Earnings Call Transcript - AFYA Q1 2024

Operator, Operator

Good night, everyone. Thank you for joining us for Afya's First Quarter 2024 Conference Call. I'm here today with Afya's CEO, Virgilio Gibbon; and Luis Andre Blanco, our CFO. During today's presentation, our executives will make forward-looking statements. Forward-looking statements can be related to future events, future financial or operating performance, known and unknown risks, uncertainties and other factors that may cause Afya's actual results to differ materially from those contemplated by those forward-looking statements. Forward-looking statements in this presentation include, but are not limited to, statements related to the business and financial performance, expectations, and guidance for future periods or expectations regarding the company's strategic product initiatives, its related benefits and our expectations regarding the market as well as any remaining impact from COVID-19. These risks include those more fully described in our filings with the Securities and Exchange Commission. The forward-looking statements in this presentation are based on the information available to us, as the date hereof. You should not rely on them as predictions of future events, and we disclaim any obligation to update any forward-looking statements, except as required by law. In addition, management may reference non-IFRS financial measures on this call. These measures are not intended to be considered in isolation or as a substitute of the results prepared in accordance with IFRS. This presentation has reconciled these non-IFRS financial measures to the most directly comparable IFRS financial measures. Now, let me turn the call over to Virgilio Gibbon, our CEO, starting with Slide number 3.

Virgilio Gibbon, CEO

Thank you, Renata, and thanks to everyone for joining us today for our inaugural conference call of 2024. To start off, we'd like to outline our operational restructuring effort in Continuing Education and Medical Practice Solutions segment, to enhance synergies between active content and technology for medical education and its specialization cost for physicians. Afya has restructured its corporate structure so that all progress and services related to medical education excluding Medcon the grad courses are now managed in the same structure. Moving to the next page. We can now observe our new business structure taking shape, comprised of our three segments: Undergrad programs, Continuing Education and Medical Practice Solutions. In the Undergrad segment, we have maintained the existing structure. However, notable changes have occurred in the Continued Education. And it is previously accounted for a content and technology from medical education, Medcel, Além da Medicina, CardioPapers and Medical Harbour, within Medical Practice Solutions are now accounted for in the Continuing Education segment. Simultaneously, the segment commonly known as Digital Services has been renamed to Medical Practice Solutions. These structural adjustments have already been implemented for the results presented in the first quarter 2024 onwards. Additionally, the comparative base from the previous year has been recalculated to account for these restructuring efforts. So moving now on to Page number 5. Let's start with our performance highlights. Once again, Afya has recorded another strong beginning of the year. First, net revenue increased 13%, reaching R$804 million, followed by an adjusted EBITDA growth of almost 21% year-over-year, reaching R$398 million, with a margin of 49.5%, 300 bps over the same period last year. Once again, assets recorded another strong quarter, showing a solid organic growth with high profitability boosted by all three segments. The adjusted net income stood at R$251 million, representing an increase of 51% when compared to the same period of 2023. And our adjusted EPS scaled to R$2.74, a jump of 55% over last year. We also reported a strong cash flow from operating activities of R$429 million, an increase of 22% year-over-year, leveraged by the solid operational results of the company, with an operating cash conversion of 110% and a solid cash position of R$611 million at the end of the quarter. Moving to our operational update of the quarter. We expanded our operational medical school seats capacity to 3,152 seats. Additionally, our number of medical school students has reached over 22,000 representing an 8.6% growth compared to the first quarter of the previous year. Lastly, our physician and medical student ecosystem reached 334,000 accounting for around 41% of all medical students and physicians in Brazil. In the next slide, we will talk about our solid business execution within our three business units. Starting with the Undergrad segment, we saw an important movement throughout the quarter, such as the higher tickets in medicine courses with more than 6% increase in tickets of medicine schools. The 40 seats expansion Guanambi Campus authorized in January of 2024 and gross margin expansion. Continuing Education was marked by an operational structure that comes with growth and margin expansion. Considering this new segmentation, we saw an increase in B2B students, while both net revenue from B2P and B2B increased by 11% and 30%, respectively, achieving a net revenue of R$65 million in the first quarter. In our Medical Practice Solutions segment, we ended the quarter with a 15% increase in active payers aligning for our gross margin expansion. In Slide number 7, we are also excited to expand our offer in the Undergrad business with the signing of the acquisition of Unidompedro and Faculdade Dom Luiz. This acquisition will contribute to 300 operating medical seats in Salvador, the capital of Bahia and the fifth largest city in Brazil in terms of population. Unidompedro will be active for medical school in Bahia and will serve as a strategic hub for all other medical campuses in the state, besides all the synergies that we can track from all Continuing Education campuses in Salvador. We are reaffirming our strategy; Unidompedro is focused on medicine, its projected net revenue for 2024 is R$110.5 million, with 88% coming from medicine courses. By 2027, when the medical school reaches full maturity, the projected net revenue is R$267 million with over 95% coming from medicine. Highlighting the actions, Unidompedro received a score of 4 out of 5 in both institution concept and course concept metrics, affirming the high quality of their medical course at the campus in question. The aggregate purchase price amounts to R$660 million. We also anticipate achieving an EV/EBITDA of 4.2x at maturity post synergies. We expect the closing of the transaction to be on July 1, 2024. Now, I will turn the call over to Luis Andre Blanco, Afya's CFO to give more color on the financial and operational metrics. Thank you all.

