UNITED STATES
SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549

 

FORM 20-F

 

(Mark One)

 

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2018

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from       to      .

 

OR

 

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Date of event requiring this shell company report              

 

Commission file number: 001-38673

 

Arco Platform Limited
(Exact name of Registrant as specified in its charter)

 

Not applicable 

(Translation of Registrant’s name into English)

 

Cayman Islands
(Jurisdiction of incorporation or organization)

 

Rua Augusta 2840, 9th floor, suite 91 

Consolação, São Paulo – SP 

01.305-000, Brazil 

+55 (11) 3047-2699
(Address of principal executive offices)

 

David Peixoto dos Santos, Chief Financial Officer 

Tel: +55 (11) 3047-2699 

Rua Augusta 2840, 9th floor, suite 91 

Consolação, São Paulo – SP 

01.305-000, Brazil 

+55 (11) 3047-2699 

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

Copies to :
Manuel Garciadiaz
Davis Polk & Wardwell LLP
450 Lexington Avenue
New York, NY 10017
Phone: (212) 450-4000
Fax: (212) 450-6858

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of each class 

Name of each exchange on which registered 

Class A common shares, par value US$0.00005 per share The NASDAQ Global Select Market

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

None

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

The number of outstanding shares as of December 31, 2018 was 22,602,737 Class A common shares and 27,658,290 Class B common shares.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes                No

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

Yes                No

 

Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes                No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

 

Yes                No (not required)

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer, "accelerated filer,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer                Accelerated Filer                Non-accelerated Filer                Emerging growth company

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.

 

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this annual report:

 

U.S. GAAP
  
International Financial Reporting Standards as issued by the International Accounting Standards Board
  
Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

 

Item 17                Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes                No

 

 

Table of Contents 

Arco platform limited

TABLE OF CONTENTS

 

 

Page

 

Presentation of Financial and other Information 1
Forward-Looking Statements 5
PART I
ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 7
A.   Directors and senior management 7
B.   Advisers 7
C.   Auditors 7
ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE 7
A.   Offer statistics 7
B.   Method and expected timetable 7
ITEM 3.  KEY INFORMATION 7
A.   Selected financial data 7
B.   Capitalization and indebtedness 12
C.   Reasons for the offer and use of proceeds 12
D.   Risk factors 13
ITEM 4.  INFORMATION ON THE COMPANY 34
A.   History and development of the company 34
B.   Business Overview 37
C.   Organizational structure 53
D.   Property, plant and equipment 53
ITEM 4A.  UNRESOLVED STAFF COMMENTS 54
ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS 55
A.   Operating results 55
B.   Liquidity and capital resources 74
C.   Research and development, patents and licenses, etc. 76
D.   Trend information 76
E.   Off-balance sheet arrangements 76
F.   Tabular disclosure of contractual obligations 76
G.   Safe harbor 76
ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 77
A.   Directors and senior management 77
B.   Compensation 78
C.   Board practices 79
D.   Employees 80
E.   Share ownership 81
ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 82
A.   Major shareholders 82
B.   Related party transactions 83
C.   Interests of Experts and Counsel 84
ITEM 8.  FINANCIAL INFORMATION 85
A.   Consolidated statements and other financial information 85
B.   Significant changes 87
ITEM 9.  THE OFFER AND LISTING 88
A.   Offering and listing details 88
B.   Plan of distribution 88
C.   Markets 88
D.   Selling shareholders 88
E.   Dilution 88
F.   Expenses of the issue 88
ITEM 10.  ADDITIONAL INFORMATION 89
A.   Share capital 89
B.   Memorandum and articles of association 89

 

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C.   Material Contracts 97
D.   Exchange Controls 97
E.   Taxation 97
F.   Dividends and Paying Agents 100
G.   Statement by Experts 100
H.   Documents on Display 100
I.   Subsidiary information 100
ITEM 11.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 100
ITEM 12.  DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 101
A.   Debt securities 101
B.   Warrants and rights 101
C.   Other securities 101
D.   American Depositary Shares 101
PART II
ITEM 13.  DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 102
A.   Defaults 102
B.   Arrears and delinquencies 102
ITEM 14.  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 102
A.   Material modifications to instruments 102
B.   Material modifications to rights 102
C.   Withdrawal or substitution of assets 102
D.   Change in trustees or paying agents 102
E.   Use of Proceeds 102
ITEM 15.  CONTROLS AND PROCEDURES 102
A.   Disclosure Controls and Procedures 102
B.   Management’s Annual Report on Internal Control over Financial Reporting 103
C.   Attestation Report of the Registered Public Accounting Firm 103
D.   Changes in Internal Control over Financial Reporting 103
ITEM 16.  RESERVED 103
ITEM 16A.  Audit committee financial expert 103
ITEM 16B.  Code of Ethics 103
ITEM 16C.  Principal Accountant Fees and Services 103
ITEM 16D.  Exemptions from the listing standards for audit committees 104
ITEM 16E.  Purchases of equity securities by the issuer and affiliated purchasers 104
ITEM 16F.  Change in registrant’s certifying accountant 104
ITEM 16G.  Corporate governance 104
ITEM 16H.  Mine Safety Disclosure 109
PART III
ITEM 17.  FINANCIAL STATEMENTS 110
ITEM 18.  FINANCIAL STATEMENTS 110
ITEM 19.  EXHIBITS 110
Index To Consolidated Financial Statements F-1

 

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Presentation of Financial and other Information

 

Unless otherwise indicated or the context otherwise requires, all references in this annual report to “Arco” or the “Company,” “we,” “our,” “ours,” “us” or similar terms refer to Arco Platform Limited, together with its subsidiaries.

 

The term “Brazil” refers to the Federative Republic of Brazil and the phrase “Brazilian government” refers to the federal government of Brazil. “Central Bank” refers to the Brazilian Central Bank (Banco Central do Brasil). References in the annual report to “real,” “reais” or “R$” refer to the Brazilian real, the official currency of Brazil and references to “U.S. dollar,” “U.S. dollars” or “US$” refer to U.S. dollars, the official currency of the United States.

 

All references to “IFRS” are to International Financial Reporting Standards, as issued by the IASB.

 

Financial Statements

 

Arco was incorporated on April 12, 2018, as a Cayman Islands exempted company with limited liability duly registered with the Cayman Islands Registrar of Companies. Until the contribution of shares of Arco Educação S.A., or Arco Brazil, to Arco prior to the consummation of the initial public offering, Arco had not commenced operations and had only nominal assets and liabilities and no material contingent liabilities or commitments. The consolidated financial statements prepared by Arco subsequent to the completion of the initial public offering and the reorganization described in Note 1 of our consolidated financial statements are presented “as if” EAS is the predecessor of Arco. Accordingly, these consolidated financial statements reflect: (i) the historical operating results of EAS prior to the reorganization; (ii) the consolidated results of the Company, Arco Brazil and EAS following the reorganization; and (iii) the assets and liabilities of EAS at their historical cost.

 

We present in this annual report our audited consolidated financial statements as of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016. Our financial statements are prepared in accordance with IFRS, as issued by the IASB.

 

We maintain our books and records in Brazilian reais, the presentation currency for our financial statements and also the functional currency of our operations in Brazil. Unless otherwise noted, our financial information presented herein as of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016 is stated in Brazilian reais, our reporting currency. The consolidated financial information contained in this annual report is derived from our audited consolidated financial statements as of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016, together with the notes thereto. All references herein to “our financial statements,” “our unaudited interim condensed consolidated financial statements,” “our audited consolidated financial information,” and “our audited consolidated financial statements” are to our consolidated financial statements included elsewhere in this annual report.

 

This financial information should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements, including the notes thereto, included elsewhere in this annual report.

 

Our fiscal year ends on December 31. References in this annual report to a fiscal year, such as “fiscal year 2018,” relate to our fiscal year ended on December 31 of that calendar year.

 

Corporate Events

 

Our Incorporation

 

We are a Cayman Islands exempted company incorporated with limited liability on April 12, 2018 for purposes of effectuating our initial public offering. At the time of our incorporation, Oto Brasil de Sá Cavalcante, Margarida Maria Porto Soares de Sá Cavalcante, Ari de Sá Cavalcante Neto, Mariana Magalhães de Sá Cavalcante, Patrícia Soares de Sá Cavalcante, Paula Soares de Sá Cavalcante and Luciana Soares de Sá Cavalcante Moraes, or the Founding Shareholders, and General Atlantic Arco (Bermuda), L.P., or the GA Entity, held 7,476,705 shares of Arco Brazil, which were all of the shares of Arco Brazil, and Arco Brazil held all the shares of EAS Educação S.A., or EAS Brazil, our principal operating company.

 

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Our Corporate Reorganization

 

On February 19, 2018, SASPAR Participações Ltda., or SASPAR, through which the Founding Shareholders held their shares in Arco Brazil, was merged into Arco Brazil (formerly General Atlantic Holding Participações S.A.). Following the merger, the total number of outstanding common shares of Arco Brazil was 7,476,705.

 

On September 14, 2018, in connection with and in preparation for our initial public offering, the Founding Shareholders and the GA Entity contributed all of their shares in Arco Brazil to us. In return for this contribution, we issued 27,658,290 new Class B common shares to the Founding Shareholders and 9,725,235 new Class A common shares to the GA Entity in a one-to-five exchange for the shares of Arco Brazil contributed to us.

 

On September 14, 2018, our director Alberto Menache and his spouse, Fabiana Menache, through Alfaco Holding Inc., a company incorporated in the British Virgin Islands, or Alfaco, and the shares of which Mr. and Mrs. Menache own 100%, purchased 99,725 Class A common shares of Arco, at a price equal to R$ 31.00 per share.

 

On September 25, 2018, the registration Statement on Form F-1 (File No 333-7007) relating to our initial public offering of our class A common shares was declared effective by the SEC. On September 25, 2018, we commenced our initial public offering. On September 28, 2018, we closed our initial public offering, pursuant to which we issued and sold 12,777,777 Class A common shares of Arco for an aggregate price of US$223,611,098 (R$895.2 million).

 

Furthermore, we are currently implementing certain additional changes to the organizational structure of certain of our operating subsidiaries in Brazil. We expect to complete this reorganization during the first half of calendar year 2019. This reorganization will be an internal corporate reorganization and is not expected to affect us on a consolidated basis.

 

The diagram below depicts our organizational structure as of the date of this annual report:

 

 

 
(1)Includes Class B common shares beneficially owned by our Founding Shareholders.

 

(2)Includes Class A common shares beneficially owned by the GA Entity. See “Item 7. Major Shareholders and Related Party Transactions—A. Major shareholders.”

 

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Financial Information in U.S. Dollars

 

Solely for the convenience of the reader, we have translated some of the real amounts included in this annual report from reais into U.S. dollars. You should not construe these translations as representations by us that the amounts actually represent these U.S. dollar amounts or could be converted into U.S. dollars at the rates indicated. Unless otherwise indicated, we have translated real amounts into U.S. dollars using a rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. See “Item 3. Key Information—A. Selected financial data—Exchange Rates” for more detailed information regarding translation of reais into U.S. dollars and for historical exchange rates for the Brazilian real.

 

Special Note Regarding Non-GAAP Financial Measures

 

This annual report presents our Adjusted EBITDA, Adjusted Net Income and Free Cash Flow information for the convenience of investors. Adjusted EBITDA, Adjusted Net Income and Free Cash Flow are the key performance indicators used by us to measure financial operating performance. Our management believes that these Non-GAAP financial measures provide useful information to investors and shareholders. We also use these measures internally to establish budgets and operational goals to manage and monitor our business, evaluate our underlying historical performance and business strategies and to report our results to the board of directors.

 

We calculate Adjusted EBITDA as profit (loss) for the year plus income taxes plus/minus finance result plus depreciation and amortization plus share of loss of equity-accounted investees plus share-based compensation plan.

 

We calculate Adjusted Net Income as profit (loss) for the year plus share-based compensation plan plus amortization of intangible assets from business combinations (which refers to the amortization of the following intangible assets from business combinations: (i) rights on contracts, (ii) customer relationships, (iii) educational system, (iv) trademarks, and (v) non-compete agreement) less/plus changes in fair value of derivative instruments and contingent consideration (which refers to (i) changes in fair value of derivative instruments—finance income, plus (ii) changes in fair value of derivative instruments—finance costs, and plus (iii) changes in fair value of contingent consideration—finance costs) plus share of loss of equity-accounted investees plus interest expenses and plus/minus changes in deferred tax assets and liabilities recognized in profit or loss corresponding to financial instruments from acquisition of interests, share-based compensation and amortization of intangible assets.

 

We calculate Free Cash Flow as net cash flows from operating activities less acquisition of property and equipment less acquisition of intangible assets We consider Free Cash Flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by operating activities and cash used for investments in property and equipment required to maintain and grow our business.

 

We understand that, although Adjusted EBITDA, Adjusted Net Income and Free Cash Flow are used by investors and securities analysts in their evaluation of companies, these measures have limitations as analytical tools, and you should not consider them in isolation or as substitutes for analysis of our results of operations as reported under IFRS. Additionally, our calculations of Adjusted EBITDA, Adjusted Net Income and Free Cash Flow may be different from the calculation used by other companies, including our competitors in the education services industry, and therefore, our measures may not be comparable to those of other companies.

 

For a reconciliation of our non-GAAP measures, see “Item 3. Key Information—A. Selected Financial and Other Information—Reconciliations for Non-GAAP Financial Measures.”

 

Special Note Regarding ACV Bookings

 

This annual report presents our ACV Bookings for the convenience of investors. This operating metric is not prepared in accordance with IFRS. ACV Bookings is a non-accounting managerial metric and represents our partner schools’ commitment to pay for our solutions offerings. We believe it is a meaningful indicator of demand for our platform and the market’s response to it. In particular, we believe ACV Bookings is a helpful metric because it is designed to show amounts that we expect to be recognized as revenue for the 12-month period between October of one fiscal year through September of the following fiscal year. We deliver our educational materials to our partner schools for their convenience in the last calendar quarter of each year, so that our partner schools can prepare their classes in advance prior to the start of the following school year in January. As a result, our results of operations for the last quarter of a given fiscal year contain revenues relating to the following school year relating to the content that has been delivered prior to the start of the new fiscal

 

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year. Therefore, ACV Bookings conveys information that has predictive value for subsequent months, and which may not be as clearly conveyed or understood by simply analyzing our revenues in our statements of income, especially in view of our recent growth.

 

We define ACV Bookings as the revenue we would contractually expect to recognize from a partner school in each school year pursuant to the terms of our contract with such partner school, assuming no further additions or reductions in the number of enrolled students that will access our content at such partner school in such school year. We calculate ACV Bookings by multiplying the number of enrolled students at each partner school with the average ticket per student per year; the related number of enrolled students and average ticket per student per year are each calculated in accordance with the terms of each contract with the related partner school. Although our contracts with our partner schools are typically for three-year terms, we record one year of revenue under such contracts as ACV Bookings. For example, if a school enters into a three-year contract with us to provide our Core Curriculum solution to 100 students for a contractual fee of $100 per student per year, we record $10,000 as ACV Bookings, not $30,000.

 

We measure our ACV Bookings on a monthly basis throughout the school year, starting in November of the preceding fiscal year. Pursuant to the terms of our contracts with our partner schools, they are required, by the end of November of each year, to provide us with an estimate of the number of enrolled students that will access our platform in the next school year. Since we allow our partner schools to make small adjustments to their estimates to account for late admissions and dropouts, this number may fluctuate slightly until March 31, when it becomes more accurate. Accordingly, we believe this metric is most accurately reflected as of March 31 of each year. Average ticket per student per year reflects the average price per student for the relevant school year, and is presented in order to link this average price with the number of enrolled students in our partner schools, resulting in the ACV Bookings metric.

 

We understand that, although ACV Bookings may be used by investors and securities analysts in their evaluation of companies, it has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results of operations as reported under IFRS.

 

Market Share and Other Information

 

This annual report contains data related to economic conditions in the market in which we operate. The information contained in this annual report concerning economic conditions is based on publicly available information from third-party sources that we believe to be reasonable. Market data and certain industry forecast data used in this annual report were obtained from internal reports and studies, where appropriate, as well as estimates, market research, publicly available information (including information available from the United States Securities and Exchange Commission website) and industry publications. We obtained the information included in this annual report relating to the industry in which we operate, as well as the estimates concerning market shares, through internal research, public information and publications on the industry prepared by official public sources, such as the Central Bank, the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or IBGE, the United Nations Educational, Scientific and Cultural Organization, or UNESCO, the MEC, the Brazilian National Institute for Educational Studies and Research (Instituto Nacional de Estudos e Pesquisas Educacionais Anísio Teixeira), or INEP, as well as private sources, such as Hoper Consultoria and Gismarket, consulting and research companies in the Brazilian education industry, and FGV, among others.

 

Industry publications, governmental publications and other market sources, including those referred to above, generally state that the information they include has been obtained from sources believed to be reliable, but that the accuracy and completeness of such information is not guaranteed. Except as disclosed in this annual report, none of the publications, reports or other published industry sources referred to in this annual report were commissioned by us or prepared at our request. Except as disclosed in this annual report, we have not sought or obtained the consent of any of these sources to include such market data in this annual report.

 

Rounding

 

We have made rounding adjustments to some of the figures included in this annual report. Accordingly, numerical figures shown as totals in some tables may not be an arithmetic aggregation of the figures that preceded them.

 

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Forward-Looking Statements

 

This annual report on Form 20-F contains statements that constitute forward-looking statements. Many of the forward-looking statements contained in this annual report can be identified by the use of forward-looking words such as “anticipate,” “believe,” “could,” “expect,” “should,” “plan,” “intend,” “may”, “predict”, “continue”, “estimate” and “potential,” among others.

 

Forward-looking statements appear in a number of places in this annual report and include, but are not limited to, statements regarding our intent, belief or current expectations. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. Such statements are subject to risks and uncertainties, and actual results may differ materially from those expressed or implied in the forward-looking statements due to various factors, including, but not limited to, those identified under the section entitled “Risk Factors” in this annual report. These risks and uncertainties include factors relating to:

 

·general economic, financial, political, demographic and business conditions in Brazil, as well as any other countries we may serve in the future and their impact on our business;

 

·fluctuations in interest, inflation and exchange rates in Brazil and any other countries we may serve in the future;

 

·our ability to implement our business strategy;

 

·our ability to adapt to technological changes in the educational sector;

 

·our ability to enhance our brands;

 

·our ability to obtain government authorizations on terms and conditions and within periods acceptable to us;

 

·our ability to continue attracting and retaining partner schools;

 

·our ability to maintain the academic quality of our programs;

 

·the availability of qualified personnel and the ability to retain such personnel;

 

·changes in the financial condition of the students enrolling in our partner schools or private schools in general and in the competitive conditions in the education industry, or changes in the financial condition of our partner schools in the primary and secondary education sector;

 

·our capitalization and level of indebtedness;

 

·the interests of our controlling shareholder;

 

·changes in government regulations applicable to the primary and secondary education industry in Brazil;

 

·government interventions in the primary or secondary education industry that affect the economic or tax regime, the collection of tuition fees or the regulatory framework applicable to primary and/or secondary educational institutions;

 

·a decline in the number of our partner schools or the amount of fees we can charge for our educational platform;

 

·our ability to compete and conduct our business in the future;

 

·the success of our marketing initiatives, including advertising and promotional efforts;

 

·our ability to develop new educational products, services and concepts;

 

·changes in consumer demands and preferences and technological advances, and our ability to innovate to respond to such changes;

 

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·changes in labor, distribution and other operating costs;

 

·our compliance with, and changes to, government laws, regulations and tax matters that currently apply to us;

 

·other factors that may affect our financial condition, liquidity and results of operations; and

 

·other risk factors discussed under “Risk Factors.”

 

Forward-looking statements speak only as of the date they are made, and we do not undertake any obligation to update them in light of new information or future developments or to release publicly any revisions to these statements in order to reflect later events or circumstances or to reflect the occurrence of unanticipated events.

 

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

A.Directors and senior management

 

Not applicable.

 

B.Advisers

 

Not applicable.

 

C.Auditors

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

A.Offer statistics

 

Not applicable.

 

B.Method and expected timetable

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A.Selected financial data

 

You should read the following selected financial data together with “Item 5. Operating and Financial Review and Prospects” and our Consolidated Financial Statements and the related notes appearing elsewhere in this annual report.

 

The summary statements of financial position as of December 31, 2018 and 2017 and the statements of income for the years ended December 31, 2018, 2017 and 2016 have been derived from our audited consolidated financial statements included elsewhere in this annual report, prepared in accordance with IFRS, as issued by the IASB.

 

   For the Year Ended December 31,
   2018  2018  2017  2016  2015
   US$ millions(1)  R$ millions
Statement of Income Data               
Net revenue    98.3    381.0    244.4    159.3    116.5 
Cost of sales    (20.8)   (80.7)   (58.5)   (41.3)   (28.0)
Gross profit    77.5    300.2    185.9    117.9    88.5 
Selling expenses    (29.2)   (113.3)   (65.3)   (40.3)   (20.3)
General and administrative expenses    (33.5)   (129.8)   (48.9)   (32.7)   (24.6)
Other income (expenses), net    1.3    4.9    3.3    3.6    (2.0)
Operating profit    16.0    62.1    74.9    48.6    41.6 
Finance income    9.4    36.6    12.5    47.2    14.4 
Finance costs    (51.3)   (198.8)   (20.4)   (1.8)   (3.1)
Finance result    (41.9)   (162.2)   (7.9)   45.4    11.3 
Share of loss of equity-accounted investees    (0.2)   (0.8)   (0.7)   (1.1)   (0.6)
Profit before income taxes    (26.0)   (100.9)   66.4    92.8    52.3 
Income taxes—income (expense)    4.6    18.0    (22.7)   (18.4)   (8.3)
Current    (6.8)   (26.5)   (31.0)   (13.0)   (11.3)
Deferred    11.5    44.5    8.3    (5.5)   3.0 
Profit (loss) for the year    (21.4)   (82.9)   43.6    74.4    43.9 
Profit (loss) attributable to:                         
Equity holders of the parent    (21.3)   (82.4)   44.3    75.1    43.9 
Non-controlling interests    (0.1)   (0.5)   (0.6)   (0.7)    
Basic earnings per share—R$(unless otherwise indicated)(2)    (0.42)   (1.64)   0.88    1.49    1.05 
Diluted earnings per share—R$(unless otherwise indicated)(3)    (0.42)   (1.64)   0.85    1.49    1.05 

 

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(1)For convenience purposes only, amounts in reais as of December 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2)Calculated by dividing the profit attributable to the shareholders by the weighted average number of common shares outstanding during the year.

 

(3)Calculated by adjusting the weighted average of common shares outstanding to assume conversion of all potential common shares with dilutive effects.

 

   As of December 31,
   2018  2018  2017  2016
   US$ millions(1)  R$ millions
Balance Sheet Data:            
Assets            
Current assets            
Cash and cash equivalents    3.2    12.3    0.8    4.4 
Financial investments    208.2    806.8    83.0    65.6 
Trade receivables    35.3    136.6    94.9    65.2 
Inventories    3.9    15.1    18.8    12.6 
Taxes recoverable    2.9    11.2    5.1    3.2 
Financial instruments from acquisition of interests                4.5 
Accounts receivable from selling shareholders                2.5 
Other assets    1.6    6.1    7.3    4.1 
Total current assets    255.0    988.1    210.0    162.0 
Non-current assets                    
Financial instruments from acquisition of interests    6.9    26.6    12.5    16.1 
Deferred income tax    25.7    99.5    5.9    3.7 
Taxes recoverable    0.3    1.0    3.3    2.3 
Financial investments    1.1    4.4    0.2    0.2 
Other assets    0.6    2.3    1.3    0.8 
Investments and interests in other entities    3.1    11.9    12.7    45.8 
Property and equipment    3.4    13.3    9.1    5.7 
Intangible assets    48.5    187.7    175.5    86.3 
Total non-current assets    89.5    346.7    220.4    160.8 
Total assets    344.5    1,334.9    430.4    322.9 
Liabilities and Equity                    
Current liabilities                    
Trade payables    3.8    14.8    3.9    3.1 
Labor and social obligations    4.1    15.9    8.7    4.9 
Taxes and contributions payable    0.7    2.6    1.1    0.4 
Income taxes payable    4.5    17.3    17.4    2.6 
Dividends payable            10.5    17.8 
Advances from customers    1.5    6.0    5.9    1.9 
Financial instruments from acquisition of interests            1.8    4.7 
Accounts payable to selling shareholders    0.2    0.8    14.9    8.1 
Other liabilities    0.1    0.4    5.5    6.4 
Total current liabilities    14.9    57.9    69.7    50.1 
Non-current liabilities                    
Financial instruments from acquisition of interests    6.4    25.0    11.9    25.4 
Provision for legal proceedings    0.0    0.1         
Deferred income tax    0.4    1.4    0.1    6.2 
Accounts payable to selling shareholders    46.6    180.6    43.1     
Total non-current liabilities    53.4    207.1    55.0    31.6 
Total liabilities    68.4    265.0    124.7    81.7 
Equity                    
Share capital            55.9    48.5 
Capital reserve    281.2    1,089.5    160.7    81.9 
Earnings reserves            82.0    105.5 
Share-based compensation reserve    17.4    67.4    7.1    5.2 
Accumulated losses    (22.4)   (86.7)        
Equity attributable to equity holders of the parent    276.2    1,070.2    305.6    241.1 
Non-controlling interests    (0.1)   (0.3)   0.1    0.1 
Total equity    276.1    1,069.9    305.7    241.2 
Total liabilities and equity    344.5    1,334.9    430.4    322.9 

 

 
(1)For convenience purposes only, amounts in reais as of December 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

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Non-GAAP Financial Measures

 

Adjusted EBITDA, Adjusted Net Income and Free Cash Flow

 

   For the Year Ended December 31,
   2018  2018  2017  2016
   US$ millions(1)  R$ millions
Adjusted EBITDA(2)    36.6    142.0    91.1    56.4 
Adjusted Net Income(3)    29.0    112.3    66.6    60.3 
Free Cash Flow(4)    14.4    55.9    51.3    34.1 

 

 
(1)For convenience purposes only, amounts in reais as of December 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2)For a reconciliation between our Adjusted EBITDA and our profit for the year, see “—Reconciliations for Non-GAAP Financial Measures—Reconciliation between Adjusted EBITDA and Profit for the Year.”

 

(3)For a reconciliation of our Adjusted Net Income, see “—Reconciliations for Non-GAAP Financial Measures—Reconciliation of Adjusted Net Income from Profit for the Year.”

 

(4)For a reconciliation of our Free Cash Flow, see “—Reconciliations for Non-GAAP Financial Measures—Reconciliation of Free Cash Flow from Net Cash Flows from Operating Activities.”

 

Operating Data

 

ACV Bookings

 

   As of March 31,
   2019(1)  2019(2)  2018(3)  2017(4)  2016(5)
   US$ (Except
number of
enrolled
students)(1)
  R$ (Except number of enrolled students)
Number of enrolled students    n/a    498,553    405,814    322,031    265,354 
Average ticket per student per year    228.2    884.3    793.8    711.9    622.0 
ACV Bookings (in millions)(6)    113.8    R$440.9    R$322.1    R$229.3    R$165.1 

 

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(1)For convenience purposes only, amounts in reais as of March 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2)For the 2019 school year (which we define for purposes of ACV bookings as the period starting in October 2018 and ending in September 2019).

 

(3)For the 2018 school year (which we define for purposes of ACV bookings as the period starting in October 2017 and ending in September 2018).

 

(4)For the 2017 school year (which we define for purposes of ACV bookings as the period starting in October 2016 and ending in September 2017).

 

(5)For the 2016 school year (which we define for purposes of ACV bookings as the period starting in October 2015 and ending in September 2016). Includes the ACV Bookings of SAE, which we acquired in June 2016, for the full year 2016. On a standalone basis, SAE had ACV Bookings for the full year 2016 totaling R$21.5 million and net revenue totaling R$11.9 million. If the acquisition had taken place on January 1, 2016, SAE’s total net revenue would have been R$24.6 million and our total net revenue would have been R$172.7 million.

 

(6)We define ACV Bookings as the revenue we would contractually expect to recognize from a partner school in each school year pursuant to the terms of our contract with such partner school, assuming no further additions or reductions in the number of enrolled students that will access our content at such partner school in such school year. ACV Bookings is a non-accounting managerial operating metric and is not prepared in accordance with IFRS. For more information about ACV Bookings, see “Presentation of Financial and Other Information—Special Note Regarding ACV Bookings.”

 

As of March 31, 2019, our total number of students enrolled was 498,553, our average ticket per student per year was R$884.3 and our total ACV Bookings were R$440.9 million

 

Reconciliations for Non-GAAP Financial Measures

 

The following tables set forth reconciliations of Adjusted EBITDA and Adjusted Net Income to our profit for the years ended December 31, 2018, 2017 and 2016, our most recent directly comparable financial measures calculated and presented in accordance with IFRS, as well as reconciliations between Free Cash Flow and net cash flows from operating activities for the years ended December 31, 2018, 2017 and 2016, our most recent directly comparable financial measures calculated and presented in accordance with IFRS. For further information on why our management chooses to use these non-GAAP financial measures, and on the limits of using these non-GAAP financial measures, please see “Presentation of Financial and Other Information—Special Note Regarding Non-GAAP Financial Measures—Adjusted EBITDA, Adjusted Net Income and Free Cash Flow.”

