Arco Platform Limited Q1 2023 Earnings Call

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Speaker 2: This event is being recorded and all participants will be in a listen-only mode during the company's presentation. After our remarks, there will be a question and answer session. At that time further instructions will be given.

Speaker 2: Should any participant need assistance during this call, please press star 0 to reach the operator. This event is also being broadcast live via webcast and may be accessed through Arco?s website at www.investor.arcoplatform.com where the presentation is also available.

Speaker 2: Now, I'll turn the conference over to Roberto Otero, ARCO CFO . Otero, you may begin your presentation.

Speaker 2: Thank you. I'm pleased to welcome you to ARCO's first quarter of the 2023 conference call. With me on the call today we have ARCO CEO , Ari Gisard Caboclincinet.

Speaker 2: During today's presentation, we 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.

Speaker 3: Four looking statements in this presentation include what 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.

Speaker 3: These risks include those not set forth in the documents that we issued earlier today, as well as those more fully described in our findings with the Securities and Exchange Commission.....

Speaker 3: The forward-looking statements in this presentation are based on the information available to us as of the date thereof. You should now rely on them as predictions of future events and we disclaim any obligation to update any forward-looking statements except as required by law.

Speaker 3: In addition, Management B referenced 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.

Speaker 3: We have provided a reconciliation of these non-IFRS financial measures to the most directly comparable IFRS financial measures in our press release.

Speaker 3: Please note that, except for revenue, gross margin, selling expense, G&A, and cash flow from operations, all other financial measures we discuss here are non-IFRS, and growth rates are compared to the prior year comparable period unless otherwise stated.

Speaker 3: We also note that year-over-year comparisons are affected by acquisitions that were not included in our 2022 financials.

Speaker 3: Let me now turn the call over to Ali Arcosio.

Speaker 4: Thank you, Otero, and thank you everyone for joining today's conference call.

Speaker 4: I would like to start with the highlights of the quarter on slide 3.

Speaker 4: On our coast pedagogical business which includes our core supplemental brands

Speaker 4: We delivered a 28% top line and EBITDA growth in the 2023 cycle so far.

Speaker 4: with adjusted EBITDA margin at 41.5%.

Speaker 4: despite an already anticipated pressure on costs to print our content.

Speaker 4: Since 2022, the industry has suffered from a material increase in printing costs.

Speaker 4: resulting from higher paper prices globally.

Speaker 4: which has been impacting our gross margins since last year.

Speaker 4: We expect this pressure to slow down in the second half of the year.

Speaker 4: with a significantly lower impact on our gross margin in 2023, and we are working to mitigate such circumstantial effects.

Speaker 4: as we discuss further in the presentation.

Speaker 4: We remain confident we will deliver our EBITDA margin guidance for the fiscal year between 36.5 and 38.5%.

Speaker 4: Our pedagogical business has posted material and structural improvements.

Speaker 4: adjusted EBITDA minus CAPEX metric cycle to date expanded 10 percentage points year over year and we posted significant improvement in cash flow generation in the first quarter of the 2023 cycle allowing article to generate cash

Speaker 4: reflecting improvements across working capital, capex and taxes.

Speaker 4: which Otero will discuss in more detail soon. The quarter, we also launch a new segment resulting from the acquisition of ISAC.

Speaker 4: the financial and management solution segment, the boots in ARCO P&L adding growth with 133% increase in that revenue year over year.

Speaker 4: with ISAC that enables ARCO to further strengthen its dominant position in Brazil's education ecosystem.

Speaker 4: by diversifying the scope of its portfolio of products, making us a true one-stop shop platform for our partner's goal while establishing closer relationships with families.

Speaker 4: I wanted to remind that we have been implementing several initiatives to drive a more efficient, agile, and scalable operation.

Speaker 4: which is shown by metrics whose performance is under our control, such as capital deployment, SG&A management, and working capital.

Speaker 4: The bridging cost pressure is circumstantial and those initiatives that we are taking are already unlocking margin gains in 2023.

Speaker 4: and will significantly improve our cache generation.

Speaker 4: On top of our efforts to improve internal operation, we must always keep our partner schools at the center of all our decisions.

