Arco Platform Limited (ARCE) Q4 2021 Earnings Call Transcript

Arco Platform Limited (NASDAQ: ARCE) Q4 2021 earnings call dated Mar. 31, 2022

Corporate Participants:

Carina Carreira — Investor Relations

Ari de Sa Cavalcante Neto — Chief Executive Officer

Roberto Otero — Chief Financial Officer

Analysts:

Vinicius Figueiredo — Itau BBA — Analyst

Vitor Tomita — Goldman Sachs — Analyst

Marcelo Santos — J.P. Morgan Chase & Co. — Analyst

Vinicius Ribeiro — UBS — Analyst

Presentation:

Operator

Good afternoon everyone. Thank you for standing by and welcome to Arco Platform Fourth Quarter and Full Year 2021 Earnings Call. This event is being recorded. [Operator Instructions] This event is also being broadcast live via webcast and may be accessed through Arco’s website at https://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 fourth quarter and full year 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 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 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 would like to present three topics today. First on the results, we had a very strong top line growth in the fourth quarter of 55% year-over-year to BRL460.8 million as a result of the extremely successful 2022 commercial cycle leading to net revenues of BRL1.2 billion in 2021. Adjusted EBITDA margin was 48.7% in the fourth quarter of ’21. Despite the challenges, 2021 margin excluding M&A concluded in 2021 was 36% for the year within the guidance range of 35.5% and 37.5%.

This is a very important achievement considering the impacts from the COVID-19 pandemic in our revenue recognition during the year. Second, we concluded the 2022 commercial cycle and as schools return to in-person classes and restrictions related to the COVID-19 pandemic are gradually lifted we are resuming our growth trajectory. 2022 ACV was BRL1.56 billion, representing a strong 46% growth year-over-year and a 32% organic growth year-over-year. These numbers comes above the guidance initially provided to the market back in November.

This strong ACV is a combination of healthy retention rates and price increase added to a sound organic growth for both our core and supplemental solutions powered by the successful cross-sell initiatives. We expect to continue to do so as our key differentiating factors gain further relevance and we want to consolidate our leadership position and strengthen our value proposition. Finally, we conclude this presentation detailing our three priorities for 2022; strong growth, efficiency and cash generation and ESG.

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 now to slide number 5; net revenues for the fourth quarter of 2021 were BRL460.8 million, a 55% increase year-over-year and representing a 29.5% revenue recognition of the 2022 ACV, which we will detail a few slides ahead. Net revenues for 2021 reached BRL1.232 billion, a 23% growth versus 2020 or 18% organic growth when excluding the M&As announced last year.

Organic growth of our cost of sales in 2021 was in line with organic top line growth while selling expenses outpaced top line with a 30% year-over-year organic growth aligned with our strategy to invest in go-to-market and customer support to boost future growth and G&A expenses had an important dilution growing organically only 10% year-over-year. As a result, adjusted EBITDA was BRL224.4 million in the fourth quarter, 78% above the fourth quarter in 2020 and BRL430.9 million in 2021, 13% higher than 2020.

When excluding the M&As concluded in 2021 adjusted EBITDA was 12% higher year-over-year, with a margin of 36% within the guidance range we provided for the year. On slide 6, we present the adjusted net income, which contracted 32% year-over-year in 2021 due to the lower revenue recognition observed in the nine months and higher financial expenses. We also wanted to highlight that we are reducing the number of adjustments to our adjusted net income metric as part of our commitment to evolve and improve corporate governance and disclosure. We eliminated three adjustments that we believe did not prevent investors to assess Arco’s operational results.

Interest on acquisition of investments linked to our fixed rate, foreign exchange on cash and cash equivalents and share of loss of equity-accounted investees. Moving to slide 8, we are excited with the results of our 2022 commercial cycle with schools resuming in-person classes and students returning to the classroom, we reaccelerate growth. Our ACV bookings reached BRL1.560 billion, above the previously guided range, representing a strong 46% year-over-year growth or 32% organic growth when excluding assets acquired from Pearson last year. The Core segment grew 32% organically year-over-year to an ACV of BRL1.109 million and over 1.6 million students.