Luis Andre Blanco, CFO

Thank you, Virgilio, and good evening, everyone. Starting with Slide number 9, for discussions of key operational metrics by business unit. Our number of medical students grew 9% over first quarter 2023, reaching 22,600 students due to the maturation of our medical seats and the seat increase in Guanambi authorized in January 2024. Therefore, we reach 3,203 seats and expect to achieve over 23,000 Undergrad medical students at maturity. Our medical school net average ticket increased by 6.4%, reaching more than R$90,000 in the first quarter of 2024. In addition, net revenues for the Undergrad programs saw over a 13% increase, achieving R$705 million, R$87 million related to medicine. All this effort means one thing, our medical education business remains and will continue to be the cornerstone of our business, in the short and midterms delivering high predictable growth, combined with solid profitability and cash generation. On the next page, I will present our continued educational metrics. As Virgilio mentioned, we have probably presented the new structure for the Continuing Education and Medical Practice Solutions. Strategically, we look into our Continuing Education in three different journeys. Starting from left to right with the residency journey, which encompasses the products of continued medical education focused towards mentoring and net sale B2P. We saw an increase of 62% in active payers, obtaining around 15,000 students at the end of the period. Following the graduate journey, which includes the students from graduate courses and Afya Papers, it grew 12%, reaching more than 30,000 students. In other courses and B2B offerings, Afya reached 21,000 students, which represented an increase of 44%. Summarizing, our efforts made possible for Continuing Education of net revenue to reach R$65 million in the first quarter of 2024. Compared to R$58 million in the first quarter of 2023, a growth of over 12%. Moving to Slide number 11, I will discuss the Medical Practice Solutions operational metrics. On the first graph, you can see our total active payers, which are the ones that generate revenues in B2P. With a continuous growth trend, we've reached 191,000 paying users, a 12% growth compared to the last year. As you can see in the second graph in line with the previous years, we achieved 263,000 monthly active users. Lastly, in our final graph, represents the net revenue of our Medical Practice Solutions, which has expanded 9% compared to the same quarter of last year, reaching R$37 million. Breaking down the revenue within the B2P and B2B segments, we observed that R$32 million originated from B2P, while R$5 million came from B2B. It's important to mention that during the first quarter of 2024, some B2B invoices were postponed and are expected to occur in the next quarters. In the next slide, we are proud to present the impact of Afya on the medical community in Brazil. We ended in the first quarter of 2024 with more than 334,000 medical students and physicians in our ecosystem; experience our service and products, representing a 41% market penetration. Moving forward, I would like to discuss our financial overview for the first quarter of 2024. Starting with the next slide, with great satisfaction, I'm pleased to present another robust quarterly result for Afya. Net revenue for the first quarter of 2024 reached R$804 million, marking a significant 13% increase over the same period of the prior year. This growth can primarily be attributed to higher tickets in medicine courses at 6.4%. The maturation of the medical seats, the 40 seats expansions are in the Guanambi campus, the continuing education in taking performance as the Medical Practice Solutions execution. In first quarter 2024, adjusted EBITDA increased more than 20% to R$398 million, with an adjusted EBITDA margin of 49.5%, marking an increase of 300 basis points compared to the first quarter 2023. The adjusted EBITDA margin expansion is mainly