Speaker 4: This commitment requires continuous investment in our products and solutions, full dedication while serving our customers and a result to always evolve as a company.

Speaker 4: I will now turn the call to Otero who will continue the presentation. Otero, please go ahead.

Speaker 3: Thank you Ali and good evening everyone.

Speaker 3: We will begin by presenting the results of our pedagogical business initiated on slide six.

Speaker 3: Given the difference in revenue recognition this quarter when compared to the first quarter of 2022, we strongly recommend investors to analyze our business performance on a cycle-to-date basis, starting in Q4 2022 up to Q1 2023. Net revenue in the 2023 cycle grew 28% year-per-year.

Speaker 3: reaching 1 billion 136 million REIs, with car solutions up 26% year-over-year and supplemental solutions driving a robust 38% year-over-year growth cycle to date.

Speaker 3: In the first quarter, revenues for the pedagogical business were up 10% year-over-year, reflecting the lower revenue recognition versus last year. We maintained our guidance for 1.9 billion RIs of ACV in 2023, with 24% growth versus 2022.

Speaker 3: Moving to slide 7, we discussed the pedagogical business, Adjuce-CDP down margin. Despite the cost pressures, we managed to keep our Adjuce-CDP down margin in line year over year in the 2023 cycle at 41.5%.

Speaker 3: While the content providing costs consumed 5.5% of margins, our SG&A efforts managed to generate the same positive impact on our profitability for a flat performance versus the 2022 cycle.

Speaker 3: On the next slide, we discuss in more detail the leverage behind our EBDOT margin guidance achievement this year.

Speaker 3: Moving to slide 8, we expect an important improvement on gross margin behavior in the second half of the year, reflecting a few initiatives, including printing prices renegotiation due to volume relocation and integrated supply management strategy.

Speaker 3: Direct paper negotiation and acquisition from producers, and more intense technology usage will allow for more scalable content production and delivery setups.

Speaker 3: All in, we expect the pedagogical business cash flows margin to be down at approximately 2.5% in 2023.

Speaker 3: At this point, we have already signed contracts for the 2024 Cyclone printing process, which starts next August . Thus, we have a very high visibility on our content production costs for the second half of the year. On SG&A, we will continue to unlock scale gains and grow our expenses at a much slower pace when compared to our top-line growth.

Speaker 3: We have posted significant results over the last three years and expect this trend to continue in the future.

Speaker 3: On slide nine, we disclosed the main metrics behind the significant improvement in the pedagogical business cash generation in the quarter. Improvements in days of sales outstanding, delinquency, and days of inventory were key to revamp our working characteristics this quarter. Moving to slide 10, once more, we disclosed the effect of the company's footprint.

Speaker 3: 2023 cycle at 6.4% of net revenue from 16.3% in 2022.

Speaker 3: This enabled us to expand almost 10 percentage points the adjusted EBITDA minus capex metric in 2023 cycle to 35 percent from 25.2 percent in 2022.

Speaker 3: As a result, in slides 11 and 12, we show the improvement in every line of our operating cash flow, leading our pedagogical business to a free cash flow to firm of 187.6 million re-eyes in the first quarter. That represents almost 40% of net revenues in the quarter and 174.5 million expansion when compared to the first quarter 2022 figures.

Speaker 3: When looking at the 2023 cycle, we delivered 96.8 million RIs for cash flow generation at 321.1 million expansion versus the negative 224 million for cash flow registered in the 2022 cycle to date.

Speaker 3: Now moving to slide 14, we officially debuted our financial and management segment with a brief recap on ISAC's business model and trajectory.

Speaker 3: ISAC was founded in August 2020 to address K-12 schools' overarching needs with software and financial solutions as an all-in-one platform.

Speaker 3: IVEX has already reached 266 million REIs in annual recurring revenue as of March 31st and currently transact almost 3 billion REIs in yearly total payment value or TPZ.

Speaker 3: ISAC's first product, the Revenue Guarantee, aids Brazilian schools' financial struggles, once helping them surpassing, first, limited managerial skills, second, pen and paper, or in legacy ERP systems that made billing mostly offline through paper invoices, collecting unstructured and laborious.

