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Arco Platform Limited (NASDAQ:ARCE)
Q2 2020 Earnings Call
Aug 17, 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 the Arco Platform Second Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to introduce your host for today's program, Roberto Otero, Arco's IR Director. Please go ahead.

Roberto Otero -- Director of Investor Relations

Thank you. I am pleased to welcome you to Arco's second 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 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 benefit and our expectations regarding the market.

These risks include those set forth in the press release that we issued earlier today as well as those more fully described in our filings with the Securities and Exchange Commission. The forward-looking statements in this presentation are based on the information available to us as of the date hereof. You should not rely on them as predictions of the 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 results to the most directly comparable IFRS financial measure 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 second quarter 2020 conference call. We hope that you and your families are all healthy and safe. I would like to start this call by thanking the efforts of our team who have been dedicated an enormous amount of energy to serve our partner schools and reaffirm our mission of being the best possible one-stop shop partner to our clients.

During today's call, we would like to discuss five topics. First, a recap on our quality recognition, a result of over 50 years of education experience and the gear behind our industry-leading growth rates. Second, an update about our new go-to-market strategy. We have been achieving significant results with it. Third, our financial results, which have been once again in line with our expectations. Fourth, an update regarding the integration of Positivo. We completed the corporate reorganization and now start amortizing the goodwill for fiscal benefit. Lastly, I would like to talk about Geekie, which is a very successful outcome from our strategy to invest in early stage disruptive companies. We will continue to invest in such companies as M&A continues to be an important pillar of our growth strategy and we are excited about it.

Moving to Slide number 4 and to go over the first topic on today's agenda, I would like to discuss why we are confident that we will continue to win this game in Brazil. In this industry, the ability to attract new partner schools is directly related to reputation, brand equity, and consistency of superior academic results over the years. This is not only a result of focus and a customer-oriented culture, but also our quality leadership track record and brand reputation driven by the academic results generated by our proprietary methodology, which has been evolving over the years as a result of investments in quality and content.

Our breakthrough technology-driven portfolio of services and innovative DNA, which has allowed us to be ahead of the competition in terms of developing its fully integrated educational platform and anticipate industry movements such as the adoption of supplemental solutions by schools. This was possible because of our tireless focus on creating value and generating returns focused on the long-term. An extremely powerful distribution network composed by over 5,000 schools and 1.3 million students. The combination of scale with trustworthy long-lasting relationships with our clients creates a phenomenal value for us to continue to offer new products and services to our schools.

These three pillars are not established overnight. They come from over 50 years of experience in education with a clear focus on quality and innovation. A result of this effort is shown in Slide number 5. For another year, schools using our solutions are listed among the best in the country and like last years [Phonetic], we have four partner schools ranked in the top 10 in Brazil's national exam. This is a remarkable result and shows the strength of our product across the country to position our client schools as top schools countrywide and not only in their cities. We also have the highest market share on top 10 schools at the ENEM exam with presence in 24 states out of the 27. Moreover, our students achieved on average scores 15% higher than the competition.

The superior academic results are possible because we have a customer-centric approach. To ensure our students will receive the most up-to-date and engaging content, our experienced in-house editorial team updates and improves the solution every single year and throughout the school year. Because we have segregated teams per brand, each of the teams is able to quickly react to customer feedback and make sure we implement those changes while maintaining the brand identity.

Added to that, each brand also has its own technology team focused on bringing new features that enhance the academic performance of our partner school and as a consequence, transform their students lives. Our technology is only meaningful because it is adaptive, fully integrated with our content and improved every year through our feedback and data generated by the users. Our in-house team is well-trained and fast [Phonetic]. During the quarantine, we were able to develop and implement several new features such as integration with third-party platforms, a podcast in live videos environment and further expand our online assessment platform.

As we just mentioned, quality and brand equity in this business are crucial to succeed and it takes time to build with no shortcuts. Our success shown by increasing market share and industry-leading retention rates came from our consistent and intense investment in people, content, and technology over the last years, putting us in a strong competitive position as our value proposition becomes stronger to all schools.

Now I would like to move to Slide number 8 to talk about our new go-to-market strategy. As we mentioned in the previous conference call, to start an internal project to redesign our go-to-market strategy as a way to boost the growth potential by remodeling our remote selling process and bringing our digital marketing to a new level. By implementing the change proposed and to further train our sales force, we were able to significantly increase the weekly lead generation with more efficient client acquisition costs.

