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Arco Platform Limited (NASDAQ:ARCE)
Q3 2019 Earnings Call
Nov 26, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen thank you for standing by and welcome to the Arco's Third Quarter 2019 Conference Call.

[Operator Instructions]

I'd now like to hand the conference over to your speaker today, Mr. Roberto Otero, Investor Relations Director. Thank you. Please go ahead, sir.

Roberto Otero -- Investor Relations, Director

Thank you. I'm pleased to welcome you to Arco's third quarter 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, uncertainties and other factors that may cause our actual results to differ materially from those contemplated by these forward-looking statements.

Forward-looking statements in this presentation include, but are not limited to statements related to our business and financial performance, expectations and guidance for future periods, our expectations regarding our strategic product initiatives and their related benefits and our expectations regarding the market. These risks include those set forth in the press release that we issued earlier today, as well as those more fully described in our filings with the Securities and Exchange Commission.

The forward-looking statements in this presentation are based on the information available to us, as of the date hereof. We 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 constitute for results, prepared in accordance with IFRS. We've provided a reconciliation of these non-IFRS formation 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.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thanks, Roberto. And thanks everyone for joining Arco's third quarter 2019 conference call. We are now approaching the end of fiscal year and I would like to take the chance to do a short recap of our efforts to deliver our guidance, build our next year's ACV and integrate our recent acquisition, Positivo. I'll talk about them briefly and David will go over them in detail later.

Also, at the end of our presentation, I will share with you some of the results from a broad research, conducted by EY-Parthenon with over 1200 principles, school owners and parents of children enrolled in K-12 schools.

So starting with 2019, we've reached our guidance with BRL446 million in revenues in the last 12 months, what confirms the resilience and high visibility of our business model. Regarding the full-year of 2019 EBITDA margin guidance, we're on track to achieve the range of 35.5% and 37.5%. Now I'll talk about our successful 2020 Sales cycle. Before I comment on the guidance for ACV bookings, I wanted to provide a more qualitative update on what we saw throughout the sales process.

There are three important aspects to share with you all. The first is that once again, the majority of our growth came from the addition of new schools to our network, with significant contributions from both schools migrating from textbooks to learning systems and from schools changing their learning system to one of Arco's brands.

As a result, this year we had the largest intake of new students in our history. This confirm our thesis that as a pure-play, we offer the best alternative for schools and that the industry's structural shift from textbooks to high-quality learning systems, will continue to support our dominance in this market. The second point is that, once again we're able to maintain very high retention rates, which is a confirmation of the satisfaction of our partner schools with the superior content and service we provide.

This is one of the most important goals for our sales team and also for the management of the Company, and we are very proud to once again deliver industry-leading retention of clients. The third and final point, is that we continue to increase our share of wallet in the schools we serve, through up-sell and the offering of a more diverse portfolio of products. Those three factors are consequences of being a pure-play and having our customers and the quality of our products at the center of every business decision we make.

In this sense, we're glad to announce that our guidance for ACV bookings for 2020, including Positivo, will likely surpass BRL1 billion. The growth of Arco, excluding Positivo will be between 32% and 34% year-over-year. As most of you know, the ACV is the most important metric, dictating the growth of the company for the next 12 months. Such growth reflects our tireless focus on product, Arco brands were one of the first movers to implement the new national curriculum guideline, the so-called [Indecipherable].

After one entire year, would the new material being used by the students and with the feedback collected from our partner schools, we've further improved our content, which strengthens our brand equity with our clients. We intend to keep investing in product evolution and innovation with the objective to bolster our competitive advantage.

In addition to the quality of our solutions, a relevant part of our growth derives from the investment in our sales force. We intend to keep investing in both these key factors, quality in our sales team, in order to continue our growth, through an efficient mix of adding new partner schools, up-selling with our existing clients, cross-selling our solutions and maintaining high retention rates.

Finally, I would also like to talk about a very important achievement for us this year. As published in the beginning of the month, we officially welcomed Positivo into Arco's family. The more we learn about Positivo, the more excited we get about the future.

Positivo has a very solid brand reputation and we're convinced that we'll be able to accelerate its growth by combining [Phonetic] our forces, invest in technology and benefiting from a wider product portfolio and geographic exposure.

With that, I will turn the call to David, who will discuss all these topics in detail. Please David go ahead.

David Peixoto dos Santos -- Chief Financial Officer

Thank you, Ari. I'll go over our financial highlights and then give more details about our margins and free cash flow and provide guidance from 2020 ACV and ACV recognition for the fourth quarter of 2019.

And finally, I will talk about Positivo's acquisition. Also, please note that except for revenue, gross margin, selling expenses, G&A and cash flow from operations, all financial measures I discuss here are non-IFRS and growth rates are compared to the prior year comparable period, unless otherwise stated. First, reviewing our numbers. Net revenue for the third quarter of 2019 was BRL70.6 million, which represented 16% of the 2019 ACV versus 20% in the same quarter of the last year.

In 2019, a higher portion of our ACV was delivered between the fourth quarter of 2018 and the second quarter 2019, mainly because of international school growth, as most of their materials delivered between December and March and also booked and shipped in deliver months from some sort of schools. This trend is expected to continue and we will likely see an higher portion of ACV being recognized in the fourth quarter.

