Arco Platform Ltd (ARCE) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Arco Platform's third-quarter 2018 earnings conference call. (Operator Instructions)

I'd now like to have a conference over to Vitor. Please go ahead.

Thank you. I am pleased to welcome you to Arco's third-quarter 2018 conference call. With me on the call today is Arco's CEO Ari and CFO David.

During today's presentations, 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 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, Arco's CEO.

Thanks, Vitor, and thanks, everyone, for joining Arco's first earnings call as a public company. For those of you we met during the IPO roadshow, thank you again for letting us share Arco's story.

While the IPO was the first step in our journey as a public company, it was the culmination of a lot of hard work by many people. Thus, on behalf of myself and the entire management team, I'd like to thank you, our employees, our customers, and partners, for their continued support in helping us reach this important milestone.

Today I will provide highlights from the third quarter 2018 and then I will turn it over to our CFO, David, who will walk you through our financial performance. And then we will open the call for questions.

Because this is our first earnings call, let me briefly provide some background on Arco, our market opportunity, and the significant value that our platform delivers to our customers. Since our inception, we have focused on delivering high-quality education at scale. And the way we do this is through an education platform with all the other tools for private K-12 schools in Brazil.

We provide educational content through a SaaS subscription model that drives recurring and predictable revenue. In 2018's school year, we served 405,000 students on our platform in more than 1,100 schools. In Brazil, there are over 8 million students in 40,000 private K-12 schools. Education is a top priority for Brazilian families and there is no government funding for private schools.

These two dynamics create a huge market opportunity for us. Our product offerings are comprised of two segments that operate side-by-side: our core solutions and supplemental solutions. Our core is comprised of high-quality content solutions that are designed to address the K-12 mandatory curriculum requirements. Our supplemental is comprised of content for which partner schools can opt in as an additional to their core curriculum.

We believe we deliver a win-win solution that engage and connects all the stakeholders in the education ecosystem. For students, we deliver a personalized learning experience through high-quality content and technology. For school owners, we provide additional revenue, innovative methods, and data analytics for improved processes.

And for teachers, we offer tools to help them save time, be more effective, and simplify administrative functions. And finally, for parents, we deliver more a cost-effective solution versus traditional textbooks. We have built a resilient, predictable, and profitable business with high margins, which gave us confidence about the sustainability of our business model.

All in all, this is a very exciting time for us. We built a company that demonstrated strong growth on multiple vectors, despite the challenging macroeconomic scenario in Brazil. We believe we are positioned to capture an increasing portion of the larger market opportunity over time.

Now on to our Q3 results. Net revenue of BRL64.9 million was up 69% year over year. Adjusted EBITDA was BRL10.8 million, up 19% year over year. Also note that year to date, our net revenue of BRL260 million was up 49% year over year. Adjusted EBITDA was BRL95.9 million, up 36% year over year.

Let me share more context behind what is driving our performance. The revenue growth we saw is due to the 41% ACV growth between 2018 and 2017 and it reflects the commercial efforts of our team in 2017. ACV means annual contract value, calculated by multiplying the number of enrolled students at each partner school with the average ticket per student per year.

Also, as you may know, we sign up new contracts through the year, but we only start to provide the content in the next school year. This year's effort of our sales team will be reflected in our 2019 ACV bookings and will determine the revenues from 4Q 2018 to the 3Q 2019, as David will explain in more details later. So as you also may know, we are in the end of the sales cycle for 2019 and starting to look to our sales for 2020.

As we promised, we are still increasing investment in our sales force. Since Q3 of 2017, we added 196 professionals to our sales team. Since our return on sales investment is very positive, we believe there is still room for improvement and intend to keep investing in order to continue our growth through an efficient mix of adding new partner schools, upselling with our existing clients, high retention rates, and price increases.

We also created a new department that we call value creation. The main goal of the department is to enhance the logistics, operation, and sales process among our brands. There are some synergies that can be extracted as we grow our partner schools base and processes can be improved over time.

The value creation department also includes corporate activities such as M&A, financial planning, compliance, investor relations, shared service centers, and legal. We hired around 100 professionals to build this team this year.

We concluded developing new content as per the new national guideline. This was a huge differentiator during the 2018 sales cycle, positioning Arco's brands as the first movers in the sector. This investment represents our strong commitment to quality. We believe that only with a focus on quality we can build a successful company in the long term.

In summary, we are very pleased with the strong results we delivered in our first quarter as a public company. And once again, big thanks to all our customers, our shareholders, our authors, and our employees for your continued support. We took Arco public on September 26. We are very proud of all we have accomplished and the confidence our investors have put in us. But I must say that this is just the beginning. We are here for the long run.

With that, I will turn to David so we can discuss the financials. David?

