Earnings Call Transcript - AFYA Q2 2023

Operator, Operator

Thank you for joining us for Afya’s Second Quarter 2023 Conference Call. Today I'm here with Afya’s CEO, Virgilio Gibbon; and Luis André Blanco, our CFO. During this 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 these 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 the potential 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 of 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. Let me now turn the call over to Virgilio Gibbon, Afya’s CEO.

Virgilio Gibbon, CEO

Thank you, Renata, and thanks everyone for joining us today for our second quarter and first half conference call for 2023 results. For us in Afya, this quarter’s results reinforce that our strategy has been successful, marked by the consistent growth of our operational and financial results. Once again, we are proud to present the strong execution of our unique business model, combining high growth in all three segments, profitability and strong cash generation, proving its resilience. During this presentation, I will first run through some main strategic topics, such as our performance highlights, the successful business execution within our three segments, 2023 guidance, recent awards recognition, the new brand strategy and to finalize our future expectations. Further on, Luis Blanco will shed some color over our financial and operational overview. So, moving now to page number 3, let’s start with our quarter highlights. Adjusted net revenue increased 24% year-over-year, reaching R$712 million, followed by an adjusted EBITDA growth of more than 22%, reaching R$268 million with a margin of 38%. We also reported a record cash flow from operating activities of R$566 million, an increase of 26% year-over-year, boosted by the solid operational results of the company, with a cash conversion of 99% and a solid cash position of R$741 million at the end of the quarter. Adjusted net income was R$132 million, a growth of 11% year-over-year, with an EPS of R$1.42 representing a growth of 12% even considering a higher net debt and interest rate period during this quarter over last year. Moving to our operational updates of the quarter. We have reached 3,113 operating seats, an increase of over 25% over the second quarter last year, with the beginning of four Mais Médicos campuses, along with organic seat expansion in Itabuna and also the acquisition of UNIT Alagoas and FITS Jaboatão. In addition, our number of undergrad medical students has reached almost 21,000, representing an 18% growth compared to the second quarter of the previous year. Once again, we saw great results from Continuing Education presenting a strong net revenue growth of 50% year-over-year. Also, we are happy to say that Afya reported great results in the Digital Health Services segment, which ended the quarter growing 28% in revenues year-over-year. These results materialize the great opportunity ahead in Digital Services and it is explained by the strong ramp-up on B2B engagements, reaching more than 100 contracts with pharmaceutical industry companies, and the continuing ramp-up on B2P contracts business to physician. Our ecosystem reached almost 282,000 active users, a growth of 6% year-over-year. This represents around 34% of the Brazilian physicians and medical students market. Moving on to slide number 4, we will talk about our solid business execution within our three business units. Starting with the Undergrad segment, we saw important movements throughout the quarter such as higher tickets in Medicine courses, with almost 9% increase in medicine tuition, the maturation of medical seats, the consolidation of UNIT and FITS acquisition, and 64 additional seats in Faculdade Santo Agostinho, in the City of Itabuna. We are delighted to present that the most significant growth in terms of revenue came from the Continuing Education segment with 50% growth year-over-year, due to a robust intake process, new campuses, and course maturation. On our Digital Services segment, we ended the quarter with a revenue increase of 28% compared to last year. This result reinforces the opportunity ahead in Digital Services, and it is explained by the ramp-up in B2B engagements, with new contracts with the pharmaceutical industry, and the continuous ramp-up in B2P contracts. And it is with great excitement that we present to you RX Insights, the new data intelligence platform that will allow pharmaceutical industry companies a real-time in-depth look at physician prescriptive behavior. In the next slide, we are reaffirming our guidance for 2023, which considers the successfully concluded acceptances of new medical students, ensuring 100% occupancy in all of its medical schools. Considering the above factors, the guidance for 2023 is defined as shown in the charts. Adjusted net revenue is expected to be between R$2.750 billion and R$2.850 billion, and adjusted EBITDA is expected to be between R$1.100 billion and R$1.200 billion, excluding any acquisition that may be concluded after the issuance of the guidance, and also considering the increase of FG-FIES contribution rate. Under the new FIES Program, Higher Education Financing Fund, introduced in 2018, a retention is applied to the amount paid by the program to cover the