Arco Platform Ltd (ARCE) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. And welcome to the Arco Platform Second Quarter 2020 Earnings Call. (Operator Instructions)

As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, Roberto Otero, Arco's IR Director. Please go ahead.

Thank you. I'm pleased to welcome you to Arco's Second Quarter 2020 Conference Call. With me on the call today, we have Arco's CEO, Ari De Sá Cavalcante Neto; and CFO, David Peixoto.

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 our strategic product initiatives and their 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 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 results to 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.

Thanks, Roberto. And thanks, everyone, for joining Arco's Second Quarter 2020 Conference Call. We hope that you and your families are all healthy and safe. I would like to start this call by thanking the efforts of our team, who have been dedicated an enormous amount of energy to serve our partners' goals and reaffirm our mission of being the best possible one-stop shop partner to our clients.

During today's call, we would like to discuss 5 topics. First, a recap on our quality recognition, a result of over 50 years of education experience and the gear behind our industry-leading growth rates. Second, an update about our new go-to-market strategy. We have been achieving significant results with it. Third, our financial results, which have been, once again, in line with our expectations. Fourth, an update regarding the integration of Positivo. We completed the corporate reorganization and now start amortizing the goodwill of our fiscal benefit. Lastly, I would like to talk about Geekie, which is a very successful outcome from our strategy to invest in early-stage, disruptive companies. We will continue to invest in such companies as M&A continues to be an important pillar of our growth strategy, and we are excited about it.

Moving to Slide #4, and to go over the first topic on today's agenda, I'd like to discuss why we are confident that we'll continue to win this game in Brazil. In this industry, the ability to attract new partner schools is directly related to reputation, brand equity and consistency of superior academic results over the years. This is not only a result of focus and a customer-oriented culture, but also our quality leadership track record and brand reputation, driven by the academic results generated by our proprietary methodology, which has been evolving over the years as a result of investments in quality and content.

Our breakthrough, technology-driven portfolio of services and innovative DNA, which has allowed us to be ahead of the competition in terms of developing a fully integrated educational platform and anticipate industry movements, such as the adoption of Supplemental Solutions by schools, this was possible because of our tireless focus on creating value and generating returns focused on the long term.

An extremely powerful distribution network composed by over 5,000 schools and 1.3 million students. The combination of scale with trustworthy, long-lasting relationships with our clients creates a phenomenal value for us to continue to offer new products and services to our schools.

These 3 pillars are not established overnight. They come from over 50 years of experience in education with a clear focus on quality and innovation.

The result of this effort is shown in Slide #5. For another year, schools using our solutions are listed among the best in the country. And like last year's, we have 4 partner schools ranked in the top 10 in Brazil's national exam. This is a remarkable result and shows the strength of our product across the country to position our client schools as top schools countrywide and not only in their cities. We also have the highest market share on top 10 schools at the ENEM exam with presence in 24 states out of the 27. Moreover, our students achieved on average scores 15% higher than the competition. The superior academic results are possible because we have a customer centric approach. To ensure our students will receive the most up-to-date and engaging content, our experienced in-house editorial team updates and improve the solution every single year and throughout the school year because we have segregated teams per brand. Each of the teams is able to quickly react to customer feedback and make sure we implement those changes while maintaining the brand identity.

Added to that, each brand also has its own technology team focused on bringing new features that enhance the academic performance of our partner school and as a consequence, transform their students' lives. Our technology is only meaningful because it is adaptive, fully integrated with our content and improve every year through our feedback and data generated by the users. Our in-house team is well trained in SAS. During the quarantine, they were able to develop and implement several new features, such as integration with third-party platforms, a podcast in live videos environment and further expand our online assessment platform.

As we just mentioned, quality and brand equity in this business are crucial to succeed, and it takes time to build with no shortcuts. Our success, shown by increasing market share and industry-leading retention rates, came from our consistent and intense investment in people, content and technology over the last years putting Arco in a strong competitive position as our value proposition becomes stronger to all schools.

