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Arco Platform Limited (ARCE) Q1 2019 Earnings Call Transcript

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Arco Platform Limited (NASDAQ: ARCE)
Q1 2019 Earnings Call
May 21, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen. And welcome to Arco first quarter 2019 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct the question and answer session, and instructions will follow at that time. If anyone should require operator assistance, please press the * then the 0 key on your touchtone telephone. As a reminder, this call will be recorded. I would now like to introduce your host for today's conference, Vitor Hiraiwa, Arco IR Director. You may begin.

Vitor Hiraiwa -- Investor Relations

Thank you. I am pleased to welcome you to Arco's first quarter 2019 conference call. With me on the call today is Arco's CEO, Ari de Sá Cavalcante Neto and CFO David Peixoto dos Santos. 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 defer materially from those contemplated by these forward-looking statements. Forward-looking statements in this presentation includes but are not limited to statement related to our business and financial performance, expectations and guidance for future periods, or 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-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. Let me now turn the call over to Ari de Sá Cavalcante Neto, Arco's CEO.

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Ari de Sá Cavalcante Neto -- Chief Executive Officer

Thanks, Vitor. And thanks everyone for joining Arco's first quarter 2019 conference call. Today, I will provide highlights from the first quarter and discuss the recent acquisition of Sistema Ensino Positivo. Next, I'll turn it over to our CFO, David, who will walk you through our financial performance. And then we will open the line for Q&A. For those who are new to our story, we'd like to reinforce our recommendation to analyze Arco on an annual basis. Since our revenues are 100% subscription-based, the upper-800 annual contract value, or ACV metric. ACV is calculated by multiplying the number of enrolled students at each partner school by average ticket per student per year. As a result, we have high predictability of our revenue on an early basis. But revenue can vary between quarters. The amount of revenue recognized is proportional to the amount of content made available which is not linearly distributed among the quarter and also depends on our customers' decision on when to receive the content.

Now onto our Q1 results. Net revenue was 117.1 million reais above our expectations for the quarter, representing 27% of 2019 ACV versus our guidance of 22% or 25%. We are on track to reach the ACV 2019 of 441 million reais. Moving to M&A, let me give you a quick recap of our strategy that is on slide five of our presentation. It is divided into three areas. First, expand our network of schools. We believe that school's cornerstone should be education and should become the center of the learning experience, offering both core and supplemental solutions to improve students' outcome. Therefore, increasing our number of partner schools is essential to thrive in this business. And M&A is an accretive and fast way to achieve this objective. Second, expand our product offering. It is important to have high-quality content with technology to offer to the schools. Most of the schools don't have the concept or the methodology to build a pedagogical curriculum.

That's where Arco can make a difference and become a mission-critical partner by offering high-quality content and methodology embedded with technology and supported by brands with a strong legacy in the K through 12 segment. Once we have a large network of schools, it becomes easier to offer new solutions that could fit their needs. Third, deliver value-add technology features. We believe there are several opportunities to impact students' learning experience with technology as well as provide additional services to schools. This drive to continuously look for innovation is key to staying ahead of the competition and evolving our products. On our last call, we announced the acquisition of Sistema Positivo de Ensino, a highly regarded brand with more than 40 years of history and education. Positivo will give Arco more firepower and scale to continue investing in content and technology.

We are accelerating our growth rate by adding 698,000 students distributed across 3.4 thousand schools, adding complementary brands with different price points and regional footprints. The acquisition is subject to the antitrust regulatory approvals. We have already started to plan the integration of Positivo. We are working with strategic consulting companies to help us with the process. Over the last years, we have been able to build a strong pipeline of talented people, especially after the IPO. Additionally, since Positivo's business model is the same as Arco's, we believe that we can share best practice and long knowledge to improve Positivo's operation, products, and technology. Following the acquisition, our student base will be 1.2 million students. And that will be three times higher than our student base at the time of the IPO distributed among 4.8 thousand partner schools. With a student base and a network of schools of this size, there's a lot we can do.

We can increase our product offering more efficiently, bring scalable technology to partner schools and students, and collect feedback from a broader network of students and teachers to continuously improve our solution. And our mission goes far beyond our current solution and numbers. There are still a lot of opportunities to innovate and positively impact the learning experience of the students. With that, I'll turn to David so he can discuss the financials.

David Peixoto dos Santos -- Chief Financial Officer

Thank you, Ari. We are pleased with our first quarter performances and excited about the recently announce acquisition of Sistema Positivo de Ensino. It's in line with our M&A strategy as we increase our network of schools with complementary rems that will increase our product offering. Before we dig into numbers, please note that except for revenues, gross margin, selling expenses, G&A, and all the financial measures I discuss are non-IFRS, and growth rates all compare to the prior-year comparable period unless otherwise stated. I will review our first-quarter results and provide guidance for the ACV recognition for the second quarter of 2019 and EBITDA margin for 2019 fiscal year. So, now let's take a look at the numbers. Net revenue for the first quarter of 2019 was 117.1 million reais, which represented 26.6% of the 2019 ACV versus 35.3% in the same quarter of the last year. Due to product mix, the revenue recognition may vary among quarters but with no impact in the total ACV.

We are on track to reach the 2019 ACV of 441 million reais by the end of the third quarter of 2019. Gross margin was 81.3% for the first quarter versus 77.3% for the same period in 2018. And it is in line with our historical trends of increasing gross margins. Selling expenses for the first quarter of 2019 was 36.1 million reais, up 49% compared to 2018 in the first quarter when we had 24.3 million reais. Quarter-over-quarter, selling expenses increased 3%. That's mostly because our hiring force to recruit new hunters happened during the fourth quarter of 2018. As mentioned on our previous call, we're continuing to invest in selling expenses as part of our strategy to gain market share year-over-year. G&A expenses was 20.8 million reais, up 52% compared to 13.7 million reais for the first quarter of 2018. Quarter-over-quarter, G&A was down 5% since we're able to cover most of the area that needed improvement since the IPO.

