Earnings Call Transcript - AFYA Q3 2023

Operator, Operator

Thank you for joining us for Afya's Third Quarter 2023 Conference Call. Today, I'm here with Afya's CEO, Virgilio Gibbon; and Luis Andre Blanco, our CFO. During this presentation, our executives will make forward-looking statements. Forward-looking statements could be related to future events, future financial operating performance, known and unknown risks, uncertainties and other factors that may cause 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. 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 that 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 measures on this call. These measures are not intended to be considered in isolation or as a substitute for 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. As we approach the end of the year, we can see Afya maintaining the strong pace. So moving on to Page number 3. Let's start with our quarter highlights. Adjusted net revenue grew almost 25% year-over-year, reaching BRL723 million, followed by an adjusted EBITDA growth of nearly 22% year-over-year, reaching BRL278 million with a margin of 39%. We also reported a record cash flow from operating activities generated, ending the nine-month period with BRL934 million, 26% higher than last year, with a cash conversion of 109%, and we were able to reduce our net debt to BRL418 million compared to December 2022, even with UNIT and FITS acquisition in January, as we will see on Slide 14. Adjusted net income followed the same positive trend of last quarter and reached BRL128 million, a growth of 7% year-over-year with an adjusted EPS of BRL1.38, 7% higher than last year, even considering a higher net debt level and a higher interest rate. This result reflects Afya's great capital allocation discipline on buybacks, M&A and an efficient capital structure. In this quarter, we have reached 3,113 operating seats with the acquisition of UNIT and FITS, the beginning of Mais Medicos operations, along with Ji-Parana campus, representing an increase of 15% year-over-year. Our number of undergrad medical students has reached more than 21,000, representing a 20% growth compared to the same period last year. In the Continuing Education segment, we continue to see great results, presenting a net revenue growth of 35% year-over-year. Once again, after reporting great results on the Digital Health Services revenue, which ended the quarter with an increase of more than 19% year-over-year, reaching more than BRL53 million in the three-month period. This result reinforces the great opportunity ahead in the Digital Services and is explained by the strong ramp-up on B2B engagements with new contracts with pharmaceutical industry companies and the continuous ramp-up on B2B contracts. Last but not least, our ecosystem reached 280,005 active users, which represents around 34% of the Brazilian physicians and medical students market. Moving now 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 ticket prices in medicine courses with a 9% increase in medicine tuition for the nine-month period and the maturation of medical seats. We are delighted to present that the most significant growth in terms of revenue came from the Continuing Education segment with a 35% 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 19% compared to last year. This result reinforces the opportunity ahead in Digital Services and is explained by the ramp-up in B2B engagements that boosted net revenues and grew more than 75% with new contracts with the pharmaceutical industry and the continuous ramp-up on B2B contracts. In the next slide, we are reaffirming our guidance for 2023, which considers the successful concluded acceptance of new medical students, ensuring 100% occupancy in all 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 BRL2.750 billion and BRL2.850 billion, and the adjusted EBITDA is expected to be between BRL1.1 billion and BRL1.2 billion, excluding any acquisitions that may be concluded after the issuance of this guidance. And also, considering the increase of the contribution rate. In other words, after 2023, net revenues and adjusted EBITDA will be almost 4 times higher than 2019, the year of our IPO. Furthermore, the cash conversion rate will continue to perform above 90%, which shows our capacity to deliver strong growth, expanding our profitability and cash generation. Once again, we are guiding for another strong round ahead at the top of the year guidance, improving Afya's resiliency and ability to keep delivering solid results with a high predictability. And now moving to Slide number 6. On October 4, the Ministry of Education announced the rules for the Mais Medicos 3, which defined the criteria for medical seats expansion throughout Brazil, aiming to achieve the OECD average of 3.3 physicians per 1,000 inhabitants in 10 years. The new program will allow the opening of nearly 10,000 new undergrad seats, of which 5,700 seats will be distributed through 25 health regions across 95 cities, considering 66 per entity. In addition, approximately 2,000 will be allocated to existing private institutions and another 2,000 will be allocated to the public system. As separating the notice from Mais Medicos 3, each organization is eligible to compete for two health regions. Afya has 18 entities with 17 of them offering high-quality medical courses. Mais Medicos 3 presents a significant opportunity to expand Afya's medical courses in Brazil and address the pressing need for more healthcare professionals in underserved areas. Afya is committed to engage in the program with high-quality proposals and enhancing the standards of medicine courses throughout the country. Now I'll turn the call over to Luis Blanco, Afya's CFO, to give more context on the financial and operational metrics. Thank you.

