Arco Platform Limited
Q4 2020 Earnings Call Transcript

Published: 31 Mar 2021

[Operator:]

Good afternoon, everyone. Thank you for standing by and welcome to Arco Platform Fourth Quarter 2020 Earnings Call. This event is being recorded and all participants will be in a listen-only mode during the company's presentation. After Arco remarks, there will be a question-and-answer session. At that time, further instructions will be given. This event is also being broadcast live via webcast and may be accessed through Arco's website at investor.arcoplatform.com where the presentation is also available. Now, I'll turn the conference over to Carina Carreira, Arco's IR Director. Carina you may begin your presentation.

[Carina Carreira:]

Thank you. I'm pleased to welcome you to Arco's fourth quarter and full year 2020 conference call. With me on the call today, we have Arco's CEO, Ari de Sa Cavalcante and Arco's COO, Pedro Guerra. During today's presentation, our executives will make forward-looking statements. Forward-looking statements generally relate to future events or future financial or operating performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from those contemplated by these forward-looking statements. Forward-looking statements in this presentation include, but are not limited to, statements related to our business and financial performance, expectations and guidance for future periods, our expectations regarding strategic product initiatives and their related benefit and expectations regarding the market. These risks include those set forth in the documents that we issued earlier today as well as those more fully described in our filings with the Securities and Exchange Commission. The forward-looking statements in this presentation are based on the information available to us as of the date hereof. You should not rely on them as predictions of the future events and we disclaim any obligation to update any forward-looking statements except as required by law. In addition, management may reference non-IFRS financial measures on this call. The non-IFRS financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with IFRS. We have provided a reconciliation of these non-IFRS financial measures to the most directly comparable IFRS financial measure in our press release. Please note that except from revenue gross margins, selling expense, G&A and cash flow from operations, all other financial measures we discuss here are non-IFRS and growth rates are compared to the prior year comparable period unless otherwise stated. We also note that year-over-year comparisons are affected by acquisitions that were not included in our 2019 financials. Let me now turn the call over to Pedro Guerra, Arco's COO.

[Pedro Guerra:]

Thank you, Carina, and thanks, everyone for joining today's conference call. We hope that you and your family are all healthy and safe. We'd like to discuss four topics today as shown in slide 3. First, our financial results for the quarter and for the 2020 fiscal year. Despite the challenging scenario, we delivered solid revenues of R$1 billion and an adjusted EBITDA margin of 38% above the guidance provided for the fiscal year.

[Ari de Sa Cavalcante:]

Thank you, Pedro, and good evening, everyone. Thank you for your time, and I also hope that you and your relatives are all safe and healthy. Moving now to slide 7 to start discussing the recent evolutions of our latest acquisitions. First, the acquisition of COC and Dom Bosco two of the main core learning systems in Brazil that have built solid and nationally known brands over their 50-plus years of history. We see clear value creation opportunities arising from the transaction. It reinforces our leadership position in Core solutions for the private K-12 segment by complementing our portfolio with brands that have different price positioning, geographical footprint, and pedagogical approaches, allowing our platform to better serve the overall market. We believe that by implementing Arco's expertise in high-quality content, relevant technology, reliable customer service and effective distribution, we will positively impact students' learning experience, strengthen our relationship with partner schools and deliver attractive growth. And we believe that by adding COC and Dom Bosco to Arco's platform, we can leverage their strong relationship with partner schools to capture current and future cross-sell opportunities. We already have an integration team in place to define strategies related to brand, product, go-to-market and people, so when we closed the acquisition, expected for the second half of the year, we are ready to apply Arco's winning factors and start unlocking value. This acquisition will be paid using our current cash position. According to our initial assessments, we expect the amortization of intangible assets and goodwill to generate a tax benefit with net price value of R$214 million, a relevant value creation lever. Moving now to Slide 8. Arco's pro forma business profile for 2021. The acquisition of COC and Dom Bosco results in a company that will serve almost 2 million students in 6,900 partner schools with an ACV of R$1.3 billion. The scale allow us to increase investments to enforce our winning factors linked to long-term value creation, attract the best talent and offer a phenomenal venue to distribute additional solutions in line with our vision to become a one-stop shop to K-12 schools. Moving now to Slide 9 to discuss another recently announced acquisition. The acquisition of Me Salva!, allows Arco to enter the exciting test prep and tutoring Supplemental vertical, a fragmented and still mostly off-line R$5 billion market with a high-growth, high-quality company.

[Operator:]

Thank you. The floor is now open for questions. Our first question comes from Vinicius Ribeiro with UBS.

[Vinicius Ribeiro:]

Hi guys. Good afternoon. Hope everyone is fine and thanks for taking our question. The first just on the last comments. Just like if you guys could try to help us reconcile your indebtedness level after the Pearson assets payments by the end of 2021 with your M&A pipeline, should we expect considerably lower -- smaller targets or should we see no more stock-based operations or something like that? My second question will be on the supplemental solutions. Do you guys have any specific strategy besides M&A? So, we completely understand that COVID was really, really a drag down for the sector -- for the segment as a whole. But assuming that we don't have any kind of visibility as to vaccinations by the second half of 2021, do you guys have any kind of approach or strategy to try to offset these impacts with new sales be it through some kind of commercial approach or prices or something like that? That will be the first. Thanks guys.

