TOTVS S.A. (TOTS3) Earnings Call Transcript

[Interpreted] Good morning, and welcome to the earnings video conference of the second quarter of '23. I'm Sergio Filho, and as always, I'm here today with Dennis and our CFO, Maia, to present the main highlights of the quarter. And by the end, we will have our usual Q&A session. Before moving forward, it's important to remember that predictions about TOTVS future performance are based on current information and assumptions. The encompass uncertainties and risks and many factors may change company's outcome. They may be different from the expectations here presented. Now I give the floor to Dennis that we will start the presentation on Slide 3.

[Interpreted] Okay. Sergio, thank you very much. Good morning, and Land ho! This is how I started my message at the results earnings release, and this is how I start our video conference. In the age of discovery, the top man is that salesman in the top of the main mass basket had his moment of glory with this very cry. Well then, after a period of fog that may have obscured the view for a segment of the market, the man cried loud and clear, positive impact of AI landed on TOTVS. And we are among the winners. The signs are unmistakable. We have discovered and already landed in a new world. And what are these signs? Our financial and operational results continue to accelerate, increasingly driven by AI enablers. As we shown in our earnings release, the indicators most closely linked to our ability to convert our competitive advantages into new sales as well as the strength of customer demand are the ones that have accelerated the most in recent months. 1/3 of the incremental recurring revenue between fourth quarter '25 and this quarter came from enablers. They already account for 28% of the net new ARR additions for this quarter, a strong acceleration from the 22% seen in the fourth quarter of '25. That was already amazing. Our gross ARR addition jumped from 9% year-over-year growth in the second quarter of 2025 to 28% in this quarter. Lastly, we got 3 quarters of ongoing 2-digit growth on recurring revenue organically, ranging from 15% to 25% over the last 21 quarters, more than 5 years in a row. So as I said, we are selling a lot and selling what moves AI. In February, we launched Linx, our foundation, and we are preparing a spectacular Universo TOTVS event that will be held on October. At that time, we will unveil a portfolio of agents that execute tests directly linked to the most integrated and sophisticated management process, something no other technology company offers using test model and driving a massive expansion of our TAM. This is just a preview as we have other high-impact announcements. What explains our arrival in the new world earlier than previously expected, the secret that a large part of the market has failed to grasp is that for many years now, TOTVS has been far more than just a software ERP or even less a SaaS company. We are the trusted advisers to Brazilian SMBs. This means that any technology important to SMBs could be of interest to us. That is why we expanded into front office solutions and Techfin. We have with created cloud and launched Linx. We added real value to each client's operations in order to capture a larger share of wallet and increase our remittance. As confirmed by recent proprietary research from Morgan Stanley, AI adoption among SMBs in Brazil is still in its early stages, yet it is taking place through a trusted partner. Just as with all previous technological cycles, TOTVS is the definite vehicle through which SMBs access artificial intelligence. Let's now turn to the details of the quarterly figures, starting with Slide 4. Before we begin, it is important to mention that 5 years after the acquisition of RD Station, we have achieved a high level of integration across products, technology infrastructure and back-office operations, unifying our go-to-market strategies to optimize new revenue capture and increase our relevance in the SMB segment. As a result of this maturity and of operating as a single unit, the company has evolved its organizational structure and starting this quarter has begun reporting its financial and operational results on a consolidated basis from this quarter on. So we will start with the comments through the ARR, the best proxy we have for the recurrent revenue trend. It has in its composition of net addition, 3 elements. The first, the gross additions representing the level of new sales to both existing and new customers, directly reflecting demand strength and the conversion capability of the total sales machine, gross price additions and lastly, of course, retention. In recent months, what has distinguished the winners from losers according to the market is the ability to sustainably accelerate the gross addition of ARR volume, the very first element. In other words, that we can show we had an incremental demand. Our sales show amazing sequential growth since the end of 2025, even more taking into account that 2024 was an amazing year on performance for TOTVS. The year-over-year growth on volume additions went from 9% on Q2 2025 to 28% this quarter, surpassing the record milestone of BRL 400 million in ARR in a single quarter. Net ARR additions reached BRL 208 million with AI enablers accounting for 28% of this total, undeniable evidence of the positive impact of AI in TOTVS. Compared to 2Q '25, we saw 80% growth, excluding the effects of TOTVS Inteligência Tributária , TIT and transaction volume. Against first quarter of 2026, the growth was 26%, stripping out the impact of the payroll tax restatement. And the net addition was not even larger only because the price component lost relevance due to lower inflation-linked contract adjustments and also because of a 60-basis point drop in the retention rate, reflecting the reduced average financial capacity of some clients resulting from the prolonged high interest rate environment. Now I give the floor to Maia, who will talk about net income and EBITDA. Maia, the floor is yours.

