Arco Platform Ltd
NASDAQ:ARCE
Earnings Call Analysis
Q2-2023 Analysis
Arco Platform Ltd
Arco Platform Ltd., in its 2023 second quarter earnings call, presented a strong operational performance with notable improvements in cash flow dynamics. Specifically, the Pedagogical segment displayed a commendable adjusted EBITDA minus CapEx growth of 56% year-over-year, highlighting a margin expansion of 7 percentage points from the previous cycle. This segment also showed a remarkable 20 percentage point improvement in free cash flow, totaling R$205 million, which was a significant recovery from a minus R$81 million in the previous year.
For the 2023 cycle, Arco Platform reported an 18% rise in net revenue reaching R$1.532 billion, driven by gains in both Core and Supplemental solutions, which grew by 17% and 24% year-over-year, respectively. The delay of some June revenues into July, with an impact of R$36 million, did not halt the momentum as the adjusted EBITDA margin expanded to 36.3%, up from 34.8% from the prior period. Management's guidance for an adjusted EBITDA margin of 36.5% to 38.5% for the fiscal year remains on track to be achieved.
Arco's focus on operational efficiencies led to a decrease in Capital Expenditures (CapEx) to 6.7% of net revenues, representing a reduction of 7.7 percentage points, with margins expanding by 7 percentage points to 29.6% from 22.4% in the prior cycle. The company marked stable sales outstanding year-over-year and improved delinquency by 1 percentage point, which suggests a bolstered financial stability.
Arco's Financial & Management Solutions segment (F&M) experienced an impressive 104% increase in net revenue year-over-year and significantly improved the adjusted EBITDA margin by 86 percentage points, albeit still negative at minus 2.4%. These outcomes underpin the segment's product-market alignment and scalability efficiencies. The company remains optimistic about achieving the targeted minus 10% adjusted EBITDA margin for the fiscal year.
The report highlighted a robust free cash flow performance with R$252 million accumulated in the first half of 2023, a 6.5 percentage point increase over the same period in 2022, signifying effective capital allocation. The company's pro forma net debt over adjusted EBITDA ratio improved to 3.1x, displaying a leveraging down-trend from 3.3x, which could appeal to debt-conscious investors.
In pursuit of a healthier balance sheet, Arco Platform issued a nonconvertible debenture of R$550 million and via its subsidiary isaac, raised R$112 million in a receivables-backed investment fund. These strategic financial maneuvers bolster the company's pro forma cash position to an ample R$1.2 billion, suggesting strong liquidity to cover short-term obligations and a commitment to further debt reduction.
Arco Platform announced an agreement to transition into a private entity, which is expected to close between the fourth quarter of 2023 and the first quarter of 2024. Shareholders are offered $14 per share in cash, which is a 38% premium over the average prior to the initial proposal. The transaction, still subject to customary closing conditions, is a pivotal strategic move that could reshape the company's future operations and investor relations.
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Good afternoon, everyone. Thank you for standing by, and welcome to Arco Platform Second Quarter 2023 Earnings Call. This event is being recorded and all participants will be in a listen-only mode during the company's presentation. [Operator Instructions] This event is also being broadcast live via webcast and may be accessed through Arco's website at investor.arcoplatform.com, where the presentation is also available.
Now I will turn the conference over to Roberto Otero, Arco's CFO. Otero, you may begin your presentation.
Thank you. I'm pleased to welcome you to Arco's second quarter 2023 conference call. With me on the call today, we have Arco's CEO, Ari de Sá Cavalcante Neto. During today's presentation, we'll make 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 or expectations regarding strategic product initiatives and the 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, as 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 for revenue, gross margin, selling expense, G&A and cash flow from operations, all other financial measures we discussed here are non-IFRS, and growth rates are compared to the prior year's comparable period unless otherwise stated. We also note that year-over-year comparisons are affected by acquisitions not included in our 2022 financials.
With that, I'd like to turn the call over to Ari, Arco's CEO.
Thank you, Otero. I would like to start with the highlights of the quarter on Slide 3. 2023 second quarter posted strong operating cash flow dynamics across all business verticals with consistent improvement of all important underlying cash flow driving, such as operating working capital and capital allocation.
Arco's Pedagogical segment comprising both our Core and Supplemental solutions have maintained solid operational performance in the current 2023 cycle, yielding an adjusted EBITDA minus CapEx of R$453 million, a 56% growth year-over-year. This represents an expansion of margin of adjusted EBITDA minus CapEx of 7 percentage points compared to the prior year cycle. This is also a strategy of capturing efficiency gains with centralized functions while increasing operation leverage with our continued growth effectively mitigating the recent volatility in cost pressures highlighted in our previous reports.
Our free cash flow to affirm for the Pedagogical segment in '23 cycle is R$205 million, up from minus R$81 million during equivalent period last year. The 20 percentage points improvement in free cash flow to firm represents the result of optimized working capital dynamics reducing effective tax rates and better allocating CapEx.