delinquency of the financed students. There was a transition rule that capped the retention at certain levels until 2022. From 2023, the limit was lifted, and the retention was updated according to the delinquency per educational entity for those FIES students that entered into the amortization phase. For Afya, the expected impact on the increase of the FG-FIES in 2023 is around R$24 million which was already considered when we issued the 2023 guidance. In other words, Afya's 2023 net revenues and Adjusted EBITDA will be almost 4x higher than in 2019, the year of our IPO. Furthermore, the cash conversion rate will continue to perform above 90%, showing our capacity to deliver strong growth, expanding our profitability and cash generation. Once again, we are guiding another strong round ahead, aiming at the top of the year guidance and proving AFYA's resilience and ability to keep delivering solid results with high predictability. And now, moving to slide number 6. I am really proud to announce that Afya's remarkable performance garnered three significant awards within the second quarter: First one, Valor Econômico's Best Education Company in Innovation; second one, another prestigious recognition for being the best Company in the Education Sector in the Valor 1000 Award; and third, the Executivo de Valor Award that I was recognized in the Education Sector in June. We are very proud of all these achievements, as they reflect the work and passion of our thousands of employees around a unique vision: to transform health together with those who have medicine as a vocation. On the next slide, I would like to talk about Afya brand strategy and its new architecture. We recognize the importance of incorporating the value we create into our brand and the importance of strengthening an integration that reflects our sense of unity and mission. We already are the leaders and pioneers of a solid and profitable business, now is the time to be perceived as such. We have almost 282,000 physicians and medical students using our digital solutions, but only some of them know the brand Afya. This brings us a huge opportunity to become the reference in solutions for medicine, to hook them up, improve the engagement, cross-sell and upsell along the journey. Therefore, one of our main objectives is to make Afya hub known and relevant to students, physicians, healthcare companies and society, becoming the top of mind and most recurrent brand by physicians throughout their journey. With this new logo, we reviewed Afya's brand architecture, to no longer let the value of Afya be fragmented or diluted. To consolidate all this value under a single brand, simplifying the comprehension of our portfolio, avoiding brand conflicts, and working towards strengthening Afya as the one-stop shop for physicians. To finalize, I would like to talk about our future expectations. When we analyze our goals for 2028, six years ahead, and consider our three business segments, we have a very ambitious plan ahead. With Undergrad, we have three avenues for growth: First by maturing the existing seats; second, through organic growth of half of the requested seats that have been asked to the Ministry of Education; and last, through acquisitions. The fact that undergrad is our biggest cash generator allows us to maintain our goal of constant growth with the plan to increase our available seats by 200 per year through acquisitions. Considering the increase in inorganic and organic seats, we expect to reach a total capacity of more than 32,000 students and capture 15% of the market share in terms of private seats by 2028, which represents a growth of over 2x in top line. It's worth remembering that Afya manages to extract significant value from every acquisition. In Continuing Education, which is the next natural step for those who study medicine, we have a product that has shown great potential. And despite being significantly impacted by COVID-19 pandemic, it has experienced an expansion that has exceeded our expectations and still has a lot of room for growth. Through strong top line growth, ramp up of new units, and additional 50 new courses, we expect to reach R$440 million of net revenue by 2028, 4x higher than 2022. Afya Digital Services is where we can expand beyond our physical structure and reach a vast number of physicians with tools that offer productivity, assertiveness and up-to-date information. Our strength in this segment lies in serving as a bridge between the pharmaceutical industry, payers and providers and a vast community of physicians at various stages of their journey. Our goal for 2028 is to increase penetration and engagement in B2P business acquisition sector and consolidate our B2B offerings, reaching a net revenue of $1.2 billion in Digital Services by 2028. To summarize, we intend to grow more than 2x 2022 net revenue in Undergrad by 2028, 4x in Continuing Education and over 6x in the Digital segment. This means that Afya will almost triple its net revenue between 2022 and 2028. Despite being ambitious goals, they are achievable, supported by strong execution, focus on the medical journey and a dedicated team. I will now turn the call over to Luis Blanco, Afya's CFO, to give more color on the financial and operational metrics. Thank you.

