Q2 2019 Earnings Call

Good day, ladies and gentlemen, and welcome to the Arco platform in Q2 2019 earnings Conference call. At this time all participants are in a listen only mode. Following management's prepared remarks, we will host a question answer session and our instructions will be given at that time. If during your conference that you require operator assistance Press Star then zero at Arbor will be happy to assist you. As a reminder, this conference call may be recorded. It is now my pleasure to conference over to Victor Sir you may begin.

Thank you Brian I am pleased to welcome you to Arcos second quarter 2019 conference call.

With me on the call today, we had gross see equal you saw a couple of congenital CFO WPP shortens the census in or new SP and maybe in the IR director go back to that.

Well, Barry I will turn the call to you for the Safe Harbor remarks.

Thanks, Victor and thanks, everyone for joining the call during todays 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 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 expectations and guidance for future periods, our expectations regarding our strategic product initiatives and their related benefits and our expectations regarding the market.

These risks include those set forth in the press release 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 I FRS financial measures on this call.

No hi, FRS measures financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with IRS. We have provided a reconciliation of these no idea for financial measures to the most directly comparable financial measure in our press release, Let me now turn the call over to do this on a couple of questions to our co CEO .

Thanks, Ben and thanks, everyone for joining our call second quarter 2019 conference call.

As we approach the month of September and the first anniversary of our IPO, we find it appropriate to recap our commitments from year ago and be accountable with investors, who have been supportive of our trajectory ever since.

For those who have been following our story since the beginning.

You might remember that we mentioned during the IPO some important goals we wanted to accomplish.

The first and most important goal directly related to our ambition was to continue to deliver a high quality education at scale and be recognized as the leader in terms of quality in education in Brazil.

The second commitment was to continue to hopefully grow our organic business by investing in our product and strengthening our relationship with our partner schools.

And lastly to continue to pursue new opportunities launch new products and deliver successful acquisitions.

In terms of quality our solutions have proven once again to have superior outcomes for another year schools using our solutions are listed among the best in the country and similar to last year. We have three partner schools ranked in the top 10 in Brazil National exam in.

The number of schools classified as the top three in their Cds has increased since the IPO, which currently stands at 216 partner schools.

Those academic results combined with our focus on our clients continue to show US that we are on the right path to enhance their could then make performance of our partner schools and as a consequence transform their students' lives.

As we've mentioned many times before quality and brand equity in this business are crucial to succeed and this is not built overnight.

It takes time to build a strong brand given the long sales academic cycles of the K to 12 industry.

If you move to slide five we'd like to remind what we consider to be the gear our success.

Our focus on the long term and our investments in our product.

We think this chart shows the reasons for our outgrowth over the years.

As we invest in content quality and technology, we enable our partner schools and students to achieve superior academic results.

Those results combined with the work of our farmers lead to higher brand equity high retention rates and high net promoter scores.

This has been fundamental for us to grow and gain market share.

Which translates into scale gains to re invest in our product.

This is our mantra our long term focus is what drives us every day.

Moving to M&A, Let me give you a quick recap of our strategy that is on slide six of our presentation. It is divided into three objectives.

First.

Expand our network of schools.

Increasing our network of partner schools gives us scale to continue to invest in our products.

This is key to succeed in this industry and both achieved was a unique opportunity for us to acquire an iconic brand that will add nearly 700000 students to our platform the higher the scale the higher rubiales capability to invest in content technology and deliver a better solution for our customers.

The second pillar is to deploy acquisitions that expand our product offering.

As we mentioned in the last call. We believe that the school is the cornerstone in the tudors allocation and should become the center of the learning experience offering both core and supplemental solutions to improve the student outcomes.

On the supplemental segment most of the schools don't have the content, nor the methodology to build a pedagogical correctly.

For that reason article season opportunity to offer new programs as we have been doing successfully with international school.

In order to further enhance our portfolio, we invested in Nazi avail, a competency based.

Supplemental solution.

I will share some color on this soon.

The third M&A pillar is to deliver value added technology features to our partner schools.

This strategy complements our efforts to develop in house solutions and tech enabled products to our clients.

We are constantly monitoring the market to identify trends and great products that fit our platform and enhance the student learning experience with technology.

It's going well demand to fulfill this need and we are excited about the opportunity ahead.

Now I'll talk about the new acquisitions in more detail.

On slide seven we show that Navios Ela fits precisely into our supplemental offering.

Let me share more more content on our strategy and the associated opportunities.

