Good morning. Welcome to Ser Educacional conference call to discuss the company's results for the third quarter of 2019. With me today are Jânyo Diniz, Chief Executive Officer, João Aguiar, Chief Financial Officer, and Rodrigo Alves, Investor Relations Officer. We would like to inform you that this event is being recorded, and all participants will be in a listen-only mode during the company's presentation. After the presentation, we will start the Q&A session for analysts and shareholders when further instructions will be provided. Should any participant need assistance during the call, please press star zero to reach an operator. The event will also be broadcast live via the internet at ir.sereducacional.com. You can also access the webcast audio and slides through the tablets and smartphones equipped with iOS or Android systems. The replay of this event will be available soon after its conclusion for a period of one week.
Before proceeding, we would like to make clear that forward-looking statements may be made during this conference call relating to the business prospects of Ser Educacional, as well as its operating and financial forecasts and targets. Forward-looking statements are not guarantees of future performance. They involve risks, uncertainties, and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur. Investors should understand that general economic conditions, conditions in the industry, and other operating factors may also affect the future performance of Ser Educacional and could lead to the results that differ materially from those expressed in these forward-looking statements. I would now like to turn the call over to Mr. Jânyo Diniz, Chief Executive Officer, who will begin the presentation. You may begin, Mr. Jânyo.
Good morning, everyone, and welcome to our 2019 third quarter earnings conference call. Please go directly to slide three, where we have the highlights of the winter intake season, which as we can see from the numbers, was very positive with a growth of over 50% in total new enrollments, 13% in on-campus, and distance learning posting a growth of almost 130%. This was an important result as it showed that demand is returning to the sector. We also had a positive response from our new units and our expanded portfolio of course, especially in the healthcare area. As we know that labor market demand is stronger, and we also noticed an overall improvement in the consumer confidence in the state capitals of the northeast.
It is also worth mentioning that third quarter 2018 had an easier comparison base as it was a period impacted by extraordinary events such as truck strikes, World Cup, and presidential elections. On slide four, we have the evolution of the student base, which also showed positive results with double-digit growth in total student base. Another highlight was the stabilization of the on-campus students base, an important factor as the students dropout is in the segment decline compared to the third quarter of 2018. As a final highlight, we had our distance learning student base, which surpassed the 30,000 student mark in the quarter. A result that we can say is even above expectations. On slide five, we present the evolution of the FIES student base and average ticket. Note that the FIES is becoming less significant in our results, and this quarter is about 18% of total students.
As we have already pointed out in other conference calls, the average ticket for all quarters has changed somewhat since the intake of our out-of-pocket students gained relevance. These students are usually enrolled at promotional tuitions of BRL 49.9 and BRL 99, depending on the market that are valid for one or two months, which generate more pressure in these quarters. As we had a positive intake season in this quarter, we had a little more pressure, but I believe that in the following quarters, this impact will be diluted. As for market conditions, I believe that prices are stable compared to the last two or three intake seasons, but still a very competitive market. These were my initial comments on the operating results, and I turn to Aguiar to comment on the financial results.
Thanks, Jânyo. Hello, everyone, and thanks again for coming to our earnings conference call. Turning to slide six, where we present a summary of the quarter's results. In this third quarter, we had the return to the net revenue growth due to the growth of the student base that occurred due to the success of our last intake season, as well as an improvement in dropout indicators. We had a 1 percentage point increase in our gross margin, mainly due to the operational optimization we have been doing since last year. Our adjusted EBITDA, on the other hand, fell by approximately 9% in the quarter due to higher volume of market expenses increase from the second quarter to 2019. Because we believe that the economy was returning slowly and of the intake results. We note that it was a decision that proved to be right.
In addition, we had a higher volume of personal and third-party services expenses as we have not yet diluted the results with the consolidation of Uninorte. Our initial expectation was to have the consolidation as of August, September, but there was a delay in the appointment of CADE's Directors, and the decision came in November. In this scenario, our net income, despite having decreased last year, was much less impacted than in the second quarter 2018 versus second quarter 2019, and the additional impact we had in this quarter was mainly the decrease in depreciation and amortization. Moving on to slide seven, we present some non-recurring effects that ended up impacting the quarter's accounting results by around BRL 12 million.
The first was the acceleration of the Ser Digital project, which resulted in an expense of BRL 4.5 million, which we now work on strongly in the new distance learning platform, student and faculty portals, as well as process robotization and artificial intelligence deployment. The second effect was a write-off of property, plant, and equipment of about BRL 4 million related to property returning during the year. And the third, other BRL 4 million related to the severance expenses of the staff and teachers due to the work of adapting the students paying the fees with greater variation as well as beginning of operational optimization work that had not been carried out more consistently during the year.
