Arco Platform Limited
Q2 2019 Earnings Call Transcript

Published: 28 Aug 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to the Arco Platform Q2 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, we will host a question answer session and our instructions will be given at that time. [Operator Instructions] As a reminder, this call may be recorded.It is now my pleasure to hand the conference over to Vitor, Sir, you may begin.

[Vitor Hiraiwa:]

Thank you, Brian. I am pleased to welcome you to Arco’s second quarter 2019 conference call. With me on the call today, we have Arco’s CEO, Ari de Sá Cavalcante Neto; CFO, David Peixoto dos Santos and our new SPMA and IR Director, Roberto Otero [Ph]. Roberto, I will turn the call to you for the Safe Harbor remarks.

[Unidentified Company Representative:]

Thanks, Vitor and thanks everyone for joining the call. 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 differ materially from those contemplated by these forward-looking statements.Forward looking statements in this presentation includes, but are not limited to statements related to our business and financial performance, expectations and guidance for future periods our expectations regarding our strategic product initiatives, and the related benefits and our expectations regarding the markets. 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 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 measures 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, Roberto, and thanks everyone for joining Arco’s second quarter 2019 conference call. As we approach the month of September and the first anniversary of our IPO, we find it appropriate to recap our commitments from year ago and be accountable with investors who have been supportive of our trajectory ever since.For those who have been following our story since the beginning, you might remember that we mentioned during the IPO some important goals we wanted to accomplish. The first and most important goal directly related to our mission was to continue to deliver a high quality education at scale and be recognized as the leader in terms of quality in education in Brazil.The second commitment was to continue to grow our organic business by investing in our products and strengthening our relationship with our partner schools. And lastly to continue to pursue new opportunities, launch new products and deliver successful acquisitions.In terms of quality, our solutions have proven once again to have superior outcomes. For another year, schools using our solutions are listed among the best in the country and similar to last year, we have three partner schools rank in the top 10 in Brazil National Entrance ENEM.The number of schools classified as the top 3 in their cities has increased since the IPO which currently stands at 216 partner schools. Those academic results combine with our focus in our clients continue to show us that we are on the right path to enhance the academic performance of our partner schools and as a consequence, transform their students’ lives.As we mentioned many times before, quality and brand equity in this business are crucial to succeed and this is not build overnight. It takes time to build a strong brand given the long sales and academic cycles of the K-12 industry.If you move to Slide 5, we like to remind what we consider to be the gear of our success. Our focus on the long-term and our investments in our products. We think this chart shows the reasons for our outgrowth over the years as we invest in content, quality and technology, enable our partner schools and students to achieve superior academic results.Those results combine with the work of our farmers, lead to higher brand equity, high retention rates and high net promoter scores. This has been fundamental for us to grow and gain market share, which translates into scale gates to reinvest in our products. This is our mantra. Our long-term focus is what drives us every day.Moving to M&A, let me give you a quick recap of our strategy that is on Slide 6 of our presentation. It is divided into three objectives.First, expand our network of schools. Increasing our network of partner schools gives us scale to continue to invest in our products is a key to succeeding this industry and positive – it was a unique opportunity for us to acquire an iconic brand that will add nearly 700,000 students to our platform. The higher to scale, higher capability to invest in content, technology and deliver