Afya Limited (AFYA) Q3 2019 Earnings Call Transcript

Afya Limited (NASDAQ: AFYA)
Q3 2019 Earnings Call
Dec 02, 2019, 1:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the Afya third-quarter 2019 earnings conference call. [Operator instructions] With me, on the call today, are Afya's CEO, Virgilio Gibbon; CFO, Luciano Campos; and Head of IR Renata Couto. During today's presentation, our executives will make forward-looking statements. Forward-looking statements generally relate to future events or future financial or operating performance and involve known and unknown risk, uncertainties, and other factors that may cause our actual results to differ materially from those contemplated by the forward-looking statements.

Forward-looking statements in this presentation include, but are not limited to, statements related to our business and our financial performance, expectations and guidance for our future periods or expectations regarding our strategic period -- strategic product initiatives, and the 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 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 refer to non-IFRS financial measures on this call. The non-IFRS financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with IFRS. We have provided a reconciliation of the non-IFRS financial measures to the most directly comparable IFRS financial measures in this presentation. Let me now turn the call over to Virgilio Gibbon, Afya's CEO.

You may begin.

Virgilio Gibbon -- Chief Executive Officer

Thank you, and thanks, everyone, for joining Afya's third-quarter conference call. I'll begin with an overview of the key highlights of the quarter. And then Luciano, our CFO, will discuss our financial result. To begin, I'm very pleased to report a strong third-quarter and nine-month result that reinforced our guidance for the second half of 2019.

In the M&A front, we have completed in August, the acquisition of IPEC, with 120 medical school seats in the state of Para. Additionally, in November, we announced plans to acquire UniRedentor, a medical school in the state of Rio de Janeiro, with additional 112 seats and a strong portfolio of medicine and healthcare graduate programs, fully aligned with our strategy to expand our services to every stage of the medical career. We had a great quarter across all key metrics. Our revenue increased 124% over the same period last year, driven by the maturation of our medical schools and the consolidation of our acquisitions since September 2018.

Our strong top-line growth, combined with synergies from our recent acquisition, supported an adjusted EBITDA of BRL 80.9 million, representing a growth of 147% over the same period last year, with a margin expansion of 380 basis points. Our cash generation has remained very strong, with an operating cash conversion of 108% of our adjusted EBITDA for the nine months ended September 30, up 84% in the same period in 2018. Finally, with respect to our key operating metrics in Slide No. 4, we have reached 1,572 medical seats approved and 6,400 medical students enrolled by the end of the third quarter, 15% above the final student-base in the first half of 2019.

Afya is the leading medical education player in Brazil, with a potential to reach 11,300 medical students, considering the seats already authorized. Our average tuition fees in the third quarter reached BRL 8,100, 8% above the second quarter this year. This increase is in line with our strategy and explained by the mix effect of the new students cohort enrolling with a higher tuition, combined with the students graduating with a lower tuition. As regard to BU2, our prep course and CME and medical specialization student-base grew by 12% over the first semester, showing already a strong growth in the first intake process concluded after IPO.

Now, I'll turn this presentation to Luciano Campos, Afya's CFO, to detail our financial results.

Luciano Campos -- Chief Financial Officer

Thank you, Virgilio, and good morning, everyone. As I will demonstrate in my presentation, our focus on medical education provides highly predictable growth, strong profitability and cash generation for Afya's investment case. Before I get into the details of the quarter, as a reminder along with our reported figures, we also provide pro forma figures for some key line items. The 2019 pro forma figures give effect to the acquisitions of Medcel, FASA, and IPEMED, as if they had occurred in January 1st, 2019.

It is also important to remember that our adjusted EBITDA and net income exclude the impact of IFRS 16. Starting with net revenue on Slide No. 5. We have provided a bridge for our reported figures in 2019 through to our third-quarter and nine-months' results in 2019.

Our net revenue in the third-quarter 2019 increased 124% year over year to BRL 207 million. And for this quarter, the reported and pro forma figures are the same. Growth was driven by an increase in medical school enrollments, higher average tuition fees, as well as, the acquisitions of Novafapi, FADEP, FASA, IPEMED, and Medcel. For the nine-month period, revenue increased 133% to BRL 530 million, and on a pro forma basis, reached BRL 609 million, with a contribution of approximately BRL 79 million from Medcel, FASA, and IPEMED.

On Slide No. 6, we have our net revenue by business unit. Business Unit 1 net revenue of BRL 176 million represented 85% of total net revenue of the third quarter and increased 91% year over year. The factors driving our growth were: first, medical school seat maturation, remember that [Inaudible] medical school takes six years to mature and reach full potential; second, medical tuition fees increased above inflation; and finally, acquisitions in the period.