To start soon as in Brazil is still in school on average five hours per day.

Usually during the morning, compared to nine and a half hours in China.

In a half in France, and seven and a half hours in the U.S.

So schools in Brazil are usually idle in the afternoon.

This time could be used to offer other activities for students and turn to school into the center of the learning experience as a one stop shop concept for education.

Also according to enact a research agency linked to Brazil's Ministry of Education. There was an increase of 45% in the number of full time students in Brazil from 2010 to 2017.

There is a demand for schools to offer new activities for their students and we believe that 16, 20, onest century skills and language could fill the gap that Brazil in schools have.

Among the supplemental solutions, we believe that teaching our new skills, such as critical thinking problem solving creativity and innovation and communication are not only important from a pedagogical standpoint, but also essential to succeed in a 20 Onest century Society.

This is part of a growing international trend focusing more on the development of competence berths learning.

Then the traditional content knowledge based.

With the statements scenario, we decided to invest in Najaf Erle.

It is one of the best competency based learning solution with a proprietary high quality content and methodology fully integrated with K to 12 curriculum.

It is adopted by top rated schools in Brazil growing significantly over the last years with zero turn.

Now the Villa has the same b to B to C model with presence in more than 50 schools and 15000 students and represents not only a promisingly business unit on a standalone basis, but also a cross sell opportunity once blood into our network of schools.

Moving now to our score in movement like acquisition on slide eight.

He is a powerful app with more than 500000 active students enrolled at more than 800 schools operating under a b to B to C model.

It connects all the stakeholders in the school environment, allowing them to communicate and interact through a digital platform.

He and adds enormous value to parents by allowing them to easily follow and monitored in school activities and be more present on the education life of their children.

With E M. The school can offer an app that enhanced the communication with parents, providing chat based interaction.

Location based identifications NPS tool to assess parents satisfaction in a pilot project on payments.

This acquisition brings article new capabilities that further increases our value preposition to partner schools parents and students and also allows us to access E M's network of schools.

We're very excited about the future prospects of Navient Vela installing movement.

Despite the fact that we've been working on these initiatives already more importantly, the contribution to the short term results is our belief that both companies fit well on our efforts to build a sustainable differentiated business for the long term.

With that I'll turn to the call to that we who will discuss the financials. David. Please go ahead.

Thank you bye.

We are excited about our recent acquisitions of positive will not develop any scalable remained.

All of which increased our net worth of coal supplement their solution and features offered to our partners of course.

Before we dig into the numbers.

I would like to introduce for those who are new to our store our recommendations to analyze our coal on an annual basis.

Since our revenues are 100% subscription base.

We operate under the annual contract value or HCV metric.

TV as calculated by multiplying the number of enrolling students at each partner is called by the average ticket per student per year.

As a result, we have high predictability of our revenue on a yearly basis.

But revenue can vary between quarters.

The amount of revenue recognized as proportional to the amount of content made available.

Which is not only in early distributed among the quarters and also depends on our customers decision of when to receive the content.

Also please note that except for revenues gross margin selling expenses.

Gionee and cash flow from operations.

All financial measures discussed here are no I FRS.

And growth rates are compared to the prior year comparable period, unless otherwise stated.

Now I will go over our financial highlights then give more details about our margin and free cash flow and finally provide a guidance 40 eightv recognition for the third quarter of 2019, and EBITDA margins for the 2019 fiscal year.

First review our numbers.

Net revenue for the second quarter of 2019 was 137.6 million realized.

Which represented 31% of the 2019 HCV versus 25% in the same quarter of the last year.

The revenue recognition may vary among quarters with no impact in the total HCV and that happens due to that product mix logistic.

And our customers decision on when should we see the content.

Despite the higher revenue recognition.

We maintain our 2019 HCV guidance of 441 million Reais and change.

Net revenue for the first half of 2019 was 254.6 million realized.

Versus $195.1 million in the same period last year.

Combining the last three quarters revenue, we have recognized 85% of the 2019 HCV compare to 82% of 2018 HCV.

Gross margin was 81.2% for the second quarter versus 79.3% for the same period in 2018.

And as in line with our historical trend of increasing gross margin, but also reflects the higher revenue recognition in this quarter.

In the first semester, our gross margin was 81.3%.

300, bips year over year.

Selling expenses for the second quarter of 2019 was 39.3 million realized.

63% comp achieved 24.1 million reais.

For the second quarter of 2018.

The higher selling expenses reflect our investment in our sales team, including hunters and farmers.