Now I'd like to move to Slide #8 to talk about our new go-to-market strategy, as we mentioned in the previous conference call, to start an internal project to redesign our go-to-market strategy as a way to boost the growth potential by remodeling our remote selling process and bringing our digital marketing to a new level. By implementing the change proposed and further train our sales force, we were able to significantly increase the weekly lead generation with more efficient client acquisition costs; redesigned the go-to-market strategy in order to conduct a fully remote negotiation, sales and onboarding process more customized to our needs in reality; improved the lead quality. We have currently 400 leads using our solutions on our trial version with a high level of customer satisfaction. We are confident that those changes will be valuable to us not only during this time, while the remote sales model is needed, but also in the upcoming years with the acceleration of the digital transformation in schools.

With that, I'll turn the call to David, who will discuss the financials. Please, David.

Thank you, Ari. We can now turn to Slide #9, where we are pleased to discuss our second quarter performance. Before we dig into the numbers, please note that except for revenue, 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. We also note that year-over-year comparisons are affected by acquisitions that were not included in our 2019 financials.

Now I will go over financial highlights, then give more details about our margins and free cash flow, and, finally, provide guidance for the ACV recognition for the third quarter of 2020 and EBITDA margin for the 2020 fiscal year.

First, reviewing our numbers. Net revenue for the second quarter of 2020 was BRL 234.9 million, which represented 23% of the 2020 ACV. The revenue recognition may vary among quarters with no impact in the total ACV, and this happens due to product mix, logistics and our customers' decision on when to receive the content. As mentioned in our financial statements, given the quarantine, schools change the schedule of the content delivered. Then eventually, we will recognize revenues related to the 2020 ACV during the fourth quarter of this year.

Net revenue for the first half of 2020 was BRL 496.4 million versus BRL 254.6 million in the same period last year. Gross margin was 81.6% for the second quarter versus 81.2% for the same period in 2019 and is in line with our historical trend. In the first semester, our gross margin was 77.8%, down 349 bps year-over-year, reflecting a different revenue recognition seasonality among our brands as compared to the previous year. Selling expenses for the second quarter of 2020 was BRL 88.1 million, up 124% compared to BRL 39.3 million for the second quarter of 2019. The higher year-over-year selling expenses reflect our investment 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. The sequential quarter-over-quarter increase in selling expenses indicates our investments in the new go-to-market strategy in order to boost the 2021 growth potential, given the new opportunities that are arising from this environment.

Keep in mind that given our very high lifetime value-to-CAC ratio, those are investments with very high returns to our company.

G&A expenses was BRL 60.1 million compared to BRL 44.9 million for the second quarter of 2019, and both numbers include nonrecurring expenses. Adjusting for share-based compensation in 2019 and 2020 and M&A and other one-off expenses in 2020, G&A would have been BRL 38 million in the second quarter of 2020, in line with the first quarter of this year.

Adjusted EBITDA was BRL 100.6 million for the second quarter of 2020, up 64% year-over-year. We are on track to achieve adjusted EBITDA margin of 35.5% to 37.5% in 2020. In terms of cash position, we ended the second quarter with BRL 892 million in cash and equivalents and an approximately BRL 300 million of bank loans for a very comfortable liquidity situation, even considering the future M&A payables.

Moving now to the guidance. Our guidance for the adjusted EBITDA margin full year 2020 is 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 integration process, which is on Page 10.

On August 1, we finalized the corporate reorganization and the incorporation of Positivo, meaning we have a tax benefit of the deductibility of the goodwill and fair value adjustment of BRL 529 million. The fair value adjustment should be deductible over the next 5 to 20 years, according to the use of life of the identified assets and the goodwill should be deductible for at least 5 years under the Brazilian tax laws, depending on the utilization curve established by the company in the initial use of the benefit.

We also completed 90% of the back-office activities migration to Arco's shared services center despite the challenges imposed by the COVID-19 social distancing measures. We are very proud of our team, given that even during this unprecedented time, was able to successfully complete this step of the integration process.

And with that, I would like to turn the call back to Ari for the closing remarks. Ari?

Thank you, David. I would like to conclude this call by sharing about Geekie, a 100% digital learning system with artificial intelligence embedded and adaptive learning platform to drive a completely personalized learning experience to students.