Our Supplemental Content Solutions comprised in 2021 of international school NPS in English as a second language, Escola da Inteligencia and Pleno in social-emotional learning and Nave grew by 35% organically to an ACV of BRL275 million and over 660,000 students, an important acceleration largely attributed to our successful cross-selling initiatives, which were key to the 80% increase in the number of our core schools using at least one supplemental solution. Finally, we are breaking down other supplemental solutions comprised of our tech and services brands WPensar, Escola em Movimento, Studos and Eduqo as well as our B2C solution Me Salva! and our education as a benefit solution Edupass, which grew 38% organically year-over-year.

On slide 9 we detailed a build-up of our 2022 ACV bookings. Our growth has always relied on our ability to retain our clients, improve our value proposition driving price increases, upsell our solutions within our partner schools and attract new partner schools. This year was not different. Even in such a challenging year, we were able to deliver a retention rate stable when compared to the previous cycles at 93% including both core and supplemental while adjusting prices on average by 6%.

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

Ari de Sa Cavalcante Neto — Chief Executive Officer

Thank you Otero. On slide 11, we present our four main priorities for 2022. First priority is about using the power of our platform to continue to boost growth. We reinforce on slide 13 the relevance of delivering a superior value proposition to our customers. In 2021, we increased our net promoter score among core partner schools to 84 as we continue to improve the solutions and to support our partner schools. We also saw an important improvement in the academic results of our students. Students admitted in first place in public universities through the ENEM exam growing 27% year-over-year.

Students admitted in the top 10 growing 17%. In total students admitted growing 27%. Moving to slide 14, as Arco consolidates its leading position, cross-sell becomes a central piece in our growth strategy and we had important learnings and major achievements in our first year of cross-selling initiatives. First, we saw a substantially higher lead conversion when the new solutions is introduced by an Arco farmer with a pre-existing relationship. It was almost seven times the conversion rate without cross-sell.

Second, we had lower churn among core partner schools once they adopted other solutions from Arco. It was half of the churn of the schools without other solutions. And third, it is very clear to us that schools have space to adopt more than one supplemental solution and we continue to see an increase of case of schools with two or three supplemental solutions in our school base. On slide 15, we present an analysis of the potential increase in our ACV inside our school base with our existing students through cross-sell initiatives.

When we consider the migration of students in our base that use only one supplemental solution or that use only a core solution or that use a core and only one supplemental solution to the format of a core solution plus two supplemental solutions, we see the potential to add BRL1.8 billion in ACV, or more than double our current ACV. In other words, we have a large potential to increase the ARPU or average revenue per user of our student base by cross-selling additional solutions to that specific student. Our second priority is about integrating our structure to unlock efficiencies and benefits of scale.

On slide 17, we present our efficiency roadmap. We have concluded the corporate reorganization in 2021 with the creation of the Core hubs, ArcoPlus, ArcoTech and Services business unit. We are now working on supply chain and technology initiatives. Moving to slide 18, the supply chain integration is already on track and presenting positive results. In 2021, we have integrated our printing efforts, decreased the number of logistics suppliers and build a unique supplier chain culture leading to a 10% reduction in the operations cost per student and almost doubled the days payable outstanding.

For 2022 we plan on unifying our supply teams according to business verticals, create a performance team and create the planning service introduction functional verticals. On slide 19 we present our technology integration plan, which will be made gradually over the next two to three years and should reduce complexity, increase agility and improve out your user experience. On the education technology front, we plan on reducing to one assessment platform, one boarding sign-on and five content structures. On the IT optimization front, we should evolve to eight IT systems from the existing 23.