As a math for Q offer continued support to our partner schools and expand our network of clients.

Jane expenses was 44.9 million realized.

Compared to 17 million realized for the second quarter of 2018 and included 20.8 million realized of share based compensation and 4.4 million realized of M&A related expenses.

Which we consider to be non recurring.

Adjusting for these two items Gionee would be 19.7 million realized showing significant SK again year over year.

Adjusted EBITDA was 61.4 million realized for the second quarter of 2019.

128% year over year.

We are on track to achieve adjusted EBITDA margin of 35.5% to 37.5% in 2019.

Free cash flow for the second quarter of 2019 was.

49.5 million we eyes.

Increasing 28% compared to the second quarter of 2018.

And we flat at 81%.

Adjusted EBITDA conversion.

In the first semester, we generated 81.7 million realized in free cash flow or 74% of our EBITDA.

Moving now to the guidance.

For the third quarter of 2019, we expect to recognize around 15% of the HCV 2019.

Or 65 million realize of revenues.

Also we expect our adjusted EBITDA margins full year 2019 to be in that range.

Between 35.5% to 37.5%.

And before turning the call back to Eddie for any closing remarks.

I would like to provide an update on positive as acquisition approval process.

On August 16.

We got the great news that the superintendent of the Brazilian antitrust agency catching.

Publish it on their official Gazette, the approval of the acquisition with no restriction.

Now we are waiting for the nomination of the card is new board members.

For the process to move on.

Was this board is duly compose.

Our 15 day period starts to account and if there is no objection that transaction is formally approved.

It's important also to highlight that since this defining of the transaction we have a dedicated team working together with consultant firms to prepare for the integration.

We remain confident vertex excess of this operation.

And we will keep the market update of any new developments on this matter.

And with that I would like to turn the call back to I'd for closing remarks.

Ari.

Thank you Debbie.

I just like to quickly point out a key factor of our success throughout all these years our strong culture.

We have six important pillars, which we show on slide 13 that we believe as essential to run our business.

Today I want to talk about one specifically, which is the value we attribute to our people.

Without our great team, we wouldn't be here right now a company that is able to deliver high quality education at scale and impact the learning experience of thousands of students.

In order to keep improving and growing further we need to constantly find new talents that we promote our kirker harder.

This year, we achieved a remarkable accomplishment and became one of the largest trainee programs in Brazil, we're very proud of that our program.

Had over 46000 applicants and we manage to find 14, new talents to be part of our team.

Being recognized as a great place to work and having those thousands of young talents willing to join our team means a lot to us and is a proof that we are on the right path to continue to deliver our mission.

With that we conclude our presentation. Thank you for your time and we can now open for questions.

Thank you, Sir ladies and gentlemen at this time, if you would like to ask a question over the phone lines. Please press star and then one on your telephone keypad. If your questions have been answered English movistar fusin surpassed the alky and to our audience over the phone lines. If you are participating in today's today's session kindly limit yourself to one question and one follow up.

Our first question will come from the line of Vidor told me.

Your line is now open.

Hi, good morning, and congratulations.

Good afternoon, and congratulations on the result.

On our side. There are question would it be if you could elaborate more on the price paid for any acquisitions and the structure of the transactions and also on whether this company's management, we remain with Arco.

Thank you.

That.

Hi, Peter and thank you for for your question so regarding the acquisitions.

So the first one and now be avella a wide.

Acquisition in four installments and we start with the first stack when we acquired 13% of the company for 4.2 million realized and the remaining 87% will be acquired in three installments. According to the company's performance and as we stated in the financial statements.

In the other the other acquisition is calling of main too yes.

And this one was already fully acquire for 18 million realized worth 60 million. We are paid upfront and two medians remain to be paid in two installments.

Both of the companies we keep the management. We are we are working with us.

Gee extract the synergies and grow the business.

And and and I believe that I answer most of your question right.

Yes, perfect. Thank you.

Thank you.

Thank you and our next question will come from the line of Mariana tremendous with credit Suisse. Your line is now open.

Hi, good afternoon, ladies that he thanks for taking my question. My question is there also about the recent acquisitions, but in the sense that I would like to get more color about how the business models work. So for instance, as far as calling moved them into how are going to charge for it or go into it to provide as a as a free tool for partners go to have access to or how is that going to work and in regards to have a valid I mean, how how much parents, we need to pay for it is addition to tuitions than they have in estimates about the potential addressable market size of this business or any order more details I do worry but to share about this acquisition in terms of how the operations work it would be very useful. Thanks.