 

Reconciliation between Adjusted EBITDA and Profit for the Period / Year

 

   For the Year Ended December 31,
Adjusted EBITDA reconciliation  2018  2018  2017  2016
   US$ millions(1)  R$ millions
Profit (loss) for the year    (21.4)   (82.9)   43.6    74.4 
(+) Income taxes    (4.6)   (18.0)   22.7    18.4 
(+/-) Finance result    41.9    162.2    7.9    (45.4)
(+) Depreciation and amortization    5.1    19.6    14.3    5.8 
(+) Share of loss of equity-accounted investees    0.2    0.8    0.7    1.1 
(+) Share-based compensation plan    15.6    60.3    1.9    2.0 
Adjusted EBITDA    36.6    142.0    91.1    56.4 

 

 
(1)For convenience purposes only, amounts in reais for the year ended December 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

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Reconciliation of Adjusted Net Income from Profit for the Period / Year

 

   For the Year Ended December 31,
Reconciliation of Adjusted Net Income  2018  2018  2017  2016
   US$ millions(1)  R$ millions
Profit (loss) for the year    (21.4)   (82.9)   43.6    74.4 
(+) Share-based compensation plan    15.6    60.3    1.9    2.0 
(+) Amortization of intangible assets from business combinations(2)    3.0    11.8    9.6    4.4 
(+/-) Changes in fair value of derivative instruments and contingent consideration(3)    33.6    130.4    6.7    (31.7)
(+) Share of loss of equity-accounted investees    0.2    0.8    0.7    1.1 
(+) Foreign exchange on cash and cash equivalents   8.9    34.4           
(+) Accrued Interest expenses from Acquisitions    2.5    9.8    11.2    0.1 
(+/-) Tax effects(4)    (13.3)   (51.5)   (7.1)   9.9 
Adjusted Net Income    29.0    112.3    66.6    60.3 

 

 
(1)For convenience purposes only, amounts in reais for the year ended December 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2)Refers to the amortization of the following intangible assets from business combinations: (i) rights on contracts, (ii) customer relationships, (iii) educational system, (iv) trademarks, and (v) non-compete agreement. For further information, see note 13 to our audited consolidated financial statements.

 

(3)Refers to (i) changes in fair value of derivative instruments—finance income, plus (ii) changes in fair value of derivative instruments—finance costs, and plus (iii) changes in fair value of contingent consideration and accounts payable to selling shareholders—finance costs. For further information, see note 21 to our audited consolidated financial statements.

 

(4)Refers to tax effects of changes in deferred tax assets and liabilities recognized in profit or loss corresponding to financial instruments from acquisition of interests, share-based compensation and amortization of intangible assets. For further information, see note 22 to our audited consolidated financial statements.

 

Reconciliation of Free Cash Flow from Net Cash Flows from Operating Activities

 

   For the Year Ended December 31,
Reconciliation of Free Cash Flow  2018  2018  2017  2016
   US$ millions(1)  R$ millions
Net cash flows from operating activities    23.8    92.1    62.7    41.2 
Acquisition of property and equipment    (1.8)   (6.9)   (5.3)   (1.6)
Acquisition of intangible assets    (7.6)   (29.4)   (6.0)   (5.6)
Free Cash Flow    14.4    55.9    51.3    34.1 

 

 
(1)For convenience purposes only, amounts in reais for the year ended December 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

Exchange Rates

 

The Brazilian foreign exchange system allows the purchase and sale of foreign currency and the international transfer of reais by any person or legal entity, regardless of the amount, subject to certain regulatory procedures.

 

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The real depreciated against the U.S. dollar from mid-2011 to early 2016. In particular, during 2015, due to the poor economic conditions in Brazil, including as a result of political instability, the real depreciated at a rate that was much higher than in previous years. On September 24, 2015, the real fell to its lowest level since the introduction of the currency, at R$4.1945 per US$1.00. Overall in 2015, the real depreciated 47.0%, reaching R$3.9048 per US$1.00 on December 31, 2015. In 2016, the real fluctuated significantly, primarily as a result of Brazil’s political instability, appreciating 16.5% to R$3.2591 per US$1.00 on December 31, 2016. In 2017, the real depreciated 1.5% against the U.S. dollar, ending the year at an exchange rate of R$3.308 per U.S.$1.00. The real/U.S. dollar exchange rate reported by the Central Bank was R$3.8748 per U.S.$1.00 on December 31, 2018, which reflected a 17.1% depreciation in the real against the U.S. dollar during 2018, primarily as a result of lower interest rates in Brazil, which reduced the volume of foreign currency deposited in Brazil in the “carry trade,” as well as uncertainty regarding the results of the Brazilian presidential elections held in October 2018. There can be no assurance that the real will not depreciate or appreciate further against the U.S. dollar.

 

The Central Bank has intervened occasionally in the foreign exchange market to attempt to control instability in foreign exchange rates. We cannot predict whether the Central Bank or the Brazilian government will continue to allow the real to float freely or will intervene in the exchange rate market by re-implementing a currency band system or otherwise. The real may depreciate or appreciate substantially against the U.S. dollar in the future. Furthermore, Brazilian law provides that, whenever there is a serious imbalance in Brazil’s balance of payments or there are serious reasons to foresee a serious imbalance, temporary restrictions may be imposed on remittances of foreign capital abroad. We cannot assure you that the Brazilian government will not place restrictions on remittances of foreign capital abroad in the future.

 

The following table sets forth, for the periods indicated, the high, low, average and period-end exchange rates for the purchase of U.S. dollars expressed in Brazilian reais per U.S. dollar. The average rate is calculated by using the average of reported exchange rates by the Central Bank on each day during a monthly period and on the last day of each month during an annual period. As of March 31, 2019, the exchange rate for the selling real/dollar exchange rate was R$3.897 to U.S.$1.00, as reported by the Central Bank. The real/dollar exchange rate fluctuates and, therefore, the selling rate at March 31, 2019 may not be indicative of future exchange rates.

 

Year  Period-end  Average(1)  Low  High
2014    2.656    2.355    2.197    2.740 
2015    3.905    3.339    2.575    4.195 
2016    3.259    3.483    3.119    4.156 
2017    3.308    3.193    3.051    3.381 
2018    3.875    3.656    3.139    4.188 

 

Month  Period-end  Average(2)  Low  High
September 2018    4.004    4.117    4.004    4.188 
October 2018    3.718    3.758    3.637    4.027 
November 2018    3.863    3.787    3.697    3.893 
December 2018    3.875    3.885    3.829    3.933 
January 2019    3.652    3.742    3.652    3.860 
February 2019    3.738    3.594    3.669    3.776 
March 2019    3.897    3.847    3.776    3.968 
April 2019 (through April 15, 2019)

   3.873    3.859    3.835    3.873 

 

 

Source: Central Bank.

 

(1)Represents the average of the exchange rates on the closing of each business day during the year.

 

(2)Represents the average of the exchange rates on the closing of each business day during the month.

 

B.Capitalization and indebtedness

 

Not applicable.

 

C.Reasons for the offer and use of proceeds

 

Not applicable.

 

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D.Risk factors

 

Our business, results of operations, financial condition or prospects could be adversely affected if any of these risks occurs, and as a result, the trading price of our common shares could decline. The risks described below are those known to us and those that we currently believe may materially affect us.

 

Certain Factors Relating to Our Business and Industry

 

We face significant competition in each program we offer and each geographic region in which we operate. If we experience increasing consolidation in the K-12 school industry in Brazil or if we fail to compete efficiently, we may lose market share and our profitability may be adversely affected.

 

We compete directly with private education platform providers and indirectly with certain traditional educational content providers. Our competitors may begin to offer educational solutions similar to or better than those offered by us, have access to more funds, be more prestigious or well-regarded within the academic community, or charge lower fees. To compete effectively, we may be required to reduce our fees that we charge partner schools or increase our operating expenses in order to retain partner schools or attract new schools or to pursue new market opportunities. As a result, our revenues and profitability may decrease. We cannot assure you that a migration from traditional education content providers to education platform providers will be successful in the future, or that we will be able to compete successfully against our current or future competitors. Moreover, at present, there have been certain isolated cases of market consolidation in the K-12 industry in Brazil. In the event that such industry consolidation intensifies, a trend that has been and is currently taking place in the post-secondary education industry in the country, we may face increasing levels of competition in the markets in which we operate. If we are unable to maintain our competitive position or otherwise respond to competitive pressures effectively, we may lose our market share, our profits may decrease and we may be adversely affected.

 

We may not be able to update, improve or offer the content of our existing educational platform on a cost-effective basis.

 

Our educational platform is designed to offer a complete suite of turnkey curriculum solutions intended to prepare the primary and secondary education students at our partner schools to sit the National Exam for the Assessment of Student Performance (Exame Nacional de Desempenho de Estudantes), or ENADE, which is used by the Brazilian Education Ministry (Ministério da Educação), or MEC, to evaluate and grade our partner schools and their students, and the ENEM (National High School Exam, equivalent to the Gaokao), for entry into post-secondary educational institutions. To differentiate ourselves and remain competitive, we must continually update our content and develop new educational solutions, including through the adoption of new technological tools to deliver our content. Updates to our current content and the development of new educational solutions may not be readily accepted by our partner schools, their students or by the market. Also, we may not be able to introduce new educational solutions at the same pace as our competitors or at the pace required by the labor market. If we do not adequately modify our educational platform in response to market demand, whether due to financial restrictions, technological changes or otherwise, our ability to attract new schools and retain partner schools may be impaired and we may be materially adversely affected.

 

Our business depends on the continued success of our brands, and if we fail to maintain and enhance the recognition of our brands, we may face difficulty increasing our network of partner schools, and our reputation and operating results may be harmed.

 

We believe that market awareness of our brands, SAS, SAE and International School, has contributed significantly to the success of our business. Maintaining and enhancing our brands is critical to our efforts to increase our network of partner schools, which is in turn critical to our business. We rely heavily on the efforts of our sales force and our marketing channels, including online advertising, search engine marketing, social media and word-of-mouth. Failure to maintain and enhance the recognition of our brands could have a material and adverse effect on our business, operating results and financial condition. We have devoted significant resources to our brand promotion efforts and the training of our sales force in recent years, but we cannot assure you that these efforts will be successful. Our ability to attract new partner schools depends not only on investment in our brand, our marketing efforts and the success of our sales force, but also on the perceived value of our services versus competing alternatives among our client base. In addition, a failure by our clients to distinguish between our brands and the different content that they provide may result in a reduction in sales volume and revenue, margins or market share of one of our brands at the expense of the others. If our marketing initiatives are not successful or become less effective, if we are unable to further enhance our brand recognition, or if we incur excessive marketing and promotion expenses, or if our brand image is negatively impacted by any negative publicity, we may not be able to attract new partner schools successfully or efficiently, and our business and results of operations may be materially and adversely affected.

 

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In addition, if any partner school using our educational platforms engages in unlawful activities or uses our educational platforms in an unauthorized manner, the general public may associate such school’s behavior with our brand, generating negative publicity that may adversely affect our reputation.

 

If we continue to grow, we may not be able to appropriately manage the expansion of our business and staff, the increased complexity of our software and platforms, or grow in our addressable market.

 

We are currently experiencing a period of significant expansion and are facing a number of expansion-related issues, such as the acquisition and retention of experienced and talented personnel, cash flow management, corporate culture and internal controls, among others. These issues and the significant amount of time spent on addressing them may result in the diversion of our management’s attention from other business issues and opportunities. In addition, we believe that our corporate culture and values are critical to our success, and we have invested a significant amount of time and resources building them. If we fail to preserve our corporate culture and values, our ability to recruit, retain and develop personnel and to effectively implement our strategic plans may be harmed.

 

We must constantly update our software and platform, enhance and improve our billing and transaction and other business systems, and add and train new software designers and engineers, as well as other personnel to accommodate the increased use of our platform and the new solutions and features we regularly introduce. This process is time intensive and expensive, and may lead to higher costs in the future. Furthermore, we may need to enter into relationships with various strategic partners other online service providers and other third parties necessary to our business. The increased complexity of managing multiple commercial relationships could lead to execution problems that can affect current and future revenues, and operating margins.

 

We cannot assure you that our current and planned platform and systems, procedures and controls, personnel and third-party relationships will be adequate to support our future operations. In addition, our current expansion has placed a significant strain on management and on our operational and financial resources, and this strain is expected to continue. Our failure to manage growth effectively could seriously harm our business, results of operations and financial condition.

 

An increase in delays and/or defaults in the payment of amounts owed to us by partner schools may adversely affect our income and cash flow.

 

We depend on the full and timely payment of the amounts owed to us by partner schools. Our partner schools may face financial difficulties, and in certain cases, insolvency or bankruptcy. An increase in payment delinquency or default by partner schools may have a material adverse effect on our cash flows and our business, including our ability to meet our obligations, and in certain circumstances, we may, at no cost to us, decide to terminate our contracts with such partner schools, increasing our attrition rates. Our allowance for doubtful accounts expenses as a percentage of our net revenue was 2.5%, 2.1% and 3.5% for the years ended December 31, 2018, 2017 and 2016, respectively.

 

Our business is subject to seasonal fluctuations, which may cause our operating results to fluctuate from quarter-to-quarter and adversely impact our working capital and liquidity throughout the year, adversely affecting our business, financial condition and results of operations.

 

Our revenues and operating results normally fluctuate as a result of seasonal variations in our business, principally due to the number of months in a fiscal quarter that our partner schools are fully operational and serving students. Our main deliveries are shipped to partner schools in the last quarter of each year (typically in November and December), and in the first quarter of each subsequent year (typically in February and March). Furthermore, the materials we deliver in the fourth quarter are used by our partner schools for the following school year, and as such, our fourth quarter results reflect the growth in the number of our students from one school year to another, leading to generally higher revenues in our fourth quarter compared to the preceding quarters in each fiscal year. Consequently, in aggregate, the seasonality of our revenues has generally produced higher revenues in the first and fourth quarters of our fiscal year. In addition, we bill partner schools and collect the sales we charge them in the first half of each academic collections year, generally resulting in a higher cash position in the first half of each fiscal year relative to the second half of each fiscal year.

 

A significant portion of our expenses are also seasonal. Due to the nature of our business cycle, we require significant working capital, typically in September or October of each year, to cover costs related to production and accumulation of inventory, selling and marketing expenses, and delivery of our teaching materials at the end of each fiscal year in preparation for the beginning of each school year. Therefore, such operating expenses are generally incurred in the period between September and December of each year.

 

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Accordingly, we expect quarterly fluctuations in our revenues and operating results to continue. These fluctuations could result in volatility and adversely affect our liquidity and cash flows. As our business grows, these seasonal fluctuations may become more pronounced. As a result, we believe that sequential quarterly comparisons of our financial results may not provide an accurate assessment of our financial position.

 

Our working capital needs have increased, and may continue to increase for the near future. We have historically relied on our cash flow generation to satisfy our working capital needs. If we do not increase our cash flow generation or gain access to additional capital, whether through a line or credit or other sources of capital, which may not be available on satisfactory terms or in adequate amounts, then our cash and cash equivalents may decline, which will have an adverse impact upon our liquidity and capital resources. We expect our working capital needs to increase as our business expands. If we do not have sufficient working capital, we may not be able to pursue our growth strategy, respond to competitive pressures or fund key strategic initiatives, which may harm our business, financial condition and results of operations.

 

The sales cycle of our business may cause our operating results to fluctuate from quarter-to-quarter and adversely impact our working capital and liquidity from year to year, adversely affecting our business, financial condition and results of operations.

 

Our platform has evolved into a complex solution. The adoption of our platform by partner schools requires us to first build a high level of trust and confidence in our solutions, which can only be achieved by demonstrating a proven track record of success and quality, while constantly monitoring client satisfaction and feedback.

 

We have a lead time (which we define as the period from the moment of first contact to the execution of a contract) for the acquisition of new partner schools, and we typically enter into contracts with new partner schools within one year from the moment of first contact, which requires a series of interactions and constant contact, including dedicated sessions for experimentation with our platform and testing, events aimed at target partner schools, product journeys and guided visits to our business units, and industry fair exhibits. Accordingly, we expect quarterly fluctuations in our cash flows. These fluctuations could result in annual volatility and adversely affect our liquidity. As our business grows or if our business stops growing and we lose clients, these fluctuations may become more pronounced.

 

We do not currently control some of our acquired technologies, which could adversely affect our ability to develop and commercialize our products.

 

We acquire interests in third parties for the expansion, development or commercialization of our products. To date, we have acquired a 25% interest in WPensar, a company engaged in the development and licensing of school management systems software, with an option to acquire the remaining 75% of its outstanding share capital between 2020 and 2021. We have also acquired an 8.05% interest in Geekie, a company that provides adaptive assessment and learning products, as well as develop and license educational software, with an option to acquire the remaining 91.95% of its outstanding share capital in May 2022. We do not currently have a controlling interest in these companies and any disagreements or disputes with these or other companies where we have a minority interest could adversely affect our ability to develop and commercialize our products and in turn, our financial condition and results of operations. To date, we have not directly implemented the technologies related to these investments in our educational platform, but we may do so in the future. The failure to continue any investment arrangement or to resolve disagreements with current or future companies where we have a minority interest could materially and adversely affect our ability to transact the business that is the subject of such investment arrangement, which would in turn negatively affect our financial condition and results of operations.

 

We may pursue strategic acquisitions or investments. The failure of an acquisition or investment to produce the anticipated results, or the inability to integrate an acquired company fully, could harm our business.

 

We are currently evaluating possible acquisition opportunities, and we may from time to time submit non-binding proposals or acquire or invest in complementary companies or businesses, as part of our strategy to expand our operations, including through acquisitions or investments that may be material in size and/or of strategic relevance. The success of an acquisition or investment will depend on our ability to make accurate assumptions regarding the valuation, operations, growth potential, integration and other factors related to that

 

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business. We cannot assure you that our acquisitions or investments will produce the results that we expect at the time we enter into or complete a given transaction. Furthermore, acquisitions may result in difficulties integrating the acquired companies, and may result in the diversion of our capital and our management’s attention from other business issues and opportunities. We may not be able to integrate successfully the operations that we acquire, including their personnel, financial systems, distribution or operating procedures. If we fail to integrate acquisitions successfully, our business could suffer. In addition, the expense of integrating any acquired business and their results of operations may harm our operating results. We may also require approval from Brazil’s Administrative Council for Economic Defense (Conselho Administrativo de Defesa Econômica), or CADE, or other regulatory authorities, in order to conduct certain acquisitions or investments.

 

We may require additional funds to continue our expansion strategy. If we are unable to obtain adequate financing to complete any potential acquisition and implement our expansion plans, our growth strategy may be adversely affected.

 

If we lose key personnel our business, financial condition and results of operations may be adversely affected.

 

We are dependent upon the ability and experience of a number of our key personnel who have substantial experience with our operations. Many of our key personnel have worked for us for a significant amount of time or were recruited by us specifically due to their industry experience. It is possible that the loss of the services of one or a combination of our senior executives, certain members of our board of directors or key managers, including Ari de Sá Cavalcante Neto, our chief executive officer and founder, and Oto Brasil de Sá Cavalcante, our chairman, could have a material adverse effect on our business, financial condition and results of operations. Our business is particularly dependent on our chairman, who is also our controlling shareholder. We currently do not carry any key man insurance.

 

The ability to attract, recruit, retain and develop qualified employees is critical to our success and growth.

 

In order for us to successfully compete and grow and increase the number of partner schools, we must attract, recruit, retain and develop the necessary personnel who can provide the required expertise across the entire spectrum of our high-quality educational content needs, including with respect to sales and marketing. While a number of our key personnel have substantial experience with our operations, we must also develop succession plans capable of maintaining continuity in the midst of the inevitable unpredictability of human capital. However, the market for qualified personnel is competitive, and we may not succeed in recruiting additional personnel or may fail to effectively replace current personnel who depart with qualified or effective successors. We must continue to hire additional personnel to execute our strategic plans. Our effort to retain and develop personnel may also result in significant additional expenses, which could adversely affect our profitability. We cannot assure that qualified employees will continue to be employed or that we will be able to attract and retain qualified personnel in the future. In particular, we may not achieve anticipated revenue growth from expanding our sales and marketing teams if we are unable to attract, develop and retain qualified sales and marketing personnel in the future.

 

Failure to retain or attract key personnel could have a material adverse effect on our business, financial condition and results of operations.

 

Any increase in the attrition rates of students in our partner schools may adversely affect our results of operations.

 

We believe that the attrition rates at our partner schools are primarily related to the personal motivation and financial situation of their current and potential students, as well as to socioeconomic conditions in Brazil. Significant changes in projected student attrition rates and/or failure to re-enroll may affect the enrollment numbers of our partner schools, as well as their ability to recruit and enroll new students, each of which may have a material adverse effect on our projected revenues and our results of operations.

 

We may face restrictions and penalties under the Brazilian Consumer Protection Code in the future.

 

Brazil has a series of strict consumer protection laws, referred to collectively as the Consumer Protection Code (Código de Defesa do Consumidor). These laws apply to all companies in Brazil that supply products or services to Brazilian consumers. They include protection against misleading and deceptive advertising, protection against coercive or unfair business practices and protection in the formation and interpretation of contracts, usually in the form of civil liabilities and administrative penalties for violations. Although we are a B2B2C business, some parents may allege that we are directly liable for any problems in our solution and try to assess us based upon the Consumer Protection Code.

 

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These penalties are often levied by the Brazilian Consumer Protection Agencies (Fundação de Proteção e Defesa do Consumidor, or PROCONs), which oversee consumer issues on a district-by-district basis. Companies that operate across Brazil may face penalties from multiple PROCONs, as well as from the National Secretariat for Consumers (Secretaria Nacional do Consumidor, or SENACON). Companies may settle claims made by consumers via PROCONs by paying compensation for violations directly to consumers and through a mechanism that allows them to adjust their conduct, called a conduct adjustment agreement (Termo de Ajustamento de Conduta, or TAC).

 

Brazilian public prosecutors may also commence investigations of alleged violations of consumer rights and require companies to enter into TACs. Companies that violate TACs face potential enforcement proceedings and other potential penalties such as fines, as set forth in the relevant TAC. Brazilian public prosecutors may also file public civil actions against companies who violate consumer rights or competition rules, seeking strict adherence to the consumer protection laws and compensation for any damages to consumers. In certain cases, we may also face investigations and/or sanctions by the CADE, in the event our business practices are found to affect the competitiveness of the markets in which we operate or the consumers in such markets.

 

Our success depends on our ability to monitor and adapt to technological changes in the education sector and maintain a technological infrastructure that works adequately and without interruption.

 

Information technology is an essential factor of our growth given that we deliver content through an integrated online educational platform. Our information technology systems and tools may become obsolete or insufficient, or we may have difficulties in following and adapting to technological changes in the education sector. Moreover, our competitors may introduce better products or platforms. Our success depends on our ability to efficiently improve our platform while developing and introducing new features that are accepted by schools (including our partner schools) and their students.

 

Additionally, a failure to upgrade our technology, features, content, security infrastructure, network infrastructure, or other infrastructure associated with our platform could harm our business. Adverse consequences could include unanticipated disruptions, slower response times, bugs, degradation in levels of customer support, impaired quality of users’ experiences of our educational platform and delays in reporting accurate financial information.

 

In addition, we face risks associated with unauthorized access to our systems, including by hackers and due to failures of our electronic security measures. These unauthorized entries into our systems can result in the theft of proprietary or sensitive information or cause interruptions in the operation of our systems. As a result, we may be forced to incur considerable expenses to protect our systems from electronic security breaches and to mitigate our exposure to technological problems and interruptions.

 

Our business depends on our information technology infrastructure functioning properly and without interruptions. Several problems regarding our information technology structure, such as viruses, hackers, system interruptions and other technical difficulties may have a material adverse effect on us and our business.

 

We recently engaged a third party consultant to conduct a risk and vulnerability assessment of our cybersecurity infrastructure. The third party report made the following key recommendations: (1) establish asset controls and create application lists to monitor and mitigate malware infection risk; (2) establish data-loss prevention measures for our hardware and servers; (3) develop a model to access and manage data through automation and controls of user profile information; (4) build an audit and event-log infrastructure throughout our software platforms to help us monitor potential cybersecurity breaches; (5) introduce scheduled routine infrastructure intrusion tests to verify the adequacy of our systems; (6) create background procedures to protect secure access to our video applications; and (7) establish a cybersecurity training and awareness program for our employees. We are currently implementing the recommendations and intend to conclude their implementation by the second half of 2020.

 

Our revenue derives from the contract fees per student that we generate from the sales of our educational content to our partner schools. Any disruption in our relationship with our partner schools may materially adversely affect us.

 

Our network of partner schools to which we make available our educational platform and to which we supply the related educational materials comprises 1,462 partner schools as of December 31, 2018. Our net revenue was R$381.0 million and R$244.4 million for the years ended December 31, 2018 and 2017. We typically enter into contracts with our partner schools for three-year terms, which contemplate penalties ranging between 20% and 100% of the remaining total value of the contract in the event of termination. In addition, we

 

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also rely in part on existing partner school referrals to attract new partner schools. Accordingly, maintaining a good relationship with our partner schools and developing new relationships and expanding our network of partner schools are essential to the success of our business. We may also not be able to renew our contracts with our partner schools, including as a result of new leadership in our partner schools deciding to discontinue the use or expansion of our educational platform in their curriculum. Any deterioration in our relationship with our partner schools, and any early termination of, or a failure to renew, our contracts with our partner schools may harm our image, impair our ability to pursue our growth strategy, and materially adversely affect our business, our operating and financial results and our cash flows.

 

To support our growth and to help us retain our clients, we have a dedicated sales support team that provides pedagogical assistance to partner schools and helps them train students and teachers to fully engage with the features of our platform, in order to maximize their results from using our solutions. Our pedagogical support team also make visits and perform field work for these purposes, building rapport and strengthening our ties with our partner schools. If we fail to provide efficient and effective customer support, or to maintain our customer support standards as our business grows, our ability to maintain and grow our operations may be harmed and we may need to hire additional support personnel, which could harm our results of operations.

 

Increases in the price of certain inputs used to produce our printed educational materials and increases in the fees of our third-party printer providers may materially affect us.

 

Increases in the price of the inputs used for editing and publishing the materials related to our educational platform, particularly the price of paper, the cost of printing services and publishing, as well as increases in the fees of our third-party printer providers, which produce our printed educational materials, could adversely affect our results, if we are not able to fully pass these cost increases onto our partner schools.

 

Paper and postage prices are difficult to predict and control. Paper is a commodity and its price may be impacted by fluctuations in foreign exchange rates and commodities prices, and can be subject to significant volatility. Our third-party printer providers have adjusted their fees to account for changes in prevailing market prices of their inputs, especially paper. Though we have historically been able to realize favorable pricing through volume discounts, particularly as a result of our significant recent growth, no assurance can be provided that we will be able to continue to realize favorable printing and publishing pricing. We cannot predict with certainty the magnitude of future price changes for paper, postage, and printing and publishing in general. Further, we may not be able to pass such increases on to our partner schools.

 

We may not be able to pass on increases in our costs by adjusting the contract fees we charge our partner schools.

 

Our primary source of income is the payments we receive from our partner schools in connection with the contract fees per student that we charge them to use our educational platform. For the year ended December 31, 2018, operation, sales and corporate personnel expenses represented 30.9% and third-party services expenses represented 4.4% of our total costs and expenses for the period. Personnel costs are adjusted periodically using indices that reflect changes in inflation levels. Personnel costs are also adjusted annually as a result of customary annual employee salary adjustments in line with inflation. If we are not able to transfer any increases in our costs to partner schools by increasing the contract fees per student that we charge them, our operating results may be adversely affected.

 

Any change or review of the tax treatment of our activities, or the loss or reduction in tax benefits on the sale of books (including digital content) may materially adversely affect us.

 

We benefit from tax Law No. 10,865/04, as amended by Law No. 11,033/04, which establishes a zero rate for the social integration program tax (Programa de Integração Social, or PIS) and the social contribution on revenues tax (Contribuição para o Financiamento da Seguridade Social, or COFINS) on the sale of books. The sale of books is also exempt by the Brazilian constitution from Brazilian municipal taxes, Brazilian services tax (Imposto Sobre Serviços, or ISS) and from the Brazilian tax on the circulation of goods, interstate and intercity transportation and communication services (Imposto sobre Operações relativas à Circulação de Mercadorias e sobre Prestações de Serviços de Transporte Interestadual e Intermunicipal e de Comunicação, or ICMS). If the Brazilian government or any Brazilian municipality or tax authority decides to change or review the tax treatment of our activities, or cancel or reduce the tax benefit applied on the sale of goods (including digital books and e-readers) and/or challenge it, and we are unable to pass any cost increase onto our partner schools, our results may be materially adversely affected.

 

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If we are unable to maintain consistent educational quality throughout our partner schools network, including the education materials we provide to our partner schools, we may be adversely affected.

 

The quality of our academic curricula is a key element of the quality of the educational platform we provide. We cannot assure you that we will be able to develop academic curricula for our educational platform with the same levels of excellence as existing curricula and meeting the requirements of the Base Nacional Comum Curricular, or the BNCC (established by Law No. 9,394 dated December 20, 1996), to which we are currently subject, or meeting the requirements of our partner schools. Deficiencies in the quality of academic curricula for our educational platform and the requirements of the BNCC may have a material adverse effect on our business.

 

In addition, our partner schools and their students are regularly evaluated and graded by the MEC. If our partner schools’ campuses, programs or students receive lower scores from the MEC than in previous years in any of their evaluations, including the IDEB (National Index for Basic Education) and the ENEM, or if there is a decline in our partner schools students’ acceptance rates at prestigious post-secondary schools, we may be adversely affected by perceptions of decreased educational quality of our educational platform, which may negatively affect our reputation and, consequently, our results of operations and financial condition.

 

We may become subject to various laws and regulations applicable to educational platform providers, and failure to meet such future laws and regulations could harm our business.

 

Currently, we are subject to the requirements of the BNCC, and we are not regulated by the MEC nor are we subject to any government regulations that are imposed by the CNE, or by the Primary and Secondary Education Board (Câmara de Educação Básica), or CEB. Should we become subject to the supervision and regulation of the MEC or any other authority or any government laws and regulations imposed by the CNE or the CEB or any other authority, we may be required to meet certain legal and regulatory requirements that may be imposed on our operations, including, but not limited to, MEC accreditation or re-accreditation requirements for our educational platform, which may adversely affect us. We may be adversely affected by changes in the laws and regulations applicable to educational platform providers, particularly by changes that impose accreditation and re-accreditation requirements on educational platforms and impose certain academic requirements for educational platform courses and curricula. In addition, we may be materially adversely affected if we are unable to obtain these authorizations and accreditations in a timely manner or if we cannot introduce new features to our educational platform as quickly as our competitors.

 

The quality of the pedagogical content we deliver to our clients is significantly dependent upon the quality of our editors, publishers and purchased content.

