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Arco Platform Limited (NASDAQ:ARCE)
Q3 2020 Earnings Call
Nov 30, 2020, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon everyone. Thank you for standing by and welcome to Arco Platform Third Quarter 2020 Earnings Call. This event is being recorded and all participants will be in a listen-only mode during the company's presentation. [Operator Instructions] This event is also being broadcast live via webcast and may be accessed through Arco's website at investor.arcoplatform.com where the presentation is also available.

Now, I will turn the conference over to Carina Carreira, Arco's IR Director. Carina, you may begin your presentation.

Carina Carreira -- Investor Relations

Thank you. I'm pleased to welcome you to Arco's third quarter 2020 conference call. With me on the call today, we have Arco's CEO, Ari de Sa Cavalcante Neto; and Arco's COO, Pedro Guerra. 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 strategic product initiatives and their related benefits and expectations regarding the market.

These risks include those set forth in the documents 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 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 measure in our press release. Please note that except for revenue, gross margin, selling expense, G&A, and cash flow from operations, all other financial measures we 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.

Let me now turn the call over to Pedro Guerra, Arco's COO.

Pedro Guerra -- Chief Operating Officer

Thank you Carina and thanks everyone for joining Arco's third quarter 2020 conference call. We hope that you and your relatives are all healthy and safe. During today's call we would like to discuss four topics as shown in slide 4. First, our financial results for the quarter and for the 2020 school year. The resilience of our business model and the importance of our solution to partner schools allowed us to deliver a 2020 school year ACV in line with the contracted value. Net revenues and adjusted EBITDA presented triple-digit growth and we are confirming the margin guidance for the 2020 fiscal year of 35.5% to 37.5%.

Second, our guidance for 2021 ACV bookings; we expect solid growth of 20% to 25% with a broader range reflecting a delayed commercial cycle due to COVID. Third, an update on our operational results; we believe the accelerated evolution in our products, service and go-to-market practices implemented during the first nine months of 2020 further differentiated the quality for our solutions, our brand reputation and distribution capability.

As a result, we are experiencing record levels of user engagement, client satisfaction, retention and lead generation. These evolutions will bear fruits for years to come and we believe that Arco is emerging from this pandemic as a stronger company with even brighter growth prospects. Finally, we continue to approach our business with a Day 1 mindset promising a small market share in a large and fragmented addressable market. We are excited at the opportunities ahead for organic growth and M&A execution. Moving to slide number 5, we delivered BRL961.7 million of our 2020 ACV representing a gap of 4% to the contracted ACV.

This small gap is mainly related to temporary dropouts of pre K, Kindergarten and test prep courses. We expect the students to be reenrolled as in-school learning resumes. As a side note, BRL8.9 million of the 2020 ACV has been recognized in the fourth quarter. This delay follows requests of partner schools to receive the quarterly content later in the year due to COVID-related delays in their pedagogical calendars. We would like to highlight that the delivered ACV represents the totality of our revenue, as our business is fully subscription based. Therefore, our ACV is an excellent proxy to our expected revenues, with small possible adjustments to reflect actual enrollment in partner schools.

Turning now to slide number 6 to discuss our third quarter financial performance; we are pleased to announce strong financial results amid a challenging global scenario. Net revenue for the third quarter of 2020 was BRL208.7 million, which represented a 196% growth year-on-year. Our net revenue in the first nine months of 2020 was BRL705.2 million, 117% above the first nine months of 2019. Gross margin was 78.7% for the third quarter versus 79.9% for the same period in 2019. In the first nine months of the year, our gross margin was 78%, down 3 percentage points year-on-year due to small differences in the cost structure of Positivo acquired in the final quarter of 2019.

Adjusted EBITDA was BRL57.6 million for the third quarter of 2020 from negative BRL7.3 million in the third quarter of 2019, mainly due to the reduction of selling expenses and G&A expenses as a percentage of revenues. Adjusted EBITDA margin for the first nine months of 2020 was 36.2% compared to 31.7% for the same period of 2019. We are on track to deliver an adjusted EBITDA margin of 35.5% to 37.5% for the 2020 fiscal year. Finally, adjusted net income was BRL38.8 million for the third quarter of 2020 from BRL0.8 million in third quarter 2019. Moving now to slide 7 on Arco's guidance for 2021 ACV; 2020 has been a challenging year for schools where the suspension of in-person activities for more than six months and the sudden need to adapt to a completely new reality.

Despite this tough scenario, we expect to deliver an ACV growth of 20% to 25% for the 2021 school year. In regular years, we would typically have close to full visibility of our next year ACV by the end of November. This year, as we experienced a longer sales cycle following school year delays due to COVID we have partial visibility. For this reason, we've opted to share a broader guidance range. On slide number 8, we present the moving parts accounted for in this range. The lower limit considers conservative assumptions and no expected dropout recovery. While the upper limit considers further growth coming from additional renewals and new school intake, mainly in our supplemental solutions and partial recovery of the student dropout seen during 2020.