We designed the go-to-market strategy in order to conduct a fully remote negotiation, sales and onboarding process more customized to our needs in reality. Improve the lead quality, we have currently 400 leads using our solutions on a trial version with a high level of customer satisfaction. We are confident that those changes will be valuable to us not only during this time while the remote sales model is needed, but also in the upcoming years with the acceleration of the digital transformation in schools. With that, I'll turn the call to David who will discuss the financials. Please David.

David Peixoto dos Santos -- Chief Financial Officer

Thank you, Ari. You can now turn to Slide number 9 where we are pleased to discuss our second quarter performance. Before we dig into the numbers, 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. We also note that year-over-year comparisons are affected by acquisitions that were not included in our 2019 financials. Now, I will go over financial highlights, then give more details about our margins and free cash flow, and finally provide guidance for the ACV recognition for the third quarter of 2020 and EBITDA margin for the 2020 fiscal year.

First reviewing our numbers, net revenue for the second quarter of 2021, BRL234.9 million, which represented 23% of the 2020 ACV. The revenue recognition may vary among quarters with no impact in the total ACV and this happens due to product mix, logistics, and our customers' decision on when to receive the content. As mentioned in our financial statements, given the quarantine, schools changed the schedule of the content delivered. Then eventually, we will recognize revenues related to the 2020 ACV during the fourth quarter of this year.

Net revenue for the first half of 2020 was BRL496.4 million versus BRL254.6 million in the same period last year. Gross margin was 81.6% for the second quarter versus 81.2% for the same period in 2019 and is in line with our historical trend. In the first semester, our gross margin was 77.8%, down 349 bps year-over-year reflecting a different revenue recognition seasonality among our brands as compared to the previous year. Selling expenses for the second quarter of 2020 was BRL88.1 million, up 124% compared to BRL39.3 million for the second quarter of 2019.

The higher year-over-year selling expenses reflect our investment in our sales team including hunters and farmers as an effort to offer continued support to our partner schools and expand our network of clients. The sequential quarter-over-quarter increase in selling expenses indicates our investments in the new go-to-market strategy in order to boost the 2021 growth potential given the new opportunities that are arising from this environment. Keep in mind that given our very high lifetime value-to-CAC ratio, those are investments with very high returns to our company.

G&A expenses was BRL60.1 million compared to BRL44.9 million for the second quarter of 2019 and both numbers include non-recurring expenses. Adjusting for share based compensation in 2019 and 2020 and M&A and other one-off expenses in 2020, G&A would have been BRL38 million in the second quarter of 2020, in line with the first quarter of this year. Adjusted EBITDA was BRL100.6 million for the second quarter of 2020, up 64% year-over-year. We are on track to achieve adjusted EBITDA margin of 35.5% to 37.5% in 2020. In terms of cash position, we ended the second quarter with BRL892 million in cash and equivalents and approximately BRL300 million of bank loans for a very comfortable liquidity situation even considering the future M&A payables.

Moving now to the guidance. Our guidance for the adjusted EBITDA margin full year 2020 is between 35.5% to 37.5% and before turning the call back to Ari for the closing remarks, I would like to provide an update on Positivo's integration process, which is on Page 10. On August 1st, we finalized the corporate reorganization and the incorporation of Positivo meaning we have a tax benefit of the deductibility of the goodwill and fair value adjustment of BRL529 million. The fair value adjustment should be deductible over the next five to 20 years. According to the use of life of the identified [Phonetic] assets and the goodwill should be deductible for at least five years under the Brazilian tax laws depending on the utilization curve established by the company in the initial use of the benefit. We also completed 90% of the back office activities migration to Arco's shared services center despite the challenges imposed by the COVID-19 social distancing measures. We are very proud of our team given that even during this unprecedented time, was able to successfully complete this step of the integration process. And with that, I would like to turn the call back to Ari for the closing remarks. Ari?

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, David. I would like to conclude this call by sharing about Geekie, a 100% digital learning system with artificial intelligence embedded and adaptive learning platform to drive a completely personalized learning experience to students. We first invested in Geekie in 2016 and have now achieved 53% of interest in the company. Since its inception, Geekie has been ahead of its time. It's white-label platform allows for content customization and more integration between the stakeholders and optimization of the teachers' daily activities by saving on average 60 [Phonetic] hours per month of their time.

During this impressive time, Geekie has been showing impressive results and is well positioned to post exciting growth with the acceleration in technology adoption by schools. The investment in Geekie is one more reason why we are positioned on the edge of education technology and why we continue to lead the industry transformation in Brazil. The financial and academic outcomes we deliver are possible because we have been making investments with a long-term return perspective. With that, we conclude our presentation. Thank you for your time and we can now open for questions.

Questions and Answers:

Operator

Thank you, sir. [Operator Instructions] I show our first question comes from the line of Pedro Mariani from Bank of America. Please go ahead.