better solutions to our customers.The second pillar is to deploy acquisitions that expand our product offering. As we mentioned in last call, we believe that the school is the cornerstone in the children’s education and should become the center of the learning experience offering both core and supplemental solutions to improve the students’ outcomes.On the supplemental segment, most of the schools don’t have the content nor the methodologies to build a pedagogical curriculum. For that reason, Arco is seizing opportunities to offer new programs as we have been doing successfully with international schools.In order to further enhance our portfolio, we invested in Nave à Vela, a competence-based supplemental solution. I will share some color on this soon. The third M&A pillar is to deliver value-added technology features to our partner schools. This strategy complements our efforts to develop in-house solutions and tech-enabled products to our clients.We are constantly monitoring the market to identify trends and great products that fit our platform and enhance the student learning experience with technology. It’s calling augment to fulfill this need and we are excited about the opportunity ahead.Now I will talk about the new acquisitions in more detail. On Slide 7, we show that Nave à Vela fits precisely into our supplemental offering. Let me share more content on our strategy and the associated opportunities. To start, students in Brazil stay in school on average five hours per day, usually during the morning, compared to 9.5 hours in China, 8.5 in France and 7.5 hours in the U.S.So, schools in Brazil are usually idle in the afternoon. This time could be used to offer other activities for students and turn the school into the center of the learning experience as a one stop shop concept for education. Also according to INEP, a research agency linked to Brazil’s Ministry of Education, there was an increase of 45% in the number of full-time students in Brazil from 2010 to 2017.There is a demand for schools to offer new activities for their students and we believe that scheme 21st century skills and language could fill the gap that Brazilian schools have.Among the supplemental solutions, we believe that teaching of new skills such as critical thinking, problem solving, creativity and innovation and communication are not only important from a pedagogical standpoint, but also essential to succeed in the 21st century society.This is part of a growing international trend focusing more on the development of competence first learning, than the traditional content knowledge-based. With the stable scenario, we decided to invest in Nave à Vela. It is one of the best competence-based learning solution with a preparatory high quality content and methodology, fully integrated with K-12 curriculum.It is adopted by top rated schools in Brazil growing significantly over the last years with zero churn. Nave à Vela has the same B2B2C model with presence in more than 50 schools and 15,000 students and represents not only a promising business unit on a standalone basis, but also a cross-sell opportunity once floats into our network of our schools.Moving now to our Escola em Movimento acquisition on Slide 8. EEM is a powerful App with more than 500,000 active students enrolled at more than 800 schools operating under a B2B2C model. It connects all the stakeholders in the school environment allowing them to communicate and interact through a digital platform.EEM has enormous value to parents by allowing them to easily follow and learn to school activities and be more present on the education life of their children.With EEM, the school can offer an App that enhance the communication with parents providing chat-based interaction, location-based identifications, NPS tool to assess parents’ satisfaction and a pilot project on payments.This acquisition brings Arco new capabilities that further increases our value proposition to partner schools, parents and students and also allows us to access EEM’s network of schools.We are very excited about the future prospects of Nave à Vela and Escola em Movimento. Despite the fact that we’ve been working on these initiatives already, more important to the contributions to the short-term results is our belief that both companies fit well on our efforts to build a sustainable differentiated business for the long-term.With that, I will turn the call to David, who will discuss the financials. David, please go ahead.

