Arco Platform Limited
Q4 2018 Earnings Call Transcript

Published: 20 Mar 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to the Arco Platform Ltd Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference maybe recorded. I would now like to turn the call over to Vitor, of IR Director. You may begin.

[Vitor Hiraiwa:]

Thank you. I am pleased to welcome you to Arco’s fourth quarter and full-year 2018 conference call. With me on the call today is, Arco’s CEO, Ari de Sá Cavalcante Neto; and CFO David Peixoto dos Santos. 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 risk, uncertainties and other factors that may cause our actual results to defer materially from those contemplated by these forward statements. Forward looking statements in this presentation includes, but are not limited to statement related to our business and financial performance, expectations and guidance for future periods or expectations regarding our strategic product initiatives, and the related benefits and our expectations regarding the market. These risks include those set-forth in the press release 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 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 the isolation or as a substitute for results prepared in accordance with IFRS. We have provided a reconciliation of this non-IFRS financial measures to the most directly comparable IFRS financial measure in our press release. Let me now turn the call over to Ari de Sá Cavalcante Neto, Arco’s CEO.

[Ari de Sá Cavalcante Neto:]

Thanks, Vitor, and thanks everyone for joining Arco’s fourth quarter and full-year 2018 conference call. A year ago, we set highly ambition goals for 2018. We wanted to improve the quality of our solutions and increase our customer satisfaction while expanding our network of schools. We’re pleased with what we accomplished and was a direct result of the hard work of our talented people and strong culture. We believe this is the only way to succeeding there long-term. Before discussing our results, let me quickly provide a quick back ground on Arco for everyone new to our story. Arco delivers high quality education upscale through a one-stop shop platform to private K-12 schools. We operate with long-term contracts under a subscription model that drives recurring and predictable revenues in Brazil over 8 million students in 40,000 private K-12 schools. Education is a top priority for families and there is no government funding for private schools. These two dynamics create a huge market opportunity for us. Our unique B2B2C model engage and connects all stakeholders in the education ecosystem ranging from students to teachers, administrators, and parents. Over time, we’ve developed strong and trusted brands that were built by the academic results at ongoing sectors of our partner schools and we are the only pureplay in the industry, 100% focused on solutions to private K-12 schools. Now, on to our results. Fourth quarter 2018 net revenue was R$121 million. Adjusted EBITDA was 46 million. For the full-year 2018, net revenue was 381 million, and adjusted EBITDA was 142 million, both up 56% from 2017. Our fourth quarter and full-year 2018 performance was marked by several milestones. To begin, we increased our 2019 Annual Contract Value or ACV to R$441 million, a 37% increase from the prior year. At the end of 2018, we had nearly 500,000 students in our platform. Our retention rate was 95%, which demonstrate the high level of satisfaction of our partner schools. Next, because of the high level of efficiency and dedication of our in-house content producing team, we were able to develop new content to the national curriculum guidelines staying ahead of competition. This represents our relentless commitment to quality. Finally, in 2018, we continue to invest in our sales capacity as part of our ongoing strategy to growth. We evolved the recruiting process for the sales team. Specifically, we enhanced the training and implemented a rigorous exam and sales simulation so they can be better prepared for their jobs. In Q4 2018, we started a hiring process to add more hunters to target more schools for the 2019 sales cycle. We have now increased our sales force to 115 hunters in early 2019, up from 85 in the end of 2018. Also, we established higher incentives to encourage greater cross-selling of our core and supplemental solutions. The current overlap between our core supplemental students is close to 4%, an improvement from 2% overlap in 2018. We view our cross-sell strategy as a long-term opportunity and while our return on sales investments is very positive, we believe there is still room for improvement and intent to keeping vesting to promote growth through an efficient mix of adding new partner schools, upselling our existing clients, maintaining high retention, and price increases. Our largest sales forces is still not enough to cover our addressable market in one sales cycle. So, it is still beneficial to keep increasing the size of our sales team. On the M&A side, we are still focused on three main areas, core, supplemental, and technology. In terms of our core solutions strategy let me share a bit about what M&A could entail. We could acquire a small regional content provider and supply Arco solution to that player as we’ve done previously. These are high accretive acquisitions that help increase our footprint in specific regions. We also could acquire a medium-to- large content provider with a sticky customer base and good brand reputation. We will enhance its product by improving its pedagogical quality and deploying our technology. We did this in 2016 with our acquisition of the [indiscernible] brand. After the acquisition, we substantially improved the operations, increasing retention, and implementing a new online platform with more video classes, assessments, and adaptive learning for students. In the supplemental strategy, we see many targets with excellent products and high demand from the student’s parents. It’s an impacted market and as we grow our student base, our platform could boost these initiatives, increasing the average ticket in our partner schools base. When we acquired our English solution, we increased our Supplemental student base from 6,000 students in 2016 to almost 85,000 students in 2019. This is a strong demonstration of our capacity to add new products to our platform and scale them. In the technology strategy, we are looking for relevant features that we could plug in to our platform. These features should enhance our solution into a more comprehensive platform. We are optimistic about prospect in all the three areas. We are very pleased with the strong results we delivered in 2018. It was a reflection of our commitment in delivering the best one-stop-shop platform to our partner schools with high-quality content, personalized services, and the relevant technology. While Arco achieved several milestones in 2018, we recognized it’s just the beginning. There is a long road ahead and 2019 comes with a new opportunity to impact the lives of 1000 students get their feedback from our clients to improve our platform, strengthen our relationship with our current partner, and attract new ones. We are here for the long-run. With that, I’ll turn to David, so we can discuss the financials.

