Arco Platform Ltd (ARCE) 2019 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Arco Platform Ltd. Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions) I would now like to turn the conference over to your speaker today Roberto Otero, Investor Relations Director. Please go ahead, sir.

Thank you. I'm pleased to welcome you to Arco's Fourth Quarter and Full Year 2019 Conference Call. With me on the call today, we have Arco's CEO, Ari De Sa 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, uncertainty and other factors that may cause our actual results to differ materially from those contemplated by these forward-looking statements.

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 De Sa Cavalcante Neto, Arco's CEO.

Thank you, Roberto, and thank you, everyone, for joining Arco's Fourth Quarter and Full Year 2019 Conference Call. 2019 was an exciting year for us, and we are very pleased with the milestones we achieved in the year. We have much to celebrate, and we are confident that 2020 will be even more successful. Once again, we were able to deliver high quality solutions to our schools, generating high retention rates and a very strong organic growth. We continue to build an amazing management team, adding new members and strengthening our existing colleges. It is essential to pursue our long-term mission of being the best education platform for schools in Brazil. Regarding our 2020 sales cycle, we reached an amazing mark of 1.360 million students in 5,400 schools. That translates into annual contract values of BRL 1.006 billion. Arco ex Positivo post a 35% ACV growth, above our 32% to 34% preliminary guidance provided.

Despite closing the transaction by the end of the year, Positivo was able to post a 9% growth on ACV, which is an acceleration from the previous period and already an evidence of the growth potential of the business. In terms of financials, the full year of 2020 we achieved 37.9% of adjusted EBITDA margin, which was above the high-end of our 2019 guidance at 37.5%. This number excludes our recent M&As and is the confirmation that Arco is able to post a very strong organic growth and keep our margin levels. During today's call, we will discuss our stand alone results, so we can properly compare to the number from last year. Then we will go over our quarter results and our 2020 guidance.

Finally, we will give you more details about Positivo's integration as we have been working really hard to implement important changes and accelerate its growth. Before I turn the call to David, I would like to discuss the situation regarding the coronavirus and what we, as a company, are doing to protect our employees, our partner schools and our business. As of today, no employee has been diagnosed with the disease. However, we have already approved and implemented preemptive measures and a contingency plan in case the disease proliferates.

Regarding our partner schools, we are ready to deliver all the content to our students, even if schools' activities are impacted. Students will be able to access all the solution in our platform and also receive online support from the teachers. We believe that our digital solutions will be important to mitigate any impact to our partner schools and their students. Finally, I would like to reinforce the resiliency of our business model and remind investors that we operate under annual contracts. We expect the full content to be delivered to students throughout the school year, meaning that once again, our revenue recognition should be in line with our confirmed ACV. We are actively monitoring the situation to guarantee a fast reaction in case of the escalation of the problem.

Now I'll turn the call to David, who will discuss some of these topics in more detail. David, please go ahead.

Thank you, Ari. I will start with Arco results without the recent acquisitions, Positivo, Nave à Vela, and Escola em Movimento. Please note that except for revenues, gross margin, selling expenses, G&A and cash flow, all financial measures I discuss here are non-IFRS and growth rates are compared to the prior year comparable period, unless otherwise stated. So let me start reviewing our numbers. Net revenue for the fourth quarter of 2019 was BRL 158.8 million, which represented a growth of 31% compared to the same quarter of the last year.

Our net revenue for the full year was BRL 482.6 million representing a growth of 27% against 2018. Gross margin was 82.2% for the fourth quarter versus 80.2% for the same period in 2018. The improvement is a result of: one, economies of scale; and two, gains from negotiation with suppliers. For the full year, our gross margin was 81.6%, up 277 basis points year-over-year.

For the fourth quarter, the adjusted EBITDA was BRL 77.4 million compared to BRL 46.1 million in the same period last year. As I mentioned earlier, we surpassed the adjusted EBITDA margin guidance of 35.5% to 37.5% for 2019, delivering a margin of 37.9% for the full year 2019. (inaudible) Arco (inaudible) has been posting extremely healthy financial figures just as expected.

Now let's move to the results as reported on our financial statements, which means it includes 2 months of Positivo and our other recent acquisitions. Net revenue for the fourth quarter of 2019 was BRL 247.6 million, which represented 25% of the 2020 ACV versus 27% in the same quarter of the last year. Our net revenue for the year was BRL 572.8 million, an increase of 50% versus 2018.