We have opted for a conservative assumption on dropout recovery, adding back only part of it given that at this point it is still unclear whether schools will be able to fully resume in-person classes in the beginning of 2021. However, it is important to mention that as the situation normalizes, we expect a full recovery into the dropouts in the coming cycles. We will confirm the 2021 ACV in the fourth quarter earnings release, together with 2021 fiscal year adjusted EBITDA margin guidance. As a reminder, we expect this ACV to be fully delivered and recognized as revenue between October 2020 and September 2021.

With that, I will now turn the call Ari. Ari, please go ahead.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, Pedro, and good evening, everyone. Thank you for your time and I also hope that you and your relatives are all safe and healthy. Let's now turn to slide 9. This year has been a period of intense change for Arco. We believe that we are even more prepared now to win this game, as structural changes in the sector favor the adoption of technology by students, teachers and parents while reinforcing our reigning factors of having a high quality and client center reputation and distinguished distribution capabilities. Moving to slide 10, while protecting our team we acted fast to offer comprehensive support to our partner schools and generate growth opportunities for our company. Beginning in March and continued to this day, we have designed and launched several innovations in the way we serve our clients and convert prospects.

We believe changes such as 100% of our content available in video, tools for live classes embedded in our platforms, fully remote pedagogical consultancy, and trusted investments in digital marketing and large scaled training of our salesforce for remote negotiations have further differentiated Arco. On slide 11 we offer a glimpse into the fully digital experience that our partner schools and prospects have enjoyed during this period. Almost 16,000 video classes delivered 340 webinars with global keynote speakers, a portfolio of online assessment tools with over 250,000 additional activities, and more than 9,100 remote pedagogical meetings with schools for teacher training and management support.

As we rolled out these innovations to meet the remarkable new levels of tech adoption by schools, we have experienced outstanding operational results as shown in slide 12. The engagement of teachers and students with our solutions has increased three fold. Customer satisfaction has reached record levels and we expect to deliver very high retention rates and healthy price increases. To deliver such strong operation and performance in a challenging year is a source of pride for us. In our business, trust and reputation are paramount to long-term success. And these results will drive referrals and growth for years to come.

Our revamped go-to-market strategy also contributes to an even brighter scenario ahead of us, as shown in slide 13. Combined, adopting fully digital strategies for generating leads, offering a premium solution to over 400 prospect schools and using a hybrid online/offline negotiation process have delivered record pipeline of qualified leads 2.5 times greater than the 2019 figure. These go-to-market changes are here to stay. And we believe that in the long run, they will contribute to higher salesforce productivity and an additional growth. Additionally, leads generated but not converted this year will be cultivated for closing over the following cycles. The conversion of these leads into new school intake has accelerated after schools start to reopen in mid-September as shown in the slide 14.

Given that signing a new school relies on a complex technical and trust-based decision process, prospect schools have postponed their decision to adopt new pedagogical solutions, while they were focused on assessing and dealing with the implications of COVID. Additionally, we believe that the last mile of negotiations will continue to benefit from in-person meetings. Therefore, schools starting to reopen and our sales team resuming traveling drove higher conversion of leads into contracts and strong year-on-year results for the later months of 2020. We expect that it will continue to be the case for the remaining months of the current sales cycle.

Let me now turn the call back to Pedro who will share our thoughts on the path ahead for Arco. Pedro, please go ahead.

Pedro Guerra -- Chief Operating Officer

Thank you, Ari. I will now switch to slide 15. We are excited with the opportunities ahead of us as we are only scratching the surface of a huge and fragmented market with underserved clients that share a pressing need for high quality solutions. We will continue to approach these opportunities from three angles: growing organically through our superior solutions and distribution capabilities; pursuing disciplined M&A for scale and scope, and wisely making bets in adjacent markets that might create additional growth engines in the long run without distracting us from more obvious and immediate prizes. As seen on slide 16, we currently have only 4% share in BRL25 billion market. Our five core brands together represent only 12% of the market share on BRL6.5 billion market.

We believe there's space to acquire additional core brands that offer attractive growth potential. The opportunities in supplementals are even greater as we have just begun our journey. Our supplemental brands have around 1% market share on a BRL18.7 billion market. On the verticals we already operate, we see space to complement our portfolio with new brands that have complementary position. Additionally, we have the potential to serve new and large verticals such as coding, robotics, and tutoring through in-house development or acquisitions. On slide 17, we present the factors that make us confident on our organic growth prospects.