Next Business Unit 2, net revenues of BRL 31 million represented approximately 15% of our net revenues in the third quarter. It is important to remember that Business Unit 2 revenues are concentrated in the first and fourth quarters of each year, and while it's still a smaller portion of our business, we are very excited about the growth opportunity for the segment of medical education. Moving on to profitability on Slide No. 7.

Adjusted EBITDA increased 147% year over year to approximately BRL 81 million in the third quarter of 2019, with the EBITDA margin expanding 380 basis points to 39.2%, driven by operating leverage from the maturation of medical schools, higher average tuition and synergies from acquisitions. For the first nine months of 2019, adjusted EBITDA increased 150% year over year to BRL 203 million with adjusted EBITDA margin expanding 260 basis points to 38.3%. Note that on a pro forma basis, adjusted EBITDA for the nine months reached BRL 231 million. Moving to Slide 8.

Adjusted net income increased 155% year over year to BRL 72 million in the third quarter of 2019. Our net income benefited from top-line growth, margin expansion, and higher financial income and FX gains associated with the cash proceeds from our IPO. For the nine-month period, our adjusted net income increased 130% year over year to BRL 164 million. Moving next to a discussion of balance sheet and cash flow on Slide No.

9. We maintained a healthy financial position with net cash of BRL 911 million, which we believe to be sufficient to support our growth strategy. The increase in cash compared to the year-end of 2018 reflects the IPO proceeds. In addition, as we show in the right side of the slide, we continued to deliver a strong operating cash flow generation with a cash-conversion of approximately 108% of EBITDA in the first nine months of 2019, supported by tuition prepayment and seasonality of Business Unit 2.

And especially because of the seasonality effect, we recommend to focus on longer periods rather than on quarters for the analysis of this cash conversion metric. Summing up, I would like to conclude my remarks with a discussion about market consensus, our guidance for the second half of 2019, and the seasonality of our business. On Slide 10, we show that our adjusted EBITDA of approximately BRL 81 million in the third quarter is approximately 9% above the average consensus of BRL 74 million that we had gathered from the analysts and published on November 11th, 2019. As a reminder, it is important to normalize consensus estimates for the impact of IFRS 16 and for the impact of acquisitions, and that is why we published the normalized consensus for this quarter and plan to continue to provide that in the future.

Moving to Slide 11. Our results for the third quarter of 2019 are well aligned with our guidance. Therefore, we are maintaining our guidance for the second half of 2019, which includes net revenues between BRL 415 million and BRL 430 million and adjusted EBITDA margin in the range of 38% and 40%. As a reminder, our guidance eliminates the impact of IFRS 16 and excludes the acquisitions consolidated after the first half of 2019.

Thus, it excludes the results of IPEC. Finally, moving to Slide 12. I would like to remind everyone about the two seasonality factors that affect our business and it's important to pay attention to in order to properly interpret our results in this quarter and in future quarters. The first and most important factor is the revenue recognition of Business Unit 2, which is concentrated in the first and fourth quarter when printed books and e-books are delivered to our prep students.

The second is the ramp-up of our medical schools, which have two admission cycles for new students and run at 100% occupancy rates. As a consequence, while we have schools ramping up, the second half of each year would normally have more students and higher tuition revenues, compared to the first half. In the balance of these two factors, in a typical year, the first and fourth quarters are the strongest for revenues and EBITDA. The second quarter tends to be the weakest while the third quarter fits in between these two groups.

So far, 2019 seems a typical year. With that, we end our prepared remarks, and we would like to open up for questions. Operator, please open up the lines.

Questions & Answers:

Operator

[Operator instructions] Our first question comes from Marcelo Santos with JP Morgan.

Marcelo Santos -- J.P. Morgan -- Analyst

Hi, good morning. For my questions, I have two. The first is regarding the Revalida exams for departments [Inaudible] going to [Inaudible] again. How do you [Inaudible] the opportunity for BU2? Do you think this could also have a risk to BU1 because you have doctors coming from abroad? So, if you could just make some considerations on that? The second question would be about IPEMED.

You've just acquired the asset, which was kind of flat in terms of students. When should we expect to see changes there? How are you in the process of improving the intake? When should we expect to start seeing results? These are the two questions.

Virgilio Gibbon -- Chief Executive Officer

Hi, Marcelo, this is Virgilio. I'm not sure if everybody got your question, but we couldn't hear the first question at least. If you could repeat for us it would be great. Thank you.

Marcelo Santos -- J.P. Morgan -- Analyst

Sure. I'll try to [Inaudible] speak [Inaudible]. The first question is --

Operator

Pardon me, Marcelo, this is the operator. Your phone line was breaking up, so I'm pretty sure they didn't hear the question. Do you mind requeuing for -- queuing up again?

Marcelo Santos -- J.P. Morgan -- Analyst

Yes, yes. I'll ask my question later. Thank you.