Thank you, Ari. And I would like to highlight again how pleased we are with our third-quarter performance. And before we dig into the numbers, please note that except for revenues, gross margin, salary expenses, G&A, and cash flow from operations, all the financial measures that we will discuss are non-IFRS. And the growth rates are compared to the prior-year comparable period unless otherwise stated.

And for your convenience only, I will state the numbers referring to the period ended in September 30, using the FX rate of 3.701, the FX of the date. I will review our third-quarter results and provide our outlook for the fourth quarter and the full year 2018.

But first, given that this is our initial earnings call, I would like to briefly provide an overview on our business model. Our revenue is driven by our ACV bookings, which is the contractual revenue we expect to recognize from a partner school in each school year, based on the number of enrolled students and the terms of our contracts with each partner school.

We recognize our revenue once our content is made available to our partner schools. And we typically deliver our core curriculum content four times a year: in December, prior to the beginning of the school year; then March, June, and August. We typically deliver our supplemental solutions twice a year in December and June. In both cases, we deliver content two to three months prior to the start of each school year quarter.

The amount of revenue recognized is proportional to the amount of content made available, which is not liberally distributed among the quarters. And it also depends on our client decisions of when to receive the content. This causes significant revenue seasonality in our business, in which the third-quarter revenue is the lowest point of the year.

A significant portion of our expenses is also seasonal. Due to the nature of our business cycle, we require significant working capital typically in September or October of each year to cover costs related to production and accumulation of inventory, selling and marketing expenses, and delivery of our materials. Therefore, such operating expenses are generally incurred in the period between September and December of the year.

In summary, we strongly advise our investors to analyze our financial numbers on an annual basis. For instance, our third-quarter revenue growth of 69% is the consequences of the revenue recognition among quarters comparing to the full-year 2018 ACV growth of 41%, as you can see in our presentation.

So now let's take a look at the numbers. The net revenue for the third quarter of 2018 was BRL64.9 million or $17.5 million, up 69%. It's important to highlight the last 12 months revenue of BRL329.8 million was only 2.4% above our ACV bookings 2018 of BRL322.1 million, as we indicated in the F-1, demonstrating the high predictability ACV bookings have on our revenues.

Since we only operate through annual contracts, the ACV reflects our revenue from the fourth quarter of a year to the third quarter of the next year. And on a year-to-date basis, the revenue was BRL260 million or $70.2 million, up 49%.

The gross margin was 78.2% for the third quarter versus 84.2% for the same period in 2017. There were positive nonrecurring impacts that actually benefited the third-quarter 2017 margins. If we adjust these nonrecurring items, the third-quarter 2017 margins would have been 73.7%. On a year-to-date basis, the 2018 gross margins was 78.1% compared against 76.8% in 2017.

Our historical numbers show our trend to increase gross margins. Since we have a percentage of our costs that are fixed, as we grow our school base, we can deliver our core and supplemental solutions at scale.

The selling expenses for the third quarter of 2018 was BRL29.7 million or $8 million, up 81% compared to BRL16.4 million for the third quarter of 2017. On a year-to-date basis, in 2018, selling expenses was BRL78.1 million or $21.1 million against BRL45.6 million in 2017, up 71%.

As Ari said, we are continuing to invest in selling expenses as part of our strategy to gain market share year over year. In our case, these investments should be seen positively, since our track record demonstrates our capacity to retain our clients for a long period, upsell our solutions, and increase price on a yearly basis.

Just to give you an example: an increasing BRL5 million in our ACV could represent a lifetime value of BRL25 million. Also, considering our long sales cycle, the benefits of this investment in sales should be more evident one or two years forward.

G&A expenses was BRL17.5 million, up 64% compared to BRL10.7 million for the third quarter of 2017. On a year-to-date basis, 2018 G&A expenses was BRL47.6 million against BRL29.7 million in 2017, up 60%. And these numbers are excluding the stock-option expenses for both periods.

The stock-option expenses were in the amount of BRL59.5 million in the third quarter 2018 and BRL0.5 million in third quarter of 2017. On a year-to-date basis, stock-option expenses were BRL60.2 million in 2018 and BRL1.2 million in the same period of 2017.

The expenses is related to a stock-option plan created in 2014 and it was fully vested upon the IPO. The expenses of this plan was already recognized in our financial statements in the past quarters. However, because of the IPO, the value of these options change and the total amount of the difference is valued at BRL59.5 million. A new long-term incentive plan after the IPO has been implemented for the management team for the next year.

G&A expenses also increased due to higher headcount and other expenses related to the offering, such as consulting, lawyers, and listing fees. But unlike selling expenses, the investments in G&A were mainly a result of the IPO process. We have expanded our internal resources and created new functions to match the standards of a publicly listed company in the US. And there is still room for improvement in some areas, but we don't expect to keep increasing at this pace for the next years.

