Totvs SA

BOVESPA:TOTS3

Earnings Call Transcript 2018-Q1

[Operator]

Good morning. Welcome to TOTVS Conference Call to discuss the Results of the First Quarter of 2018.

Today, we have with us Gilsomar Maia, CFO; Alexandre Apendino, Services and Relationship Officer; and Sérgio Serio, Investor Relations Manager. [Operator Instructions]

The audio is being simultaneously webcast at ri.totvs.com.br.

Before proceeding, we wish to clarify that any forward-looking statements that may be made during the conference call related to the business outlook, operational and financial projections. And targets of TOTVS are based on the beliefs and assumptions of the company's management as well as on information currently available.

Forward-looking statements are not guarantee of future performance. They involve risks, uncertainties and assumptions, as they refer to future events, and hence, depend on circumstances that may or may not occur. Investors should understand that general economic conditions, industry conditions and other operational factors could affect the future performance of TOTVS and could lead results to differ materially from those mentioned in such forward-looking statements.

I will now turn the call over to Mr. Maia, who will begin the presentation. Mr. Maia, please go ahead.

[Gilsomar Sebastião, executive]

Good morning, everyone. Thank you for participating in our conference call. I'll begin the presentation by commenting on the main recent events on Slide 3.

The first is the Shareholders Meeting held on April 5, in which shareholders representing 85% of total shares participated, with shareholders representing 49% of total shares being represented via remote voting form.

The meeting approved all the items on the agenda, among which I highlight the following: the new Board of Directors' composition consisting of 7 reelected members, Pedro Passos, Claudia Elisa, Gilberto Mifano, Laércio Cosentino, Maria Letícia Costa, Mauro Cunha and Wolney Betiol. And 2 new members elected, Guilherme Stocco Filho and Paulo Sergio Caputo.

Guilherme Stocco Filho was an advisory member of the Strategy and Technology Committee of TOTVS last year and is currently a member of the Technology Committee at B3, as well as consultant to Buscapé and [indiscernible].

Paulo Sergio Caputo, independent board member at CSU Cardsystem, only partner of ÓRIA Gestão de Recursos, with large experience in technology companies such as Bematech and Datasul. And also served as Vice President of Strategy at TOTVS between 2008 and 2009.

The elected board members will hold their mandates until the Annual Shareholder Meeting of 2019, and their profiles are available on TOTVS's investor relations website, ir.totvs.com.br, in the corporate governance board of directors session.

Another item approved at the meeting was the change in shareholder base incentive and retention plan, which includes the linked investment of annual bonus of participants in shares of the company or eligibility to incentive plan.

We established the annual individual performance appraisal as a criteria for operating the restricted shares set by the Board of Directors, within the limits approved by the general meeting of 2015. And for the shareholders' program to require eligible participants to hold, continuously and uninterruptedly, equivalent of 12 gross salaries in TOTVS shares on the date of the grant.

These changes were made to improve the plan approved in 2015, to achieve the following objectives: increase the medium and long-term alignment of interest between participants and shareholders; enhancing the sense of ownership and commitment of participants through the concept of investment in risk; and strengthen incentives for retaining and providing long-term stability to participants reading the context of a public company.

Moving on to Slide 4. Another event of the period occurred on April 3. With the election by the Board of Directors of Juliano Tubino as Vice President of Business Strategy and Digital. In his career, Tubino has gathered experience in the areas of digital marketing, sales and innovation, having held diverse executive positions include Chief Marketing Officer at Accenture Digital, Netshoes and Amazon.

In this quarter, we also inaugurated the new Bematech hardware plants in São José dos Pinhais, Paraná, which enables us to unify the operations previously distributed over 3 facilities in the cities of Curitiba and São José dos Pinhais. TOTVS also entered in the Internet of Things solutions market, with the launch of the Bema platform that brings together data from connected device and be used in business applications.

Before beginning the comments on the results of the quarter, I wish to point out that the new accounting standards, IFRS 9 and IFRS 15 came into effect this quarter. The adoption of IFRS 9 resulted in a provision of allowance for doubtful accounts, based on the historical losses recorded in the accounts receivable aging-list range, including trading notes to, combined it with the clients' propensity to pay provided by the credit bureaus.