Operator

OK. Our next question comes from Bruno Giordano with Bank of America.

Bruno Giordano -- Bank of America-- Analyst

Good afternoon, everyone. Congratulation on the results. First question on the EBITDA of third quarter. A quite strong number, assuming that fourth quarter, you're seasonally -- results are seasonally stronger.

Is it fair to assume that it's a lot of upside for the second half in terms of -- compared to your guidance? Or are you expecting anything different in the fourth quarter in terms of seasonality? And second question on capex. Correct me if I'm wrong, but I did a calculation here, I saw an BRL 80 million expenditure in PP&E plus intangibles, and it's substantially higher than what you have spent for or to spend in the second -- in the first half. So, could you please -- note if it's correct. And also, what do you expect in terms of capex for the full year? Thank you.

Luciano Campos -- Chief Financial Officer

Hi, Bruno, it's Luciano speaking. Starting in the first part of your question about seasonality. We do not expect anything different in terms of seasonality when we think about it in conceptual terms. So, we do expect the recognition of the revenues of all the new products and contracts we are selling in our prep business, for example, which then increases revenues in the Business Unit 2.

That's not different in the conceptual terms. What will be different then is the intensity, every year will be a little bit different than the other. And especially while we are growing, the fourth quarter could be a little bit higher or a little bit lower than the first quarter, OK? But that's within the range of expectations. The second question about capex, just to consider, please, that the acquisition of IPEC, since it does not have an operation, it's considered as we are buying intangibles.

So, if we exclude that, because that's not organic capex, our organic capex then is pretty much where it should be, OK?

Bruno Giordano -- Bank of America-- Analyst

Understood. Very clear. Thank you.

Operator

Our next question comes from Thiago Bortoluci with Goldman Sachs.

Thiago Bortoluci -- Goldman Sachs -- Analyst

Yes. Hi, good afternoon, everyone. Thanks for the question. First, I'll just explore a little bit more [Inaudible] on the guidance.

Given that, as Luciano mentioned, the seasonality should be stronger in the third quarter as expected, I see that 73% of the high-end guidance for our revenues is already delivered, 72% of the high-end for adjusted EBITDA, shouldn't be there any space for upside revisions to the guidance or at least to the mid -- to the average of the guidance, given where we are right now? This is the first question. The second question is on Business Unit 2. I think results were very strong when the ramp-up of Medcel seems to be going higher and faster than expected. Any update on the go-to-market that we're using within the platform, new partnerships that you got for the second semester, and initial feedbacks from this -- the first year post-integration would be very welcome.

Those are the questions. Thank you very much.

Luciano Campos -- Chief Financial Officer

This is Luciano, again. Starting with the first question, Thiago. The results are very supportive, but not enough to make us to change the guidance, OK? You can make those calculations in terms of what it means, to what position of the range we would fit if we compare the third semester -- the third quarter with the total guidance, but we are not changing the guidance at this moment, OK? The second question about Business Unit No. 2, just consider that what you are looking at there is not Medcel yet, OK? Do you have other products that would help the results that we are looking at, at that moment? Medcel, the new sales would show up only in the fourth quarter.

Virgilio Gibbon -- Chief Executive Officer

Just to add on that -- just to add on that what Luciano said, Thiago, about the Business Unit 2. We closed the second half intake in September, and IPEMED have a very strong intake compared to the figure that we have on the last year. So, as we mentioned in the second-quarter announcement, we had a student-base that was decreasing at that moment. So, we had an inflection point because of the very strong intake in the second half.

So, we see some kind of stable, about 2% growth quarter over quarter. And Medcel, although we don't have any revenue recognition, we also finished a very good intake at the end of this first to second half of 2019.

Thiago Bortoluci -- Goldman Sachs -- Analyst

OK. The direct sale Virgilio just told just show ramp-up here. Is it fair to assume that Business Unit 2 overall is running above your expectations for 2019?

Virgilio Gibbon -- Chief Executive Officer

We are kind of above, and at least in line what the expectation that we had in the second half of 2018, that we just concluded acquisitions that raised those [Inaudible]. So, we had a very strong intake and execution that we have that we believe at this moment was better than expected.

Thiago Bortoluci -- Goldman Sachs -- Analyst

That's clear. Thank you very much, Virgilio.

Operator

Our next question comes from Bruno LaTorre with J.P. Morgan. Bruno, your line is open, you can ask your question or if your phone is muted, can you please unmute the phone line? Looks like he's having phone trouble. Did you want to move to the next question?

Bruno LaTorre -- J.P. Morgan -- Analyst

Hey, are you listening to us?

Operator

I'm sorry?

Bruno LaTorre -- J.P. Morgan -- Analyst

Can you hear us?

Operator

Is this Bruno?

Bruno LaTorre -- J.P. Morgan -- Analyst

Yes, it's Bruno but you [Inaudible] Marcelo will be speaking for me.

