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Arco Platform Limited (NASDAQ:ARCE)
Q1 2021 Earnings Call
May 24, 2021, 6:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good evening, everyone. Thank you for standing by, and welcome to Arco Platform's First Quarter of 2021 Earnings Call.

This event is being recorded and all participants will be in a listen-only mode during the company's presentation. After Arco remarks, there will be a question-and-answer session. At that time, further instructions will be given. [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'll turn the conference over to Carina Carreira, Arco's IR Director. Please Carina, you may begin your presentation.

Carina Carreira -- Investor Relations Director

Thank you. I'm pleased to welcome you to Arco's first quarter 2021 conference call. With me on the call today, we have Arco's CEO, Ari de Sa Cavalcante and Arco's CFO, Roberto Otero.

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. Our expectations and guidance for future periods, our expectations regarding strategic product initiatives and their related benefit and our 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 in 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 from revenue gross margins, selling expense, G&A and cash flow from operations, all other financial measures we disclose 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 2020 financials.

Let me now turn the call over to Ari, Arco's CEO.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, Carina and thanks everyone for joining today's conference call. We hope that you and your family are all healthy and safe. We would like to present three topics today as shown in slide three. First, our healthy operating results for the quarter, despite the challenging scenario, with a strong 28.5% revenue recognition and an adjusted EBITDA margin of 35.7%. We are maintaining our margin guidance of 35.5% to 37.5% and expect our free cash flow to improve along the year, as we collect the receivables, reduce capex and benefit from a lower effective tax rate. As we now have better visibility on the actual numbers of students enrolled, revenue recognition for 2021 is leading to slightly lower versus ACV impact by the second wave of COVID-19 in Brazil.

Second, the commercial cycle for 2022 school year continues to show encouraging results and we are excited about our recent movements for growth in the years to come. We have strengthened our core segment with the acquisition of COC and Dom Bosco. We are achieving great results from our cross-sell initiatives and continue to leverage on our superior value proposition and consistent improvement in our offering and the interest in B2C will allow us to explore this huge and promising market. And finally, we will present an update on our ESG Agenda and we conclude our materiality assessment.

I will now turn the call to Otero to discuss the results for the quarter. Otero, please go ahead.

Roberto Otero -- Chief Financial Officer

Thank you, Ari And good evening everyone. Thank you for your time and I also hope that you and your relatives are all safe and healthy.

Moving to Slide four. Net revenues for the first quarter of 2021 were BRL331.7 million, representing a 27% growth year-over-year. Revenues for core solutions increased 20% versus the first quarter in 2020 and supplemental solutions delivered a 64% growth impacted by the addition of Escola da Inteligencia to the portfolio.

Cost of sales increased 30% year-over-year, leading to a gross margin of 73.7%, in line with the same period last year. When excluding depreciation and amortization related to our Educational platform, cash gross margin actually expanded 160 basis points to 78.7%. Selling expenses, excluding depreciation and amortization increased 35% year-over-year, representing 36% of revenues versus 34% last year. This increase reflects the additional sales personnel resulting from the restructuring of the commercial teams from recently acquired solutions such as Positivo. General and administrative expenses, excluding depreciation and amortization on the other hand increased only 7% to 22% of revenues from 26% in the first quarter last year, as a result of our reduction on travel expenses and gains on scale. As a result, adjusted EBITDA reached BRL118.4 million, 22% above the first quarter last year with 35.7% EBITDA margin. Finally, adjusted net income was BRL61.1 million for the quarter from BRL56.2 million in the first quarter 2020 with adjusted net margin of 18.4%.

Turning to slide six, we'd like to make a quick recap on the dynamics for ACV bookings, revenue recognition and cash collection for our business. We kick-off the commercial cycle for the ACV bookings on the year prior to the beginning of the school year and we start recognize revenue as we deliver the material to partner schools. For the Core segment we have on average four deliveries per year, usually one month prior to the usage in the classroom. For the supplemental solutions, we usually deliver the material twice a year. The cash collection matches the fiscal year or the school year. In a normal year, the vast majority of our partner schools pays for our solutions in up to eight instalments with only a small portion pay in up to 12 instalments. However, due to the COVID-19 pandemic and the challenging environment for the educational segment, we opted to support our schools and protect our pricing and retention through slightly more flexible payment terms. Therefore, receivables from 2021 school year are more concentrated between the second and fourth quarters with only 2% having slipped to 2022.