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

Hey guys, good evening, thanks for taking my question and congrats for the results here. So I have two questions, first is regarding the M&A activity. I mean the company is still highly capitalized from the follow-on next year and given the macroeconomic context right now, are you seeing a higher number of M&A opportunities? What should we expect from M&A activity going forward? And secondly, I was wondering if you could please briefly comment about the competitive landscape during the pandemic. If there was any change in the environment both to grow organically or for the best targets of M&A as well. These are my questions. Thank you.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, Pedro for your question. So the pipeline is very active. We are looking at M&A as always in a very disciplined way and the pipeline is moving. We're very encouraged with the potential positive outcomes. We are looking in the three segments: core, supplemental, and tech. We still believe that we have a large room to diversify our portfolio of supplemental-type features with the progress of supplemental that we can offer both in terms of pricing and marketing positioning. The addition of Positivo network really increased our possibilities in terms of distributing new products, supplemental ones into our base. The integration of Positivo is moving well and we feel very comfortable to pursue new M&A opportunities in the future.

In terms of competition, we have been in the market for a while, it's a competitive and fragmented market and it's played on a quality basis, on a regional basis. I think we're still continuing to gain market share from our competitors because of the reason that we mentioned in the beginning of the call. We are a pure-play, we are 100% focused on K-12 [Phonetic] learning systems. Also, we're very focused on quality and we believe that we will be able to keep pursuing M&A opportunities as well as gaining market share from our customers.

And regarding M&A, I think we have been developing relationships with potential targets for a while right now and we have been building a reputation and I think we are in a very privileged position to continue to consolidate the sector organically. The potential sellers in industries in the industry, they attribute in a normal relevance the legacy and the growth of their business. So I think we're very well positioned to continue the consolidation of the sector.

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

This is great, Ari. Thank you very much.

Operator

Thank you. Our next question comes from Vitor Tomita from Goldman Sachs. Please go ahead.

Vitor Tomita -- Goldman Sachs -- Analyst

Hello, good afternoon everyone. So on our side, if you -- first question is if you could give us some more color on the school that led your number of schools in the top 10 ranking to go from 3 to 4, and also a related question on that is also a follow-up on Pedro's question is if you -- could you give some more color on how the competitive landscape has been evolving in terms of academic quality. So, namely if you have seen other players increasing investments to try to achieve a better level of academic quality and the exam results and competition on those metrics. Thank you.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Hi, Vitor, thank you. Thank you for your question. So I'm going to start for the second part. So regarding the competitive landscape in terms of organic growth, what -- so we haven't seen any changes in the competitive landscape or significant changes. So even though we are still early in the sales cycle because as you know, the majority of the new contracts they come later in the year, but even though that we haven't seen significant changes in the competitive landscape and the schools, they still focus a lot on quality and that's the main driver for decision and as you said, we are keeping delivering the high quality results that beat our history the way that we have been operating in the last 50 years and all those record is definitely helping us to keep our organic growth healthy and gain real market share from all the competitors and keep the prices of our products and solutions. So we haven't seen changes.

And give you more color about the sales cycle itself, as you also know, we have actually, the ACV bidding for the following year, it's composed by existing client schools. So we renew these contracts and also by adding new schools to our network and those two blocks, they happen at different stage of the year. The new category of these schools usually starts early in the year, which allows us to at this point have a very good visibility about the renewal process and it has been doing pretty well. So at this time, we have the same percentage of our contracts that we had last year. So it's in line with the previous and historical numbers, which shows a very healthy renewal rate. And as I said, the new ones, is it too early in the sales cycle? That's the same answer that we gave late last year when we had the second quarter results, but we are seeing things in line with what we have been expecting.

Vitor Tomita -- Goldman Sachs -- Analyst

All right, thank you very much for the answer.

Operator

Our next question comes from the line of Samuel Alves from BTG Pactual. Please go ahead.