Gross margin was 77.6% for the fourth quarter versus 80.2% for the same period in 2018 as our acquisitions have lower gross margin than Arco. For the full year, our gross margin was 79.5%, up 72 basis points year-over-year. Selling expenses for the fourth quarter of 2019 was BRL 76.7 million, up from BRL 35.2 million in the fourth quarter of 2018 and BRL 47.6 million in the third quarter of 2019. Even disregarding the effect of the M&A, the sequential increase in selling expenses reflects a higher number of Hunters and Farmers and a higher travel expenses. Those investments are reflected in our 2020 ACV growth, and given our very high lifetime value to CAC ratio, those investments are very high return to our company.

G&A expenses was BRL 56.2 million compared to BRL 22 million for the fourth quarter of 2018, and both numbers include nonrecurring expenses. Adjusting for share-based compensation in 2018 and 2019 and M&A and other one-off expenses in 2019, G&A would have been BRL 24.4 million in the fourth quarter of 2019, increasing 12% versus the same period last year. As a result of all those factors combined, adjusted EBITDA was BRL 106.3 million for the fourth quarter of 2019 compared to BRL 46.1 million in the same period last year. For the year, adjusted EBITDA was BRL 209.4 million, representing a margin of 36.5% and a growth of 47% compared to 2018.

Moving now to the guidance. For the next year, we expect our consolidated ACV bookings to be BRL 1.006 billion, representing an increase of 130% compared to the last year. This reflects Arco's stand alone excluding Positivo, growing at 35%, which as Ari said, is another confirmation of the superior quality of our solutions.

As a reminder, the ACV is recognized as revenues between October 2019 and September 2020. Our full year 2020 adjusted EBITDA margin will remain the same, varying between 35.5% to 37.5%. It's important to mention that this range is consistent with our strategy of growing while reinvesting the gains from economies of scale to improve sales force, product and technology and also reflects the impact from the recent M&A, which had lower margins if compared to the Arco's mature products.

Now I would like to explain the components of our ACV growth. The Core Solutions, which includes 4 brands grew by 136% year-over-year, totalizing BRL 803.6 million of ACV. And 1.132 million students. We were able to readjust the average ticket per student on average by 6.2% in over nearly 2% above inflation. It is a clear representation of our high quality and strong brand equity, given the constant investment in product and innovation with the objective to bolster our competitive advantage. Our Supplemental Solutions grew by 101% achieving BRL 202.2 million of ACV and 230,000 students. As we have mentioned in the past, Supplementals are an important pillar to our future growth, and we will continue to look for M&A that can either expand our product offering or add technology features to our partner schools.

Moving to our consolidated breakdown. ACV growth is a mix of our ability to retain our customers, the price increase, the upsell of our solutions; and finally, attracting new partner schools. We retained 93% of our customer base, while adjusting prices on average by 6%. The lower retention, if compared to previous years, reflect the incorporation of Positivo, but we expect to gradually improve Positivo's retention rates. As Ari said, the results of 2020 sales cycle is a remarkable achievement for our company, and we are very proud of it. We once again were consistent with our commercial discipline and grew the right way by leveraging our track record and the best solution for schools to improve their academic results.

And before I turn the call back to Ari, I would like to share exciting news about Positivo's integration. After 5 months since the closing of the transaction, we were able to reassess and revise our synergy numbers. We now expect that by the end of the third year of integration we will be able to capture between BRL 50 million and BRL 70 million in synergies impacting our annual EBITDA. A significant part of this effect comes from corporate reorganization, which includes the redesign and consolidation of backoffice areas.

Other important pillars of our integration plan are changes to the go-to-marketing strategy to increase retention rates and ability to attract new students, accelerate the organic growth and boost Positivo's ability to increase prices. And also strategic sourcing and operation optimization, both benefiting from scale gains.

Finally, as announced in our third quarter 2019 earnings call, we have finally -- we have finalized the purchase price allocation for the Positivo's acquisition, totaling BRL 1.5 billion in goodwill to be amortized, which should generate significant tax efficiencies for the company. With that, I would like to turn back the call back to Ari for his closing remarks.

Thank you, David. Positivo is the most transformational project for the company, and we are extremely excited and encouraged by what we found out since the closing of the deal in November 2019. We have been careful not to make abrupt changes as we must protect our operations and make sure our schools will continue to be well served. We truly believe a smooth process will ensure that our people and partner schools remain as our priority. Having said that, there are 3 pillars that we are focusing right now, fortify and motivating the Positivo's team and culture, strengthening and redesigning the sales force and integrating the shared service centers and operations. The first 2 pillars focus on combining Arco's DNA into Positivo. Through a clear and transparent communication process, more meritocratic compensation structure and training programs, we hope to retain the talented people and create the ACV growth mindset. The third pillar, the integration of shared service center and operations should help us optimize process, capture synergies and be a more productive and efficient company.