Luis André Blanco, CFO

Thank you, Virgilio, and good evening, everyone. Moving to slide number 10 to discuss the financial highlights of the second quarter. It is with much satisfaction that I present another strong quarter of results for Afya. Adjusted net revenue for the quarter was up 24% year-over-year to R$712 million, reflecting the maturation of medical seats, higher tickets in Medicine courses, the impressive growth from Continuing Education, consolidation of Digital Services and the integration of new acquisitions. For the six-month period, adjusted net revenue was R$1,422 million, an increase of 24% over the same period of last year. Adjusted EBITDA for this quarter increased 22% to R$268 million, while the adjusted EBITDA margin decreased 50 basis points to 38%. For the six-month period, adjusted EBITDA was R$598 million, an increase of 22% over the same period of the prior year, with an adjusted EBITDA margin decrease of 80 basis points in the same period. The adjusted EBITDA margin reduction is due to the mix of net revenues, with higher participations of the Digital and Continuing Education segments, and the consolidation of four new Mais Médicos campuses that operation started on third quarter 2022 and UNIT Alagoas and FITS Jaboatão dos Guararapes, which are performing better than expected but still present lower margins when compared to the integrated companies. Moving to the next slide. Cash flow from operating activities for the semester was 26% higher year-over-year, totaling R$566 million, resulting in a strong cash conversion ratio of 99%. Adjusted net income for the second quarter of 2023 was R$132 million, an increase of almost 11% over the same period of the prior year. Even with higher interest rates year-over-year, and an increase in debt with the acquisitions of UNIT Alagoas and FITS Jaboatão dos Guararapes, our adjusted EPS kept increasing due to operational leverage reaching R$1.42 in the second quarter. Moving to slide number 12 for a discussion of key operational metrics by business unit, starting with the Undergrad segment. Our number of medical students grew 18% year-over-year, reaching almost 21,000 students, with approved medical seats increasing nearly 15% year-over-year to 3,163 approved seats. Considering additional organic and inorganic seats increase, we expect to achieve a capacity of more than 32,000 undergrad medical students in 2028. With our net average ticket increasing almost 9% year-over-year for medical school, we’ve reached R$1,616 million of combined tuition fees, up from R$1,310 million from the prior year, an increase of 23% for the six-month period. Regarding revenue mix, 78% of these are derived from medical school students and 90% from health-related courses. On the next page, I will present our Continuing Education metrics. As said before, we saw another impressive growth from our Continuing Education segment, which reported a strong intake process, increasing the number of students by 31% year-over-year. In the quarter, net revenues grew almost 50% when compared to the same period of the prior year. And for the six-month period, we saw an increase of 48%, reaching a net revenue of R$71 million. This recovery is due to the better performance of Afya Educação Medica, mainly related to robust intake process, and course maturation. Moving to slide number 14, I will discuss the Digital Services 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, so far, in this quarter, we have reached 207,000 paying users, an increase of 8% to the same period of 2022. As you can see in the second graph, our ecosystem reached almost 282,000 monthly active users, representing around 34% of all medical students and physicians in Brazil, as Virgilio said before. And finally, on our last two graphs, we can see our Digital Services net revenue, which for the quarter increased over 28% reaching R$54 million; and regarding the six-month period increased by almost 24% year-over-year. The organic growth is a combination of the start of the B2B segment with pharmaceutical companies, and the expansion of the active payers in the B2P. In addition, since 2022, we started to break down our Digital Service net revenue within B2P and B2B segments. So, from the R$111 million of Digital Service net revenue in the first half of 2023, more than R$91 million came from B2P, and almost R$20 million came from the B2B. B2B strategy holds huge potential and is still ramping up. And now, moving to my three last slides, I will discuss our cash and net debt positions, also giving more color on our cost of debts. Cash and cash equivalents at the end of this quarter were R$741 million, an increase of 20% over the second quarter 2022 and an increase of 2.6% over the first quarter 2023. In this quarter, net debt totaled R$2.004 billion, a decrease of 1.3% compared to the first quarter 2023. The increase of R$623 million when compared with fourth quarter 2022, was mainly due to the R$825 million UNIT Alagoas and FITS Jaboatão acquisition closed in January 2023, which was partially offset by the free cash flow generation in the first half of 2023 as we can look closely on the next page. In this slide, I presented the net debt reconciliations for 2023. The cash flow from operating activities was allocated to income tax and lease payments, CapEx activities and for the service of the financial debt. Even considering that we had executed part of our share buyback in this quarter, we were able to generate R$202 million as free cash and reduce our net debt in the semester. On the next slide, you can see a table with the breakdown of our gross debt and our average cost of debt, considering our main debts, the Softbank transactions, other loans and financings, and the accounts payable to selling shareholders. Our capital structure remains solid with a conservative leveraging position and a low cost of debt. This ends our prepared remarks. I will now open the conference for the Q&A session, thank you.

