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Arco Platform Limited (NASDAQ:ARCE)
Q1 2020 Earnings Call
May 27, 2020, 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 Arco's Q1 2020 Earnings Call. [Operator Instructions] After the speaker presentation there will be a question-and-answer session. [Operator Instructions].

I would now like to hand the conference over to your speaker Mr. Roberto Otero, Arco's IR Director. Please go ahead, sir.

Roberto Otero -- Director of Investor Relations

Thank you. I'm pleased to welcome you to our first quarter 2020 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 presentations, our executives will make forward-looking statements. Forward-looking statements generally relate to future events or future financial or operating performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from those contemplated by these forward-looking statements.

Forward-looking statements in this presentation include, but are not limited to statements related to our business and financial performance, expectations, and guidance for future periods. Our expectations regarding our strategic project initiatives, and the related benefit and their execution 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 now rely on them as predictions of future events, and we disclaim any obligation to update any forward-looking statement 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.

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

Thank you, Roberto. And thank you, everyone, for joining Arco's first quarter 2020 conference call.

Given the unprecedented moment we are right now, I would like to start this call by thanking the efforts of all the frontline workers. I would also like to thank the Brazilian teachers who have been equally brave in adapting to an unprecedented context in finding alternatives to keep the students learning. Finally, I would like to recognize the tireless work of our 1,900 employees who have been dedicated an enormous amount of energy in further strengthening our platform to once again [Indecipherable] our mission of being the best mission-critical partner to the school's.

During today's call, we would like to discuss three important topics. First, how COVID-19 has impacted us so far and the actions we took to overcome the challenges and help our clients. Second, I would like to do a short recap on our strategic pillars and growth plans. Lastly, our financial results which have been once again in line with our expectations. This quarter proves the results of our business model and the fact that we operate under annual contracts. David will go over our results in more detail soon.

Moving to slide number four and to go over the first topic on today's agenda. I would like to start with a recap of Arco history and its mission. I think it will help us understand why -- how Arco was able to react so fast to the challenge imposed by COVID and with incredibly positive feedback from our clients so far. At the end, it's all about focus, focus on the long term, focus on quality and focus on our people.

When we started business 13 years ago, our mission of transforming the lives of our studets through education was already alive. This means that since Arco's inception, our energy resources have been allocated in a way to create the best education platform in Brazil and being the best possible partner to our clients. This goes beyond our product development process or our IT platform. This is about the quality of our people, our customer focus culture, and that values based on which we run this company, make the decisions and plan for the future.

As a result of this focus is what we see on the slide number five. We have been investing in our product, in our team and created integrated platform to our clients. We are able to offer a comprehensive set of products, features and services to the schools, its teachers and their students. This broad array of elements under a one-stop shop concept creates a powerful solution to the schools, offering from pedagogical support services to online assessment, digital books and teacher training programs.

So as we show on the slide six, when the COVID-19 pandemic hit, affecting an important part of the school environment, the classroom, we are ready to support our client schools. We had everything the partner school need in order to keep teaching their students, study guides, video classes, online assessment, digital books and teacher training. And they were all integrated with our content and is extremely important. We decided to move one step forward and help our partner school even more. So we created a virtual school by offering daily live classes to all students across all grades.

In our last earnings release call, we mentioned we had designed and approved a contingency plan. As soon as the disease started to proliferate, we started to execute it. We acted fast, we are able to change and adapt our product operations, consultancy services and go-to market strategy under unprecedented conditions.

I would like to go in more details about these changes divided in four main categories as shown in slide number seven. First, the changes to the product. An important part of the school environment was critically affected, the classroom. To replace it, we created a virtual school by offering daily live classes. Given the inadequate quality of the public education in Brazil, we understood that we had to step forward to support our community. So we made the live classes available to any student in Brazil free of charge.

In terms of our operations, we had to guarantee the safety of our employees and the stability of the operations while working from home. With that taken care of, we focused on maintaining the physical and mental health of our team by providing psychological support and telemedicine service.

