Arco Platform Limited (ARCE) Q1 2022 Earnings Call Transcript

Arco Platform Limited  (NASDAQ: ARCE) Q1 2022 earnings call dated May. 24, 2022

Corporate Participants:

Carina Carreira — IR Director

Ari de Sa Cavalcante Neto — Chief Executive Officer

Roberto Otero — Chief Financial Officer

Analysts:

Vitor Tomita — Goldman Sachs — Analyst

Javier Martinez — Morgan Stanley — Analyst

Presentation:

Operator

Good afternoon everyone, thank you for standing by, and welcome to Arco Platform First Quarter 2022 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. [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 — IR Director

Thank you. I’m pleased to welcome you to Arco’s first quarter 2022 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 were fully described in the 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 day 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 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 2021 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. I would like to start with the highlights for the quarter on Slide 3. First, as mentioned in our fourth quarter results, the year started at a very strong pace favored by the resumption of classes in the Brazilian private K-12 schools and the return of students who dropped out from school during the pandemic, creating a really positive momentum in the sector. This movement led to a significant number of additional orders placed in the first quarter.

Second, as a result of this high level of late orders being placed in the first quarter, part of these orders were delivered in April, causing an unusual effect of revenues that are traditionally recognized in the first quarter, slipping to the second quarter. When analyzing figures cycle to date from October 2021 through April 2022, which will neutralize this effect, we show that the ACV recognition was 66%, the highest level at this stage over the best years, confirming our expectation of 100% conversion of our ACV into revenues this year.

Third, our adjusted EBITDA margin increased 300 basis points year-over-year for the first four months of 2022, evidence in our commitment to improve processes and improve efficiency. We are reaffirming our margin guidance for 2022 fiscal year of 36.5% to 38.5%. Finally, on cash generation. This quarter we already had CapEx as a percentage of revenues returning to historical levels in a healthier receivable profile, indicating strong cash generation ahead. Also in May, we concluded the incorporation of COC and Dom Bosco, leading to important tax savings going forward. This is a key priority for us this year.

I will now turn the call to Otero, who will continue the presentation. Please, Otero.

Roberto Otero — Chief Financial Officer

Thank you, Ari, and good evening, everyone. Thank you for your time. Starting on Slide 4, we illustrated, the effect of high enrollments and consequent high volume of late orders placed by partner schools in the first quarter. Part of those orders had to be delivered in April, resulting in a BRL57 million incremental revenue that is usually recorded in the first quarter is lifting to the second quarter of 2022. To better show the effect of those additional orders to our results, we also present today the results for the accumulated four months of 2022 between January and April, as we think this will be a better proxy of how the business profitability is performing.

Moving to Slide number 5, net revenues for the first quarter of 2022 were BRL430 million, a strong 30% top line growth year-over-year and representing 27.6% revenue recognition of the 2022 ACV. When excluding the acquisitions concluded recently, organic top line growth was 19%. As mentioned by Ari, the typical high level of late orders placed by partner schools in the first quarter led to part of this content being delivered in early April. To neutralize these unusual seasonal effect, we are presenting top line growth for the first four months of 2022, which increased by 47% year-over-year or 32%, excluding the acquisitions. As a result, we have reached the highest ACV recognition cycle to date over the past several years of approximately 66%, which makes us confident of the 100% ACV recognition for the 2022 cycle.

Moving to Slide 6, selling expenses, excluding M&As that were not consolidated last year, grew in line with top line, as we strategically decided to anticipate some of our commercial initiatives to the first quarter, including high investments in cross-selling to take advantage of the positive environment in schools across Brazil, as students return to their classrooms. On the other hand, G&A expenses continue to show important improvement, growing below top line at 7% year-over-year and actually contracting 6% when excluding the acquisitions. On Slide 7, we detailed gains obtained from the efficiency initiatives with corporate personnel, third-party services and software, real estate and other expenses, representing BRL10 million in savings this quarter.

Moving to Slide 8, adjusted EBITDA for the first quarter reached BRL146.6 million, 24% above the first quarter of 2021, leading to a margin of 34.1% or 35.9% when excluding the acquisitions, flat year-over-year. Looking at the four-month figures, adjusted EBITDA jumped 64% year-over-year, with a margin expansion of 300 basis points, which we think is a better proxy of how the business profitability is reflecting the strong top line growth expected for the year and internal efficiency initiatives. Adjusted net income contracted 43% year-over-year in the quarter, representing higher financial costs and higher depreciation, amortization and top of continuous investments in product and the event of recently acquired businesses.