Speaker 3: leading to friction with parents, eliminates financial volatility to schools once ISAC becomes responsible for all tuition collection, incorporating the delinquency risk that is priced in the applied take rate and guarantees a monthly stake to streamline to schools.

Speaker 3: Such product provides recurring and monthly revenue once schools are paid in monthly installments during a 12-year long education cycle and a reduced working capital as most parents often delay a few days.

Speaker 3: And delinquency at the end of the cycle is a structured law, as delinquent students cannot re-enroll for the next school year, as stated by law.

Speaker 3: On side 15, we go through the business model fundamentals of ISAC that enables such powerful and complementary early drivers.

Speaker 3: First, intense growth based on K-grade model mandatory for all students provides significant scale.

Speaker 3: Second, such rapid growth straightened the relationship with schools that already use our core and supplemental solutions by offering complementary financial and managerial solutions and additionally provide the next-generation intake sales motion that adds new schools into our cost portfolio and paves the way for monetizing a pipeline of products going forward. Third.

Speaker 3: On top of that, ISAC's state-of-the-art technology team and structure is a main pillar while enhancing pricing and collection processes and reducing our costs to serve while gaining scale. ISAC's trajectory as March 23 is on track to its historically robust growth profile, as we can see in slide 16.

Speaker 3: ARR growth year-over-year surpassed the 80% mark and is combined with a powerful increase of efficiency.

Speaker 3: When analyzing school over total headcount metric in a single year, EZAC was able to almost double such ratio, demonstrating the power and scalability of its tech-enabled model.

Speaker 3: Moving to slide 17, we show the first earnings result of our close financial and management segment. Net revenue in the first quarter were 62.5 million REIs and 133% growth versus a pro-forma net revenue of the first quarter 2022 prior to the acquisition.

Speaker 3: I just said the Vida margin was minus 23.6%, an expressive 74 percentage points year-over-year expansion versus a pro forma adjusted Vida of the first quarter.

Speaker 3: EBITDA improvement correlates directly to scale gains resulting from its growth and type profile. Due to its rapid growth pace, it's expected that margins will gradually increase quarter over quarter, ramping up on revenue growth and scale gains. We are confident in reaching our net revenue guidance of between 300 and 350 million reais e miles per hour.

Speaker 3: and FMM results.

Speaker 3: First quarter consolidated figures delivered a net revenue of 534.9 million REIs and adjusted the BDA of 110.7 million with 20.7% adjusted the BDA margin.

Speaker 3: Confident data adjusted net income was minus 42 million reais, representing a minus 7.9% adjusted net income margin. Confident data for cash flow to four reached 207.6 million reais, representing 38.8% of net revenue in the period.

Speaker 3: Moving to slide 20, we present the evolution of our free cash flow to firms since 2018 in order to highlight the significant performance of this beginning of the year. Definitely a milestone once we deliver the highest rate over revenues in such periods. On slide 21, we highlight Parco's free cash flow generation after financial expenses.

Speaker 3: reaching 94.4 million REI or 17.7% of net revenues in the first quarter, initiating a year of robust cash collection as disclosed on slide 22.

Speaker 3: From the 937 million reais of accounts receivables that are not passed due on March 31, we expect to collect approximately 460 million up until the end of June .

Speaker 3: Such results collaborate to work on a continuous deleveraging process, as disclosed in slide 23.

Speaker 3: In the first quarter, we further reduced our net debt over just a bit less than a month to three times, calculating according to our covenant specifications.

Speaker 3: While analyzing our current obligations, we continue to deploy our liability management strategy in order to meet our obligations for short and long term.

Speaker 3: As mentioned in previous calls, we are confident in our cash generation capacity, and on top of that, we are currently at final stages of issuing an additional credit line to strengthen our balance sheet to make for the future capital disbursements. With that, we conclude our presentation. Operator, we can now open for questions. Thank you.

Speaker 2: Thank you. The floor is now open for questions. If you have a question, please press star 1 on your touch tone phone at this or any time. If at any point your question is answered, you may remove yourself from the queue by pressing star 2.

