Arco Platform Limited (ARCE) Q2 2021 Earnings Call Transcript

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Arco Platform Limited (ARCE)
Q2 2021 Earnings Call
Aug 19, 2021, 5:00 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 Second Quarter 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 through 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 -- Director of Investor Relations

Thank you. I'm pleased to welcome you to Arco's second quarter 2021 conference call. With me on the call today, we have Arco's CEO, Ari de Sa Cavalcante Neto 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 benefits 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 on the information available to us as of the date hereof. You should not rely on them as prediction 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 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 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 families are all healthy and safe. We'd like to present four topics today as shown in Slide 3. First on the results, we had a 21.9% revenue recognition in the quarter, leading to a net revenue of BRL588 million for the first six months of 2021 or a 18% increase versus the same period of 2020. Adjusted EBITDA this quarter was impacted by lower revenue recognition, product development, and sales force increase as we prepare for a post-pandemic recovery leading to an accumulated adjusted EBITDA margin for the first six months of the year of 32.4%.

Despite an even softer third quarter ahead, following historical seasonality trends as Otero will show in a few minutes, we are confident that the fourth quarter will lead us to meet the adjusted EBITDA margin guidance of 35.5% and 37.5% range. The free cash flow improved this quarter as we collected the receivables generated by the extension of the payment terms to assist our partner schools, taking us back to our strong cash generation profile.

Second, the commercial cycle for 2022 school year continues to show encouraging results as pandemic-related restrictions are progressively lift. At this point, we see organic growth pace for core solutions in line with pre-pandemic levels while supplemental solutions accelerate versus 2020 but indicate a two-step recovery to pre-pandemic growth rate levels. We are achieving great results from our cross-sell initiatives, which will now be powered by the creation of a centralized supplemental business unit called ArcoPlus.

Third, as we continued to search for innovative ways of better service our clients and consolidate our leadership position in the industry, we launched this year SAS Adapt, a customizable and data oriented version of SAS, our most premium core solution, allowing us to better serve the premium segment. SAS Adapt was developed on top of Eduqo's LMS, a solution we acquired in July that will integrate our ArcoTech portfolio and has great data analytics capabilities.

And finally, we concluded our first step toward disclosure improvement and commitment to increase our impact with the release of our first ESG report. 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. I also hope that you are all safe and healthy. Moving to Slide 5. Net revenues for the second quarter of 2021 were BRL256 million, representing a 9% year-over-year growth and 21.9% revenue recognition, below the historical average for the quarter, impacted by the second wave of COVID-19.

As a result, net revenues for the six months of 2021 totaled BRL588 million, 18% above the same period for last year. Lower revenues added to higher costs related to product development and higher selling expenses aiding [Phonetic] a stronger sales cycle led to an adjusted EBITDA for the quarter of BRL72.3 million, 28% below the second quarter last year with 28.2% EBITDA margin.

Adjusted EBITDA for the first six months of the year totaled BRL190.6 million BRL resulting in a 32.4% accumulated margin. Finally, adjusted net income was BRL36.4 million for the quarter with a 14.2% net margin and BRL97.5 million for the first six months with 16.6% margin.

On Slide 6, we present a breakdown for our receivables, which reduced 19% from the first quarter level as we collected the receivables from our partner schools to whom we provided support through a more flexible payment terms. That added to the lower effective tax rate resulting from the corporate restructuring led to a significant improvement in the free cash flow this quarter.

On Slide 7, we present an update on our ongoing corporate restructuring, which will further contribute to our cash generation in the future. We concluded the incorporation of SAS subsidiaries on July 1st leading to annual savings amounting to BRL30 million.. Next steps include incorporation of Nave a Vela this year and Escola Em Movimento, Pleno, and Studos in 2022. As we incorporate businesses acquired in the past, we will be able to capture additional tax benefits and further reduce our effective tax rate.

To conclude the session, moving to Slide 8, we'd like to take the opportunity to make a quick recap on the seasonality of our business and how we expect this year to behave when compared to historical trends. Adjusted EBITDA and the cash flow from operating activities have different behaviors along the year as you can see in the two charts.