Samuel Alves -- BTG Pactual -- Analyst

Thanks. Good evening, Ari, David, Roberto. Good evening everyone. Just two questions here from my side. The first one is regarding 2020 ACV. I think you guys just mentioned that may be part of the ACV of 2020 could be postponed to be recognized in the fourth quarter of this year. Maybe if you guys can quantify this effect. Do you think that this could be meaningful or not? And the second question regarding Geekie, just to hear more thoughts on the strategy for the company. I mean, do you guys expect to exercise the call option to have 100% interest in the company? When this is going to occur? If you could provide some big numbers on the company as well. That's it. Thank you very much.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Hi, so yeah, thank you, thank you for your question. So also talking about the ACV, so, yeah, as you could see in the presentation, considering the circumstances imposed by the COVID, we probably will have some revenue in the fourth quarter related to the 2020 ACV. That's mainly due to the close of these schools and the anticipation of vacations. So the school year this year should be longer than expected and should be beyond November and that's why we expect 2020 ACV to be also recognized in the fourth quarter. So overall, we have the ACV recognition has been postponed due to COVID. So it's hard to say now and to be precise about how much of the ACV will be recognized in the fourth quarter because it depends on when the classes are going to start. So we are monitoring this progress, but it should not be so significant. So we are optimistic that because we'll be back at some point in the third quarter and then we can finish the school year in the fourth quarter this year. So it's early to tell, but as you said, probably we will have some revenues in the fourth quarter this year. And regarding Geekie -- Go ahead, David, go ahead.

David Peixoto dos Santos -- Chief Financial Officer

So regarding Geekie, yes, we plan to exercise the option. So the idea is to have 100% of the company in 2022. So we are very, very excited about this opportunity and in creating something pretty unique and the potential of the business is huge. So we are happy with the entrepreneurs and all the team there and the idea is to keep helping them pursue their goals and when the contract is due, we will probably -- we will definitely exercise it.

Samuel Alves -- BTG Pactual -- Analyst

Okay, thank you very much.

Operator

Thank you. Our next question comes from the line of Caio Moscardini from Morgan Stanley. Please go ahead.

Caio Moscardini -- Morgan Stanley -- Analyst

Hi, good afternoon, everyone. So I have a question on the evolution of this new digital go-to-market, how is the evolution going and if you have been able to track if farmers and hunters productivity and results are actually improving, and also if I may, can you please give some color on the next year ACV as well. I believe we are already well advanced in the process, right?

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Sure, I can start here. So regarding the go-to-market strategy, we developed a process internally and we trained both farmers and hunters extensively so that they could be prepared to conduct a sales process 100% online. I think the results are already starting to show up since the number of leads that we have been generating has significantly increased for the last months and we are converting contracts with the sales 100% online. We have also achieved very qualified leads because of the different kind of events that we are hosting with keynote speakers. So the interest in the events and therefore the generation of leads has been very successful.

Regarding your second question, so most of the sales of new schools -- attracting new schools, they take place in the second semester. This is true for the previous years and this is also true for this years and the way we build our ACV is really by renewing existing contracts, up selling to different grades and products in existing in schools and this starts earlier in the year, but the second part, attracting new schools to the platform takes place mostly on the second semester. So, as we mentioned in the same 2Q call last year, it was too early at that time as well to predict how the sales cycle will take place. What we can tell is definitely since the school year will be longer, we can expect to add new schools and new students in the whole second semester and eventually in January or February since we have the school closure.

Caio Moscardini -- Morgan Stanley -- Analyst

Actually, just one follow-up. So the renewing process is more on the first half and has this been in line with your expectation or a little bit above, below. I remember that the churn increased a little bit in the past couple quarters mainly because of the integration of Positivo. Has the churn already started to come down or not really?

Ari de Sa Cavalcante Neto -- Chief Executive Officer

So talking about the renewal rate, the renewal rate is pretty much in line this year on what we have seen last year. So the numbers look good. In talking about Positivo, I think it's too early to see the impact, but what we have done there is really to have a chance to improve not only the go-to-market strategy, the incentive of the farmers, but also the digital platform because during the COVID, we could put in place significant new features of Positivo platform. So we can expect in the following years to have an improvement [Phonetic] in the renewal rates, but again, we will see as the cycle of closure, if we could have this improvement in renewal rate of Positivo in the first year.

Caio Moscardini -- Morgan Stanley -- Analyst

All right, thank you very much.

Operator

Thank you. Our next question comes from the line of Vinicius Ribeiro from UBS. Please go ahead.

Vinicius Ribeiro -- UBS -- Analyst

Hi, good afternoon, everyone. Thanks for taking my question. There are two. The first is another one on the go-to-market. What does exactly a lower customer acquisition cost mean? Are you guys -- is it related to logistics or the lead acquisition is cheaper. So what can we understand about this lower CAC? And my second is a shorter one. If you could give some color on the non-recurring expenses and the COVID-related extraordinary expenses that affected your results would be interesting. Thanks.

Roberto Otero -- Director of Investor Relations

Hi, Vinicius, Roberto here. We couldn't understand the first part of the question. Could you please repeat it?

Vinicius Ribeiro -- UBS -- Analyst

Yeah, sure, sorry. So on the go-to-market market strategy, I just want to understand what does the lower CAC mean? So is it related to the logistics that the farmers and the hunters need to visit or is that the acquisition cost of the lead cheaper? So what exactly does that mean?