Speaker 2: Questions will be taken in the order they are received. We do ask that when you pose your question that you pick up your handset to provide optimum sound quality.

Speaker 2: Our first question comes from Luca Marchezzini with ItaubBA. Please go ahead.

Speaker 5: Good evening everyone and thank you for taking our questions. We've got two questions from our side. So first, Otero, you mentioned that during the call that alcohol has already negotiated the bidding contract for next year's commercial cycle. Can you please put on your caller on the terms negotiated?

Speaker 5: and also how they compare to this year's cost. And then secondly regarding cash flow generation, we saw a significant improvement that was mainly caused by better working capital. So can you please comment on the recurrence of these effects that led to this improvement in working capital? Thank you.

Speaker 3: Hi Luca, thanks for the question. So, starting with the first one, as you said, yes, we already have signed contracts for the first batch of the 2024 content. We start at the screening process by the end of...

Speaker 3: a budget decline in prices per page for the initial deliveries, which, as I said, we started creating in August and we started delivering to schools by mid to the end of the fourth quarter. Okay?

Speaker 3: On your second point on cash flow generation, you're right, I think that's the most important highlight of the quarter. It is 100% repaired, okay. There's no one-off effect in this cash flow generation. Actually, this goes back to the business.

Speaker 3: and the incorporation of the acquisitions. So assuming a normalized environment, which is the one we are operating at right now, the business generates cash naturally. I don't want to minimize the impact or the influence of internal initiatives.

Speaker 3: and the work the team is doing to improve of course and accelerate the return to this very healthy, cash-full profile. So we've been putting a lot of focus on that through internal processes, through incentives to the management.

Speaker 3: This has become the key metric through which we measured success in the company. And now this is reflecting in concrete results. Okay, so again, this is recurring. There's no one of effect and you should see these behaviors throughout the year. Okay.

Thank you. Our next question comes from Lucas Nagano with Morgan Stanley . Please go ahead. You

Okay, good evening. Thanks for taking our questions. We have two questions.

The first one is related to cost. I understand that for the 2024 cycle, the printing cost should reduce, but what are your expectations on the margins for the rest of the 2023 cycle, even though the materials must have been ready to print? And the second question is related to the...

the next the 2024 sales process. So could you give some color on your perception on the competitive environment and which level of ACV growth you're targeting for current and supplemental and do you see Isaac helping to accelerate the growth in the pedagogical segment as well?

As I said during the opening remarks, we expected the gross margin this year, in the fiscal year, to be down around 2 to 3 percentage points max. So this means an improving curve in the upcoming quarters.

and this reflects negotiations that are already affecting the 2023 cycle. So we were mostly exposed to higher prices for the first batches of the 2023 cycle, but along the process we managed to relocate volume.

in other suppliers and other printing companies and managed to reduce prices for the current cycle. But for the 2024 cycle which we start printing in August , this affects the Q4 directly and helps ourselves minimize the impact in the entire year.

But again, at the 2023, as I said, we saw pressure, especially from the beginning of the pre-link process, but we managed to relocate capacity and not be fully exposed to those higher prices for the entire cycle. And again, we expected the gross margin to be down this year at a much lower pace than what we showed in the first video.

ACV build-up process, we are ahead of the curve in pretty much every metric that we look at. So in terms of a price increase, in terms of cross-selling, up-selling, and new school addition, we are performing ahead of the curve and slightly ahead.

of our expectations. Okay, but again, it's important to emphasize that it's early. So let's keep expectations very in mind that we're still beginning the process. But the data we have at this point shows encouraging expectations for

early to focus on what we would call a reverse cross-sell which we do for supplemental products and I think we will end up doing with Isaac. Isaac already has more than 1,200 schools as clients so it is a relevant base of potential clients to our cross-pedagogical business. It is important.

But for a matter of focus and priority, we are at this point focusing more on the cross-sell of the pedagogical sales force, helping create leads and sell ISAC to our current pedagogical clients. I think it's much more a matter of privatization and focus.

and probably we're going to start the reverse cross-help more likely towards the end of this year or in 2024.