Adjusted EBITDA was BRL10.8 million for the third quarter of 2018, up 19% compared to BRL9.1 million for the third quarter of 2017. On a year-to-date basis, in 2018, adjusted EBITDA was BRL95.9 million against BRL70.4 million in 2017, up 36%.

The adjusted net income for the third quarter of 2018 was BRL6.1 million or BRL0.12 per share compared to BRL6.3 million or BRL0.14 per share for the third quarter of 2017. And year-to-date adjusted net income was BRL69.2 million or $18.7 million for 2018 and BRL52.2 million for 2017, an increase of 33%. For more detailed information about the reconciliation of net income and the adjusted net income, please see the investor presentation on our website for the earnings release.

As of September 30, 2018, our cash, cash equivalents, and financial investments amounted to BRL903.8 million. Free cash flow was BRL18 million for the third quarter 2018 compared to BRL14.1 million for the third quarter 2017, an increase of 27%.

Year to date, the free cash flow was BRL88.2 million for 2018, up 4% when compared to BRL84.7 million for 2017. The free cash flow was impacted by financial results, higher CapEx, and income taxes related to the 2017 fiscal year but paid in 2018.

To exclude these effects, which are not related to our operations, we used the unlevered free cash flow. On a year-to-date basis, it was BRL84.6 million, up 22% year over year. And if we adjust the unlevered free cash flow to exclude the tax impact, we would have had 26% growth.

I would like to finish today's remarks explaining the way we plan to give guidance moving forward as well as the guidance itself. As mentioned above, our business operates through annual contracts only. Therefore, we strongly recommend our investors to analyze our numbers on an annual basis.

And we intend to provide guidance as follows. So first, with the third-quarter results, we will give an ACV estimate for the next four quarters. And we will confirm and update this number when we report the fourth-quarter results.

Also, each quarter we will give revenue estimates for the next quarter, but as a percentage of the ACV recognized. And also, we will give a range of the adjusted EBITDA margin for the year on a quarterly basis.

Now, to the guidance itself, we estimate the ACV 2019 to be in the range of BRL420 million to BRL425 million, an increase of 31% at the midpoint of the range compared to the ACV 2018. For the fourth quarter, we expect to recognize from 25% to 27% of the ACV 2019, which will result in the revenue ranging from BRL105 million to BRL115 million.

For the full year 2018, we expect revenue to be in the range of BRL365 million to BRL375 million, an increase of 51% at the midpoint compared to the full year of 2017. And we expect our adjusted EBITDA margin to be in the range of 35% to 37%. Using the guidance of revenue and adjusted EBITDA margin previously stated, we expect an adjusted EBITDA ranging from BRL129 million to BRL138 million.

And with that, I would like to turn the call back to the operator for Q&A. Operator?

(Operator Instructions) Matheus Nascimento, Goldman Sachs.

Hi, thanks for taking my question. And for Ari, David, and Arco team, congrats for your first result as a listed company. My question is about competition. Yesterday we saw the largest educational player in Brazil being very vocal about the K-12 market opportunity for them.

So could you share your thoughts about the competitive landscape? And at this point, what are Arco's main competitive advantage? Thank you.

Thank you for your question, Matheus. So first of all, I'd like to say that we respect competition a lot. We are constantly evolving our solution in terms of quality and we want to keep distance and differentiate ourselves.

I think one important point to address is that in the competitive market right now, we are on track to mark our record number of new students in schools for 2019. So it's been a great sales cycle year.

We do not compete directly with any specific brand or a company. And if you take a look on the growth numbers from new students and new schools, you will see a variety of players from both learning systems and also from publishers.

I believe we are very benefited to be 100% focused on the sector. So we are pure play, born as a B2B provider for K-12 private schools. And because of that, we have agility and real perception on what the client needs are.

So if you think about the barriers to entry that we created in our business, we have a strong quality methodology. You have brand reputation, you have solid academic results, and that takes a lot of time to replicate. So we are very confident about our growth prospects for the future.

Thank you, Ari.

Robert Otero, Bank of America Merrill Lynch.

Hey, guys. Congratulations on the quarter and also on the IPO. So two questions from our side. The first one is on the ACV bookings guidance. You mentioned between 30% to 32% growth year over year. So if you could just please walk us through the basis behind this growth in terms of your expected enrollment growth, cohort average ticket growth.

And the second question is regarding M&A. So if you could provide any update on the M&A front, that would also be helpful. That is pretty much it.

Hi, Otero. Here is David and thank you for your questions. So as you mentioned, we would like to on this moment on the third-quarter results to provide the guidance for the ACV numbers for the next year. And we believe that we will keep doing this to provide more information for the investors and the community of the analysts.

