. Stone issued and sold 45.8 million Class A common shares and certain selling shareholders sold an additional 4.9 million Class A common shares.

The underwriters fully exercised their 30-day option to purchase additional 7.6 million Class A shares from certain selling shareholders at the initial public offering price less the underwriting discount. We issued 4.2 million Class A common shares to Ant Financial for $100 million with the placement closing on November 21, 2018.

Before turning the call up to questions I would like to highlight some important aspects about the way we look at our balance sheet and our ability to generate cash. So first I will give you a background on the way we look at our net cash position.

In the Brazilian market accounts receivable from card issuers are usually easily exchangeable for cash through the sale of such receivables to financial institutions at a discount. For that reason, whenever we sell a receivable to a financial institution our cash position increases and our receivables on balance sheet decreases.

That operation by itself does not mean that our business is generating cash, but rather that we have taken a funding decision and are exchanging a liquid asset for another even more liquid which is cash. We could opt for other funding sources such as raising debt (inaudible) or raising equity instead of selling the receivables.

On the other hand, whenever we stop selling receivables our cash position tends to decrease in the short term and our receivables on balance sheet tend to increase as our operations grow. This wouldn't mean that our ability to generate cash deteriorated, but rather that we have chosen a different working capital financing option.

Given this dynamic we look internally at what we call net liquidity in our balance sheet. This is equivalent to traditional net cash metric, but factoring in our position of both receivables from card issuers and payable to clients. So net liquidity would be the sum of cash and cash equivalents, short-term investments and accounts receivables from card issuers excluding for value adjustments minus accounts payables to clients, loans and financing, and obligations to FIDC senior quota holders.

Whenever our net liquidity improves it's strictly now effect from equity events such as capital increase, share repurchase and acquisitions. We can see that we have the ability to generate positive cash flow. With that said, operator, we will open the call up to questions.

(Operator Instructions). Felipe Salomao, Citibank.

I had one follow-up question about competition. And first of all, thanks, Thiago, for sharing your thoughts on that topic. Basically one of your largest competitors changed the speech regarding its pricing strategy. And now they are willing to quantify this (inaudible) up to 30% in order to prevent further market share losses.

How this shift has impacted (inaudible) some expectation for top- and bottom-line growth compared to a month ago during the management road show? I just need to get a color on how you guys are expecting competition to change the speech (inaudible) change the strategy. Now if you could share some thoughts on that that would be fantastic. Thanks.

Thank you for your question. Let me tell you how we frame this competitive dynamic here in the Company. So first is important to notice that we face competition since day one. And in the early beginnings we just had the licenses from Visa and MasterCard to offer in our payment solution.

So we created a lot of depreciation in terms of better value proposition with customer service, technology and distribution to our clients, but we still had to price below incumbents until the second half of 2017 when we started to price head to head with incumbents.

So the first quarter this year, first-quarter 2018 (inaudible), we started to see that incumbents started to price below us in many cases. But we have been growing in the previous three quarters despite that. So I think that the main message here is that these kind of recent discussions are not new to us. We are used to this kind of environment for more than a year.

In terms of pricing strategy, we remain focused on lifetime value. So our goal here is to increase lifetime value over time. And we have the ability to show our clients that in the dollar amount it's not worth it to accept a much poorer customer service and support for 5% to 10% discount is what we have seen from the incumbent.

So if we take into account a client that does on average BRL35,000 in sales per month with around the 2% take rate, so 5% to 10% discount should be around $10 to $20. So we don't think that it's worth it for our clients to sometimes wait almost an hour in the line and not having somebody at the doorstep whenever they have a problem.

So we really believe that our differentiation in terms of value proposition is much stronger than the kind of pricing dynamic that incumbents have tried to provide.

And regarding fourth quarter, I can tell you that we have very strong results. We are on track with our planning both in growth metrics as productivity and take rates and churn. When we look to those metrics in the fourth quarter so far we have [bettered] this quarter than in the third quarter results.

So we are very confident about our ability to continue to expand our business and offer value propositions which are very superior to our clients. And over time we want to provide much more software and financial products that will help those clients grow. So we are not seeing any kind of difference in the fields regarding the metrics. We are on track with our plans and with very strong results for fourth quarter. Do you want to add something, Rafael?