First, our competitive advantages; the reputation of our brands, quality of our solutions and distribution capabilities, the reigning factors that have propelled Arco to this day have been further strengthened by the pandemic and we continue to drive our growth by disrupting textbooks and gaining share for other learning systems. Second, supplemental benefits from structural trends that will continue driving our organic growth for years to come. Educators, parents and students demand that 21st century skills take a leading role alongside traditional cognitive development. And the migration from out-of-school to in-school lowers the cost of education and delivers convenience to parents and students.

Finally, we benefit from having three powerful growth sources within our base of partner schools; 360,000 students for upselling almost all of our student base for cross-selling and space to increase prices following evolutions of our solutions that improve their value proposition to partner schools. Moving out to our M&A perspectives on slide 18; we believe that disciplined and accretive M&A will continue to be an important source of growth for Arco. There are three components to this belief. First, we play in a highly fragmented market where scale matters. There are over 400 companies in core supplemental and medtech in Brazil that generally lack the resources to scale and thrive.

Second, Arco is well positioned to be the prime buyer for the best assets, founders and owners prefer to partner with us. We make decisions and execute extremely fast given the benefits of being a focused pure play company. And we offer unrivaled growth potential for founders who wish to grow their companies within our ecosystem. Third, we have been consistently executing our M&A strategy for a long time, creating relationships with several owners and founders, resulting in active talks with 15 potential targets. We are actively pursuing opportunities to increase our scale by adding new brands in core to strengthen our portfolio and enter new verticals in the supplemental market and to improve our value proposition to clients through the acquisition of fintechs with great products and teams.

I will now turn the call back to it Ari for the final part of our presentation.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, Pedro. As we approach the end of our call, I would like to share good news regarding Positivo and Escola da Inteligencia. On Positivo, two pieces of good news. First, we are closing to concluding our back office integration that has been executed within the expected timeframe and cost. Second, it is gratifying to see significant improvement in customer satisfaction and retention just one year after the acquisition by reinforcing Positivo's frontline team, invigorating the company's leadership team and culture and by improving its products and services, our team has delivered a 15% increase in client NPS and 5 percentage points improvement in retention rates. As Positivo starts to shine brighter, we expect to capture growth synergies over the coming cycles.

Finally, on Escola da Inteligencia, we expect the Brazilian Antitrust Authority to present its final approval tomorrow, December 1, and a closing to happen on December 2. We are looking forward to EI joining Arco's portfolio of great companies. EI is the clear winner within the exciting social, emotional learning vertical and its talented team shares our same long-term focus on quality, clients and growth. With that, we conclude our presentation. I would like to thank our clients for the trust in our work; to thank our investors for all the support and our team for their relentless pursuit of excellence and value to our partner schools. We are here for the long run. Thank you for your time.

Operator, we can now open for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Vitor Tomita, Goldman Sachs.

Vitor Tomita -- Goldman Sachs -- Analyst

Good evening, all. Hope you all are well with you and your families. So we have two questions on our side. The first one is on competition. If you could give us some more color on how you are seeing competition moving during this final stretch of the sales cycle, and especially on how well competitors have been able to digitalize their sales approach, as you detailed on your side? And whether you have seen any competitors get more aggressive at this point? And our second question would be regarding digital-only offerings, with no printed content, if you already are seeing increased demand or increased opportunity for accelerating the introduction of this type of offering, or is the cultural factor related to physical books is still much a barrier at this point? Thank you.

Pedro Guerra -- Chief Operating Officer

Thank you for your questions, Vitor, Pedro here. First on competition; it is important to note that we have been competing in a fragmented market with basically the same players for a long time. We've been gaining share from existing learning systems, including disrupting textbooks from a combination of winning factors and distribution in brand reputation, and in quality of our solutions. You've seen that historically, and you'll also see that this year with record levels of retention and a very healthy price increase. We don't see significant changes this year in competition. Regarding your second question on tech adoption, yes, we believe tech will now even more be a key part of our solutions to schools. And that is represented both in the record levels of user engagement that we've experienced this year, but also in evolution of our product offerings, where we had significant acceleration in the rollout of new features and solutions for partner schools. We expect that in the coming years that will continue to be the case with growing levels of user engagements, and accelerating the evolution of our technology offering to partner schools.

Vitor Tomita -- Goldman Sachs -- Analyst

Thank you very much.

Operator

Our next question comes from Vinicius Ribeiro, UBS.

Vinicius Ribeiro -- UBS -- Analyst

Hi, guys. Good afternoon, everyone. Hope everyone is safe as well. Two questions on our side here. The first would be if you could give us a little bit of color on how much the complementary solution to the representative of the ACV particularly when guidance is provided? And the second, I just want to understand one thing a little bit in more detail. You said that the conversion of new schools accelerated when the school reopens. Can you just help us consider how does that mean for the go-to-market when you're using more digital or more digital part of our visit, with the conversion, it's only in fact materialized when the visit is made, or just so that we can understand how to secure in the sense further sales cycles. Thanks. Hello?

