Totvs SA

BOVESPA:TOTS3

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, and welcome to the TOTVS conference call to discuss the results of the fourth quarter and full year 2017. Today, we have with us Laércio Cosentino, CEO; Gilsomar Maia, CFO; and Sérgio Serio, Investor Relations Manager. [Operator Instructions] The audio is being simultaneously webcast at ir.totvs.com.

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 beliefs and assumptions of the company's management as well as information currently available.

Forward-looking statements are not guarantee of future performance. They involve risks, uncertainties and assumptions, as they refer to the 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. As usual, we'll begin the presentation by commenting on key recent events on Slide 3. The first was TOTVS presence once again as the only Brazilian tech company in the global ranking published annually by the consulting firm, Strategy&, which ranks the 1,000 public companies that most invest in research and development. This is further evidence of the importance of innovation for TOTVS as a driver of its own transformation and also to bring to client solutions that simplify the business world.

The second event was TOTVS Day, Investor Day held at the beginning of last December at the new headquarters of TOTVS, where presentations were made on the latest developments in the digital journey and transition to subscription strategies. Also, the over 60 analysts present in the event had the opportunity to visit the new facility and had demonstration of some of the solutions for the Education and Manufacturing segments as well as Carol, our artificial intelligence platform.

The third event was the Board of Directors' decision in December regarding the distribution of interest on capital for the second half of 2017 in the amount of BRL 17.4 million.

Now I'll begin my comments on the results on Slide 4. In 2017, net revenue grew 2% while recurring revenue grew 8.7%, corresponding to 67.5% of net revenue in the quarter and 65.8% in the year, which is 4 percentage points higher than in 2016.

As shown on Slide 5, this revenue growth is mainly driven by software revenue, which grew 6.2% in the year and 5.6% in the fourth quarter. Software revenue in turn was driven by 34% growth in subscription revenue, shown on Slide 6, which accounted for 20.7% of software revenue in 2017 and 23.2% in Q4 '17. The growth of 9.5% in subscription revenue in comparison with the third quarter represented the highest growth rate in this line in a quarter since the beginning of the transition to subscription 2 years ago when TOTVS Intera was launched. This transition brought challenges related to the reduction in license revenues and its diverse effect on maintenance revenues, which were worsened by the economic recession in Brazil.

On the other hand, subscription sales accelerated and software revenue already returned to the growth trend during 2017, as shown on the chart on the left side in Slide 7. However, we don't consider revenue as the best metric to measure the performance of subscription sales in the quarters. The first monthly fee billing of TOTVS Intera is made in the following month after the sale. Thus, revenue in the quarter is positively affected by 2 monthly fees from subscription sales closed in the first month of the quarter by 1 monthly fee from sales closed in the second month while sales in the third month contribute only to the revenue of the subsequent quarter.

We believe that the annual recurring revenue, ARR, shown on the chart on the right maintains comparability between the periods by analyzing all the subscriptions sold. Note that as ARR accelerates, subscription revenue accelerate in subsequent periods. ARR from subscription totaled BRL 368 million in Q4 '17. This amount is 19.5% higher than the subscription revenue of BRL 309 million in 2017, which represents revenue growth in 2018 resulting from sales made throughout 2017.

Now I turn the presentation to Sérgio Serio, which will comment on software result on Slide 8. Sérgio took over the position of Investor Relations Manager early this year. He's in TOTVS since 2006 and has led the area of institutional relations in the past 3 years. Please, Sérgio, proceed the presentation.

[Sérgio Serio, executive]

Thanks, Maia, and good morning, everyone. The decrease of 40 basis points in adjusted contribution margin of 2017 result mainly from the increase in research and development expenses above the adjustment level of recurring software contracts. This cost increase is essentially related to wage adjustments resulting from collective bargaining agreements in the period and additional investments in innovation, especially those related to specialization of business solutions, open platforms and the micro enterprise segment.

In the quarter, the increase in adjusted contribution margin from software chiefly reflects the growth in subscription revenue and the reduction in costs due to the layoffs in the quarter.