Finally, we'd like to report that it is part of our culture and one of the most important value for us to put quality and people in the first place. Those will be always our priorities as we are here to build a great company in the long run. With that, we'd like to conclude this presentation and start the Q&A session. Operator, please.

(Operator Instructions) And our first question comes from Susana Salaru with Itaú.

Actually, we have 2 questions. First, regarding the ACV growth for Positivo for next year, you're saying that you expect 9% growth, which was the same that we had the previous year. I was just wondering if that figure seems a little bit conservative given that you guys are going to reformulate the whole commercial strategy. So should we expect that number to be big? That would be our first question. And the second question, if you could elaborate what are the key points that will change in the selling strategy that should improve the performance of Positivo?

So thank you, Susana. Here, David. Thank you for your question. So regarding the 9% growth of Positivo, just to be sure that we said clearly -- the message that the growth from 2020 ACV versus 2019 ACV. And this number is a little bit higher than the numbers -- the historical numbers of Positivo. So Positivo, before they have been growing close to 5%, 6% and in this last season of sales, the ACV 2020 is 9%, higher than 2019 ACV. And which represents an increase in 3% of the historical growth. The point is even though we closed the transaction only November 1, so we have only, I mean a couple of weeks of work, and it's very hard to really give some -- any meaningful impact in the sales season of 2020. However, when we sign the deal -- sorry?

No. That's exactly my point. So you didn't have any -- your influence in the -- in this figure was very limited. In this year, you're a bit -- yes, exactly -- Sorry, go ahead.

No, you're right. However, when we signed the transaction in the beginning of the year -- in the first half of the year 2019, we included in the agreement some incentives to the Hunters team in order to increase the retention rate of the company and also incentives to the sales team just to make sure that they will keep focus on their goals. And so even though we were not able to really operate the business, so we had very low influence in the operations. Just because we add some incentives in the signing process, we could see some impact already in the numbers for 2020. So the point is we are excited because even though we were not operating, we could see the positive impact of all these small changes in the incentives of the sales team and the Hunters team. So Positivo 2019 to 2020, we had a higher retention rate than we had in the last 5 years of Positivo. And basically, that's -- that, in our view, the first impact of those incentives changes that we expect to implement better since now we can operate the business.

And then moving to your second question, you asked about what we are planning to do in terms of the go-to-market strategy, and when we expect to see some impact. So we expect to see some impact in 2021 ACV and mainly, we are adapting the go-to-market strategy of Positivo to the strategy that we use in the other brand of Arco. So we are separating Hunters and Farmers team, we are increasing the training program of those Hunters and Farmers. Also, we have add more Hunters and Farmers to the team of Positivo in the end of the year. And also, we increased the variable incentives of the team. So these are the main changes that we implemented. And through the year, we expect also to change the product itself and implement and evolve the solution. But regarding go-to-market strategy, those are the 3 main changes that we implemented from last year to this year. And this team is going to work throughout 2020 with the new incentives, this new training program and the sales teams separated, and we expect positive results for 2021. And this 9% growth actually is also -- we are optimistic (inaudible) can impact positively the business for 2021.

(Operator Instructions) We have a question from Joao Dutra with Goldman Sachs.

This will actually be Diego Aragao for Goldman Sachs. And I guess (inaudible) if you can kind of walk us through the synergies with Positivo. I mean on the operation front, what exactly are you considering? And what should be extracted in the coming 4 years? And also, if you can comment quickly on the tax synergies. I mean I'm a bit surprised if you see the (inaudible) earnings are not baked into numbers. The amount of tax synergies that you announced back in December, this should bring your tax rate down to somewhere in the range of 10% to 15% next year, right? So am I missing something? Or do you think we should expect some (inaudible) revisions for consensus going forward?

So thank you for your question. I can start with the first question, and then I turn to Otero to help you with the second one. So in terms of synergies, when we signed the transaction, we had low visibility about the business itself, and then we shared with the market a conservative estimate about the synergy of the business based on the information that we had at the due diligence process. So now that we could work with the team and understand better the business and go into more detailed analysis, we are confident to review this number and increase the synergies, almost double the synergies that we expect. And these synergies also include sales. So it's already contemplating some retention rate and pricing and increase in pricing that we believe we can capture in the following years. But even though that, it's 2x the synergies that we had shared with the market at the signing. And it's basically a gain of scales mainly in the back office area, but also changes in the procurement and supply chain and also some incentives in content providing. So as we used to say, everything that is behind the curtains, we try to extract synergies and integrate those areas. And these numbers contemplate -- the measure of these number contemplate those synergies. The idea is to really get the full benefit of the synergies in the third year. So after 3 years now that the transaction is closed, but we -- you should -- we start -- you should see clearly the benefit of the synergies in the second year. So the first year is not affected because we had some investments to pursue. So those investments that I just mentioned in the sales team and also in the product evolution, they offset the synergies in the first year. So we use the gain of scales that it can extract from the back office area to invest in sales and Hunters any product evolution. However, those investments, they are not replicable in the years gone by. So in the second year, the synergies should be more clear. And in the third year that we should achieve the maturity. And in regarding the tax synergies, I will ask Roberto to help us and then I can complement.