Turning now to slide eight, we have the breakdown of the results between on-campus, new units, and the distance learning, which, by the way, has been the main highlight in operation results and from 2019 in financial results, as well, contributing positively with the adjusted EBITDA for the third quarter in a row, a fact that happened for the first time since the beginning of the operations. Our legacy units continued their trend to reduce the impact on results due to the adjustment we made since last year to provide this effect that we are currently seeing. On-campus operations have been concentrating more on impacts of the economic slowdown as they are located in the largest cities. But we hope this will be able to reverse in the medium term as we are beginning to see the first signs of improvement, although still shy.
Moving on to slide nine, we have the analysis of our average collection period that went from 75 to 91 days, mainly due to the increase in the average collection period of regular students and FIES. In the case of FIES, we had receipts that happened last year during the third quarter, which this year are being realized in the fourth quarter. This slight later behavior by the federal government does not affect our operation but has led to a change in cash and cash flow behavior. In the case of an increase in the out-of-pocket students net receivable days, this is related to the change in our provisioning methodology that we announced in the first quarter 2019, which now incorporates this highest credit recovery rate over 360 days in our PDA calculation base.
In addition, we have our out-of-pocket students base that is growing more than 20% year over year, and the chart below illustrates this effect on our gross receivables and comparing this increase with that of the total, and total of out-of-pocket students base, as well as the out-of-pocket undergraduate base. Therefore, because of the substantial decrease in the FIES student base in a still challenging economic period, we understand that this average term increase is natural to the scenario we are going through and more accurately reflects the actual payment cycle of regular students. Moving on to slide 10, we provide a pro forma analysis of cash generation to make it easier to understand its behavior.
The main point of analysis is that the third quarter 2018 had been the last quarter of additional operating cash generation due to the payment of the last installment of PEP 2.3, which was BRL 137 million. If we remove these effects and consider some specific issues such as the judicial deposits made in the year and the FIES payment term adjustments, our cash generation is behaving quite in line with our adjusted EBITDA and our post-CapEx cash generation. On slide 11, we present our CapEx, which as already observed the other quarters of the year, is falling from 7% of the net revenues last year to 5% this year as a result of the significant expansion already contracted due to investments in previous periods.
On slide 12, we have our debt, which as we can see, had a significant reduction of close to 35% since that year was paid one of the portions related to the acquisition of UNG and the first series of our issuance of debentures. Thus, our company continues to be in a very comfortable cash position, even considering that in the fourth quarter of 2019, we paid BRL 185 million related to the acquisition of Uninorte. These were my comments on the results, and I give the floor back to Jânyo who will update our business plan.
Thank you, Aguiar. Moving to slide 14 for an overview of our business plan. We are cautiously optimistic about the future of the sector as the Brazilian economy is showing its first signs of recovery despite a still very high unemployment scenario. The sector is undergoing a major transformation that should have positive impacts in the medium to long term. We understand that the distance learning regulatory framework will bring many of these positive changes, because it allows this teaching model to be increasingly integrated with the classrooms and with the support of technology and active teaching methodologies available today, enabling the Brazilians to access higher education in new formats. These new formats, coupled with a smaller cost structure, allow for a greater capillarity of supply with even better student experience and affordable teaching quality.
It is with this vision that we are working on our third digital project, which aims precisely to achieve these objectives, increasingly integrating the offer of classroom course with distance learning process. As a result, we developed the Campus 2.0 concept that allows us to open CapEx units at about one-third of what we were doing in the past, with a much more efficient and interesting unit model for young people aging between 18 and 24 years, including units allocated within shopping malls, which has shown promising results in 2019. To this end, as we have shown on slide 15, we have invested heavily in our platform to improve the student experience in each pillar of student contact. We invested in our back office, both in the student portal, the internal process that impact their routine in our institutions.
This semesters, we launched several new features on our distance learning platform so that students can have market news available on our platform. These are increasingly friendly and lightweight content that allows students to access their studies in an increasingly convenient way. We are doing an important job implementing our active methodologies program in all our course. This is starting gradually. Today, most of our house course are already using active methodology in the first or second semester. This is an important movement because this is the model we already use in distance learning, and this should help students feel less and less difference between teaching modalities. And we take better care of our distance learning partner centers. We have created a lot of news so that they can better manage their student base and have the incentive to serve more and more students.