Hi, My Deanna. Thank you for your question. So the two companies that we have acquired the operating the same business model as our current business do so we sell that to the schools and the schools resell that.

To the students of both the App from Squali movement too.

As well as non yes Ella.

We intend to keep them as independent operations. So they have their sales force team. They go to the schools in the negotiating long term contracts with the schools. So that the schools can use the solutions, but we also plan to extract synergies, especially in the back office area and we do see across opportunities. Both in the case thats not your villa in scaly movement.

Perfect and just a quick follow up Oh, sorry, but dish or any details about how much does it cost first calls or in yen for parents, who acquired is is the personalities.

So seems to the novella business as we all know yeah consolidating we expect you disclosed this information when we when we perform the second installment payment and when we acquired a new form of control of the company and then we can shared his financial numbers with you.

Perfect. Thanks, a lot.

Thank you. Thank you.

Thank you and our next question will come from the line of San Diego are a gal with Goldman Sachs. Your line is now open.

Okay. So my name is now a San Diego and that's a that's great. So good afternoon, everybody and thank you for taking my question and follow up to date on positive I guess my question is a follow up on the two smaller deals.

You mentioned, so first how should we think about their organic growth.

2020, and second how is the revenue recognition for these companies.

I understand that you also want to keep them independent, but how fast do you see them, gaining some penetration would be saying your customer base. Thank you.

Thank you Diego for question.

These companies have a very strong track record.

Inorganic growth through all the last years.

It's it's too soon to predict how they will.

For the following year.

But since the quality of the products and that we have seen.

We are very optimistic in how they will grow organically.

Of course, we expect to do a cross sell between.

Among our business units and these new solutions, but.

I think it's too early to predict any kind of revenue or numbers in terms of these two companies.

You can can you. Please repeat the last part of your question. Please.

Diego's line has left the queue.

Our next question will come from life Javier Martinez with Morgan Stanley . Your line is now open.

Hi, Thank you, thank you already and really be a.

It was.

Well the thing idea that San Diego and was asking not to try to understand.

Maybe the penetration I under somebody's, maybe you celebrate early.

Our commercial team. So you will have it independent I understand that I understand why but I guess that your commercial team will be already ready to sell that as part of your platform and in the mix and commercial and yet no I guess not this year do you still like to dwell in all that is that I would the assumption and second when will be the second stalmann. So win win from where from wing will you be able to consolidate the control of the company and have they ask for control of the company of the Nebula sorry.

So just answering the last part of your question. So I think you have here.

For for for your comment so just jumping to the end of the question. We expect you consolidate for the Navio valid company, a four day CVG 2020.

And based calling of May two as I said, we already acquired 100%. So from the from the next quarter they will be already consolidating all things your statements.

And have you had answering your question regarding how we are selling this product, yes, we intend to keep the Sims four separate but of course, we are studying possibilities to bundle the solutions in order to offer a more comprehensive product to this launch sometimes it makes sense to school to buy the learning system together with the tech app or the 20, onest social emotional skills product. So.

Yes, we see an opportunity to enter new schools with these products are calling moving into and not the ela, but also we are planning to develop specific solutions bundling or each of these solutions together with our current products.

I'd so.

As far as my where there is a similar product and that it used to be in the market that was the leader in me.

I'm, sorry, I'm not aware of any all their product and also used if you start with the understanding that it is a market with really low level of competition. So the snow. So you see potentially big market without many competitors and juice on maybe one or maybe somebody else or so if you. If you could give us an ideal for how many please do we have on the table to try to understand how this is going to look like will be very helpful.

Yes.

I think I think you are correct aren't there are few players.

In the competition up this market I think we can benefit from the scale in order to develop a very high quality solution and delivered that into the platform of schools that we already have relationships with the operate in the same supplemental segment as International School and also you can see a very strong trained in the education area to start to teach the kids not only the traditional core curriculum, but also just kind of skills. So we see a good trend on that opportunity on that market.

And this finally defease TCEP product correct me, if I'm wrong more for for the secondary students or or this is supported for all the years I not 100% sure about that she has to try to understand from your addressable market, which portion of the students who will balance would be line. This is a pretty small for the for the secondary students right.

So it's for all the segments actually.

This is a product that works with the skills of our culture of innovation entrepreneurship creativity. So you have a specific products for all the segments of the K 12.

Private school.

And the public works.

It sounds like a pretty exciting proposition for apartments I want my kids two to go to that.