[Pedro Guerra:]

Hello Vinicius, Pedro here. Thank you for your questions. Regarding the M&A pipeline as Ari mentioned, we have 10 targets -- around 10 targets today in our M&A across core, supplemental, and tech companies. We do expect the M&As in the short term to be smaller. Therefore, both for our current sellers notes and other smaller M&As in the future, we will take care of the payments using our cash position and eventually debt without the need to go to the market for additional cap raises. On your second question on supplemental, first there is a component of portfolio. We still see space to continue complementing our supplemental portfolio with additional brands in the segments we already serve and enter new verticals in segments we don't yet serve, such as coding and robotics. We can do that through M&A. We can do that through in-house projects. We have pursued both in the past. And we are also going to do that through the partnership that we've entered into an agreement with Pearson to distribute specific supplemental products that complement our current offering. The year for supplemental has started strong similar to core. We are already seeing supplemental a much larger and stronger intake of new students compared to the years of 2020 and 2019. That's the reason why we believe it shares the same ingredients with core to have a strong year repressed demand from 2020 that was not executed, an improving outlook situation for COVID in Brazil which schools expect in 2022 to approach normality and stronger brands and companies from a go-to-market perspective and technology adoption. Given those factors, our base case is both for core and supplemental to have a strong organic growth.

[Vinicius Ribeiro:]

Great. Thanks for the answers.

[Operator:]

Our next question comes from Diego Aragao with Goldman Sachs.

[Diego Aragao:]

Yes. Hi. Thanks Ari, Pedro and team. Thank you for taking my question. Actually I just wanted to follow-up on this question regarding your M&A strategy. I mean now that you have acquired let's say three traditional learning systems such as Positivo, COC, and Dom Bosco, how do you see your position your business position? And what exactly are you looking to acquire in the core solutions segment? I mean almost half of your revenue in the core segment seems to come from more traditional legacy platforms that apparently are growing at a very low pace, right? So, I am wondering what type of growth first you should be able to achieve in the segment until you can really ramping up those business? And what kind of business you are looking for in the core segment? And maybe just a final question if I may. Now, that Pearson and Eleva are basically out of the core content business in Brazil, is there any other player outside of you and Vasta that we should be aware of? Thank you.

[Ari de Sa Cavalcante:]

Hello, Diego. Thanks for the question. Good to hear from you. Regarding the Core, we have engaged in M&A in the past, both from acquiring exceptional brands that we believe we could ramp up growth, but also acquiring smaller companies that we rolled up into one of our existing businesses. We expect to continue this strategy. We'll continue looking for exceptional brands and there are quite a -- there's still a few in Brazil that we love to do business with, but also pursue smaller brands that were already fragilized pre pandemic into the lower scale, smaller scale and the pandemic with the additional need for SKU to invest in technology became further fragilized. Regarding the growth for those companies, we believe that there are two categories here. Positivo being on one side. It's the market leader. It's by far the largest company in the sector. And although, we already saw an acceleration of the growth of the company in 2020, it is our expectation that we'll have somewhat lower growth rate compared to SAS and SAE has had in the past given the size of the company. However, for smaller brands such as COC and Geekie we see a lot of potential for those companies to continue growing at attractive rates comparable to that those of COC -- of SAS and SAE in the past few years. Regarding the second question, could you please repeat the second question Diego, if you don't mind?

[Diego Aragao:]

Yeah. I guess look the second question was more related to the competitive landscape. I'm just curious to hear from you now that both Pearson and Eleva they basically sold their content business right for K-12 in Brazil. Is there any other player outside of you and Vasta that we should be aware of?

[Pedro Guerra:]

Perfect. In our estimate in the Core segment, Vasta and Arco have around 30% of the students in the K-12 private sector in Brazil. So there is around 70% of the market that is comprised of weaker -- smaller learning systems and textbooks. In the learning system space there's still quite a few regional or even brands that belong to international groups. We have brands from Santillana. We have regional brands such as Poliedro, Bernoulli, , Etapa. And it continues to be quite a fragmented market that offers opportunities in M&A both from exceptional brand standpoint that we believe could grow at a faster pace within Arco, but also smaller brands that we believe we could roll out into one of our brands.

[Diego Aragao:]

That make sense. Thank you, Pedro.

[Operator:]

Our next question comes from Javier Martinez with Morgan Stanley.

[Javier Martinez:]

Hi, thank you Ari, Pedro. I would like to ask three questions, if I may. The first one is on the bookings. I wanted to double check is the guidance you're bringing on the table is not corrected by the fact that many private schools may be losing students to the public schools this year. And maybe it's corrected. And if not, if you have some visibility on what may be that figure? That will be the first one. Maybe if you want to go one by one?

