Arco Platform Limited (NASDAQ:ARCE) Q4 2019 Results Earnings Conference Call March 16, 2020 4:30 PM ET
Roberto Otero – Investor Relations Director
Ari De Sá Cavalcante Neto – Chief Executive Officer
David Peixoto – Chief Financial Officer
Conference Call Participants
Susana Salaru – Itaú
Diego Aragao – Goldman Sachs
Ladies and gentlemen, thank you for standing by. And welcome to the Arco Platform Ltd. Fourth Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [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 am 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 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.
The forward-looking statements in this presentation are based on the information available to us as of the date hereof. You should not rely on them as predictions of future events and we disclaim any obligation to update any forward-looking statements except as required by law.
In addition, management may reference non-IFRS financial measures on this call. The non-IFRS financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with IFRS. We have provided a reconciliation of these non-IFRS financial measures to the most directly comparable IFRS financial measures in our press release.
Let me now turn the call over to Ari De Sá Cavalcante Neto, Arco’s CEO.
Ari De Sá Cavalcante Neto
Thanks, Roberto. And 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 talents. This 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 1,360,000 students in 5,400 schools. That translates into annual contract values of BRL1.6 million. 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 its ACV, which is acceleration from the previous period and already in essence of the growth potential of the business.
In terms of financials, the full year of 2020, we achieve 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&A and is a 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 standalone results so we can properly compare to the numbers from last year. Then we will go over our reported 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 employee, our partners schools and our business.
As of today, no employee has been diagnosed with the disease. However, we have already approved an implemented preventive measures and a contingency plan in case the disease proliferate.
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 backlog 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 contract. We expect the full content to be delivered to students through all 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 would turn the call to David who will discuss all these topics in detail. David, please go ahead.
Thank you, Ari. I would start with Arco results without the recent acquisitions of 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 discussed here are non-IFRS and growth rates are compared to the prior year comparable period unless otherwise stated.
So let’s start with viewing our numbers. Net revenue for the fourth quarter of 2019 was BRL158.8 million, which represented a growth of 31% compared to the same quarter of the last year. Our net revenue for the year was BRL482.6 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 negotiations 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 BRL77.4 million, compared to BRL46.1 million in the same period last year. As Ari 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. As seen, Arco standalone 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 that includes two months of Positivo and our other recent acquisitions. Net revenue for the fourth quarter of 2019 was BRL247.6 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 BRL572.8 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 BRL76.7 million, up from BRL35.2 million in the fourth quarter of 2018 and BRL47.6 million in the third quarter of 2019. Even disregarding the impact 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 returns to our company.
G&A expenses was BRL56.2 million, compared to BRL22 million for the fourth quarter of 2018 and both numbers include non-recurring 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 BRL24.4 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 BRL106.3 million for the fourth quarter of 2019, compared to BRL46.1 million in the same period last year. For the year, adjusted EBITDA was BRL209.4 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 BRL1.6 billion, representing an increase of 130% compared to the last year. Since we flagged Arco’s standalone excluding Positivo growing at 35%, which as Ari said, is another confirmation of the superior quality of our solution. As a reminder, this 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 technologies, and also reflect the impact from the recent M&A, which have lower margins as compared to the Arco’s mature products.
Now, I’d like to explain the components of our ACV growth. The core solution, which includes Arco brands grew by 136% year-over-year, totalizing BRL803.6 million of ACV and 1,132,000 students.
We were able to readjust the average ticket per students on average by 6.2% over nearly 2% above inflation. It is a clear representation of our high quality and strong brand equity, given the constant investments in product and innovation, with the objective to bolster our competitive advantage.
Our supplemental solutions grew by 101%, achieving BRL202.2 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’s that can either expand our product offerings 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 partners schools. We retain 93% of our customer base, while adjusting prices on average by 6%. The lower retention is compared to previous years, we flagged the incorporation of Positivo, but we expect to gradually improve Positivo’s retention rate.
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 integration. After five 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 BRL50 million and BRL70 million in synergies, impacting our annual EBITDA. A significant part of this effect comes from corporate reorganization, which includes the redesign and consolidation of the Arco three areas.
Other important pillars of our integration plan are changes to the go-to-market 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 a strategic sourcing and operations 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 BRL1.5 billion in goodwill to the amortized, which should generate significant tax efficiencies for the company.
With that, I would like to turn back the call back to Ari for the closing remarks.
Ari De Sá Cavalcante Neto
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 as most process will ensure that our people and partner schools remain as our priority.
Having said that, there are three pillars that we are focusing right now, fortifying more and more trading the Positivo’s team and culture, strengthening and redesigning the sales force and integrating the shared service centers and operations.
The first two 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 would like to reinforce 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 priority as we are here to build a great company in the long run.
With that, we would like to conclude this presentation and start the Q&A session. Operator, please.
Thank you. [Operator Instructions] And our first question comes from Susana Salaru with Itaú. Your line is open.
Hi, guys. Thank you for taking our questions. Actually, we have two questions. First, regarding the ACV growth for Positivo for next year, you are saying that, you expect 9% growth, which was the same that we had the previous year. I was just wondering if that ACV seemed a little bit conservative given that you guys are going to reformulate for whole commercial strategy. So, should we expect that number to be built? That would be our first question. And the second question, if you could elaborate what are the key points that you change in the selling strategy that should improve the performance of Positivo? Thank you.
So, thank you, Susana. Here is David. Thank you for your question. So regarding the 9% growth of Positivo, just be sure that, we said, clear the message, but that’s the growth from 2020 ACV versus 2019 ACV. And this number is a little bit higher than the numbers the total numbers of Positivo.