Our Financial & Management Solutions segment referred to as F&M, continues its accelerated growth trajectory, posting a 104% increase in net revenue year-over-year, reflecting the segment's product market fit aligned with solid execution. This growth was accompanied by an adjusted EBITDA margin expansion of 86 percentage points, reaching minus 2.4% in this quarter. These gains were enabled by our focus on scalability and pursuit of operational efficiency with healthy delinquency levels in our portfolio.
I will now turn the call to Otero, who will continue the presentation. Otero, please go ahead.
Thank you, Ari, and good evening, everyone. We'll begin by presenting the results of our Pedagogical segment initiated on Slide 6. Considering the fluctuations in revenue recognition of the orders, we strongly advise investors to analyze our business performance on a cycle state basis.
In the 2023 cycle, net revenue grew 18% year-over-year, reaching R$1.532 billion. Our Core solutions marked 17% year-over-year growth, and Supplemental solutions grew 24% year-over-year. As anticipated, this quarter posted lower ACV recognition compared to the second quarter in 2022. This shift was driven by our new supply strategy aimed at streamlining operations and reducing delivery count, resulting in concentrated ACV on the first quarter of each cycle.
Additionally, a portion of revenue is expected to be recognized in June were deferred to July for an impact of R$36 million. For this reason, we are bringing P&L figures for the cycle between October and July.
Moving to Slide 7, we discuss the Pedagogical business' adjusted EBITDA. In the 2023 cycle up until June, our margins remained in line with the previous years despite recent cost pressure. To account for the aforementioned deferral of June ACV to July, we present cycle-to-date results up until July. Between October and July we presented a 36.3% adjusted EBITDA margin, up from 34.8% margin in the same period in 2022. Our projected 2023 adjusted EBITDA margin guidance for the 2023 fiscal year of between 36.5% to 38.5% remains on track. This outlook benefits from normalized ACV recognition curve alongside the 2024 cycle growth and the implementation of new printing contracts that will impact the later half of the year.
Moving to Slide 8, we disclose our CapEx results. Current cycle-to-date figures show CapEx at 6.7% of net revenues, a 7.7 percentage point reduction compared to the corresponding period in the 2022 cycle. This attests to our optimized capital allocation strategy, which reflects and increased collaboration and investment coordination among our brands that continues to reflect our focus on product evolution and quality.
On Slide 9, we disclose adjusted EBITDA minus CapEx. 2023 cycle-to-date posted 29.6% margins versus 22.4% in the previous cycle to date, a significant 7 percentage points expansion. We are on track for our fiscal year guidance for adjusted EBITDA minus CapEx, trending towards the higher end of the 26.5% to 30.5% margin guidance provided last year.
Moving to Slide 10. We disclosed the main drivers behind the significant improvement trend in the Pedagogical business working capital cash generation. Base of sales outstanding remained flat year-over-year, while delinquency improved 1 percentage point year-over-year. On a comparative basis, we improved days of inventory by 9% year-over-year. We are disclosing pro forma days of inventory due to a one-off initiative to capture better conditions in our supply chain, in which we advanced R$58 million to anticipate paper acquisition for the 2024 cycle with printers, guaranteeing better conditions for the next cycle.
As a result, in Slide 11, we show the consistent improvement across drivers in Pedagogical free cash flow for cycle to date, leading our Pedagogical business free cash flow of R$205 million in the cycle so far, which represents 13.4% of net revenues of the period, a R$286 million expansion versus the negative free cash flow registered in the equivalent period in 2022.
On Slide 12, we highlight the consistent improvements over cycles.
Now moving to Slide 14, we disclose our Financial & Management segment. In the second quarter of 2023, our net revenue amounted to R$75 million, growing 104% year-over-year when compared to the pro forma net revenue of the second quarter last year prior to the acquisition. Accumulated net revenue for the first half of 2023 reached R$137 million, a growth of 116% year-over-year.
Adjusted EBITDA margin in the quarter reached minus 2.4%, a very important 86 percentage points year-over-year expansion. Adjusted EBITDA margin in the first half of 2023 landed at minus 12%, an 80 percentage points year-over-year expansion. This improvement in margins is tied to scale and efficiency gains enabled by the growth and tech-enabled profile of our platform. We're confident in achieving our net revenue guidance projected to be between R$300 million and R$350 million and our minus 10% adjusted EBITDA margin guidance for the segment in this fiscal year.
On Slide 16, we provided a snapshot of our consolidated Arco second quarter '23 and first half 23 results, combining both Pedagogical and the Financial & Management results. Second quarter consolidated figures delivered a net revenue of R$471 million and adjusted EBITDA of R$83.5 million with adjusted EBITDA margin at 17.7%. Adjusted net income was R$78 million, representing 16.6% adjusted net income margin. The first half of 2023 delivered a net revenue of R$1.5 billion, and adjusted EBITDA of R$194 million, with 19.3% adjusted EBITDA margin. Consolidated adjusted net income was R$36 million, representing 3.6% adjusted net income margin.
Moving to Slide 17. Consolidated free cash flow for the first half of 2023 reached R$252 million, including isaac, representing 25% of net revenues in the period, a 6.5 percentage point expansion versus the first half of 2022.
