Arco Platform Ltd (ARCE) 2018 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Arco Platform LTD Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded. I would now like to turn the conference over to Vitor of IR Director. You may begin.

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 Neto; and CFO, David Peixoto Dos Santos.

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 includes, but are not limited to, statements related to our business and financial performance, expectations and guidance for future periods, or 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 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 Neto, Arco's CEO.

Thanks, Vitor, and thanks, everyone, for joining Arco's fourth quarter and full year 2018 conference call.

A year ago, we set highly ambitioned 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've accomplished. It was a direct result of the hard work of our talented people and strong culture. We believe this is the only way to succeed in the long term.

Before discussing our results, let me quickly provide a quick background on Arco for everyone new to our story. Arco delivers high-quality education at scale 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, there are over 8 million students in 40,000 private K-12 schools. Education is a top priority for families and there's no government funding for private schools. These 2 dynamics create a huge market opportunity for us. Our unique B2B2C model engage and connect 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 and ongoing success of our partner schools. And we are the only pure play in the industry, 100% focused on solutions to private K-12 schools.

Now on to our results. Fourth quarter 2018 net revenue was BRL 121 million, adjusted EBITDA was BRL 46 million. For the full year 2018, net revenue was BRL 381 million, and adjusted EBITDA was BRL 142 million, both up 66% 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 BRL 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 demonstrates 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 at have 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 grow.

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 '18, 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 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 and 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 intend to keeping that in to promote growth through an efficient mix of adding new partner schools, upselling our existing clients, maintaining high retention and price increases. Our larger sales force is (inaudible) enough to cover our addressable market in 1 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 3 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 through 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 SAE brand. After the acquisition, we substantially improved the operations, increasing retention and implementing a new online platform with more video class assessments and adaptive learning for students.

In the Supplemental strategy, we see many targets with excellent products and high demand from the students' parents. It's an untapped 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're looking for relevant features that we could plug into our platform. These features should enhance our solution into a more comprehensive platform. We are optimistic about prospect in all the 3 areas.

We're very pleased with the strong results we delivered in 2018. It was the reflection of our commitment in delivering the best one-stop-shop platform to our partner schools, with high-quality content, personalized services and relevant technology. While Arco achieved several milestones in 2018, we recognize it's just the beginning. There's a long road ahead, and 2019 comes with a new opportunity to impact the lives of thousands of students, gather feedback from our clients to improve our platform, strengthen our relationship with our current partner schools and attract new ones. We're here for the long run.

With that, I'll turn to David so he can discuss the financials.

Thank you, Ari. Before we dig into the numbers, please note that except for revenues, gross margin, selling expenses, G&A and cash flow from operations, all financial measures I discuss are non-IFRS and growth rates are compared to the prior year comparable period, unless otherwise stated.

Overall, our 2018 results showed 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 the 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 fourth quarter of a year to the third quarter of the following year. For those who are not familiar with them -- with the term, ACV is the contractual revenue we expect to recognize from partner schools in each school year, based on the number of enrolled students and 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 4 times in the year, in December, March, June and August. And we typically deliver our Supplemental Solutions twice a year, in December and June.

The amount of revenue recognized is proportional 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 fluctuations between quarters, but in the end, they do sum up very close to the ACV.

So now, let's take a look at the numbers. 2019 ACV is BRL 441 million, an increase of 37% versus the 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 average by 8%, which is over 4% above inflation, and the 2018 sales season was the highest intake of additional students in Arco history, representing BRL 111 million ACV.

New clients accounts for nearly 70% of this amount and the upsell for the remaining 30%. Net revenue for the fourth quarter of 2018 was BRL 121 million, up 73% from BRL 70 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 the 2018 full year gross margin was 78.8% versus 76.1% in 2017. The gross margin increase was positively impacted by 3 factors: The economies of scale of our business; the gains from negotiation with suppliers; and third, the capitalization of content-producing team that work exclusively in updating our content to the new national curriculum guideline, which is a one-time project that we mentioned in our last earnings call and that we expect to be concluded in 2020.

Selling expenses for the fourth quarter of 2018 was BRL 35 million, up 78% compared to the BRL 20 million the fourth quarter of 2017. On a full year basis, 2018 selling expenses was BRL 113 million, again, BRL 65 million in 2017, 73% growth. That's part of our strategy to continue to invest in our sales effort to grow. There is still a large market opportunity in front of us, and we are confident that these investments in selling expenses will generate profitable returns in the long-term.