[David Peixoto dos Santos:]

Thank you, Ari. We are excited about our recent acquisitions of Positivo, Nave à Vela and Escola em Movimento. All of which increased our network of schools, supplemental solutions and features offered to our partner schools.Before we dig into the numbers, I would like to introduce for those who are new to our story, our recommendations to NOI article on a annual basis. Since our revenues are 100% subscription-based, we operate under the annual contract value or ACV metric. ACV is calculated by multiplying the number of enrolled students at each partnered school by the average ticket per student per year.As a result, we have high predictability of our revenue on a yearly basis, but revenue can vary between quarters. The amount of revenue recognized is proportional to the amount of content made available, which is not linearly distributed among the quarters and also depends on our customer decisions of when to receive the content.Also please note that except for revenues, gross margin, selling expenses, G&A and cash flow from operations all financial measures I discuss here are non-IFRS and growth rates are compared to the prior year comparable period, unless otherwise stated.Now I will go over our financial highlights, then give more details about our margins and free cash flow and finally provide a guidance for the ACV recognition for the third quarter of 2019 and EBITDA margin for 2019 fiscal year.First, review our numbers. Net revenue for the second quarter of 2019 was BRL 137.6 million, which represented 31% of the 2019 ACV versus 25% in the same quarter of the last year. The revenue recognition may vary among quarters, with no impact in the total ACV and that happens due to the product needs, logistics, and our customer decision on when to receive the content.Despite the higher revenue recognition, we’ve maintained our 2019 ACV guidance of BRL 441 million unchanged.Net revenue for the first half of 2019 was BRL 254.6 million versus BRL 195.1 million in the same period last year. Combining the last three quarters revenue, we have recognized 85% of the 2019 ACV compared to 82% of 2018 ACV.Gross margin was 81.2% for the second quarter versus 79.3% for the same period in 2018, and it’s in line with our historical trends of increasing gross margins but also reflects the higher revenue recognition in this quarter. In the first semester, our gross margin was 81.3%, up 300 BPS year-over-year.Selling expenses for the second quarter of 2019 was BRL 39.3 million, up 63% compared to BRL 24.1 million for the second quarter of 2018. The higher selling expenses reflects our investments in our sales team including hunters and farmers as an effort to offer continued support to our partner schools and expand our network of clients.G&A expenses was BRL 44.9 million compared to BRL 17 million for the second quarter of 2018 and included BRL 20.8 million of share-based compensations and BRL 4.4 million of M&A-related expenses, which we consider to be non-recurring. Adjusting for these two items, G&A would be BRL 19.7 million showing significant scale gains year-over-year.Adjusted EBITDA was BRL 61.4 million for the second quarter of 2019, up 128% year-over-year. We are on track to achieve adjusted EBITDA margin of 35.5%, achieve 37.5% in 2019.Free cash flow for the second quarter of 2019 was BRL 49.5 million increasing 28%, compared to the second quarter of 2018 and reflects a 81% adjusted EBITDA conversion. In the first semester, we generated BRL 81.7 million in free cash flow or 74% of our EBITDA.Moving now to the guidance. For the third quarter 2019, we expect to recognize around 15% of the ACV 2019 or BRL 65 million of revenues. Also, we expect our adjusted EBITDA margins full year 2019 to be in the range between 35.5% to 37.5%.And before turning the call back to Ari for the closing remarks, I would like to provide an update on Positivo’s acquisition approval process. On August 16, we got the great news that the Superintendent of the Brazilian Antitrust Agency, CADE published on their official gazette the approval of the acquisition with no restriction.Now we are waiting for the nomination of the CADE’s new Board members for the process to move on. Once this Board is duly composed, our 15 day period starts to count and if there is no objection, the transaction is formally approved. It’s important also to highlight that since the signing of the transaction, we have a dedicated team working together with consultant firms to prepare for the integration.We remain confident with the success of this operation and we will keep the market update of any new developments on this matter.And with that, I would like to turn the call back to Ari, for the closing remarks. Ari?

[Ari de Sá Cavalcante Neto:]

Thank you, David. I would just like to quickly point out a key factor of our success throughout all this years, our strong culture. We have six important pillars which we show on Slide 13 that we believe as essential to run our business. Today I want to talk about one specifically which is the value we attribute to our people.Without our great team, we wouldn’t be here right now. A company that is able to deliver high quality education at scale and impact the learning experience of thousands of students. In order to keep improving and growing further, we need to constantly find new talents that will promote our cultured partners.This year, we achieved a remarkable accomplishment and became one of the largest training programs in Brazil. We are very proud of that. Our program had over 46,000 applicants and we manage to find 14 new talents to be part of our team.Being recognized as a great place to work and having those thousands of young talents willing to join our team means a lot to us and is a proof that we are on the right path to continue to deliver our mission.With that, we conclude our presentation. Thank you for your time and we can now open for questions.

[Operator:]

[Operator Instructions]Our first question will come from the line of Vitor Tomita with Itau. Your line is now open.

[Vitor Tomita:]

Hi, good morning and congratulations. Good afternoon. Congratulations on the results. On our side, our question would be, if you could elaborate more on the price base for any acquisitions and the structure of the transactions? And also on whether this company’s management will remain with Arco? Thank you.