Our third priority is about improving cash generation to strengthen our balance sheet and allow for future investments. On slide 21, we present the main pillars that will lead us to a healthy cash generation in 2022. We will focus on improving our cash cycle with the return of these receivable and inventories to historic levels and further improvement on payable days. We will continue to incorporate the recently acquired business leading to lower effective tax rate. And we will optimize our capex, which we expect to be 10% to 12% of revenues in 2022.

Finally, our fourth priority is about continue to expand disclosure on ESG initiatives and increase our impact. We are releasing today our 2021 ESG report where we detail our 2025 goals, listing our projects to achieve these goals and update the main metrics in our three material pillars. For 2022, our focus will on measuring the evolution in learning at our partner schools and increasing the number of students learning 21st century skills, reduced turnover, increase the employees NPS and strengthening our diversity programs and mapping our paper lifecycle and starting to measure our carbon emissions.

We know we have an important and critical role in our society and we are committed to continue impacting lives through education of high quality. And to end this call, I would like to thank Arco’s team for the their resiliency, effort, talent and exceptional deliveries in such a challenging year. We are extremely excited with the outlook ahead of us. Thank you very much for your trust and time.

Operator, we can now open for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Vinicius Figueiredo, Itau BBA.

Vinicius Figueiredo — Itau BBA — Analyst

Good evening, everyone, and thanks for taking my question. My first question is regarding ACV shown on slide 9 that the churn rates to that 7% this year. Could you please provide how this rates performed historically just to understand how it has been like, and this number is in accordance to last year’s? If yes, how could you increase the retention rate going forward? And the second question is regarding ACV break, one of your competitors mentioned that is fair to assume ACV break very close to zero this year. Is it fair to assume that for Arco too? Thanks.

Roberto Otero — Chief Financial Officer

This is Otero here and thank you for the questions. The first one on churn, yes the 7% is pretty much in line with the historical figures that we have posted or that our brands have posted over time. And to your point on how we can improve this rate, I’ll tell you this is pretty much by improving the brands that to post retention rates below the most mature ones. So for example, we are quite still achievable, pretty much three years ago we had retention rate of 86%. This year retention rate was 97%, right? So I mean it takes a little bit of time, right, but we definitely improved the retention rate of the brands that we acquired.

And don’t forget that inside this churn there are supplemental brands as well, which we have been able to retention very well in case so improving very much like the mix of the brands that showing agree that some product technology and the go-to-market strategy. And to your other point on the conversion of ACV to revenue. So I mean, this change in the ACV number is pretty much based on the actual number of students currently using our solution and accessing the platforms, okay? So the BRL1.5 billion is no longer a projection, okay? So this is based up until now almost the month of April on the number of actual students in this quarterly sales that are using the platforms, okay? So this is what gives us confidence that we will not see a breakage of ACV into revenue at this time.

Vinicius Figueiredo — Itau BBA — Analyst

Okay, perfect, very clear. Thank you Otero.

Roberto Otero — Chief Financial Officer

Thank you.

Operator

Our next question comes from Vitor Tomita, Goldman Sachs.

Vitor Tomita — Goldman Sachs — Analyst

Good evening all and thanks for taking our questions. Two questions from our side. The first one is on tickets. So given that acquisitions have added quite a few new price points and that the relatively high inflation levels we have been seeing Brazil, could you give us some more color on the dynamics of average ticket growth for core solutions in this year’s ACV bookings? And on how you expect tickets to evolve going forward? This is our first question.

And our second question would be on the supplemental tech solutions. So, traditionally Arco had mostly included technological or software features in the core solution bundles, but I understand that newer software solutions like WPensar and some of the acquisitions have been sold separately supplemental offerings. From a strategic sense how do you see this going forward? Do you expect most new technological solutions you acquire or develop to be included within core solution bundles to support tickets and retention or is the plan to grow these solutions as a separate revenue line via cross-selling and make them more relevant in the longer term as revenue sources by themselves? Thank you.

