Conference Call Transcript 2Q07 Results Anhanguera Educacional August 14 th, 2007

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1 Operator: Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to s 2Q07 results conference call. Today with us, we have Mr. Ricardo Scavazza, COO and Investor Relations Officer; and Mr. Marcos Guimarães, CFO. We would like to inform you that this event is recorded and all participants will be in a listen-only mode during the Company s presentation. After s remarks, there will be a question and answer session for analysts and investors. At that time, further instructions will be given. Should any participant need assistance during this call, please press *0 to reach the operator. Today s live webcast, both audio and slide show, may be accessed through s Investor Relations website at by clicking on the banner Webcast 2Q07. The following presentation is also available to download on the webcast s platform. The following information is available in Brazilian reais and on BR GAAP, except when otherwise indicated. Before proceeding, let me mention that forward-looking statements will be made under the Safe Harbor of the Securities Litigation Reform Act of Forward-looking statements are based on the beliefs and assumptions of s management and on information currently available to the Company. They involve risks, uncertainties and assumptions because they relate to future events and, therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of and could cause results to differ materially from those expressed in such forward-looking statements. Now, I will turn the conference over to the COO, Mr. Ricardo Scavazza, who will begin the presentation. Mr. Scavazza, you may begin your conference. Ricardo Scavazza: Good morning, everyone. We are very happy to talk to you to present this 2Q07 results. As some of you may have had the chance to see in our release, results came in very strong, showing a very solid and strong top line growth, consistent with the strategy that we have discussed and with the same drivers that we presented in our last conference call discussing the 1Q07. On top of that, we also posted a substantial margin gain that we will discuss over the course of this conference call. First of all, we would like to restate the key elements of our strategy. We showed this at the last conference call, we have this at our Investor Relations presentations. Although it is a little boring to keep restating this all the time, it is very important for us. These are the key elements of our strategy, which have been driving all the actions of our management team on a day-to-day basis. 1

2 The first aspect is the segment that we are focusing on. Anhanguera is a Company, that was created and that focuses on only one segment, which is the working adult segment. It is a fragmented segment; a segment that has a substantial growth potential due to still a low penetration in Brazil. This is a segment that didn t exist 15 years ago. We believe it is going to represent the majority of the number of students in Brazil in a few years. So, this is our positioning. And our strategy is to deliver these students a best value proposition, courses with differentiated quality at very affordable prices. This value proposition has proven to be very successful. That is demonstrated by the dominant market share that we have in this segment, as we see in the markets where we operate for more than four years, markets where we are consolidated already. We will discuss further in the presentation the evolution of the size of our addressable market and the evolution that we expect on market shares, in the new markets that we will enter, which evidence that we are confident that we can replicate the same positioning that we have in mature markets in the new markets that we are entering in the next few years. The third factor, the third view of our strategy is our replicable campus model. This is a key in our strategy. We have developed this model of standard, administrative and academic processes, that ensures us consistency of quality of education at the campus level and a very strong control of operations, and allows us to replicate our business model very rapidly into bringing our product to new campuses. You have seen, through the first eight months of this year, we were able to implement ten new campuses that is an average of more than one campus per month - and always due to our business model, always with a very strong control of operations and a very consistent quality of education. The last but not less important factor is the gain of scale that we have been experiencing due to our business model of centralized academic and administrative structure with centralized several activities that are traditional in Brazil, performed at the campus to a centralized headquarter. There was a substantial investment for the Company between 2004 and In past two years, we experienced a substantial dilution of those expenses and, going forward, we expect that dilution to continue to happen. We believe that today Anhanguera is the most efficient provider of fortunate adult education. And going forward, we believe that these gains of scale that we are experiencing will put us even at a more competitive position, and at a more favorable cost structure than we experience today. All that together, our goal is to be the leading working adult education provider in Brazil. We intend to be a national Company. During this quarter, you notice that we added two campuses in the South of Brazil. That is consistent with everything that we have been saying, that although today most of our operations are concentrated in the state of São Paulo, our view is to become a national provider. So, we are analyzing opportunities in all regions of Brazil, and in our five-year business plan, we intend to be a national Company and the leader of the segment, and 2