[Ari de Sá Cavalcante Neto:]

Hi, Vitor. Thank you for your question. So, regarding the acquisition, so, the first one, Nave à Vela, it was the acquisition in four installments and we start with the first step when we acquired 13% of the company for BRL 4.2 million and the remaining 87% will be acquired in three installments according to the company’s performance and as we stated in the financial statements.The other acquisition is Escola em Movimento, EEM, this one was already fully acquired for BRL 18 million where BRL 16 million paid upfront and BRL 2 million remains to be paid in two installments. Both of the companies we keep the management. They are working with us to extract the synergies and with the business and I believe that I answered both of your questions, right?

[Vitor Tomita:]

Yes. Perfect. Thank you.

[Ari de Sá Cavalcante Neto:]

Thank you.

[Operator:]

Thank you. And our next question will come from the line of Mariana Hernandes with Credit Suisse. Your line is now open.

[Mariana Hernandes:]

Hi, good afternoon, Ari, David. Thanks for taking my question. My questions are also about the recent acquisitions, but in the sense that I would like to get more color about how the business models work. So for instance, first, Escola em Movimento, how are you going to charge for it or going to provide as a free tool for partner school to have access to or how is it going to work?And in regards to Nave à Vela, I mean, how much payments we need to pay for this addition to tuitions and do you have any estimates about the potential addressable market size of this business or any other details that you worry about your share about this acquisition in terms of how the operations work, it would be very useful. Thanks.

[Ari de Sá Cavalcante Neto:]

Hi, Mariana, thank you for your question. So, the two companies that we have acquired they operate in the same business model as our current business do. So, we sell that to the schools and the schools resell that to the students both the App from Escola em Movimento, as well as Nave à Vela.We intend to keep them as independent operations, so they have their sales force team, they go to the schools and negotiate long-term contracts with the schools, so that the schools can use the solutions. But we also plan to extract synergies, especially in the back office area and we do see cross opportunities both in the case of Nave à Vela and Escola em Movimento.

[Mariana Hernandes:]

Perfect. And just a quick follow-up. Are you able to share any details about how much is it cost for schools or in the end for parents to acquire these optionalities?

[David Peixoto dos Santos:]

So, since the Nave à Vela business we are not yet consolidating we expect to disclose this information when we perform the second term in payment and when we acquire the formal – of the company and then we can share the financial numbers with you.

[Mariana Hernandes:]

Perfect. Thanks a lot.

[Ari de Sá Cavalcante Neto:]

Thank you.

[David Peixoto dos Santos:]

Thank you.

[Operator:]

Thank you. And our next question will come from the line of San Diego Aragao with Goldman Sachs. Your line is now open.

[Diego Aragao:]

So, my name is now San Diego and that’s great. So, good afternoon everybody and thank you for taking my question and for the update on Positivo. I guess, my question is a follow-up on the two smaller deals you mentioned. So first, how should we think about their organic growth in 2020?And second, how is the revenue recognition for these companies? I understand that you also want to keep them independent, but how far do you see them gaining some penetration within your customer base? Thank you.

[Ari de Sá Cavalcante Neto:]

Thank you, Diego for your question. These companies have a very strong track record in organic growth throughout the last years. It’s still soon to predict how they will perform for the following year. But since the quality of the products and that we have seen, we are very optimistic in how they will grow organically.Of course, we expect to do cross-sell between among all our business units and these new solutions. But I think it’s still early to predict any kind of revenue or numbers in terms of these two companies. You – can you please repeat the last part of your question please?

[Operator:]

Diego’s line has left the queue. Our next question will come from the line of Javier Martinez with Morgan Stanley. Your line is now open.

