TOTVS S A : Earnings Conference Call – Transcript_1Q23

Earnings Videoconference 1Q23

TOTVS (TOTS3 BZ)

May, 9th 2023

Sérgio Sério:

Good morning to all and thanks for attending this conference call. I am Sérgio Sérgio, Head of RI and today with me are Denis, our CEO, Maia, CFO and Tubino, VP of New Business and CEO of RD Station. As we usually do, we are going to present the highlights and then we will move on to the Q&A session. We kindly ask participants who want to ask a question live, that raise your hand by pressing the bottom on the lower part of the platform on Zoom. Otherwise use the Q&A Zoom bottom and we will try to answer live or later.

Before proceeding, we would like to clarify that any forward-looking statements that may be made during this video conference relating to the business outlook, projections, operating and financial targets are based on the beliefs and assumptions on the part of the company's management and on information currently available. Forward-looking statements are no guarantee of performance as they involve risks, uncertainties and assumptions, which have to do with future events and depend on circumstances that may or may not occur. Investors should understand that general economic conditions, other operating factors may affect the future performance of TOTVS and conduct to results which differ materially from those expressed in such forward-looking statements. I'll now turn the floor over to Dennis and he's going to talk about Slide 3.

Dennis Herszkowicz:

Thank you, Sergio. Good morning to all who are attending this video conference. I would like to start by thanking our associates, their families, the thousands of clients and millions of users throughout Brazil and Latin America. Once more, they have engaged in our journey to build and strengthen our 3D ecosystem, which is interconnected and interdependent. Together, we started 2023 with the same focus and determination we showed in 2022. We have become the trusted adviser of our clients by bringing our value proposition to improve the results of companies through innovation and technology. Every quarter, we had more and more towards that direction. This quarter was no different. We saw important achievements and new records. And as you can see on Slide 3, we have maintained the balance of our dual mandate, growth of revenue driven by SaaS Management, which accounted for half the growth year on year of the revenue and by Business Performance.

On the other hand, profitability. Our adjusted EBITDA Margin for Management and Business Performance, pardon me, increased beyond the Consolidated Margin. In terms of growth, as you can see on Slide 5, consolidated Net Revenue was in excess of R$1.1 billion, an 18% increase relative to the same period last year. This was possible because of the achievements in all the three dimensions of business and I would like to highlight the 33% growth in revenue of SaaS Management, 32% of the revenue in Business Performance and 16% of the revenue of Techfin.

These three revenue streams drive the total growth of TOTVS and account for more than 67% of the growth of consolidated Net Revenue in the quarter. Also the consolidated ARR, as you can see on the right hand of the slide, is to be highlighted. Despite a weak quarter and normal fluctuations in the short term in the renewal rate, especially in an operation that focuses on large accounts like Dimensa, our sales force showed its strength. At the end of the quarter, we had a consolidated organic net addition of R$185 million and the volume component increased its share. That is the signings of new clients together with cross and up-selling to the clients of our base, continues to be strong and -- moving forward. We also have record levels of NPS, the expansion of the solution portfolio, migrations of clients to the Cloud, productivity and efficiency in commercial distribution, reduction of TCO for the client and orders. Moving on to Slide 6, in terms of profitability, I would like to highlight the increase of the adjusted EBITDA Margin on a consolidated basis. This was in excess of R$1 billion in the last 12 months. This substantial result was driven by the adjusted EBITDA Margin of Management and Business Performance, which was 26%, a 170 basis points above Q1 2022 and 310 basis points above Q4. This shows the excellence of our operations and the healthiness of the recurrency model.

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Earnings Videoconference 1Q23

TOTVS (TOTS3 BZ)

May, 9th 2023

Then, on the right side of the slide, cash earnings ended at 25% because of the higher rates for interest on equity capital and for financial losses of R$20 million in fixed income funds which had less than 1% of its equity invested in debts in debt bonds of Americanas. These impacts were partially offset by the 13% growth in adjusted EBITDA. Year-on-year, there was 9.4% in terms of cash earnings. And this would be 26%, if we excluded the negative impact of financial investments, that is it would be in line with the behavior of EBITDA in the period. These results placed TOTVS in a unique position when compared to any other technology operation and allow us to continue to invest in building the competitive advantages that we have even in a more challenging scenario.

Now, I turn the floor over to Tubino to speak about the results of Business Performance on Slide 8.