Yes, Felipe. Rafael here, just to add to what Thiago said. You mentioned regarding what we said in the road show of our IPO one month ago. So by that time we already forecasted a lot of competition. And what we have seen now is no different than what we expected. So this is very important to highlight. That's why we have seen results strong and on track with our own expectations.

Eduardo Rosman, BTG.

Also I have a question here on competition. As you know, some of your incumbents, they have been more vocal about calling the sector a commodity. Pretty much saying that it's all about prices, that it's not worth having good service. So I want to know your take on that.

One of your competitors that sells information for instance, the competitor says, look, it's very hard to sell that kind of information to the SME because the average Brazilian can't read the charts. So my question is how to convince the client that he needs help in managing that business. And why do you believe that you can make different than incumbents? That's my question. Thanks.

I think that regarding the way that we explain how we differentiate ourselves to our clients is that we learned that helping them to manage their cash flow, being very fair about the rate and very transparent to show them how much they are paying for -- and being very close to them to listen to their needs and provide more solutions to them is the best way to establish this relationship of trust in which we can provide more products over time.

So as we said during the IPO process, we started with the payments which is the main pain point of the client. And keep in mind that mostly inside of Brazil they are not used to the kind of service level that we offer to them. And once we start to explain then how they have to manage their working capital better and all the fees that they pay, we can move and provide much more solutions as we are doing nowadays with the reconciliation with the POS solutions.

So I think that we are mainly focused here on providing the best customer service and support, the best solutions to our clients. And we see that whenever our clients experiment (sic - experience) this kind of service and our solutions we can have better yields in terms of our solutions and that's what creates more lifetime value. So we drive lifetime value both creating more stickiness and creating more yield as we put more products in the same clients over time.

So, I do think that it's all about being close to the clients, offering the best value proposition, being very focused on their needs and provide all the solutions that they need to manage and grow the business over time. So I think that the client centric culture that we have developed, it's the most important thing for us and we will keep this kind of mentality as we grow as a company.

Carlos Macedo, Goldman Sachs.

I had one question. Piau and I think also Rafael mentioned that with Cielo becoming a lot more aggressive now we see Safra Pay basically giving the POS terminal away, charging no rent, no fee. The competition is escalating and one of the things you have to do to retain your clients is to increase the switching costs and doing so with software and I think, Thiago, you mentioned that before.

What is the pipeline for the rollout of more software solutions that would increase stickiness? Is the digital account upcoming, is that something you guys expect to roll out in the next few months. Outside of Linked Gourmet and Equals is something else coming that we can pinpoint that would help you reduce the churn even more than you already have particularly as the competition escalates? Thanks.

I think that to address that, first I would say that when you look to churn rates we are better in November than October. So in fourth quarter actually we are better than the third quarter and that's very encouraging results for that regarding these competitive dynamics.

And regarding the roadmap of solutions, more than the reconciliation, the POS that we currently have, we are looking for new verticals in which we can invest in more POS and ERP solutions over time. In the solutions that we are developing in-house, yes, the banking solutions is something that we really believe will be a huge opportunity for us.

And we have decided to create the whole platform from scratch as we did in payments in order to control the experience of our clients and adapt solutions to the process of our clients. And we think that we have opportunity doing lending in the future in the medium-term using our relationship with the clients to generate opportunity for third parties to offer solutions to our clients.

So when you think about lending, and we've seen that some different players in the marketplace are already doing, we do not think of using our balance sheet but using the relationship that we have and third-party capital to provide those solutions to the merchants.

So that is the kind of roadmap that we have and we are still looking for new POS solutions for our clients. So we decided to create our own operational system from the beginning. We were the first mover on that. And we think that we have a lot to capture in the near future providing solutions integrated with the operational system that we did.

Can you provide a time table for the launch of these things even if it's just within the next 12 months or the next 24 months or the next 36 months?

So, we are planning to have a relevant evolution regarding the bank and the lending opportunity in the next year.

(Operator Instructions). Lucas Lopes, Credit Suisse.