Turning our attention to Slide 18, we present Arco's net debt and obligations as of June. Our commitment to reducing leverage remains a focal point, enabled by organic cash generation growth. In the second quarter of 2023, our net debt over the trailing 12 months adjusted EBITDA was 3.3x.
To account for the aforementioned deferred of June ACV and EBITDA to July, we also present a pro forma net debt over adjusted EBITDA in the last 12 months as of July, which reached 3.1x.
Going forward, we continue to deploy our balance sheet management strategy. In July, we have issued a nonconvertible debenture amounting to R$550 million with an interest rate of CDI plus 2.6% in paid semiannually and amortized over three years starting in 2026.
In July, we also have another important milestone to share. isaac has successfully raised a K-12 dedicated FIDC. This FIDC or receivables-backed investment fund secured R$112 million to be amortized in 2025. This allows isaac to raise capital from third parties to fund its revenue guarantee product capital requirements. The stake was oversubscribed despite the lack of a well-established track record and will boost isaac's growth even further.
Taking into account these issuances in early third quarter, our pro forma cash position totals R$1.2 billion. The financial position confidently covers our short-term obligations, and we are confident in our cash generation capacity and future perspectives to implement a full deleveraging process in years to come.
On Slide 20, we disclose a brief process recap of our recently announced agreement to take Arco private. Upon the receipt of the initial nonbinding proposal from the bidders at $11 per share in November 2022, the Board of Directors formed a special committee consisting of four independent directors to evaluate the nonbinding proposal. In January 2023, the special committee retained financial and legal independent advisers. In May, the special committee received a revised nonbinding proposal from the bidders at $13 per share and agreed to engage in negotiations of definitive agreements. On August 10, 2023, Arco entered into an agreement to go private in which shareholders received $14 per share in cash, 38% premium versus weighted average for 30 days prior to the initial offer.
The transaction is subject to closing conditions, including, among other conditions, the authorization and approval of the agreement by the affirmative vote of shareholders representing at least 2/3 of the voting power of the company's common shares present and voting in person or by proxy at a general meeting of the company's shareholders and require regulatory approval, the antitrust.
Shareholders will receive proxy instructions for the general meeting in due time. The merger is currently expected to close during the fourth quarter of 2023 for the first quarter of 2024.
With that, we conclude our presentation. Operator, we can now open for questions. The floor is now open for questions.
[Operator Instructions] Our first question comes from Mauricio Cepeda with Credit Suisse.
I have two questions from our side. The first is about the reestablishment of the margin equilibrium in relation to the paper, the cost of paper. So if you -- how confident you are that in the next cycle, you'll be able either to negotiate with schools, a service fee that is corresponded to the paper costs? Or if you are kind of confident that there may be an alleviation in the price of the commodity?
And the second question is a little bit to get details on this delivery postponement to July if it was due to any troubles on cash -- on the cash cycle of your clients? Or if it was an internal decision about logistics or any other of internal factor here?
Cepeda, Otero here. Thank you so much for the question. So on the first one, actually, we are very confident with the recovery of gross margin already in the second half coming from the better terms with pretty suppliers. Actually, those contracts have already been signed, okay? And so we have a research and feasibility on the terms of those contracts. And for the first batch of deliveries, which are the ones that we sent to schools between November, December and January, the price per page printed will be down in nominal terms around 12% year-over-year in case. So this is a proxy of our unit cost per page printed all-in in paper down 12% year-over-year in nominal terms. So again, we have visibility of those are contracts that are already signed and this will impact the P&L mostly towards the end of Q3, beginning of Q4.
On your second question regarding the revenue postponement from June to July, this is actually a pretty normal course of business. Sometimes, it's a decision that it comes from its core in some situations. So this whole question which we receive the packs of content in a certain week. And for the reason this week is to next move, right?
So the business operates under annual contracts. So it's very common to see the deliveries of the content moving from one week to another, and as a consequence from one month to another, and as a consequence from one quarter to another, because really it's an annual business, and that's how this course also see the business. But I mean, as we report the earnings on a quarterly basis, sometimes we see this movement in revenue, okay? This does not coincide with cash. This has no correlation with cash necessarily. It's much more logistics or operational decision either from the company or from the school to receive the content in a certain date, okay, and we recognize the revenue as we deliver the content to the school.
Okay. And just to clarify. So about the first question, you are more confident on the reduction of costs through negotiations than in necessarily adjusting prices.
Yes. So the minus 12%, as I mentioned to you, is the unit cost to print. And also in parallel, we are in the process of renewing ACV for the next cycle and also, of course, during the intake process for new schools. And we are targeting a high single-digit price increase to -- I mean, to prices, right? So we're going to see those two components contributing to gross margin, the price increase and unit cost down in nominal terms for printing.
Ladies and gentlemen, there are no further questions at this time. So that concludes our Q&A session. That concludes Arco's Second Quarter 2023 Earnings Call. Thank you very much for your participation, and have a great night.