[David Peixoto dos Santos:]

Thank you, Ari. Before we dig into the numbers, pleased note that except for revenues, gross margin, selling expenses, G&A, and cash flow from operations, all financial matters I discuss are non-IFRS and growth rates are compared to the prior year comparable period unless otherwise stated. Overall, our 2018 results show how consistent our business is. Our results were in-line or above our expectations, which reflect our ability to execute our strategy. I will review our fourth quarter and full-year 2018 results and provide our guidance for 2019 year, but first as a reminder, we strongly advise our investors to analyze our business on a yearly basis. The ACV is the main driver of our growth, since it reflects our revenue from the first quarter of the year to the third quarter of the total year. For those who are not familiar with them – with the term, ACV is the contractual revenue we expect to recognize from past partner school in each school year based on the number of enrolled students in the terms of our contracts with each partner school. We recognize revenue once our content is made available to our partner schools. And we typically deliver our core solution content four times a year in December, March, June and August. And we strictly deliver our supplemental solutions twice a year in December and June. The amount of revenue recognized is proportionate to the amount of content made available, linked to our clients' consumption, which is not linearly distributed among the quarters. Thus, you can expect revenue fluctuation between quarters, but in the end, you sum up very close to ACV. So now, let’s take a look at the numbers. 2018 ACV is BRL441 million, an increase of 37% versus 2018 ACV. ACV growth is a mix of our ability to repay our clients, price increase, upsell our solutions and also attracting new partner schools. We retained 95% of our customer base. We adjusted prices on leverage by 8%, which is over 4% above inflation, and the 2018 sale season was the highest intake of additional students in our core history, representing RBL111 million ACV. New clients accounts for nearly 7% of this amount and the upsell for the remaining 30%. Net revenue for the fourth quarter of 2018 was RBL121 million, up 73% from RBL7 million in the fourth quarter of 2017. We recognized 27% of the ACV in the fourth quarter of the last year, against 21% in the fourth quarter of 2017, due to the increased content consumption from our clients mainly driven by the international school growth. The gross margin was 80.2% for the fourth quarter versus 74.1% for the same period in 2017. For 2018 full-year gross margin was 78.8 versus 76.1% in 2017. The gross margin increase was positively impacted by three factors

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Diego Aragao of Goldman Sachs. Your line is now open for stock

[Diego Aragao:]

Hi. Thank you, Ari, David, and team for the call. My question is on your top line growth, can you comment about your strategy to keep a solid growth base in the coming years. I mean where do you think your growth should come from in the short-term upselling, cross-selling or from new partner schools, and also if you would – if you would consider your portfolio of products, how each one of them should behave in terms of growth in 2019? Thank you.

[Ari de Sá Cavalcante Neto:]

Thank you, Diego for your question. The growth in the top line is mainly because we could achieve at a very high retention rate and of course because of the level of satisfaction of our customers, we could also upsell to different rates to these customers. Of course, there is a very important piece of adding new schools to platform. So, from the top line growth, 70% came from students from new and 30% came from students from existing schools. In the following years, we really want to invest more in the salesforce. Right now, we don't have enough team to cover all the addressable market, and we are constantly adding new people. We added 30 people, 30 hunters to go to the market and attract new schools. And also, there is a very interesting opportunity in supplemental business, so as you can see, I believe we have shown that international school is growing a lot. It went from 42,000 students to 85,000 students and we are very, very focused on adding new schools and new students. And there is a great untapped opportunity to cross-sell, which is supposedly easier to do than sell international schools to new schools. So, I'd say that it's a piece of sales force investment, of course, adding new schools to core solutions as we did last year, but also an opportunity to grow the Supplemental also to new schools and cross-selling to our existing customer base.