I have two, if not a problem. First of all our [elections set a bit on] the team of competition. I do understand that customer experience matters and the retention of new clients. But for new ones, I used to gain clients with more expensive price, let's say with -- by being more -- 5%, 10%, 15% more expensive than income is on average. Do you think that you can deliver your business plan? I know that the [GAAP] is not there yet, not 5%, 10%, 15%. But I mean the [speech] of the incumbent indicate they are able to lower price as much as needed.

And my second question, if I may, on the franchise model. In the second quarter in a row you only had four franchises, but if you go to your website you do say that the Company or the execution of (inaudible), there is the potential to open up to 200 franchises in the long term. And I understand that the model is quite new.

I was curious to see how the evolution has been. Could you share -- I mean the level of (inaudible) of potential new franchisees? And if you can see the number of franchises going from 4 to 50, 100 perhaps in a short period of time? And again thanks. That's my two questions. Thanks for taking them.

So first regarding our ability to and commitment with our business plan. Yes, we have seen very strong results in terms of growth and we don't think these price dynamics are going to impact the productivity and the ability to win new clients. Actually as we said, we are already seeing this kind of movement that incumbents are trying to price below us since the beginning of the year.

And you can see that we are adding clients very fast by that. And I can assure that in the fourth quarter we had very strong results in terms of traction and productivity with the same level of take rates. And we think that we can have better take rates over time mainly because of the value proposition that we offer.

So, we are 100% committed with our business plan. Actually we can see we are a little bit ahead of what we had planned before. So very encouraging results and very confident with the work that the team is doing here in terms of execution. I think that having this very focused and disciplined execution is really paying off and the most important thing to us is to keep our minds in our clients, so that's the first thing.

Regarding the franchise model, we are still in the beginnings of that. We don't have any update. So we have a huge opportunity in terms of the Hubs in Brazil. We are seeing positive trends in terms of entrepreneurs that want to know more about the franchisee model.

So, we are really in the early beginnings of that. I don't have any relevant comments regarding that. But I think that's revenue growth that we can use over time, but we are mainly focused on the opening up of the new Hubs and drive market share in the current Hubs that we have.

Domingos Falavina, JPMorgan.

Also two quick questions. The first one is actually more of an accounting question. If we go through your IFRS reconciliation on page 6 of your press release, it seems there are like five basic items you are adjusting in there and there is only one that's not present in 2017 in the first three months.

So by exclusion I am assuming the tax effects are in relation to the gain on the equals. However, the gain on the equals is negative, so you are adjusting negative, but then you basically remove again the tax effect. My question here is to what does the 7.3 million refer to? And if it is related to the 21.4 shouldn't it be a positive sign instead of a negative?

And the second question, if I may, is I read your release and on the qualitative side it seems you are trying to convey a message to the market that competition is not -- shouldn't be a reason for alarm, at least not as far as you can see the 4Q. I would like to get some more quantitative data. So basically when you look year on year the first two months with November almost ending, are volumes striking growth year on year in line with the secure -- the accelerating versus the third Q, are they decelerating versus the third Q?

So I think I will start here with the last question regarding some color on numbers of the fourth quarter. So we have decided to provide you guys with some guidance in the 2018 full-year adjusted net income. So the range that we are providing here is 313 to 330 adjusted net income for full-year 2018.

So we decided to provide this guidance because we are very comfortable with the execution and we received some feedback that would be great to our shareholder base to provide some color in the results of the full year. So given that said, I will move here to Rafael to explain a little bit the IFRS reconciliation.

Hi, Domingos; Rafael here. We can get also off-line then afterwards if you have any more follow-ups. But basically this difference in tax and the adjustment is basically deductibility of our base expenses that change a little bit over the quarters. So that's why you have that effect of the tax.

But just to remind that when there is a gain we put it as a negative, right, to adjust for the gain, so we take the gain out. And in case of share-based it is an expense, so we adjusted positively, so you add it to the adjusted net income.

And in 2017 basically there was a different kind of share compensation that did not create any tax shield?

Yes, we have -- in 2017 we had different types of share-based compensation. Basically one is equity classified, another one is liability classified. And then we have different tax treatments for each one of them. And if you want we can get in more details regarding its trench and how they are treated in terms of tax and that's why you see that difference.

(Operator Instructions). Since there are no further questions left in the queue, this does conclude today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.