Juliano Tubino:

Thank you, Dennis, and good morning to all. In March, we moved forward in terms of building the 3D ecosystem by having RD Station as the core of the Business Performance of TOTVS. All the operations of e-commerce, Tail and all the other offerings were consolidated under RD Station. This together with other changes that had been planned lead us towards greater integration, not only within the dimension of business performance, but with the other dimensions as well. This came together with one of the most important changes in my career as an executive because I became not only Vice President of New Business, but also I became CEO of RD Station.

Eric Santos, the founder of RD Station became the Executive Chair of the Board of RD Station and he's going to focus on strategic projects and on developing the ecosystem of partners and clients. In terms of the results of the quarter, the dimension continued to grow very strongly and Net Revenue increased 32% year-on-year.Quarter-on-quarter, revenue grew 3.7%. And mind you, there is a favorable seasonality in terms of ARR in Q4 in Business Performance. The Net Addition of R$21 million in the quarter took the ARR to R$374 million in Q4, as you can see in the center of the slide.

This performance in terms of the addition of ARR reflects the strategy of multiproducts of RD Station which accelerates cross and up-selling with a special focus on CRM and a solution for conversational commerce, which has been performing much above what we expected. Also, the launch of the advanced version of RD Station, which delivers innovation to more sophisticated clients and a higher volume of transactions. 27% of the revenue of RD Station is coming now from multiproduct clients that is those who use in their operations two or more products of the portfolio.

Also in terms of GMV, gross merchandise volume under the Digital Commerce offering, this continued to grow and has achieved R$137 million in the quarter, 85% above Q1 2022. In terms of Digital Commerce, we announced yesterday the partnership between RD Station and Shopify, the leading technology e-commerce company for small and medium-sized companies. Shopify is one more leader that we bring in to help us build the biggest and most complete ecosystem of Business Performance in Brazil.

This will be a complete portfolio focusing on the digitization of the sales funnel of the clients, which is essential for e-commerce. The integration of Shopify in the products and with the ecosystem of RD in terms of business deals and things and order is essential to serve small and medium-sized companies. This will help us solve problems for a very fragmented market. We are leaders in terms of automation of marketing with thousands of clients and agencies. And with our alliance with Shopify, a leading e-commerce platform, we will build a complete portfolio that we would like TOTVS to lead e-commerce with small and medium-sized companies.

Now the Contribution Margin on Net Revenue reached 49.1%. This is an increase of 140 basis points when compared to the same quarter last year. As mentioned in the last quarter, despite being a young business dimension and currently focused on revenue growth, this is a profitable operation with operational leverage as one of the strong characteristics of a SaaS model, which reinforces the high potential for value generation. Despite this current growth mandate, profitability will continue, not being a

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TOTVS (TOTS3 BZ)

May, 9th 2023

dilemma for TOTVS. I will now turn it over to Maia, so he can talk about Management starting on Slide 10. Maia?

Gilsomar Maia:

Thank you, Juliano. The Management dimension is following its balance trajectory of growth and profitability. The Net Revenue grew 17% year-on-year, again driven by a 20% growth of Recurring Revenue and by the increase of the Corporate Model Licenses. The main driver of Recurring Revenue growth continues to be SaaS revenue. This grew 33% in the period with a 29% increase in new signings, which set a new record for the first quarter of new sales and a 41% growth in Cloud.

As in previous quarters, the good performance of new signings has one of the main reasons, the consistent evolution of the quality perception by customers, which is reflected in the Net Promoter Score (NPS), which once again reached new records. This NPS behavior, the expansion of the portfolio, the drop of the TCO contributed to generate new sales lead and consequently the volume component to the addition of Annualized Recurring Revenue (ARR).

As shown in the chart in the center of the slide, the Net Addition of ARR totaled R$164 million during the Q. Excluding the seasonal effects of the Corporate Model, the reduction in organic ARR, well, this went to R$168 million on Q4 to R$130 million on Q1 this year. This lower Net Addition of ARR even with the growth of new signings, mentioned earlier, was mainly due to the combination of some factors:

1. The strong and expected decrease in the price component which translated the readjustment of recurring contracts approximately 55% lower than Q1 2022 and 40% lower than Q4;
2. the renewal rate which ended the quarter at 98%, slightly below the average of past years and mainly connected to the renewal of Dimensa contracts, which differently from other Management operations is more concentrated in a little more than 100 large accounts in the financial market which may generate greater volatility within its quarterly renewal rates. Given this scenario, the volume component totaled 82% of the gross addition of ARR in the last 12 months vis-a-vis 78% on Q4 and 67% on Q1 and this percentage refers to the average of the last 12 months, the level of the quarter was even higher than 82%.