 

The educational materials we provide are a combination of content developed by our internal production team and content purchased from certain publishers in our market. Our editorial team is responsible for producing our materials, working in conjunction with our EdTech team, to implement additional features and technology delivery. Our content production process requires significant coordination among different teams as well as qualified personnel with appropriate skill sets to ensure the quality of our pedagogical content is maintained. We may not be able to retain, recruit or train qualified employees or obtain pedagogical content that meets our standards. Delays in the delivery of content purchased from authors may have a severe impact on our annual content creation schedule. Additionally, a shortage of qualified editors, employees, publishers or suitable purchased content or a decrease in the quality of produced or purchased content, whether actual or perceived, or a significant increase in the cost to engage or retain qualified personnel or acquire content, would have a material adverse effect on our business, financial condition and results of operations.

 

We utilize third-party logistics service providers for the shipping of all of our collections of printed teaching materials. The successful delivery of our materials to our clients depends upon effective execution by our logistics team and such service providers. Any material failure to execute properly for any reason, including damage or disruption to any service providers’ facilities, would have an adverse effect on our business, financial condition and results of operations.

 

The delivery of printed books to schools is a seasonal activity, with a cycle beginning with the creation and revision of content generally from April to July, the purchase of printing services from August to October, and delivery from November to January. We have expanded our operations rapidly since our inception. As our size increases, so does the size and complexity of our logistics operation.

 

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There is a high volume of deliveries in November and December, requiring significant involvement in inventory/demand management and relationship and planning alongside the printers. In an industry where one of the most valued indicators by the schools is the timely delivery of printed materials, failure to meet deadlines, inadequate logistical planning, disruptions in distribution centers, deficient inventory management, and failure to meet client requirements may damage our reputation, increase returns of our materials or cause inventory losses and negatively impact our gross margins, results of operations and business.

 

Substantially all of the inventory for our printed teaching materials is located in warehouse facilities leased and operated by us and then delivered by a third-party shipping company that handles shipping of all physical learning materials. If our logistics service providers fail to meet their obligations to deliver teaching materials to partner schools in a timely manner, or if a material number of such deliveries are incomplete or contain assembly errors, our business and results of operations could be adversely affected. Furthermore, a natural disaster, fire, power interruption, work stoppage or other unanticipated catastrophic event, especially during the period from August through October when we are awaiting receipt of most of the curriculum materials for the school year and have not yet shipped such materials to partner schools, could significantly disrupt our ability to deliver our products and operate our business. If any of our material inventory items, warehouse facilities or distribution centers were to experience any significant damage, we would be unable to meet our contractual obligations and our business would suffer.

 

Failure to protect or enforce our intellectual property and other proprietary rights could adversely affect our business and financial condition and results of operations.

 

We rely and expect to continue to rely on a combination of trademark, copyright, patent and trade secret protection laws, as well as confidentiality and license agreements with our employees, consultants and third parties with whom we have relationships to protect our intellectual property and proprietary rights. As of December 31, 2018, we did not have issued patents or patent applications pending in or outside Brazil. We are party to approximately 2,703 agreements with third-party authors with respect to educational content, for indefinite terms. We own 47 trademark registrations. As of December 31, 2018, we owned 62 registered domain names in Brazil. We also have a number of pending trademark applications in Brazil and the U.S. (126 in Brazil and 3 in the U.S., as of December 31, 2018) and unregistered trademarks that we use to promote our brand. From time to time, we expect to file additional patent, copyright and trademark applications in Brazil and abroad. Nevertheless, these applications may not be approved or otherwise provide the full protection we seek. Any dismissal of our “Arco Educação” trademark application may impact our business. Third parties may challenge any patents, copyrights, trademarks and other intellectual property and proprietary rights owned or held by us. Third parties may knowingly or unknowingly infringe, misappropriate or otherwise violate our patents, copyrights, trademarks and other proprietary rights and we may not be able to prevent infringement, misappropriation or other violation without substantial expense to us.

 

Furthermore, we cannot guarantee that:

 

·our intellectual property and proprietary rights will provide competitive advantages to us;

 

·our competitors or others will not design around our intellectual property or proprietary rights;

 

·our ability to assert our intellectual property or proprietary rights against potential competitors or to settle current or future disputes will not be limited by our agreements with third parties;

 

·our intellectual property and proprietary rights will be enforced in jurisdictions where competition may be intense or where legal protection may be weak;

 

·any of the patents, trademarks, copyrights, trade secrets or other intellectual property or proprietary rights that we presently employ in our business will not lapse or be invalidated, circumvented, challenged or abandoned; or

 

·we will not lose the ability to assert our intellectual property or proprietary rights against or to license our intellectual property or proprietary rights to others and collect royalties or other payments.

 

If we pursue litigation to assert our intellectual property or proprietary rights, an adverse decision in any of these legal actions could limit our ability to assert our intellectual property or proprietary rights, limit the value of our intellectual property or proprietary rights or otherwise negatively impact our business, financial condition and results of operations. If the protection of our intellectual property and proprietary rights is inadequate to prevent use or misappropriation by third parties, the value of our brand and other intangible assets may be diminished, competitors may be able to more effectively mimic our service and methods of operations, the perception of our business and service to customers and potential customers may become confused in the marketplace and our ability to attract customers may be adversely affected.

 

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We may in the future be subject to intellectual property claims, which are costly to defend and could harm our business, financial condition and operating results.

 

Because of the large number of authors that participate in our publications, from time to time, third parties may allege in the future that we or our business infringes, misappropriates or otherwise violates their intellectual property or proprietary rights, including with respect to our publications. Many companies, including various “non-practicing entities” or “patent trolls,” are devoting significant resources to developing or acquiring patents that could potentially affect many aspects of our business. There are numerous patents that broadly claim means and methods of conducting business on the Internet. We have not exhaustively searched patents related to our technology. In addition, the publishing industry has been, and we expect in the future will continue to be, the target of counterfeiting and piracy. We may implement measures in an effort to protect against these potential liabilities that could require us to spend substantial resources. Any costs incurred as a result of liability or asserted liability relating to sales of unauthorized or counterfeit educational materials could harm our business, reputation and financial condition.

 

Third parties may initiate litigation against us without warning. Others may send us letters or other communications that make allegations without initiating litigation. We have in the past and may in the future receive such communications, which we assess on a case-by-case basis. We may elect not to respond to the communication if we believe it is without merit or we may attempt to resolve disputes out-of-court by electing to pay royalties or other fees for licenses. If we are forced to defend ourselves against intellectual property claims, whether they are with or without merit or are determined in our favor, we may face costly litigation, diversion of technical and management personnel, inability to use our current website or inability to market our service or merchandise our products. As a result of a dispute, we may have to develop non-infringing technology, including partially or fully revise any publication that infringes intellectual property rights, enter into licensing agreements, adjust our merchandising or marketing activities or take other action to resolve the claims. These actions, if required, may be unavailable on terms acceptable to us or may be costly or unavailable. If we are unable to obtain sufficient rights or develop non-infringing intellectual property or otherwise alter our business practices, as appropriate, on a timely basis, our reputation or brand, our business and our competitive position may be affected adversely and we may be subject to an injunction or be required to pay or incur substantial damages and/or fees and/or royalties.

 

Most of our services are provided using proprietary software and our software is mainly developed by our employees, who do not specifically assign to us their copyrights over the software. In this regard, though applicable law establishes that employers shall have full title over rights relating to software developed by their employees, we could be subject to lawsuits by former employees claiming ownership of such software. As a result, we may be required to obtain licenses of such software, incurring costs relating to payments of royalties and/or damages and we may be forced to cease the use of such software. If we are unable to use certain of our proprietary software as a result of any of the foregoing or otherwise, this could have a material adverse effect on our business, financial condition and results of operations.

 

In addition, we use open source software in connection with certain of our products and services. Companies that incorporate open source software into their products have, from time to time, faced claims challenging the ownership of open source software and/or compliance with open source license terms. As a result, we could be subject to suits by parties claiming ownership of what we believe to be open source software or noncompliance with open source licensing terms. Some open source software licenses require users who distribute or use open source software as part of their software to publicly disclose all or part of the source code to such software and/or make available any derivative works of the open source code on unfavorable terms or at no cost. Any requirement to disclose our proprietary source code or pay damages for breach of contract could have a material adverse effect on our business, financial condition and results of operations.

 

We are susceptible to illegal or improper uses of our educational platform, which could expose us to additional liability and harm our business.

 

Our educational platform is susceptible to unauthorized use, copyright violations and unauthorized copying and distribution (whether by students, schools or otherwise), theft, employee fraud, and other similar breaches and violations. These occurrences may potentially harm our business and consequently negatively impact our results of operations. Additionally, we may be required to employ a significant amount of resources to combat such occurrences and identify those responsible.

 

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Unfavorable decisions in our legal, arbitration or administrative proceedings may adversely affect us.

 

We are, and may be in the future, party to legal, arbitration and administrative investigations, inspections and proceedings arising in the ordinary course of our business or from extraordinary corporate, tax or regulatory events, involving our suppliers, commercial practices, students, faculty members, as well as environmental, competition, government agencies and tax authorities, particularly with respect to civil, tax and labor claims. We cannot guarantee that the results of these proceedings will be favorable to us or that we have made sufficient provisions for liabilities that may arise as a result of these or other proceedings. Even if we adequately address issues raised by any inspection conducted by an agency or successfully defend our case in an administrative proceeding or court action, we may have to set aside significant financial and management resources to settle issues raised by such proceedings or to those lawsuits or claims. Adverse decisions in material legal, arbitrational or administrative proceedings, even if such proceedings are without merit, may adversely affect our reputation, results of operations and the price of our Class A common shares.

 

We depend on dividend distributions by our subsidiaries, and we may be adversely affected if the performance of our subsidiaries is not positive or if Brazil imposes legal restrictions on dividend distributions by subsidiaries.

 

We control a number of subsidiary companies in Brazil that carry out our business activities. Our ability to comply with our financial obligations and to pay future dividends, if any, to our shareholders depends on our ability to receive distributions from the companies we control, which in turn depends on the cash flow and profits of those companies. There is no guarantee that the cash flow and profits of our controlled companies will be sufficient for us to comply with our financial obligations and pay future dividends or interest on shareholders’ equity, if any, to our shareholders, or that the new Brazilian federal government elected in October 2018 will not impose legal restrictions or tax payments on dividend distributions by our subsidiaries.

 

We and our subsidiaries may be held directly or indirectly responsible for labor claims resulting from the actions of third parties, including independent contractors and service providers.

 

To meet the needs of our partner schools and offer greater comfort and quality in all areas and aspects of our activities, we depend on service providers and suppliers for a variety of services. We may be adversely affected if these third-party service providers and suppliers do not meet their obligations under Brazilian labor laws. In particular, according to Brazilian law we may be liable to the employees of these service providers and suppliers for labor obligations of these service providers and suppliers, and may also be fined by the relevant authorities. If we are held liable for such claims, we may be adversely affected.

 

We operate in markets that are dependent on Information Technology (IT) systems and technological change. Failure to maintain and support customer facing services, systems, and platforms, including addressing quality issues and execution on time of new products and enhancements, could negatively impact our revenues and reputation.

 

We use complex IT systems and products to support our businesses activities, including customer-facing systems, back-office processing and infrastructure. We face several technological risks associated with online product service delivery, information technology security (including virus and cyber-attacks), e-commerce and enterprise resource planning system implementation and upgrades. Our plans and procedures to reduce risks of attacks on our system by unauthorized parties may not be successful. Thus, our businesses could be adversely affected if our systems and infrastructure experience a failure or interruption in the event of future attacks on our system by unauthorized parties.

 

We rely upon a third-party data center service provider to host certain aspects of our platform and content and any disruption to, or interference with, our use of such services, could impair our ability to deliver our platform, resulting in customer dissatisfaction, damaging our reputation and harming our business.

 

We utilize data center hosting facilities from a global third-party service provider to make certain content available in our platform. Our operations depend, in part, on our provider’s ability to protect its facilities against damage or interruption from natural disasters, power or telecommunications failures, criminal acts and similar events. The occurrence of spikes in user volume, traffic, natural disasters, acts of terrorism, vandalism or sabotage, or a decision to close a facility without adequate notice, or other unanticipated problems at our provider’s facilities could result in lengthy interruptions in the availability of our platform, which would adversely affect our business.

 

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Failure to prevent or detect a malicious cyber-attack on our systems and databases could result in a misappropriation of confidential information or access to highly sensitive information.

 

Cyber-attacks are becoming more sophisticated and pervasive. Across our business we hold large volumes of personally identifiable information including that of employees, schools, customers, students and parents and legal guardians. Individuals may try to gain unauthorized access to our data in order to misappropriate such information for potentially fraudulent purposes, and our security measures may fail to prevent such unauthorized access. A breach could result in a devastating impact on our reputation, financial condition or student experience. In addition, if we were unable to prove that our systems are properly designed to detect an intrusion, we could be subject to severe penalties and loss of existing or future business.

 

Failure to comply with data privacy regulations could result in reputational damage to our brands and adversely affect our business, financial condition and results of operations.

 

Any perceived or actual unauthorized disclosure of personally identifiable information, whether through breach of our network by an unauthorized party, employee theft, misuse or error or otherwise, could harm our reputation, impair our ability to attract and retain our customers, or subject us to claims or litigation arising from damages suffered by individuals. Failure to adequately protect personally identifiable information could potentially lead to penalties, significant remediation costs, reputational damage, the cancellation of existing contracts and difficulty in competing for future business. In addition, we could incur significant costs in complying with relevant laws and regulations regarding the unauthorized disclosure of personal information, which may be affected by any changes to data privacy legislation at both the federal and state levels.

 

A material weakness in our internal control over financial reporting has been identified, and if we fail to establish and maintain proper and effective internal controls over financial reporting, our results of operations and our ability to operate our business may be harmed.

 

Prior to our initial public offering, we were a private company with limited accounting personnel and other resources to address our internal control over financial reporting and procedures. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. In connection with the audit of our consolidated financial statements, we and our independent registered public accounting firm identified two material weaknesses as of December 31, 2018. A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected on a timely basis. The material weaknesses identified relates to insufficient accounting resources and processes to fully comply with reporting and compliance requirements of IFRS and the U.S. Securities and Exchange Commission, or the SEC, and to IT general controls that make us continue using of manual processes as a result of the implementation and monitoring of controls in our enterprise resource planning (ERP) system.

 

We plan to adopt several measures that will improve our internal control over financial reporting, including increasing the depth and experience within our accounting and finance team, designing and implementing improved processes and internal controls, implementing formal access and change controls to our systems and make changes to our information technology systems, and retaining outside consultants with extensive technical expertise. Some of these measures are already being adopted, in connection with a project to prepare the company for the upcoming adoption of Section 404 of the Sarbanes-Oxley Act, and will be worked extensively through 2019. However, we cannot assure you that our efforts will be effective or prevent any future material weakness or significant deficiency in our internal control over financial reporting.

 

We are subject to the Sarbanes-Oxley Act, which requires, among other things, that we establish and maintain effective internal controls over financial reporting and disclosure controls and procedures. Under the current rules of the SEC starting in 2019 we will be required to perform system and process evaluation and testing of our internal controls over financial reporting to allow management to assess the effectiveness of our internal controls. Our testing may reveal deficiencies in our internal controls that are deemed to be material weaknesses or significant deficiencies and render our internal controls over financial reporting ineffective. We expect to incur additional accounting and auditing expenses and to spend significant management time in complying with these requirements. If we are not able to comply with these requirements in a timely manner, or if we or our management identifies material weaknesses or significant deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our Class A common shares may decline and we may be subject to investigations or sanctions by the SEC, the Financial Industry Regulatory Authority, Inc., or FINRA, or other regulatory authorities.

 

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Neither we nor our independent registered public accounting firm have performed an evaluation of our internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act for purposes of identifying and reporting any weakness or significant deficiency in our internal control over financial reporting, as our independent registered public accounting firm will be required to do once we cease to be an emerging growth company. Had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional control weaknesses may have been identified.

 

In addition, these new obligations will also require substantial attention from our senior management and could divert their attention away from the day-to-day management of our business. These cost increases and the diversion of management’s attention could materially and adversely affect our business, financial condition and operation results.

 

Certain Factors Relating to Brazil

 

The Brazilian federal government has exercised, and continues to exercise, significant influence over the Brazilian economy. This involvement as well as Brazil’s political and economic conditions could harm us and the price of our Class A common shares.

 

The Brazilian federal government frequently exercises significant influence over the Brazilian economy and occasionally makes significant changes in policy and regulations. The Brazilian government’s actions to control inflation and other policies and regulations have often involved, among other measures, increases or decreases in interest rates, changes in fiscal policies, wage and price controls, foreign exchange rate controls, blocking access to bank accounts, currency devaluations, capital controls and import restrictions. We have no control over and cannot predict what measures or policies the Brazilian government may take in the future. We and the market price of our securities may be harmed by changes in Brazilian government policies, as well as general economic factors, including, without limitation:

 

·growth or downturn of the Brazilian economy;

 

·interest rates and monetary policies;

 

·exchange rates and currency fluctuations;

 

·inflation;

 

·liquidity of the domestic capital and lending markets;

 

·import and export controls;

 

·exchange controls and restrictions on remittances abroad;

 

·modifications to laws and regulations according to political, social and economic interests;

 

·fiscal policy and changes in tax laws;

 

·economic, political and social instability;

 

·labor and social security regulations;

 

·energy and water shortages and rationing;

 

·commodity prices, including prices of paper and ink;

 

·changes in demographics, in particular declining birth rates, which will result in a decrease in the number of enrolled students in primary and secondary education in the future; and

 

·other political, diplomatic, social and economic developments in or affecting Brazil.

 

Uncertainty over whether the Brazilian federal government will implement changes in policy or regulation affecting these or other factors in the future may affect economic performance and contribute to economic uncertainty in Brazil, which may have an adverse effect on our activities and consequently our operating results, and may also adversely affect the trading price of our Class A common shares. Recent economic and political instability has led to a negative perception of the Brazilian economy and higher volatility in the Brazilian securities markets, which also may adversely affect us and our Class A common shares. See “Item 5. Operating and Financial Review and Prospects—A. Operating results —Brazilian Macroeconomic Environment.”

 

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The ongoing economic uncertainty and political instability in Brazil may harm us and the price of our Class A common shares.

 

Brazil’s political environment has historically influenced, and continues to influence, the performance of the country’s economy. Political crises have affected and continue to affect the confidence of investors and the general public, which have historically resulted in economic deceleration and heightened volatility in the securities offered by companies with significant operations in Brazil.

 

The recent economic instability in Brazil has contributed to a decline in market confidence in the Brazilian economy as well as to a deteriorating political environment, and weak macroeconomic conditions in Brazil are expected to continue. In addition, various ongoing investigations into allegations of money laundering and corruption being conducted by the Office of the Brazilian Federal Prosecutor, including the largest such investigation, known as “Operação Lava Jato”, have negatively impacted the Brazilian economy and political environment. In August 2016, the Brazilian Senate approved the removal of Dilma Rousseff, Brazil’s then-President, from office, following a legal and administrative impeachment process for infringing budgetary laws. Michel Temer, the former Vice-President, who had previously assumed the interim presidency of Brazil in a caretaker capacity since the former President’s suspension in May, was sworn in by the Brazilian Senate to serve out the remainder of the presidential term which ended in December 2018. Presidential elections took place in October 2018, and the election of Jair Bolsonaro as president could significantly change the course of the ongoing fiscal reforms and the economic policies being undertaken. Uncertainty about the new president’s ability to adoption and implement new policies may reduce investor and market confidence, and as a result we are unable to predict the country’s political and economic direction in coming years.

 

The potential outcome of these investigations is uncertain, but they have already had an adverse impact on the image and reputation of the implicated companies, and on the general market perception of the Brazilian economy. We cannot predict whether the ongoing investigations will result in further political and economic instability, or if new allegations against government officials and/or executives of private companies will arise in the future.

 

In addition, political demonstrations in Brazil over the last few years have affected the development of the Brazilian economy and investors’ perceptions of Brazil. For example, street protests, which started in mid-2013 and continued through 2016, demonstrated the public’s dissatisfaction with the worsening Brazilian economic condition (including an increase in inflation and fuel prices as well as rising unemployment), and the perception of widespread corruption. Moreover, in October 2018, elections were held in Brazil for the following public offices: members of the federal house of representatives, members of the state houses of representatives, two-thirds of the senators, governors and the presidency, in which Jair Bolsonaro was elected president. Jair Bolsonaro began his term at the beginning of 2019. Furthermore, uncertainty over whether the acting Brazilian government will implement changes in policy or regulation in the future may contribute to economic uncertainty in Brazil and to heightened volatility in the securities offered by companies with significant operations in Brazil. We cannot predict which policies the new president of Brazil may adopt or change during his mandate or the effect that any such policies might have on our business and on the Brazilian economy. Any such new policies or changes to current policies may have a material adverse effect on us or the price of our Class A common shares.

 

Any of the above factors may create additional political uncertainty, which could harm the Brazilian economy and, consequently, our business and the price of our Class A common shares.

 

Inflation and certain measures by the Brazilian government to curb inflation have historically harmed the Brazilian economy and Brazilian capital markets, and high levels of inflation in the future would harm our business and the price of our Class A common shares.

 

In the past, Brazil has experienced extremely high rates of inflation. Inflation and some of the measures taken by the Brazilian government in an attempt to curb inflation have had significant negative effects on the Brazilian economy generally. Inflation, policies adopted to curb inflationary pressures and uncertainties regarding possible future governmental intervention have contributed to economic uncertainty and heightened volatility in the Brazilian capital markets.

 

According to the National Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo), or IPCA, which is published by the IBGE, Brazilian inflation rates were 3.75%, 2.9% and 6.3% in 2018, 2017 and

 

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2016, respectively. Brazil may experience high levels of inflation in the future and inflationary pressures may lead to the Brazilian government’s intervening in the economy and introducing policies that could harm our business and the price of our Class A common shares. In the past, the Brazilian government’s interventions included the maintenance of a restrictive monetary policy with high interest rates that restricted credit availability and reduced economic growth, causing volatility in interest rates. For example, the official interest rate in Brazil oscillated from 13.75% as of December 31, 2016 to 6.50% as of December 31, 2018, as established by the Monetary Policy Committee (Comitê de Política Monetária do Banco Central do Brasil—COPOM). On February 7, 2018, the Monetary Policy Committee reduced the SELIC rate to 6.75% and further reduced the SELIC rate to 6.50% on March 21, 2018. The Monetary Policy Committee reconfirmed the SELIC rate of 6.50% on May 16, 2018 and subsequently on June 20, 2018. Conversely, more lenient government and Central Bank policies and interest rate decreases have triggered and may continue to trigger increases in inflation, and, consequently, growth volatility and the need for sudden and significant interest rate increases, which could negatively affect us and increase our indebtedness.

 

Exchange rate instability may have adverse effects on the Brazilian economy, us and the price of our Class A common shares.

 

The Brazilian currency has been historically volatile and has been devalued frequently over the past three decades. Throughout this period, the Brazilian government has implemented various economic plans and used various exchange rate policies, including sudden devaluations, periodic mini-devaluations (during which the frequency of adjustments has ranged from daily to monthly), exchange controls, dual exchange rate markets and a floating exchange rate system. Although long-term depreciation of the real is generally linked to the rate of inflation in Brazil, depreciation of the real occurring over shorter periods of time has resulted in significant variations in the exchange rate between the real, the U.S. dollar and other currencies. The real depreciated against the U.S. dollar by 47.0% at year-end 2015 as compared to year-end 2014, and by 13.4% at year-end 2014 as compared to year-end 2013. The real/U.S. dollar exchange rate reported by the Central Bank was R$3.9048 per U.S. dollar on December 31, 2015 and R$3.2591 per U.S. dollar on December 31, 2016, which reflected a 16.5% appreciation in the real against the U.S. dollar during 2016. The real/U.S. dollar exchange rate reported by the Central Bank was R$3.308 per U.S. dollar on December 31, 2017, which reflected a 1.5% depreciation in the real against the U.S. dollar during 2017. The real/U.S. dollar exchange rate reported by the Central Bank was R$3.8748 per U.S.$1.00 on December 31, 2018, which reflected a 17.1% depreciation in the real against the U.S. dollar during 2017. There can be no assurance that the real will not again depreciate against the U.S. dollar or other currencies in the future.

 

A devaluation of the real relative to the U.S. dollar could create inflationary pressures in Brazil and cause the Brazilian government to, among other measures, increase interest rates. Any depreciation of the real may generally restrict access to the international capital markets. It would also reduce the U.S. dollar value of our results of operations. Restrictive macroeconomic policies could reduce the stability of the Brazilian economy and harm our results of operations and profitability. In addition, domestic and international reactions to restrictive economic policies could have a negative impact on the Brazilian economy. These policies and any reactions to them may harm us by curtailing access to foreign financial markets and prompting further government intervention. A devaluation of the real relative to the U.S. dollar may also, as in the context of the current economic slowdown, decrease consumer spending, increase deflationary pressures and reduce economic growth.

 

On the other hand, an appreciation of the real relative to the U.S. dollar and other foreign currencies may deteriorate the Brazilian foreign exchange current accounts. We and certain of our suppliers purchase goods and services from countries outside Brazil, and thus changes in the value of the U.S. dollar compared to other currencies may affect the costs of goods and services that we purchase. Depending on the circumstances, either devaluation or appreciation of the real relative to the U.S. dollar and other foreign currencies could restrict the growth of the Brazilian economy, as well as our business, results of operations and profitability.

 

Infrastructure and workforce deficiency in Brazil may impact economic growth and have a material adverse effect on us.

 

Our performance depends on the overall health and growth of the Brazilian economy. Brazilian GDP growth has fluctuated over the past few years, with growth of 3.0% in 2013 but decreasing to 0.5% in 2014, a contraction of 3.8% in 2015, a contraction of 3.6% in 2016, growth of 1.0% in 2017 and a growth of 1.1% in 2018. Growth is limited by inadequate infrastructure, including potential energy shortages and deficient transportation, logistics and telecommunication sectors, the lack of a qualified labor force, and the lack of private and public investments in these areas, which limit productivity and efficiency. Any of these factors could lead to labor market volatility and generally impact income, purchasing power and consumption levels, which could limit growth and ultimately have a material adverse effect on us.

 

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Developments and the perceptions of risks in other countries, including other emerging markets, the United States and Europe, may harm the Brazilian economy and the price of our Class A common shares.

 

The market for securities offered by companies with significant operations in Brazil is influenced by economic and market conditions in Brazil and, to varying degrees, market conditions in other Latin American and emerging markets, as well as the United States, Europe and other countries. To the extent the conditions of the global markets or economy deteriorate, the business of companies with significant operations in Brazil may be harmed. The weakness in the global economy has been marked by, among other adverse factors, lower levels of consumer and corporate confidence, decreased business investment and consumer spending, increased unemployment, reduced income and asset values in many areas, reduction of China’s growth rate, currency volatility and limited availability of credit and access to capital. Developments or economic conditions in other emerging market countries have at times significantly affected the availability of credit to companies with significant operations in Brazil and resulted in considerable outflows of funds from Brazil, decreasing the amount of foreign investments in Brazil.

 

Crises and political instability in other emerging market countries, the United States, Europe or other countries could decrease investor demand for securities offered by companies with significant operations in Brazil, such as our Class A common shares. In June 2016, the United Kingdom had a referendum in which the majority voted to leave the European Union. We have no control over and cannot predict the effect of the United Kingdom’s exit from the European Union nor over whether and to which effect any other member state will decide to exit the European Union in the future. On January 20, 2017, Donald Trump became the President of the United States. We have no control over and cannot predict the effect of Donald Trump’s administration or policies. These developments, as well as potential crises and forms of political instability arising therefrom or any other as of yet unforeseen development, may harm our business and the price of our Class A common shares.

 

Any further downgrading of Brazil’s credit rating could reduce the trading price of our Class A common shares.

 

We may be harmed by investors’ perceptions of risks related to Brazil’s sovereign debt credit rating. Rating agencies regularly evaluate Brazil and its sovereign ratings, which are based on a number of factors including macroeconomic trends, fiscal and budgetary conditions, indebtedness metrics and the perspective of changes in any of these factors.

 

The rating agencies began to review Brazil’s sovereign credit rating in September 2015. Subsequently, the three major rating agencies downgraded Brazil’s investment-grade status:

 

·Standard & Poor’s initially downgraded Brazil’s credit rating from BBB-negative to BB-positive and subsequently downgraded it again from BB-positive to BB, maintaining its negative outlook, citing a worse credit situation since the first downgrade. On January 11, 2018, Standard & Poor’s further downgraded Brazil’s credit rating from BB to BB-negative.

 

·In December 2015, Moody’s placed Brazil’s Baa3’s issue and bond ratings under review for downgrade and subsequently downgraded the issue and bond ratings to below investment grade, at Ba2 with a negative outlook, citing the prospect of a further deterioration in Brazil’s debt indicators, taking into account the low growth environment and the challenging political scenario. In April 2018, Moody’s maintained Brazil’s credit rating at Ba2 but revised outlook from negative to stable, which it maintained in September 2018, citing expectations of further cuts to government spending.

 

·Fitch initially downgraded Brazil’s sovereign credit rating to BB-positive with a negative outlook in December 2015, citing the rapid expansion of the country’s rapidly expanding budget deficit and the worse-than-expected recession and subsequently downgraded it to BB with a negative outlook in May 2016. In February 2018, Fitch downgraded Brazil’s sovereign credit rating again to BB-negative, citing, among other reasons, fiscal deficits, the increasing burden of public debt and an inability to implement reforms that would structurally improve Brazil’s public finances. Brazil’s sovereign credit rating is currently rated below investment grade by the three main credit rating agencies. Consequently the prices of securities offered by companies with significant operations in Brazil have been negatively affected.

 

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The full consequences of a credit rating downgrade are inherently uncertain, as they depend upon numerous dynamic, complex and inter-related factors and assumptions, including market conditions at the time of any downgrade. A prolongation or worsening of the current Brazilian recession and continued political uncertainty, among other factors, could lead to further ratings downgrades. We cannot assure you that the rating agencies will maintain their current ratings or outlooks, and such changes could increase our funding costs and adversely affect our results of operations. Any further downgrade of Brazil’s sovereign credit ratings could heighten investors’ perception of risk and, as a result, cause the trading price of our Class A common shares to decline.