[Diego Aragao:]

That's very helpful. And my second question, if I may. It's – sorry, if I missed some of your comments on the opening remark. But can just help us to understand the high financial cost booked in the quarter? Did you buy some minorities during the quarter? And also, if you can just quickly comment about the prospects for M&A in 2019, that will be very helpful. Thank you.

[Ari de Sá Cavalcante Neto:]

Thank you, Diego, for your question. Could you just repeat the first sentence – the first question?

[Diego Aragao:]

Yes. I just want to understand your financial results in 2018, especially the one booked in the fourth quarter, if and whether these reflect some acquisition or the acquisitions to minorities?

[Ari de Sá Cavalcante Neto:]

Okay. So, when you look to the financial expenses, you can see that they were negatively impacted in this quarter, and that's mainly because yearly, we have to reevaluate the selling payment that we have to report in the international school acquisition. So, since the business plan of the international school was updated with the historical numbers and since this company is growing very, very fast, the projected numbers had to be reassessed and we do this yearly. So, with the new projections, you have new payment – new number of payments – a new payment that you have to do to the selling shareholders and then you have to adjust this number, and as a consequence, you can see the impact in the financial results. So, it's a non-cash impact mainly related for the international school reassessment that due to the company has outperformed the projections that we have before.

[Diego Aragao:]

Okay, perfect. And the prospects for M&A?

[Ari de Sá Cavalcante Neto:]

Yes. So, we are still focused on those three main areas of M&A, the Core solutions, the Supplemental ones and the technology one. We are actively working on the three types and we are optimistic on the deal flow for all the three types, so the strategy is the same, and we're working hard in order to pursue these acquisitions.

[Diego Aragao:]

Perfect. Thank you. Congratulations on the result.

[Ari de Sá Cavalcante Neto:]

Thank you, Diego.

[David Peixoto dos Santos:]

Thank you, Diego.

[Operator:]

Thank you. And our next question comes from Maria Azevedo of UBS. Your line is now open.

[Maria Azevedo:]

Hi, guys, thank you for the call, and congratulations on the strong execution. Two questions from my side. The first one is, if you can comment on penetration and growth prospects, if we're seeing that with an improvement of the macro environment, you expect more private schools and more demand for learning systems? And if you think that you have a multi-brand strategy, if you think there is more demand right now for your more low-end product or for the high-end product? And if you're seeing some penetration issues in key market? And whether your growth strategy for 2019 and beyond is going to be geographically more specific in one region or another? And then the second question would be on your supplemental services. Again, in the line that you mentioned on the M&A, what do you think are the opportunities there in terms of products and offers that you can think would enhance your product? And do you expect to continue to have this very strong growth in this area for the coming quarters? Thank you.

[Ari de Sá Cavalcante Neto:]

Thank you for your question. So, we have a very resilient business that does not go together with the macro environment. We have been growing a lot despite the severe crisis that the country went through. So, we don't feel the economic depression a lot. So, I would say that we have pretty much prospects that are very similar in all the brands that we have. Of course, you can expect in the future that if you have an economic growth, some students from public schools would go to private schools, probably the lower level of private schools, and the students can upgrade into private schools, trying to move to more expensive and higher-quality private schools. So, the growth is not addressed in any specific region or any specific brand. As you asked before, we have – all our brands are growing a lot. We have execution that is being done more efficiently in the sales force perspective and the product that we are delivering to our client and the level of satisfaction. So, all of that contributes to renew our contracts to up-sell and to attract new customers to the schools. And I'll hand to David so that he can answer your question on the Supplemental side opportunities.

[David Peixoto dos Santos:]

Yes. So, thank you, again. Yes, I think that the international school case show how powerful it is, this idea to be a platform, and we are very optimistic with all the opportunities that we can see in the Supplemental side. So, if I could, I mean, show and talk a little bit more with you about your strategy, so today, we are focused on mainly to attract more clients and increase the customer base. And that's why we are so committed between that and sales force and increase the team. And – because we've seen that as soon as we get a client, the clients, they love our products, and not only they stay with us for a long, long time, but they are also willing to consume our products and services such as new educational products like 21st century skills, coding, social and emotional skills, and other content products that their school is looking for like the international school K1. Also, you have additional services to school and parents' tutoring programs. So, we believe that there's like a whole ecosystem that we can explore surrounding the school. And as soon as we have this channel among students, teachers, school owners and parents and they see us as trusted providers, we believe that we can leverage on this relationship, and with the win that we have, to really extract more value from this chain. So that's – we're very excited because we believe that's very powerful in the international school case only to improve this.

[Maria Azevedo:]

Perfect. Thank you very much, Ari, and David.

[Ari de Sá Cavalcante Neto:]

Thank you.

[David Peixoto dos Santos:]

Thank you.