Operator, Operator

So if you want to ask a question, please just raise your hand. Our first question is from Lucca Marquezini from Itaú.

Lucca Marquezini, Analyst

So we saw that adjusted EBITDA margin was impacted by revenue mix and the consolidation of new campus and acquisitions. So if you could please just provide us more color on the integration process of UNIT and also comment on the profitability performance of Medcel specifically, that will be very helpful?

Luis André Blanco, CFO

I will address your questions, Lucca. Regarding UNIT, we expect to complete the migrations to our shared service in the fourth quarter. The integration will take place within this year, less than a year after the business combination. For Medcel, the second and third quarters are not significant for the business, as revenues are primarily generated in the first and fourth quarters. Therefore, Medcel's performance in the second quarter is not crucial for our results.

Operator, Operator

Yes. To give you more color Lucca, it’s important to say that if you look to our gross margin of Digital Services and Continuing Education, we increased the margins of both segments and now in the second quarter. And also, if you look for the ex-acquisition results that we present in the first table of the earnings release, you also can see that you need to have a margin that's below what we can see now of our other results. So in the end of the day, as we said, everything is going as predicted and we are still seeing operational leverage in all segments.

Lucca Marquezini, Analyst

Very helpful. Thank you, guys.

Operator, Operator

Okay, of course. So the next question will come from Lucas Nagano from Morgan Stanley.

Lucas Nagano, Analyst

We have two questions. The first one is related to the regulation on medical seats. Now that we have some visibility on the Supreme Court's decision, do you have any expectations for the approximately 170 requests that were made outside of Mais Médicos that will still be analyzed by MEC? And in parallel, do you have any guess on the format of the new Mais Médicos' III program like in terms of size, regions? That was my first question. The second question is related to FG-FIES. You mentioned that the expected impact for the year is R$24 million. And I wanted to ask you how much of these were reflected in the first half? Can we assume it R$12 million? And was this effect concentrated in the second quarter or spread between the first quarter and the second quarter?

Virgilio Gibbon, CEO

Okay, Lucas, it's Virgilio. I'll address the first question regarding FG-FIES, with Blanco assisting me. Concerning the request for new seats from the Mais Médicos process, I believe it’s too early to assess that. We are currently in the midst of the judgment, and the second judge just released his full decision this afternoon. He was entirely against the continuation of the process already underway with the MEC and the Ministry of Education. However, it is still too early to determine the impact of these issues related to the current Mais Médicos process. Regarding Mais Médicos III and the seats, I think you'll need to wait one or two weeks to see the public bid in the market and analyze which seats will be acquired for Mais Médicos III.

Luis André Blanco, CFO

Hi, Lucas, it's Luis. In talking about FG-FIES, when we saw the increases in the retention piece of FG-FIES that was at the beginning of March, we foresaw that and we did this expectations of R$24 million and we put it under our guidance. So since the inception of the guidance of 2023, it's reflected under our guidance of 2023. So we don't expect any kind of changes in our guidance and our expectations of this impact in terms of net revenues for the year would be R$24 million.

Operator, Operator

Yes. And we don't see a lot of seasonality between the quarters for us to see a lot of concentration in one quarter or another, okay Lucas.

Virgilio Gibbon, CEO

Yes, but the FIES contract is based on semester. So you can consider that most of them, 50% of them will be in the first and the second half. But consider that we have maturation, and we still have more students enrolling in the second half. So it is a little bit higher in the second half when you compare it to the first half because of the maturation.

Lucas Nagano, Analyst

Very clear. Thank you, guys.

Operator, Operator

Of course. So just a reminder, if you want to ask a question, just raise your hand. The next question is coming from Jessica from JPMorgan.

Jessica Mehler, Analyst

It's a follow-up question on FG-FIES. So if you could give a little bit more color on the outlook for this contribution on 2024? And do you think it should remain stable as a percentage of medical revenues, assuming no changes in regulations?