 

Certain Factors Relating to Our Class A Common Shares

 

The Founding Shareholders, our largest group of shareholders, own 100% of our outstanding Class B common shares, which represents 92.4% of the voting power of our issued share capital, and will control all matters requiring shareholder approval. This concentration of ownership and voting power limits your ability to influence corporate matters.

 

As of December 31, 2018, the Founding Shareholders control our company and do not hold any of our Class A common shares, but beneficially own 54.8% of our issued share capital through their beneficial ownership of all of our outstanding Class B common shares, and consequently, 92.4% of the combined voting power of our issued share capital. Our Class B common shares are entitled to 10 votes per share and our Class A common shares, which are publicly traded, are entitled to one vote per share. Our Class B common shares are convertible into an equivalent number of Class A common shares and generally convert into Class A common shares upon transfer subject to limited exceptions. As a result, the Founding Shareholders will control the outcome of all decisions at our shareholders’ meetings, and will be able to elect a majority of the members of our board of directors. They will also be able to direct our actions in areas such as business strategy, financing, distributions, acquisitions and dispositions of assets or businesses. For example, the Founding Shareholders may cause us to make acquisitions that increase the amount of our indebtedness or outstanding Class A common shares, sell revenue-generating assets or inhibit change of control transactions that benefit other shareholders. The Founding Shareholders’ decisions on these matters may be contrary to your expectations or preferences, and they may take actions that could be contrary to your interests. They are able to prevent any other shareholders, including you, from blocking these actions. For further information regarding shareholdings in our company, see “Item 7. Major Shareholders and Related Party Transactions—A. Major shareholders.”

 

So long as the Founding Shareholders continue to beneficially own a sufficient number of Class B common shares, even if they beneficially own significantly less than 50% of our outstanding share capital, acting together, they will be able to effectively control our decisions. For example, if our Class B common shares amounted to 15% of our outstanding common shares, beneficial owners of our Class B common shares (consisting of the Founding Shareholders), would collectively control 63.8% of the voting power of our outstanding common shares. If the Founding Shareholders sell or transfer any of their Class B common shares, they will generally convert automatically into Class A common shares, subject to limited exceptions, such as transfers to affiliates, to trustees for the holder or its affiliates and certain transfers to U.S. tax exempt organizations. The fact that any Class B common shares convert into Class A common shares if the Founding Shareholders sell or transfer them means that the Founding Shareholders will in many situations continue to control a majority of the combined voting power of our outstanding share capital, due to the voting rights of any Class B common shares that they retain. However, if our Class B common shares at any time represent less than 10% of the total number of shares in the capital of the Company outstanding, the Class B common shares then outstanding will automatically convert into Class A common shares. For a description of the dual class structure, see “Item 10. Additional Information—B. Memorandum and articles of association.”

 

Our Articles of Association contain anti-takeover provisions that may discourage a third-party from acquiring us and adversely affect the rights of holders of our Class A common shares.

 

Our Articles of Association contain certain provisions that could limit the ability of others to acquire our control, including a provision that grants authority to our board of directors to establish and issue from time to time one or more series of preferred shares without action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series. These provisions could have the effect of depriving our shareholders of the opportunity to sell their shares at a premium over the prevailing market price by discouraging third parties from seeking to obtain our control in a tender offer or similar transactions.

 

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If securities or industry analysts do not publish research, or publish inaccurate or unfavorable research, about our business, the price of our Class A common shares and our trading volume could decline.

 

The trading market for our Class A common shares will depend in part on the research and reports that securities or industry analysts publish about us or our business. Securities and industry analysts do not currently, and may never, publish research on our company. If no or too few securities or industry analysts commence coverage of our company, the trading price for our Class A common shares would likely be negatively affected. In the event securities or industry analysts initiate coverage, if one or more of the analysts who cover us downgrade our Class A common shares or publish inaccurate or unfavorable research about our business, the price of our Class A common shares would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our Class A common shares could decrease, which might cause the price of our Class A common shares and trading volume to decline.

 

We do not anticipate paying any cash dividends in the foreseeable future.

 

We currently intend to retain our future earnings, if any, for the foreseeable future, to fund the operation of our business and future growth. We do not intend to pay any dividends to holders of our Class A common shares. As a result, capital appreciation in the price of our Class A common shares, if any, will be your only source of gain on an investment in our Class A common shares.

 

Our dual class capital structure means our shares will not be included in certain indices. We cannot predict the impact this may have on our share price.

 

In 2017, FTSE Russell, S&P Dow Jones and MSCI announced changes to their eligibility criteria for inclusion of shares of public companies on certain indices to exclude companies with multiple classes of shares of common stock from being added to such indices. FTSE Russell announced plans to require new constituents of its indices to have at least five percent of their voting rights in the hands of public stockholders, whereas S&P Dow Jones announced that companies with multiple share classes, such as ours, will not be eligible for inclusion in the S&P 500, S&P MidCap 400 and S&P SmallCap 600, which together make up the S&P Composite 1500. MSCI also opened public consultations on their treatment of no-vote and multi-class structures and has temporarily barred new multi-class listings from its ACWI Investable Market Index and U.S. Investable Market 2500 Index. We cannot assure you that other stock indices will not take a similar approach to FTSE Russell, S&P Dow Jones and MSCI in the future. Under the announced policies, our dual class capital structure would make us ineligible for inclusion in any of these indices and, as a result, mutual funds, exchange-traded funds and other investment vehicles that attempt to passively track these indices will not invest in our stock. These policies are new and it is unclear what effect, if any, they will have on the valuations of publicly traded companies excluded from the indices, but it is possible that they may depress these valuations compared to those of other similar companies that are included. Exclusion from indices could make our Class A common shares less attractive to investors and, as a result, the market price of our Class A common shares could be adversely affected.

 

The dual class structure of our common stock has the effect of concentrating voting control with the Founding Shareholders; this will limit or preclude your ability to influence corporate matters.

 

Each Class A common share, entitles its holder to one vote per share, and each Class B common share will entitle its holder to ten votes per share, so long as the total number of the issued and outstanding Class B common shares is at least 10% of the total number of shares outstanding. Due to the ten-to-one voting ratio between our Class B and Class A common shares, the beneficial owners of our Class B common shares (comprised of the Founding Shareholders) collectively will continue to control a majority of the combined voting power of our common shares and therefore be able to control all matters submitted to our shareholders so long as the total number of the issued and outstanding Class B common shares is at least 10% of the total number of shares outstanding.

 

In addition, our Articles of Association provide that at any time when there are Class A common shares in issue, additional Class B common shares may only be issued pursuant to (1) a share split, subdivision of shares or similar transaction or where a dividend or other distribution is paid by the issue of shares or rights to acquire shares or following capitalization of profits, (2) a merger, consolidation, or other business combination involving the issuance of Class B common shares as full or partial consideration, or (3) an issuance of Class A common shares, whereby holders of the Class B common shares are entitled to purchase a number of Class B common shares that would allow them to maintain their proportional ownership interests in Arco (following an offer by us to each holder of Class B common shares to issue to such holder, upon the same economic terms and at the same price, such number of Class B common shares as would ensure such holder may maintain a proportional ownership interest in Arco pursuant to our Articles of Association).

 

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Future transfers by holders of Class B common shares will generally result in those shares converting to Class A common shares, subject to limited exceptions, such as certain transfers effected to permitted transferees or for estate planning or charitable purposes. The conversion of Class B common shares to Class A common shares will have the effect, over time, of increasing the relative voting power of those holders of Class B common shares who retain their shares in the long term.

 

In light of the above provisions relating to the issuance of additional Class B common shares, the fact that future transfers by holders of Class B common shares will generally result in those shares converting to Class A common shares, subject to limited exceptions as provided in the Articles of Association; as well as the ten-to-one voting ratio of our Class B common shares and Class A common shares, holders of our Class B common shares will in many situations continue to maintain control of all matters requiring shareholder approval. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. For a description of our dual class structure, see “Item 10. Additional Information—B. Memorandum and articles of association—Voting Rights.”

 

We are a Cayman Islands exempted company with limited liability. The rights of our shareholders, including with respect to fiduciary duties and corporate opportunities, may be different from the rights of shareholders governed by the laws of U.S. jurisdictions.

 

We are a Cayman Islands exempted company with limited liability. Our corporate affairs are governed by our Articles of Association and by the laws of the Cayman Islands. The rights of shareholders and the responsibilities of members of our board of directors may be different from the rights of shareholders and responsibilities of directors in companies governed by the laws of U.S. jurisdictions. In particular, as a matter of Cayman Islands law, directors of a Cayman Islands company owe fiduciary duties to the company and separately a duty of care, diligence and skill to the company. Under Cayman Islands law, directors and officers owe the following fiduciary duties: (i) duty to act in good faith in what the director or officer believes to be in the best interests of the company as a whole; (ii) duty to exercise powers for the purposes for which those powers were conferred and not for a collateral purpose; (iii) directors should not properly fetter the exercise of future discretion; (iv) duty to exercise powers fairly as between different sections of shareholders; (v) duty to exercise independent judgment; and (vi) duty not to put themselves in a position in which there is a conflict between their duty to the company and their personal interests. Our Articles of Association have varied this last obligation by providing that a director must disclose the nature and extent of his or her interest in any contract or arrangement, and following such disclosure and subject to any separate requirement under applicable law or the listing rules of the Nasdaq, and unless disqualified by the chairman of the relevant meeting, such director may vote in respect of any transaction or arrangement in which he or she is interested and may be counted in the quorum at the meeting. Conversely, under Delaware corporate law, a director has a fiduciary duty to the corporation and its stockholders (made up of two components) and the director’s duties prohibits self-dealing by a director and mandates that the best interest of the corporation and its shareholders take precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the shareholders generally. See “Item. 16G Corporate Governance—Principal Differences between Cayman Islands and U.S. Corporate Law.”

 

As a foreign private issuer and an “emerging growth company” (as defined in the JOBS Act), we will have different disclosure and other requirements than U.S. domestic registrants and non-emerging growth companies.

 

As a foreign private issuer and emerging growth company, we may be subject to different disclosure and other requirements than domestic U.S. registrants and non-emerging growth companies. For example, as a foreign private issuer, in the United States, we are not subject to the same disclosure requirements as a domestic U.S. registrant under the Exchange Act, including the requirements to prepare and issue quarterly reports on Form 10-Q or to file current reports on Form 8-K upon the occurrence of specified significant events, the proxy rules applicable to domestic U.S. registrants under Section 14 of the Exchange Act or the insider reporting and short-swing profit rules applicable to domestic U.S. registrants under Section 16 of the Exchange Act. In addition, we intend to rely on exemptions from certain U.S. rules which will permit us to follow Cayman Islands legal requirements rather than certain of the requirements that are applicable to U.S. domestic registrants.

 

We will follow Cayman Islands laws and regulations that are applicable to Cayman Islands companies. However, Cayman Islands laws and regulations applicable to Cayman Islands companies do not contain any provisions comparable to the U.S. proxy rules, the U.S. rules relating to the filing of reports on Form 10-Q or 8-K or the U.S. rules relating to liability for insiders who profit from trades made in a short period of time, as referred to above.

 

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Furthermore, foreign private issuers are required to file their annual report on Form 20-F within 120 days after the end of each fiscal year, while U.S. domestic issuers that are accelerated filers are required to file their annual report on Form 10-K within 75 days after the end of each fiscal year. Foreign private issuers are also exempt from Regulation Fair Disclosure, aimed at preventing issuers from making selective disclosures of material information, although we will be subject to Cayman Islands laws and regulations having substantially the same effect as Regulation Fair Disclosure. As a result of the above, even though we are required to file reports on Form 6-K disclosing the limited information which we have made or are required to make public pursuant to Cayman Islands law, or are required to distribute to shareholders generally, and that is material to us, you may not receive information of the same type or amount that is required to be disclosed to shareholders of a U.S. company.

 

The JOBS Act contains provisions that, among other things, relax certain reporting requirements for emerging growth companies. Under this act, as an emerging growth company, we will not be subject to the same disclosure and financial reporting requirements as non-emerging growth companies. For example, as an emerging growth company we are permitted to, and intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. Also, we will not have to comply with future audit rules promulgated by the U.S. Public Company Accounting Oversight Board, or PCAOB, (unless the SEC determines otherwise) and our auditors will not need to attest to our internal controls under Section 404(b) of the Sarbanes-Oxley Act. We may follow these reporting exemptions until we are no longer an emerging growth company. As a result, our shareholders may not have access to certain information that they deem important. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of our initial public offering, (b) in which we have total annual revenues of at least US$1.07 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our Class A common shares that is held by non-affiliates exceeds US$700.0 million as of the prior June 30th, and (2) the date on which we have issued more than US$1.0 billion in non-convertible debt during the prior three-year period. Accordingly, the information about us available to you will not be the same as, and may be more limited than, the information available to shareholders of a non-emerging growth company. We could be an “emerging growth company” for up to five years, although circumstances could cause us to lose that status earlier, including if the market value of our Class A common shares held by non-affiliates exceeds $700 million as of any June 30 (the end of our second fiscal quarter) before that time, in which case we would no longer be an “emerging growth company” as of the following December 31 (our fiscal year end). We cannot predict if investors will find our Class A common shares less attractive because we may rely on these exemptions. If some investors find our Class A common shares less attractive as a result, there may be a less active trading market for our Class A common shares and the price of our Class A common shares may be more volatile.

 

As a foreign private issuer, we are permitted to, and we will, rely on exemptions from certain Nasdaq corporate governance standards applicable to U.S. issuers, including the requirement that a majority of an issuer’s directors consist of independent directors. This may afford less protection to holders of our Class A common shares.

 

Section 5605 of the Nasdaq equity rules requires listed companies to have, among other things, a majority of their board members be independent, and to have independent director oversight of executive compensation, nomination of directors and corporate governance matters. As a foreign private issuer, however, we are permitted to, and we will, follow home country practice in lieu of the above requirements. See “Item 16G Corporate Governance—Principal Differences between Cayman Islands and U.S. Corporate Law.”

 

We may lose our foreign private issuer status which would then require us to comply with the Exchange Act’s domestic reporting regime and cause us to incur significant legal, accounting and other expenses.

 

In order to maintain our current status as a foreign private issuer, either (a) more than 50% of our Class A common shares must be either directly or indirectly owned of record by non-residents of the United States or (b)(i) a majority of our executive officers or directors may not be U.S. citizens or residents, (ii) more than 50% of our assets cannot be located in the United States and (iii) our business must be administered principally outside the United States. If we lose this status, we would be required to comply with the Exchange Act reporting and other requirements applicable to U.S. domestic issuers, which are more detailed and extensive than the requirements for foreign private issuers. We may also be required to make changes in our corporate governance practices in accordance with various SEC and Nasdaq rules. The regulatory and compliance costs to us under U.S. securities laws if we are required to comply with the reporting requirements applicable to a U.S. domestic issuer may be significantly higher than the costs we will incur as a foreign private issuer.

 

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Our shareholders may face difficulties in protecting their interests because we are a Cayman Islands exempted company.

 

Our corporate affairs are governed by our Articles of Association, by the Companies Law (as amended) of the Cayman Islands and the common law of the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under the laws of the Cayman Islands are not as clearly defined as under statutes or judicial precedent in existence in jurisdictions in the United States. Therefore, you may have more difficulty protecting your interests than would shareholders of a corporation incorporated in a jurisdiction in the United States, due to the comparatively less formal nature of Cayman Islands law in this area.

 

While Cayman Islands law allows a dissenting shareholder to express the shareholder’s view that a court sanctioned reorganization of a Cayman Islands company would not provide fair value for the shareholder’s shares, Cayman Islands statutory law does not specifically provide for shareholder appraisal rights in connection with a merger or consolidation of a company. This may make it more difficult for you to assess the value of any consideration you may receive in a merger or consolidation or to require that the acquirer gives you additional consideration if you believe the consideration offered is insufficient. However, Cayman Islands statutory law provides a mechanism for a dissenting shareholder in a merger or consolidation to apply to the Grand Court for a determination of the fair value of the dissenter’s shares if it is not possible for the company and the dissenter to agree on a fair price within the time limits prescribed.

 

Shareholders of Cayman Islands exempted companies (such as us) have no general rights under Cayman Islands law to inspect corporate records and accounts or to obtain copies of lists of shareholders. Our directors have discretion under our Articles of Association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

 

Subject to limited exceptions, under Cayman Islands’ law, a minority shareholder may not bring a derivative action against the board of directors. Class actions are not recognized in the Cayman Islands, but groups of shareholders with identical interests may bring representative proceedings, which are similar.

 

United States civil liabilities and certain judgments obtained against us by our shareholders may not be enforceable.

 

We are a Cayman Islands exempted company and substantially all of our assets are located outside of the United States. In addition, the majority of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside of the United States. As a result, it may be difficult to effect service of process within the United States upon these persons. It may also be difficult to enforce in U.S. courts judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors who are not resident in the United States and the substantial majority of whose assets are located outside of the United States.

 

Further, it is unclear if original actions predicated on civil liabilities based solely upon U.S. federal securities laws are enforceable in courts outside the United States, including in the Cayman Islands and Brazil. Courts of the Cayman Islands may not, in an original action in the Cayman Islands, recognize or enforce judgments of U.S. courts predicated upon the civil liability provisions of the securities laws of the United States or any state of the United States on the grounds that such provisions are penal in nature. Although there is no statutory enforcement in the Cayman Islands of judgments obtained in the United States, courts of the Cayman Islands will recognize and enforce a foreign judgment of a court of competent jurisdiction if such judgment is final, for a liquidated sum, provided it is not in respect of taxes or a fine or penalty, is not inconsistent with a Cayman Islands’ judgment in respect of the same matters, and was not obtained in a manner which is contrary to the public policy of the Cayman Islands. In addition, a Cayman Islands court may stay proceedings if concurrent proceedings are being brought elsewhere.

 

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Judgments of Brazilian courts to enforce our obligations with respect to our Class A common shares may be payable only in reais.

 

Most of our assets are located in Brazil. If proceedings are brought in the courts of Brazil seeking to enforce our obligations in respect of our Class A common shares, we may not be required to discharge our obligations in a currency other than the real. Under Brazilian exchange control laws, an obligation in Brazil to pay amounts denominated in a currency other than the real may only be satisfied in Brazilian currency at the exchange rate, as determined by the Central Bank, in effect on the date the judgment is obtained, and such amounts are then adjusted to reflect exchange rate variations through the effective payment date. The then-prevailing exchange rate may not afford non-Brazilian investors with full compensation for any claim arising out of or related to our obligations under the Class A common shares.

 

Our Class A common shares may not be a suitable investment for all investors, as investment in our Class A common shares presents risks and the possibility of financial losses.

 

The investment in our Class A common shares is subject to risks. Investors who wish to invest in our Class A common shares are thus subject to asset losses, including loss of the entire value of their investment, as well as other risks, including those related to our Class A common shares, us, the sector in which we operate, our shareholders and the general macroeconomic environment in Brazil, among other risks.

 

Each potential investor in our Class A common shares must therefore determine the suitability of that investment in light of its own circumstances. In particular, each potential investor should:

 

·have sufficient knowledge and experience to make a meaningful evaluation of our Class A common shares, the merits and risks of investing in our Class A common shares and the information contained in this annual report;

 

·have access to, and knowledge of, appropriate analytical tools to evaluate, in the context of its particular financial situation, an investment in our Class A common shares and the impact our Class A common shares will have on its overall investment portfolio;

 

·have sufficient financial resources and liquidity to bear all of the risks of an investment in our Class A common shares;

 

·understand thoroughly the terms of our Class A common shares and be familiar with the behavior of any relevant indices and financial markets; and

 

·be able to evaluate (either alone or with the help of a financial adviser) possible scenarios for economic, interest rate and other factors that may affect its investment and its ability to bear the applicable risks.

 

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ITEM 4. INFORMATION ON THE COMPANY

 

A.History and development of the company

 

We were founded in 2004. However, our history goes back to 1941, when the grandfather of our CEO and founder, Ari de Sá Cavalcante Neto, acquired a small school in downtown Fortaleza. Over decades, the school grew into a large educational group with several branches providing K-12 education to over 7,000 students becoming recognized by its quality nationally and for successfully preparing students for the most rigorous national and international college admission exams for admission into institutions such as Massachusetts Institute and Technology, Stanford University and Princeton University, and national and international science competitions such as the International Physics Olympiad (IPhO), the International Mathematical Olympiad (IMO) and the International Chemistry Olympiad (IChO).

 

 

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Colégio Ari de Sá developed a proprietary educational methodology aimed at improving student academic performance. The methodology is based on instilling discipline and a culture of hard work, stimulating students to develop a study routine and to demonstrate a proactive and considerate attitude toward their learning habits.

 

In 2004, our CEO and founder, Ari de Sá Cavalcante Neto, decided to start an independent company exclusively focused on content and technology for K-12 schools, SAS. The SAS method was created with the aim of offering it as a solution to private schools across Brazil. Our system uses technology as a powerful tool to promote improvements in student performance. This is achieved, in part, by allowing students to prepare for class in advance by using our platform’s video lessons, homework tools and daily class reviews, as well as our practical workbooks with class-specific content, homework and performance reports. The SAS method is based

 

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on the concept of personalized and adaptive learning, aimed at providing tailored education to each student according to his or her individual needs, with concentration on the main areas in need of improvement, which manifests in higher levels of academic achievement.

 

Since 2015, we have been investing in technology and our printed methodology has evolved into an educational platform capable of delivering its curriculum content in both printed and digital format. It has also evolved into a robust omni-channel platform, capable of delivering the entire K-12 curriculum in both printed and digital format, with lecturettes featuring expert, on-screen teachers and tailored assignments and assessments to engage students and ensure subject-area mastery across all grades.

 

With this integrated approach, students can track their progress and performance, teachers have access to real-time data to evaluate students and personalize their teaching, and school administrators have access to their school’s performance both on absolute and comparative terms.

 

Since our founding through 2019, we have achieved a compound annual growth rate, or CAGR (defined as the compounded average annual rate of growth between two periods) of 48% in terms of number of students, as shown in the chart below.

 

 

 

With an asset-light and highly scalable business model that emphasizes operating efficiency and profitability, we were able to grow the number of students served at a 48% CAGR since 2006, reaching a total of 498,553 students served in 2019, combining organic growth, strategic investments and acquisitions to grow our K-12 education exposure. These initiatives have helped us identify new business potential to enhance our overall growth prospects, such as education IT systems (WPensar), supplemental instruction content (International School) and digital-native content platform (Geekie).

 

On September 25, 2018, the registration Statement on Form F-1 (File No 333-7007) relating to our initial public offering of our class A common shares was declared effective by the SEC. On September 25, 2018, we commenced our initial public offering. On September 28, 2018 we closed our initial public offering, pursuant to which we issued and sold 12,777,777 Class A common shares for an aggregate price of US$223,611,098 (R$895.2 million).

 

Following a decade of growth, and our initial public offering in 2018, we are excited about the future and how technological advances can impact education. We believe that students are increasingly looking for modern, dynamic and client oriented educational platforms and that our tech-enabled approach is positioned to deliver a variety of content and provide a new learning experience that is more effective, personal, engaging and enjoyable.

 

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Acquisitions

 

In December 2016, we acquired a 6.54% interest in Geekie, an entity that provides technology for adaptive assessment and learning products and engages in the production, development and licensing of software tailored to the specific requirements of education sector customers. Pursuant to the share purchase agreement dated as of December 8, 2016, as part of our acquisition of our initial 6.54% interest in the share capital of Geekie, we contracted for put and call options to acquire the remaining 93.46% of the outstanding share capital of Geekie in May 2022. On July 3, 2018, we acquired an additional 1.51% interest in the share capital of Geekie, increasing our total interest to 8.05%. For further information, see note 11 to our audited consolidated financial statements.

 

In June 2016, we acquired a 70% interest in the share capital of SAE. In October 2017, we acquired the remaining 30% in the share capital of SAE. As of December 31, 2018, we held a 100% interest in the share capital of SAE.

 

In December 2015, we acquired a 40% interest in the share capital of International School. In January 2017, we acquired an additional 11.48% interest in the share capital of International School. As of December 31, 2018, we held a 51.48% controlling interest in the share capital of International School. Pursuant to an investment agreement between EAS Brazil and the seller, as part of our acquisition of our current 51.48% interest in the share capital of International School, we contracted for put and call options to acquire (i) a further 25% of the outstanding share capital of International School between January 1, 2020 and April 30, 2020, and (ii) the remaining 23.52% of the outstanding share capital of International School between January 1, 2021 and April 30, 2021, in each case at a purchase price to be calculated based on the EBITDA of International School. To the extent EAS Brazil approves its IPO, the seller’s option is accelerated and becomes exercisable at any time and the seller may, at its discretion, require us to acquire the remaining 48.52% interest in the share capital of International School. We have estimated the impact of this obligation in our consolidated financial statements based on the most liquid option, which assumes that the full amount is paid in cash. The seller may, at its discretion, require us to pay the purchase price either (i) in cash, or (ii) in cash, with up to 50% of the purchase price with EAS Brazil shares calculated according to the same EBITDA multiple, which could result in a materially different accrued liability. For further information, see note 4 to our audited consolidated financial statements.

 

In April 2015, we acquired a 99.99% interest in Editora e Livraria Alegre POA Ltda., a content provider to upper and middle income private schools in Brazil. In June 2015, we acquired a 99.99% interest in Material Didático Desterro Ltda., a content provider to upper and middle income private schools in Brazil. In September 2017, we acquired a 100% interest in NS Educação Ltda., or NS Educação. NS Educação is an educational content provider to middle class private schools in Brazil.

 

In April 2015, we acquired a 25% interest in WPensar, a company that develops and licenses school management systems software. Pursuant to the shareholder agreement entered into in connection with the acquisition, we have an option to acquire the remaining 75% of the outstanding share capital of WPensar between July 10, 2020 and July 10, 2021, and the sellers have a put option that requires us to acquire such outstanding share capital between July 10, 2021 and July 10, 2022. To the extent these options are exercised, the seller may, at its discretion, require us to pay up to 50% of the purchase price with EAS Brazil shares. For further information, see note 11 to our audited consolidated financial statements.

 

Corporate Information

 

Our principal executive offices are located at Rua Augusta 2840, 9th floor, suite 91, Consolação, São Paulo—SP, 01.305-000 , Brazil. Our telephone number at this address is +55 (11) 3047-2699

 

Investors should contact us for any inquiries through the address and telephone number of our principal executive office. Our principal website is www.arcoeducacao.com.br. The information contained in, or accessible through, our website is not incorporated into this annual report.

 

B.Business Overview

 

Our mission is to transform the way students learn by delivering high-quality education at scale through technology to private K-12 schools.

 

We provide a complete pedagogical system with technology-enabled features to deliver educational content to private schools in Brazil. Our turnkey curriculum solutions provide educational content in both printed and digital formats delivered through our platform to improve the learning process.

 

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Our network as of February 25, 2019 consisted of 1,462 partner schools, compared to 1,140 schools as of March 31, 2018, 835 schools as of March 31, 2017 and 667 schools as of March 31, 2016, representing annual growth rates of 28.2%, 36.5% and 25.2%, respectively. We had 498,553 enrolled students across all Brazilian states as of March 2019, compared to 405,814 enrolled students as of March 31, 2018, 322,031 as of March 31, 2017 and 265,354 as of March 31, 2016, representing annual growth rates of 22.9%, 26.0% and 21.4%, respectively.

 

We have an asset-light, highly-scalable business model that emphasizes operational efficiency and profitability. We operate through long-term service contracts with private schools. These contracts generally have initial terms that average three years, pursuant to which we provide educational content in printed and digital format to private schools. Our revenue is driven by the number of enrolled students at each customer using the solutions and the agreed price per student per year, all in accordance with the terms and conditions set forth in each contract. As a result, we benefit from high visibility in our net revenue and operating margin, which we calculate by dividing our operating profit by net revenue over a given period.

 

Our business model has allowed us to grow and achieve profitability since our founding. Our net revenue totaled R$381.0 million, R$244.4 million, and R$159.3 million in 2018, 2017 and 2016, respectively, representing annual growth rates of 55.9% and 53.4% in 2018 and 2017, respectively. We generated operating profit of R$62.1 million, R$74.9 million and R$48.6 million in 2018, 2017 and 2016, respectively. We had a loss of R$82.9 million in 2018, and profit of R$43.6 million and R$74.4 million in 2017 and 2016, respectively. Our partner school base is highly diversified, which reduces our dependence on a concentrated number of large clients. Our 10 largest clients represented only 9.6% and 12.0% of our net revenue in 2018 and 2017, respectively.

 

We believe that the quality of our platform, together with the credibility of our client base and the strong reputation of our brand, has driven our significant growth, allowing us to quickly and efficiently expand our footprint in Brazil since our founding. As of December 31, 2017, 183 (or 16%) of our partner schools ranked as one of the top three schools of their respective cities, according to the ENEM, the principal national standardized test for university entrance in Brazil.

 

Context

 

The 21st century has been characterized by rapid and accelerating technological innovation, with students at the forefront of the adoption of new technologies. We believe that we can deliver a more effective, personal, engaging, and enjoyable learning experience for students by combining high-quality proprietary content and software applications in our simple, integrated, and personalized educational platform. We aim to move beyond traditional educational models used by schools by empowering educators, school administrators and students to achieve their highest potential through our educational platform.

 

We founded our company with the aim of creating high-quality products that simplify learning and make the education process more efficient. Traditionally, school administrators required a multitude of vendors for developing content, engaging in teacher training, commercializing and managing K-12 education. Simultaneously, students acquired educational content through textbooks from various publishers across retail channels. Our platform aims to replace this multitude of third-party educational providers with a streamlined, one-stop solution that delivers high quality education at scale.

 

Our Core Curriculum and Supplemental Solutions enable students, teachers and school administrators to have access to engaging and easy-to-use resources that propel academic success and meet students’ diverse learning needs. Pairing our printed and digital curriculum with real-time data and teacher-led learning allows us to personalize learning at the individual level, improving both individual student and aggregate school performance.

 

We develop our educational content using a model based on extensive research and performance-based standards. We combine printed and digital content with online lecturettes featuring expert, on-screen teachers and tailored assignments and assessments to engage students and help them master their subject areas. With this integrated approach, students can track their progress and performance, teachers can access real-time data to evaluate students and personalize their teaching, and school administrators can better manage their school’s performance both on absolute and comparative terms.