Sure. Thank you, David. So yes, so I mean in the previous earnings call, we announced what would be the preliminary PPA for the goodwill amortization, which, at that time, we estimated BRL 1.5 billion. Now we are bringing the final number. So it's pretty much BRL 1.557 billion. So it's -- as I said, I mean, it's a very relevant amount especially when we relate it to the full acquisition price paid by Arco for Positivo. So almost the entire amount is being considered as amount to be amortized for tax benefits for the company. So basically, what we have to do now is the incorporation of Positivo by EAS Educacao. This is a process that will allow us to do the statutory book consolidation between the buyer and the acquired company. And this is the process that unlocks or allows us to start amortizing the goodwill for tax purposes. This, I would say -- this corporate reorganization should happen in the first half of this year, it's already taking place, actually. So it means that we might start benefiting from the tax benefit in the second half of the year. We estimate -- actually, we released the benefit schedule in the Slide 9 of the presentation, but in the first 5 years, we estimate BRL 70 million of savings per year, right? So probably this year, we're going to have half of this benefit. And then from next year onwards, we are going to have the full benefit from this goodwill amortization. Again, it's a cash saving, right? So it's a relevant amount. And so yes, you can have the full benefit we scheduled in Slide 9 of the presentation.

That's a great thing, David. And just a follow-up question. I mean I think you have like an interesting M&A pipeline in front of you. When considering the amount of cash you have on hands right now and the potential of free cash flow to benefit from not only like a great operation and the synergies from Positivo, but also this great tax benefits that you just talked about. How should we be thinking about your plans, let's say, 2, 3 years from now? I mean are you still focusing on consolidating the Brazilian market by adding new, let's say, new capabilities to your platform? Generally buy stuff in the core, eventually adding more to the Supplemental? Or it might be the time that you would consider going abroad and investing into new regions?

So thank you for the questions. And so regarding the M&A strategy, we plan to keep our strategy that we share with the investors since the IPO and that we have been very disciplined with. So the idea is to pursue all the 3 categories of acquisitions. The first one is Core Solutions. So regional players that they deliver learning systems, but with an outdated product, and we see them as an opportunity to grow faster in an organic way. And the second category, you have the Supplementals, mainly increase the portfolio of products that we have and really dominate the distribution channel and the channel in the school. And the third is new capabilities through mainly technology business that we look to acquire. As a quick recap, we did all the 3 kinds of acquisitions. And we see room for -- look for more opportunities in all the 3 categories. In our view, that we are -- we have a priority to look for Supplemental because we see a very strong opportunity to consolidate this business in Brazil, and our portfolio of products is not yet complete. So in all the categories, inside supplemental, we split in 4 categories, which is like language, (inaudible), 21st century skills and tutoring. And in all those categories, you can have 1 or 2 brands targeting mainly different client profile and separate by price. And currently, we have only 3 out of 8 potential products in our portfolio of supplemental business. So there are 5 products to look for and of course, we can develop internally, but depending on the price negotiations the main idea is to use our cash in the balance sheet and very strong cash generation of the business to acquire those products if we find products with the quality that fits with our portfolio. Yes. But also, you have a very active pipeline of the startups of technology in Brazil. Usually, those companies they create very beautiful products, but they have a hard time (inaudible) those solutions because the cost of acquisition of the client. So the idea is to acquire those technology companies and then we plug the platform and enhance the value proposition of our clients. So I would say that we keep looking for all the 3, mainly Brazil, so the idea now is to -- in the short term as you really consolidate the Brazilian market, there is a huge room to explore. And we are very well positioned to capture and dominate this business in Brazil. So the main idea is to consolidate Brazil first. And then at some point, we can look forward -- we can look to something outside of the country. But now, the main focus is just to consolidate the country and looking for M&A in these 3 categories.

Thank you. And there no other questions. I would like to thank the ladies and gentlemen, for participating in today's conference call. You may now disconnect. Everyone, have a great day.