[Interpreted] Thank you, Dennis. Good morning, everyone. As Dennis mentioned, in the opening of this conference, we've reached the 30th consecutive quarter of organic -- double-digit organic growth in recurring revenue with growth ranging between 15% and 25% over the last 21 quarters. Over the 7.5-year period, the net ARR additions rose from BRL 40 million to BRL 200 million per quarter and recurring revenue grew more than 4.3x, resulting in a 22% CAGR, while its share of total revenue increased from 74% to 93%. As in ARR, the enablers have also contributed to recurring revenue performance. This driver accounted for 1/3 of the incremental recurring revenue of the semester with some of the enablers accelerating even from already high growth basis. For example, growth in API consumption database organization and system updates that rose from 50% year-over-year in the first quarter to 56% year-over-year in the second quarter. This recurring revenue performance has enabled us to increase operating leverage. Adjusted EBITDA grew 22% year-over-year with a 190 basis point margin expansion, even amid the execution of multiple strategic initiatives such as the integration of Linx, which has already expressed a 20% margin. Similarly, with the RD portfolio, the year-over-year expansion once again exceeded 2 percentage points. Beyond operational leverage and track record of rigorous cost control, it's worth highlighting the progress made in integrating AI into our internal processes without compromising financial discipline, steering clear of the excess of the so-called token maxing seen among various global players. How has this been achievable? The answer lies in Linx, which focuses on specialized intelligence to provide business context and model agnosticism, ensuring the flexibility to select the best model for each specific task and the use of proprietary metadata. The combination of technology and a down-to-earth approach has driven the 11% year-over-year increase in net revenue per FTE, our preferred metric in this regard, consolidating efficiency gains across a wide range of areas such as R&D, customer support, implementation services, sales and back-office solutions. Moving to Slide 6. Adjusted net income for the quarter rose 5.9% year-over-year and fell 11% compared to the previous quarter, primarily due to the net debt resulting from the issuance of debentures to fund the Linx acquisition. On the other hand, EPS increased 16% year-over-year. By analyzing the operational metrics for example, NOPLAT it shows a significant 3% year-over-year growth, reaching BRL 370 million, substantially outpacing the 22% growth in EBITDA for the period. The free cash flow followed a similar trend, posting a strong 50% increase compared to the previous quarter. This positive performance reflects quarter-over-quarter growth in operational cash generation, combined with the lower CapEx intensity during the period following a concentration of equipment investments in first quarter '26 ahead of the ES offering launch. Moving on to Slide 7. It's important to mention that Techfin is launching Conta Mais. This is a strategic offering that brings the ERP finance concept that fruition by establishing the foundation for Techfin to become the primary financial partner for TOTVS customers. Conta serves as the cornerstone of the cash management offering. It enables an ongoing relationship with customers and it's supposed to become as a key source for credit organization. The product is a dynamic center natively integrated with TOTVS ERPs with unique differences, topics such as integrated and complete reconciliation, a major payoff for SMB, greater agility and integration and cash flow management and total automation with ARP. For example, the receipts offer represented by Pix Techfin is one of the biggest beneficiaries. In fact, this transactional offer continues to scale with its TPV reaching BRL 2.8 billion in 2Q '26, which represents an increase of 31% year-over-year. The significant 24% year-over-year increase in net funding revenue was driven by a combination of 20% revenue growth and greater efficiency in funding costs, and it grew only 14%, being this the funding efficiency, one of our main competitive advantages. As I have noted previously, better does not mean immune. Techfin portfolio has an average term of close and growing on origination portfolio and net revenue, even in a credit scenario where some had to hit the brake. As we have noted previously, better does not mean immune, evidenced by the fact that additional provisions for expected losses pushed both EBITDA and net income into negative territory. However, given the Techfin portfolio has an average term of close to 2 months, modeling led to adjustments in credit branding and that had already been implemented and had resulted in default rates for the new originations that align with the portfolio's best historical levels, 2x or 3x lower than the market average.