 

The increase in internet penetration and the rapid increase in the use of mobile devices and cloud-based services is broadening access to educational content and services and expanding the potential reach of educational institutions. Our platform does not require our partner schools to make any significant capital expenditures or setup investments, and is compatible with most mainstream computing platforms (including tablets and mobile phones). Our solutions are designed to be highly interactive and enjoyable, which we believe results in enhanced educational outcomes when compared to traditional models.

 

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Underlying Trends

 

We believe that the strength of our business and our growth prospects is supported by strong underlying market and industry trends, including:

 

Demand for quality education is driving a shift from public to private K-12 education

 

A wide gap in education quality exists between public and private K-12 institutions in Brazil, and within the private school market itself. Test performance is significantly better in private primary and secondary education, as illustrated by the average quality index differential of the primary and IDEB. As of December 31, 2015, private K-12 education schools had an average education quality index score 41% higher than that of public primary and secondary schools across all school years according to the IDEB quality index differential. As a result, over the last eight years, student enrollments in private K-12 institutions have increased 15.9%, from 6.9 million in 2010 to 8.0 million in 2018.

 

Technological innovation is driving enhancements in private K-12 education

 

In a 2018 survey conducted by FGV, the number of smartphones in Brazil was expected to reach 220 million by April 2018, or approximately one smartphone device per Brazilian. Brazil is a mass adopter of disruptive technological innovations in a number of areas and it is the second largest market for Waze®, the digital traffic map application for Android® and iOS®, with São Paulo serving as its largest city in terms of number of users worldwide, according to an October 2016 article in Valor, a Brazilian financial newspaper. Brazil is also the second largest market in the world for Instagram® in terms of number of users according to a March 2018 article in VentureBeat, an online technology news source, and one the most popular destinations for Airbnb® with Rio de Janeiro ranking fourth behind Paris, London and New York City, according to a March 2016 article in O Globo, a Brazilian newspaper.

 

We believe that this digital transition can confer significant benefits on, and opportunities for, education service and content providers, such as:

 

·revenue diversification, as technological developments in education platforms, such as new tools or capabilities, may be sold for different purposes and to different consumers;

 

·customization enabled by technology and tied to a soft adaptation, which allows for distribution to different customers and a scaling by companies that offer different solutions; and

 

·margin gains, given a lower cost per student and a larger consumer base that is accessible through technological developments.

 

Technology has created opportunities to make learning more affordable, accessible, flexible, personal and effective. Classroom instruction and delivery models are changing and are likely to have a substantial impact on the industry.

 

Schools shifting resources towards digital educational solutions

 

Education platforms have emerged in private K-12 education to improve teaching and learning by enabling educational materials and tools used by teachers and students (such as content, multimedia materials, teaching materials, class preparation guides, performance evaluation of students and schools, teacher training and others), to be customized for each student’s learning experience.

 

Teacher advocacy plays a major role in the penetration of educational solutions and digital materials across private K-12 schools. A 2009 study conducted by Fundação Lemann, Instituto Paulo Montenegro and the IBOPE showed that 92% of the teachers interviewed supported the availability of quality digital learning materials, including games, videos, exercises and websites, as well as adequate training focused on the use of technology applied to learning.

 

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Importance of K-12 performance in university admissions process

 

The best higher education institutions in Brazil are public, with a highly competitive admissions process based largely on challenging standardized admissions exams. According to Oliver Wyman, 49 out of the 60 top-ranked universities in Brazil were public as of December 31, 2016. In recent years, competition for admission into public universities has increased, a trend driven both by greater student demand and a decrease in the number of available seats. In 2012, there were on average 11 applicants per available seat in public universities, as compared to 14 applicants in 2016, according to Oliver Wyman, while the number of public university seats decreased by 6.3% from 2012 to 2016. As a result of this competition, parents are increasingly focused on schools that over-perform in the standardized university admissions tests. According to a 2017 study by the IBOPE, education is the number one spending priority for Brazilian families. Our solution is designed to enhance our students’ ability to perform on these exams.

 

Expansion of school hours and after-school programs including, but not limited to ESL bilingual programs

 

The increased focus on education has led to an increase in the length of the average school day. After-school education, comprised of tutoring, language courses and robotics, among other extra-curricular activities, is also becoming more popular, offering a variety of training and learning programs in which students can participate according to their personal interests and preferences. Language courses are among the most popular after-school activities and represent an area with significant room for growth, primarily as a result of:

 

·the increasing relevance of languages, especially English, in a globalized context;

 

·the low English proficiency level in Brazil; and

 

·the emphasis in language classes currently offered by K-12 schools on reading and written communication, despite the fact that the labor market relies more heavily on oral communication (which also creates a market for bilingual schools).

 

For many parents, after-school education is considered a lifeline that helps them work without worry and balance their schedules, given (i) that Brazil has one of the highest average working hours per week in the world, and (ii) the increased participation of women in the workforce. In addition, an increase in disposable income has increased demand for private education and after-school programs, and parent expectations for their children’s education are high considering the strong competition to gain admission into top public universities. Accordingly, after-school education represents a growing opportunity for private institutions. This is especially the case given the wide variety of supplemental solutions that can be offered to students during after-school hours.

 

Obsolescence of traditional content distribution models

 

We believe that traditional content distribution models are becoming obsolete. Traditional educational publishers are almost exclusively focused on physical textbooks, which they sell through retailers rather than directly to schools. These traditional suppliers have limited capability to develop and offer integrated digital solutions to schools, teachers and students, and typically rely on third-party authors, illustrators and graphic designers to develop new content. In contrast, because of our robust technology backbone, use of data and strong relationships with teachers and administrators, we can offer a comprehensive solution and content that is continuously updated and improved.

 

Limited and unintegrated product offering

 

Due to the lack of turnkey education solutions, school administrators often rely on a multitude of third-party vendors for K-12 educational content, teacher training, student testing, management and communication tools.

 

Traditional education providers have struggled to develop mission critical education platforms for several reasons, including the significant costs associated with the development of content and technologies, as well as the lack of extensive in-house technological expertise. In addition, developing a comprehensive and effective methodology is difficult to achieve since it requires many years of proven educational experience and a successful track record.

 

We are able to replace a multitude of third-party educational vendors with a streamlined and consolidated solution, offering a one-stop shop that delivers enhanced learning across the educational spectrum.

 

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Our Market Opportunity

 

According to Oliver Wyman, the existing addressable market in Brazil for core curriculum solutions and supplemental English language learning is approximately R$12.1 billion in sales revenues as of April 2018, of which we currently capture approximately 3.1% based on our net revenues for the year ended December 31, 2018. However, we believe that our total addressable market is larger and includes all education solutions purchased by students in private schools in Brazil. We can address this larger market by launching new solutions and entering new categories.

 

We benefit from structural differences in our market, when compared to the education markets in the United States and Europe. Private schools in Brazil are generally for-profit institutions, and the private education market in Brazil is large and highly fragmented, primarily a result of lower overall levels of government funding for K-12 public education. As of December 31, 2018, approximately 8.0 million students were enrolled in approximately 37,985 private schools (17% of the total number of K-12 students in Brazil), according to the INEP and the IBGE. In addition, the national curriculum set by the Ministry of Education requires standardized content across Brazilian schools, which helps create demand for a unified curriculum. Finally, teachers’ unions in Brazil are relatively less influential than their counterparts in the United States and Europe, where such unions often serve as obstacles to the adoption of innovations.

 

We believe that the challenges inherent in the traditional content distribution model, coupled with increasing demand for modern content and integrated value-added services, present a unique market opportunity for our business. By providing an affordable, modern and efficient platform, we believe that we can continue to disrupt the Brazilian education market and increase our penetration into current and new markets.

 

The Arco Way

 

We believe that by combining our platform, our ability to innovate and our corporate culture, we can help create value for our partner schools and competitive advantages for our business.

 

 

 

Our Business Model

 

Our B2B2C model is financially aligned with our partner schools. Our revenues consist of wholesale content fees paid by our partner schools annually on a per-student, per-year basis. On average, partner schools charge students’ parents an incremental markup on top of our wholesale fees, ensuring that their incentives are aligned with ours. Accordingly, we provide a supplemental revenue stream to our partner schools through our B2B2C model, which is a feature that the traditional education model does not employ. Once schools adopt our platform for a particular class year, access to, and payment for, our platform becomes mandatory for all enrolled students in each class year, and such payments are charged as a supplement to tuition. Typically, we revise our contract fees annually, in line with our price-setting policies which are usually above published inflation indices, to account for changes in our cost and expenses structure and for improvements in our platform.

 

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The following chart illustrates our business-to-business-to-consumer model:

 

 

Long-term contracts, high retention rates and high financial predictability. Our three-year standard contract provides a revenue stream with long-term cash flow visibility. We have a lead time (which we define as the period from the moment of first contact to the execution of a contract) for the acquisition of new partner schools, and we typically enter into contracts with new partner schools within one year from the moment of first contact. Once our content is adopted, switching costs (which are the costs that schools incur as a result of switching to our platform) and time associated with updating the teaching curriculum for each class year work to our advantage.

 

Asset-light and scalable business model, with high operating leverage and limited capex requirements. By outsourcing distribution activities to third parties and developing standard solutions, we have an asset-light and scalable business model that enables us to quickly expand our customer base with low associated expenses and capital expenditures. This allows us to increasingly expand our margins as we grow the number of students we serve, while generating cash to fund the development of new products and features, as well as identify acquisitions and strategic investments.

 

Our platform is difficult to replicate. We have continuously developed our platform since our founding, with the benefit of over 50 years of an evolving educational methodology and a dedicated team of education specialists focused on developing and improving our Core Curriculum and Supplemental Solutions materials. Accordingly, we believe that the depth of our educational content and the technological experience necessary to develop our products makes our platform difficult to replicate.

 

Our Solutions

 

In the education sector, we believe that quality is fundamental. Our platform was developed with the benefit of over 50 years of an evolving educational methodology and robust track record of academic results. Our track record of high-performing educational outcomes motivated us to create a digital, technology-driven product that could deliver high quality education at scale.

 

We provide a complete suite of turnkey curriculum solutions and technology-enabled features to help our students, teachers, partner schools and parents, targeting our students’ educational success.

 

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Our turnkey educational platform solutions comprise core K-12 curricula, as well as supplemental instructional content currently focused on English as a second language.

 

Benefits Across Our Educational Platform

 

We deliver the following benefits to all the stakeholders engaged in the learning process:

 

·Students: We deliver a personalized, multimedia learning experience, in an omni-channel format. Students can access content in various formats, including digital, video, print, and other audiovisual media aligned with the daily curriculum of their classes. Our platform provides real-time feedback to students on areas for improvement and benchmarking relative to their peers, which enables us to simultaneously ensure that education is provided on an individual basis, and that our content is complete, up-to-date and readily available.

 

·Teachers: We offer a range of tools to help improve teacher efficiency and learning outcomes. We provide teaching plans for each class, digital content for classroom review, pre-made class videos, a test builder platform and homework correction automation tools. In addition, teachers are able to access students’ performance reports and identify which students are having difficulties in progressing in a given class at any time.

 

·Administrators: We provide a supplemental revenue stream to our partner schools. In addition, our platform provides back office administrative support, alongside data and analytics to support decision-making processes. Administrators receive student reports and are able to analyze student participation rates, detailed individual performance, an overview by area of knowledge and their schools’ national ranking. They are also able to benchmark teacher performance to optimize the effectiveness of their teaching staff.

 

·Parents: Our software brings parents closer to the education process, through an informal communication channel and the opportunity to closely monitor and engage with their children’s performance and development.

 

Our Products

 

We believe that innovation is an important part of our success. As a technology company in the education sector, we believe that our dynamic and adaptive nature is essential to our continued growth. Our product offerings are comprised of two main segments that operate in concert: (i) Core Curriculum; and (ii) Supplemental Solutions.

 

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Our Core Curriculum comprises high-quality content solutions that are designed to address the Ministry of Education’s national K-12 curriculum requirements through a personalized and interactive learning experience. Students access content in various formats, such as digital, video, print, and other audiovisual media that are aligned with the daily curriculum of their classes. Our Core Curriculum offering serves a broad range of price points, allowing us to maximize our market reach and penetration. It is offered in two different versions, consisting of (i) SAS, a premium solution focused on high-income private schools, and (ii) SAE, a basic solution focused on upper-middle income private schools.

 

SAS and SAE share certain key attributes, such as:

 

·Online homework assessment: An extensive questions and problem-solving activities database that provides additional teacher-led instructional content to help meet individual student or small student group needs. Assessments enable thorough, customized evaluations of student performance over a single lesson, over the course of a topic, or throughout the entire academic year.

 

·Adaptive learning: A personalized instruction and assessment tool delivered through our exam management portal to help students prepare for and take exams. The user-friendly reporting and ongoing progress monitoring features enable educators to pinpoint student needs down to the sub-skill level, while providing real-time feedback at the class level, school and national level. The platform also enables teachers to generate exams based on a given class profile, using a database containing a broad range of questions.

 

·Interactive learning: Leveraging the combined abilities of our pedagogical and EdTech teams, we have created augmented reality and video features throughout our materials, allowing students to point their digital devices at certain sections in our materials to view educational animations or recorded videos that provide further information on the topic in question, contributing to a more interactive and engaging learning experience.

 

·Students and teachers web portal: An online environment aggregating relevant content for students and teachers by grade in the form digital classes, exam database, assessment templates, teachers’ guides and lesson plans, exams and textbooks’ problem solving in addition to articles and general educational-related tips.

 

·In-app communication: A responsive, simple and user-friendly communication tool for partner schools, students and parents, giving them access to exam results and problem solving, video classes, student grades, as well as the school calendar and attendance records.

 

As part of our Core Curriculum, we offer complementary support services to partner schools consisting of:

 

·Back office management tools: HR tools with financial, student recruiting and administrative features.

 

·Educational consulting services to partner schools: Personalized support to ensure complete understanding and appropriate implementation of our learning platform. This includes, constant support to partner schools throughout the school year in connection with educational practices, administrative, human resources and financial aspects, development of customized students’ assessment models, organization of education congresses and pedagogical meetings, as well as parents and students counselling.

 

·Training programs for teachers and school administrators: A suite of materials to allow partner schools and teachers to assess the quality of their teaching methods and how they can improve them. This includes local, regional and national educational congresses, forums, seminars and lectures, in addition to training sessions.

 

·School marketing advisory: A comprehensive range of marketing and communication materials, events and support, including marketing brochures and recruitment campaigns.

 

Our Supplemental Solutions are comprised of additional value-added content for which partner schools can opt in as an addition to our Core Curriculum. Currently, our primary Supplemental Solutions offering is an ESL bilingual program, first offered in 2015 following our acquisition of an interest in International School. International School provides students with an internationally-oriented education, in a multi-cultural environment, based on a curriculum like the International Baccalaureate or Cambridge International Examinations. We intend to add additional, non-core supplemental educational modules to our Supplemental Solutions over time.

 

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The key attributes of our Supplemental Solutions are:

 

·Proprietary applications: Two complementary applications providing content and English-based games that form part of students’ school year collections, including a communications tool for partner schools, students and parents.

 

·Robotics: Pioneering activities that enable students to build and program their own Lego® robots as a way to maximize learning beyond the classroom experience.

 

·Combination of concrete materials and animations: Print and digital textbooks combined with interactive animations, educational videos and exercises.

 

·Crowdsourced education: Collaborative and versatile platform for classrooms that allows students to collaborate in project building and problem solving.

 

Our Team and Culture

 

We have a strong corporate culture, and we encourage our employees to actively adopt it. We believe in:

 

·A customer first focus;

 

·Ethics, respect and humility;

 

·Excellence and a willingness to learn;

 

·Meritocracy, discipline and an execution mindset; and

 

·Cost focus, with a school owner’s mindset.

 

Technology

 

We believe that the use of technology is fundamental to achieving our goal of placing each student at the center of the educational experience. In our view, technology is a means to delivering content through several formats and devices, creating a connection between each student and our common curriculum through a unique and comprehensive pedagogical approach.

 

Our application programming interfaces, or APIs, provide a standardized way to provision, manage, engage and deliver content to students, faculty and administrators. The APIs manage authentication and access for our entire technology stack and is designed to manage and interface with new technologies as they are introduced.

 

All of our APIs, applications, and application components are designed from the ground up to produce significant, readable and interpretable data. Log monitoring allows us to proactively identify and mitigate potential capacity, performance and security issues, whilst advanced analytics on student usage data provides the company with powerful insights to evaluate course content, communicate new technology releases and improve user experience and engagement.

 

To implement our innovative vision, we have a specialized in-house EdTech team comprised of over 84 engineers, software engineers, software developers, product owners, user experience and user interface designers, data scientists and digital content developers, who are responsible for envisioning and creating the ideal digital presentation of our materials within our platform, bringing the work of our pedagogical and content teams to life. Our core technology platform is fully developed and customized by our in-house EdTech team.

 

Following the best frameworks in digital product development, we offer a buy-and-build solution from the customer stand point, as users and customers have the opportunity to influence product evolution and participate in early stages of new-product conception.

 

The main drivers of our technology strategy are:

 

·Connectivity—connecting content and stakeholders in a seamless way;

 

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·Omni-channel—full access to our content, anywhere, anytime, across devices;

 

·Empowerment—ability to identify individual needs and build a personalized learning experience;

 

·User Centered—intuitive design so users can quickly adapt and fully use features to their advantage;

 

·Management—data and analytics to support educators’ decision-making; and

 

·Data Analytics—monitor and assess student performance, engagement and the impact of our solutions.

 

What Sets Us Apart

 

We believe that we have the following business strengths that allow us to disrupt the private K-12 education market:

 

Disruptive approach to traditional school model

 

Instead of simply delivering content as a product through textbooks, we provide an education solution through a technology-based platform. We believe that our platform is cutting-edge, modern, dynamic and client-oriented. We offer a multi-channel experience, combining proprietary content and software that would otherwise require the purchase of multiple, non-integrated solutions.

 

According to internal studies, we believe that the parents of the partner schools’ students enjoy significant savings since our content solutions are less expensive than a traditional collection of textbooks, mainly because we can avoid incremental costs associated with a traditional retail distribution chain by primarily selling directly to our partner schools, as well as certain incremental costs relating to content production. In contrast, the sale of traditional textbooks often requires publishers to pay authors’ royalties for each book sold, and traditional textbooks are frequently marketed as penned by specific authors, each of which generally entails higher total royalty costs, whereas we generally acquire rights to content from a large pool of available authors, without variable payments relating to royalties. Furthermore, we deliver a supplemental revenue stream for our partner schools.

 

As of December 31, 2018, partner schools charged parents an incremental markup on our wholesale per student prices.

 

Strong combination of content development team and technology to develop a best-in-class learning experience

 

As of December 31, 2018, we had a dedicated team of over 351 technology and content development employees focused on developing and improving our Core Curriculum and Supplemental Solutions materials. They achieve this by leveraging feedback from our (i) highly-qualified base of over 1,200 experienced educational authors in Brazil on the quality of materials we produce, and (ii) network of partner schools and teachers on the impact of our materials on student performance. The advanced state of our platform reflects a process of evolution spanning over a decade, making it difficult to replicate. We also have a team of over 142 employees focused on the product design and digital presentation of our education materials on our platform.

 

Widespread positive customer satisfaction and strong academic outcomes

 

Our customer satisfaction is driven by our ability to meaningfully improve the performance of our partner schools’ enrolled students in the ENEM exam, a prerequisite for entrance into almost all higher education undergraduate institutions in Brazil. According to the 2017 results of the ENEM exam:

 

·Three of the 10 top schools in the Brazilian national school rankings use our solutions; and

 

·183 of our partner schools are ranked among the top three schools in their respective cities.

 

Strong brand equity and aligned incentives resulting in high retention rates

 

We prioritize quality by employing a “white glove” service model across our business, with clear financial incentives (in the form of bonuses) to our sales force that drive long-term relationships with our partner schools. Educational performance is one of the main drivers of school growth, and the success of our partner schools is a critical part of our value proposition. Due to the quality of our academic outcomes, we rarely lose clients. In addition, we have historically been highly effective in increasing contract values.

 

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Attractive financial model with a high level of visibility and predictability

 

We have cash flow visibility given our long-term contracts with partner schools. Initial contract terms generally average three years, with high switching costs resulting in a customer churn of approximately 5.0% in 2018. In addition, we benefit from increasing enrollments across partner schools as our relationships mature and deployments increase, leading to revenue growth and increased operating margins, which contribute to the predictability of our business.

 

Founder-led and experienced management, innovation-driven culture

 

Our culture flows from our founder and CEO’s family, who have specialized in education for over 50 years. Our founder and CEO, Mr. Ari de Sá Cavalcante Neto, has brought his family’s successful school formula to scale by creating a leading educational platform. We strive to innovate and instill in our professionals a passion for serving all of our stakeholders and seeking impactful next-generation solutions for private K-12 education.

 

As of December 31, 2018, the average age of our employees was 30 and 53% of our employees were women. We also offer a long-term incentive plan for key employees and apply meritocratic methods to engage all of them, recognize their value and maintain their motivation.

 

Our Growth Strategies

 

We aim to continue driving rapid, profitable growth and to generate greater shareholder value by implementing the following strategic initiatives:

 

Deepen relationships with our existing customer base

 

We intend to increase student enrollments within our existing partner schools at a minimum marginal cost as we see major opportunities for increased penetration through:

 

·Increasing the number of class years that adopt our Core Curriculum at each partner school. As of December 31, 2018, our up-selling potential would increase our student enrollments by 44%; and

 

·Cross-selling our Supplemental Solutions to currently-enrolled class years at our partner schools. As of December 31, 2018, only 3.6% of our students base used both our Core Curriculum and Supplemental Solutions.

 

Expand our partner school base

 

We believe that the top three private education providers in Brazil accounted for less than 2% of the private education market as of December 31, 2018. We believe that our sales efforts will benefit as the performance of partners schools using our educational platform becomes more widespread and widely known.

 

Add new Supplemental Solutions

 

We consistently review potential opportunities to provide additional after-school educational solutions that we may integrate into our Supplemental Solutions. We plan to enforce a disciplined approach to growth by using market validation techniques to assess the likelihood of our partner schools adopting our solutions and their potential spending. We will also aim to ensure that any new vertical fits within our proven business strategy, through a careful assessment of available alternatives, such as the number and size of potential adjacent market opportunities, and their relative risk and return.

 

Continue to innovate and extend our technological leadership

 

Innovation is a cornerstone of our culture. As such, we employ significant efforts and resources to ensure the constant development and improvement of our portfolio of solutions. We have also invested in a select group of education technology startups in an effort to bring new ideas and solutions into our ecosystem. These initiatives have helped us identify new business potential to enhance our overall growth prospects, such as education IT systems (WPensar), supplemental instruction content (International School) and digital-native content platform (Geekie).

 

We intend to increase the functionality of our platform and continue our investment in the development and acquisition of new applications that extend our technological leadership. We also intend to continue to improve and update our print and digital content based on the real-time feedback we receive from our partner schools.

 

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Continue to pursue M&A opportunities

 

We plan to continue to opportunistically pursue acquisitions that are complementary to, or that will help us diversify, our business. We intend to maintain a disciplined approach towards evaluating possible targets and integrating acquisitions into our business model. Our preferred acquisition targets are core or supplemental educational platform providers that engage in delivering K-12 educational content through software-based platforms. We are currently evaluating possible acquisition opportunities and submit non-binding proposals from time to time.

 

We believe that we have developed a strong capability and track record of identifying, negotiating and integrating acquisitions. Moreover, we have developed a systematic model that enables us to integrate our acquired businesses in a timely and efficient manner. Since 2011, we have successfully acquired or invested in 11 companies. Our acquisition strategy is focused on expanding our operations into new regions within Brazil and adding new products and technologies to accelerate our pace of innovation and broaden our footprint. For example, our acquisition of Sistema de Ensino Integral Bahiense reinforced our presence in the State of Rio de Janeiro, our acquisition of Sistema de Ensino Energia expanded our presence in the southern region of Brazil, and our acquisition of International School enabled us to enter the ESL bilingual market.

 

Marketing and Sales

 

Our platform has evolved into a complex solution. The adoption of our platform by partner schools requires us to first build trust and confidence in our solutions, which can only be achieved by engaging them with our solutions and demonstrating a proven track record of success and quality, while constantly monitoring client satisfaction and feedback.

 

We have a non-traditional sales approach, which is structured around a practice we refer to as “Educational Consulting,” which reflects both our core value of ensuring that education is our first priority, as well as the unique sales dynamics associated with our industry.

 

We have a lead time (which we define as the period from the moment of first contact to the execution of a contract) for the acquisition of new partner schools, and we typically enter into contracts with new partner schools within one year from the moment of first contact, which requires a series of interactions and constant contact, to build a trust based relationship with target and partner schools. Our sales strategy is based on creating touch points to highlight the quality of our solutions. We aim to achieve this with dedicated sessions for experimenting and testing with our platform. We also hold a number of specialized events aimed at target and partner schools, product journeys and guided visits to our units, and participate in industry fairs.

 

The success of our sales process requires uniquely qualified professionals, who must not only have an academic background, but are also sales-oriented. We invest a significant amount of time and resources to recruit and train our sales force, averaging approximately 306 hours of training per year per person. After the initial training and exposure to our Educational Consulting environment, each professional begins working by shadowing an experienced consultant. It takes approximately a year of shadowing before each new professional can work individually on our behalf. In 2018, we had approximately 38,520 applicants for our consultant positions, 35,000 applying through our trainee program and 3,520 applying for specific sales consultant positions. Currently, we employ more than 300 sales and support professionals. Our consultants’ incentives are also aligned with our long-term goals and are tied to our profitability, as a significant portion of their annual compensation is variable and is paid out to them annually in the form of a bonus provided certain targets are met. Furthermore, we believe that our sales consultants have achieved improved efficiencies as measured by the increase of students per sales consultants from 2016 to 2018.

 

In order to improve and optimize our partner school acquisition process, we structured a market intelligence division, which focuses on mapping and segmenting our target markets to support and focus our sales strategies, as well as providing our sales consultants with industry knowledge and high-level market analysis and insights. Our market intelligence division has access to a significant volume of data, is continuously undertaking industry research and analysis and receives regular feedback from, and is in regular contact with, our consultants deployed in the field.

 

In addition, we work in conjunction with a branding agency, which assists us in developing and strengthening our brands, increasing their national awareness, and building our institutional image. Our brand portfolio is structured to reflect our value proposition and leverage our marketing and sales strategy.

 

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Our Customer Service and Support

 

We believe that the best way to ensure the loyalty of our customers is to maintain a healthy, long-term relationship with our partner schools. We aim to achieve this through our customer engagement and support service, which supports partner schools in the implementation and integration of our educational solutions into their systems, as well as help them identify and achieve their pedagogical and business objectives. We assign independent and dedicated client-centric customer support teams to each of our solutions. Customer service and support is comprised of two departments which are focused on developing partner school relationships and are available to address any post-implementation issues that may arise: (1) pedagogical consulting, and (2) customer service:

 

Pedagogical Consulting

 

Our pedagogical consulting department is responsible for the pedagogical supervision and educational development of our partner schools. It aims to ensure that our educational platform is being used efficiently, and to actively assist our partner schools in improving the learning experience of their students and helping them develop the necessary skills inside and outside the classroom. It also leverages a dedicated management team to train and support our partner schools in maximizing their supplemental revenue streams.

 

Our pedagogical consulting team activities with partner schools include:

 

·implementing pedagogical methodologies in connection with our educational platform and associated educational materials, making pedagogical recommendations, understanding school communities, and coordinating lesson planning;

 

·periodic in-person meetings and coordinated site visits to evaluate the educational process, assisting partner school owners and faculty members to develop learning and interaction projects through the use of educational media content and new technologies, and conducting lectures for parents and students;

 

·continuous online or on-site training for teachers and school coordinators; and

 

·developing educational evaluation models tailored to each partner school’s profile and needs, and training school owners and managers to use the school owner/manager specific features of our educational platform.

 

Customer Support

 

Our customer support department provides day-to-day customer and administrative support to our partner schools in connection with our educational platform by e-mail and/or by telephone. Our customer support department interacts with our pedagogical consulting department when necessary to minimize the risk of miscommunication and ensure a unified approach to customer satisfaction.

 

Our Geographic Presence

 

We believe our platform can be adopted by virtually any private K 12 school in Brazil. As of March 31, 2019, our network consisted of 1,462 unique partner schools and 498,553 enrolled students across all Brazilian states and in 488 cities, comprising students from kindergarten to high school. Our national presence has consistently expanded over the last five years, through both organic and non-organic growth and our largest client accounted for only 1.6% of our net revenue.

 

Our Clients

 

We offer our clients a complete suite of turnkey curriculum solutions intended to prepare their K--12 students for educational success. Our partner school base is highly diversified, which reduces our dependence on a concentrated number of large clients. Our 10 largest clients represented only 9.6% and 12.0% of our net revenue in 2018 and 2017, respectively. Even though our partner schools pay for our solutions, we view students, parents, teachers, school management and teachers as our customers.

 

Our Competition

 

We compete with traditional publishers and textbook providers, other providers of core curriculum solutions, as well as with online education platforms. Factors influencing competition in this industry may include price, overall education experience and track record, industry experience and reputation, content quality, availability of technology, faculty, facilities, location and program offerings, among others.

 

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Most traditional publishers and textbook providers are typically focused exclusively on physical textbooks. They do not produce their own content, do not update their content frequently, and do not have developed digital platforms. Furthermore, we believe that traditional publishers and textbook providers whose strategy it is to develop education solutions similar to ours do not possess the content development expertise, brand awareness, or the track record to sell such solutions directly to schools.

 

Other core curriculum solutions providers offer primarily printed content and a limited amount of digital content. Other online platforms that offer education solutions through digital channels face difficulties to efficiently integrate solutions for schools, parents, students and teachers. We believe our proprietary content is engaging to students, teachers and parents, as illustrated by our ability to persuade schools to switch from other products to our products.