3 the pillars that will sustain this expansion are mostly the value proposition of our courses and the cost competitive advantages that we have vis-à-vis our direct competitors. Moving on to the second slide. It represents a summary of our financial performance this quarter. Results came in very strong, in line with what we expected, above what was the analysts consensus. Again, in our business, results within the academic semester are very predictable, so we had revenues very much in line with expectations, and margins slightly above what the market was expecting. But, in summary, no big surprises in the results, as it should be in a post-secondary education company. We posted a net revenues growth of 107%, comparing 2Q06 and to the 2Q07. In terms of comparing the 1H07 with 1H06, 109%. Both periods are pretty much in line. In terms of gross profit, for the semester, we experienced a substantial gain. Analyzing quarter versus quarter, a slight decrease, but not anything meaningful. Basically, gross margins were in line with what we experienced last year, but for the semester, we saw a substantial increase, which we will discuss further on the presentation. In terms of EBITDA for the semester, we also experienced also important gains; quarter versus quarter, a slight decrease, which we will discuss. And in terms of net income, both analyzing the quarter information and the semester information, a very strong growth: 270%, analyzing the quarters; 236%, analyzing the semester financial performance. It is important to notice that the financial information for 2006 was adjusted to reflect allocation of certain items in the appropriate quarter. As we discussed in the last call, when the Company was private, last year, we did not allocate properly a few items in our accounting in the appropriate quarter. The relevant items for this analysis are some adjustments in revenues, as well as some adjustments in provision for doubtful accounts. So, what we are doing here is We are deducting, for the 2Q06, an amount of R$1.7 million that was accounted in the 2Q06, but refers to the 1Q06. So, to do this analysis, we are adjusting that revenue item. In addition, we are also adding the provision for doubtful accounts in That provision was not accounted for up to the 3Q06, so that made the number between 2006 and 2007 not comparable. So, we are adding that provision, using the same percentage that we had for the full fiscal year of Those adjustments that should make 2006 and 2007 comparable for our analysis during this call. Moving forward to the next slide, we are presenting our analysis of our net revenues growth. 3

4 The key driver for our growth was the increasing number of campuses. We grew from 11 campuses, in the 1H06, to 19 campuses, 1H07. Consistent with our strategy, we believe that in order to reach more students in the segment, the working adults segment, we need to be close to these students work. So, each campus reaches only restricted population surrounding the campus. The key driver of our expansion is always going to be an increase in the number of campuses, driving an increase of addressable market as well. On top of that, we also experienced a growth in the average student per campus. That indicator evolved from 2,100 in the 1H06 to 2,400 in 1H07, a 14% growth. Both of that growth came from maturation of the campuses. This is something we always expect when we first launch a campus, we only have freshmen students, and as the campus matures, we keep on adding new groups of students, and that is responsible for most of that growth in average enrollment. The average size of the enrollments that we have been adding to our network of campuses is of a 40,000 students, so this is where we expect to take this average number of students per campus in a few years, as the network becomes more mature. This is the number of students that we see in our most matured campuses today. The current average of students per campus that we see in the network is an average of campuses with only first year students that have significantly less students than in the matured campuses, which, again, we expect to achieve an average close to 4,000. So, over the next few years, as the proportion of more matured campuses and newer campuses starts to change, we should see this indicator tend up, tending to 4,000 in the long run. This should be a significant driver which multiplies by the increase in the number of campuses. Altogether, we saw growth in average enrollment of 97%. When we compare the data from the 1Q06 with the data for the 1H06, we see an increase. That increase relates, in 2006, to an intake of students that happened in March of last year. We had 20,000 students in the 1H06; we had an intake of around 3,000 students, and that led us to this average of 23,000 students for the half; and these additional 3,000 students accounted for the additional revenues that we had in the 2Q06, that we have just referred to in the last page. Last year, what we did was: we got these 3,000 students, and we accounted for the whole revenue of the semester, of these 3,000 students, in the 2Q. So, what we are doing for the financial analysis here is: when we analyze the 2Q, we are taking the first three months of installments from these 3,000 students, which should have been accounted for the 1Q, and we are adjusting for that. But when we analyze the full half, that adjustment is not necessary, because, again, you have all the installments in the proper half. When we analyze the 1H average enrollment, this is the result of the growth in the number of students that we experienced throughout the semester. 4