Turning now to services on Slide 9. The adjusted contribution margin decreased in 2017 mainly due to the 3% drop in revenue from implementation services and by the 11% decline in revenue from consulting services. These decreases were mainly due to the lower pace of sales and consequently lower locations of professional, especially in the first half of 2017. In the quarter-on-quarter comparison, the decreases in services revenue and adjusted contribution margin were essentially due to the fewer business days. In the year-on-year comparison, the adjusted contribution margin from services in the fourth quarter increased mainly due to the restructuring, which resulted in a negative impact of BRL 3.9 million from layoffs.

Moving now to hardware in Slide 10. The decline in adjusted contribution margin from hardware in 2017 and in the fourth quarter was mainly due to the decline in sales of fiscal printer, whose gross margin is higher, and to the drop in revenue from economic subsidy, especially in the third quarter due to inventory levels. Revenue from sales of other solutions grew 2.3% in the year, mainly driven by the growth in revenue from Bemacash sales. In 2017, more than 6,500 Bemacash units were sold compared to almost 2,800 units in 2016.

To discuss about selling and administrative expenses, please go to Slide 11. The year-on-year increase in selling expenses and commission as a percentage of net revenue essentially reflects the growth in software sales in the subscription model. As subscription revenue expands its recurring base and as new sales reduce its share in the base, selling expense will get diluted.

In the year, the increase in general and administrative expenses plus management fees and other expenses as a percentage of net revenue was mainly due to wage adjustments resulting from collective bargaining agreements, which were higher than inflation adjustments obtained on recurring revenues and additional expenses with the merge of PC Sistemas and Virtual Age and the administrative integrations of Bematech, all of which contribute to the structural adjustment carry out in fourth quarter '17. The decline in comparison with the third quarter was strictly due to the structural adjustments and the effect on bonus provision related to the achievement of individual and overall targets.

With regard to allowance for doubtful accounts, the increase in recent quarters despite the gradual improvement in overall timely payment of the portfolio reflects the additional provision made on accounts of the worsening situation of some companies in difficult, such as petitions for judicial reorganization.

Now I will turn the presentation back to Maia to discuss EBITDA on Slide 12.

[Gilsomar Sebastião, executive]

Thanks, Sérgio. In 2017, the decline in adjusted EBITDA resulted from the combination of the following factors. The more than proportional increase in selling expense due to transition to the subscription model, decline in services revenue caused by the reduction in sales of projects and to the first half of the year and the lower allocation of professionals, the decline in sales of fiscal printers and lower economic subsidy on hardware, and the increase in general and administrative expense mainly due to inflation adjustment of costs and in additional expenses with the operational integration of the companies acquired in previous periods.

In the quarter, EBITDA grew 13.8% year-on-year and 11% quarter-on-quarter. The structural adjustment carried out in the fourth quarter combined with the growth in recurring revenues should adjust our structure to the SaaS reality in order to recover profitability without compromising the company's capacity to grow and innovate.

And to conclude the comments on the results on Slide 13, apart from the variation in adjusted EBITDA, as commented, the decline in adjusted net income this year is mainly related to the increase in depreciation resulting from investments made, especially in the second half of 2016. In the quarter, the tax on financial income calculated on the investment of proceeds from the issue of debentures in the third quarter and the inflation adjustment of provision for contingencies are reflected in the financial results. The variation in income tax and social contribution is essentially linked to the reduction in the interest on capital during the period.

Now I'll move to Slide 14 for the comments on cash flow and debt. Despite the decline in net income, as commented in previous slides, operating cash flow grew 26% in the year and 34% over Q4 '16, mainly due to the 92% reduction in working capital requirements. This growth in operating cash flow combined with the 49% reduction in CapEx in 2017 resulted in the 57% increase in free cash flow. As a result of this cash flow generation, net debt declined 33% in 2017, corresponding to 1.1x adjusted EBITDA in the year.

I now turn the presentation to Laércio for his closing remarks on Slide 15.