 

We seek to differentiate ourselves from our competitors primarily on the basis of our simple, integrated and personalized educational platform. We believe the following factors are critical to success in the private K-12 education in Brazil:

 

(1)       Level of a solution’s effectiveness, personalization, engagement and enjoyment;

 

(2)       Quality of the user experience and customer service;

 

(3)       Breadth and depth of features and functionalities;

 

(4)       Brand recognition and academic outcomes; and

 

(5)       Overall cost of education solutions.

 

Seasonality

 

Our revenues and operating results normally fluctuate as a result of seasonal variations in our business. For further information on seasonal variations in our business, please see “Item 5. Operating and Financial Review and Prospects—A. Operating results—Revenue Recognition and Seasonality.”

 

Legal Proceedings

 

See “Item 8. Financial Information—A. Consolidated statements and other financial information—Legal Proceedings.”

 

Regulatory Overview

 

The Brazilian constitution establishes education as a right of all citizens, the provision of which is a duty of the state and the family. Accordingly, the government is required to provide all Brazilian citizens with access to free primary education that requires compulsory attendance. Private investment in education is permitted so long as entities providing education services comply with the applicable rules and regulations.

 

The Brazilian education system is organized as a cooperation regime among federal, state and municipal governments. The federal government is required to organize and coordinate the federal education system in order to guarantee equal opportunity and quality of education throughout Brazil. Brazilian states and the Brazilian Federal District are required to focus on primary and secondary education, while municipalities are responsible for providing preschool and primary education, and each is responsible for establishing and implementing the relevant rules and regulations for each educational stage the subject of its focus, including monitoring and evaluation, and the issuance of all relevant authorizations, recognitions and qualifications for each such educational stage.

 

Law No. 9,394/1996, or the National Education Guidelines Law (Lei de Diretrizes e Bases da Educação Nacional), or LDB, establishes the guidelines for the provision of education services in Brazil and sets forth the federal government’s duty to: (1) coordinate the national education system; (2) prepare the National Education Plan; (3) provide financial assistance to the states, the Federal District and municipalities; and (4) define, in cooperation with other federal entities, the responsibilities and guidelines for primary and secondary education.

 

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In addition, the federal government, through Law No. 13,005 of June 25, 2014, implemented the National Education Plan (Plano Nacional de Educação), or PNE, with a duration of ten years from the date of its publication. The National Education Plan established objectives for primary and secondary education that must be met by the Brazilian federal system. These objectives are: (1) the universalization of preschool education, with a target to enroll at least 50% of all children up to three years of age in schools by 2024; (2) the universalization of primary education, with a target to enroll at least 95% of children between the ages of six and 14 in schools by 2024; (3) the universalization of secondary education, with a target to enroll at least 85% of adolescents between the ages of 15 and 17 in schools by 2024; (4) to ensure that all children learn the Portuguese alphabet by the third year of primary education; (5) to make available full-time education in at least 50% of public schools; (6) to improve the quality of primary education as evaluated by the IDEB; (7) to ensure that all students are literate by the time they are 15 years-old; (8) to make available at 25% of primary and secondary education to young adults and adults; and (9) to increase enrollment in professional studies to three times the current enrollment rate. Accordingly, each of the federal, state and municipal governments was required to prepare a ten-year education plan and establish policies, guidelines and objectives applicable to the segment of the Brazilian education system over which it is responsible. In addition, these objectives act as guidelines for the private education sector.

 

Primary and Secondary Education

 

Primary and secondary education in Brazil is equivalent to K-12 education in the United States, and consists of elementary school, junior high and high school, which are regulated by the LDB and the National Education Plan.

 

The LDB regulates a nationwide, common core curriculum, the number of teaching hours, the minimum classroom attendance and grade advancement. States, municipalities and educational institutions can pass rules and regulations according to specific regional and local requirements, such as differences in curricula and calendar, grade advancement and issuance of academic documentation for primary and secondary education students.

 

The National Education Plan establishes ten-year targets for all the levels and stages of education, mandating that states and municipalities create and establish similar plans compatible with such national targets. It is incumbent upon the Primary and Secondary Education Secretariat (Secretaria de Educação Básica), or the SEB, under the supervision of the MEC, to monitor compliance with the PNE by states and municipalities. This inspection and monitoring includes guidance and rules for assessing the primary and secondary education stages.

 

Under the federal constitution and the LDB, access to primary and secondary education is a right of all children from the ages of four to 17. Following amendments to Law No. 11,274 on February 6, 2006, the duration of primary and secondary education was extended from a period of eight years to a period of nine years. Among the purposes of primary education are: (1) development of the capacity to learn, including basic abilities in reading, writing and arithmetic; (2) comprehension of the natural and social environment, the political system, technology, arts and social values; (3) development of the capacity to acquire new knowledge and abilities and the formation of attitudes and values; and (4) strengthening family ties, social cohesion and mutual tolerance. Assessment of primary education is coordinated by the state legislation of each individual state, on a case-by-case basis.

 

Secondary education is designed to fulfill the government’s duty to progressively complete the formation of the citizen, seeking universalization of scope and coverage. Secondary education is conducted for a period of not less than three years and seeks: (1) the consolidation and deepening of the knowledge acquired in primary education; (2) the basic preparation of the person being educated for work and to be able to adapt within the labor market or pursue further education; (3) the improvement of the student as a person, including ethical formation and the development of intellectual autonomy and critical thinking; and (4) the comprehension of the scientific and technological bases of the productive processes, relating theory to practice in each discipline. Assessment of secondary education is conducted on a national scale and coordinated by the MEC.

 

Regulatory Bodies

 

The main regulatory bodies of the Brazilian education system are:

 

MEC;

 

INEP;

 

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CNE;

 

CEB;

 

Higher Education Board (Câmara de Educação Superior), or CES;

 

State and Municipal Secretaries (Secretarias Estaduais de Educação and Secretarias Municipais de Educação, respectively); and

 

State and Municipal Councils of Education (Conselhos Estaduais de Educação and Conselhos Municipais de Educação, respectively).

 

The MEC is Brazil’s highest governmental body for education. It formulates and evaluates Brazilian national education policy, ensuring the quality of education and compliance with education regulations. The INEP is a related federal entity responsible for evaluating educational institutions in Brazil, as well as conducting research in order to provide a reliable database for public use.

 

The MEC is assisted by the CNE, which is the entity with regulatory power and deliberative authority to ensure national education improvement. The CNE is comprised of the CEB, which is the federal agency responsible for the regulation of the K-12 education system, and the CES, which is the federal agency responsible for the higher education system. Both regulatory bodies are composed of 12 members appointed by the President of Brazil.

 

States and municipalities are responsible for regulating K-12 education. State Secretaries of Education (Secretarias Estaduais de Educação) are assisted by the State Councils of Education (Conselhos Estaduais de Educação), and are the main regulatory bodies for primary and secondary school education. The Municipal Secretaries of Education (Secretarias Municipais de Educação) are assisted by the Municipal Councils of Education (Conselhos Municipais de Educação), and are the main regulatory bodies of preschool education.

 

The LDB grants power to states and municipalities to authorize, accredit and supervise primary and secondary education institutions. This is achieved through each governmental entity’s respective Department of Education.

 

Regulations Applicable to the Company’s Activities

 

The Company is not directly regulated by the MEC nor any other regulatory agency. However, our educational platform and related educational materials seek to comply with the LDB and the guidelines established by the BNCC. In addition, our partner schools are K-12 education providers and are directly regulated by the MEC and must comply with their regulations.

 

The BNCC is a set of guidelines that provides a curriculum specifying the core skills and knowledge required to be taught as part of primary and secondary education in Brazil and each school has the autonomy to elaborate or adapt their curricula and pedagogical projects according to such guidelines. The BNCC guidelines were established following overall poor student performance levels achieved while the predecessor education guidelines were in effect. Several indicators suggest that the predecessor guidelines were failing in several ways, leading the MEC to initiate discussions relating to a new method based upon a comparison between Brazil and other countries’ results, which formed the basis for developing the BNCC. The LDB and the BNCC establish what subject matters shall be taught for each level of education (early childhood education, primary education and secondary education), and we have ensured that our educational materials and platform meet the requisite standards and thus comply with these guidelines.

 

As provided by the LDB and the BNCC, early childhood education should enable children to live in society, to play, to participate, to explore, to express themselves, and to know themselves. Primary education, in turn, shall offer the following subject matters: (i) Portuguese; (ii) Arts; (iii) Mathematics; (iv) Geography; (v) History; (vi) Religious Studies; (vii) English; and (viii) Science. Also, according to the current BNCC, approved by Ruling No. 1,210, 2018, secondary education shall offer curricula covering the following subjects (i) Portuguese; (ii) Arts; (iii) Mathematics; (iv) Geography; (v) History; (vi) Physics; (vii); Chemistry; (viii) Biology; (ix) English, (x) Science, (xi) Sociology; and (xii) Philosophy. As our partner schools are private and have the autonomy to establish their pedagogical projects, there are no other guidelines relevant to the materials provided.

 

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While following the BNCC is still required of every school in the country, there are opportunities to provide content solutions and after-school solutions to improve and adapt to the new status quo in Brazil’s education market.

 

Syndicates

 

Teachers and professors may contribute to the Brazilian Teacher’s Union (Sindicato dos Professores), as they work as registered employees under the CLT (Labor Laws Consolidation) regime. The syndicate contribution may be deducted once a year by employers directly from the employee’s payroll in an amount equal to one working day’s salary, subject to the express authorization of such employee. Such syndicate contribution does not imply syndicate association.

 

C.Organizational structure

 

We are a Cayman Islands exempted company incorporated with limited liability on April 12, 2018. Arco became the holding company of Arco Educação S.A. and its operating subsidiaries, including EAS Brazil, which provides educational content from basic to secondary education (“K-12 curriculum”).

 

The table below is a list of the Company’s subsidiaries, joint ventures and associated companies:

 

        Direct and indirect  interest (%)
Name Principal activities Country Investment type 2018 2017 2016
Arco Brazil Holding Brazil Subsidiary 100.0 -  
EAS Educational content Brazil Subsidiary 100.0 100.0 100.0
Barra Américas Editora Ltda. Educational content Brazil Subsidiary 100.0 100.0 100.0
Distribuidora de Material Didático Desterro Ltda. Educational content Brazil Subsidiary 100.0 100.0 100.0
Novagaúcha Editora e Livraria Ltda. Educational content Brazil Subsidiary 100.0 100.0 100.0
SAS Sistema de Ensino Ltda. Educational content Brazil Subsidiary 100.0 100.0 100.0
SAS Desenvolvimento Educacional Ltda. Educational content Brazil Subsidiary 100.0 100.0 100.0
SAS Livrarias Ltda. Educational content Brazil Subsidiary 100.0 100.0 100.0
SAE Digital S.A. Educational content Brazil Subsidiary 100.0 100.0 70.0
Escola de Aplicação São José dos Campos Ltda. Educational services Brazil Subsidiary 69.6 69.6 51.0
International School Serviços de Ensino, Treinamento e Editoração, Franqueadora S.A. Educational content Brazil Subsidiary 51.5 51.5 40.0
NS Ventures Participações Ltda. Educational content Brazil Subsidiary 100.0 100.0 -
NS Educação Ltda. Educational content Brazil Subsidiary 100.0 100.0 -
WPensar S.A. Educational technology Brazil Joint venture 25.0 25.0 25.0
Geekie Desenvolvimento de Softwares S.A. Educational technology Brazil Associate 8.05 6.5 6.5

 

For more details about our organizational structure please see “Presentation of Financial and Other Information—Our Corporate Reorganization” and refer to notes 1 and 2 to our audited consolidated financial statements.

 

D.Property, plant and equipment

 

Intellectual Property

 

Most of our services are provided using proprietary software. We rely on a combination of industrial property, copyright and software laws, as well as employee and third-party non-disclosure, confidentiality and other types of contractual arrangements to establish, maintain and enforce our intellectual property rights, including with respect to our proprietary rights related to our products and services. In addition, we license technology from third parties, and do not hold or own licenses regarding all software employed in the business. However, we have not received any legal notices related to such non-licensed software and are employing measures to obtain pending licenses.

 

As of December 31, 2018, we own 47 trademark registrations and 62 registered domain names in Brazil. We also have a number of pending trademark applications in Brazil and the U.S. (126 in Brazil and 3 in the U.S., as of December 31, 2018). We have a number of registered copyrights, most notably copyrights for text formatting, critical reading, books, drafting, text editing and review, reformulation, book updates, content coordination, illustrations and diagramming.

 

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Properties

 

Our corporate headquarters, which houses our sales, marketing, and business operations, are located in São Paulo at Rua Augusta and comprise 1,960 square meters under a lease that expires in 60 months. We also lease 5,869 square meters in Fortaleza for our product development, sales, and business operations under a lease that expires in 2025. We have offices in several other locations and believe our facilities are sufficient for our current needs.

 

In addition to our corporate headquarters and as of December 31, 2018, we leased operational, sales, and administrative facilities in Rio de Janeiro, Florianópolis, Campinas, Cotia, Diadema, Curitiba and Porto Alegre. As of December 31, 2018, we had a services agreement with a data center service provider for the provision of data services to us from its data centers located globally, which expires in 2019. We believe that our facilities are suitable and adequate for our business as presently conducted, however, we periodically review our facility requirements and may acquire new space to meet the needs of our business or consolidate and dispose of facilities that are no longer required.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

 

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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the notes thereto as well as the information presented under “Item 3. Key Information—A. Selected financial data. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including those set forth in “Item 3. Key Information—D. Risk factors”

 

A.Operating results

 

We provide a complete pedagogical system with technology-enabled features to deliver educational content to private schools in Brazil.

 

We founded our company with the aim to create high-quality products that simplify learning and make the education process more efficient. Traditionally, school administrators required a multitude of vendors for content development, training, commercializing and managing K-12 education. Simultaneously, students acquired educational content through textbooks from various publishers across retail channels. Our platform aims to replace this multitude of third-party educational providers with a streamlined, one-stop solution that delivers high quality education at scale.

 

We believe the success of our platform, together with the quality of our client base and the popularity of our brand, has driven our significant growth, allowing us to quickly and efficiently expand our footprint in Brazil.

 

We provide a complete suite of turnkey curriculum solutions and technology-enabled features to help our students, teachers, partner schools and parents, targeting our students’ educational success. Our turnkey educational platform solutions comprise core K-12 curricula, as well as supplemental instructional content currently focused on English as a second language.

 

As of March 31, 2019 we had 1,462 unique partner schools. These schools are spread across 488 cities located across all of the states of Brazil. Our partner schools base is highly diversified, which reduces our dependence on major accounts.

 

Our Cohort Economics

 

We believe that an annualized cohort analysis is a useful indicator of demand for our platform. We define a cohort as the amount spent by all of our partner schools on our platform over each 12-month period. We calculate the total contractual fees payable by our partner schools in each cohort as of the end of each academic year, or the yearly contract fee amount. These amounts increase as a result of (i) increases in the total number of enrolled students at our partner schools served by our platform, and (ii) annual adjustments of our contract fees. These amounts decrease when customers terminate their contracts, downgrade their contracts to a lower price point, or if there is a decrease in the number of enrolled students at our partner schools.

 

 

 

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We focus on attracting new partner schools and increasing the value we offer to them. Accordingly, each cohort of new partner schools tends to generate higher fees payable to us over time. We have a track record of attracting new partner schools and increasing the amount of fees they pay us over time, as illustrated by the chart below.

 

Customer expansion can be seen in the Annual Contract Value, or ACV, growth in cohorts over the last five fiscal years. Our cohorts of customers from 2014 through 2018 have grown their ACV, on a real-weighted average basis, by an average of 27% by the end of first contract year (Year 1), 39% by the end of second contract year (Year 2), 48% by the end of third contract year (Year 3), 59% by the end of fourth contract year (Year 4) and 77% by the end of fifth contract year (Year 5).

 

 

 

 

The strength of our partner schools base and our ability to expand sales is demonstrated in the increasing portion of our ACV derived from existing clients and upsell in existing clients, combining for 79.1%. 44.5%, 43.4% and 39.5% growth in 2016, 2017, 2018 and 2019. respectively.

 

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Our Growth

 

Our revenue growth has been driven by:

 

·Expansion of our partner school base: The increase in the number of partners schools using our educational platform.

 

·Deepening of relationships with our existing customer base: The increase in the number of enrolled students we serve in our partner schools, through (i) the increase in the number of class years that adopt our Core Curriculum solutions, and (ii) cross-selling our Supplemental Solutions.

 

·Price increases: The annual adjustments of our contract fees, in line with our price-setting policies which are usually above published inflation indices, to account for changes in our cost and expenses structure and for improvements in our platform.

 

·M&A: The acquisition of complementary businesses. Since 2011, we have successfully acquired or invested in 11 companies that have helped us expand our operations regionally and nationally, and also add new products and technologies.

 

Revenue Recognition and Seasonality

 

Prior to the adoption of IFRS 15, revenue was recognized when the significant risks and rewards of ownership have been transferred to the customer, recovery of the consideration is probable, the associated costs and possible return of educational content can be estimated reliably, there is no continuing management involvement with the educational content and the amount of revenue can be measured reliably. Upon the adoption of IFRS 15, revenue is recognized when the performance obligation is satisfied. We recognize our revenue at the moment we deliver our content to our partner schools in printed format or via access to our digital platform. The technology is provided solely to optimize the use of our educational content. Our printed materials can be used independently of the technology we provide, as the content of both our printed materials and online materials is substantially the same.

 

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We generate substantially all of our revenue from contracts that have an average term of three years, pursuant to which we provide educational content in printed and digital format to partner schools. Our revenue is driven by the number of enrolled students at each partner school using our solutions and the agreed price per student per year, all in accordance with the terms and conditions set forth in each contract. Each contract contemplates penalties ranging between 20% and 100% of the remaining total value of the contract in the event of termination, and the content already delivered by us through the termination date is not returned to us by the partner school.

 

Our partner schools pay us our fees directly, and pass that cost on to their enrolled students’ parents, who in turn are charged through a mandatory supplement to school tuition, in lieu of paying for textbooks from several vendors. Most of our partner schools charge parents an incremental markup from which we do not earn any additional revenue on top of our wholesale prices.

 

Pursuant to the terms of our contracts with our partner schools, they are required, by the end of November of each year, to provide us with an estimate of the number of enrolled students that will access our content in the next school year (which typically starts in February of the following year). Since we allow our partner schools to make small adjustments to their estimates to account for late admissions and dropouts, this number may fluctuate slightly until March 31, when it becomes more accurate.

 

We typically deliver our Core Curriculum content four times each year in March, June, August and December and our Supplemental Solutions content twice each year in June and December, typically two to three months prior to the start of each school quarter. This allows our partner schools and their teachers to prepare classes in advance of each school quarter. Because we recognize revenue at the moment of delivery of our educational content, our fourth quarter results reflect the growth in the number of our students from one school year to another. Consequently, we generally produce higher revenues in the fourth quarter of our fiscal year compared to the preceding quarters.

 

In addition, we bill partner schools and collect the sales we charge them in the first half of each academic collections year, generally resulting in a higher cash position in the first half of each fiscal year relative to the second half of each fiscal year.

 

Accordingly, we expect quarterly fluctuations in our revenues and operating results to continue. These fluctuations could result in volatility and adversely affect our liquidity and cash flows. As our business grows, these seasonal fluctuations may become more pronounced. As a result, we believe that sequential quarterly comparisons of our financial results may not provide an accurate assessment of our financial position.

 

A significant portion of our expenses is also seasonal. Due to the nature of our business cycle, we require significant working capital, typically in September and/or October of each year, to cover costs related to production and accumulation of inventory, selling and marketing expenses, and delivery of our teaching materials at the end of each fiscal year in preparation for the beginning of each school year. Therefore, such operating expenses are generally incurred in the period between September and December of each year.

 

Key Business Metrics

 

We review the following key metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans and make strategic decisions:

 

Enrolled Students

 

The number of enrolled students is the primary operational metric our management reviews. It represents the total number of students at our partner schools served by our platform during a given school year. Although our primary customers are the partner schools we attract to our base, our revenues are determined by the number of students enrolled in our partner schools.

 

We typically have high visibility of the number of students we will serve before the school year starts, typically by the end of November. Since we allow our partner schools to make small adjustments to their estimates to account for late admissions and dropouts, this number may fluctuate slightly until March 31, when it becomes more accurate. Accordingly, we believe this metric is most accurately reflected as of March 31 of each year.

 

As of March 31, 2019, 2018, 2017, and 2016, we had 498,553, 405,814, 322,031, and 265,354 enrolled students, respectively, representing a CAGR of 23.4%.

 

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In our Core Curriculum segment, we had 413,678, 363,824, 303,950, and 265,354 students as of March 31, 2019, 2018, 2017 and 2016, respectively, representing a CAGR of 16.0%. In our Supplemental Solutions segment, which we began consolidating in our financial statements in 2017, we had 84,875, 41,990 and 18,081 students as of March 31, 2019, 2018 and 2017, respectively.

 

The following table sets forth the number of enrolled students at our partner schools as of the dates indicated.

 

   As of March 31,
   2018  2017  2016  2015
Number of enrolled students    405,814    322,031    265,354    156,011 

 

As of March 31, 2019, our number of enrolled students was 498,553.

 

ACV Bookings

 

ACV Bookings is an operating metric and represents our partner schools’ commitment to pay for our solutions offerings. We believe that they are a meaningful indicator of demand for our platform and the market’s response to it.

 

We define ACV Bookings as the revenue we would contractually expect to recognize from a partner school in each school year pursuant to the terms of our contract with such partner school, assuming no further additions or reductions in the number of enrolled students that will access our content at such partner school in such school year. We calculate ACV Bookings by multiplying the number of enrolled students at each partner school with the average ticket per student per year, all in accordance with the terms of our contract with such partner school. Although our contracts with our partner schools are typically for three-year terms, we record one year of revenue under such contracts as ACV Bookings. For example, if a school enters into a three-year contract with us to provide our Core Curriculum solution to 100 students for a contractual fee of $100 per student per year, we record $10,000 as ACV Bookings, not $30,000.

 

We measure our ACV Bookings on a monthly basis throughout the school year, starting in November of the preceding fiscal year. Pursuant to the terms of our contracts with our partner schools, they are required, by the end of November of each year, to provide us with an estimate of the number of enrolled students that will access our platform in the next school year. Since we allow our partner schools to make small adjustments to their estimates to account for late admissions and dropouts, this number may fluctuate slightly until March 31, when it becomes more accurate. Accordingly, we believe this metric is most accurately reflected as of March 31 of each year.

 

The following table sets forth our ACV Bookings for the periods presented.

 

   As of March 31,
   2019(1)  2019(2)  2018(3)  2017(4)  2016(5)
   US$ (Except
number of
enrolled
students)(1)
  R$ (Except number of enrolled students)
Number of enrolled students    n/a    498,553    405,814    322,031    265,354 
Average ticket per student per year    228.2    884.3    793.8    711.9    622.0 
ACV Bookings (in millions)(6)    113.8    R$440.9     R$322.1    R$229.3    R$165.1 

 

 
(1)For convenience purposes only, amounts in reais as of March 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2)For the 2019 school year (which we define for purposes of ACV bookings as the period starting in October 2018 and ending in September 2019).

 

(3)For the 2018 school year (which we define for purposes of ACV bookings as the period starting in October 2017 and ending in September 2018).

 

(4)For the 2017 school year (which we define for purposes of ACV bookings as the period starting in October 2016 and ending in September 2017).

 

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(5)For the 2016 school year (which we define for purposes of ACV bookings as the period starting in October 2015 and ending in September 2016). Includes the ACV Bookings of SAE, which we acquired in June 2016, for the full year 2016. On a standalone basis, SAE had ACV Bookings for the full year 2016 totaling R$21.5 million and net revenue totaling R$11.9 million. If the acquisition had taken place on January 1, 2016, SAE’s total net revenue would have been R$24.6 million and our total net revenue would have been R$172.7 million.

 

(6)We define ACV Bookings as the revenue we would contractually expect to recognize from a partner school in each school year pursuant to the terms of our contract with such partner school, assuming no further additions or reductions in the number of enrolled students that will access our content at such partner school in such school year. ACV Bookings is a non-accounting managerial operating metric and is not prepared in accordance with IFRS. For more information about ACV Bookings, see “Presentation of Financial and Other Information—Special Note Regarding ACV Bookings.”

 

As of March 31, 2019, our total number of students enrolled was 498,553, our average ticket per student per year was R$884.3 and our total ACV Bookings were R$440.9.million

 

 

 

 

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(1)Includes the ACV Bookings of SAE, which we acquired in June 2016, for the full year 2016. On a standalone basis, SAE had ACV Bookings for the full year 2016 totaling R$21.5 million and net revenue totaling R$11.9 million. If the acquisition had taken place on January 1, 2016, SAE’s total net revenue would have been R$24.6 million and our total net revenue would have been R$172.7 million.

 

The following table sets forth the approximate number of enrolled students and ACV Bookings for our supplemental segment for the periods presented.

 

   As of March 31,
   2019(1)  2019(2)  2018(3)  2017(4)  2016(5)
   US$ (Except
number of
enrolled
students)(1)
  R$ (Except number of enrolled students)
Number of enrolled students    n/a    84,875    42,000    18,000    6,000 
ACV Bookings (in millions)(6)   25.9    R$100.4    R$45.0    R$20.0    R$6.0 

 

 
(1)For convenience purposes only, amounts in reais as of March 31, 2018 have been translated to U.S. dollars using an exchange rate of R$3.875 to US$1.00, the commercial selling rate for U.S. dollars as of December 31, 2018 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “Item 3. Key Information—A. Selected financial data—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2)For the 2019 school year (which we define for purposes of ACV bookings as the period starting in October 2018 and ending in September 2019). Presented as of February 25, 2019, nearest available date to March 31 as of the date of this form 20-F.

 

(3)For the 2018 school year (which we define for purposes of ACV bookings as the period starting in October 2017 and ending in September 2018).

 

(4)For the 2017 school year (which we define for purposes of ACV bookings as the period starting in October 2016 and ending in September 2017).

 

(5)For the 2016 school year (which we define for purposes of ACV bookings as the period starting in October 2015 and ending in September 2016).

 

(6)We define ACV Bookings as the revenue we would contractually expect to recognize from a partner school in each school year pursuant to the terms of our contract with such partner school, assuming no further additions or reductions in the number of enrolled students that will access our content at such partner school in such school year. ACV Bookings is a non-accounting managerial operating metric and is not prepared in accordance with IFRS. For more information about ACV Bookings, see “Presentation of Financial and Other Information—Special Note Regarding ACV Bookings.”

 

For our supplemental segment, as of March 31, 2019, the approximate number of enrolled students was 84,875 and ACV Bookings were approximately R$100.4 million.

 

Brazilian Macroeconomic Environment

 

We believe that our results of operations and financial performance are and will continue to be affected by the following macroeconomic trends and factors:

 

All of our operations are located in Brazil. As a result, our revenues and profitability are affected by political and economic developments in Brazil and the effect that these factors have on the availability of credit, disposable income, employment rates and average wages in Brazil. Our operations, and the industry in general, are particularly sensitive to changes in economic conditions.

 

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Brazil is the largest economy in Latin America, as measured by gross domestic product, or GDP. The following table shows data for real GDP, inflation and interest rates in Brazil and the U.S. dollar/real exchange rate at the dates and for the periods indicated.

 

   For the Year Ended December 31,
   2018  2017  2016
Real growth (contraction) in gross domestic product    1.1%   1.0%   (3.5)%
Inflation (IGP-M)(1)    7.5%   (0.5)%   7.2%
Inflation (IPCA)(2)    3.4%   2.9%   6.3%
Long-term interest rates—TJLP (average)(3)    6.7%   7.0%   7.5%
CDI interest rate (average)(4)    6.5%   10.1%   14.1%
Period-end exchange rate—reais per US$1.00    3.875    3.308    3.259 
Average exchange rate—reais per US$1.00(5)    3.656    3.203    3.483 
Appreciation (depreciation) of the real vs. US$ in the period(6)    (17.1)%   (1.5)%   16.6%
Unemployment rate(7)    12.3%   12.7%   11.5%

 

 

Source: FGV, IBGE, Central Bank and Bloomberg.

 

(1)Inflation (IGP-M) is the general market price index measured by the FGV.

 

(2)Inflation (IPCA) is a broad consumer price index measured by the IBGE.

 

(3)TJLP is the Brazilian long-term interest rate (average of monthly rates for the period).

 

(4)The CDI (certificado de depósito interbancário) interest rate is an average of interbank overnight rates in Brazil (daily average for the period).

 

(5)Average of the exchange rate on each business day of the year.

 

(6)Comparing the US$ closing selling exchange rate as reported by the Central Bank at the end of the period’s last day with the day immediately prior to the first day of the period discussed.

 

(7)Average unemployment rate for year as measured by the IBGE.

 

Historically, inflation has been offset by adjustments to the contractual fees per student that we charge our partner schools, the average adjustment of which was 8.3% for the years ended December 31, 2018, 2017, 2016 and 2015.

 

Our financial performance is also tied to fluctuations in interest rates, such as the CDI rate, because such fluctuations affect the value of our financial investments.

 

Printer Costs; Raw Materials

 

We outsource the printing and binding of our educational materials. Printer costs are one of our principal costs; printer fees are impacted by changes in the price of paper, one of the principal raw materials required for the production of our educational materials. The cost of paper is generally impacted by fluctuations in the U.S. dollar/real exchange rate, and is also impacted by inflation, but not necessarily linked to a specific inflation index. Such changes in prices are reflected as inflation adjustments in the fees charged by our third-party printers, which produce our printed materials. To the extent we cannot offset the impact of printer costs by adjusting the contractual fees per student that we charge our partner schools, our margins may be negatively affected.

 

Critical Accounting Estimates and Judgments

 

Our consolidated financial statements are prepared in conformity with IFRS. In preparing our audited consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on amounts reported in our consolidated financial statements. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. We regularly reevaluate our assumptions, judgments and estimates. Our significant accounting policies are described in note 3 to our audited consolidated financial statements. We believe that the following critical accounting policies are more affected by the significant judgments and estimates used in the preparation of our consolidated financial statements:

 

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Impairment of Non-Financial Assets

 

Impairment exists when the carrying value of an asset or cash generating unit (“CGU”) or a group of CGUs exceeds its recoverable amount, defined as the higher of its fair value less costs of disposal and its value in use. The fair value less costs of disposal calculation is based on data available from binding sales transactions, conducted at arm’s length, for similar assets or observable market prices less incremental costs of disposing of the asset. The value in use calculation is based on a discounted cash flow model (“DCF” model). The cash flows are derived from the budget for the next five years and do not include restructuring activities to which we have not yet committed or significant future investments that will enhance the performance of the assets of the CGU being tested. The recoverable amount is sensitive to the discount rate used for the DCF model as well as to expected future cash-inflows and the growth rate used for extrapolation purposes. These estimates are most relevant to goodwill that is recognized by us. The key assumptions used to determine the recoverable amount for the different CGUs, including a sensitivity analysis, are disclosed and further explained in note 13 to our audited consolidated financial statements.