[Javier Martinez de Olcoz Cerdan:]

Hi, thank you. Thank you, Ari. The reason why I delighted is I was – with the same idea that San Diego was asking to try to understand in the penetration, I understand it’s – maybe a little bit early. Your commercial team, so you will have it independent, I understand that. I understand why. But I guess that your commercial team will be already ready to sell that as part of your platform in the next commercial year, no.I guess, no, this year is too early, you know, that is a good assumption. And second, when will be this second installment? So when – from where – from when will you be able to consolidate the control of the company and have the extra control of the company – of the Nave à Vela? Sorry.

[David Peixoto dos Santos:]

So, just answering the last part of your question and sorry, thank you, Javier for your comment. So, jumping to the end of the question, we expect to consolidate for the Nave à Vela company for the ACV 2020 and the Escola em Movimento, as I said we already acquired 100%. So, from the next quarter it would be already consolidated in our financial statements.

[Ari de Sá Cavalcante Neto:]

Javier, answering your question regarding how we are selling this products. Yes, we intend to keep the sales force separate. But of course, we are studying possibilities to bundle the solutions in order to offer a more comprehensive product to the schools. Sometimes it makes sense to a school to buy the learning system together with a tech App or the 21st social emotional skills product.So, yes, we see an opportunity to enter new schools with these products, Escola em Movimento and Nave à Vela. But also we are planning to develop a specific solutions bundling each of these solutions together with our current products.

[Javier Martinez de Olcoz Cerdan:]

Ari, so, as far as I am aware, these are similar products that used to be in the market that of course the leader in NIM, but I am not aware of any other product, no, so, with the understanding it’s a market with really low level of competition. So there is no – so it’s a potentially big market without many competitors use maybe one or maybe somebody else. So, if you could give us an idea for how many players do we have on the table to try to understand how this is going to look like will be very helpful.

[Ari de Sá Cavalcante Neto:]

Yes. I think you were correct. There are few players in the competition of this market. I think we can benefit from the scale in order to develop a very high quality solution and deliver that into the platform of schools that we already have the relationships with. They operate in the same supplemental segment as international school.And also, you can see a very strong trend in the education area to start to teach the kids not only the traditional core curriculum, but also these kind of skills. So, we see a good trend on that opportunity on that market.

[Javier Martinez de Olcoz Cerdan:]

And this – finally – this is a product, correct me if I am wrong, more for the secondary students or this is separate for all the areas. I am not 100% sure about that. Just to try to understand from your virtual market, which portion of the students, partner school relying these? It’s more for the secondary students, right?

[Ari de Sá Cavalcante Neto:]

So, it’s for all the segments, actually. This is a product that works with the skills of culture of innovation, entrepreneurship, creativity. So you have specific products for all the segments of the K-12 private school.

[Javier Martinez de Olcoz Cerdan:]

And the product works? Just like a pretty exciting proposition for parents. I want my kids to go to that school. But there is – you know what I mean that sometimes, so to visualize how it is very innovative. So, works well?

[Ari de Sá Cavalcante Neto:]

Yes. The product works very well. Two things that we can mention about the company is that, there are two very talented founders who came from – and developed that curriculum there. And the second one is that they are already in the top rated schools in Brazil.

[Javier Martinez de Olcoz Cerdan:]

Okay. Okay, it sounds very exciting. Thank you very much.

[Ari de Sá Cavalcante Neto:]

To add one more comment, which I think it’s important. In the last four years, the company had zero turn which is a very important metric to access the quality.

[Javier Martinez de Olcoz Cerdan:]

That’s – this is a pricing figure, because in a product like this, it’s like a – it sounds like amazing, no. It’s like – this is the kind of thing that you try as a parent, you say, okay, let’s try with my kids. But then, they like it and you send them to soccer.But so, not having – having been successful with all the schools is quite surprising no. So, it sounds like you have a very interesting thing in your hands, no? It will be good if you can give us more information to try to quantify the potential of this whole market, et cetera, et cetera?

[Ari de Sá Cavalcante Neto:]

Sure, sure. We can do that. We believe so. Thank you.

[Javier Martinez de Olcoz Cerdan:]

Thank you.