But at this moment, we are still working with the sales team to finish all the contracts. So we believe that it's not going to be beneficial for the investors to share the figures with more details.

But we believe that we can do this on our fourth-quarter results and when we have all the contracts signed up with the schools in house and we have the final numbers. So all the analysis will be more beneficial to be done we believe with the annual results instead of provide more details at this point.

Otero, thank you for your question. This is Ari. So we want to do three types of acquisitions, as we discussed before. We want to make acquisitions in core solutions, in supplemental, and in technology.

We have been actively pursuing all the three types, but we haven't signed binding agreements with any of the targets. And for the benefit of the Company investors, we believe that's the right level of disclosure that we should be giving. But we are working actively in order to pursue all the three types of acquisitions.

Great. Thank you.

Susana Salaru, Itau.

Hi, guys. Thank you for taking our questions. The first question we have is related to international school integration. How is that evolving and how do you expect that to evolve in 2019? And how relevant is a revenue guide reduction we should expect to be in 2019? That would be our first question.

And then the second question is related to this new area that Ari mentioned in the beginning of the call. If you could elaborate a bit more what are the key goals and the key metrics of this new area? Thank you.

Hi, Susana, here is David. I will start to answer your first question. And sorry, the second one we couldn't hear. So after, if you could repeat it, it would be beneficial for us.

So talking about the international school integration, the Company is fully integrated today. As part of our strategy of the acquisitions we have done, and we decided to integrate all the functions and sectors and areas that are behind the curtains, which means that all the back office, all the intelligence, all the corporate structures are integrated.

However, we decide to keep the sales team, the marketing, the brand, and the product team separately. Because we believe that that's the only way to really create a real DNA in the product and in the brand of their solutions. So not only for international schools, but [their] strategy, it remains the same for SaaS side also. So we integrate everything that is behind the curtains, but we believe that our clients need to have the communication and contact with each of the brands independently.

And sorry, like the last question we couldn't hear right. If you could repeat, please. Sorry for that.

Sure. In the beginning of the call, I believe we didn't hear well. That's why we are asking again that Ari mentioned that you guys have a new area, a new department with some commercial growth. If you could elaborate a bit more what are the goals of this new area and what are the name of the area, please?

Sure. Thank you for your question, Susana. So the name of the area is value creation and in this area, we want to take advantage of many functionalities that we can do behind the curtains, as David said. So there are some synergies that we can extract as we grow our partner school base, and then you can improve the process over time.

So we are considering in the department corporate activities, M&A, financial planning, compliance, investor relations, shared service centers, and legal. And then we have hired something like 100 professionals to build this team. So it's pretty much everything that is behind the curtains that we can cooperate between the different business units to extract synergies and operate the business in a better way.

Perfect. Perfectly clear. Thank you.

(Operator Instructions) Javier Martinez, Morgan Stanley.

Hi, thank you. Ari, David, I understand that you still don't want to give any detailed guidance on the bookings for next year, but maybe trying to understand if anything has changed in the competition dynamic. Have you noticed any new dynamic on prices during this end of the year when you were doing all the commercial effort and closing all the contracts? This is my first question.

The second question also, we have been seeing in local media talking about some changes in regulation impacting the potential weight of distance learning being delivered to I think also mainly about public schools. But I don't know if that may have any impact at all whatsoever in your business. If you can comment on that, please.

Sure. So thank you for your question, Javier. Talking about the ACV growth, what we are seeing is that the price readjustments are in line with what we expected and also the average ticket from the new contracts.

So as I said before, what we have seen so far is that we are on track to mark a record in number of new students in schools for 2019. And price readjustments are in line on what we expected.

Yes, and Javier, here is David. Again, thank you for your question. And just to build on Ari's comment, I would like to add that and highlight and emphasize that in our sector, the kind of clients that we deal with, they are not so price-sensitive. They are more focused on quality.

And since we are not selling a commodity product and since from our history, we have been able to grow despite of having premium prices comparing with the average of the sector, we don't believe that the competition should affect this price dynamic. Because as I said, our client is much more focused on quality than price itself.

And also, we have this B2B2C model, which aligns the client with us since we are selling to the school, they are reselling to the parents with the markup. With all this dynamic considered, we believe that the competition will not affect the price dynamic by itself.

And talking about your second question, that's not clear yet if the guideline will allow that you can use distance learning content. But if they decide to do so, this could be an opportunity for us because we could be ready to produce content with videos.

Because of the benefit of the scale, we can hire the best teachers in the country and deliver content from a distance learning perspective to the schools so that they can have more content and more quality in order to impact the learning experience.

Crystal clear. Thank you very much, Ari and David.

As I see no further questions in queue, I'd like to thank everybody for their participation today. This will conclude the conference. You may all disconnect. Have a wonderful day.