5 We started the semester with 40,000 students. Throughout the semester, we did two acquisitions and that drove the average enrollment up to 48,000 at the end of the semester. If you consider the number of students that we had each month, only accounting for the acquisitions after the month that they were actually closed, the actual average that we observed is of 46,000 students. The average ticket now for Anhanguera had an increase of 6%, slightly above of what we showed in the last conference call, comparing the 1Q07 to 1Q06. This translates, basically, the fact that the acquisitions had a slightly higher average ticket, that is driving the average ticket a little bit higher than just pure adjustment of inflation. Altogether, we posted this net revenue growth of 109%, year over year, resulting from,all factors that we have just discussed. Moving forward to the next slide, we present our recent expansion track record. This is showing all the units that we have acquired, the developed greenfield for the past few months. We are up to ten units, year-to-date. That is an average of more than one unit per month, that is the pace that we said that we were going to expand, and we have given a guidance for the market of one campus per month, on average. We are going faster than that, and we believe we have the opportunities, the resources and the manpower to continue to grow at this kind of pace. And so far we have had the opportunity to increase that pace. What that is bringing to Anhanguera It is not only bringing additional students, as we have seen in the average number of students and the growth in net revenues, but it is also bringing a substantial growth in the size of the addressable market for Anhanguera. I cannot stress that enough: Anhanguera in, the 2Q06 had only 11 campuses, reaching out for a market that had 100,000 students at the time. So, we had a market share of about 25% in those markets. If you consider only our segment, our market share was really dominant in this market. That translates our competitive advantages vis-à-vis our local competitors. And by doing all those campuses additions over the course of the past 12 months, we grew the size of our addressable market by more than six times. We see that just by exploring these new cities that we have entered in the past 12 months, we could see a very substantial growth in our number of students. If you assume that we could achieve the same market share that we had in the markets where we operated back in 2Q06, we should be achieving the same market share in the markets that we operate currently, it could grow the size of the Company by more than three times. So, without adding any new cities, just by entering the few markets that we entered in the past 12 months, we already had a really substantial growth potential for the future. On top of that, it is also important to know Although we had a substantial growth in addressable market in the past 12 months, this still represents a small proportion of the total market in Brazil. The cities where we operate currently represent less than 10% of the Brazilian postsecondary market. So, by continuing to open new campuses at the pace that we have 5

6 been executing currently, we should continue to expand the size of our addressable market, and as we have the opportunity to build up our market share, and as our units mature, we are very bullish on the growth of the Company for the next few years. Going forward to the next slide, we discuss our profitability. You see, on the chart on the left, that we have experienced a substantial improvement in our net margins. That improvement came from a gain of 270 b.p. on costs. That gain basically came from the maturity of the units. As the units mature, we tend to dilute fixed costs at the unit level. Our mature units have a margin that is substantially higher than the new units, so, the same process that is driving up our revenues, as we discussed a few slides ago, are driving also higher margins. And the gain that we had in this process of maturing the units was offset by some pressure in gross margin, that we experienced from doing a few acquisitions in the period. All the acquisitions that we have done had substantial lower gross margins. So, as we acquired those Companies, in the first year of the acquisition, they tend to put a substantial pressure on margins. Although we experienced significant gains in our existing operations, we had this pressure coming from acquisitions. We expect that We already building our projections and our budgets, but we consider a great achievement to be able to, considering the outlook of the sector, to improve our gross margins by 270 b.p. Sales represented a decrease in margins of 190 b.p.. That came from the fact that we, first, and most important, we did a marketing effort for the mid-year intake that we did not do last year. Our mid-year intake last year was restricted to very few of our units. This year, with bigger efforts, with more units; that accounted for this additional cost in terms of marketing. Additionally, we also built a stronger sales team in comparison to We believe that it is going to be key for sustaining the growth rates that we expect to have in the next few years. So, we have in 2007 a sales team that is stronger than what we had in But the most important fact of that is the marketing. That was already built in our budget within our expectations, and it basically comes from the fact that we are doing intakes in more units than what we did in We also experienced an important gain in terms of G&A expenses, 170 b.p. of dilution. We have discussed that several times. We expect this trend to continue in the next few years, and we expect to have this continuous dilution of our G&A expenses. On the chart in the right, we show how between 2004 and 2005 we really fixed up our G&A expenses. That was an investment that the Company did at the time, to support the growth that we saw coming, after 2005, we see this constant trend of dilution of G&A. 6