due to gross margin expansion within the three segments, the end of UNIMA and Afya Jaboatão integration process in November 2023, the ramp-up of the four medical campuses that started operations in the third quarter of 2022, and operational restructuring efforts in Continuing Education and Medical Practice Solutions segments. Moving to the next slide. The cash flow from operation activities for the year increased 23%, reaching a total of R$429 million, driven by our strong operational performance. The operational cash flow conversion ratio stood at 110% for the first quarter 2024, slightly decreasing from the 112% in the first quarter 2023. Adjusted net income for the first quarter of 2024 amounted to R$251 million, an increase of 51% over the same period of 2023, mainly due to the enhancement of operational results, the reductions in financial expenses due to the decrease in net debt and lower interest rates and lower effective tax rates. In terms of adjusted EPS, we achieved R$2.74 for the quarter, a remarkable 54% increase compared to the previous year. Our EPS was positively influenced by the increase in our net income with an impact from the previous year shares reputation. And now, moving to my last two slides, I will discuss our cash and net debt position. I also give you more color on our cost of tax. On the next slide, you see a table with the breakdown of our gross tax and the total cost of tax, considering our main debt, the soft-based transactions, debentures, account payables to selling shareholders and other financial obligations. On the next page, we can look closely at the net debt variation. In the first quarter of 2024, our net debt reached R$1.577 billion, compared to December 2023, we reduced our net debt by R$237 million. Even considering the seat going to be earn-out over R$49 million, we reduced our net debt per adjusted EBITDA from 1.6x in 2023 to 1.2x in the first quarter of 2024, considering the mid-point of the guidance for 2024. Considering the additional debt regarding only Unidompedro acquisition, we expect an updated net debt per adjusted EBITDA of 1.6x. This ends our prepared remarks, strong performance, consistent growth and success in all segments. We are committed to providing an ecosystem that integrates educational and Medical Practice Solutions for the entire medical journey, enhancing the development, updating effectiveness, and productivity of health professionals. We are very proud of our business and what we have achieved so far and excited about what we plan for the future. I will now open the conference for the Q&A session. Thank you.

Operator, Operator

The first question comes from Lucca Marquezini from Itau. Lucca, you may now go.

Lucca Marquezini, Analyst

Hey, good evening, everyone. Thank you for taking our questions. We have two questions from our side. The first one, the release mentioned that there was a gross margin expansion in all three segments. Can you please give more color on which of the segments most contributed to this expansion and the drivers behind this enhancement? And then the second question would be after the acquisition, you already surpassed the guidance of acquiring 200 seats per year. Should we expect another acquisition in new Undergrad courses this year or should M&A now be focused on other verticals? Thank you.

Luis Andre Blanco, CFO

Hi Lucca, it's Luis. I'll address your second question first. Regarding mergers and acquisitions, we previously provided guidance of acquiring 200 seats per year, which we shared in 2022. So far, we have completed two business combinations, with this being the second one. Over the past three years, we have achieved a total of 640 seats. After the grant's approval, we will meet our guidance for 2024. We are always open to discussing assets that fit our profile at the right price. We have specific targets in mind and will try to manage this risk, but matching the size of transactions with our targets can be challenging.