The Polo em Jogo was undoubtedly an initiative that greatly increased the capture of our distance learning. On slide 16, we present the unit we opened in Brasília last October, and we make its first intake process in this 2020 first semester. This is a typical Campus 2.0 model with about 2,600 square meters located within a mall. The unit has just approved the course, including the most demanded in the city, such as law, dentistry, nutrition, and psychology. Brasília is a city that recognized the UNINASSAU brand for having a very strong Northeast migrant population. The city is one of the best income per capita and employment in Brazil, and this market that has no competitors are dominant. We are confident of the success of this unit as it marks the return of our unit opening activity after almost two years.
On slide 17, we move on to remember that we have finally completed Uninorte's transaction in November. We started the first phase of integration, which is the commercial one. Uninorte is already offering 100% online course after only a week the integration started. We are confident of this integration and the value creation that we will have with this important institution that strengthens our position in the Northern region of Brazil. On slide 18, we present some analogies that we received this year that were important to demonstrate that we are moving positively in our activity. In addition to awards for the Guardian Tutor project, which aims to reduce the dropout of distance learning by using tutors who routinely communicate with the students to increase their sense of belonging.
Some important quality recognitions, such as positive qualification at distance learning rankings, where we had three course among the top 10 ranking course, but also four highest-rated ENADE course in Brazil and four highest-rated ENADE course in the Northeast and North. Finally, UNINASSAU Fortaleza has been accredited as a university center, a significant recognition of our quality in the city that we have performed well in recent years. On slide 19, last of our presentation, summarize the strategic objective that we are seeking to achieve in the short to medium term. First, we continue to develop our organic growth plan after resuming the opening of new units this year. We want to open between four and six units per year already in the concept of Campus 2.0, favoring regions where we have solid brand recognition.
In addition, we will continue to open distance learning centers, I believe at least 30 a year. We realize that there is still room for maturity of our existing operations, and it is possible to recover more mature operation as soon as there is a sharp drop in our unemployment. Second, we have the opportunity to start generating synergies at Uninorte. A plan we have been designing for almost a whole year can finally begin its execution. In addition, the higher education market is still very hot for acquisition, and we are continuing to work to bring new recognized brands into their markets to make up a regional brand portfolio. Third, let's continue our investment in Ser Digital. It's a fundamental process for our company to be prepared to capture the positive change that we will have in the coming years.
Fourth, we will keep our company with a lean cost and expense structure, focusing on operating cash flow and generation, and preparing for new strategic M&A moves. As you can see, this is a relatively simple plan that we have been repeating since our IPO. Focus on the business, seek operational efficiency, valorizing acquisitions, and organic growth. These are my comments, and get [the layout] for the section of question and answers.
Thank you. We will now begin the question and answer session for investors and analysts. If you have a question, please press star one on your touch-tone phone. If your question is answered during the session, you may remove yourself from the queue by pressing star two. The questions will be answered in the order that they are received. We ask that you use your handset when asking your question in order to maintain excellent sound quality. Please stand by while we collect the questions. The first question today comes from Vinicius Ribeiro of UBS. Please go ahead.
Hey, guys. Good morning. Thanks for taking our question. Two, actually. The first one is, ahead of the upcoming 2020 intake cycle, would just like to understand your expectations on discounts level for the on-campus segment and on tuition on the distance learning. Just like to understand how is competition in your view, and how should overall intake behave. That will be my first question, and I will ask the second one afterwards.
Well, thank you, Vinicius, for your questions. We believe that for a regulated course, there is a possibility given the lower availability of seats. Our business plans does not foresee significant price recovery in the coming years, as we believe that the recovery will be gradual, and the industry still needs to prioritize student-based recovery. We believe that the scenario of this quarter and say second will be very competitive as it has been in previous quarters, and we did not expect those significant pricing change in our market. We believe the market is still trying to recover part of reduced student base due to graduation of grad students and amid an economic scenario.
Okay, thanks. My second question would be, in regards to your organic growth as you outlined during the presentation, just would like to understand, both in the on-campus and the distance learning, which regions are you targeting to enter, or what is the rationale for these regions?
Hi, this is Rodrigo speaking. We think the key points for us in terms of expansion is to focus more and more in the Northeast and the North regions. We have the acquisition of Uninorte. There is an opportunity for us to open more units with Uninorte as well. We are aiming more to the countryside of the Northeast, where we believe that our brand have a higher penetration. Just to explain the [Azevedo], we opted to do [Azevedo] this time more opportunistically because we found an interesting real estate to rent and that the city itself is very important in the higher education market.
Okay, thanks, guys. Thanks for taking my questions. Have a good day.