The third pillar is the pedagogical consultancy. COVID-19 brought changes to the school that not all stakeholders were ready for. To help school owners and teachers navigate through this new technology environment, we have been promoting webinars on relevant subjects, such as communicating with parents, engaging students and managing crash course.

Last group of changes is the go-to-market strategy. Schools that use textbooks or less visual learning system are struggling to maintain classes. We are unbundling part of our solution to enable potential customers to use it. This helps them to better serve their students during this difficult time, while having the chance to sense our technology in high quality content and methodology.

We have also hired a consulting firm to help us boost the 2,021 growth potential given the new opportunities that are arising from this environment. The impact of all those changes are well displayed on the video provided in the earnings release presentation. I suggest that you take the time to watch it because it's also a great way to learn a little bit more about our solutions.

We not only impact the lives of 1.3 million students, but also the lives of students all over Brazil from both public and private schools. As we show on slide eight, today we have accumulated more than 24 million views of our 6,400 live classes and the number of subscribers from our YouTube channels multiplied by five since January. This exposure brings benefits to the business and our strategic pillars.

Before I turn to call to David, I would like to say that given the uncertainties around the COVID-19 situation, we have also mapped several efficiency levers and cost cutting initiatives, which together with the synergies from Positivo should protect our profitability and our cash flow generation in case of potential negative impacts to our business.

I'll turn the call now to David to go through our strategic goals and discuss our quarterly financial in details. David, please go ahead.

David Peixoto Dos Santos -- Chief Financial Officer

Thank you, Ari. We can now go to slide nine. And here, we would like to reinforce where we have been focused in order to continue to generate value to our shareholders. Our first pillar is to strengthen our quality leadership in Brazil and continue to bring sustainable organic growth. We continue to see strong academic results from our client schools, and we sense increased client satisfaction coming from the response we provided during the COVID-19 crisis. We also expect increased digitalization of schools and an even clearer value proposition advantage of learning system against textbooks. This should further accelerate the structural shift we have witnessed in the industry over the last years.

Our second strategy is to value creation through the integration of Positivo. The integration continues to move despite the remote operation. We took important steps in terms of product development, go-to-marketing strategy and shared services integration and people. As mentioned in the previous call, we are confident with our plan to generate between BRL15 million to BRL17 million in annual EBITDA synergies by the fourth year of integration.

Lastly, we continue to look for M&A opportunities with three different purposes. The first, to increase our network of schools and gain further scale; second, to expand our portfolio of programs mainly on supplemental; and finally, to have new text features to our platform and further enhance our client experience. Those three pillars remain intact and continue to drive our focus and resource allocation.

We can now turn to slide 10 where we are pleased to discuss our first quarter performance. And before we dig into the numbers, please note that except for revenues, gross margin, selling expenses, G&A and cash flow from operation, all financial measures I discuss here are non-IFRS and the growth rates are compared to the prior year comparable period unless otherwise stated. We also note that year-over-year comparisons are affected by acquisitions that were not included in the 2019 financials.

So let me start reviewing our numbers. Net revenue for the first quarter of 2020 was BRL261.6 million, which represented 26% of the 2020 ACV versus 26.5% in the same quarter of the last year. The gross margin was 74.3% for the fourth quarter versus 81.3% for the same period in 2019, reflecting a deeper revenue recognition seasonality among our brands as compared to the previous year.

Selling expenses for the first quarter of 2020 was BRL87.9 million, up from BRL36.1 million in the first quarter of 2019 and BRL76.7 million in the fourth quarter 2019. The sequential quarter-over-quarter increase in salary expenses reflect a higher number of hunters and farmers and higher travel expenses. Those investments are reflected in our 2020 ACV growth and given our value -- our very high lifetime value to CAC ratio, those are investments with a very high returns to our company.