[Interpreted] Thank you, Maia. Well, looking at all these advances, we see a unique opportunity. Our share price reflects a scenario completely disconnected from reality. That is the perspective of someone is still lost in the fog. Just for reference, the IGV has risen approximately 40% from the recent low, whereas TOTVS has climbed only 20% despite delivering a financial and operational performance far superior to the sector average. We executed half of the time with the retail buyback program in our history in half the scheduled time and already announcing a new one that is 50% larger. Combining the 2 programs for '26 and '24 program, we will repurchase and cancel a total volume of 70 million shares, nearly 50% of our free float. This places us among the world's largest technology companies in terms of share buybacks over the past 3 years. It represents one of the best examples of capital allocation and value creation, rewarding those who continue to believe in TOTVS's future. Now I give the floor to Sergio, who will open the Q&A.

[Interpreted] [Operator Instructions] We will get started with Marcelo Santos, JPMorgan.

[Interpreted] I have 2 questions. The first one relates to the gross ARR that you showed. This acceleration is very strong. Are these related to AR enabler? Or are there other elements? And within AR enablers, what were the more relevant? This is for me to understand this gross ARR. The second question regards the churn motivated by macro. Do you expect an intensification of this trend for the second quarter due to the complicated economic environment?

[Interpreted] Marcelo, I will start with the second question and being very straightforward. No, we don't see any worsening and what we saw in the first semester were isolated cases of clients that were in an extra judicial recovery, but we don't see this journey following the same level. At least, our panel does not show this, and we see the situation going back to normality. There is no expectations for worsening, just the opposite. For the gross ARR, you are right. I think this is the first time we opened it. Many times, we have just commented on it but never showed the graph. But we thought this was the right moment because in this last month, since the SaaS apocalypses it is simplifying the analysis, trying to show that those who have a sequential acceleration is a winner and who possibly doesn't have is a loser. So, our acceleration -- sequential acceleration of the gross ARR, and it is intentionable. We have almost an unbelievable volume if we consider our 43 years of life we have and the base of the -- its ARR was over these 4 decades. If you imagine that in 1 single quarter, we were able to generate almost 5.5% of all these accumulated ARR in new sales. You cannot consider this an incredible result. But no, it was not only based in the AI enablers. These are being more representative, specifically in the cloud case, which is the most important AI enabler. We have many other products. Basically, what we have in our portfolio has been demanded by our clients. Now let me take one more minute about enablers. There is a very clear connection with engagement of our clients and this incremental additional acceleration of the enablers. The more the client knows about the subject, the more the client understand how AI works and where it should be applied and how it should be applied, more our enablers become important and make sense to our clients because our enablers, they treat, for instance, about subjects as governance, security, control, efficiency. So, when we say that AI adoption for a sophisticated, complex, critical process and it's mainly integrated as are the prices connected to the management system, the back office. These elements of security control, governance, efficiency, they become even more important. And how will the client ensure that this is really available? Being in our cloud, organizing their database going to the last version of our systems and consuming the APIs that connect this heart, this brain that is represented by the management system in any other type of activity they perform. So, enablers are not the consumption of tokens by itself, but they are the enablers as the name said. And when we say -- when we talk about AI consumption in this type of process or task, this is the best proxy, the best indicator of the relevance we have and the opportunity we are already converting.

[Interpreted] The next question, Luis Chagas from XP.

[Interpreted] Congratulations for the results. I have 2 questions here. The first, you said you were bringing a new portfolio in October. What will be the pricing model task consumption? And what is the margin expected for this revenue? And the second, we see important margin. How much has been captured? And how do you expect to evolve this energy capture in the next 12 months?