The next question is from Susanna Saluru of Itaú. Please go ahead.
Hi, good morning. Thank you for taking our question. We have two questions as related to Ser Digital. Could you elaborate when do you expect it to be fully concluded, and what kind of savings should we expect once the Ser Digital is fully implemented? Thank you.
Hi, this is Rodrigo again. Ser Digital will be in full production until the end of next year. In the end of next year, we will reevaluate, but probably the level of investments will reduce because most of the programming and the expenses related to that will be already done. However, it is a cultural change, so the project will be the change of the overall company in order to have us jumping into this hybrid education mode. But in terms of expenses until the end of next year, we will be okay.
Perfect. Thank you.
The next question comes from Marcelo Santos of JP Morgan. Please go ahead.
Hi. Good morning to all. Thanks for taking my questions. The first question would be about the synergies on Uninorte. I wonder if you could give us a little bit more color on the source of the synergies and the timing of realization now that you're already controlling the asset. The second question is about the distance learning ticket, where we have a few moving pieces there. You have a strong intake, probably with some discounts, but you also mentioned something about the course mix, more 100% online. Could you just help us to understand a little bit more how is your distance learning mix evolving? Where do you think it's going to be going forward, and how that should impact prices? Thank you.
Hi, Marcelo. Thank you. It's Aguiar speaking. The idea about Uninorte is to make the company at least double.
It adjusts a little margin. Considering that there is a three years of execution plan by integrating the institutions curriculum matrix, efficiency gain with the centralization of the structure, the time, of course, and expenses with suppliers. To accomplish this, we have a team of integration with solid track records execution in previous transaction. Which is already formed for the clean team, analyzing everything that can be done in detail. Our synergistic absorption scenario would be 30% in the first year, 7% in the second year, and the remainder in the third year of consolidation, working a scenario where the systems turnaround would take place in December, no later than July 2020.
Thank you.
Hello, this is Rodrigo speaking. Talking about the distance learning average tickets. We feel that the decline that is happening today is quite in line to what we were expecting. As a matter of fact, in the beginning of the year, we were expecting even lower average tickets for distance learning. This explains why the overall performance in terms of EBITDA distance learning is behaving better than we were expecting. We were expecting this year to reach about 25,000 students, and we are a little bit above 30. But the overall performance of distance learning probably will continue to decline slightly, given that what is happening to us is a network effect, where the partner distance learning centers are beginning to sell more. As they do not have the labs installed, what they end up selling are the courses that are 100% online.
What we are also learning is that they are having more facility here to sell the post-graduation courses, and those are the cheaper courses we have in the network. We believe that the trend should continue. We also think that this is positive for us because it is important for us to reach a network effect and further dilute the whole structure and have our partners happier. The business we created is set to operate with average ticket that will probably be in line to what we are seeing today. We expect, of course, the distance learning to remain a competitive market. Obviously, the moment that we mature the partner distance learning centers, the pricing should probably stabilize.
Great. Thanks. Just follow up on Aguiar's question. The last thing you mentioned, which should turn in mid-2020. Sorry, could you just clarify that phrase? I did not get that.
Sure. I thought that our scenario of synergies absorption would be about 30% in the first year, 7% in the second year, and the remainder in the third year of consolidation. Working a scenario that where the systems turnaround would take place in December, no later than July 2020. I mean that we will start the integration of the systems right now in December, and it will take place until July of 2020.
Okay.
It gets around six months to have the whole integration of the systems.
He's saying that because we need a semester to make each rollout, so you cannot roll out a system in the middle of the semester.
Okay. No, makes sense. Thanks a lot.
The next question comes from Bruno Giardino of Bank of America. Please go ahead.
Hi, good morning, everyone. Could you please tell us what are your expectations for the G&A expense line? This has clearly hurt your results recently. Can you expect that we have reached the top in terms of these expenses, and some dilution could be seen going forward? Also, with the integration of Uninorte, do you expect that this line to be temporarily pressured in the first quarter? Thank you.
Hi, Bruno. This is Rodrigo speaking. This is a good point. We refrained from carrying a lot of G&A this year as we were doing in the past years, given that we had to wait until Uninorte to be consolidated, and we had a three month delay this year. What we are doing now is precisely to execute the business plan at Uninorte. During this period, we are also working on a fine-tuning of G&A expenses as of the fourth quarter. Our expectation is to make this fine-tuning now during the fourth quarter. During the first quarter, we will have a better sense of the intake season, so we will do a second fine-tuning, or not, depending obviously on the summer intake. The idea is to make the G&A expenses to be more in line to the revenues we are getting.