Operator

OK, we can hear you now.

Bruno LaTorre -- J.P. Morgan -- Analyst

OK, thanks.

Marcelo Santos -- J.P. Morgan -- Analyst

Hello, can you hear me now?

Renata Couto -- Head of Investor Relations

Yes.

Marcelo Santos -- J.P. Morgan -- Analyst

OK, sorry.

Operator

Please go ahead.

Marcelo Santos -- J.P. Morgan -- Analyst

I have two questions. First is regarding the Revalida exam. How do you see as an opportunity for BU2 since you could take part on that? And do you see the threat for BU1? So, if you could make some comments on that. And the second question is regarding IPEMED, which you just incorporated.

The number of students were a bit flat this quarter. How do you see that evolving? When do you think you are going to change the intake process and when should we start seeing that expanding more quickly? Thank you. These are the two questions.

Virgilio Gibbon -- Chief Executive Officer

OK, Marcelo, now your question is much more clear. Beginning the first question about the [Inaudible] This changing that was announced but we still don't have the normative instruction how they're going to be -- the structure will work. We are thinking a very good trend about the [Inaudible] that can leverage our prep course volumes also combining the prep course with some prep residency offering. So, as soon as we get the first proposal, making clear how big are those that Revalida will follow, we are thinking that we have a very strong Revalida prep course in place, combined with the residence prep, that's a very good opportunity for our Business Unit 2.

And going to your second question. IPEMED, a kind of flat quarter over quarter. That was because the student-base was decreasing when we acquired these assets. We have a very strong intake at the end of this first half.

Beginning the second half that we worked in our student-base trend, and we could see already a 2% of growth quarter over quarter, a very good expectation on student-base growth on IPEMED at this moment.

Marcelo Santos -- J.P. Morgan -- Analyst

Thank you very much.

Operator

Our next question comes from Susana Salaru with Itau.

Susana Salaru -- Ita BBA -- Analyst

Hi, guys. Good morning. Our first question comes -- is related to the M&A space. We are seeing that other companies are looking for med school -- undergrad med schools acquisitions.

So, should we expect the multiples to go up going forward, compared to the previous acquisitions? That would be our first question and related to the ramp-up of the recently acquired med school companies, how has been the process of matching up the tuition with the integrated companies? How fast do you believe it will be matched? Thank you.

Virgilio Gibbon -- Chief Executive Officer

Hi, Susana. So, about the M&A pipeline, we are not seeing any difference in terms of competition and scale these last nine months. We are seeing the same competition that we saw in the last two years and what is getting even more clear is the price. So, the price based on the multiples that are shown on the screen, and also, all the announcements about the recent acquisitions are not by other players.

So, the price is going to be more clear for all negotiations that we have in the pipeline. So, the pipeline is fertile. We are very focused to deliver these 1,000 seats after the IPO. We already delivered 25% of this guidance.

In terms of tuition maturation, that depends on the asset. These last two acquisitions, one of them, the first one, with IPEC, they have -- we are having a tuition that is very close to the average that we have and UniRedentor, that is -- we are not operating, still have to wait the [Inaudible] approval. They have a very high tuition that's combined with what we have, we expect even a higher tuition increase moving forward. So even that -- even consider that we are not pushing our price above inflation, just the effect of the mix that we have graduating students with a very low tuition in the fifth and the sixth year, and we are enrolling new students with very higher fees into the first and the second year.

This effect will give us 1 to 3 percentage points above inflation by 2025. That's our guidance in the long-term and we are not changing that.

Susana Salaru -- Ita BBA -- Analyst

Virgilio, thank you. Very clear.

Operator

[Operator instructions] And I'm not showing any further questions at this time. I'd like to turn the call back over to Virgilio for closing remarks.

Virgilio Gibbon -- Chief Executive Officer

Well, thank you. We are very pleased with our year-to-date performance and confident to deliver our second half 2019 guidance. We continue to deliver strong organic and inorganic growth based on the maturation of our schools, the acquisition of new medical schools, and also, the addition of new content and technology to our platform. Our team is successfully executing our strategies in depreciating our products offered for the entire medical career and creating long-term value for all stakeholders.

Thank you for joining us today, and we look forward to speaking to you next quarter.

Operator

[Operator sign-off]

Duration: 29 minutes

Call participants:

Virgilio Gibbon -- Chief Executive Officer

Luciano Campos -- Chief Financial Officer

Marcelo Santos -- J.P. Morgan -- Analyst

Bruno Giordano -- Bank of America-- Analyst

Bruno LaTorre -- J.P. Morgan -- Analyst

Thiago Bortoluci -- Goldman Sachs -- Analyst

Renata Couto -- Head of Investor Relations

Susana Salaru -- Ita BBA -- Analyst

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