Pedro Guerra -- Chief Operating Officer

Hi, Vinicius. Thank you for your questions. First one regarding supplemental; first, it's important to know that each supplemental is going to have a longer cycle, even than core historically schools make a decision on supplemental after they decided on core. And even this year, the decision is delayed; we believe we still have some months ahead of us. So we still don't have complete clarity on how supplemental going up and up. And that is reflected in our guidance of -- in our range for the guidance. Second, we believe this is going to be a tougher year for supplemental and we foresee slower growth in our supplemental, whereas we see a very strong year for core. However, it's important to note that we're very confident on the long-term trends for supplemental as the schools are looking for 21st century skills to strengthen their education. And second, we see a move from out of school to in-school adding more convenience at a lower cost to parents and students.

Second, regarding our digital marketing; first, we believe that our future will be a hybrid model where we continue to invest in the generation of leads to digital marketing, where we use keynote speakers at large online events to accelerate the funnel and where we continue offering premium solutions. However, we still believe that the last mile of negotiations will be taken care by in-person meetings, where our consultants help the school to understand the details of the solution and generated trust and partnerships that are important for success. Finally to your question, we book our ACV when the contract is signed, so when we have a firm commitment from the school, the school cannot let go without significant penalties.

Vinicius Ribeiro -- UBS -- Analyst

Okay. Very clear, guys. Thanks.

Operator

Our next question comes from Fred Mendes, Bradesco BBI.

Fred Mendes -- Bradesco BBI -- Analyst

Hello, everyone. Thanks. Thanks for the call. I have two questions here as well. And the first one, if I can go back to the supplemental course, if you can just give us an idea about which ones, which products, if they are performing better, they're the ones that got the highest impact. The negative effects of COVID-19, I guess mainly the international schools, if you can describe a little bit more about this would be great. And then on the second question is there difference in the performance of your products? For example, if the more premium products they're performing they are like SAS, or they're performing quite even across the board? Thank you very much.

Pedro Guerra -- Chief Operating Officer

Hi, Fred, thank you for your questions. First, on supplemental, we're seeing similar dynamics for our supplemental solutions, longer sales cycle overall slower growth for the year, but with strong trends for the coming cycles that make us believe they will continue to be strong engines of growth for Arco. Second, on core, we're seeing similar behaviors for our solutions and the tendency of our price points, high customer satisfaction, very high levels of customer retention, healthy price increases and a strong pickup and rebound in new school intake after sales team returned to the field as the schools reopened.

Fred Mendes -- Bradesco BBI -- Analyst

Perfect, perfect, Pedro. Very clear. Thank you.

Operator

We have a question from the webcast. Ian Seskin [Phonetic] from BTG. Good evening, everyone. Does the guidance for 2021 ACV growth already considered Escola da Inteligencia? Thank you.

Pedro Guerra -- Chief Operating Officer

Thank you for the question. As you expect, Escola da Inteligencia to become part of Arco post-closing which is due to happen in the first days of December. We are including Escola da Inteligencia in our guidance.

Operator

Excuse me. We have another question from webcast. It's from Andres Davis. It says, good afternoon. Thank you for taking my question. Is your M&A growth strategy, how do you envision future acquisitions affecting our ACV and gross profits?

Pedro Guerra -- Chief Operating Officer

Thank you for the question. First, it's important to note that we believe the main engine of our growth will continue to be organic growth. Second, M&A will continue to have an important part in our growth as it has had in our past performance. We will pursue acquisitions in core with either other brands that have attractive growth potential or by gaining scale in our current brands. Second, we pursue M&A in supplemental solutions, either by reinforcing the portfolio where we already playing at or adding new verticals to Arco. Third, we continue to acquire great [Indecipherable] that offer high quality solutions and talented teams to help us increase our value proposition to clients. We will pursue these acquisitions with discipline and we only do so if we believe they are accretive to our company and to our shareholders.

Operator

[Operator Instructions] We have a question from the webcast. It comes from Alex. Good afternoon. Can you talk about the growth rate of EI for 2021 assumes and what it means for organic growth in 2021?

Pedro Guerra -- Chief Operating Officer

Thank you, Alex, for your question. Overall, we see Escola da Inteligencia following the same path as other supplemental solutions with a longer sales cycle with overall slower growth for the year, but with attractive long-term trends for growth and for adding new skills to schools and to students. We're not disclosing Escola da Inteligencia whole detail. We believe it is not material for Arco.

Operator

[Operator Closing Remarks]

Duration: 34 minutes

Call participants:

Carina Carreira -- Investor Relations

Pedro Guerra -- Chief Operating Officer

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Vitor Tomita -- Goldman Sachs -- Analyst

Vinicius Ribeiro -- UBS -- Analyst

Fred Mendes -- Bradesco BBI -- Analyst

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