So Positivo before they have been growing close to 5%, 6% and in the last season, our sales the ACV 2020 9% higher than 2019 ACV and which represent an increase in 3% of the historical growth.
The point that even though we close the transaction only November 1st, so we have only a couple of weeks of work and it — it’s very hard to really give some any meaningful impact in the sales season 2020. However…
… when we sign the deal — sorry?
No. No. That’s exactly my point. So you don’t have any your influence in this figure was very limited. In this year your…
You have — exactly. Sorry, go ahead.
Yeah. You are 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 focused 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 had 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 operating, we could see that the Positivo 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 have in the last five years of Positivo and basically that’s in our view the first impact of those incentives changes that we expect to implement better things 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-marketing strategy and when we expect to see some impact? So we expect to see some back in 2021 ACV and mainly we are adapting the go-to-market strategy of Positivo to the strategy that we used in the other brands 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 this 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 marketing strategy those are the three main changes that we implemented from last year to this year.
And that team is going to work throughout 2020 with these new incentives, this new training program and the sales team separated. And we expect positive results for 2021 and the 9% growth actually is also we are very optimistic [Technical Difficulty] can impact positively the business for 2021.
Perfect. That’s it. Thank you. Very clear.
Thank you. [Operator Instructions] We have a question from Joao Dutra with Goldman Sachs. Your line is open.
Yes. Thank you. This is actually Diego Aragao from Goldman Sachs. Thank you, Ari and David, for taking my question. First, I hope that you and family are well these days. Well, I guess, at some if you can walk us through the synergies with Positivo. I mean, on the operation front, what exactly are you considering and what should be extracted in coming — in the coming four years? And also if you can comment quickly on the facts being released, I mean, I am a bit surprised if you see the consensus estimates for earnings are not baking to numbers, the amount of extract synergies that you announced back in December, this should bring your tax rate down to somewhere in the rate of down 50% next year, right? So am I missing something or do you think we should expect some more revisions for consensus going forward? Thank you.
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 have 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 detail analysis, we are confident to review the number and increase the synergies almost double the synergies that we expect.
And that synergies also include sales, so it’s already contemplating some retention rate and pricing and increasing pricing that we believe we can capture in the following years, but even though that it’s two times the energies that we had our share with the market at the signing. And it’s basically gave upscale and mainly in the back half 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 those numbers contemplate — the majority of those number contemplate those synergies.
The idea is to really get the full benefit of the synergies in the third year. So after three years now, that the transaction is closed, but you should — we saw — you should see a clearly the benefit of the synergies in the second year. So this 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 gains of scales that you can extract from the back office area to invest in sales and hunters, and any product evolution.
However, those investments, they are not replicable in the years going by. So, in the second year, the synergies should be more clear and in the third year they — that we should achieve the maturity. And regarding the fact synergies, I will ask Roberto to help us and then I can complement.
Sure. Thank you, David. So — yeah, 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 BRL1.5 billion. Now, we are bringing the final number, so it’s pretty much BRL1,567 million, so it’s — as I said, I mean, it’s a very relevant amount especially when it related 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 Educação. This is the 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 organization should happen in the first half of the year is already taking place actually. So that means that we might start benefiting from the tax benefit in the second half of the year.
We estimate — actually we released benefitted schedule in the slide nine of the presentation that in the first five years, we estimate BRL70 million of saving per year, right? So probably this year, we are going to have half of this benefit and then from next year onwards, we will then have the full benefit from this goodwill amortization. Again, these are cash savings, right? So it’s a relevant amount, and so, yeah, you can have the full benefited schedule in the slide nine of the presentation.
That’s great. Thank you, David and thanks Roberto for this. 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 as the potential of free cash flow to benefit from not only like a great operation and the synergies from Positivo overall with great tax benefits that you just talk about. How should we be thinking about your plans, let’s say, two years, three years from now, I mean, are you still focusing on consolidating in all the Brazilian markets by adding new, let’s say, new capabilities to your platform, roughly, by starting 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? Thank you.
So thank you for the questions. And so regarding the M&A strategy, we plan to keep our strategy that we share with the investor since the IPO and that we have been very disciplined with. So the idea is to pursue all the three categories of acquisitions.
The first one is core solutions. So our regional players that they believe are learning systems but with an outdated product and we see them as an opportunity to grow faster in organic way.
And the second category you have the supplemental, 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 the new capabilities through mainly technology business that we will look to acquire.
As a quick recap, we did all the three kinds of acquisitions and we see room for — look for more opportunities in all the three categories. In our view that we are — we have a priority to move 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 that inside supplemental, we split in four categories, which is like language, stamp [ph], 21st century skills and tutoring. And in all those categories, you can have one or two brands targeting mainly different client profile and separate by price, and currently we have only three out of eight potential products in our portfolio of supplemental business.
So there are five products to look for, and of course, we can develop internally, but depending on the price negotiation that is — the main idea is to use our cash and the balance sheet and a very strong cash generation of the business to acquire those products if we find products with the quality that fits with our portfolio.
Yeah, but also you have a very active pipeline of startups of technology in Brazil. Usually, those companies, they create very beautiful products, but they have a hard time to prepare those solutions because the cost of acquisition of the client. So the idea is to acquire those technology companies and then we plug in the platform and enhance the value proposition of our clients.
So, I would say that, we keep looking for all the three, mainly Brazil, so the idea now is to in the short-term is to really consolidate the Brazilian market. There is a huge room to explore and we are very well-positioned to capture and dominate the 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 industry category.
That’s super helpful. Thank you, David and Ari.
Thank you. And there are 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.
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