[Operator:]

Thank you. And our next question will come from the line of Maria Azevedo with UBS. Your line is now open.

[Maria Azevedo:]

Hi guys. Thank you for the call. You are on track to reach your targets. Do you see any upsize risks for your EBITDA guidance for the year? And if you can comment on marginal terms about 2020 commercial outlook, commercial and competitive and now that you have reached stronger sales force. If we should expect some accelerated growth in that line? Thank you.

[Ari de Sá Cavalcante Neto:]

Hello, Maria. Thank you for your question. Talking about of the sales cycle, we believe it’s too early in the year. But we are optimistic with the sales of this season and I think David can answer your question regarding the margins and EBITDA.

[David Peixoto dos Santos:]

So, the margins are actually in line with our expectations. So, we – so, every quarter, we will discuss this as we like to update these numbers and look for changing any projection. But so far we are still in line with first projections that we discussed with you.

[Maria Azevedo:]

Perfect. Thank you. And just as a follow-up question, David, did you consider accessing the equity markets in the future in the short-term to foster more acquisitions and also improve its stock liquidity? Is this a scenario you are considering?

[David Peixoto dos Santos:]

Yes. So, we are, I mean, we are always analyzing opportunities to a better capital structure. But considering the acquisitions that we already performed, we can finance with the cash generation from our operation without the need of new capital injections. And also, if we see new opportunities for M&A, and pin up your side, we already have a pre-approved financial line that can work - has agreed to finance new targets.

[Maria Azevedo:]

Perfect. Thank you very much.

[Operator:]

Thank you. [Operator Instructions] Our next question will come from Guilherme Palhares with BTG. Your line is now open.

[Guilherme Palhares:]

Good afternoon everyone. Two questions here. One is, Nave à Vela just to be clear. This product is different from what – and it’s called intelligentsia because of its maker feature, right. So, just to get that clear.And the second question is, on Escola em Movimento, we understand that, the company itself has other learnings within those clients and I want to understand what are the plans for their business units in terms of this relationship to the further learning systems and what is the company thinking about which steps after solution here? Thanks.

[Ari de Sá Cavalcante Neto:]

Thank you, Guilherme for your question. So, the Nave à Vela product is quite unique in terms of the quality of the content and the approach. It’s not a feature. So it’s really a product that we are selling to the schools and the schools are putting into its class per week and they are reselling that to the parents.So that’s pretty much how it works. But talking about Escola em Movimento, Escola em Movimento is more like a feature that you sell to the schools and the school sell that to the parents and that feature is a tech feature, is an APP that enables the interaction and communication among parents and the school, the academic performance and we believe we can add new capabilities to this App.But it’s a feature that the school uses to communicate with the parents and we believe there is a lot of opportunities to add new features and enhance the school and the parents’ experience through that.

[Guilherme Palhares:]

Thanks. That’s very clear.

[Operator:]

Thank you. And we have follow-up questions coming from the line of Diego Aragao with Goldman Sachs. Your line is now open.

[Diego Aragao:]

Yes. Thank you guys. Thank you for the follow-up. Unfortunately I got disconnected previously. So my apologies if I missed some of your comments. But just want to check, whether there are some earn outs related to these acquisitions? Thank you.

[David Peixoto dos Santos:]

So, Diego, thank you for the follow-up question. So, regarding Escola em Movimento, we don’t have and talking about Nave à Vela, yes. So, this other three installments, they are related with the company’s performance and they are valid on average in five time revenues last twelve months.So, it’s an average, because it varies depending on the installments, but on average it’s six and then four and then three and on average it’s five times revenue last twelve months and we provide more details about this on our financial statement.

[Diego Aragao:]

Okay. That’s helpful. Thank you.

[David Peixoto dos Santos:]

Thank you.

[Operator:]

Thank you. And I am showing no further questions in the queue. Ladies and gentlemen, thank you for your participation on today’s conference. This does conclude our program and we may all disconnect. Everybody have a wonderful day.