Luis Blanco, CFO

Thank you, Virgilio, and good evening, everyone. Starting with Slide number 8 to discuss the financial highlights of the third quarter. It is with much satisfaction that I present another strong quarter's results for Afya. Adjusted net revenue for the quarter was up almost 25% year-over-year to BRL723 million. For the nine-month period, adjusted net revenue was BRL2,145 million, an increase of 24% over the same period of last year, reflecting the maturation of medical seats, higher ticket prices in medicine courses, and the ramp-up of Continuing Education, boosted by the growth in the number of students. Once again, the Digital Services segment has also contributed to the revenue growth this quarter with the increase of the B2B engagements and the active payers expansion in B2B. Adjusted EBITDA for this quarter increased almost 22% to BRL278 million, while the adjusted EBITDA margin decreased by 90 basis points to 38.5%. For the nine-month period, adjusted EBITDA was BRL877 million, an increase of around 22% over the same period of the prior year, with adjusted EBITDA margin decrease of 80 basis points in the same period. The adjusted EBITDA margin reduction is mainly due to the mix of net revenues with higher participation from the Continuing Education segments and the consolidation of four Mais Medicos campuses that started operation in the third quarter of 2022 and UNIT Alagoas and FITS Jaboatao, 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 nine-month period was 26% higher year-over-year, totaling BRL934 million, resulting in a strong cash conversion ratio of over 109%. Adjusted net income for the third quarter of 2023 was BRL128 million, an increase of 7% over the same period of the prior year, mainly due to the increase in operational results, which was partially offset by higher financial expenses. Adjusted net income for the nine months of 2023 was BRL427 million, an increase of 5% year-over-year. Even with higher interest rates year-over-year and an increase in debt with acquisitions of UNIT Alagoas and FITS Jaboatao, our adjusted EPS continued to increase due to operational leverage reaching BRL1.38 and BRL4.58 per share in the third quarter and nine-month periods, respectively. Moving to Slide number 10 for a discussion of key operational metrics by business unit. Starting with the Undergrad progress. Our number of medical students grew 20% year-over-year, reaching more than 21,000 students with operating medical seats increasing 15% year-over-year. With our net average ticket for the nine months of medical school increasing 9% year-over-year, we've reached BRL2,446 million in combined tuition fees, up from BRL1,978 million from the prior year, an increase of 24%. Regarding the revenue mix, 79% was derived from medical school students and 91% from health-related courses. On the next page, I will present our Continuing Education metrics. As said before, we saw another quarter with great recovery in our Continuing Education segment, with an increase of nearly 23% in the number of students compared to last year, reaching 4,954 students. In this quarter, net revenues for the segment grew 35% compared to the same period of the prior year. And for the nine-month period, we saw an increase of 43%, reaching a net revenue of BRL108 million. Moving to Slide number 12, I will discuss the Digital Services operational metrics. On the first graph, you can see our total active payers, which are those that generate revenues in B2B. With a continuous growth trend in this quarter, we've reached 217,000 paying users, a 12% growth compared to last year. As you can see in the second graph, our ecosystem reached 285,000 monthly active users, representing around 34% of all medical students and physicians in Brazil, as Virgilio said before. Finally, our last graph shows our digital service net revenues for the quarter, which increased more than 19% year-over-year and regarding the nine-month period increased by almost 22% year-over-year. The organic growth is the combination of the start of the B2B engagements with pharmaceutical companies and the expansion of active payers in the B2P. In addition, since 2022, we started to break down our Digital Services net revenue within B2P and B2B segments. So from the BRL164 million of Digital Services net revenues during the nine-month period, more than BRL134 million came from the B2P and almost BRL30 million came from B2B. B2B strategy holds a huge potential, and we are on a great path. 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 debt. Cash and cash equivalents at the end of the quarter were BRL822 million, an increase of 15% over the third quarter of 2022 and an increase of 11% over the second quarter of 2023. Net debt, excluding IFRS 16, totaled BRL1,788 million compared to the net debt of BRL1,348 million in the same period of 2022. The increases when compared to the third quarter of 2022 is mainly due to the BRL825 million of UNIT Alagoas and FITS Jaboatao acquisitions, closed on January 2, 2023, which was partially offset by the free cash flow generation in the first nine-month period of 2023, as we can look closely at 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 for the service of the financial debt, and our share buyback program. We were able to generate BRL418 million as free cash and reduced our net debt in the nine-month period. On the next slide, you can see a table with the breakdown of our gross debt and our total cost of debt, considering our main debt, the Softbank transaction, other loans and finance, account payables to selling shareholders plus other financial obligations. Our capital structure remains solid with a conservative leverage position and a low cost of debt. This ends our prepared remarks. As we approach the end of the year, even considering the challenging economic and political scenario, we can gladly see Afya delivering strong results. With a quarter marked by significant increases in net revenues in our three segments, positive EBITDA, cash generation, EPS growth, and consistent business expansion. I will now open the conference for the Q&A session. Thank you.