On slide seven, we present the breakdown for our receivables and the year-over-year increase mainly relates to the neither past due, nor impaired portion, reflecting the more flexible payment terms. As the profile of our receivables improve and we evolve our interim processes, we see the allowance for doubtful accounts returning to pre-pandemic levels.

Moving now to slide eight, we intensified investments in content development and technology in the first quarter to further strengthen our solutions ahead of the commercial cycle. Positivo was the brand with the largest investment, part of our goal to improve acquired solutions to increase customer satisfaction and retention rates, as well as accelerate organic growth. Investments should reduce as a percentage of revenues in the upcoming quarters and finish the year below the historical 10% level.

On slide nine, we detail the corporate restructuring the company is undergoing and the potential for additional tax benefits. Today, only Positivo and part of SAS both incorporated under CBE or Companhia Brasileira de Educacao e Sistemas de Ensino S.A. benefit from amortization of intangible assets and goodwill from business combinations, representing around BRL60 million per year. This year we should conclude the incorporation of the four remaining subsidiaries of SAS into CBE and save additional estimated BRL30 million in taxes, starting in 2022. As we incorporate other businesses into CBE, we will be able to capture additional tax benefits and therefore further reduce our effective tax rate, currently at 20.3% from 32% in the first quarter of last year. As a result of the improvement in the upcoming months in these three lines, receivables, capex and taxes, we expect our free cash flow generation to increase. In fact, results from April already show our free cash flow 2 times higher versus April in 2020, which means collection accelerated in line with our expectation and cash flow generation should be concentrated between Q2 and Q4.

Finally on slide 10, we present a schedule for the payment of our debt and sellers notes. Our cash position is enough to cover for the short-term and mid-term obligations and we already have firm proposals from banks for a credit line between BRL600 million to BRL700 million to strengthen the balance sheet at attractive conditions.

I will now turn the call back to Ari. Ari, please go ahead.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, Otero. We are very excited about our recent initiatives and the prospects for the future. First on slide 12, the acquisition of COC and Dom Bosco was very important in a strategic standpoint for Arco. It was financially accretive as price paid is equivalent to 14.4 times 2020 EBITDA and is expected to generate tax benefit of net present value of BRL214 million once the business are incorporated.

COC and Don Bosco are very complementary to Arco's current portfolio, both on price and geographic presence. They are top-of-mind brands in the Southeast region where 50% of the student base is concentrating, being 36% in the Sao Paulo state. According to a study concluded by EY Parthenon, in 2019, COC is the top three brands in the high-priced year with best awareness among parents in the top five brands with best awareness among Principals. COC and Dom Bosco have a proven track record on students' admissions with 48% of COC schools and 28% of Dom Bosco schools being among the top three in their national exam ranking of their cities.

Arco has an extensive M&A track record of acquiring and improving and will accelerate growth of the acquired solutions by applying its winning factors of high-quality content, relevant technology, reliable customer service and effective distribution. Additionally, initial assessment from integration team already shows approximately BRL15 million in cost synergies, leading to a post synergy multiple of 11.6 times 2020 EBITDA.

Finally, the deal includes a commercial agreement to distribute selected supplemental solutions from Pearson, which are complementary to our current offer, boosting cross-sell opportunities.

Second, on slide 13, we share the promising results from the strategy designed to capture cross-sell opportunities. We have invested in more incentives, bundle benefits and training and as a result, 72% of 2022 year-to-date new school intake for supplemental solutions comes from cross-sell initiatives.

On slide 14, we are proud to present the results of our continuous product evolution by putting investments in digitalization and innovation in first place we deliver differentiated technology, content and pedagogical services leading to high-customer satisfaction and excellent academic results. In 2020, our NPS has increased 15% for our legacy brands, SAS and SAE to 88% and 13% for Positivo to 75%, making us leaders in the industry. We are also leaders in academic results related to admissions in public universities through the national exam, ENEM, far ahead of the second player on the students admitted in first place, students admitted in second and third place and students admitted in fourth to tenth place.