[Operator:]

Thank you. And our next question comes from Roberto Otero of Bank of America Merrill Lynch. Your line is now open.

[Roberto Otero:]

Hey, guys, congratulations for the results and thank you for taking my questions. I have two. The first one is regarding the update on the ACV bookings. You now see a growth of 37% from our previous expectation between 30% and 32%. So, if you could comment on a high-level qualitative perspective, how was the performance of the different products? That will be quite helpful. And the second question, you mentioned an EBITDA margin range between 35.5% and 37.5%, which is, of course, a great level. But it would be helpful if you could walk us through what you consider to be the potential drivers for margins to eventually move to the low-end of this range? Am I right assume that this could be related to eventually higher outstanding expenses given a higher perceived growth to be captured in the following years? That's pretty much it. Thank you, guys.

[Ari de Sá Cavalcante Neto:]

Thank you, Otero, for your question. So, the ACV growth is mainly because of the retention rate – a very high retention rate. Of course, we were able to raise prices roughly 4 points above inflation. And of course, there's an interesting piece of up-sell, as we said before, 30% came from up-sell and 70% came from new students from new schools. So, we were able to renew most of our contracts. We were able to raise prices. We were able to up-sell and to add new customers to our platform. And all of the – the two segments that we have, Core, Supplemental, had very interesting growth. Of course, international schools seems as a business that has a smaller site, had a huge growth. It went from 42,000 students to 85,000 students. So, it’s an interesting portion of this growth. So, I think the execution of the business, the ability to attract new schools and the ability to renew our contracts because of the level of satisfaction with our solutions contribute to the ACV growth.

[Roberto Otero:]

And talking about the margin, so you see that what happened this year is that the G&A is pretty much in the same level if you take considering to revenues, excluding the stock option plan. So, what happened is, we increased the gross margin in 2 points and we reinvest all those levers that we get in selling expenses, so the margins were at the same level. We – so for next year, as we stated in the guidance, we do not expect significant changes in the margins. So, as we used to say, our margins could be higher because of our business is scalable, but it's our decision to keep reinvesting in order to keep ahead of the competition to cover all these schools in our addressable markets that we are not covering yet to invest in the products and the solutions. So, as we said and we keep saying that, we believe that the margin should be at the same level. We do not expect significant changes and we'll use this leverage that comes with scale to keep reinvesting.

[Roberto Otero:]

That’s clear. Thank you.

[Operator:]

Thank you. And our next question comes from Susana Salaru of Itau. Your line is now open.

[Susana Salaru:]

Hi, guys, thank you for taking our questions. We have two. The first one, if you could elaborate a bit more about the sales force continued investment? You mentioned that you had three new hunters. You used to have 200 in total last year. So, what would be the ideal size of your sales force? For how long do you expect to continue to be investing in the sales team? That would be our first question. Our second question is related to the CapEx. If you could provide some guidance for the CapEx that we expect for 2019? Thank you.

[Ari de Sá Cavalcante Neto:]

Thank you for your questions, Susana. So, the strategy around sales is really about very careful recruiting process of hunters, because it's very strategic that we have the best qualified people to address the schools. We believe that's a competitive advantage that we have, the quality of our sales force. We added 30 new more and we are trying to accelerate as we improve our execution on attracting these people. That's because it's really, really profitable to add new salespeople. As we've discussed before, we don't have the ability to address all the market. We spend – with the current team in 2018, we would spend four years to visit each target school. So, we want to keep increasing the number of salespeople, and the reason we didn't go from 85 to four times that is just because we are very careful in recruiting these people and the quality of the sales force team. So, we want to keep investing as long as we believe that it's profitable to add new salespeople, so that they can bring new customers, new schools to us.

[David Peixoto dos Santos:]

So, talking about the CapEx, we – if you consider like the current – the regular operation, we should expect 5% of the revenues should be the CapEx. That's the historical numbers, that's the way that we see the business. But if you look to this number in 2018 and 2019, you see that this number should be higher than this, but mainly because of one-time project, call it, BNCC, which is a project that we renew and update, part of our content in order to be more in line with this new national guidelines. So that's something that just happened once, and so that's why we do not consider like regular in our business. And if you take the two years, we do not expect to – we expect actually to invest close to $10 million in these two years. So, if you take out this, you'll see that the CapEx should be in line with the historical numbers, which is 5% of the revenues.

[Susana Salaru:]

Great. Very clear. Thank you, guys, and congrats on the results.

[Ari de Sá Cavalcante Neto:]

Thank you.

[Operator:]

Thank you. And ladies and gentlemen, this does conclude our question-and-answer session. Thank you for participating in today's conference. This concludes today’s program. You may all disconnect. Everyone, have a great day.