7 That G&A as a percentage of net sales, was down to 11% in the 2Q07. And I have to highlight that this level of G&A where we are right now, we were able to achieve that level, although during this period, we had costs that we were added to our structure, coming from the acquisitions, and we are constantly integrating those acquisitions, but, at the same time, doing other acquisitions. So, we always have to carry the additional cost of the structures of the acquired companies, which is correlated with the time to fully integrate those acquisitions. We have been able to do those G&A integrations on a fast pace, but as we are also buying companies every one or two months, we always have that additional cost from the acquisitions, even though we are able to take G&A down to 11% in the 2Q07. Moving on to the next page, we do an analysis of our EBITDA margins and net margins quarter versus quarter. We experienced a slight decrease in our margins between 2006 and We do not think that is a representative of whether the cost structure of the Company is today. We think it is more relevant to analyze the 1H06 versus 1H07, but the factors that drove this evolution of margins of EBITDA were: first, our gross margins were slightly below, about 0.5 p.p. below what we saw in The main factor that negatively affected these margins was the marketing expenses that we have just discussed. Those represented, in the quarter, a decrease in margins of 250 b.p., but, again, it is not comparable, since we It is not the same number of units that were opened for each of the years. We are basically having the same standards of marketing expenses, when we look at each unit, but in terms of the size of the profits, it is not comparable. In terms of G&A, we saw a substantial gain, 240 b.p. of dilution, annualizing the quarter. That led to an improvement of 180 b.p. in margins for this quarter. When we look at the net margins, besides all the factors that we have just discussed, we had a substantial impact of the financial revenues, which is what explain, the substantial increase in margins between 2006 and Moving on to the next slide, we analyze the 1H06 versus 1H07. You see we gained more than 200 b.p. in EBITDA margin, and about 1,000 b.p. in net margins. The gains in EBITDA margin came from a better gross margin, as we have discussed, the dilution of G&A, those were the two positive drivers, while the impact of marketing expenses offset some of those gains that resulted on the net result of 200 b.p. of improvement in EBITDA margin. In terms of net margins, on top of the gains that we experienced in G&A, we had a substantial revenues coming from the investment from proceeds from the IPO, and that drove, on top of this 200 b.p. we gained in EBITDA, and additional 860 b.p. of net margins, driving our net margin in the 1H07 up to 29%. Moving on to the next slide, we discuss the cash flow of the Company for the quarter. 7

8 We had cash flow from operations at R$13 million. On top of that, we also had strong financial revenues of R$8.5 million. We are exempt of taxes from almost 100% of our revenues, but some of the revenues still pay taxes, so we had this small tax expenses in the period. Regarding working capital, we had this working capital of R$6 million of cash in the quarter. This is common in the seasonality of our business. This is mostly coming from accounts receivables and advances for vacations; this is the worst moment of the year for us in terms of working capital. We have two factors that take significant cash flows. The students that get past due the tuition over the semester, at the end of the semester, you have your highest amount of past due tuition. After the semester ends, those students come in and renegotiate. The level of accounts receivables that we see at this point in the year is very much in line with what we have seen in past years. Nothing new there, just reflecting the seasonality of the business. On top of that, there is also a seasonal effect that in June, you do an advanced payment of salaries for people that will go off on a vacation in July. As most of our faculties leaves on vacation in July, you have these short-term assets, you have these advanced payments that we do especially for the faculties. That offsets in July, when people will actually leave on vacation, so that comes from the typical seasonality of the business. And the third important factor affecting our working capital is tax credits, that we are accumulating from the investments of our proceeds from the IPO. We had, at our holding Company, substantial losses that came from the IPO expenses. So, basically, the investment of our cash position is not paying any income taxes at this point. Together, the expenses of the IPO, plus some goodwill that we can amortize over the next two years, is covering all the financial revenue that we have at our holding Company. But, at this point, what happens is that the funds where the money is invested they collect the income taxes to keep those taxes as a tax credit and then at over the course of the year, we will be able to offset these tax credits for the public Company. In fact, our holding Company is not going to have a profit this year. But that is affecting our working capital at this point. Non-operating expenses mostly reflect sale of some fixed assets that we did during the quarter, fixed assets that were not much going to be used in our operations anymore. In addition, the most relevant items of our cash flow were the investments that we did in acquisitions and greenfield expansion. We invested R$30 million in acquisitions in the quarter, and also R$90 million in CAPEX. Basically, that amount has been directed to field units that will be launched in the beginning of You should also notice that although the acquisitions amounted to R$30 million, most of that investment was financed by some tax liabilities that we brought together with the acquisition plus a partial seller financing. So, the actual cash disbursement that we had 8