Operator, Operator

Yes. Regarding the gross margin, Lucca, we are going to disclose to you guys our consolidated spreadsheet as soon as we finish the call. But all the segments, as we already said, had margin expansion. The Undergrad was around 1.5 points, Continuing Education a little less than 4 points, and the Digital Services a little bit higher than 5 points.

Virgilio Gibbon, CEO

The contribution from the Undergrad is primarily due to the maturation of our medical school campuses, which we initiated in the latter half of 2022/2023. We are now in the third year of this process, leading to an increase in our margins. Additionally, the integration of UNI has progressed more quickly than we originally anticipated in our business plan, further enhancing our margins. The other business units have also contributed to both growth and improving margins in the Undergrad segment, which is operating closely to what we currently see in the Graduate segment. Moreover, the Digital Service is not just showing top-line growth but is also delivering positive results on the bottom line. Overall, the improvements in margin are rooted in these three segments.

Operator, Operator

Yes. I would like to add that in addition to cost savings, our reorganization between the segments related to content technology for medical education and Continuing Education has allowed us to save a significant amount of money. This change made operational sense and has also improved our results, positioning us to enhance our growth.

Virgilio Gibbon, CEO

Yes. Just for a little bit additional color on that Lucca, for Digital Services as an example, we were operating with different companies. So we had two commercial areas, two growth areas, and two IT teams for development. So we have now fully integrated close related to the physician journey for the mission that they have. So now it's only one team focus on the entire mission that we are prioritizing for that quarter for that screen. So there were a lot of synergies after the restructuring. The same applied for Pillar 1 combined with Continuing Education that we had last year. So we have all the marketing commercial team working together and also the content creator, the critical development working together. So there was a lot of synergy implementations in the fourth quarter in 2023.

Lucca Marquezini, Analyst

That's very clear, guys. Thank you.

Operator, Operator

Of course. The next question will come from Mirela from Bank of America. Mirela, you may now go.

Mirela Oliveira, Analyst

Good evening, everyone. I have a follow-up question on the gross margin one. Could you comment a bit also on what to expect from both the Continuing Education and the medical specialization margins going forward? And a second question on the guidance on last year's Investor Day, the company mentioned a long-term guidance for the Continuing Education revenues of around R$1.2 billion in 2028. And I was just wondering how should we think this guidance and the one for Digital Services also considering the new structure?

Luis Andre Blanco, CFO

Hi Mirela, Blanco speaking here. We don't have this opening of gross margins in terms of the guidance; we give the EBITDA guidance for the year. And we don't have changes in our view for the year of 2024 regarding the guidance that we provided when we released the results of 2023. So what we can expect for the year is adjusted EBITDA between R$1.3 billion and R$1.4 billion for the year. We reaffirmed this guidance with these results.

Virgilio Gibbon, CEO

And Mirela, regarding the guidance of our Digital Services because of the restructuring, one important part of that guidance is Pillar 1 that now is combined and has a lot of synergy with Continuing Education. So the R$1.2 billion now is split between two segments, we will have to reorganize this guidance for the long term, and we will come to the market at the right time to clarify how much of each segment will compound this R$1.2 million that would come from the Digital Services. But as soon as we get that, we will come to the market in more detail, okay?

Operator, Operator

Of course. Our next question comes from Marcelo Santos from JPMorgan. Marcelo, you may now go.

Marcelo Santos, Analyst

Thank you. Good evening, Virgilio, Luis, Renata, I appreciate you taking my questions. I have two as well. The first is about the growth in Undergrad revenue. If I recall correctly from the last call, you indicated that this segment was expected to grow around 10% for the year. However, you've reported a 13.5% growth this quarter. I would like to understand if there’s a seasonal factor that suggests growth will be higher in the first half, or if this performance is indeed exceeding your expectations. I'm looking to get a sense of the timing and alignment with your forecasts. My second question pertains to the B2B revenues you mentioned. Luis noted that there was a delay in recognizing some invoices from the first quarter to the second. If everything had been recognized in the correct quarter, what would a more accurate measure of this revenue growth look like? Thank you.