[Interpreted] Thank you. Again, I will start with the second question. Well, Linx, yes, we have been capturing synergies. If you go to my LinkedIn, you see the last post of yesterday was exactly about the fact that all over Brazil in the cities where TOTVS and Linx have teams, we did last Monday, the formal arrival of these teams in all TOTVS offices. This is the most concrete evidence of the speed of integration and capture of synergies. Yes, Linx's margin is increasing. It exceeded 20%, but we still have a long road on. In the next quarter, we have a management margin of 30%. We still need much more, our expectations is that Linx will operate in the same level of efficiency and profitability of other management operations that we have. So, we still have some way to go, but we are very satisfied with the level of activity and capturing this value for Linx operation. And in terms of agents, yes, the TOTVS universe will along to a great amount of agents extremely sophisticated and connected to everything I just mentioned, process and tasks that are integrated with the company's operations, this is something special. We see usually agents that are applied over tasks that are not connected with the rest of the company. And usually, these are the most difficult tasks to be performed. So, I invite you to go there because this will be very cool. And in terms of pricing, we will launch this task model, task as a service and consumption will have an important weight in this pricing, but we will leave this part for this universe. We are not going to anticipate this. But basically, the parameters that you can consider is that -- of course, we will have the cost -- the computing cost associated to these agents, and we will have a markup over this, our margin. And as a ceiling, what we have is the equivalent cost of the task being performed by a human being less discount that naturally would give some advantage to our customer. So the pricing will be between these 2 parameters. Now the way we will execute these agents we are using our Linx, our foundation launched in February. Up to now, we haven't seen any other company in this market with the foundation, just like Linx, it brings incredible competitive advantages, both in terms of the composition of the agents, but also it brings very important elements linked to security governance that I have just mentioned and also the effective use of this model. So, it's more than proven what we have been saying for over 2 years that these models will be or will exist in hundreds and maybe thousands of different models that requires a high level of systems. And this agnosticism level is given by Linx. At the same time, we generate what we call the metadata. Exactly the answers, the responses, what works better with every type of model. And this is proprietary that help us to improve more and more efficiency, productivity and the cost of each agent. Well, of course, it's a competitive advantage, an important competitive advantage and very difficult to be replicated by any other company.

[Interpreted] Next question, Irma from Goldman Sachs.

[Interpreted] Going back to the Linx question, you've explained quite well the room for improvement. And I understand that we have room to re-accelerate revenue to leverage in the -- leverage that we have with this model. So, I understand that we are still in the very beginning of this journey. You've mentioned about integrating Linx, and this must be a go-to-market step. But if you could tell us a little bit about -- feedbacks about the initial channel on the customer base. I know this product serve -- I don't know if the churn is the right word, but well, it was a little bit out of focus coming from the previous management. So, could you give us a little bit about the feedback you've received so far and a little bit about this curve? I know it's more related to 2027. So -- but in order to give us an idea on what is to come. A second question is connected to that topic about the expenses. So, for example, the dilution and a low growth it brings this dilution and I believe great part comes from Linx. But could you tell us if there is any other element that you have identified as opportunity on the sales expenses mainly, please?

[Interpreted] Okay. Thank you, Irma. I will answer the first one, and Maia will answer the second. As for Linx sales, you are right. Since day 1, I've been saying that the large part of the margin and synergy from Linx will come from reaccelerating sales. We have opportunities -- great opportunities on the cost perspective. And part of this, we are already capturing, but the main will come from the sales reacceleration. Linx spent some years walking side by side, I would say. And we see this reacceleration as a key to deliver what we expect to deliver. That said, first reactions are the best possible. Here at TOTVS, we have a tradition, Irma, a large tradition of hosting in-person events with our clients. We have more than 8,000 in-person events per year if we consider 215 business days in a year. So, we are saying that whatever is the business day, we have at least 4 in-person events being hosted throughout Brazil from TOTVS with our clients. And this has already started with Linx. On the last 2 weeks, I've been here in our headquarters for at least 3 events gathering from 30 to 80 Linx clients on different verticals and the feedback is the best possible. Clients are -- clients know that Linx now within TOTVS -- and TOTVS is a company that knows deeply Linx business. So, the level of trust and expectation that we will close all the gaps that eventually may come -- that came from the previous management, we will close those gaps for sure. There is also a positive expectation on the cross-sell and integration among products. TOTVS developed a product portfolio -- a horizontal product portfolio. I mean, segment agnostic. And Linx have never had a portfolio like that. So, clients now see the benefit on integrating both products. So, for example, our human capital management suite, the workflow, the front office portfolio from RD, even Techfin. So, a wide range of possibilities and opportunities that we have beyond accelerating the Linx product sales. So, we are excited and Linx clients are excited as well. But please, Maia.