Operator, Operator

We are going to start our Q&A with Lucas Nagano from Morgan Stanley. Lucas, you can now talk.

Lucas Nagano, Analyst

Hello. Good evening. Thanks for taking our questions. We have two questions. First one is related to Mais Medicos 3. Is it possible to provide us some color on your plans for the program in terms of how many proposals you plan to submit, how many seats does it represent, and which regions you're targeting? And the second question is related to tuition readjustment for the next year. So how much are you increasing prices for 2024? And if there is any variation between schools, could you give us some color on the range of tuition readjustment in all of Afya's schools? Thank you.

Virgilio Gibbon, CEO

Hi, Lucas. Virgilio, thanks for your question. Regarding the Mais Medicos 3, we have 18 institutions that are all going to propose for an additional two medical schools. We will be allowed to send the proposal for 36 new additional schools. So the number of medical seats will be 36 multiplied by 60 per school. That is the number we are going to participate in this entire process. Regarding the tuition adjustment, I'll pass to Blanco here to give you more details.

Luis Blanco, CFO

Hi, Lucas. It's Blanco speaking. Regarding the second question about readjustments, we have defined the increase in tuition fees for the next year. Specifically from the medicine courses, we are increasing most of the courses by 4.95% for freshmen and existing students. Most of our institutions will have this kind of readjustment.

Lucas Nagano, Analyst

Okay. Thank you. Thank you very much.

Operator, Operator

Thank you, Lucas. The next question comes from Marcelo Santos from JPMorgan. Marcelo, you may now go ahead and start.

Marcelo Santos, Analyst

Thank you. Thank you very much. Good evening, Virgilio, Luis, Renata. Thanks for the opportunity. I have two questions. The first is, considering we are already in the middle of the fourth quarter, would you please provide an update on the outlook of the prep business? It would be interesting to see how do you see this next cycle? The second question is, if you could comment a bit on the Digital business. We saw a slight sequential decline in revenues. Isn't this a business where we should be hoping for a little bit higher growth? Could you please comment on this change from the second to the third quarter, what are the moving parts here? And how do you see this moving forward? Thank you.

Virgilio Gibbon, CEO

Marcelo, I will take the question about the prep course here. So this is basically regarding the Medcel operations. For the nine months, we are operating below the trend when compared to last year during the same period. Remember that the seasonality; we have the new offer for 2024 cohort starting in late September, October. What we are seeing from October and November is that the volume intake we are seeing is ahead of last year. It is the first month compared to the last 12 months where we see a stronger intake. So we expect to reduce the gap between last year and for 2024, resuming growth also on prep course offerings. Regarding the Digital, Blanco will give more details on that.