Virgilio Gibbon, CEO

Hi Marcelo, regarding your question about revenues being around 10%, that figure relates more to volume than to top-line growth. If you look at Table number 2 in our release, you'll see that medical school undergraduate revenues increased by about 15.5%, with 9% from volume and 6% from tuition. Additionally, we are seeing organic growth in net revenue from health science and other programs that previously experienced declining revenues. This is no longer negatively impacting our top-line growth as it did in the past due to restructuring and sharing our programs. Now, we are more organic, and this growth is not seasonal, as we have a strong intake, not just for medical programs but also filling 100% of our seats for health and non-health programs during the first quarter. We're expecting to maintain a good trend in the first half of 2024 with around 13% to 15% growth from the undergraduate segment. Luis will address the second question.

Luis Andre Blanco, CFO

Yes. To add to the first point, despite the performance of the first quarter, we maintain our expectations for net revenues in 2024 as outlined in our guidance, which ranges from R$3.150 billion at the lower end to R$3.250 billion at the higher end. When we discussed performance across each segment, we aimed to illustrate the overall anticipated results among our three segments. However, our guidance always focuses on consolidated figures, which remain between R$3.150 billion and R$3.250 billion for 2024. Regarding your second question about B2B, yes, we are experiencing some delays in recognizing revenues from medical practice tools. If we look at it this way, we anticipate growth of around 20% to 30% compared to the same period last year.

Virgilio Gibbon, CEO

Just to add here, Marcelo, so in terms of guidance, seeing the overall results from top and bottom line in the first quarter. Of course, there is a positive bias when you compare to the one-year guidance that we released last quarter, but still show in the process. We have the second quarter intake, everything there is still uncertainty. So it's still soon to admit that we are going to change or not our guidance for 2024, okay?

Marcelo Santos, Analyst

Perfect. Very clear. And so 20% to 30%, the minus 6% would become 20% to 30%. That's it Luis?

Luis Andre Blanco, CFO

Yes.

Operator, Operator

Yes.

Lucas Nagano, Analyst

Thank you and good evening to participate here. We have some questions related to the Unido acquisition, three to be precise. The first is how you're planning to fund the acquisition. Second is what is the expected impact on margin once you consolidate when you don't? I think also you mentioned that you expect this to close on July, right? And the third is, in practical terms, what is the likelihood that those incremental 175 seats are canceled? If you could comment a bit on the stage of this process? Thank you.

Luis Andre Blanco, CFO

Thank you, Lucas, for your three questions. I will address all of them. Regarding funding, we finished the first quarter with over R$600 million in cash. We have sufficient funds for the down payments related to the acquisitions, and we also have the cash generation from the second quarter. If we come across an attractive opportunity, we would seek additional funding for it. Concerning margins, we can anticipate some dilution. The margins for these operations are not comparable to those of our Undergrad segment, so we expect some dilutions this year. However, we foresee increasing margins from 2025 onward, and we will work to integrate Unidompedro into our ecosystem as quickly as possible. As for the 175 seats, they have been in operation since the beginning of 2021 with the first intake. We have a positive outlook regarding the continued approval of these seats and have set a 10-year payment schedule to safeguard against any possible remote scenarios where these seats may not operate. Our base case expectation is that the seats will continue to operate.