[Pedro Guerra:]

Sure, Javier. I can start here with this one. So regarding bookings, we have R$96 million around 10 percentage points of lost revenue due to COVID. They were not considering to be recovered in the 2021 guidance of R$1.163 billion. We expect that is our base case scenario. We expect these almost R$100 million of revenue to be recovered in upcoming cycles as the dropout is recovered by the private sector schools. We don't see in the moment schools in the private sector losing students to schools in the public sector. If you take the number for São Paulo for example, the increase has been absolutely immaterial. What we're seeing is mostly parents taking their young kids out of school because they don't benefit as much from technology as the older kids. So we expect those kids to return to school once the COVID situation improves.

[Javier Martinez:]

So this booking that you mentioned today 21% growth is already taking into consideration those students that probably are not going to be there at least in the first half of the year or maybe in 2021?

[Pedro Guerra:]

You're correct. That considers our base case of those students not returning to school in 2021. So we might have some upside, if for example vaccination happens at a faster pace than this base case of ours.

[Javier Martinez:]

Fantastic. And now the -- so with that in mind so bookings growing 21%. It's a good figure. And I would expect to see some operating leverage in the companies and you deliver already 38% EBITDA margin -- adjusted EBITDA margin in 2020. So why did the guidance below the margins of this year? So the guidance is 35.5% to 37.5%, shouldn't we expect some operating leverage? And yes, because you are growing top line margins expanding a little bit this year?

[Pedro Guerra:]

Perfect. Javier, you're right. We have strong operational leverage. As we grow, we generate more income that we have traditionally chosen to reinvest into our business. We continue to see very strong ROI from investing in sales and marketing and from increasing the quality of our solutions. From a sales and marketing perspective, our team yet doesn't touch on most of the schools every year in the country. So we take quite a few years to talk to every school in the country. We expect to continue increasing our capability to supply those schools with our solutions, and this will require additional investments. On the content and solution side, we continue to see a lot of space to deliver additional technology features to our clients, and they tend to reward us with higher retention rates, better price increases, upselling and new school intake, that comes from stronger solutions. So, our guidance considers this factor that we'll reinvest most of our operational leverage into those factors of the business and keep the margins in line with best margins. It's important to note that 2020 was a special year, where most of our sales team didn't travel for most part of the year. Schools were closed for six months and our sales team wasn't able to travel, traveling being a large cost component for our company. As the COVID situation improves in Brazil, we expect to resume traveling. We expect to resume in-person visits, and that we tend to increase our costs. So those are the factors that we believe will drive margins to 35.5% to 37.5% for the 2021 fiscal year.

[Javier Martinez:]

Just to be sure about that. So thank you very much. I was wondering if maybe pricing dynamics may yes or not be changing, a, because of COVID but also because with the acquisitions you did in the last few years, obviously now you are covering a broader market. And obviously SAS maybe more defensive, but you have also other brands that are covering a market that maybe more focused on prices. I wonder if the price dynamics have changed or continue to be the same that we had in the past where price is not a key factor in terms of sales.

[Pedro Guerra:]

Javier, from our perspective, prices continue not to be a main decision criteria for schools. Schools decide based on brand, based on the quality of the solutions, based on the trust they have on our commercial teams. And that is especially true in a situation where learning systems represent only a fraction of the expenditures of the parents in indication and where schools are effectively distributors of our solutions. So, they tend to like better solutions that have stronger brands, because it's easier to resell to parents. If you take a look in 2020, we had price increases, even considering Positivo that is still in its initial years of the turnaround. We already had price increases that were above those of 2019. So even in a very challenging year where schools were facing difficulties, we are able to increase our prices at healthy levels. And that comes on the back, not only on the first factors that I mentioned, but also because our price increases are usually related to more value created to schools, either improving the learning processes that helps schools attract more students or reducing costs in schools therefore offsetting the price increases.

[Javier Martinez:]

Very clear. So if I may ask a final one on retention rates and NPS, I'm not sure if maybe the way or the semantic, because the way we are talking about those metrics may have changed or maybe it's because of mix, the new brands that may have impacted the calculation or the absolute figure. But if I remember well, during the IPO times in retention rates, we were talking about 95%, 97% and NPS of 86% to 90%, and now we are talking about 92% and 83%. So, still high figures. So it's still good retention and good NPS, but below the historical levels. And I was wondering if this is true, or maybe it's just a difference because of mix or maybe because of COVID, if something has changed over there?

[Pedro Guerra:]

Perfect. Javier, your perception is correct. There is a mix factor, but there is also COVID factor. On the mix front, the most discrepancy comes from Positivo brands. Positivo had a strong evolution in retention and in customer satisfaction, but their brands still lag those Arco legacy brands in those two metrics. We expect to close this gap over the next two to three years. Regarding the COVID impact, what we saw was a somewhat lower retention, not on Core that had generally higher record retention levels but on Supplemental. It is a tougher year for Supplemental, and that also resulted in a bit lower retention rates for the Supplemental Solutions.

[Javier Martinez:]

Thank you very much, Pedro. It’s very clear. Thank you.

[Operator:]

Thank you. This concludes the Q&A session. As there are no further questions, Arco's conference call is concluded for today. Thank you very much for your participation, and have a nice evening.