Luis Blanco, CFO

Hi, Marcelo. Blanco speaking here. Medcel tends to have a pushback on the Digital results as a whole. Medcel is not our most important business in the Digital area. As you noticed in our release, the number of students in Medcel decreased by more than 50% year-over-year. We anticipate that the new intake starting in the fourth quarter may help us recover and stop the fall from last year. As for the Digital as a whole, to achieve the BRL1.2 billion net revenue that we have guided for 2028, it must grow around 35%. You are right; we delivered 19% in this quarter. However, the decline in net revenues came mostly from Medcel. When we take the main part of our Digital business, we are growing around 30%. The numbers of the active base users are up 16%, and the number of the B2B business is growing at a rate of 75%. We have this specific pushback because of Medcel but expect improvements with the first numbers of the fourth quarter showing sales recovery year-over-year.

Virgilio Gibbon, CEO

Just summarizing, Marcelo, the way I like to see that is by separating Digital into two pillars: Pillar 1, which is medical education, most of that comes from Medcel operations, and Pillar 2, which consists of medical practices. Although there is a downturn from Medcel operations, we are experiencing growth in the B2B segment. Specifically, we are experiencing growth rates above 75% with the efforts we put to leverage our Digital operations.

Operator, Operator

If I may complement, Marcelo, it's important to remember that when we look at the future of the company, especially in the Digital area, most of the revenue comes from the B2B part of the Digital Services, right? And to accomplish this, we don’t need Pillar 1. I don’t want to make you think that it’s not important or anything like that. However, we need to have contact with the physicians. The products that matter here are the ones under Pillars 2, 3, 4, 5, and 6. So Medcel is significant to us. However, what we are observing with Medcel does not make us believe that we cannot achieve the BRL1.2 billion target. Our B2B segment is performing well.

Marcelo Santos, Analyst

Perfect. Thank you very much for all the explanations.

Operator, Operator

Thank you. The next question comes from an unidentified participant.

Unidentified Participant, Analyst

Thank you. Good evening, everyone. I have two questions as well. If I can just go back to the Mais Medicos program, just trying to understand, do you think that eventually, as it looks like the restrictions on the request per institution are more constrained than in previous programs, this could present an opportunity for you in terms of M&A? As smaller companies may gain some of these seats, and eventually, they might not have the CapEx to invest, could you eventually acquire seats in the Mais Medicos program? That is my first question. The second one is more about perspective—do you have any idea or view on when the Supreme Court will eventually resume the case?

Virgilio Gibbon, CEO

Hi, France. This is Virgilio. About the first question, there is a restriction about two proposals for each institution. There are also limits that allow small players access to two different cities. Thinking about M&A opportunities, for sure, we may have some small players that can come to the table with new opportunities for M&A. However, to be sincere, it’s not something we are focusing on right now. We still have a hot pipeline for more traditional schools. Considering the size of our pipeline coming from the Mais Medicos 3 program, which includes more than 30 new possible institutions, I think this is much more important than acquiring additional institutions to be implemented using Mais Medicos 3. Regarding the Supreme Court, we are observing that a federal judge is moving and has many questions concerning the sector. I think they are preparing to release additional votes. We may have some additional votes pending by the end of this year, but honestly, we don’t know if they will complete this session by year’s end or start in 2024. Thus, we have a lot of speculation about that, and we currently lack anything tangible for you.

Luis Blanco, CFO

And France, this is Blanco speaking. Just to give more details about the M&A in Mais Medicos, you need to remember that we always maintain our capital allocation discipline. Regarding the restrictions on potential new targets with Mais Medicos, we must buy the entity as a whole. As you know, we have the threshold of having 60% of the revenues coming from the medicine business. Therefore, if an institution doesn’t have medicine and wants only the Mais Medicos 3 license, we need to evaluate how valuable these licenses will be for the future operations of the company. Why am I saying that? It's essential to understand that with the Mais Medicos program, you cannot carve out the license if the course is not recognized by the Ministry of Education. So that will take some time to lead to a table. But we will maintain our capital discipline.