Virgilio Gibbon, CEO

Just to add here, Lucas, first on the second question about the margin impact and how we want to leverage operationally the new campus. Remember that it's our largest medical program, campus, 300 seats concentrated in one large city with a very high level of tuition. So the capacity that we'll have to fulfill all the seats available, the vacancy that we are seeing there in a very fast track, as soon as we get the operation closed and improved margins, I think taking what we had as experience in Uni going to view and also UNIMA that we could leverage 30 percentage points in almost one year. I think we will do something very close to that and reach the same level of what we are operating now in the Undergrad business in 2025. And the 175 seats, I think it's important to mention here that not only we are operating the seats since the beginning. We have approval, not only in the just but also from the Ministry of Education who recognizes it. And all the trends that we are seeing from the Supreme Court is that everything that was approved, considering the current regulation, the Ministry of Education, it's not canceling, not only for this case here, but all the precedents that we are seeing in the market, it's quite positive in that regard. So it's very rare. It's completely remote, the chance that it will be canceled. Even in a worst-case scenario that has happened, we have all the framework that we are paying the installments, which protect us in 10 years. And also, we will cancel all the payments at the right moment. So, that's the way that we construct the deal, okay?

Operator, Operator

Yes. Just a reminder, the first one that they required for those seats was before my medical law. So it was before 2020. And the second reminder that in this worst-case scenario that Virgilio told to stop paying, we still have the positive effect of the students that are already enrolled for the next six years. So we also have the economic benefit without having to pay and increasing our IR.

Lucas Nagano, Analyst

Thank you. And also a quick follow-up on the Supreme Court debate. When do you expect them to resume the voting process?

Virgilio Gibbon, CEO

It's expected to happen now in May. Actually, the due date is tomorrow, but we don't know if they will release or not the voting by tomorrow.

Operator, Operator

Yes, just a clarification. The due date for tomorrow is for the timeframe to return with results.

Leandro Bastos, Analyst

Yes. Thank you, guys. Two questions on our side. First one about kind of the rationalization of costs, the restructuring that you mentioned. I'm just wondering if you could comment how far advanced you think the company is in the process of rationalization? If you see additional levers for reducing applications and unlocking efficiencies or if we could expect basically what we saw during Q1 to carry the impact from these initiatives through the year? If you could provide some color on how should we think about this margin dynamic forward, I think would be helpful. That will be the first one. The other, if you could also talk about how you saw competition during this recent intake season in terms of candidates per seat. How was the strategy for pricing with, of course, good volumes and kind of a pricing ahead of inflation? So if you could comment a little bit on how sort of the competitive environment, I think would be interesting to hear. That will be it, thank you so much.

Luis Andre Blanco, CFO

Thank you for your question, Leandro. I will begin with the first part, and Virgilio will address the second. Concerning the expected margins moving forward, we do not provide guidance on gross margins for the year. However, we are optimistic about achieving the adjusted EBITDA guidance we set for the year. We have not only provided annual guidance but have also met our targets in previous years, and we are confident that we will do the same in 2024. Therefore, I prefer to emphasize the guidance we provide to the market instead of offering specific guidance on gross margins going forward.

Virgilio Gibbon, CEO

In the last quarter of 2023, we underwent a significant restructuring, which resulted in the dismissal of around 200 employees as we integrated the companies we acquired, particularly in the digital sector. Consequently, our focus has shifted from cost efficiency to growth and top-line expansion. We have also matured our structure post-IPO, now five years in, leading to synergies in our general and administrative expenses. This is factored into our release guidance provided to the market last quarter. Regarding competition, we are seeing similar candidate intake rates as in the previous two years, with stable conditions. Our efforts to enhance our brand are beginning to attract more leads, supported by over 300,000 physicians and medical students engaging with Afya and utilizing our solutions. This engagement is crucial as it helps us fulfill increasing demand for our programs effectively. Our candidate-to-seat ratio has remained consistent, and we continue to have a strong intake even in smaller campuses in remote areas. On the pricing front, we maintain favorable conditions to pass on inflationary increases to our pricing year-over-year since 2019.

Operator, Operator

All right. Since we do not have any other questions, we are going to end the call. If you have any other questions, we are in the Investor Relations area, and we are going to be happy to help you. Have a good night.