We first invested in Geekie in 2016 and have now achieved 53% of interest in the company. Since its inception, Geekie has been ahead of its time. Its white-label platform allows for content customization and more integration between the stakeholders and optimization of the teachers' daily activities by saving on average 50 hours (sic) [20 hours] per month of their time.

During this unprecedented time, Geekie has been showing impressive results and is well positioned to post exciting growth, with the acceleration in technology adoption by schools.

The investment in Geekie is one more reason why we are positioned on the edge of education technology and why we continue to lead the industry transformation in Brazil. The financial and academic outcomes we deliver are possible because we have been making investments with a long-term return perspective.

With that, we conclude our presentation. Thank you for your time, and we can now open for questions.

(Operator Instructions) Our first question comes from the line of Pedro Mariani from Bank of America.

Congrats for the results here. So I have 2 questions. First, regarding the M&A activity. I mean, the company is still highly capitalized from the follow-on last year. And given the macroeconomic context right now, are you seeing a higher number of M&A opportunities? What should we expect from M&A activity going forward?

And secondly, I was wondering if you could please briefly comment about the competitive landscape during the pandemic. If there was any change in the environment, both to grow organically or for the best targets of M&A as well. These are my questions.

Thank you, Pedro, for your questions. So the pipeline is very active. We are looking at M&A, as always, in a very disciplined way. And the pipeline is moving. We're very encouraged with the potential positive outcomes. We are looking in the 3 segments, core, supplemental and tech. We still believe that we have a large room to diversify our portfolio of supplemental-type features with the progress of Supplemental that we can offer, both in terms of pricing and marketing positioning.

The addition of Positivo network really increased our possibilities in terms of distributing new products, supplemental ones into our base. The integration of Positivo is moving well and we feel very comfortable to pursuing new M&A opportunities in the future.

In terms of competition, we have been in the market for a while. It's a competitive and fragmented market, and it's played on a quality basis, on a regional basis. I think we're still continuing to gain market share from our competitors because of the reasons that we mentioned in the beginning of the call. We are a peer play. We are 100% focused and continuing to grow our learning systems. Also, we're very focused on quality. And we believe that we will be able to keep pursuing M&A opportunities as well as gaining market share from our customers.

And regarding M&A, I think we have been developing relationships with potential targets for a while right now and have been building a reputation. And I think we are in a very privileged position to continue to consolidate the sector organically. The potential sellers in the industries -- in the industry, they attribute a normal relevance, the legacy and the growth of their business. So I think we're very well positioned to continuate that consolidation of the sector.

Our next question comes from Vitor Tomita from Goldman Sachs.

So on our side, if you -- first question is, if you could give us some more color on that school that led your number of schools in the -- in a top 10 ranking to go from 3 to 4. And also a related question, that's also a follow-up on Pedro's question, is if you could give us some more color on how the competitive landscape has been evolving in terms of academic quality. So namely, if you have seen other players increasing investments to try to achieve a better level of academic quality and exam results and competition on those metrics.

Vitor, thank you. Thank you for your questions. So I'm going to start for the second part. So regarding the competitive landscape in terms of organic growth, what -- so we haven't seen any changes in the competitive landscape or significant changes. So even though we are still early in the sales cycle because, as you know, the majority of the new contract, they come in the -- later in the year. So -- but even though that we haven't seen significant changes in the competitive landscape. And the schools, they still focus a lot on quality and that's the main driver for decision. And as you said, we are keeping delivering the high-quality results that beat our history is the way that we have been operating in the last 50 years. And all this record has -- is definitely helping us to keep our organic growth healthy, gain real market share from all the competitors and keep the prices of our products and solutions. So we haven't seen changes and it just give you more color about the sales cycle itself.

As you also know, we have actually the ACV bidding for the following year, it's composed by existing client schools. So we renew these contracts and also by adding new schools to our network. And those 2 blocks, they happen at different stage of the year. The renew category of the schools usually starts early in the year, so which allows us to, at this point, have a very good visibility about the renewal process. And it has been doing pretty well. So at this time, we have the same percentage of our contracts that we had next year -- last year. So it's in line with the previous and historical numbers, which shows a very healthy renewal rate.