On the other hand, the adoption of IFRS 15 resulted in revenue recognition during grace periods, upon deferral and/or provisioning of selling expenses and commissions, in order to linearize the result over the estimated life cycle of recurring contracts. Revenue from services was also adjusted by determining the percentage of completion. Projects based on the costs incurred versus the updated estimates of total costs required to conclude the projects.

The adoption of this new accounting standard resulted in a positive impact of BRL 5.9 million in net revenue, BRL 3 million in EBITDA and BRL 2 million in net income in the quarter. The application of these standards on balance of December 31, 2017, resulted in a negative impact of BRL 8 million, which was recognized under equity in January 2018.

I now turn the presentation to Alexandre Apendino, who will comment on revenues in the quarter on Slide 5. Apendino, please go ahead.

[Alexandre Haddad Apendino, executive]

Thanks, Maia. Good morning, everyone. As shown on chart on the right, with the last 12 months figures and in the chart at the center, comparing year-on-year net revenue growth has been driven by recurring revenues, which already exceeds 2/3 of the total revenues in the quarter, corresponding to almost 3 percentage points above the level of 2017.

In this quarter, nonrecurring revenues grew 2% quarter-on-quarter, and as we can see on Slide 6, this increase is mainly associated with softer revenue, which grew 6.8% over the previous quarter and 6.5% year-on-year.

As shown on the Slide 7, software revenue was leveraged year-on-year by the 38% growth in the subscription revenue and 14% in growth in the licensing revenue.

Here I wish to draw your attention to the growth in subscription and licensing revenue in the all comparison base, which reflects sales growth and market to recover in the period. The reduction in maintenance revenues shows that the growth in license, combined with the inflation update by IGP-M has not yet been sufficient to offset the financial churns of this recurring revenue.

In the chart to the left on Slide 8, we can see that the growth of the licensing model during the quarter came mainly from increment in the corporate model, which totaled BRL 17.9 million, an increase of almost 29% compared to the increment in 2017, which itself was 29.5% higher than in 2016.

In this model, clients have unrestricted access to the TOTVS management fees, for which they pay an increment of license fee at the beginning of each year, based on their actual growth in the prior year.

As such, this growth in the increment amount reflects the pace of growth among clients under this model in 2017. Especially in the manufacturing, healthcare, logistics industries.

Another aspect that draws attention to this chart, is the increase of the subscription revenue came in from 18% of software revenue to almost 24% in an year. This performance is mainly due to sales of subscription, which can be observed from the net addition of annual recurring revenue from subscription, which is shown in the chart to the right on the slide.

Note that as ARR accelerates, subscription revenue accelerate in the subsequent periods.

I now hand over the presentation to Sérgio Serio, who will comment on the software results on Slide 9.

[Sérgio Serio, executive]

Thank you, Apendino, and good morning, everyone. The year-on-year increase of 20 basis points in adjusted software contribution margin is essentially to the result of the growth in subscription revenue, as just commented by Apendino. The reduction of recurring costs with personnel in fourth quarter '17, also contributed to the performance and to phase the probable effect on the wage bill, resulted from the collective bargaining agreement to be concluding São Paulo.

In the quarter-on-quarter comparison, apart from the growth in subscription revenue, decisional contributions from the increment in the corporate model also contributed to the 210 basis points growth in adjusted software contribution margins.

Talking now about services on Slide 10. By the decline in revenue, adjusted contribution margin grew 390 basis points year-on-year, and 140 basis point quarter-on-quarter. This is mainly due to the reduction in the recurring cost with personnel during the second half of 2017, and the effects of BRL 3.70 million, resulting from the adoption of IFRS 15.

In the comparison with the last 12 months, the reduction was due to the decline in the revenue from software implementation services and the reduction in revenue from consulting services. These decreases were mainly due to the lower pace of sales and consequently, lower allocation of professionals, especially in the first half of 2017.