Now when we go to Slide 11, the adjusted Management Contribution Marg surpassed the R$0.5 billion, reaching R$532 million. This is a reflection of the continuous evolution of Recurring Revenue and also the seasonal revenue from Corporate increased and productivity gains which translate into an operational leverage even in the face of the effects of the adjustments of the collective bargaining agreements in the state of Sao Paulo in January. As a result, the Contribution Margin over the Contribution Margin on the Management revenue reaches the highest level in the years with a growth of 30 basis points when compared to Q1 of 2022. This is a record. This is a high time record when we compare it to other years.

Now Techfin, Slide 12. It is worthwhile remembering that different from the Management and Business Performance dimensions, the revenue of the Techfin dimension is entirely transactional and by nature it is less predictable. On the other hand, this kind of revenue enables a higher take rate and captures market growth, therefore, complementing the Recurring Revenue characteristics present in other dimensions.

Currently this dimension is made up of two operations. One is Supplier, which is a company with over 20 years in the market consolidated in its niche, and that its main funding has the largest FIDC in Brazil, classified as AAA and the organic Techfin operation created over three years ago, which has been building a portfolio of solutions based on strong competitive differentials, a B2B journey integrated with TOTVS management software and an intensive use of the data available in the software.

Within this quarter, the revenue of credit products which still has Supplier as the largest part of the revenue had a drop of 28% when compared to Q4 due to three factors: (i) the lower volume of credit in the period due to the seasonality of the agribusiness production and lower performance of some segments, due to slowdown in economic activity; (ii) the reduction in the average production term, also

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Earnings Videoconference 1Q23

TOTVS (TOTS3 BZ)

May, 9th 2023

explained by agrobusiness seasonality; and (iii), the growth of funding costs, 7% above the last quarter, mainly because the cash position, both for Supplier and FIDC has been lower. And therefore, the financial revenue generated by the invested cash reduced these funding costs. It is worth mentioning that a lower volume of credit during this period is not directly connected to the reduction of Supplier credit limits since the default rates remained quite sound.

As you can see on the right box of the slide, even with the increase in defaults in Brazil average, the impact on Supplier was small since the difference between Brazil average and Supplier increased from 170 points on Q4 to 190 basis points during this quarter.

Additionally, the provision for expected loss also showed a strong reduction being 48% below Q4 of 2022 and 19% below Q1 of 2022. In the chart in the center of the slide, we can see that the loan portfolio presented an increase of 8.4% year-on-year with an average maturity of 69.5 days. The increase in the loan portfolio even in the face of reduced production is significantly associated to the agrobusiness produced in the last quarters with longer terms and that seasonally increase the relevance of the Supplier portfolio and the mix of FIDC. Also worthwhile mentioning the cross-sell of the Mais Negocios products in the TOTVS' client base. And these clients account for 65% of the new affiliates and 48% in the implementation of the affiliates.

Now on Slide 13, the scenario of the first quarter with a certain economic slowdown in some important segments, which affected Suppliers' credit production and reduced its Net Funding Revenue and its profitability. Suppliers' focus remains on its most valuable assets that is to preserve a low level of default. Thus, the reduction in the EBITDA Margin in Techfin when compared to Q1 of 2022 and Q4, reflect: (i) the already mentioned reduction in Techfin Net Funding Revenue; (ii) costs and expenses of primarily fixed nature, which have already begun to include lines of investments in R&D, administrative and other expenses to accelerate Techfin via Joint Venture. It's worth reinforcing that Suppliers have very profitable operation and that will benefit from the cost funding through the JV. On the other hand, JVs…still loss-making operation with accelerated growth and there are different strategies of products and portfolio to maximize the capture of value of the operations identified together with TOTVS client base. Now I will hand it over back to Dennis, so he can talk about ESG and then his final message. Dennis?