9 from those acquisitions were around R$7 million. They are all taking us to a cash position of R$286 million at the end of the quarter. On the next slide, we are showing data from the stock performance. We are very pleased to see that the stock has performed well since last quarter. We think that it reflects the confidence of investors in the execution of the strategy, the strong results that the Company has posted in the 1Q06, in the 1Q07, and the 2Q07. So, we are very happy with the stock performance and the confidence that investors have shown in Anhanguera. And for the last slide, it is the same slide that we showed in the last presentation, in March. We hope to not being boring here, but we like to stress these three points. It is a very simple and concise statement of what management is focusing on right now. First, and more important point of our strategy for this year, is: we need to focus on expanding the number of campuses through greenfield openings and acquisitions. We think that is the key driver for the expansion of our Company. We are very confident that our product is going to be very successful in the few markets that we are entering. We think that the key driver, really, of our expansion is to be able to enter those markets, and take our proposition of quality education at affordable prices to more and more people in Brazil. The second element is to keep a very strong control of costs. Since we have delivered, over this 1H, on our cost control, and I expect to continue to be very diligent in that front. The last point and that is very tied to our strategy and everything that is behind the development of our business model. We expect to continue to dilute our administrative expenses. We have seen that, quarter over quarter, we continue to dilute our expenses. We discussed, in the last quarter, that we already had some gains, but we are expected to continue to focus on a further dilution. We were able to, again, this quarter, post a lower administrative expense as a percentage of net sales. Going forward, we still see substantial room for dilution of those administrative expenses. We are now open for questions. Efrann Chavez, Artha Capital: Hello. Thanks for taking my question. On the EBITDA margin, if I understand it correctly, the 2Q decreased compared to the 1Q. It really has to do with your new campuses, is that correct? And the expansion? I guess what I am trying to get to is: if you are continuing to be aggressive on the campus openings, would that pressure not continue to come through; and what should be kind of a normalized margin that we should expect in the 2H or into 2008? 9

10 Ricardo Scavazza: Hi. Thanks for the question. Well, the first thing that is important to notice: the margins decreased from the 1Q to the 2Q; that is what you should expect because of the seasonal cycles of our business. During a specific semester, what you experience over the course of a semester is: you have your expenses basically fixed, and you expect to add a regular dropout of students over the course of the semester. So, always, you should expect, in our business, the 1Q of our business semester to be higher than the 2Q. That was one thing. In our business, the 2H of a semester always has a lower margin than the 1H of the semester, when you have your peak of students for that given semester at each of our units. The second aspect that impacted our revenues was the acquisitions. Those Companies that we acquired had a lower gross margin, and they put some pressure on our cost structure in the 2Q. In the 1Q, we had a relatively small impact from acquisitions, we did two deals at a time, they only impacted mostly the last month of the quarter. In the 2Q, we had the full impact of those acquisitions, so they were relevant in terms of driving this gross margin reduction. So, yes; going forward, what you should expect is that you will always have the seasonality on the business. The 2Q of the year is always going to be lower than the 1Q. Then, in the 3Q, you build back your gross margin, because there is a small intake in the mid-year, so your top line grows a little, on a same-program basis, and then the 4Q is lower than the 3Q. So, the seasonality of the gross margins in the business is: 1Q is the peak of profitability, then moves down in the 2Q, back up in the 3Q, but typically below the 1Q and then down again the 4Q. So, this, you should always expect. On top of that, the acquisitions are also relevant factors. So, going forward, if we continue to grow organically and through acquisitions at a pace of close to one new campus per month, we expect to see some pressure in gross margins for 2007 and 2008, but not a substantial change from what we saw in I think that the earnings models are catching that pressure. I think all the projections that I have seen from analysts show that, by growing from 20,000 students in the beginning of 2006 to more than 50,000 students now, and part of that, the acquisitions, in new units, we are seeing some pressure in gross margins. For the year, there should be a very small change from what we saw in

11 Efrann Chavez: And just to follow up on that. You mentioned the seasonality issue, but also on a yearover-year basis, when I look your adjusted EBITDA margin, what is the contributing factor and why that declined if seasonality is taken out? Ricardo Scavazza: Well, the factor here, when you look at slide number eight, comparing quarter versus quarter, you see that the gross margins are very much in line for the quarters. For the semesters, we had a gain of 240 basis points, so, for the semester, which is the most relevant timeframe for doing this analysis, we had a slight change for the quarter it was more or less in line. What drove this reduction in EBITDA margin were the marketing expenses. We, basically, had a very small investment in marketing last year, for the mid-year intake. We only did open intakes in two campuses last year. So, it was a very, very small asset. This year, we opened for more units, for marketing. That was already considered in our budget for the year, but that represented most of this change. We gained a few basis points in G&A, so, therefore, the change. The changes came from those factors. Efrann Chavez: Thank you. Operator: There appears to be no further questions. I will turn the floor back over to you, for any final remarks. Ricardo Scavazza: Well, thank you all for participating. We had a great attendance in this call and we are very happy with the results we posted in this quarter. We remain very confident in our guidance for this year, and I hope to talk to you again in our next conference call. Thank you very much, have a good afternoon. Operator: Thank you. That thus concludes today s teleconference. You may disconnect your lines at this time, and have a wonderful day. 11