On slide 15, our B2C Prep [Phonetic] through the acquisition of Me Salva in March is showing promising early results. We have already started investing in team and marketing, while focusing on increasing the share of premium offerings such as medicine test-prep courses to accelerate Me Salva's growth. As a result, Me Salva sale is expected to nearly double in 2021. By leveraging on Me Salva's outstanding test-prep offering, we expect to launch a B2B best-prep solution to partner schools already in the second half of this year.

Moving to slide 16, our ESG agenda evolves as we conclude our materiality assessment. We have engaged many stakeholders in the process and I would like to take the opportunity to thank all of you, who took the time to contribute to such an important theme. Our materiality map confirms the relevance of topics related to impact in education and team as an asset, in line with our strategy. Next steps include the definitions of main indicators and disclosure of results in upcoming months.

Thank you very much for your time. And operator, we can now open for questions.

Questions and Answers:

Operator

Thank you. The floor is now open for questions. [Operator Instructions]. Our first question comes from Pedro Mariani with Bank of America. Please Pedro, go ahead.

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

Hey, Ari, hey Otero. Good evening all and thanks for the opportunity here. I have two questions from me. And my first one is related to the impact in revenue recognition. I mean, Otero, if you could please tell us again, what do you expect an impact coming from this lower recognition of revenues related to the COVID-19 second wave. And also, I mean, what have changed in the environment compared to engage with that, Me Salva. This is the first question.

And my second question goes to Ari, regarding the B2C product. Ari, could you share what are the -- for initiatives already mentioned in order to expand this business line right and if possible, I mean how much of your total revenues you expect these to represent in five weeks from now. These are my two questions as well.

Roberto Otero -- Chief Financial Officer

Thanks, Pedro, hope you're doing fine. So thanks for the question. So as we mentioned in the presentation, we expect the revenue recognition for this year to be slightly below the ACV announcement, may be a low to mid single digit. This reflects the pandemic of course and lower enrollments for 2021 than initially expected by the schools. So as you know, we delivered the content to schools divided in four of deliveries along the year. We are not including the second delivery, which allows us to have a much clear view on revenue for the year and the size of the enrollments. And this is the reason why we are providing such guidance to the market at this time. This potentially lower revenue recognition does include any potential upside, all right. So this could come from eventually reenrollments in pre-K and kindergarten or supplemental products being sold in the second half of the year, but we prefer to be conservative to you for the benefit of transparency.

I'm returning to Ari for his comment on B2C.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Hello Pedro. Thank you for your question. So, regarding your question on Me Salva, we really expect Me Salva to be sizable portion of our business in five years. I think there is a big opportunity there. And just to remind you, we have a 70% of the students coming from public school. So it's a large TAM that we don't address yet and we already started to strengthen the team, especially in the commercial and digital marketing area, where we are investing to capture more customers. We also see an opportunity to expand the products that are offered there. So for instance, we right now have a course to med school that it's going very well with a very interesting ticket. So we are starting to work together with Miguel [Phonetic] and we are very optimistic that in the long run, this will be a very strong and sizable business for Arco.

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

[Indecipherable] thanks a lot.

Operator

Our next question comes from Vitor Tomita with Goldman Sachs. Please Mr. Tomita, go ahead.

Vitor Tomita -- Goldman Sachs -- Analyst

Hello Ari, hello Otero, hello all and thanks for taking my questions. So my first question would be, if you could give us any additional detail on the initiatives to provide more flexible payments per school. So maybe here [Technical Issues] negotiate the contract [Technical Issues] included expanding their publishing actual gain with Arco and whether we should expect additional negotiation with Me Salva.

And our second question would be also on this market [Technical Issues] pay tariffs on schools, not thinking about our overall market, if you have already seen significant number of schools closing down due to financial difficulties and if you have [Technical Issues]. Thank you.

Roberto Otero -- Chief Financial Officer

Hey Vitor, it is Otero here. Thanks for the question. So as you know, I mean we have a lot of discipline. So we care a lot about the brand reputation and we don't use prices, discounts or creative contracts to I mean renew or add schools to the portfolio, but if schools or -- the market or the schools are going through a very difficult unusual environment and our goal to provide support and to help them, and to help them navigate this period, of course, without causing any damage to the business model, without causing any damage to our operations and our financials. So I mean, given a little bit more detail broadly in the presentation.