Dennis Herszkowicz:

Okay, Maia. On the ESG front, we highlight our ordinary yearly meeting held on April 19th. It was attended by more than 80% of the voting capital of the company and had all the proposed matters approved. Among them, it is worth mentioning capital budget global Management compensation and change in the company's share-based incentive plan. We also maintain the AA+ rating by Fitch, and according to the agency, reflects the company's leadership in the software solutions sector, a broad distribution network with a diverse portfolio of solution, increased more integrated and better evaluated by customers in addition to consistent margins and volatile macroeconomic scenarios among other factors.

Now on Slide 17, we continue to move forward the construction of the 3D ecosystem, an innovative and pioneering system strategy that gives to the client new journeys and to TOTVS, new markets. In the Management dimension, Recurring Revenue progressed 20% year-on-year compared with a higher level of Contribution Margin in a year mainly due to the growth in SaaS revenue associated with productivity gains, which translated into good operational leverage. In Business Performance, the construction of the largest ecosystem in Brazil continues at an accelerated pace of growth with a highlight on the recent results and acquired operations on the planned transition of the RD Station command reinforcing the center world of this structure and then helping customers and partners to leverage their marketing and sales initiatives.

Finally, in Techfin, we continue preparing for the approval of the Itau JV. This is transactional with transformational potential and will lead to a much more broader sustainable and competitive portfolio of solutions in our two operations, Supplier and the organic operation of Techfin. Within this context of preparation and expansion, we launched in April a working capital pilot project product to TOTVS based

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Earnings Videoconference 1Q23

TOTVS (TOTS3 BZ)

May, 9th 2023

customers. We will complement Techfin's portfolio. It is important to say even within a more challenging scenario, we are ready and in a privileged position to leverage the current and future opportunities, be it organically through strategic partnerships and also through M&A. Now, we are at your disposal for the Q&A session, which will be conducted by Sergio.

Questions And Answers

Sérgio Sério:

Thank you very much. Just to remind, as we said in the beginning of the videoconference, if you want to ask a question live, press the bottom, on the bottom part of the Zoom screen, and then we will regret you the microphone. If you prefer, send a question in writing, and we will try to answer the question during the session or forward it to our IR team. This is Marcelo dos Santos from JP Morgan.

You can ask your question.

Marcelo Santos:

Thank you, Sergio. Good morning to all. My question is about Shopify. What is the timeline for implementation? And can we, can you give us a little bit more color about the economics in this partnership? How are you going to make money as if its maintenance? And then how do you see the volume of new contracts in Management? So don't think about the price, just tell us about the volumes.

Dennis Herszkowicz:

Good morning, Marcelo. I'll start with the last part of your question and then I'll turn it over to Tubino.

In terms of volumes, we continue to perform in a very healthy way. We are happy with that. This component has been increasing its share and the percentage that we showed in the release is a percentage that reflects the last 12 months, which means that in the quarter, in the current quarter, this percentage was even greater than 82%. It is therefore an addition that is upscale, let's say this if we can, because this has to do with our sales force in terms of selling to new clients and cross-selling and up-selling to our client base.

Q1 is naturally a weaker quarter in terms of sales. So the fact that we were able to generate the volume that we generated is extremely positive. There is an expectation because of our track record and the seasonality that Q2 should be better than Q1 and this just taking into account the seasonality that we have seen in the past.

Before I turn the floor over to Tubino, I would also like to say that for a long time now, maybe for two years now, we have been saying that our performance in e-commerce was really good. Our JV with VTEX was really good, but we began to notice that there was a major gap in terms of serving our customer base. And that gap was in the small and medium-sized customers. So we were negotiating looking for a solution to bridge that gap. I am extremely happy and I would like to congratulate Tubino and his team who were directly involved in this negotiation.

I'm very confident that we are bringing in an excellent partner just as VTEX and I think we will be able to provide response for the needs of our clients. Congratulations Tubino.

And in terms of the economics of it, we can't give you a lot of detail, but what I can say is that this is a value sharing model. So without giving you more details, these are good conditions for us, but which involve as is the case of VTEX, it involves percentages of everything that is generated within the business.

Juliano Tubino:

So just to answer your questions, we are implementing it straight away. We have the machines, the RD team has the machines and we are thinking in terms of how we can leverage our strengths in terms of creating content, going to market and helping these 200 agencies to expand the portfolio in e-commerce. It's an excellent opportunity for RD and TOTVS, but also very good for Shopify. We are announcing this

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