The blue line for both charts represent the historical trend while the red line represents the expected behavior for 2021. When analyzing adjusted EBITDA, best performing quarter for revenue recognition is Q4 when all solutions have their first content delivered to schools. On the other hand, the worst performing quarter is Q3 as most of the content has been delivered in previous quarters.

This year, we expect a more accentuated seasonality but still following historical trends. When analyzing cash flow from operating activities, the majority of schools pay for our solutions in up to eight instalments starting around February. Q2 is usually the strongest cash generator while Q4 is the weakest. This year as we extended payment terms to assist our partner schools, the cash collection behavior will be a little different from historical trends.

Moving to Slide 10, we are very excited about the return of in-person classes in most states in Brazil as it increases the effectiveness of our commercial activities. At this point, 56% of the population received at least the first dose of the COVID-19 vaccine and 24% are fully vaccinated with vaccination of teenagers starting this month in some states. The reopening of schools and vaccination of the population has a direct impact in the commercial cycle as principals become more optimistic and open to meet our team and discuss positive changes to their schools.

As represented in Slide 11 despite in still early stage, the commercial cycle for the 2022 school year is presenting a much faster organic growth pace versus last year, indicating that the worst is definitely behind us. For our core solution, year-to-date organic growth pace is in line with pre-pandemic levels indicating a strong lead conversion on top of a suppressed demand. Positivo is the leading performer for the core segment, two times ahead of the commercial cycle for 2020 school year, proving the effectiveness of our acquire and improve strategy.

As for our supplemental solutions, year-to-date organic growth pace shows strong recovery versus last year but indicates a two-step recovery to pre-pandemic growth rate levels. We had one of the best years for renewals last year and at this point, renewal rates for core solutions are in line with historical levels while supplemental solutions are presenting a stronger renewal performance.

Moving to Slide 12, cross-sell has further accelerated and now represents 85% of the intake for supplemental solutions year-to-date. Important to mention that the economics for cross-sell are better as we see a faster lead conversion signing of larger contracts and usually with longer terms and the relationship with the partners school becomes a stronger, increasing the retention rates.

The possibilities to capture cross-sell opportunities are numerous and here are some recent examples. In the first one named cross-sell intake, we signed with a large school that did not use any Arco products before adding both SAE and NAVE, our maker solution. In the second example, renewal core plus cross-sell supplemental, we extended a contract term with Positivo partner school to five years and added Pleno.

In the third example named upselling supplemental plus cross-sell core, we extended a contract term within an international school partner school while adding other branches of the same chain and including SAS leading to a five times ACV increase. Finally, in the fourth example named renewal supplemental plus cross-sell, we extended a contract term with an Escola da Inteligencia partner school to four years and added SAE, PES and Pleno, leading to a 10 times ACV increase.

Moving to Slide 13, we are now powering the cross-sell initiatives with the creation of ArcoPlus, a business unit that will centralize our supplemental solutions. This structure will allow us to extract synergies by centralizing activities that will lead to cost savings, reducing time spent with repetitive demands and challenges, simulating cooperation between solutions, providing access to tools and resources from one to another and leveraging on Arco's employer branding while of course maintaining strong brands, pedagogical approach with clear identities, fast response to customer needs, and focus on quality and innovation.

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

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, Otero. Innovation has always been part of our DNA especially when it translates into delivering a better product or service to our clients. On Slide 15, we present SAS Adapt, a version of SAS, our most premium brand that offers more customization possibilities, generates more data on students' engagement and pedagogical gaps and allows for higher connectivity among all content available in the platform.

It's a solution that fits well with the demands of school segments that want to customize their content, which in turn will provide valuable feedback that will guide us to further improve our solutions. SAS Adapt was created using Studos and Eduqo's features, which are now part of ArcoTech alongside Escola Em Movimento, our app communication solution and WPensar, our ERP solution as presented on Slide 16. ArcoTech was recently created with the goal of centralizing the technology backbone of our solutions, gathering the best features from all platforms acquired along the years that can be the common to all into one single strong backbone.

It will allow for us cost savings and better user experience as we will be able to implement improvements and add new features much faster besides strengthening our employer branding to attract talents on the technology segment. Eduqo, acquired in July, is a great complement to ArcoTech's portfolio as it is a powerful LMS that provides a personalized learning experience and helps schools to acquire more students based on data intelligence.