Operator, Operator

The next question comes from Lucca Marquezini from Itau. Lucca, you may proceed.

Lucca Marquezini, Analyst

Good evening, everyone and thank you for taking our question. Regarding the Digital Services segment, the release mentioned that the company had a robust increase in B2B engagements. Can you provide some context on this performance and comment on new initiatives you have planned within this vertical? Do you expect still strong growth in the coming quarters? That would be very helpful. Thank you.

Virgilio Gibbon, CEO

Hi, Lucca. Just to remember, we started offering B2B offerings to the market at the beginning of the first quarter of 2022. Today, we have almost 200 contracts signed, mostly with pharma companies to access our physician ecosystem by providing content, new protocols, education, and learning objects to physicians, as well as typical ads using our social network. This type of offering is increasingly relied upon by pharma companies as they are moving away from traditional in-person sales representatives. Our strategy is based on landing and expanding contracts, so today, we have about 10 contracts with the five largest companies. This leads to recurring relationships with them and further ramps up B2B contracts.

Luis Blanco, CFO

If I may add, Lucca, one point here is that up until the first half of this year, most of our contracts were campaign-based. Pharmaceutical companies hired us for specific campaigns targeting specific drugs and types of physicians. However, in the third quarter, we launched new products and our first product that generates recurring revenues. This transition from campaign-based contracts to recurring revenues is vital for us in ramping up the business.

Lucca Marquezini, Analyst

That’s very clear. Thank you, guys.

Operator, Operator

While we wait for the next question, I'll read a question we received from the Q&A. It concerns Mais Medicos 3 and asks how the CapEx in terms of cost per seat compares to the typical M&A per seat cost of about BRL2 million per seat. Would you like to address this?

Luis Blanco, CFO

Yes, I will take this. We see that the Mais Medicos 3 will require around BRL25 million to invest and deploy the site. If we round that to BRL30 million, just considering 60 seats, we would say it’s about BRL500,000 per seat, which is much less than the BRL2 million per seat that is the kind of multiple seen in the market. So, obtaining this license and deploying these greenfields is accretive for us.

Operator, Operator

Yes, BRL25 million to BRL30 million is our expectation as of today. The next question comes from Lucas Nagano from Morgan Stanley.

Lucas Nagano, Analyst

I have a follow-up question related to regulation concerning injunctions. Now that the Ministry of Education revoked the measure invalidating the injunctions that didn't comply with Mais Medicos 3, the current value decision is up to a federal judge to evaluate some of those requests. Do you think that more medical schools could be opened outside of Mais Medicos in the meantime, while the trial does not resume? How do you assess this risk?

Virgilio Gibbon, CEO

Lucas, that's a very good question. In my opinion, I think the Ministry of Education will expect the final decision from the Supreme Court before evaluating and giving the final ruling on the process we analyzed through the injunctions. If you read this new ordinance, they expect to follow the process and visit these institutions. By the end of the process, they still need a final decision from the Ministry of Education to approve or deny these new medical institutions. Ultimately, I believe we will not see any approvals before the Supreme Court's ruling.

Operator, Operator

Perhaps if I may add, Lucas, following up on what Virgilio said, it’s important to note that since the decision on August, while this normative was not released yet, we have not seen a flow of seats being released due to that lack of municipalities as mentioned. Thus, we do not perceive a significant risk here, as Virgilio pointed out.

Virgilio Gibbon, CEO

Ultimately, they still have to adhere to the Mais Medicos requirements, such as having hospital beds, the social demand for that region, and following the academic necessities that they must pay to the municipality and the health secretary to approve new medical schools. Thus, analyzing everything, the impact on overall demand will be much lower than the overall process being analyzed by the Ministry of Education.

Lucas Nagano, Analyst

It's very clear. Thank you, Virgilio and Renata.

Virgilio Gibbon, CEO

Thank you, Lucas.

Operator, Operator

Since we do not see any other questions here, I appreciate you all participating, and we, from Investor Relations, are available if you still want any follow-up questions. Thank you and have a nice night.