And as I said, the new ones, it is too early in the sales cycle. That's the same answer that we gave late last year when we had the second quarter results, but we are seeing things in line with what we have been expecting.

Our next question comes from the line of Samuel Alves from BTG Pactual.

Just 2 questions here from my side. The first one is regarding 2020 ACV. I think that you guys just mentioned that maybe part of the ACV of 2020 could be postponed to be recognized in the fourth quarter of this year. Maybe if you guys can quantify this fact. I mean, do you think that this could be meaningful or not?

And the second question regarding Geekie. Just to hear more thoughts on the strategy for the company. I mean, do you guys expect to design the call auction to have a 100% interest in the company? When is it going into the core? If you could provide some big numbers of the company as well. That's it.

So, yes, thank you for the questions. So talking about the ACV, so, yes, as you can see in the presentation, considering the circumstances imposed by the COVID, we have -- we probably will have some revenue in the fourth quarter related to the 2020 ACV. That's mainly due to the close of these schools and the anticipation of vacations. So the school year this year should be longer than expected and should be beyond November. And that's why we expect 2020 ACV to be also recognized in the fourth quarter.

So overall, we have -- the ACV recognition has been postponed due to COVID. And so it's hard to say now and to be precise about how much of the ACV will be recognized in the fourth quarter, because it depends on when the classes are going to start. So we are monitoring this progress, but it's usually not so significant. So we are optimistic that because we'll be back at some point in the third quarter, and then we can finish the school year in the fourth quarter of the year. So it's early to tell. But as you said, probably we will have some revenues in the fourth quarter this year.

And regarding Geekie...

No, go ahead, Ari. Go ahead.

So regarding Geekie, we plan to exercise the option. So the idea is to have 100% of the company in 2022. So we are very, very excited about this opportunity and deviant in creating something pretty unique. And the potential of the business is huge, so we are happy with the entrepreneurs and all the team there. And the idea is to keep helping Geekie to pursue their goals. And when the contract is due, we will probably -- we will definitely exercise it.

Our next question comes from the line of Caio Moscardini from Morgan Stanley.

So I have a question on the evolution of this new digital go-to-market. How is the evolution going, and if you have been able to track if farmers and hunters productivity and results are actually improving? And also, if I may, can you please give some color on the next year ACV as well? I believe we are already well advanced in the process, right?

Sure. I can start here. So regarding the go-to-market strategy, we developed a process internally, and we trained both farmers and hunters extensively so that they could be prepared to conduct a sales process, 100% online. I think the results are already starting to show up since the number of links that we have been generating has significantly increased for the last months, and we are converting contracts with the sales 100% online. We have also achieved very qualified leads because of the different kind of events that we are hosting with keynote speakers. So the interest in the events and, therefore, the generation of leads has been very successful.

Regarding your second question, so most of the sales are new schools, attracting new schools that take place in the second semester. This is true for the previous years. And this is also true for this year's. And the way we build our ACV is really by renewing existing contracts up-selling to different grades and products in existing schools. And this starts earlier in the year. But the second part, attracting new schools to the platform, takes place mostly on the second semester. So as we mentioned in the same 2Q call last year, it was too early at that time as well to predict how the sales cycle will take place. What we can tell is definitely, since this school year will be longer, we can expect to add new schools and new students in the whole second semester and eventually in January or February since we have the school closure.

Actually, just one follow-up. So the renewing process is more on the first half. And has this been in line with your expectation or a little bit above, below? I remember that the churn increased a little bit in the past couple quarters, mainly because of the integration of Positivo. Has the churn already started to come down? Or not really?

So talking about the renewal rate, the renewal rate is pretty much in line this year on what we have seen last year. So the numbers look good. In terms -- talking about Positivo, I think it's still early to see the impact. But what we have done there is really to have a chance to improve not only the go-to-market strategy, the incentives of the farmers, but also the digital platform. Because during the COVID, we could put in place significant new features of Positivo platform. So we can expect in the following years to have an improval in the renewal rates. But again, we'll see as the cycle closure, if we could have this improvement in renewal rate of Positivo in the first year.

Our next question comes from the line of Vinicius Ribeiro from UBS.