On our final slide on Page 18, we bring a summary of our ESG report released last week, our first step toward mapping our strengths and gaps so we can further expand our impact on Brazilian education. The materiality analysis presented last quarter guided us to focus on three main topics, which are fully aligned with our strategy; impact on education, focus on people, and strong and sustainable structure. The report brings relevant information on each of these topics and challenges us to continue pursuing better practice going forward.

Arco is undergoing relevant changes. M&A was key to support our mission to scale quality education across Brazil and now is the time for us to organize our structure and further extract the benefits of having reportable brands, quality solution, and a highly talented team. The creation of ArcoTech and ArcoPlus allow us to centralize a structure that will generate even more value when combined. And there is more to come as we deep dive into our processes generating savings that will translate into freeing capital to invest in what really creates value, serving well our clients and unlocking value to grow. Thank you for your time. Operator, we can now open for questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Vitor Tomita with Goldman Sachs.

Vitor Tomita -- Goldman Sachs -- Analyst

Hello, good evening all and thanks for taking our questions. Two questions on our side. The first one is on ArcoPlus. If you could give us some more details on the type of activity that will be centralized particularly, if you have a single commercial team for all brands now and if so, if you see any risk to brand perception in using the same thing for higher end and lower end supplemental brands?

And the second question would be on ArcoTech. Especially how it will interact with the various core brands other than SAS Adapt or how separate the technological back-end currently is between different core brands and if there could be significant cost savings still arising from unifying the technology backbone across core brands? Thank you.

Roberto Otero -- Chief Financial Officer

Hi, Vitor. Thanks for the questions. It's Otero here. On ArcoPlus, I would say that there is no change in mindset here. I think that's something that we always mapped that was going to happen. We were just waiting for the right timing to do a search integration. So the idea here is really to join efforts in a more efficient way across those brands. Okay, so in terms of what is going to be centralized and integrated, we here internally are seeing that everything that is behind the curtain, right? So everything that will not prevent the client from perceiving the unique identity of the brand, OK. So everything related to operations and back office services will at first be integrated.

With regards to the sales team, the idea here is to keep them independent, right. So as we discussed in the presentation, we already have a team dedicated to the cross-sell. So this team dedicated to cross-sell is already selling all brands, but we're going to keep independent sales teams for each of the brands as well, right. So this is what will drive clients and customers to perceive uniqueness of each of the brands, but behind the curtains, we will integrate several areas, OK.

As to ArcoTech, I would say that similarly to ArcoPlus here, there is no change in mindset as well, right. So it's really about finding the right timing to do it. As you know, we made several acquisitions over the last two, three years and the key priority at first was really to improve the content, to improve the product, to improve the customer service and to improve the go-to-market strategy and to use the local technology at first, right. So that was the strategy for those acquisitions that we made. Now, we think it's the time to drive the integration of the technology platforms. So what we're going to do is create a one single technology backbone, right, backing those platforms and the front-end is going to be independent, right.

So we are going to have a local team at each of the brands driving the uniqueness of the front end to students and to schools, but we're going to have the centralized backbone driven by ArcoTech, right. So the idea here is to drive more efficiency. It's to drive more agility, right, and to allocate the best resources possible to all the brands, right. So that's the idea here.

Vitor Tomita -- Goldman Sachs -- Analyst

Very clear. Thank you.

Operator

Our next question comes from Pedro Mariani with Bank of America.

Pedro Mariani -- Bank of America -- Analyst

Hi guys, good evening. Thanks for the opportunity here. I also have two questions. So the first, if you could just provide an update on your ongoing commercial cycle for next year? I mean, how are you seeing your new intakes or dynamics for the most of our business lines? What is the profile of losing dates, like we see coming from competitors or through the conversion to learning systems as that would be super helpful? It's the first question.

And the second is regarding the SAS Adapt that you provided some information right now. I just wanted to understand what is the strategy here, right, so the profile of the schools you are going to test. And if there is any difference in terms of tickets versus the traditional SAS. Okay, these are the two questions. Thank you.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Hi, Pedro. This is Ari. Thank you for your question. Regarding the commercial cycle, I would say that the early signs are very strong. We still are in the beginning of the cycle. Most of the contracts are signed in the second semester of the year between September and November, but I think the main difference here is that we are now able to visit schools. Our team is traveling extensively and we are able to receive schools in our headquarter, so we are hosting events very frequently and this is the last step of the sales cycle to close the deal is very important. So we see that in core, we are multiple times ahead of 2020 and in a growth phase in line of 2019.