G&A expenses was BRL66.8 million, compared to BRL20.8 million for the first quarter of 2019 and both numbers include nonrecurring expenses. Adjusting for share-based compensation in 2019 and 2020 and M&A and other one-off expenses in 2020, the G&A would have been decreasing as a percentage of revenues due to economies of scale. As a result of all those factors combined, the adjusted EBITDA was BRL96.9 million for the first quarter of 2020 compared to BRL49 million in the same period last year.

Adjusted net income was BRL56.2 million for the first quarter of 2020, compared to BRL40.8 million in the first quarter of 2019. In terms of cash position, we ended the first quarter with BRL833 million in cash and equivalent and roughly BRL300 million of bank loans for a very comfortable liquidity situation even considering the future M&A payables.

Moving now to the guidance. For the second quarter 2020, we expect to recognize around 20% of the 2020 ATV. Also, we expect our adjusted EBITDA margin in full-year 2020 to be in the range of 35.5% to 37.5%.

And with that, I would like to turn the call back to Ari for his closing remarks.

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

Thank you, David. I'd like to once again express my gratitude to our team who once again have demonstrated their passion for education and act to serve our clients with excellence. We'd like to share our results of a net promoter score survey with the schools who use our platform during the quarantine. The NPS was 89% which shows a high level of customer satisfaction.

Our digital transformation accelerated years. We believe our consistent and intense investments in technology over last years as well as the evolution of our platform put us in a strong competitive position as our value proposition becomes stronger to all schools. We are here for all schools, for our community and for the long run.

With that, we conclude this call and can move to Q&A session.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Pedro Mariani from Bank of America. Please go ahead.

Pedro Mariani -- Bank of America Merrill Lynch -- Analyst

Hey, guys. Good evening everyone. Thanks for taking my question and congrats for the results. So, my question is more on the qualitative side here. I wanted to understand actually what do you see as next for the industry once all of the situation around the COVID-19 normalizes? And what sort of structural changes to the industry overall do you anticipate once the things go back to normal, in terms of both products and also for growth potential? So this is my question. Thank you.

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

Thank you, Pedro, for your question. I hope you're doing fine. As you said, you're correct, the pace of digitalization into schools really increased in a very intense way for the last two or three months. The schools are much less resistant. Actually they are eager to use technology. And I think that fact put us in a very strong position because our solutions were already very strong in terms of delivering content through technology. What we've done in the last period was really to accelerate the product developed pipeline. We anticipated a lot of the features that were supposed to be developed over the years and we could then -- we could do that in the last weeks.

And yes, we see a structural shift, especially for those schools who still use textbooks. They use textbooks -- printed textbooks with no technology. And I think that will definitely accelerate in the medium term, the fact that the schools recognize that technology is really essential on an education process.

And we also see a structural shift even from learning systems that have little or no technology for solutions that carry a strong technology integrated with content. So, of course, we do see challenges in the short term, but in the long term, our view is that we are confident on the value proposition of our solution to our clients and optimistic in terms of the future.

Roberto Otero -- Director of Investor Relations

[Indecipherable] thanks for the call here. And hope you are safe and well there too. Thank you.

Operator

Thank you. Our next question will come from Diego Aragao with Goldman Sachs. Please go ahead.

Diego Aragao -- Goldman Sachs -- Analyst

Yes. Hi. Thank you for taking my question. I guess I was wondering if you can comment on the current sales cycle and then give us some ideas of how your sales are trading at this time given that I would imagine most of your employees are working from home, so not necessarily they all -- they can easily reach out to their -- to the potential clients. So probably the entire situation would also make it more difficult to present, sell and convert some of the new schools. So if you can just comment on how things have been progressing so far, that would be great. Thank you.

Roberto Otero -- Director of Investor Relations

Hi, Diego...

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

Hi, Diego -- [Speech Overlap] go ahead. I can add you. Sorry.