[Interpreted] Irma, answering your second question on sales and marketing. Well, there is a gain on the scale. The revenue mix, as we mentioned in the beginning of the conference, is increasing for recurrent revenue. And the composition of incentives for channels, for example, is a better relation, and it brings scale over time. In the last 2 years, we had consolidation movements, franchises, channels that we've acquired, and we were able to get sales benefits from them. What brought other productivity improvements. In the second quarter, we had a move from Universo TOTVS from June due to the FIFA World Cup, and this is mentioned in our release. We had an impact about BRL 14 million, what may represent something about 80 basis points. It explains part of the gain, but it is very painful. All the rest is related to the mix, productivity and sales acceleration. So with time, it reverts into productivity gains as well.

[Interpreted] Now next question, Leo Olmos, UBS.

[Interpreted] I would like to talk a little bit more about margin. Please, could you talk about AI evolution within TOTVS related to efficiency as you're investing a lot on R&D to deliver a better Linx. Of course, there is AI, and we'll talk about it on investor TOTVS, many new things integrating Linx. And even though the margin was a positive surprise. So could you tell us a little bit about the positive point that raised those benefits, including AI?

[Interpreted] Thank you, Leo. I will start. Maia, please, if you want, you can add your comments. But that's it, Leo. We've even highlighted that in the release, the margin gain comes in a scenario where we are growing, accelerating our growth. You can see the gross ARR addition, not only growing, accelerating, but launching new things, new releases. So, we mentioned important examples. What makes our margin increase even more notable. Maia, let me comment something about the expenses. You've mentioned Universo being moved on date. It is important to mention that in this very year, we will not have the RD Summit. So, when we look to the whole 2026 year, the improvements from the second quarter is consolidated because what we will have from Universo in the fourth quarter is equivalent to the RD Summit cost. So, I just would like to explain that point when it comes to the full year. Coming back to your question, Leo, there is a mix of things, okay? Why are we increasing our margin? First, because we are growing where we need to grow recurring revenue. Our recurring revenue has a gross margin close to 80%. What makes the margin cost on the additional -- the real additional revenue is low. What gives us an important operational leverage. Secondly, important part of new sales are cross-sales and upselling sales. So, these are sales to those who are already part of our customer base. So, the marginal cost of the sales is also a lower cost diluted within our structure. The third element, and you will remember it, we've been already applying AI to our internal process. But this AI usage within TOTVS is a rational usage. We never had a target at TOTVS of token maxing. We have never controlled how many tokens someone needs to spend setting a token consumption target. No, things here we have our foot on the ground. We want people using AI the right way. One of the ways of using AI in the right way is through our foundation. All the metadata generation helps us both with those agents outside, but for our internal usage, we are developing concrete knowledge on what works better in different processes, different tasks where AI is applied, what translates into results, into better and better results. So, Maia, I don't know if I forget about something.

[Interpreted] No, I would like to highlight, and it's connected to Irma's question as well on cost and the big change of Universo TOTVS. It's important to mention that, that margin came even having a higher loss prediction for this quarter. When we look back to TOTVS's portfolio, it's a little bit above our history. And with time, it will converge to the similar levels of our historic series. So even though we were able to increase the margin, of course, there is a lot to be done. We have scale room at lens as well. So we have a path. But as mentioned, AI usage here is not an uncontrolled usage as we see in other companies. No. Here, we have an effective usage so that we can measure the benefit, okay?