 

Taxes

 

Deferred tax assets are recognized for deductible temporary differences and unused tax credits from net operating losses carryforward to the extent that it is probable that taxable profit will be available against which the losses can be utilized. Significant management judgement is required to determine the amount of deferred tax assets that can be recognized, based upon the likely timing and the level of future taxable profits, together with future tax planning strategies. Further details on taxes are disclosed in note 22 to our audited consolidated financial statements.

 

Fair Value Measurement of Financial Instruments

 

When the fair values of financial assets and financial liabilities recorded in the statement of financial position cannot be measured based on quoted prices in active markets, their fair value is measured using valuation techniques including the DCF model. The inputs into these models are taken from observable markets where possible, but where this is not feasible, a degree of judgement is required to estimate fair values. Judgements include considerations of inputs such as liquidity risk, credit risk and volatility. Changes in assumptions relating to these factors could affect the reported fair value of financial instruments. See note 24 to our audited consolidated financial statements for further information.

 

Contingent consideration, resulting from business combinations, is valued at fair value as of the acquisition date as part of the business combination. When the contingent consideration meets the definition of a financial liability, it is subsequently remeasured at each reporting date. This determination of fair value is based on discounted cash flows. The key assumptions take into consideration the probability of meeting each performance target and the discount factor. Any contingent consideration is classified as financial instruments from acquisition of interests. For further information, see notes 4, 14 and 24 to our audited consolidated financial statements.

 

Share-based payment

 

Estimating fair value for share-based payment transactions requires determination of the most appropriate valuation model, which depends on the terms and conditions of the grant. This estimate also requires determination of the most appropriate inputs to the valuation model including the expected life of the share option or appreciation right, volatility and dividend yield and making assumptions about them. For the measurement of the fair value of equity-settled transactions, we uses the Black & Scholes model. See note 16.b for the assumptions and models used for estimating fair value for share-based payment transactions.

 

Recent Accounting Pronouncements

 

New standards, interpretations and amendments adopted in 2018

 

We started applying IFRS 9—Financial Instruments and IFRS 15—Revenue from Contracts with Customers, beginning on January 1, 2018. For further information, see note 2.4 to our audited consolidated financial statements. Other amendments and interpretations were applied for the first time in 2018, but do not have an impact on our audited consolidated financial statements.

 

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IFRS 9—Financial Instruments

 

The IASB issued IFRS 9 relating to the classification and measurement of financial instruments. IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, and this approach replaces the previous requirements of IAS 39. The approach in IFRS 9 is based on how an entity manages its financial assets (i.e., its business model) and the contractual cash flow characteristics of those financial assets. IFRS 9 also amends the impairment criteria by introducing a new expected credit losses model for calculating impairment on financial assets and commitments to extend credit. Further, IFRS 9 includes new hedge accounting requirements that align hedge accounting more closely with risk management. These new requirements do not fundamentally change the types of hedging relationships or the requirement to measure and recognize ineffectiveness but do allow more hedging strategies that are used for risk management to qualify for hedge accounting and for more judgment by management in assessing the effectiveness of those hedging relationships. Extended disclosures in respect of risk management activity for those choosing to apply the new hedge accounting requirements will also be required under the new standard.

 

We adopted IFRS 9 prospectively, with the initial application date of January 1, 2018. The adoption of the expected credit loss requirements of IFRS 9 resulted in an increase in impairment allowances of the trade receivables. The increase in allowances resulted in an adjustment to retained earnings as of January 1, 2018 of R$4.3 million, net of tax effects.

 

For further information, see note 2.4 to our audited consolidated financial statements.

 

IFRS 15—Revenue from Contracts with Customers

 

IFRS 15 was issued in May 2014, and amended in April 2016. IFRS 15 affects any entity entering into contracts with customers, unless those contracts fall within the scope of other standards such as insurance contracts, financial instruments or lease contracts. IFRS 15 supersedes the revenue recognition requirements in IAS 18, Revenue, IFRIC 13, Customer Loyalty Programmes, and the majority of other industry-specific guidance. The standard contains a single model that applies to contracts with customers and two approaches to recognizing revenue: at a point in time or over time. The model features a contract-based five-step analysis of transactions to determine whether, how much and when revenue is recognized. New estimates and judgmental thresholds have been introduced, which may affect the amount or timing of revenue recognized.

 

We adopted IFRS 15 as of January 1, 2018 using the modified retrospective method and the effects of adopting IFRS 15 are not material. For further information, see note 2.4 to our audited consolidated financial statements.

 

Standards, interpretations and amendments not adopted yet

 

Certain IFRS standards and interpretations that have been issued but that will not be in effect until January 1, 2019 could impact the presentation of our financial position or performance once they are effective. For further information on the impact of these IFRS standards and interpretations on the presentation of our financial position or performance once they become effective, see note 2 to our audited consolidated financial statements.

 

IFRS 16—Leases

 

The IASB recently issued IFRS 16 to replace IAS 17 “Leases.” This standard introduces a single lessee accounting model and requires a lessee to recognize assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A lessee is required to recognize a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments. This standard substantially carries forward the lessor accounting requirements of IAS 17, while requiring enhanced disclosures to be provided by lessors.

 

We will adopt IFRS 16 from its effective date of January 1, 2019 using the modified retrospective transition approach. The expected impacts of the adoption for 2019 are as disclosed in note 2.4 to our audited consolidated financial statements.

 

IFRIC 23—Uncertainty over Income Tax Treatments

 

On June 7, 2017, the IFRS Interpretations Committee (IFRS IC) issued IFRIC 23, which clarifies how the recognition and measurement requirements of IAS 12—Income taxes, are applied where there is uncertainty over income tax treatments. IFRIC 23 applies to all aspects of income tax accounting where there is an uncertainty regarding the treatment of an item, including taxable profit or loss, the tax bases of assets and liabilities, tax losses and credits and tax rates.

 

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Management has assessed the new standard and does not expect any impacts on the Company’s consolidated financial statements.

 

JOBS Act

 

We are an emerging growth company under the JOBS Act. The JOBS Act provides that an emerging growth company can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

 

Subject to certain conditions set forth in the JOBS Act, if, as an “emerging growth company”, we choose to rely on such exemptions we may not be required to, among other things, (i) provide an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404, (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act, (iii) comply with any requirement that may be adopted by the PCAOB regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor discussion and analysis), and (iv) disclose certain executive compensation related items such as the correlation between executive compensation and performance and comparisons of the CEO’s compensation to median employee compensation. These exemptions will apply for a period of five years following the completion of our initial public offering or until we are no longer an “emerging growth company,” whichever is earlier.

 

Components of Our Results of Operations

 

The following is a summary of the principal line items comprising our statements of income (loss).

 

Net Revenue

 

We generate substantially all of our revenue from contracts that have a standard term of three years, pursuant to which we provide educational content in printed and digital format to partner schools.

 

Our revenue is driven by the number of enrolled students at each partner school using our solutions and the agreed price per student per year, all in accordance with the terms and conditions set forth in each contract. We recognize our revenue at the moment we make our content available to our partner schools in printed format or via access to our digital platform. We typically deliver our Core Curriculum content four times each year in March, June, August and December and our Supplemental Solutions content twice each year in June and December, typically two to three months prior to the start of each school quarter. This allows our partner schools and their teachers to prepare classes in advance of each school quarter.

 

Cost of sales

 

Cost of sales primarily consists of expenses related to the production and delivery of our content and technology, which are mainly composed of printing costs, employee-related costs and the purchase of long-term intellectual property assets such as educational content produced by third-party authors, as well as inventory write-off costs.

 

We intend to continue to invest additional resources in our content development and technology platform. The timing of these expenses will affect our cost of sales in the affected periods. Also, we may launch new products that require additional resources and can affect our cost of sales.

 

Expenses

 

We classify our operating expenses as selling expenses, general and administrative expenses and other expenses. The largest component of our operating expenses is employee and labor-related expenses, which includes salaries and bonuses, employee benefit expenses and contractor costs. We allocate expenses such as information technology infrastructure costs related to our operations and rent and occupancy charges in each expense category based on employee headcount in that category.

 

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·Selling expenses. Selling expenses consist primarily of the personnel expenses of our sales and marketing and customer support employees, including commissions and incentives, travel and travel-related expenses, benefits, marketing programs, including lead generation, costs of our education-related conferences and other miscellaneous expenses, as well as intangible assets amortization expenses. We expect that our selling expenses will increase as we increase the size of our sales and marketing teams and potentially increase the number of conferences and events that we organize.

 

·General and administrative expenses. General and administrative expenses consist of personnel expenses and related expenses, including executive, finance, legal, human resources, recruiting, employee-related information technology, administrative personnel, payroll, and benefits. They also consist of expenses in connection with professional fees for external legal, accounting and other consulting services, intangible assets amortization expenses, as well as other miscellaneous expenses. We expect general and administrative expenses to increase on an absolute real basis but decrease as a percentage of total revenue as we focus on processes, systems and controls that will enable our internal support functions to grow concurrently with the growth of our business. We also anticipate increases to general and administrative expenses as we incur the expenses of compliance associated with being a publicly traded company, including legal, audit and consulting fees.

 

We allocate share-based payment expense to general and administrative expenses. These share-based expenses represent granted share options to selected employees we consider to be key executives. We recognize our share-based payments as an expense in the statement of income based on their fair value over the vesting period. These charges have been significant in the past, and we expect that they will increase as we hire more employees and seek to retain existing employees.

 

Other income (expenses), net

 

Our other income (expenses), net, line item consists mainly of miscellaneous income and/or expense items.

 

Finance result

 

Our finance result includes finance income and finance costs.

 

Finance income includes mainly income from cash equivalents and financial investments and changes in fair value of derivative instruments from business combinations and acquisition of interest in associates and joint ventures. Finance costs includes mainly of changes in fair value of derivatives instruments and interest expenses of liabilities from business combinations and other financial discounts and bank fees.

 

Income taxes

 

Income taxes includes current and deferred income taxes. Deferred tax expenses are mainly related to provisions for bonuses, inventories reserve, allowance for doubtful accounts, share-based compensation plan, intangible amortization and derivatives from acquisition of interests and business combinations.

 

Results of Operations

 

Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017

 

The following table sets forth our consolidated statements of income (loss) for the years ended December 31, 2018 and 2017:

 

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   For the Year Ended
December 31,
   2018  2017  Variation (%)
   (in R$ millions, except for
percentages)
Statement of Income Data:         
Net revenue    381.0    244.4    55.9 
Core(1)    303.0    219.0    38.4 
Supplemental(1)    78.0    25.4    207.1 
Cost of sales    (80.7)   (58.5)   37.9 
Gross profit    300.2    185.9    61.5 
Selling expenses    (113.3)   (65.3)   73.5 
General and administrative expenses    (129.8)   (48.9)   165.4 
Other income (expenses), net    4.9    3.3    48.5 
Operating profit    62.1    74.9    (17.1)
Finance income    36.6    12.5    192.8 
Finance costs    (198.8)   (20.4)   874.5 
Finance result    (162.2)   (7.9)   1,953.2 
Share of loss of equity-accounted investees    (0.8)   (0.7)   14.3 
Profit before income taxes    (100.9)   66.4    (252.0)
Income taxes—income (expense)    18.0    (22.7)   (179.3)
Current    (26.5)   (31.0)   14.5 
Deferred    44.5    8.3    436.1 
Profit for the year    (82.9)   43.6    (290.1)
Profit (loss) attributable to:               
Equity holders of the parent    (82.4)   44.3    (286.0)
Non-controlling interests    (0.5)   (0.6)   16.7 

 

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(1)Our operating segments consist of our Core segment and our Supplemental segment. For further information, see note 23 to our audited consolidated financial statements as of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016.

 

Net revenue

 

Net revenue for the year ended December 31, 2018 was R$381.0 million, an increase of R$136.6 million, or 55.9%, from R$244.4 million for the year ended December 31, 2017.

 

This increase was primarily attributable to:

 

(i)in the first three quarters of 2018, the positive impact of our organic growth through the addition of new partner schools and an increase in up-sales of our solutions, which resulted in a 26.0% increase in the total number of students enrolled at our partner schools, to 405,814 students distributed across our partner schools as of March 31, 2018, from 322,031 students distributed across our partner schools as of March 31, 2017.

 

(ii)in the fourth quarter of 2018, the positive impact of our organic growth through the addition of new partner schools and an increase in up-sales of our solutions, which resulted in a 22.9% increase in the total number of students enrolled at our partner schools, to 498,553 students distributed across our partner schools as of March 31, 2019, from 405,814 students distributed across our partner schools as of March 31, 2018; and

 

(iii)the 11.5% increase in the average contractual fees per student that we charge our partner schools, from R$711.9 per student as of March 31, 2017 to R$793.8 per student as of March 31, 2018, which impacted the first three quarters of 2018, and a 11.4% increase in the average contractual fees to R$884.4 as of March 31, 2019, which impacted the fourth quarter of 2018.

 

In our Core segment, net revenue for the year ended December 31, 2018 was R$303.0 million, an increase of R$84.0 million, or 38.4%, from R$219.0 million for the year ended December 31, 2017.

 

This increase was primarily attributable to:

 

(i)the 19.7% increase in the number of enrolled students at partner schools, from 303,950 enrolled students as of March 31, 2017 to 363,824 enrolled students as of March 31, 2018, which impacted the first three quarters of 2018, combined with the 13.7% increase in the number of enrolled students at partner schools to 413,678 as of March 31, 2019, which impacted the fourth quarter of 2018; and

 

(ii)the 10.1% overall increase in the average contractual fees per student payable by partner schools, from R$687.9 per student for the year ended December 31, 2017 to R$757.6 per student for the year ended December 31, 2017, which impacted the first three quarters of 2018, and a 8.6% increase in the average contractual fees to R$823.0 as of March 2019, which impacted the fourth quarter of 2018.

 

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In our Supplemental segment, net revenue for the year ended December 31, 2018 was R$78.0 million, an increase of R$52.6 million, or 207.1% from R$25.4 million for the year ended December 31, 2017.

 

This increase was primarily attributable to the 102.1% increase in the number of enrolled students at partner schools, from 41,990 enrolled students as of March 31, 2018 to 84,875 enrolled students as of March 31, 2019

 

Cost of sales

 

Cost of sales for the year ended December 31, 2018 was R$80.7 million, an increase of R$22.2 million, or 37.9%, from R$58.5 million for the year ended December 31, 2017. This increase of 37.9% was primarily attributable to the overall increase in the production volume of our educational materials, resulting from the positive impact of our organic growth. The increase in cost of sales was lower than our revenue growth due to captured benefits from economies of scale.

 

As a percentage of net revenue, our cost of sales decreased to 21.2% for the year ended December 31, 2018, compared to 23.9% for the year ended December 31, 2017.

 

In our Core segment, cost of sales for the year ended December 31, 2018 was R$70.9 million, an increase of R$16.6 million, or 30.6%, from R$54.3 million for the year ended December 31, 2017. As mentioned above, this increase was primarily attributable to the overall increase in the production volume of our educational materials, resulting from the positive impact of our organic growth. As a percentage of net revenue in our Core segment, cost of sales decreased to 23.4% in the year ended December 31, 2018, compared to 24.8% in the year ended December 31, 2017.

 

In our Supplemental segment, cost of sales for the year ended December 31, 2018 was R$9.8 million, an increase of R$5.6 million, or 133.3% from R$4.2 million for the year ended December 31, 2017. This increase was also primarily attributable to the overall increase in the production volume of our educational materials, resulting from the positive impact of our organic growth. As a percentage of net revenue in our Supplemental segment, cost of sales decreased to 12.6% in 2018, compared to 16.5% in the year ended December 31, 2017.

 

Gross profit

 

For the reasons discussed above, gross profit for the year ended December 31, 2018 was R$300.2 million, an increase of R$114.4 million, or 61.5%, from R$185.9 million for the year ended December 31, 2017. In our Core segment, gross profit for the year ended December 31, 2018 was R$232.1 million, an increase of R$67.5 million, or 41.0%, from R$164.6 million for the year ended December 31, 2017. In our Supplemental segment, gross profit for the year ended December 31, 2018 was R$68.1 million, an increase of R$46.9 million or 221.2%, from R$21.2 million for the year ended December 31, 2017.

 

Selling expenses

 

Selling expenses for the year ended December 31, 2018 were R$113.3 million, an increase of R$48.0 million, or 73.5%, from R$65.3 million for the year ended December 31, 2017. This increase was primarily attributable to:

 

(i)a R$22.3 million, or 83.5%, increase in sales personnel expenses, mainly attributable to the 56.5% increase in the number of employees in our educational and pedagogical consulting teams to support our growth strategy going forward.

 

(ii)a R$9.1 million, or 111.4%, increase in customer support expenses, mainly due to the increase in our partner schools base across Brazil, as well as expenses related to promoting our growth strategy going forward; and

 

(iii)a R$8.6 million, or 92.4%, increase in sales & marketing expenses, mainly attributable to the expansion of our educational and pedagogical teams’ activities, such as traveling expenses, advertising, and other general expenses, necessary to support our growth strategy going forward.

 

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In our Core segment, selling expenses for the year ended December 31, 2018 were R$87.2 million, an increase of R$30.9 million, or 54.8%, from R$56.3 million for the year ended December 31, 2017. This increase was primarily attributable to an increase in (i) the number of employees in our educational and pedagogical consulting teams, (ii) sales & marketing and (iii) customer support expenses.

 

In our Supplemental segment, selling expenses for the year ended December 31, 2018 were R$26.1 million, an increase of R$17.1 million or 189.9%, from R$9.0 million for the year ended December 31, 2017. This increase was primarily attributable to an increase in (i) the number of employees in our educational and pedagogical consulting teams, and (ii) customer support expenses.

 

General and administrative expenses

 

General and administrative expenses for the year ended December 31, 2018 were R$129.8 million, an increase of R$80.9 million, or 165.4%, from R$48.9 million for the year ended December 31, 2017. This increase was primarily attributable to the vesting of the Long Term Incentive Plan (LTIP) as a result of our IPO in September 2018, resulting in a non-recurring expense of R$60.3 million for the year ended December 31, 2018. These expenses are also attributable to:

 

(i)a R$14.7 million increase in corporate personnel expenses totaling R$39.4 million for the year ended December 31, 2018, due to the 38.2% increase in the number of employees in our general administrative team, from 207 employees as of December 31, 2017, to 284 employees as of December 31, 2018; and

 

(ii)a R$6.5 million increase in third party services expenses totaling R$14.3 million for the year ended December 31, 2018, attributable to expenses relating to (i) the creation of our shared services center in order to centralize our administrative expenses and internal controls across our business and (ii) the creation of our new value creation team.

 

Operating profit

 

For the reasons discussed above, operating profit for the year ended December 31, 2018 was R$62.1 million, a decrease of R$12.8 million, or 17.1%, from R$74.9 million for the year ended December 31, 2017. Adjusting the impact of the vesting of the LTIP, the operating profit for the year ended December 31, 2018 would be R$122.4 million, an increase of R$47.5 million, or 63.4% from R$74.9 million for the year ended December 31, 2017, in line with our revenue growth.

 

Finance result

 

Finance result for the year ended December 31, 2018 was a finance cost, net of R$162.2 million, an increase of R$154.3 million, from a finance cost, net of R$7.9 million for the year ended December 31, 2017, for the reasons described below.

 

Finance income. Finance income for the year ended December 31, 2018 was R$36.6 million, an increase of R$24.1 million, or 192.8%, from R$12.5 million for the year ended December 31, 2017. This increase was mainly attributable to the interest generated from financial investments and by the increase in the fair value of our derivative financial instruments, comprising the put and call options of our business acquisitions and investments in associates and joint ventures.

 

Finance costs. Finance costs for the year ended December 31, 2018 was R$198.8 million, an increase of R$178.4 million, from R$20.4 million for the year ended December 31, 2017. This increase was primarily attributable to the foreign exchange rate variation on the proceeds we received from our IPO, which had an impact of R$34.1 million, and the fair value of our derivative financial instruments comprising the put and call options of our business acquisitions and investments in associates and joint ventures, primarily with respect to International School, which had an impact of R$130.4 million.

 

Share of loss of equity-accounted investees

 

Share of loss of equity-accounted investees for the year ended December 31, 2018 was a loss of R$0.8 million, as compared to a loss of R$0.7 million for the year ended December 31, 2017, mainly attributable to the performance of our equity-accounted investees.

 

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Profit (loss) before income taxes

 

For the reasons discussed above, for the year ended December 31, 2018, the loss before income taxes was R$100.9 million, a decrease of R$167.3 million, or 252.0%, from a profit of R$66.4 million for the year ended December 31, 2017.

 

Income taxes – income (expense)

 

Income taxes for the year ended December 31, 2018 were an income of R$18.0 million, a R$40.7 million difference between the R$22.7 million expense for the year ended December 31, 2017. The positive income tax was mainly attributable to the recognition of deferred tax credits over financial instruments from acquisition of interests.

 

Profit (loss) for the year

 

As a result of the foregoing, loss for the year ended December 31, 2018 was R$82.9 million, a decrease of R$126.5 million, or 290.1%, from a profit of R$43.6 million for the year ended December 31, 2017.

 

Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016

 

The following table sets forth our consolidated statements of income for the years ended December 31, 2017 and 2016:

 

   For the Year Ended December 31,
   2017  2016  Variation (%)
   (in R$ millions, except for
percentages)
Statement of Income Data:         
Net revenue    244.4    159.3    53.4 
Core(1)    219.0    159.3    37.5 
Supplemental(1)    25.4        n.m. 
Cost of sales    (58.5)   (41.3)   41.6 
Gross profit    185.9    117.9    57.6 
Selling expenses    (65.3)   (40.3)   62.0 
General and administrative expenses    (48.9)   (32.7)   49.9 
Other income (expenses), net    3.3    3.6    (8.5)
Operating profit    74.9    48.6    54.2 
Finance income    12.5    47.2    (73.4)
Finance costs    (20.4)   (1.8)   1030.8 
Finance result    (7.9)   45.4    (117.3)
Share of loss of equity-accounted investees    (0.7)   (1.1)   (36.5)
Profit before income taxes    66.4    92.8    (28.5)
Income taxes—income (expense)    (22.7)   (18.4)   23.2 
Current    (31.0)   (13.0)   139.3 
Deferred    8.3    (5.5)   (251.3)
Profit for the year    43.6    74.4    (41.3)
Profit (loss) attributable to:               
Equity holders of the parent    44.3    75.1    (41.1)
Non-controlling interests    (0.6)   (0.7)   (16.2)
                
 
(1)Our operating segments consist of our Core segment and our Supplemental segment. For further information, see note 23 to our audited consolidated financial statements as of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016.

 

Net revenue

 

Net revenue for the year ended December 31, 2017 was R$244.4 million, an increase of R$85.1 million, or 53.4%, from R$159.3 million for the year ended December 31, 2016.

 

This increase was primarily attributable to:

 

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(i)the positive impact of our organic growth through the addition of new partner schools and an increase in up-sales of our solutions, which resulted in a 21.4% increase in the total number of students enrolled at our partner schools, to 322,031 students distributed across our partner schools as of March 31, 2017, from 265,354 students distributed across our partner schools as of March 31, 2016.

 

(ii)the 14.5% increase in the average contractual fees per student that we charge our partner schools, to R$711.9 per student for the year ended December 31, 2017 from R$622.0 per student for the year ended December 31, 2016;

 

(iii)the consolidation of the results of operations of SAE into our financial statements starting in June 2016, as a result of our acquisition of a controlling interest in SAE on June 27, 2016; and

 

(iv)the consolidation of the results of operations of International School into our financial statements starting in January 2017, as a result of our acquisition of a controlling interest in International School on January 23, 2017.

 

In our Core segment, net revenue for the year ended December 31, 2017 was R$219.0 million, an increase of R$59.7 million, or 37.5%, from R$159.3 million for the year ended December 31, 2016.

 

This increase was primarily attributable to:

 

(i)the consolidation of the results of operations of SAE into our financial statements starting in June 2016, as a result of our acquisition of a controlling interest in SAE on June 27, 2016;

 

(ii)the 14.5% increase in the number of enrolled students at partner schools, to 303,950 enrolled students as of March 31, 2017, from 265,354 enrolled students as of March 31, 2016; and

 

(iii)the 10.6% overall increase in the average contractual fees per student payable by partner schools, to R$687.9 per student for the year ended December 31, 2017, from R$622.0 per student for the year ended December 31, 2016.

 

In our Supplemental segment, net revenue for the year ended December 31, 2017 was R$25.4 million, an increase of R$25.4 million, from no net revenue for the year ended December 31, 2016. We did not have a Supplemental segment prior to 2017. This increase was primarily attributable to the consolidation of the results of operations of International School into our financial statements starting in January 2017, as a result of our acquisition of a controlling interest in International School on January 23, 2017.

 

Cost of sales

 

Cost of sales for the year ended December 31, 2017 was R$58.5 million, an increase of R$17.2 million, or 41.6%, from R$41.3 million for the year ended December 31, 2016. This increase was primarily attributable to:

 

(i)a R$13.7 million, or 54.9%, increase in our content providing costs and freight costs, mainly attributable to the consolidation of SAE and International School into our financial statements starting in June 2016 and January 2017, respectively, as well as the overall increase in the production volume of our educational materials, as a result of the positive impact of our organic growth through the addition of new partner schools and an increase in up-sales of our solutions during the period; and

 

(ii)a R$1.8 million, or 19.6%, increase in operations personnel costs, mainly attributable to (i) the consolidation of SAE and International School into our financial statements starting in June 2016 and January 2017, and (ii) the 27.4% increase in the number of employees in our content and technology production team.

 

As a percentage of net revenue, our cost of sales decreased to 23.9% for the year ended December 31, 2017, compared to 25.9% for the year ended December 31, 2016. We expect these costs to continue to decrease as our products achieve greater scale going forward.

 

In our Core segment, cost of sales for the year ended December 31, 2017 was R$54.3 million, an increase of R$13.0 million, or 31.4%, from R$41.3 million for the year ended December 31, 2016. This increase was primarily attributable to the consolidation of the results of operations of SAE into our financial statements starting in June 2016, as a result of our acquisition of a controlling interest in SAE on June 27, 2016. As a percentage of net revenue in our Core segment, cost of sales decreased to 24.8% in 2017, compared to 25.9% in 2016.

 

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In our Supplemental segment, cost of sales for the year ended December 31, 2017 was R$4.2 million, an increase of R$4.2 million, from no cost of sales for the year ended December 31, 2016. This increase was primarily attributable to the consolidation of the results of operations of International School into our financial statements starting in January 2017 as a result of our acquisition of a controlling interest in International School on January 23, 2017. As a percentage of net revenue in our Supplemental segment, cost of sales represented 16.5% in 2017.

 

Gross profit

 

For the reasons discussed above, gross profit for the year ended December 31, 2017 was R$185.9 million, an increase of R$67.9 million, or 57.6%, from R$117.9 million for the year ended December 31, 2016. In our Core segment, gross profit for the year ended December 31, 2017 was R$164.6 million, an increase of R$46.7 million, or 39.6%, from R$117.9 million for the year ended December 31, 2016. In our Supplemental segment, gross profit for the year ended December 31, 2017 was R$21.2 million, an increase of R$21.2 million, from no gross profit for the year ended December 31, 2016.

 

Selling expenses

 

Selling expenses for the year ended December 31, 2017 were R$65.3 million, an increase of R$25.0 million, or 62.0%, from R$40.3 million for the year ended December 31, 2016. This increase was primarily attributable to the consolidation of SAE and International School into our financial statements starting in June 2016 and January 2017, respectively, resulting in:

 

(i)a R$10.1 million, or 61.0%, increase in sales personnel expenses mainly as a result of the increase in the number of employees in our sales team;

 

(ii)a R$3.2 million, or 53.3%, increase in sales and marketing expenses mainly as a result of marketing events aimed at strengthening our brands;

 

(iii)a R$4.1 million, or 101.6%, increase in customer support expenses; and

 

(iv)a R$5.3 million, or 117.5%, increase in amortization of intangible assets and depreciation of property and equipment.

 

In our Core segment, selling expenses for the year ended December 31, 2017 were R$56.3 million, an increase of R$16.0 million, or 39.7%, from R$40.3 million for the year ended December 31, 2016. This increase was primarily attributable to the consolidation of the results of operations of SAE into our financial statements starting in June 2016, as a result of our acquisition of a controlling interest in SAE on June 27, 2016, which increased our sales personnel expenses, and our sales and marketing and services expenses.

 

In our Supplemental segment, selling expenses for the year ended December 31, 2017 were R$9.0 million, an increase of R$9.0 million, from no selling expenses for the year ended December 31, 2016. This increase was primarily attributable to the consolidation of the results of operations of International School into our financial statements starting in January 2017, as a result of our acquisition of a controlling interest in International School on January 23, 2017, which increased our sales personnel expenses, and our sales and marketing and services expenses.

 

General and administrative expenses

 

General and administrative expenses for the year ended December 31, 2017 were R$48.9 million, an increase of R$16.3 million, or 49.9%, from R$32.7 million for the year ended December 31, 2016. The increase in general and administrative expenses was primarily attributable to:

 

(i)a R$9.9 million increase in corporate personnel expenses totaling R$24.6 million for the year ended December 31, 2017, mainly as a result of the consolidation of SAE and International School into our financial statements starting in June 2016 and January 2017, respectively, resulting in a 67.6% increase in our corporate personnel expenses due to the 37.3% increase in employees, from 603 employees in 2016, to 828 employees in 2017; and

 

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(ii)expenses related to the creation of our shared services center to centralize our administrative expenses across our business segments.