And as we mentioned in previous conference calls, G&A expenses increased due to higher headcount in our expenses related to being a public company which has consulting firms, lawyers, and leasing fees. Unlike selling expenses, the investment in G&A was mainly a result of the IPO process. And we have expanded our internal resources and created new functions to match the start of a publicly listed company in the US. Adjusted EBITDA was 48.9 million reais for the first quarter of 2019, down 16%.

The main factor driving this year-over-year comparison is the proportion of revenue recognized in each period. In the first quarter of this year, we recognized only 27% of the ACV while, in the same period of 2018, we recognized 35%. We are on track to achieve adjusted EBITDA margins of 35.5% to 37.5% in 2019. Now to the guidance. For the second quarter of 2019, we expect to recognize from 24% to 26% of the ACV 2019, which equates to revenue in the range of from 106 million reais to 115 million reais. Also, we expect our adjusted EBITDA margin for the full year 2019 to be in the range of 35.5% to 37.5%. And with that, I'd like to turn the call back to the operator for Q&A. Operator?

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, if you have a question at this time, please press the * then the 1 key on your touchtone telephone. Again, to ask a question, press the * then the 1 key on your touchtone telephone. And our first question comes from Diego Aragao with Goldman Sachs. Your line is open.

Diego Aragao -- Goldman Sachs -- Analyst

Yes. Hi. Thanks for taking my question. And congrats on the results. First question, if I may. I just want to understand the main reasons for the higher than expected revenues recognizing in the first quarter. If I'm not mistaken, revenue in the first quarter would represent roughly 27% of our ACV or of your ACV for 2019. And you were guiding the 25%. So, well above the top of the range. So, can you comment on what drove the beat and whether this would have implications for the business throughout the year? Thank you.

Ari de Sá Cavalcante Neto -- Chief Executive Officer

Thank you, Diego. So, sure. As we used to say and have been constantly repeating during the last earnings calls, we recommend you analyze our business in a annual basis since we have recurring revenue annual contracts. The best way to really analyze it would be on annual terms. And the revenue recognition, it relies on sometimes the clients' decision because it's related with the content that is made available for our partner schools. And this content is not linearly distributed among the quarters. So, it also depends, as I said, on the customers' decisions to when we see the content. And the amount that we expected to recognize in this quarter, as we said in the last one, in the guidance, it was the best estimate that we had at that time. But these fluctuations should happen. That's part of the nature of the business. But the ACV remains the same. And we are on track to reach the ACV 2019 of 441 million reais.

Diego Aragao -- Goldman Sachs -- Analyst

Okay. That's helpful. Thank you. And the second question. Look, as the year progress, I understand that schools are already signing up and starting to renew their contracts with Arco. So, my question is when, exactly, do you shift your focus to building up the ACV bookings for the next year from delivering the ACV bookings for the current year? For instance, when do you start to worry about building up the numbers for 2020 instead of delivering the contract top line in 2019? Thank you.

Ari de Sá Cavalcante Neto -- Chief Executive Officer

Okay. Thank you, Diego. Our team is on the field. As we said before, we hired more hunters. And better than last year, we did this in the end of 2018. So, the hunters are already on the field. But it's too early to tell any guidance or estimates for next year. And I believe that's also important for the benefit of the company and the investors. It's too early to share this. And actually, the ACV and most of this is built in the second semester. So, we believe that any kind of projection at this time would be not precise.

Diego Aragao -- Goldman Sachs -- Analyst

Okay. Thanks.

Operator

Thank you. Again, if you would like to ask a question, press the * then the 1 key on your touchtone telephone. And our next question comes from Roberto Otero with Bank of America Merrill Lynch. Your line is open.

Roberto Otero -- Bank of America Merrill Lynch -- Analyst

Hey, guys. Thanks for taking my question. I just have a follow-up regarding Positivo. Actually, two questions. If you could just make a quick recap on the necessary regulatory stats to be accomplished and when do you expect a full conclusion? And also, you mentioned you hired a consulting firm to help you run integration. If you could just share with us, preliminarily, how long do you think this integration may take? Maybe how complex do you think it will be given the size of the company? And based on your past M&A experience, what is usually the most complex part of a search integration process? That's pretty much it.

Ari de Sá Cavalcante Neto -- Chief Executive Officer

Hi, Roberto. Thank you for your question. So, regarding the first part of the question, the only approval that we are waiting for is the antitrust approval, which is the card which probably you are familiar with. We have just started to working with them. So, it's too early to tell when the decision is gonna come. We will work very closely with them. Should know as soon as possible. But we have to wait. It's early to tell some expectations. Regarding the integration process, we have just started to work with this consulting firm. So, it's also early to tell any detailed plan for this integration. But we do expect to share with you more color in the next earning results when we have more time to work with the theme. And then we can share with you more color.

Roberto Otero -- Bank of America Merrill Lynch -- Analyst

Great. Thank you.

Operator

Ladies and gentlemen, that's all the time we have for questions. I'd like to thank everybody for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.

Duration: 19 minutes

Call participants:

Vitor Hiraiwa -- Investor Relations

Ari de Sá Cavalcante Neto -- Chief Executive Officer

David Peixoto dos Santos -- Chief Financial Officer

Diego Aragao -- Goldman Sachs -- Analyst

Roberto Otero -- Bank of America Merrill Lynch -- Analyst

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