There are 2. The first is another one on the go-to-market. What does exactly a lower customer acquisition cost mean? Are you guys -- is related to logistics? Or the lead acquisition is cheaper? So what can we understand about this lower CAC?

And my second is a shorter one. If you could give some color on the nonrecurring expenses and the COVID-related extraordinary expenses that affected your results would be interesting.

Vinicius, it's Roberto here. We couldn't understand the first part of the question. Could you please repeat it?

Yes, sure. Sorry. So on the go-to-market strategy, I just want to understand, what does the lower CAC mean. So is it related to the logistics that the farmers and the hunters need to visit? Or is it the acquisition cost of the lead cheaper? So what exactly does that mean?

Okay. Okay. Got it. No, please go ahead, David.

Okay. So I mean, regarding the new go-to-market strategy, what -- one of the success -- successful strategy that we've adopted is to launch a feature called digital school. And the fact that we've made available to students from schools that actually didn't belong to our network, which enables us to generate digital leads, which are now part of our sales strategy. And also, as I mentioned in the previous conference call, we -- and then there were some part of our platform to really the few prospect schools. So all those things, they have been generating very qualified leads to our sales pipeline. And as a consequence, we are not spending to visit schools and travel expenses and in-person meetings and events, and all those savings have been leading to more efficiency in acquiring leads. So that's the main concept behind it. And that has an impact that one of the things that we incorporate in our sales process, even though COVID and the quarantine would stop in the future, because that essentially is capability that we are -- we expect to use more in the future in a more hybrid operation with in-person meetings as well as those digital leads.

Did you guys get the second question?

Yes. Could you say it again?

Yes. So first of all, can you give us some color on the nonrecurring and the COVID-related extraordinary expenses that impact your EBITDA?

Sorry, no. I think your line is cutting a little bit, but I think you asked about the nonrecurring expenses, right?

Yes, that's it.

Okay. I see. So yes, so, I mean, part of the nonrecurring expenses are related to COVID-19. So all those expenses related to the IT infrastructure that was due to service the schools during the pandemic and some one-off nonrecurring expenses to -- I mean, protect the health of the employees as well. So this is what you're disclosing in the financial statements. So I mean, when you have a look there, you're going to see that breaking down what is related to COVID-19. And then the remaining portion of the nonrecurring expenses are related to projects that are part of the normal course of the business. Most of them are usually related to M&A or strategic projects that are, I mean, not part of the ongoing business, okay? But in the financial statements, when you have a look, you're going to see that we are breaking down and explaining what is COVID-19 related and what is mostly related to those one-off strategic projects.

Our last question comes from the line of Susana Salaru from Itaú.

We have 2. The first one is related to the commercial team. If you could provide some data on the conversion rate. Out of every 100 schools that are visit or compared to that, how many of them actually are converted into an actual client? That would be our first question.

And the second question's related to the digital solution. If the digital solution provided currently allows for live classes or just recorded classes? And if you plan to change the approach to involve recorded versus live solution, please?

Susana...

Susana, thank you for...

Okay. Go ahead. Go ahead, David. Go ahead.

Okay. I can give you the first part, and then we can ask Ari to help you at it. No, I will just say that, Susana, as you know, the peak of the conversion rate of the sales, it happens in the next month. So it's hard to say now what the conversion rate would be, especially because we are dealing with an emergency situation imposed by the quarantine. It's hard to predict the conversion rate, but we expect to have more visibility about this in the third quarter.

Ari, go ahead to comment.

Sure. So regarding the products, Susana, thank you for your question, we have both type of classes. We have still live classes for schools to keep their education process. So we have live classes for all the subjects and all the grades. And some schools are using that product as they teach their students. And we also have prerecorded classes, a huge library with more than 3,000 video classes recorded. And this is used as a reinforcement in the process as, for instance, for the classroom methodology or some features that cannot give a specific lesson on any specific day. So the schools use as they want. So we have both types, the prerecorded classes and the live classes.

Thank you. Ladies and gentlemen, this concludes today's conference call and the Q&A session. I'd like to thank everyone for participating. Ladies and gentlemen, you may now disconnect. Have a good day.