Roberto Otero -- Director of Investor Relations

All right. So, Diego, I think in order to answer this question, I think it's important to explain or to recap how our ACV is built throughout the year. So we basically build the next year's ACV by, of course, renewing our contract with the committee and client schools and also by adding new schools to our network. So those two blocks, they happen at different stages of the year. The first one, the renewal of the contract usually starts earlier in the year, which allows us to make better comparison versus previous cycles right now.

So what we can say at this point in the cycle until now, our renewal rate and the average ticket show very healthy patterns. So we don't see any negative impact to our renewal base for 2021. So when you look at the churn or the renewal of contracts in real term, actually they look very healthy as I said.

Moving out to the second block, which is the addition of new schools. Usually, this movement starts to gain traction from the month of July onwards, so it's early to make conclusions. But I think that Ari and David, they can also add their thoughts here.

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

Sure. Hi, [Indecipherable] thank you for your question. Yes. So, I can comment and David can complement me. So, we are really conducting a new go-to-market strategy, the digital school launch generated many, many leads and we have unbundled our solution so that schools that are still not our clients can use some of the solution that is included in the platform. So we have a significant number of schools and students already using this trial version. And of course, that could translate into contracts in 2021.

This is the first time that we have schools and students that are not still clients using our solutions. And as we discussed before, the NPS has been incredible. And of course, we are optimistic in terms of conversion of these leads, but it's still too early to conclude and to forecast any kind of signed contracts. And as Roberto explained very well, the peak of the sales campaign is in the second semester.

Diego Aragao -- Goldman Sachs -- Analyst

That's very helpful. I guess just maybe as a follow-up. When you talk about like the renew, the amount of students that the schools -- the partner schools are considering, are those pretty much the same in line with the contract and hire for the year? Or are you seeing some changes to it? I'm just asking, because anecdotally speaking, I guess, some of the debate within the parents right now is whether or not they will be able to afford to be paying the private schools. So I think it would be helpful if you can just provide like some thoughts about it and how things have been trading so far? Thank you.

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

Yes. So I would say that in terms of the economics and the profile of the contracts with the schools, we're not seeing any changing behavior in terms of requests for discounts or any sort of trade down within the products. As you know, I mean, we have products across different pricing segmentations, but we're not seeing both in the renewal of the contracts and also in the new ones any change in terms of appetite for lower or higher prices or request for discounts, including for those contracts which are being renewed for next year, Diego.

Diego Aragao -- Goldman Sachs -- Analyst

Perfect. Thank you. And I guess the second question, quickly if you can comment on the integration of Positivo. I'm more curious about how have you been able to, let's say, shift some of the internal process of Positivo to your platform, putting their brand in a type of business and platform that Arco has for SAS and SAE. I mean, are you able to shift some of those process quickly? Should we be expecting something different in term of Positivo's brand and targets for next year? How those are being, let's say, so for?

David Peixoto Dos Santos -- Chief Financial Officer

Hi, Diego. Here is David. So in terms of the integration, our main concern for this year, it was focused on two things. So the first one is, organizational design. So we implemented some changes in the management level to redesign the teams more in line with the strategy that we believe is the best one. And the second, it was the go-to marketing strategy. So we had a challenge to adapt the go-to market strategy of Positivo to the go-to marketing strategy that Arco's other brand adopts. We spent the 2019 year simply signing. We spend six months only planning this transition. And then when the closing date came, we had a chance to rapidly execute those main changes.

And that's actually what usually happens once a year. So considering the nature of the business that operate minimal terms and with annual cycle, we usually do this. So we plan through the year and we execute the main changes in December and January. And then things are set and then we can have the sales season working on.

So, having said that, we had those benefit to implement the major changes in January this year which was before the corona crisis start. So that's the first thing that I would like to say about the integration of Positivo. So the main changes have happened already, and we were not expecting significant changes to happen throughout the year.

However, what actually benefited us with the situation is the client -- so we were not expecting to implement significant changes in terms of product this year. So even though we have a technology to deploy in the Positivo solution, the strategy approach that we have applied for larger M&A transactions in the past, it was to do those in phases. So the first year is more focused on go-to market strategy. And then the following years, we can implement the deployment of the technology and then changes in the product itself.