Basically in for some very specific cases, we renegotiated the length of the contract. So we prolonged in 30 days, 40 days, right. The contract, so along this close to have one month of breadth, right and then returning to it's payment toward it, right. So this is exactly what we did, we are not providing any sort of discounts or any sort of financially that goes beyond expanding a little bit this contract, right. So that's pretty much what you see on the aging of the receivables. We are not concerned with delinquency, if you see the provision for bad debt actually came down, as we go to pre-pandemic levels. We are not changing at all the policy here. So we are keeping exactly the same provisioning policy we have had over the last year, right. But we have improved the collection process, right.

So the pandemic led us to improve the collection of profit internally. And as a result, we are seeing a provision for bad debt also coming down. So that's what basically it's equal right, so just prolonging a little bit, we did the payment terms for some specific contract, right. You also asked about the schools' closures. I mean, to be very honest, it's not something that has impacted ourselves very much. Actually what we saw is the schools of course, reducing size, especially in pre-K, kindergarten and for those who have, I mean prep for university-evolution debt, right. So both extreme of the K-12 cycle, we saw the highest impact to school, right. But schools closure gave the profile of our clients, it was minimal and as a consequence, you have seen our financials that the provision for bad debt and even the receivables past due or impaired actually have come down, right. So we are not seeing that affecting the business.

Vitor Tomita -- Goldman Sachs -- Analyst

Perfect. Thank you very much.

Operator

Our next question comes from Caio Moscardini with Morgan Stanley. Please Mr. Moscardini, go ahead.

Caio Moscardini -- Morgan Stanley -- Analyst

Hi, good morning everyone. I was wondering if you guys can give some more color regarding the BRL648 million related to accounts payable to selling shareholders. How much international school represents from this amount and when do you guys expect to close the deal?

Roberto Otero -- Chief Financial Officer

Hey Caio, Otero here. Thanks for the question. So international school is almost half of that amount, right. Actually this among has not changed. There has been no update to that amount. As you know, I mean you're seeing the arbitration process. If we have any update on that, we will automatically let the market know, right. But so far we are keeping this in the short term seller note payables. And as I said, almost half of that amount relates to international school, Caio.

Caio Moscardini -- Morgan Stanley -- Analyst

That's good color. Thank you and good night.

Roberto Otero -- Chief Financial Officer

Thank you.

Operator

Our next question comes from Lucas Benjin [Phonetic] with Bradesco BBI. Please Mr. Benjin, go ahead.

Lucas Benjin -- Bradesco BBI -- Analyst

Good evening, everyone. A question from my side. Could you give us an update on how you are seeing the M&A markets going forward, especially looking at under learning system solutions after the acquisition of COC and Dom Bosco. Thank you.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Hi Lucas, thanks for the question. So on the M&A side, I would say that when we look back, we have made. I mean transformational acquisitions. We actually had the opportunity to buy what we wanted to buy and this was a very successful move for the company in terms of capital allocation and discipline. Yes, we are still waiting for the antitrust approval for as you'll see and the growth on Dom Bosco. So looking ahead, I would say that you should expect acquisitions to be more inclined to some sort of diversification of revenue pull, of course inside our core business, always inside our core business, but leveraging on the scale that we have gained over the years.

So when we look at the scale we have today on the core segment, we can explore that in two ways, right. The first one is efficiency, of course, right and the second one is growth. So we will look at this scale, we will have the core business to generate incremental growth and for that we need to use supplemental and new products that will benefit from that scale. And it's not a coincidence that the cross-sell initiatives has been been put in place, right. Finally, it's something that we've been talking about to the market for a while and this is the reason why we have kicked off the cross-sell initiatives now, because we really want to take advantage of the nearly 1.4 million we have on the core segment. And M&A will be included in that, as a way to expand other product offering and leverage on this scale. So more and more would eventually there talking about an ARPU revenue metric as we will expand cross-sell in our way going forward.

Lucas Benjin -- Bradesco BBI -- Analyst

Okay, thank you.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Well, thank you.

Operator

[Operator Closing Remarks]

Duration: 28 minutes

Call participants:

Carina Carreira -- Investor Relations Director

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Roberto Otero -- Chief Financial Officer

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

Vitor Tomita -- Goldman Sachs -- Analyst

Caio Moscardini -- Morgan Stanley -- Analyst

Lucas Benjin -- Bradesco BBI -- Analyst

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