Luis André Blanco, CFO

Thank you, Jessica. I'll take this one. And let's recap about the FG-FIES regulations. As Virgilio mentioned in his part of the presentation, the retentions started when it ended the fifth year in the beginning of the six years. So this kind of retention is coupled by the governance per educational entity, for each of the educational entities. What happened here in this first year is that the entities that have no medical education were affected because the government calculated delinquency rates regarding the program, but applied them to the revenues that are related to that financial entity. So the entities that have more known medical institutions were more affected in terms of percentage. The medical entities were not affected because we didn't have any kind of graduations of the medical programs during the beginning of the six years. The medical program, the graduations will occur at the end of the six years. So we are in this year in a transition period, okay? So regarding the impact in 2024, it's hard to foresee an impact on that. But what's definitely I could share with you the views that the entities that have Medicine and other courses, the kind of retention that we have will decrease because right now, we just have the delinquency of the non-medical part affecting all the revenues of these entities. So I would say that we can expect a reduction on that because will start to reflect the delinquency of the medical programs.

Jessica Mehler, Analyst

Thank you.

Operator, Operator

Of course. So the next question comes from Mauricio Cepeda from Credit Suisse.

Mauricio Cepeda, Analyst

I also have some questions around FG-FIES. It's kind of a controversial topic. It was kind of the hot topic in the results from the other companies as well. So it seemed that the size of the contribution was kind of took the companies off guard. The magnitude of it was kind of unexpected. So my question would be, what you as a company or as a sector, how are you working to mitigate these effects for the future? What are you proposing that could mitigate the effect from the delinquency? And a clarification as well following what Blanco was answering. You said the delinquency of the medical entities are higher or lower than the non-medical ones. This is just a clarification. And my second question would be on prep courses. I know that this is not exactly the cycle for revenues, but you have mentioned in other opportunities that you have been repositioning, right, repositioning the courses in a different tactic, commercial tactic. So if you could update us on how this repositioning is going, it would be great?

Virgilio Gibbon, CEO

Mauricio, addressing your second question about delinquency in medical programs, it's significantly lower than in other programs. Our PDA levels are around 1% to 1.5% for a pure medical campus. Regarding the retention size, we believe it's unfair to base retention calculations on the delinquency of students who have transitioned to the amortization phase, which includes non-medical students due to the FG-FIES program established in 2018. This program considers only non-medical graduates entering the amortization phase, who have a much higher delinquency rate compared to our medical programs in Afya. This misuse as a benchmark for calculating retention rates across the institution impacts overall revenues. The entire sector disagrees with this method and aims to persuade others of its unfairness, and we are advocating for an amendment being discussed in Congress to limit this retention rate in the future. If not addressed, we risk losing traction since FG-FIES is significant for the current government. We anticipate changes in upcoming semesters regarding this issue. As for your third question about Pillar 1, the second and third quarters typically exhibit low seasonality in our revenues. We're integrating various offerings, including the residence prep course from Medcel and other continuing medical education programs for physicians. The operations from Além da Medicina and CardioPapers are significantly increasing their number of students. Therefore, we expect better revenue turnover in the second half, particularly in the fourth quarter, as we merge all these products into a comprehensive portfolio, covering not just the Medcel residence prep course but also title preparation and soft skill programs under Pillar 1, our digital continuing education offerings.

Operator, Operator

Yes. Just for me to add some color on the FG-FIES. So today, we have a retention rate of something around 27% that should be 13% and what the sector's filing is to limit to 25%. So that could be a change that we can see in the pharma in the next months. And other point that's important to mention here is that we haven't seen any change on a pure player of medicine in the retention rate. So if it was 13.5%, it is still 13.5%, okay?

Luis André Blanco, CFO

Yes, just to put a color on that. What's happened is that these calculations are done by the entity, okay? So if the entity just has medicine courses, none of the medical students have graduated during the six years because they were going to graduate in the seventh year, the retention rates didn't change. What hasn’t changed is the entity that has medicine and other courses that, as Virgilio mentioned, the delinquency was calculated just for non-medical and was applied to the whole program. That's why we have some entities that had higher retentions because they calculated the delinquency of non-medical and applied it to the whole entity itself. And with this cap of 25% that's being discussed in Congress that would reduce the impact of this increase in retentions for us.

Virgilio Gibbon, CEO

Just to finalize, Mauricio, the most reasonable thing is to consider that the retention rate instead of applying for the entire entity should be applied program-by-program. So it would consider the delinquency over each program, not for the overall institution based off some sample of this unit that does not represent the total revenue of that entity. So that is, I think, the pledge of the entire sector with the new segmentation.

Operator, Operator

So I think that we do not have any more questions. If you have any other doubts that you couldn't ask here, I will be available in our email of the IR department. It was a pleasure to have you all today. Thank you for the participation. Have a nice evening.