This is something we have done a little bit differently this year than last year, but we had a very good reason for this.
Okay, thank you.
On Uninorte, well, Uninorte operates with maybe the margin of around 10%. Clearly, you cannot make the margins to go up in one quarter, so it should impact likely our combined margins in the first year. As Aguiar said, as we reach the levels of synergies, we believe that. Now that we are inside of Uninorte, we are even more confident about the synergies we are getting. This will probably generate better margins for us in 2020 onwards.
The next question today comes from Thiago Bortolussi of Goldman Sachs. Please go ahead.
Yes. Hi, good morning, everyone, and thanks for taking our questions. We have two questions. The first one is regarding working capital. You made an adjustment on PDA in the beginning of the year, and right now we are actually seeing a pressure on FIES receivable base. I know you already commented a bit about it on the opening remarks, but we would like to understand what is the trend you expect going forward, and if there is room for a potential increase on PDA levels going forward. This is the first question. The second one is regarding distance learning. You are ramping up your platform fast. On your last slide, you mentioned additional organic growth for 2021.
When you think about future growth, what is the contribution that you expect to come from same store sales and maturation of existing units versus from new units in the medium term? Those are the questions. Thank you very much.
Hi, Thiago. It's Rodrigo again. Regarding the working capital, we think that if unemployment really begins to decline in the North and Northeast, this will probably start to improve as of the next year. We also have to take in mind that on the other hand, the FIES students are finalizing the biggest chunk of graduation. So this will put a little bit more of out-of-pocket accounts receivables. What is important to keep in mind is that the regions we operate still didn't see any reduction of unemployment. So if this starts happening, this will probably compensate the larger volume of out-of-pocket students. The other question related to expansion of distance learning. I think what we still have here is a priority of maturing the existing volume of partner distance learning centers that we currently have.
Given that the distance learning centers that are open today, on average, have a third or half of the volume of students as compared to the distance learning market overall. However, if we can grow between 20- 30 new distance learning centers next year, it will be welcomed. I think the difference between what we are saying today from two years ago, is that two years ago, we needed to create a network of distance learning centers because this would be important. As we can see, it's been important for the overall intake volumes. But now we believe that most important than that is to mature and to have an operation where our partners are making good results as well as we are doing now.
Thanks, Rodrigo. It's very clear. Thank you very much.
Once again, to ask a question, please press star then one. Please stand by again while we collect the questions. The next question today comes from Leandro Bastos of Citi. Please go ahead.
Yeah, thank you. Hi, guys. Morning. One question about dropouts. What should we expect in terms of dropout rates going forward? We saw an improvement on Q3, especially on the on-campus that was eye-catching. Just to get a sense on what should we expect going forward. Thank you.
Hello, Leandro. It's Rodrigo. We think the dropouts in this year, especially the first semester, reached the top. Given that we were still with high unemployment rates, and this was dragging a lot of the negotiations to re-enroll students. Now we believe that dropouts, if unemployment in the Northeast and the North really begin to drop, it will be probably at least stabilizing to begin to decline.
That's perfect. Thank you, Rodrigo. Very clear.
The next question comes from Caio Mascaretti of Morgan Stanley. Please go ahead.
Hey, good morning, everyone. I have a question on the margins of the mature units that exclude new units and the distance learning. This quarter, the margin came at 25.4%, and when I look last year, the margin was 28.9%. Just want to make sure that both of them are comparable. If so, what has driven this strong 350 basis points deterioration, and what we should expect going forward for the mature units?
Hi, Caio. Yes, they are comparable. It shows how the graduation of FIES students and the overall economic scenario we have are really hurting the bigger operations, especially in the state capitals of the Northeast. This, on the other hand, makes us more confident that we have space to grow again margins, given that all the suffering those cities had until today. If we can start to have the recovery we showed in the third quarter, it is important to mention that the volume of intakes we had in the third quarter came mostly because of the larger cities in the Northeast began to react. It also shows that we did not make all the adjustments we usually do, given that we were expecting to have the Uninorte acquisition during this year.
As the EBITDA margin share corporate expenses, they will also charge you a little bit of the mature company as well.
All right. Thank you.
Once again, to ask a question, please press star then one. Please stand by again while we collect for questions. Thank you. That does conclude the question and answer session for investors and analysts. I would like to pass the word to Mr. Jânyo Diniz for the final considerations. Mr. Jânyo, you may proceed.
Thank you all for participating in this conference call. Please, if you have any further questions, feel free to contact our investor relations team.