Moving now to hardware on Slide 11. The drop in adjusted condition margin from hardware to year-on-year and for the last 12 months was mainly due to the drop in sales of fiscal solutions, which have a higher gross margin. And by the increased investment in research and development due to the normalization of expenses with each of those contracted to comply with the IT law or [ leading for much ].

In the quarter-on-quarter comparison, the declining adjusted contribution margin reflects, apart from the drop in sales of fiscal solutions, the negative seasonal effects on the first quarter shown on the chart to the left of Slide 12. In the chart to the right on the same slide, the drop in sales of fiscal solutions is clear, especially due to the continuation process of fiscal printers.

On the other hand, the chart clearly shows the growth in the share of sales of other solutions, especially those related to the so-called directed corporatization to large clients. These sales are largely cross-selling synergies between TOTVS and Bematech operations, by which higher value-added solutions are offered to new clients as well as of cross-selling of solutions to TOTVS's clients.

Moreover, Bemacash sales in the period totaled 1,042 units compared to 1,513 in first quarter '17. This reduction is mainly due to the change implemented in January of this year in the Bemacash sales model transaction.

Using the individual taxpayer number, this sales model is now made exclusively with credit card through the TOTVS store. Besides [ simplify ] the process for clients, this change aims to reduce the fault levels.

To discuss about selling and administrative expense, please go to Slide 13. The year-on-year decline in aggregate selling expenses and commissions essentially reflects the net effects of the reduction in recurring costs with personnel in 4Q '17. The increase in commission expense as a result of the sales mix between on-channels and franchisees and the growth in license sales.

In the year-on-year comparison, the increasing general and administrative expenses, together with management fees and other expenses is associated with the provision for continuations in first Q '17 lower than the quarterly average of 2017, and the higher provision in the first Q '18, due to the BRL 2 million adjustment resulting from the reconciliations of registered deposit balance, and our positions on the legal proceedings at the quarter.

The quarter-on-quarter decrease in this group of expenses was mainly due to the addition of expenses incurred in 4Q '17. With the merge of [ Virtual Age ] and the integration of the administrative operations of Bematech, both of which contribute to the reduction in recurring personnel costs.

Regarding to the allowance for doubtful accounts, increase in the quarter mainly reflects the higher level of clients [ default ] at the start of the year, which resulted in a negative effect of BRL 3.2 million, with the adoptions of the new IFRS 9 standard.

I now return the presentation to Maia, who will comment on the EBITDA then on Slide 14.

[Gilsomar Sebastião, executive]

As we can see the charts, the result of services was once again positive in both quarter-on-quarter and year-on-year base, despite the reduction in revenue compared to the few negative results in 12 months. The change in the product mix still continue to reduce hardware results with its continuation of physical printers in a more advanced stage than the development of high value-added solutions, which has Bemacash and a smart device for the Internet of Things.

But it should be noted that now comparisons result from software being the company's core activity has recovered its contribution to EBITDA, with growth in revenue, especially in subscription and the reduction in selling and administrative expense, this provides addition impacts of provisions for doubtful accounts and for contingencies.

As such, we concluded that year-on-year and quarter-on-quarter improvement in EBITDA is mainly driven by the growth in software result and cost control.

Moving now to Slide 15. This performance of EBITDA is the key element that combined it the reduction in amortization of intangible assets from acquisitions led to the growth in net income, both year-on-year and quarter-on-quarter.

Now I move to Slide 16, for the comments on cash flow and debt. Though taxable income grew 21% year-on-year and 625% quarter-on-quarter, operating cash flow generation decreased by 11% and 27% respectively.

The 2 main factors leading to this reduction were: increasing working capital, since the quarter did not end on a business day, which resulted in the settlement of the receivables by customers at the start of the second quarter '18; and the increase in income tax and social contribution payments, due to the new role established by the Brazilian IRS, which does not allow the offset of federal tax with credits before the filing of some fiscal obligations that we will record in June.

The decline of 37% year-on-year and 14% quarter-on-quarter in net debt, with reduction in free cash flow in the quarter, is related to the change in the flow of investments, which resulted an increase in CapEx, as opposed to the reduction in reimbursement with lease agreements, and consequentially, the reduction in gross debt.