Roberto Otero — Chief Financial Officer

Well thank Vitor. It’s Otero here. Thanks so much for the question. So the first one on the price increase. As we show on the presentation, we increased the average ticket on average by 6% [Indecipherable] for core and supplemental. For the core brands, even though we do not disclose the preferences separately you look above that level, okay? We feel it was below the 10% inflation for 2021 and here, I’ll give you pretty much two reasons, okay, maybe three. The first one is that we start building up our ACV for the next year, very early in the entire year, okay?

So when we go back to the first months of last year the run rate of inflation looks far away from 10%. So there is some lag effect as we build up to do for the following year, especially in a year when inflation [Indecipherable] a lumpy, okay? So this is the first one. The second one, there is a mix effect, okay, here. As you well pointed nowadays we have a very nice place of portfolio when you put in perspective a price point. And yes, some well performance, a brand portfolio also other ones with lower average ticket. This is not mean that they outgrow, okay, the one with the highest average ticket. Actually we saw a very homogeneous performance across the portfolio, okay? So there is a mix effect here as well. And finally, I mean, when you look at our cost inflation in case so Arco’s cost inflation in 2021 given the profile of our cost and given all those supply chain efforts that we can put in place our compensation was far away from 10% as well, okay? So this is on pricing.

On your second point about the new tax features, I think those two strategies they do not conflict. I would say we use each of them in different ways. By selling separately both tech features we start to build up relationship with new target schools, okay? As you know, I mean our core products is a complex product, right, to explain to start to use some primary schools afraid from this change and so losing the tech features to land inside this core and from that point onwards expand in something that we have started to do, okay, since last year. But this does not prevent us on selling them together with the core and the supplemental, okay? So basically, we have a two-fold strategy here. And we think both worked fine, okay?

Vitor Tomita — Goldman Sachs — Analyst

Very clear. Thank you very much.

Roberto Otero — Chief Financial Officer

Well, thank you.

Operator

Our next question comes from Marcelo Santos, J.P. Morgan.

Marcelo Santos — J.P. Morgan Chase & Co. — Analyst

Good evening Ari, Otero, Carina. Thanks for taking my questions. The first question is about the competitive environment, if you could discuss a bit, how is the comparison in core and supplemental markets? And the second question is if you could discuss on the incremental ACV you had on supplemental. I think you had BRL71 million in incremental ACV from 2021 to 2022. How much is of that roughly is sales through the current core clients and how much sales to clients that are to new clients in a sense? Thank you.

Ari de Sa Cavalcante Neto — Chief Executive Officer

Thank you Marcelo. This is Ari. So talking about the competitive environment, what we’ve seen last years. It’s pretty much similar to the environment that we’ve seen before. We still have a very fragmented market with many players, some larger, some smaller but one thing that I saw that we saw that was a little bit different in this last two years was especially the textbooks, the publishers, schools that were somehow were looking to use learning systems, they were much more willing to consider our solutions because of the needs of technology.

And of course because of the value proposition, teachers training in [Indecipherable] platforms, the brands that we add to the school. So we saw textbooks moving share in the overall market. And the other thing of course since scale becomes more important and the investment in content, innovation and technology demand in scale what we’ve seen with that of the smaller players had a harder time in order to invest in product evolution during the pandemic. But other than that, we would say that the competitive environment remains the same.

Roberto Otero — Chief Financial Officer

Sure. I mean, Marcelo, Otero here. Happy to speak to you. So on the supplemental incremental sales. So I think your questions regarding what cross-sell versus non-cross-sell, right? So I mean when we look at the penetration of supplemental progress in our base of core students, it went from 10% penetration in 2021, which means 10% of our base of course to using at least one financial solution to 15% in 2022. However, the base of course, students also grew essentially, right?

So, I mean the progress proved to be quite effective and we show on the presentation [Indecipherable] some metrics, I think are worth reminding here on the call. The first one is that the unit conversion when you cross-sell is six times faster than when you do not cross-sell for supplemental solution. The second one is that when we analyze the churn of the schools where we had cross-sell the churn is half the one where we do not have cross-sell, okay? So the truth is the more we do cross-sell from the lower going to be our churn in the future, okay?