In the supplemental in 2019, we were growing 60%. So I would say that in 2020, it's multiple times ahead of -- sorry, in 2021, it's multiple times ahead of 2020 but I would say that the recovery to the levels of 2019, it's going to be in a two-step way. So we are very optimistic at this point, still early, but the traction of the sales force and the sales team is very strong. We are very excited for the months ahead.

Regarding SAS Adapt, I would say that the idea here is most to address those schools that use textbooks and want to have a white label product and the ability to flexibilize their content and also to have the possibility that their teachers produce content and upload in their platform. I would say that these are in most of the times premium schools that they have their own content produced in-house. And regarding the pricing, it's the same pricing that we use as SAS because it's already a premium solution.

Pedro Mariani -- Bank of America -- Analyst

Super helpful. Thanks so much.

Operator

Our next question comes from Vinicius Ribeiro with UBS.

Vinicius Ribeiro -- UBS -- Analyst

Hello guys, good afternoon. Thanks for taking my question. Two things we'd like to discuss here, please. First, thanks for the meters on the ACVs, super helpful. You mentioned that core legacy sales are in line with 2019. We just wanted to clarify if those sales already include Positivo performance during 2019 or not?

And the second question is you guys reiterated your margin guidance and Ari alluded to the 4Q results. I just wanted to understand how dependent is this guidance on you achieving your internal goals for the ACV that you start to recognize during the 4Q and should result in operating leverage? Thanks.

Roberto Otero -- Chief Financial Officer

Hi, Vinicius. Otero here. So thanks for the question. As to the first one, we are including Positivo in 2019, OK. So same brands grow, OK. To the second one, with regards to the margin, yes, we are reaffirming or reiterating the range between 35.5 and 37.5. I mean, internally, of course, we assume that we will reach the internal goals for next year, right. So I mean traditionally we do, right, so we're assuming and based on the early signs for, as Ari said, for the commercial cycle, they seem achievable, right. So we brought the expectancies on liability for margins this year. So seasonality, we will reflect the historical trend, right. So we should expect a weak adjusted EBITDA margin Q3 and a strong adjusted EBITDA margin in Q4, so there should be no surprises there.

Vinicius Ribeiro -- UBS -- Analyst

Thanks, Otero. Pretty clear.

Roberto Otero -- Chief Financial Officer

Thank you.

Operator

Our next question comes from Yan Cesquim with Banco BTG Pactual.

Yan Cesquim -- Banco BTG Pactual -- Analyst

Good evening, Ari, Roberto, and Carina. I have two brief questions here on my side. The first one, I just wonder if you guys could give us more color on the two-step recovery in the supplemental ACV? I mean, does it mean that it will take two years to fully recover should we expect these supplemental ACV back to 2019 levels like in the 2023 cycle? That's the first question. And the second question I just wanted to know if you guys could give us a breakdown on the non-recurring expenses that you guys published here today? Thank you.

Roberto Otero -- Chief Financial Officer

Hi, Yan, Otero here. So to your first point on the supplemental growth, as Ari mentioned, in 2019, this was a business unit that was growing close to 60%, right. So by saying that we expect this to be a two-step recovery is not that we don't think that 60% growth is no longer achievable, right. It's just because we think that to reach those growth levels, we would need to have full one year of a normal commercial activity, which did not happen, right.

So the truth is that our sales team was able to more intensively interact with schools from the month of May beginning of June onwards, right and the level of stress at the schools was much higher in the first semester of the year, right. So our point here is that we think we would need a full year of normalized commercial activity to be able to reach those growth rates, OK. So we think that structurally this business unit is capable of having this growth and by saying two-stage, we think that possibly this could happen in 2023. Let's see. As to the non-recurring expenses, could you just repeat the question? You wanted to understand what is included in non-recurring, right?

Yan Cesquim -- Banco BTG Pactual -- Analyst

Yes, there is a line called the non-recurring expenses, but we don't have further details. So I just wonder if you could break it down for us? That's it.