As previously mentioned by Ari, we reshaped our 2019 ACV guidance. Our net revenue in the last 12 months was BRL446.2 million compared to the guidance of BRL441 million. This confirms the projectability of our business model. The gross margins was 79.9% for the third quarter versus 78.2% for the same period in 2018 and it is in-line with our historical trend of increasing gross margins, as a result of gains of scale from our business growth.

In the first nine months of the year, our gross margins was 81%, up 280 basis point year-over-year. Selling expenses for the third quarter of 2019 was BRL47.6 million, up from BRL29.7 million in the third quarter of 2018 and BRL39.3 million in the second quarter of this year.

The sequential increase in selling expenses reflect a higher number of hunters and farmers, which is directly related to our ability to expand and retain our network of clients and also higher travel expenses. Those investments are reflected in our expected 2020 ACV growth, and given our very high LTV to CAC ratio, those are investments with very high returns to our Company.

And other impact in selling expenses for the quarter, was the accounting changes in allowance for doubtful debts this year. We recommend analysts and investors to look at this figure on a nine month accumulative basis and we don't expect this line to increase further in the next year. G&A expenses was BRL69.5 million compared to BRL77.0 million for the third quarter of 2018, and both numbers include novel 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 BRL23.7 million in the third quarter of 2019, increasing 35% versus the same period last year.

This increase is mainly explained by our investment in the attracting new talent people to our team, especially those, who will be directly involved in the integration of Positivo. On top of that, we think it is worth mentioning that we're currently developing new products in-house that we plan to launch soon. And these efforts tend to increase the SG&A before contributing to revenues.

Those investments are aligned with our commitment and mission to continue to be at the industry forefront in terms of new products launching and sustained this strong growth pace in the longer run. As a result of all those factors combined and also due to a lower revenue recognition this quarter, the adjusted EBITDA was negative BRL7.3 million for the third quarter this year, comparing to BRL10.8 million in the same period last year.

As Ari said, in the beginning of the call, we're on track to achieve the adjusted EBITDA margin of 35.5% to 37.5% in 2019 full-year, excluding Positivo. Adjusted net income was BRL0.8 million for the third quarter of 2019, compared to BRL6.1 million in the third quarter of 2018. In the first nine months of 2019, adjusted net income was BRL92.4 million, an increase of 34% when comparing to the same period of 2018, while the net margins increased 180 bps between these periods. Free cash flow for the third quarter of 2019, was BRL22.3 million, increasing 24% compared to the third quarter of 2018. In the first nine months of 2019, we generated BRL103.8 million in free cash flow or 101% of our adjusted EBITDA.

Moving now to the guidance. For the next year, we expect our consolidated ACV bookings to be BRL1 billion. With Arco's stand-alone, excluding Positivo growing between 32% and 34%. We will confirm this number in the next earning release in March, together with the 2020 adjusted EBITDA margin range expectations. As a reminder, this ACV will be recognized as revenue between October 2019 and September 2020.

Now talking about 2019. For the fourth-quarter this year, we expect to recognize between 26% to 29% of the ACV 2020, already taking into consideration that Positivo, will be consolidated in November and December this year. We maintained our guidance for adjusted EBITDA margin to be in the range of 35.5% to 37.5% for Arco, excluding Positivo.

Finally, I'd like to talk about our most exciting news this year, which is the acquisition of Positivo.

So Ari [Phonetic] approved the deal on October 23 and we closed the transaction on November 1st. At the time of the closing, we've made the first payment, representing 50% of the deal and the remaining amount is due to 2020 to 2024. As Ari mentioned before, we started the integration process with our team, 26 days ago. We'll soon share more details with the market, but what we can anticipate is that the more we learn about Positivo, the clear we see the normal value to be captured ahead. Positivo brings a very strong brand and motivated team. And the combined companies will have a very strong fundamentals to continue to consolidate this market organically and inorganically.

An important news we wanted to share with the market is the preliminary results from positive purchase price allocation. For which, we estimated a preliminary sum of identifiable intangible assets and goodwill of approximately BRL1.5 billion. This number may be updated in the fourth quarter earnings release. As you know, in Brazil, those two items can be amortized for tax purposes, over a period of at least five years, provided that certain conditions are complied with. One of those conditions as they send it to our book consolidation between buyer and acquired Company, which we intended to do in the first quarter of 2020. During [Phonetic] this timing, we might see the tax benefit of the amortization in the second semester of next year.

As per our initial estimates, the amortization of goodwill and the added value, would generate around BRL70 million of annual income tax savings for Arco in the first five years, significantly contributing to the Company's cash net earnings. After that, the tax benefit start to decrease and grows over the next 15 years.

With that, I'd like to turn the call back to Ari for his closing remarks.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, David. Before we conclude this presentation, I wanted to share with you some of the key conclusions from our research conducted by EY-Parthenon, with nearly 1200 principles and parents of students in private K-12 schools in Brazil.