On Slide number 9, we summarize the year-over-year performance for the quarter for the accumulated four months of 2022 and cycle to date, showing the clear evolution of our product cycle profitability. Moving to cash generation drivers on Slide 10, we present the CapEx performance. In the first quarter CapEx was BRL47 million, roughly 11% of net revenues. When looking at figures for the accumulated four months of 2022, CapEx went down to 10.1% of revenues. This reduction reflects a much higher level of integration across the business units, driving higher cooperation and lower redundancy in projects being executed.

On the next slide, we detail the profile of our receivables, which increased as a result of the strong organic revenue growth, the incremental revenue from the acquired businesses and extended payment terms to partner schools as aid offered during the COVID-19 pandemic years. Nevertheless, lower delinquency and a better collection process led to a lower portion of past due receivables, now only 12% of total receivables. We would like to highlight that from the approximately BRL780 million of neither past due nor impaired receivables, BRL112 million was already collected in April, an additional BRL291 million is expected to be collected already in the months of May and June.

Finally, on Slide 12, we concluded the incorporation of COC and Dom Bosco in May, which will lead to lower effective tax rate from the second quarter onwards. As per the Brazilian law, amortization of goodwill from acquired businesses are tax deductible once the business is incorporated. Therefore, we will be able to net the taxes at COC and Dom Bosco going forward lowering Arco’s consolidated effective tax rate. As a reference, these solutions combined paid BRL12 million in taxes in 2021. We expect to incorporate other acquired business in the future quarters including Geekie, SAE Digital, Escola da Inteligencia and Pleno, leading to important tax savings for several years ahead.

I’ll turn the call back to Ari, for his closing remarks. Ari, please go ahead.

Ari de Sa Cavalcante Neto — Chief Executive Officer

Thank you, Otero. I would like to finish this call by emphasizing our optimism with the year ahead of us. Schools were among the sectors that suffered the most during the pandemic, as schools in Brazil were closed for the longest period globally. With the resumption of in-personal classes, we see an upbeat momentum for our clients and prospect schools as a percentage of the students who dropped out over the last couple of years has started to return to schools.

The combination of higher enrollments in a much lower level of operations is allowing schools, owners and managers to start making decisions for the future, including the adoption of core supplemental and services solutions. We more than ever have strengthened our partnership with our clients with higher NPS scores being achieved across all our brands and we are confident we will convert this relationship gains into cohort growth through the cross-sell of other solutions, up-selling to different grades, increasing prices and reducing churn. We have also decided to anticipate our go-to-market strategy this year to capitalize on this improved industry momentum and the early results are already quite encouraging at this point.

Finally, I wanted to emphasize the financial discipline, capital allocation strategy and cash flow generations have become key priorities in our company, not only through the creation of processes, but also through the alignment of incentive for management team. Our main goal is to translate this strong top line growth we expect for the years to come into earnings quality, cash flow generation and value creation to equity shareholders.

We thank you for your trust and support. Operator, we can now open for questions.

Questions and Answers:

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] The first question comes from Luca Marcussini [Phonetic] with Itau BBA. Please proceed, sir.

Unidentified Participant — — Analyst

Good evening, everyone, and thanks for taking our questions. First question is regarding this higher volume of late orders the partial recognition in April. Could you please comment on whether this appeared on the same magnitude across legacy brands and acquired brands and also if this was more intense on core supplemental solution? And our second question is related to the back office and corporate urbanization. The company has announced expected savings of BRL40 million for 2022. So, this would be the total savings or should we expect additional efficiencies to be extracted in 2023? Thank you.

Roberto Otero — Chief Financial Officer

Hi, Luca, it’s Otero here. Thanks for the questions. So, regarding the first one, I would say it was more concentrated in the core segment, okay and — but it’s split equally across all the brands. So, we saw very similar movement across all the core brands, okay. On the second one regarding the savings, I would say it’s more like a two- to three-year process. I would say in some areas we are capable of delivering most of the results in the first year such as, like office for example, supply chain, but in all areas such as technology, it takes longer in case. So, I would say that this guidance that we provided for this year is not limited for 2022 only, it’s a longer process.

Unidentified Participant — — Analyst

Very clear, Otero. Thank you.

Roberto Otero — Chief Financial Officer

Thank you.

Operator

The next question comes from Vitor Tomita with Goldman Sachs. Please proceed, sir.

Vitor Tomita — Goldman Sachs — Analyst

Thank you and good evening, all and thanks for taking our questions. We have two questions from our side. The first one is on the — also on the late enrollments. Given that enrollments have been higher than expected and that schools may have underestimated the number of dropout students that would return postpone the pandemic, do you see potential for revenue in the full cycle to actually surpass the ACV figure you announced? And our second question would be on leverage. If you could give us some more color on your strategy for expanding upcoming debt maturity considering the current capital markets environment? Thank you.