And the third one is also quite important, which helps build the argument [Indecipherable] affordability inside the schools. We show that in the number of schools moving towards supplemental solutions, okay? It’s been just one year of cross-sell. So I think we’re still learning how to do it. And so we need to share here is that this year onwards we will start to reverse cross-sell. So pretty much, we’re going to start to give cross-sell from supplemental is students to use core. So today we have pretty much upwards 400,000 supplemental students that do not meet our core solutions yet, okay? And for 2022 we are creating, I mean incentives, training, appropriate profit to do this cross-sell in a reverse way.

Marcelo Santos — J.P. Morgan Chase & Co. — Analyst

Just to understand the last point, because the first one is lead conversion six times faster, churn 50% lower and the last point is that we’re going to start doing reverse cross-sell this year, that’s it. Just to be sure I got everything.

Roberto Otero — Chief Financial Officer

Yeah, actually the third point was the number of schools in two or three supplemental solutions on top of the core product, okay? And the fourth point is that the reverse cross-sell. So pretty much selling the core product to 400,000 students that today only use one supplemental and do not meet our core learning system yet.

Marcelo Santos — J.P. Morgan Chase & Co. — Analyst

Perfect. No, very clear now. Thank you very much Otero and Ari.

Roberto Otero — Chief Financial Officer

Thank you Marcelo.

Ari de Sa Cavalcante Neto — Chief Executive Officer

Thank you Marcelo.

Operator

Our next question comes from Vinicius Ribeiro, UBS.

Vinicius Ribeiro — UBS — Analyst

Hey guys, good afternoon everyone. Thanks for taking my question. Two follow-ups on since you have already addressed so first on the price increases. I’m not sure I understood it correctly. But going forward, assuming we have a 12 month of double-digit inflation, which we’re likely to see here in Brazil. Should we expect you guys to maintain a spread over inflation on price increases or under that circumstances things got different from some perspective?

And the second question, going into the cross-selling you guys provided in slide 15 and you guys answered in the previous question, but you guys have a significant number of schools that have more than one supplemental solutions and what do you see as the main hurdle for schools that wants to adhere to such additional solutions meaning two or three as you guys provided in the slide? Thanks.

Roberto Otero — Chief Financial Officer

Sure. Thanks Vinicius for the question. So on your first one. No, I mean our goals for next year, it is implied real price increase, okay? So our goals for price increase for 2023 are above 6% better, okay? Even though I mean according to market inflation, it looks like inflation next year is going to be below 6% who knows, but I mean our goals for price increase next year are much closer to high single-digit than 6%, okay? And to your second point, I mean I would say, yes today we have a relevant a portion of schools using one core plus supplemental solution. It’s in number of hundreds, okay? So it is a relevant a member, but we also remind that I mean cross-sell continued into our — I think it’s right about facing, I mean push back in its core.

I think it’s more about — I mean execution and endpoint this restricts the strategy in practice, okay? On [Indecipherable] segments to supplementals, I mean we should be won’t see it’s one by legal product, okay, plus one social-emotional or make shift product. So, this is pretty much the standard that we are seeing on those schools, okay? And I mean the locking that you gain in schools is phenomenal. So at the end of the day, not only the acquisition cost of these [Indecipherable] is lower, but I mean when you think about the lifetime value of this contract over time, it’s higher. So this allows us to work with bundles and the competitive to penetrate those schools with more supplemental products.

Vinicius Ribeiro — UBS — Analyst

Yeah, got it. Thanks, thanks very much.

Roberto Otero — Chief Financial Officer

Well, thank you.

Operator

Our next question comes from Javier Martinez, Morgan Stanley. Mr. Javier, you may go ahead. [Operator Instructions]

[Operator Closing Remarks]