[Laércio de Lucena Cosentino, executive]

Thanks, Maia. Good morning, everyone. Based on all that was presented in this conference call, we can affirm that the year of 2017 marks the return of growth of software. We registered 6% organic growth in software. Subscription revenue grew 34% annualized. For the quarter, subscription exceed the subscription revenue in 2017 by 19.5%. The challenge relates to the beginning of transition to subscription [ some to the ] remain effects for the economic recession in Brazil prevents us for achieving our EBITDA and net income targets in 2017. We made adjustment to the cost structure to align it better with the growth in recurring revenue but without compromising the company's capacity for growth, profitability and innovation. Despite these challenges, the continued financial discipline enabled us to increase the operation cash flow and consequentially reducing net debt.

The year was also marked by significant advance in 2 pillars of TOTVS digital journey, among which I highlight the following. In culture and environment, the inauguration of the company's new headquarter in São Paulo technological campus, especially designed for TOTVS and inspired by the most moderate working environment for the technology companies around the world.

In process and service, the use of agile development and project management methodologies. In offering and portfolio, the launch of our artificial intelligence platform, Carol, and inauguration of iDEXO, an institute whose mission is to connect startups, entrepreneurs and developers to pursue the new business solutions. In 2018, TOTVS remain focus on the success of its clients with the mission of simplifying the business world, support our clients in the digital journey, offering the best business solution for companies of all size and segments.

Now we are available for the question-and-answer section.

[Operator]

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

[Andre Baggio, analyst]

So can you talk a little bit about the development of new features, new software that's you have in the pipeline? So for example, how is it going, the Carol, the artificial intelligence, and there may be other initiatives you will be taking.

[Gilsomar Sebastião, executive]

Baggio, thanks for the question. In terms of new solutions and features, based on our announcements in previous quarters, I will highlight first, Carol, artificial intelligence Platform. So when we have our Investor Day here at TOTVS, we had opportunity to show you guys some of the usages we are seeing for this kind of technology. That's somehow a kind of agnostic technology that can complement all of our solutions we have in our portfolio. And actually, it can work together with solutions provided by our competitors, too. So in case of Carol, we can also use it as one element to convince clients to move to cloud. And besides Carol, I should highlight the solution we have today in cloud. We have developed kind of a platform that manages the infrastructure of cloud. It's not a solution itself to clients, but it's more a feature as you ask me. So actually, that platform gives us the flexibility to offer more than one single option to a client in terms of the rest of our portfolio. I would also highlight solutions related to mobile application. And more recently, we have launched mobile apps to our research and -- human research solutions here and basically using services of our more traditional solutions for HR but giving more flexibility to the end user to get the information on their hands. I don't know, Laércio, if you want to highlight any other development we have.

[Laércio de Lucena Cosentino, executive]

Baggio, Laércio speaking. And we can complement this list with Fluig, the new version of Fluig. We believe so much that we need to develop platform that can -- that can be -- can use in different system. We did that in the [ person share ]. And the new technology at TOTVS we develop right now is basing platform that you can connect a different software and you can join and make the convergence of software. This is the one of the fact that's very important. We work so much that many of our customers have so many solutions that can be use Fluig, Carol or cloud platform of TOTVS, okay, and our apps in the top of the old solutions.

[Andre Baggio, analyst]

Okay. And an unrelated question. Can you discuss a little bit about the competitive environment, like say, do you think that your market share among your clients has been maintained more or less similar, like say, you don't see any new competitive pressures?

[Gilsomar Sebastião, executive]

Actually, Baggio, one thing that has changed in our market is in terms of who is the owner of the client in the past. In our view, it's not applicable anymore, this kind of view. So today, we see more and more companies using more than one technology provider. And in this sense, part of my answer could say, yes, we see more competitors surrounding our clients. But on the other hand, we have more opportunity to explore with our clients and the clients of our competitors, too. One example, some clients that are now using our classical solutions like ERPs and vertical solutions and they use Fluig on top of it. And Carol is going the same way. So it's one -- some of good examples we can give that's more in line with this new way to consume technology. So I hope I have been clear, but actually, yes, we see more names coming to the market, and -- but on the other hand, the market is more flexible to consume more than one solution together.

[Operator]

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

[Laércio de Lucena Cosentino, executive]

Thank you for participating in this conference call, and have a nice day, and have a nice year, too. Thank you.

[Operator]

That does conclude TOTVS audio conference for today. Thank you very much for your participation. Have a good day.