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Okay, got it. So, hi, -- no, please go ahead, David.

David Peixoto dos Santos -- Chief Financial Officer

So regarding the new go-to-market strategy, one of the successful strategy that we've adopted is to launch a feature called digital school and the fact that we made it available to students from schools that actually didn't belong to our network, which enables us to generate digital leads, which are now part of our sales and strategies. And also as I mentioned in the previous conference call, we [Indecipherable] some part of our platform to be able to prospect schools. So all those things, they have been generating very qualified leads to our sales pipeline.

And as a consequence, we are not spending to visit schools and travel expenses and in-person meetings and events, and all those savings have been leading to more efficiency in acquiring leads. So that's the main concept behind it. That said, as Ari said, that one of the things that we will incorporate in our sales process that we will incorporate in our sales process, even though COVID and the quarantine would stop in the future, because definitely it's something it's a capability that we expect to use more in the future in a more hybrid operations with in-person meetings as well as those digital leads.

Vinicius Ribeiro -- UBS -- Analyst

Perfect. Did you guys get the second question?

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Yeah, could you say it again?

Vinicius Ribeiro -- UBS -- Analyst

So first of all, can you give us some color on the non-recurring and the COVID-related extraordinary expenses that impact your EBITDA?

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Sorry, Vinicius, I think I got it. Your line is cutting a little bit, but I think you asked about the non-recurring expenses, right?

Vinicius Ribeiro -- UBS -- Analyst

Yeah, that's it.

David Peixoto dos Santos -- Chief Financial Officer

So I mean part of these non-recurring expenses are related to COVID-19. So all those expenses related to the IT infrastructure that was due to service the schools during the pandemic and some one-off non-recurring expenses to protect the health of the employees as well. So this is what we are disclosing in the financial statements. So I mean when you have a look there, you are going to see that by breaking down what is related to COVID-19 and then the remaining portion of the non-recurring expenses are related to projects that are not part of the normal course of the business, most of them are usually related to M&A or strategic projects that are not part of the ongoing business, but in the financial statements when you have a look, you can see that we're breaking down and explaining what is COVID-19 related and what is most related to those one-off strategic projects.

Vinicius Ribeiro -- UBS -- Analyst

Yeah, thanks guys. Thanks for the answer [Phonetic].

David Peixoto dos Santos -- Chief Financial Officer

You're welcome.

Operator

Thank you. I show our last question comes from the line of Susana Salaru from Itau. Please go ahead.

Susana Salaru -- Itau -- Analyst

Hi, thank you for taking our questions. We had two. The first one is related to the commercial team. If you could provide some data on the conversion rates. Out of every 100 schools that are visit or compared to that, how many of them actually are converted in an actual client? That would be our first question. And the second question is related to the digital solutions. If the digital solution providers currently allows for live classes or just recorded classes? And if you plan to change the approach in terms of recorded versus live solutions please?

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Hi Susana -- OK, go ahead. Go ahead, David.

David Peixoto dos Santos -- Chief Financial Officer

Okay, I can do the first part and then you can help me, Ari. Well, I will just say that, Susana, as you know, the peak of the conversion rate of the sales, it happens in the next month. So it's hard to say now that whether conversion rate would be, especially because we are dealing with an emergency situation imposed by the quarantine. It's hard to predict the conversion rate, but we expect to have more visibility about this in the third quarter. Please Ari, go ahead.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

So regarding the product, Susana, thank you for your question. We have both type of classes. We have still live classes for schools to keep their education process. So we have live classes for all the subjects and all the grades and some schools are using that product as they teach their students and we also have pre-recorded classes, a huge library with more than 3,000 video classes recorded and this is used as a reinforcement in the process as for instance, for the classroom methodology or some teachers that cannot give a specific lesson on any specific day. So the schools use as they want. So we have both types, the pre-recorded classes and the live classes.

Susana Salaru -- Itau -- Analyst

Perfect, thank you. Very clear.

Operator

[Operator Closing Remarks].

Duration: 42 minutes

Call participants:

Roberto Otero -- Director of Investor Relations

Ari de Sa Cavalcante Neto -- Chief Executive Officer

David Peixoto dos Santos -- Chief Financial Officer

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

Vitor Tomita -- Goldman Sachs -- Analyst

Samuel Alves -- BTG Pactual -- Analyst

Caio Moscardini -- Morgan Stanley -- Analyst

Vinicius Ribeiro -- UBS -- Analyst

Susana Salaru -- Itau -- Analyst

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