The outputs from this survey, confirm the messages we've been sharing with the market in general, and provide support to our strategy and long-term goals. The first output is regarding the superior value perception from both principles and parents to learning systems versus textbooks. According to the research, 76% of the parents of children in schools adopting text books, believe that learning systems have higher quality and provide better academic results. Out of those parents almost 50% are willing to move their children to schools using learning systems.

From the parents perspective, 85% of the parents who moved their children from schools with textbooks to schools, with learning systems noted higher study engagement from their children. The second conclusion from the survey that we wanted to share is regarding the impact from our platform to the School's Ranking on the national exam, the so-called ENEM Exam. The survey showed that after five years of implementation of our products, schools that start to adopt SAS has an impact on the ENEM scores five times higher than the impact shown by schools that adopt our competitor learning systems. In the case of SAE, our second brand, the impact was almost four times higher.

The third conclusion from the survey is regarding Positivo. Positivo had the highest brand awareness among mid-tier learning systems by far. This confirms our -- it is of the power of Positivo brand and how much value and growth we may be able to extract as we continue to integrate this asset. We are very excited with the opportunities ahead and we'll continue to work hard to impact the life of more than 1 million students through high quality education.

We're here for the long run. With that, we would like to conclude this presentation and start the Q&A session. Operator, please go ahead.

Questions and Answers:

Operator

[Operator Instructions] I show our first question comes from Bruno Garadine [Phonetic] from Bank of America. Please go ahead.

Bruno Garadine -- Bank of America -- Analyst

Hello. Good evening everyone. Congratulations on the ACV bookings results. Could you please give us more breakdown on this growth in bookings in terms of geographies, brands. And also could you please give us some color on how has been the competitive landscape for this new additions for 2020? Thank you.

David Peixoto dos Santos -- Chief Financial Officer

So. Hi, Bruno. Thank you for your question. So since now in the third quarter, we're only providing the guidance to the ACV. And usually, what we do is in the fourth quarter, we confirmed this number and then we provide all this breakdown that you're asking for.

So for now on, what we can say is, as Ari mentioned before, we haven't seen changes in the way that we've been growing in the last years. So we've been attracting you as called, also up-selling, cross-selling and repaying our schools in-line with what we've seen in historical trends. However, as Ari said, also this year, we are on track to deliver the largest intake of new students in our history, and there is no specific concentration.

Bruno Garadine -- Bank of America -- Analyst

Okay. Thank you, Roberto. Thank you.

Operator

Thank you. I show, our next question comes from Joe Docharm [Phonetic] from Goldman Sachs. Please go ahead.

Joe Docharm -- Goldman Sachs -- Analyst

Hi, good evening all, good evening, Ari. Good evening David, Good evening Otero and congrats on the ACV results. So we have two questions on our side. One would be how you have seen the -- if you've any updated view on which would be the key drivers for further acceleration in ACV growth at Positivo? What changes in go-to-market and other factors could drive further improvements there?

And our other question would be, what is your view right now on other potential new acquisitions, and in your acquisition strategy in general, now that you're integrating such a large acquisition as Positivo? Thank you.

David Peixoto dos Santos -- Chief Financial Officer

So good evening and thank you for your question. So as I said before, so the ACV hasn't shown differences between this year and the previous one. So it is in-line with our expectations. So we have been adding new schools, up-selling price increase and cross-sell and retention. So there is no significant changes, and we expect to give you more color and information about others, this breakdown in the fourth quarter. Regarding the strategy and the go-to marketing, what we did this year is, as we said in the beginning of the year, we reinforced our sales team in order to cover all the addressable schools or more schools that are in our addressable market, and also we invest in new products. The same way that we've been doing the last years.

So despite of the successful results so far. We didn't change any sales policies or significant changes in our strategy, so we're keeping these things that we believe are the best one for this business. And as we said in the beginning of the year, we reinforced the sales team, and now we can see that actually, the strategy has been very successful, since there's intake of new students have been great.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Hey, Joe, this is Ari here. Thank you for your questions. Just to comment on the acquisition strategy, we're really focused here right now in integrating the acquisition of Positivo. And we want to do that in the best way possible.

But yes, we're still looking for opportunities. We do have a pipeline of new acquisitions, especially in the supplemental area where we believe we can have a broader portfolio in order to better source our current schools and new schools.

Joe Docharm -- Goldman Sachs -- Analyst

Thank you. Very clear. And just to be clear, this was [Indecipherable] speaking, forgot to mention that. Thank you.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Okay, thank you, sorry.

Operator

Thank you. I show no further questions in the queue. At this time, I would like to turn the call over to the host for closing remarks.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

So if there is no additional questions, we just would like to thank you everyone, for joining us and looking forward for our next call. Thank you.

David Peixoto dos Santos -- Chief Financial Officer

Thank you.

Operator

[Operator Closing Remarks]

Duration: 29 minutes

Call participants:

Roberto Otero -- Investor Relations, Director

Ari de Sa Cavalcante Neto -- Chief Executive Officer

David Peixoto dos Santos -- Chief Financial Officer

Bruno Garadine -- Bank of America -- Analyst

Joe Docharm -- Goldman Sachs -- Analyst

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