Yeah, I think this answered the question. Thank you, Raul. Thank you, Tario. That's very helpful.

Our next question comes from Jessica Miller with JP Morgan. Please go ahead.

Hi, thank you for taking my question. I have two. So first, on that, do you continue to expect rich even by the end of 2020?

opportunities in the public sector. Thank you. Hi Jessica, Otero here. I'm sorry, but could you repeat the first and second question? I'm not sure if it's our connection here, but I lost you. If you could repeat, I would appreciate it. Thank you. Yeah, sure. My second question is,

case as you saw in the first quarter they posted a minus 26% EBITDA margin differently from from article the ISAC business builds up revenue along the year right so sorry minus 23.6 EBITDA margin and differently from articles business ISAC compounds revenue along the year right Jessica

knocking at this point that would lead us to believe that the break-even would take longer to happen than what we initially planned. Okay, so far so good that this is performing a new person in line with the expectations.

With regards to the public sector, I think it's a good question, but honestly, we think the opportunity in the private sector is so big, and we think we can explore this opportunity in the private sector in so many ways that at this point, for a matter of focus,

we will continue to focus in the private sector. Okay, we are just scratching the surface in many segments in which operate. Now we have as Isaac, I mean, adding even more strength to the platform. So for a matter of focus and for a matter of belief.

that this is the best place to focus, we will continue to focus on the private sector.

Thank you. Our next question comes from Pedro Caravina with Credit Suisse. Please go ahead.

Hi guys, thanks for taking my questions. So I would like to do a follow up on cash generation. So you improved a lot with cash generation for the 2020 cycle. If I may ask, what are behind the better working capital dynamics?

following my colleagues' questions. And what should we expect for the following two parts of the cycle? Is there a concentration of cash generation in the first two parts?

I don't know better terms and improvements at all. And also I noticed that there was a reduction in capex expanding. So were the levels higher in 2022 and what should be a recurring level going forward for capex maybe as a percentage of revenues? Thanks.

improvements at all. And also I noticed that there was a reduction in capex expanding. So were the levels higher in 2022 and what should be a recurring level going forward for capex maybe as a percentage of revenues? Thanks. Kidd.

Hey Pedro, Otero here. Thanks for the question. So in terms of the cash flow improvement, I think it's much more a normalization of the working factor behavior. I think we are leaving behind events or impactful events.

that really changed and affected the behavior of the companies working capital. I think the impact on receivables, event trees, to a lesser extent on payables as well. So we're seeing a normalization across the board.

So, if you look at delinquency, for example, our performance on delinquency right now is better than pre-COVID levels. So I would say the business is going back to its normal profile and internally we are putting much more focus on that as well. So I think this adds more fuel.

to this recovery or accelerates this recovery of Cape Edro. So internally we're putting a lot of effort. This applies to contracts with schools. This applies to SLP. This applies to all those renegotiations going on with the printing suppliers.

So it's a very ample effort that is related to this improvement in working capital, because this has become a key focus and the internal incentives are all towards this goal. In terms of the expectation for the next quarters...

The second quarter is usually a very strong quarter as well for collection. So you should not expect anything different. And the cable 4 is usually the quarter at which we see the highest consumption, right? In terms of cash and working capital consumption. So we should expect a similar trend to that.

towards being the dominant and the best player in terms of quality and product quality and technology evolution. So this has not changed at all and this is not the reason why CapEx is actually losing relevance as a percentage.

revenues. I think it has much more to do with the way we've been operating the company and the level of coordination among the brands and reduce redundancy across the brands. So all those things that some of them we even discussed at R-Code in terms of centralizing...

of the percentage of revenues of 8 to 10%. But at this point, I would say that there's a sign that a context will trend below or is slightly below or at the low end of this guidance.

of eight to ten percent, but at this point I would say that there's a sign that a complex will trend below or is slightly below or at the low end of this guidance. Okay? Very clear, Tariq. Thank you.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star 1 on your touch tone phone.

Please hold while we poll for questions. At this time, we have no further questions in the queue. That concludes ARCO's first quarter 2023 earnings call.

Thank you very much for your participation and have a good night. You may now disconnect.

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