However, with -- and mainly, we do that because the client needs time to really get a few keys as the new order of the solution. So, we prefer to not bring a lot of attrition in this relationship, implementing changes in the first day. So usually, we wait a little bit and then implement later.

Having said that, this year we had this opportunity to execute some of those changes and brought it already this year, because the clients, they have been pushed to use technology and the Positivo's client, they were with no technology in their product. So when the crisis started, they had a chance to really use the platform that we could deploy from all the grants to Positivo. And by doing that, they have a good experience and their level of engagement and their level of satisfaction increased a lot.

So what we have heard recently is that, the clients of Positivo are very happy that Arco acquired the business, and they are very happy how we embrace the whole situation. And they had a feeling that if they were with this former solution, they will be in a worse scenario right now. So in terms of the client relationship, actually, this crisis gave us an opportunity to really work closely with the client. And in the Positivo case, it's regulated to bring them some technology, and we hope that this would increase some level of satisfaction.

Diego Aragao -- Goldman Sachs -- Analyst

That's very helpful, David. Thank you for that.

Operator

Thank you. Our next question will come from Susana Salaru with Itau.

Susana Salaru -- Itau BBA -- Analyst

Hi, guys. Thank you for taking our questions. The first question is related to the NPS. Could you just elaborate who participated in the NPS? Is the teachers also participated? That would be the first question regarding the NPS. And the second one was, if the schools that are using the solution of Arco, but not clients of Arco, they -- if they did participate or not in the NPS? That would be our first question. And then our second question is related to these schools that are using the solution. What if they are not yet a client of Arco? If you could just give us a sense of how many are those schools, how did you reach them and if you expect what kind of conversion rates. Thank you.

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

Thank you, Susana. Great question. Hope you're doing well. So the net promoter score is 100% from prospective customers. In terms of evaluation of our current customers, we do have current assessment throughout the year. But in that case, the NPS is 100% taken from prospective customers and usually the school owner or the person who is responsible to do relationship with our brands or the person who is responsible for the pedagogical area of the school.

The way we are reaching these schools is through many events and lives. So we are conducting several events online with keynote speakers, with experts from education, technology. And as we attract these schools, they turn to leads, and we are conducting different events in the funnel so that we can evolve these clients in terms of the funnel.

And we are creating different ways to present the product and the solution so that they start to use the trial product. As they use the trial product, we are offering support services, consulting, so that they can understand, for instance, the performance of their kids as they do tests in the platform. They can understand how many times the students are using the platform per day. And they are using our platform at the same time that they are using, for instance, textbooks.

We have a significant number in the lead. But as I said before, it's really hard to predict what the conversion will be. What we have seen so far is that, the level of success is very high, and it's really the first time that we have been able -- that prospective students and teachers are using the platform one year before they would essentially sign the contract with us. So we expect that in the following months, we can convert many of these leads and build up strong ACV for next year.

Susana Salaru -- Itau BBA -- Analyst

Perfect. Very clear. Thank you very much.

Operator

And speakers, I'm showing no further questions in the queue. I would like to turn the call back over to you for any further remarks.

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

So thank you, all for participating in our call. We are working hard to deliver the high-quality education that we have developed over the years throughout schools. Hope everyone is fine and well. And hope to see you soon in the next months or so and hope that you all stay safe. Thank you very much.

Operator

[Operator Closing Remarks]

Duration: 36 minutes

Call participants:

Roberto Otero -- Director of Investor Relations

Ari de Sa Cavalcante Neto -- Founder, Chief Executive Officer and Director

David Peixoto Dos Santos -- Chief Financial Officer

Pedro Mariani -- Bank of America Merrill Lynch -- Analyst

Diego Aragao -- Goldman Sachs -- Analyst

Susana Salaru -- Itau BBA -- Analyst

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