Roberto Otero — Chief Financial Officer

Hi, Vitor, it’s Otero here. Thanks for the, for the questions. On the first one, I would say that given what we’re seeing on the ground, as Ari mentioned during his opening remarks, the momentum for the schools is quite strong, okay. So, we see a decouple from the overall economic mood. I would say schools are in general seeing an inflow of cash not only following the return of those students who dropped out, but a very successful price increase to tuitions that was implemented after almost a couple years without increasing prices. So, I would say that the environment is quite encouraging, okay.

In terms of the enrollments, I would say that at this point, we can’t guarantee 100% of the ACV recognition into revenues, okay. But yeah, eventually there could be some upside to the figures, okay. With regards to I mean deleveraging and the rollover of the indebtedness, I would say that deleveraging generally is a key priority for us this year and it’s already happening in case of how we finished the quarter at 3.8 times net debt to EBITDA and we plan, we expect to finish the year around 3 times, as we continue to expand the EBITDA and also cash position accelerates from April onwards, okay. So, we are already seeing the receivables coming. We have collected very significant portion of those in April and May so far.

With regards to the debenture, we cannot of course provide any a guidance at this point, okay, until the operation is closed. But we are working to extend the maturity of those debentures to three to five years, okay. So, that’s the expectation. I mean despite — the equity market is of course in a very bad momentum, but it’s not the same for debt market because of the of course where interest rates are. So, in general, there is more demand than supply for debt in the market in general in case. So, we are seeing a good environment overall to move our indebtedness a little bit further in time, okay.

Vitor Tomita — Goldman Sachs — Analyst

Very clear. Thank you very much.

Operator

Thank you. Your next question comes from Javier Martinez with Morgan Stanley. Please go ahead, sir.

Javier Martinez — Morgan Stanley — Analyst

Hi, thank you. Thank you, guys. I wanted to ask you a couple of questions on those additional orders just to make sure that I understood it well. So, are we talking about things that move from one month to the other or additional orders? So, is this, yes, about the timing of things or is about we more or less than originally expected? And if that’s the case, is that included in the guidance in the bookings guidance or not? And also I don’t know if I understood correctly, on the Slide number 9, my understanding of that is slide is that those additional or more orders, the — and the implicit margin is a bit lower, it’s like 21% in April. Is that correct or I’m missing something? Thank you.

Roberto Otero — Chief Financial Officer

Hi, Javier, Otero here. Thanks, thanks for the questions. So, I would say, on your first question, it’s a combination of both. So, it is additional orders and yes, they came later than the usual in case. So basically, the content that the schools use in the first and the second semester is usually delivered in the fourth quarter of the previous year and the first quarter of the current school year, okay. But the truth is, those schools saw the actual number of students higher than what we expected when the school year actually started, okay, and then this demand came to us and we need time to produce and deliver this content as it was really widespread across all the brands and across Brazil as a consequence, okay. So, if there is some supply chain complexity to deliver that, so that’s why those additional orders actually is limited to the first weeks of April, okay. Part of that is already reflected in the ACV guidance, okay, part of that is already reflected in the ACV guidance.

With regards to the margin, I mean if you see this is formality [Phonetic] of our margins. I mean, Q2 and Q3, usually you have lower margins, okay. So, it is typical. I mean, given the profile or the mix of brands with highest accumulation of revenues in those periods, okay. So, traditionally, you would see margins lower in second quarter or in the six months versus the first three months. The thing is that when we compare the first four months versus first four months of last year, we see a very important margin increase, okay. And I mean, we don’t think we will surpass the EBITDA margin guidance, okay. I mean we’re still committing to the EBITDA margin guidance that we provided by the end of last year, but we are very confident that we’re going to be on track to deliver the guidance.

Javier Martinez — Morgan Stanley — Analyst

Roberto, thank you very much. Now that I have you in line, so everything okay in terms of passing through the course of the incremental cost of paper this year because of the, of the incremental pricing power that you have not incremental scale that you have with the printing companies, is — has — is everything under control?

Roberto Otero — Chief Financial Officer

Sure. That’s a great question, Javier. Yes, I would say that last year, one of the first areas that we integrated was supply chain. So, we made pretty much national bid with printing companies for all the brands, okay altogether, excluding COC and Dom Bosco because of timing, but later on, they would be joined those negotiations. So in general, the price for paper this year is already fixed, okay. And we were able to increase the price per page printed a 3 percentage points below inflation, okay for 2022. We are already starting the negotiation for the next cycle and now we have the — I mean with higher volume, right. So, we think that we will be able to use this bargaining power in our benefit, okay. But for 2022, it is safeguarded. We are running 3 percentage points below inflation on a comparable basis for the price per page printed.

Javier Martinez — Morgan Stanley — Analyst

Very clear. Thank you very much.

Operator

It appears we have no further questions for today, so that concludes the Arco Educacao audio conference for today.

[Operator Closing Remarks]