Roberto Otero -- Chief Financial Officer

Yes, I'll do it. So in a non-recurring, you basically have cost related to the SOX implementation or accreditation to the company, OK. And you have other expenses related to M&A deals and to diligent process that we're undergoing, OK.

Yan Cesquim -- Banco BTG Pactual -- Analyst

Yes, thank you. Very clear. Thank you guys.

Operator

Your next question comes from Javier Martinez with Morgan Stanley.

Javier Martinez -- Morgan Stanley -- Analyst

Hi, thank you. Good evening to everybody and I would ask you again about the commercialization. I know that it's a little bit early, but I will try to get some color on maybe some new trends. And I do want to understand how COVID or foreseeability may be impacting the mix for next year? I don't know if you have noticed any recent trends in SAS side versus the new brands. And also in the supplemental, international schools, the old supplemental products versus the new ones. And that will be my first question, please.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Hi, Javier, Ari here. Thank you for your question. So we have seen, when you look at Core, a strong performance for all the brands. I would highlight SAS, which is the premium brand, is performing quite well so far but I think the good surprise here is really Positivo where we have two times higher student intake this year when you compare that to last year and I think the reason for that is it's not the price positioning, it's mainly the changes and the evolution that we made in the product and in the technology.

I would say that it has been a good year for replacing schools that use textbooks because they lack the technology necessary to pursue their activities in the post COVID scenario but I also would say that especially for the less personalized and smaller learning systems that lack the scale to invest, it has also been a trend that these schools look for more robust solution like ours. So I would say that technology is playing a very important role in shifting schools from textbooks and small learning systems to our solutions.

Javier Martinez -- Morgan Stanley -- Analyst

Thanks, Ari. I remember when you both decide that you had a bump during one year or something like that and related with some churn, related with the changing hands from the run. So it sounds like this time you're going to be able to avoid that, that would be really good news. Should we expect the same for the most portfolio once that -- and the antitrust approval?

Ari de Sa Cavalcante Neto -- Chief Executive Officer

So I would say that we will not be able to execute a full-cycle regarding both retention and school and commercial cycle both for retention and commercial cycle because the deal is expected to be approved on the fourth quarter. So far because of the antitrust, the limited figures that we have shown us that the numbers are in line with previous years. But definitely, I think we won't have enough time to conclude a full cycle in COC and Don Bosco because the antitrust will be approved on the last quarter of the year.

Javier Martinez -- Morgan Stanley -- Analyst

Makes sense. Thank you very much, Ari.

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Thank you, Javier.

Roberto Otero -- Chief Financial Officer

Hey guys, it's Otero here. We have a question from Maria from RSI from the webcast. So can you provide more color on Me Salva prospect? How does the student growth look like and what are the opportunities identified for the B2C product?

So Maria, thanks very much for the question. So we are super excited with Me Salva. I think strategically this was the movement that we have been talking about for a while. We wanted to have the possibility to serve students enrolled in public schools, right. So we wanted to impact those students, but it was very challenging to find the right product, right, and to find equilibrium between what would be affordable for those students and the acquisition cost of those students since those are traditionally digital products.

So Me Salva is a great fit to this strategy and we are confirming the thesis more and more as we know better the asset. Your point on B2C is actually very interesting because this is a possibility, right. So we think that the products offered by Me Salva and the profile of tutoring that they offer is highly capable of adding incremental value to the schools that we serve already. We are starting to test the appetite for this product already in this semester, right, in the second semester of 2021 through a freeman feature. And let's see-I mean, we are testing appetite right now and the idea is possibly next year upsell this product to a paid version.

Operator

At this time, I have no more questions in the queue. [Operator Closing Remarks]

Duration: 36 minutes

Call participants:

Carina Carreira -- Director of Investor Relations

Ari de Sa Cavalcante Neto -- Chief Executive Officer

Roberto Otero -- Chief Financial Officer

Vitor Tomita -- Goldman Sachs -- Analyst

Pedro Mariani -- Bank of America -- Analyst

Vinicius Ribeiro -- UBS -- Analyst

Yan Cesquim -- Banco BTG Pactual -- Analyst

Javier Martinez -- Morgan Stanley -- Analyst

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