But but if it sounds like you know what I mean that sometimes.

So to be stabilize how how would what research showing very nobody saw it works well.

Yes, the product works very well to think that we can mention about the company is that.

There is there are two very talented founders who came from Spi and develop that curriculum there.

And the second one is that they are already in the top rated schools in Brazil.

Okay.

Okay sounds very exciting thank you very much.

Just to add one more one more comment which is I think it's important in the last four years. The company had zero churn, yes, which is which is a very important metric to access.

That's diesel pricing figure because you know like this it's like it sounds like a amazing though.

Like it is the kind of thing that you try yes apparent you say, okay, let's let's start with my kids, but then add there they like it they like it then and you. They can you send them to do soccer or whatever you know about that so not having.

I mean being successful with all the schools is quite surprising. It also sounds like you have a very interesting thing in your hands now, let's say would be good. If you can give us amps I havent really more information to try to quantify the.

The potential of the addressable market if it does.

Sure sure we can do that we believe so thank you.

Thank you.

Thank you and our next question will come from like Maria Azevedo with you. Yes. Your line is now open.

Hi, guys. Thank you for the call.

You are on track to reach our targets do you see any upside risk for your EBITDA guidance for the year and if you can comment on more general terms about 2020 commercial outlook commercial and competitive and not I don't have a stronger sales force. If we should expect some accelerated growth in that line. Thank you.

Hello, everybody. Thank you for your question talking about the sales cycle. We believe it's too early in the year, but we are optimistic with this Brazil results of the season and I think that we can answer your question regarding the margins are moving up.

So the margins are actually in line with our expectations. So we so every quarter, we will discuss if we like to update these numbers and we bought changing and new projection, but so far we are we are still in line with the first projections discussed looking.

Perfect. Thank you and just as a follow up question not the did you consider accessing the equity markets or in the future in the short term to to foster more acquisitions and also improve our stock liquidity is this a scenario you are considering.

Yes. So we are I mean, we are.

Always analyzing opportunities gene gene gene gene.

Sure better capital structure, but considering the acquisitions that we perform.

We can finance them with the cash generation phone or operations without the need of new capital injections and also what you see if we see new opportunities for M&A.

The pillar of the size, we already have a pre approval financial line that can can award as a breach of finance new targets.

Perfect. Thank you very much.

Thank you and just as a reminder, if you would like to ask a question that is star and then one.

Our next question will come from him go ahead remain tolerance with BTG. Your line is now open.

Good afternoon, everyone.

Two questions here one is.

Not a valid just to be clear.

This product is different from what we see in rave and this cold winter, Jason because I'll fix maker feature right. So just forget that clear.

And the second question is.

On the squabbling Movimento.

We understand that with the company itself has ordered learning systems as clients and then just one to understand.

What are the plans for our data business units on in terms of.

These relationships with other learning systems and.

What is the company thinking about with that software solution here.

Thanks.

Thank you for your question so.

The the not developed products is quite unique in terms of the quality of the content and the approach.

It's not a feature so it's really a product that we are selling to the schools and the schools are putting in place.

Our class a per week and they are reselling that to the parents, so thats pretty much how it works.

But talking about calling momentous coal movement was more like a feature that you sell to the schools and the school sell that to the parents and that feature.

His attack feature is the Nab that enables the interaction and communication.

Among parents and the school that condemning performance.

And we believe we can add new capabilities to this app, but it's a feature that the score users to communicate with the parents and we believe there is a lot of opportunities.

To add new features and enhanced the school and parents experience through that.

Thanks, Thats very quick.

Thank you and we have follow up questions coming from the line of Diego Agarwal with Goldman Sachs. Your line is now open.

Yes. Thanks, guys. Thank you for the follow up Unfortunately, I got disconnected previously so my apologies if I missed some of your comments, but just wanted to check whether there are some earn outs related to this acquisition. Thank you.

So again. Thank you. Thank you for for follow up questions. So regarding this quarter. When we made that we don't have and talking about not valla, yes. So the.

This order three installments that youre related with the company's performance and they are valid on average at a five time revenues last 12 months. So at an average because it varies depending on the installment but on average is three six and then for and then frees up on average is five times revenue last 12 months and we'll provide more more details about those on our financial statements.

Okay. That's helpful. Thank you.

Thank you.

Thank you and I'm showing no further questions in the queue, ladies and gentlemen, Thank you for your participation on today's conference. This does conclude the program and we may all disconnect everybody have a wonderful day.