Compared to the last 12 months, free cash flow grew 18.7%. This increase in cash flow led to a 37% reduction in net debt, which went under 1x adjusted EBITDA in the last 12 months.

I now move on to Slide 17 for the closing remarks. During this call, we saw that recurring revenue grew 5%, driven by subscription revenue, which grew 38% year-on-year and reached almost 24% of total software revenue.

Annual recurring revenue from subscription grew more than 43% and surpassed BRL 400 million.

The growth in licensing revenue from the corporate model grew 29% year-on-year. The growth in software result and the reduction in selling and administrative expense were the main factors that contributed to the year-on-year growth of 7% in adjusted EBITDA and 9% in adjusted net income.

And net debt declined 37% year-on-year, returning to below 1x EBITDA. This result underlines our focus on sustainable growth, without compromising the capacity for growth, profitability and innovation of TOTVS.

We are now available for the Q&A session.

[Operator]

[Operator Instructions] Our first question from Andre Baggio, JPMorgan.

[Andre Baggio, analyst]

So it relates to a good stage of license adjustment since we've seen that subscription remains with healthy growth. Can you say that back of that is very attributable to an economy [ that's you? ] Or is there anything relating to software that you're developing that is also causing this acceleration in the license?

[Gilsomar Sebastião, executive]

Baggio, this is Maia speaking. So if I heard you correctly your question, you're asking about the growth of license if it's related to some -- being related to our products or related to the market [ weakness ]?

[Andre Baggio, analyst]

Correct.

[Gilsomar Sebastião, executive]

Okay. So actually no, if you take a look on our figures of license quarterly, you are going to see that the number of new clients added declined in line with the trend we've seen in the recent quarters.

And consequentially, we've seen an average ticket increase as a consequence, reflecting the average size of clients we've been [ solding ] -- we've been sold license to them. Actually, it's more a matter of economic dynamic in our market and it's not directly related to our product.

I don't know, Apendino, if you want to complement something?

So it's really more a reflect of especially entrepreneurial environment. So business owners seems to be a little bit more confident about the environment, and they are not so driven by fiscal year result, for example, they tend to take decisions in accordance with their market confidence.

[Andre Baggio, analyst]

And then as a follow-up question, I remember talking to you about the migration of people or software from the traditional model into the subscription model. How ready is the software itself for this transition, how -- when you think [ it's on declines ], in a sense, what prevents you from accelerating? I saw there was a small number of clients which migrated to [indiscernible]. So what prevent a bigger actually migration of the clients at this stage?

[Gilsomar Sebastião, executive]

Good. So yes, right, the migration is really in a very low pace. Actually, we have no change in this matter. We have been more reactive in this matter because we understand that we might be proactive when we see more clearly a very favorable moment to have this kind of conversations with our clients. Actually, our product is ready to the migration, if you mean in terms of cloud. And so that you can see among the subscribers addition. We have a majority of those subscribers who are at -- run our solution in the cloud. So -- and here, we are talking about the same -- exactly the same solutions that maintenance payers are using today. So in terms of product, there is no big issue to be addressed.

Of course, part of our research and development investment is related to some technical elements that we can improve in order to be more and more efficient in some public clouds because our software was originally designed to run on premises. And more recently we've been able to get very good performance in our own infrastructure.

Today, we are working hard in order to have a similar performance or even better in some public clouds like Amazon, in AWS or Azure from Microsoft, and more recently we were talking to Google cloud as well. So I wouldn't associate directly that low-level migration to a product reason. It's more a matter of our confidence about the moment of the market to address that conversation with our clients. We don't want to end up that conversation having some discussions about the maintenance -- the current maintenance contracts or even not having a relevant number of clients migrating to subscription. So...

[Operator]

[Operator Instructions] This concludes today's question-and-answer session. I would like to invite Mr. Maia to proceed with his closing statements. Please go ahead, sir.

[Gilsomar Sebastião, executive]

So I'd like to thank you, everyone, again for participating in our conference call today. And I wish everyone have a good day. Thank you. Bye-bye.

[Operator]

That does conclude the TOTVS audio conference for today. Thank you very much for your participation. Have a good day, and thank you for using Chorus Call.