G&A expenses were BRL 22 million, up 26% compared to BRL 17 million for the fourth quarter of 2017. On a full year basis, 2018 G&A expenses were BRL 69 million against BRL 47 million in 2017, up 48%. Assuming we exclude the stock option expenses for both periods, as we mentioned in our last earnings call, G&A was impacted by expansion of our internal resources and creation of new functions related to becoming a U.S.-listed public company. There are still some areas to invest, but we do not expect to increase at this rate for the next years.

Adjusted EBITDA was BRL 46 million for the fourth quarter of 2018, up 123% compared to BRL 21 million for the fourth quarter 2017. On a full year basis, 2018 adjusted EBITDA was BRL 142 million versus BRL 91 million in 2017, a 56% growth. This result is consistent with our strategy of growing, while keeping our margin levels and reinvesting the gains for economies of scales.

Adjusted net income for the fourth quarter of 2018 was BRL 43 million compared to BRL 14 million for the fourth quarter of 2017. And adjusted net income was BRL 112 million for the full year 2018 and BRL 67 million for 2017, an increase of 69%. For a more detailed information about the reconciliation of net income to adjusted net income, please see the investor presentation on our website or the earnings release.

The cash generated from operations for the full year 2018 was BRL 119 million versus BRL 79 million in 2017, 50% higher year-over-year, mainly driven by revenue growth. Our free cash flow was BRL 56 million in full year 2018 against BRL 51 million in 2017, an increase of 9%. It was impact by higher income tax paid in 2018, mainly related to the tax from 2017 fiscal year and investments to create and update the content in our platform to be in line with the new national guidelines, as we mentioned before.

I would like to finish today's remarks with reviewing our plan for giving guidance moving forward and provide the guidance itself. As we mentioned before, or business operate to annual contracts only, therefore, we strongly recommend our investors generalize our numbers on an annual basis. We intend to provide guidance as follows: A, with fourth quarter results, we will update the 2019 ACV; and also, we will give the guidance of the percentage of the 2019 ACV that will be recognized in the first quarter of 2019; and finally, we will give a range of the adjusted EBITDA margin for the 2019 year.

Now to our guidance, 2019 ACV, as we said, is BRL 440.9 million. For the first quarter of 2019, we expect to recognize between 22% to 25% of the 2019 ACV. And we expect our 2019 full year adjusted EBITDA margins to be in the range of 35.5% to 37.5%.

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

(Operator Instructions) Our first question comes from Diego Aragão of Goldman Sachs.

My first 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 we would consider your portfolio of products, how each one of them should behave in terms of growth in 2019?

Thank you, Diego, for your question. The growth in the top line is mainly because we could achieve 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's a very important piece of adding new schools to the platform. So from the top line growth, 70% came from students from new schools and 30% came from students from existing schools. In the following years, we really want to invest more in the sales force. 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's a very interesting opportunity in the Supplemental business. So as you can see, I believe we've 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's 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-sell into our existing customer base

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

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 of some minorities?

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 payments 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 -- 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 there is impact in the financial results. So it's a noncash impact mainly related for the international school reassessment that due to the company has outperformed the projections that we have before.

Okay. Perfect. And the prospects for M&A?

Yes. So we are still focused on those 3 main areas of M&A, the Core solutions, the Supplemental ones and the technology one. We are actively working on the 3 types and we are optimistic on the deal flow for all the 3 types, so the strategy is the same. And we're working hard in order to pursue these acquisitions.

And our next question comes from Maria Azevedo of UBS.

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 for your question. So we have a very resilient business that does not grow 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 upsell 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.

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 show and talk a little bit more with you about your strategy, so today, we are focused on mainly to attract more client and increase the customer base. And that's why we are so committed between that and sales force and increase the team. 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.

And our next question comes from Robert Otero of Bank of America Merrill Lynch.

I have 2. 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 BRL 35.5 million and BRL 37.5 million, 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 lower 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, Otero, for your questions. 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 upsell. As we said before, 30% came from upsell 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 upsell and to add new customers to our platform. And all of the -- the 2 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 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.

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 accept significant changes, and we'll use this leverage that comes with scale to keep reinvesting.

And our next question comes from Susana Salaru of Itaú.

We have 2. The first one, if you could elaborate a bit more about the sales force continued investment? You mentioned that you had 3 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 for 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 4 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 4x 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.

So talking about the CapEx, we -- if you consider like the current -- the regular operation, you 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 2 years, we do not expect to -- we expect actually to invest close to $10 million in these 2 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.

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.