 

Operating profit

 

For the reasons discussed above, operating profit for the year ended December 31, 2017 was R$74.9 million, an increase of R$26.3 million, or 54.2%, from R$48.6 million for the year ended December 31, 2016.

 

Finance result

 

Finance result for the year ended December 31, 2017 was a finance cost, net of R$7.9 million, a change of R$53.2 million, or 117.3%, from a finance income, net of R$45.4 million for the year ended December 31, 2016, for the reasons described below.

 

Finance income. Finance income for the year ended December 31, 2017 was R$12.5 million, a decrease of R$34.6 million, or 73.4%, from R$47.2 million for the year ended December 31, 2016. This decrease was primarily attributable to the decrease in the fair value of our derivative financial instruments, comprised of the put and call options of our business acquisitions and investments in associates and joint ventures.

 

Finance costs. Finance costs for the year ended December 31, 2017 was R$20.4 million, an increase of R$18.6 million, from R$1.8 million for the year ended December 31, 2016. This increase was primarily attributable to the increase in the expenses from accounts payable to selling shareholders and the fair value of our derivative financial instruments, comprised of the put and call options of our business acquisitions and investments in associates and joint ventures.

 

Share of loss of equity-accounted investees

 

Share of loss of equity-accounted investees for the year ended December 31, 2017 was a loss of R$0.7 million, as compared to a loss of R$1.1 million for the year ended December 31, 2016, mainly attributable to a net loss as a result of our investment in WPensar, and a net loss in 2016 as a result of our investment in International School prior to our acquisition of a controlling interest in International School on January 23, 2017.

 

Profit before income taxes

 

For the reasons discussed above, profit before income taxes for the year ended December 31, 2017 was R$66.4 million, a decrease of R$26.5 million, or 28.5%, from R$92.8 million for the year ended December 31, 2016.

 

Income taxes

 

Income taxes expenses for the year ended December 31, 2017 was R$22.7 million, an increase of R$4.3 million, or 23.4%, from R$18.4 million for the year ended December 31, 2016. This increase was primarily attributable to an increase in our taxable income and certain of our subsidiaries generated revenues above R$78 million in 2017 and in 2016 were taxed pursuant to the presumed profit regime, which tax rate is lower than the 34% statutory tax rate.

 

Profit for the year

 

As a result of the foregoing, profit for the year ended December 31, 2017 was R$43.6 million, a decrease of R$30.8 million, or 41.4%, from R$74.4 million for the year ended December 31, 2016.

 

B.Liquidity and capital resources

 

As of December 31, 2018, we had R$823.5 million in cash and cash equivalents and financial investments. We believe that our current available cash and cash equivalents and financial investments and the cash flows from our operating activities will be sufficient to meet our working capital requirements and capital expenditures in the ordinary course of business for the next 12 months.

 

The following discussion of our liquidity and capital resources is based on the financial information derived from the audited consolidated financial statements included elsewhere in this annual report.

 

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Cash Flows

 

   For the Year Ended
December 31,
   2018  2017  2016
   (in thousands of reais)
Cash Flow Data         
Net cash flows from operating activities    92,124    62,650    41,237 
Net cash flows from (used in) investing activities    (780,964)   (77,269)   (24,921)
Net cash flows (used in) from financing activities    734,742    11,095    (12,641)

 

Operating Activities

 

Our net cash flows from operating activities increased to R$92.1 million in 2018, from R$62.7 million in 2017, a 47% increase. In 2017, it increased by 51.9%, from R$41.2 million in 2016. Our net cash flows from operating activities were positively affected by the positive impact of our organic growth through the addition of new partner schools and an increase in up-sales of our solutions during the period, which was partially offset by increases in payments to suppliers and personnel expenses.

 

Investing Activities

 

Our net cash flows from investing activities changed from net cash used in investing activities of R$77.3 million in the year ended December 31, 2017, to net cash used in investing activities of R$781.0 million in the year ended December 31, 2018, primarily due to the increase in financial investments in 2018 as a result of the net proceeds we received from our initial public offering in 2018. The net proceeds were invested in non-exclusive funds managed by highly rated financial institutions.

 

Our net cash flows used in investing activities increased from R$24.9 million of net cash flows used in investing activities in 2016, to R$77.3 million of net cash flows used in investing activities in 2017, primarily due to the R$29.0 million we paid to acquire NS Educação Ltda. on September 28, 2017, the R$8.0 million we paid to acquire an interest in Geekie in 2017, the R$17.4 million applied in financial investments in 2017, and the R$5.3 million in property and equipment expenditures in 2017.

 

Financing Activities

 

Our net cash flows used in financing activities for the year ended December 31, 2018 was R$734.7 million, compared to R$11.1 million for the year ended December 31, 2017, primarily due to the R$816.6 million in net proceeds we received from our initial public offering in 2018.

 

Our net cash flows used in financing activities in 2016 was R$12.6 million, compared to a net cash flow from financing activities of R$11.1 million in 2017, primarily due to a capital increase of R$86.1 million in 2017, which was partially offset by a dividend payment of R$75.1 million in 2017.

 

Indebtedness

 

As of December 31, 2018, we had no outstanding indebtedness.

 

Capital Expenditures

 

In the years ended December 31, 2018, 2017 and 2016 we made capital expenditures of R$36.2 million, R$11.4 million and R$7.2 million, respectively. These capital expenditures mainly include expenditures related to the acquisition of property and equipment and the acquisition of intangible assets. Our capital expenditures increased in 2018 as compared to 2017 mainly due to (i) investments made to comply with the BNCC amounting to R$9.6 million of capitalized personnel expenses, and R$7.7 million of acquired content; (ii) the capitalization of payroll expenses within the EdTech team related to internally developed technology for our platform amounting to R$5.3 million; and (iii) investments of R$3.1 million in our Supplemental solution.

 

We expect to increase our capital expenditures to support the growth in our business and operations. We expect to meet our capital expenditure needs for the foreseeable future from our operating cash flow, our existing cash and cash equivalents. Our future capital requirements will depend on several factors, including our growth rate, the expansion of our research and development efforts, employee headcount, marketing and sales activities, the introduction of new features to our existing products and the continued market acceptance of our products.

 

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C.Research and development, patents and licenses, etc.

 

See “Item 4. Information on the Company—D. Property, plant and equipment—Intellectual Property.”

 

D.Trend information

 

For a discussion of trend information, see “Item 4. Information on the Company—B. Business Overview—Underlying Trends.”

 

E.Off-balance sheet arrangements

 

As of December 31, 2018, we did not have any off-balance sheet arrangements.

 

F.Tabular disclosure of contractual obligations

 

The following is a summary of our contractual obligations as of December 31, 2018:

 

   Payments Due By Period as of December 31, 2018
   Less than
1 year
  1 – 3 years  3 – 5 years  More than
5 years
  Total
   (in thousands of reais)
Trade payables    14,845                14,845 
Operating leases    5,293    11,218    9,596    1,290    27,397 
Financial instruments from acquisition of interests(1)    51    3,009    22,037        25,097 
Accounts payable to selling shareholders    830    176,887    3,664        181,381 
Total    21,019    191,114    35,297    1,290    248,720 

 

 
(1)Includes (i) an option to acquire the remaining 91.95% of the outstanding share capital of Geekie in May 2022 pursuant to the share purchase agreement dated as of December 8, 2016, as part of our acquisition of our current 8.05% interest in the share capital of Geekie, and (ii) an option to acquire the remaining 75% of the outstanding share capital of WPensar between July 10, 2020 and July 10, 2021.

 

G.Safe harbor

 

See “Forward-Looking Statements.”

 

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A.Directors and senior management

 

We are managed by our board of directors and by our senior management, pursuant to our Articles of Association and the Cayman Islands Companies Law (as amended).

 

Board of Directors

 

As of December 31, 2018, our board of directors is composed of four members. By 2019, we expect the size of our board of directors to increase to five members. Each director holds office for the term, if any, fixed by the shareholders’ resolution that appointed him, or, if no term is fixed on the appointment of the director, until the earlier of his or her removal or vacation of office as a director in accordance with the Articles of Association. Directors appointed by the board of directors hold office until the next annual general meeting. Our directors do not have a retirement age requirement under our Articles of Association.

 

We do not have any service contracts with our executive directors that provide benefits upon termination of employment.

 

The following table presents the names of the current members of our board of directors.

 

Name 

Age 

Position 

Oto Brasil de Sá Cavalcante 72 Chairman
Ari de Sá Cavalcante Neto 39 Director
Martin Escobari 47 Independent Director*
Alberto Menache 45 Independent Director*

 

 
*Member of our Audit Committee.

 

The following is a brief summary of the business experience of our directors. Unless otherwise indicated, the current business addresses for our directors is Rua Augusta 2840, 9th floor, suite 91, Consolação, São Paulo - SP, 01.305-000, Brazil.

 

Oto Brasil de Sá Cavalcante is the Chairman of our board of directors, a position he has held since February 2018. Mr. Brasil de Sá Cavalcante has over 50 years’ experience in the education industry. In 2001, he founded Colégio Ari de Sá in Fortaleza, and has been the chairman of its board of directors since 2001. In 2013, he founded Faculdade Ari de Sá in Fortaleza, and has been its chief executive officer since 2013. He holds a bachelor’s degree in civil engineering from Universidade Federal do Ceará in Fortaleza.

 

Ari de Sá Cavalcante Neto is a member of our board of directors and our Chief Executive Officer, positions he has held since February 2018. He has been a member of the advisory committee at Colégio Ari de Sá since 2007. Mr. de Sá Cavalcante Neto was an associate at Ernst & Young from 1998 to 2000. He was the chief operating officer of Colégio Ari de Sá from 2001 to 2005, and was an associate at McKinsey & Company in 2006. He holds an MBA from the Massachusetts Institute of Technology (MIT).

 

Martin Escobari is a member of our board of directors, a position he has held since August 2018. He has been with General Atlantic since 2012, and is a member of its Executive Committee, is the Chair of its Investment Committee, and is the head of its Latin America business. Mr. Escobari serves on the board of directors of Empreendimentos Pague Menos SA, Invekra, S.A.P.I. de C.V. (d/b/a Laboratórios Sanfer, S.A. de C.V.), Grupo Axo, S.A.P.I. de C.V. and XP Investimentos, and has previously served on the boards of Ourofino Saude Animal Participações S.A., Sura Asset Management, Smiles S.A. Aceco TI Participaҫões S.A., Grupo Linx and Decolar.com, Inc. Mr. Escobari co-founded submarino.com and was its chief financial officer from 1999 to 2007. He was an associate at the Boston Consulting Group (New York) from 1994 to 1996, an investment officer at the private equity firm GP Investimentos from 1998 to 1999, and a managing director at Advent International from 2007 to 2011. Mr. Escobari holds a bachelor’s degree in economics from Harvard College (Harvard University) and an MBA (George F. Baker Scholar) from Harvard Business School. He serves on the board of Primeira Chance, a scholarship program for gifted children in Brazil and is active with Endeavor Brazil, where he mentors young entrepreneurs. Mr. Escobari is also a member of the Brazil office of Harvard’s Rockefeller Center for Latin American Studies.

 

Alberto Menache is a member of our board of directors, a position he has held since August 2018. Currently, he is the vice chairman and chief executive officer of Linx S.A., or Linx, a position he has held since November 2013. Prior to becoming vice chairman and chief executive officer, Mr. Menache held management positions at Linx in sales, marketing, human resources, IT and finance.

 

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Executive Officers

 

Our executive officers are responsible for the day-to-day management of our business and for implementing the general policies and directives established by our board of directors. We have a strong management team led by Ari de Sá Cavalcante Neto, our Chief Executive Officer, who has broad experience in the education industry. Many of the members of our management team have worked together as a team for many years. Our executive officers were appointed by our board of directors for an indefinite term.

 

The following table lists our current executive officers:

 

Name 

Age 

Position 

Ari de Sá Cavalcante Neto 39 Chief Executive Officer
David Peixoto dos Santos 31 Chief Financial Officer
João Cunha Silva 32 Chief Operating Officer

 

The following is a brief summary of the business experience of our executive officers. Unless otherwise indicated, the current business addresses for our executive officers is Rua Augusta 2840, 9th floor, suite 91, Consolação, São Paulo - SP, 01.305-000, Brazil.

 

David Peixoto dos Santos is our Chief Financial Officer and our Vice President of Business Development, positions he has held since March 2014. Prior to joining us, Mr. Peixoto dos Santos was an analyst at Credit Suisse from November 2011 to March 2014. He holds a law degree from Universidade de São Paulo, and participated in a student exchange program at Yale University.

 

João Cunha Silva is our Chief Operating Officer, a position he has held since January 2014. Prior to joining us, Mr. Cunha Silva was an associate at Boston Consulting Group from January 2008 to September 2009. He holds a bachelor’s degree in computer engineering from Universidade Estadual de Campinas (Unicamp), in Campinas, São Paulo, and a certificate from the Executive Leadership Development program at Stanford University.

 

Family Relationships

 

Oto Brasil de Sá Cavalcante, our Chairman, is the father of Ari de Sá Cavalcante Neto, our Chief Executive Officer.

 

Directors’ and Officers’ Insurance

 

We have contracted civil liability insurance coverage for acts carried out by our directors and executive officers in the course of their duties.

 

B.Compensation

 

Compensation of Directors and Officers

 

Under Cayman Islands law, we are not required to disclose compensation paid to our senior management on an individual basis and we have not otherwise publicly disclosed this information elsewhere.

 

Our executive officers, directors and management receive fixed and variable compensation. They also receive benefits in line with market practice in Brazil. The fixed component of their compensation is set on market terms and adjusted annually.

 

The variable component consists of cash bonuses and awards of shares (or the cash equivalent). Cash bonuses or paid to executive officers and members of our management based on previously agreed targets for the business. Shares (or the cash equivalent) are awarded under our share options long-term incentive program, as discussed below.

 

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Long-Term Incentive Plan (LTIP) and Share-based Compensation

 

LTIP I

 

Certain members of our management participate in our share option long-term incentive program, or the LTIP I. Beneficiaries under the LTIP I are granted rights to buy shares based on certain criteria. These rights vest in five equal annual installments starting one year after the beneficiary’s grant date, the earliest of which was on December 22, 2014, for a 10-year term expiring on December 22, 2024. If a beneficiary is dismissed by us, resigns, retires, suffers a permanent disability or dies, the portion of his or her rights under the LTIP I that has vested at that date will be satisfied, and the beneficiary will have a term of 90 days in the case of dismissal, resignation or retirement, or 180 days in case of death or permanent disability, to exercise any vested but unexercised options, but the non-vested portion will be canceled. If a beneficiary is terminated for cause, the non-vested portion will be immediately canceled, and all vested but unexercised options may be exercised by the beneficiary on the day of termination. In the case of transfer of the control of Arco, which is defined under the plan as a transfer of an equity interest of at least 50% plus one share of the capital stock of Arco, all unvested share options will automatically vest.

 

Any shares that are issued on a subsequent vesting date during the one year after our initial public offering will be subject to the remainder of that same lock-up period, expiring one year after the closing of our initial public offering. After the close of that one-year period, shares to be issued under the program will no longer be subject to a lock-up.

 

The maximum number shares that can be issued to beneficiaries under the LTIP I may not exceed 5% of our share capital at any time.

 

Following the completion of our initial public offering in September 2018, all the options of the LTIP I were migrated to Arco and automatically vested, generating an expense in our consolidated statement of income (loss) of R$59,747 thousand in 2018 (compared to an expense of R$1,359 thousand in 2017 and an expense of R$2,043 thousand in 2016).

 

As of December 31, 2018, Arco had a total of 1,091,038 vested share options (compared to 848,642 vested share options of EAS as of December 31, 2017 and 565,762 as of December 31, 2016). In January 2019, one LTIP I participant exercised his option to acquire 98,522 shares, which were delivered to the participant in February 2019 through a capital increase.

 

C.Board practices

 

Committees of the Board of Directors

 

Our board of directors has one standing committee: the Audit Committee.

 

Audit Committee

 

The audit committee, which consists of Ari de Sá Cavalcante Neto, Martin Escobari and Alberto Menache, assists our board of directors in overseeing our accounting and financial reporting processes and the audits of our financial statements. In addition, the audit committee is directly responsible for the appointment, compensation, retention and oversight of the work of our independent registered public accounting firm. Ari de Sá Cavalcante Neto serves as Chairman of the audit committee. The audit committee consists exclusively of members of our board of directors who are financially literate, and Alberto Menache is considered an “audit committee financial expert” as defined by the SEC. Our board of directors has determined that Martin Escobari and Alberto Menache satisfy the “independence” requirements set forth in Rule 10A-3 under the Exchange Act.

 

The audit committee is governed by a charter that complies with Nasdaq rules. The audit committee is responsible for, among other matters:

 

·the appointment, compensation, retention and oversight of any auditor or accounting firm engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attest services;

 

·pre-approving the audit services and non-audit services to be provided by our independent auditor before the auditor is engaged to render such services;

 

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·reviewing and discussing with the independent auditor its responsibilities under generally accepted auditing standards, the planned scope and timing of the independent auditor’s annual audit plan(s) and significant findings from the audit;

 

·obtaining and reviewing a report from the independent auditor describing all relationships between the independent auditor and the Company consistent with the applicable PCAOB requirements regarding the independent auditor’s communications with the audit committee concerning independence;

 

·confirming and evaluating the rotation of the audit partners on the audit engagement team as required by law;

 

·reviewing with management and the independent auditor, in separate meetings whenever the Audit Committee deems appropriate, any analyses or other written communications prepared by the Management and/or the independent auditor setting forth significant financial reporting issues and judgments made in connection with the preparation of the financial statements, including analyses of the effects of alternative IFRS methods on the financial statements; and other critical accounting policies and practices of the Company;

 

·reviewing, in conjunction with the Chief Executive Officer and Chief Financial Officer of the Company, the Company’s disclosure controls and procedures and internal control over financial reporting;

 

·establishing procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal accounting controls or auditing matters, and the confidential, anonymous submission by employees of the Company of concerns regarding questionable accounting or auditing matters; and

 

·approving or ratifying any related person transaction (as defined in our related person transaction policy) in accordance with our related person transaction policy.

 

The audit committee meets as often as it determines is appropriate to carry out its responsibilities, but in any event, meets at least four times per year.

 

D.Employees

 

As of December 31, 2018, 2017 and 2016, we had 1,198, 828 and 603 employees, respectively. As of December 31, 2018, 590 of these employees were based in our offices in Fortaleza, and 608 were based in cities elsewhere in Brazil. As of December 31, 2018, 2017 and 2016, we had 122, 90 and 52 sales professionals, respectively. We also engage temporary employees and consultants as needed to support our operations.

 

The table below breaks down our full-time personnel by function as of December 31, 2018:

 

Function  Number of
Employees
  % of Total
Management    26    2.2 
Technology and Content Development    344    28.7 
Sales and Marketing    308    25.7 
Customer Support    238    19.9 
General and Administrative    282    23.5 
Total    1,198    100.0 

 

Our employees are represented by labor unions through collective agreements (convenções coletivas) they have with such labor unions. These collective agreements are renegotiated annually. We have not experienced any work stoppages, and we consider our relations with our employees to be good.

 

None of our executive officers have entered into employment agreements with the Company. We do not have any service contracts with our executive directors that provide benefits upon termination of employment.

 

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E.Share ownership

 

The shares and any outstanding beneficially owned by our directors and officers and/or entities affiliated with these individuals are disclosed in “Item 7. Major Shareholders and Related Party Transactions—A. Major shareholders.”

 

See “Item 6. Directors, Senior Management and Employees—B. Compensation—Long-Term Incentive Plan (LTIP)” for information on our share option long-term incentive program.

 

 

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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A.Major shareholders

 

The following table and accompanying footnotes presents information relating to the beneficial ownership of our Class A common shares and Class B common shares as of December 31, 2018.

 

The number of common shares beneficially owned by each entity, person, executive officer or director is determined in accordance with the rules of the SEC, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rules, beneficial ownership includes any shares over which the individual has sole or shared voting power or investment power as well as any shares that the individual has the right to acquire within 60 days through the exercise of any option, warrant or other right. Except as otherwise indicated, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all common shares held by that person.

 

The percentages of beneficial ownership in the table below are calculated as of December 31, 2018 on the basis of (i) 22,602,737 Class A common shares outstanding and 1,091,038 Class A common shares deemed outstanding and subject to options exercisable within 60 days, and (ii) 27,658,290 Class B common shares outstanding. In addition to the shares detailed below, we have a total of 12,777,777 Class A shares outstanding that are publicly traded as of December 31, 2018.

 

Unless otherwise indicated below, the address for each beneficial owner is c/o Arco, Rua Augusta 2840, 9th floor, suite 91, Consolação, São Paulo - SP, 01.305-000, Brazil.

 

   Shares Beneficially Owned as of December 31, 2018  % of Total
Voting Power(1)
   Class A  Class B   
Shareholders  Shares  %  Shares  %   
5% Shareholders               
Ari de Sá Cavalcante Neto(2)    483,487    2.0%   8,297,485    30.0%   27.6%
Oto Brasil de Sá Cavalcante(3)        %   19,224,395    69.5%   64.0%
General Atlantic Arco (Bermuda), L.P.    9,725,235    41.0%       %   3.2%
Other Shareholders                         
Other Shareholders        %   136,410    *%   *%
Executive Officers and Directors                         
Ari de Sá Cavalcante Neto(2)    483,487    2.0%   8,297,485    30.0%   27.6%
Oto Brasil de Sá Cavalcante(3)             19,224,395    69.5%   64.0%
Alberto Menache(4)   99,725    *%       %   *%
All directors and executive officers as a group (6 persons)(5)    1,190,763    5.0%   27,521,880    99.5%   *%
Total    10,915,998    100.0%   27,658,290    100.0%   100.0%

 

 
*Represents beneficial ownership of less than 1% of our issued and outstanding common shares.

 

(1)Percentage of total voting power represents voting power with respect to all of our Class A common shares and Class B common shares, as a single class. Holders of our Class B common shares are entitled to 10 votes per share, whereas holders of our Class A common shares are entitled to one vote per share. For more information about the voting rights of our Class A common shares and Class B common shares, see “Item 10. Additional Information—B. Memorandum and articles of association.”

 

(2)Indirectly owns Class B common shares through ASCN Investments Ltd. Includes 483,487 Class A common shares subject to options exercisable by Mr. de Sá Cavalcante Neto within 60 days.

 

(3) Indirectly owns Class B common shares through OSC Investments Ltd.

 

(4)Indirectly owns Class A common shares through Alfaco Holding Inc.

 

(5)Includes 1,091,038 Class A common shares subject to options exercisable within 60 days.

 

The holders of our Class A common shares and Class B common shares have identical rights, except that our Founding Shareholders as holders of Class B common shares (i) are entitled to 10 votes per share, whereas holders of our Class A common shares are entitled to one vote per share (ii) have certain conversion rights and (iii) are entitled to maintain a proportional ownership interest by purchasing additional Class B common shares in the event that additional Class A common shares are issued. For more information see “Item 10. Additional Information—B. Memorandum and articles of association—Preemptive or Similar Rights” and “Item 10. Additional Information—B. Memorandum and articles of association —Conversion.” Each Class B common share is convertible into one Class A common share.

 

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B.Related party transactions

 

Educational Agreement—International School Program

 

On August 2, 2016, Educadora ASC Ltda., or Educadora ASC, entered into an agreement with International School, pursuant to which International School agreed to (i) make available to Educadora ASC an educational platform that it developed, and (ii) supply to Educadora ASC the related materials, and Educadora ASC agreed to pay certain fees to International School in connection therewith. The agreement expires on December 31, 2019. The net revenue from sales to Educadora ASC totaled R$2.7 million and R$3.5 million for the years ended December 31, 2018 and 2017.

 

Development and Promotion of Educational Materials Agreement

 

On August 29, 2014, Educadora ASC and Livraria ASC Ltda., or Livraria ASC, entered into an agreement with SAS Desenvolvimento e Promoção de Material Didático, or SAS, pursuant to which (i) SAS agreed to (a) make available to Educadora ASC and Livraria ASC an educational platform that it developed, and (b) supply to Educadora ASC and Livraria ASC the related materials, and (ii) Educadora ASC agreed to promote the educational platform and share its expertise in educational management with SAS, and Educadora ASC and Livraria ASC agreed to pay certain fees to SAS in connection therewith.

 

The agreement is for an initial term of 10 years, and will be automatically renewed for an additional 5 years or 10 years respectively, should there be a change of control or initial public offering of EAS Brazil or any of the companies in SAS’s economic group. The net revenue from sales to Educadora ASC totaled R$0.4 million and R$0.2 million for the years ended December 31, 2018 and 2017, respectively. The net revenue from sales to Livraria ASC totaled R$5.1 million and R$5.2 million for the years ended December 31, 2018 and 2017, respectively.

 

Loan Agreement with WPensar

 

EAS Brazil is party to a loan agreement with WPensar in the amount of R$1.2 million and R$1.0 million as of December 31, 2018 and 2017, respectively. The loan accrues interest at the Brazilian Sistema Especial de Liquidação e Custódia (SELIC) rate and matures in July 2020.

 

Loan and Debentures Agreements with Geekie

 

On January 17, 2019, we entered into an agreement (the “Geekie Agreement”) with Geekie, our associated company. Pursuant to the Geekie Agreement, we purchased 100,000 debentures issued by Geekie, each at par value R$100.00, totaling R$10 million. The debentures mature in June 2022 and bears interest at 110% of the CDI. The debentures are convertible at the option of Arco on maturity through the call and put option mechanism in our investment agreement with Geekie, as described in note 11 to our audited consolidated financial statements.

 

In addition and pursuant to the Geekie Agreement, we lent R$4.0 million to Geekie Partners S.A., the controlling entity of Geekie. The loan is repayable in a single instalment in June 2022, bears interest at 110% of the CDI, and is secured by the shares of Geekie Partners S.A. in Geekie.

 

The transaction totaled R$14.0 million and its purpose was to support Geekie’s working capital needs.

 

Lease Agreements

 

On July 28, 2014, OSC Empreendimentos Ltda., an entity under common control of our controlling shareholder, entered into a lease agreement with SAS Desenvolvimento Educacional Ltda., pursuant to which OSC Empreendimentos Ltda. agreed to lease office space to SAS Desenvolvimento Educacional Ltda. in the city of Fortaleza. The agreement was for an initial term of 2 years and was subsequently tacitly extended for an indefinite term.

 

Although the lease agreements indicated above were executed among related parties, pursuant to Law 8,245/1991, whenever a lease agreement’s term expires yet remains tacitly in force for an indefinite term, any party can terminate the lease agreement, upon a 30-day prior notice to the other party. If required to vacate the property, tenants may incur relocation costs and loss of revenue during relocation.

 

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See note 10 to the audited consolidated financial statements included elsewhere in this annual report for further information.

 

Sale of Escola de Aplicação São José dos Campos Ltda.

 

On January 2, 2019, we sold the shares we owned in Escola de Aplicação São José dos Campos Ltda. to its minority shareholders. The transaction price of R$3,741 thousand will be paid in sixteen quarterly installments from January 2022 to October 2025, adjusted by the IGP-M.

 

Indemnification Agreements

 

We have entered into indemnification agreements with each of our directors and officers. Pursuant to these agreements, we have agreed to indemnify and hold harmless each director and officer to the full extent permitted by applicable law in the event of any claim made against him or her in any proceeding due to the fact that he or she is or was a director or officer of our company or served at our request as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise.

 

In addition, under the terms of these agreements we have agreed to cover all expenses actually and reasonably incurred by each director and officer in connection with any such proceeding, with certain limited exceptions.

 

The indemnification extends to the beneficiary’s services as a director or officer prior to the date of the indemnification agreement as well as afterward. It continues after the beneficiary ceases to be a director or officer.

 

C.Interests of Experts and Counsel

 

Not applicable.

 

 

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ITEM 8. FINANCIAL INFORMATION

 

A.Consolidated statements and other financial information

 

Financial statements

 

See ‘‘Item 18. Financial Statements,’’ which contains our audited financial statements prepared in accordance with IFRS.

 

Dividends and Dividend Policy

 

We have not adopted a dividend policy with respect to future distributions of dividends. The amount of any distributions will depend on many factors such as our results of operations, financial condition, cash requirements, prospects and other factors deemed relevant by our board of directors and, where applicable, our shareholders. We currently intend to retain all available funds and any future earnings, if any, to fund the development and expansion of our business and we do not anticipate paying any cash dividends in the foreseeable future.

 

Subject to the Companies Law, Arco’s shareholders may, by resolution passed by a simple majority of the voting rights entitled to vote at a general meeting, declare dividends (including interim dividends) to be paid to shareholders but no dividend shall be declared in excess of the amount recommended by the board of directors. The board of directors may also declare dividends. Dividends may be declared and paid out of funds lawfully available to Arco. Except as otherwise provided by the rights attached to shares and the Articles of Association of Arco, all dividends shall be paid in proportion to the number of Class A common shares or Class B common shares a shareholder holds at the date the dividend is declared (or such other date as may be set as a record date); but, (i) if any share is issued on terms providing that it shall rank for dividend as from a particular date, that share shall rank for dividend accordingly, and (ii) where we have shares in issue which are not fully paid up (as to par value) we may pay dividends in proportion to the amounts paid up on each share.

 

The holders of Class A common shares and Class B common shares shall be entitled to share equally in any dividends that may be declared in respect of Arco’s common shares from time to time. In the event that a dividend is paid in the form of Class A common shares or Class B common shares, or rights to acquire Class A common shares or Class B common shares, (1) the holders of Class A common shares shall receive Class A common shares, or rights to acquire Class A common shares, as the case may be; and (2) the holders of Class B common shares shall receive Class B common shares, or rights to acquire Class B common shares, as the case may be.

 

We have not declared or paid any dividends to our shareholders since our incorporation in the Cayman Islands on April 12, 2018. However, EAS Brazil, our principal operating company and the wholly-owned subsidiary of Arco Brazil at that time, paid significant dividends to the shareholders of EAS Brazil, including R$13.5 million in February 2016 and R$75.0 million in September 2017.

 

In addition, a dividend payment of R$10.5 million (based on EAS Brazil’s net profit for the year ended December 31, 2017, and pursuant to the Brazilian Corporate Law which requires EAS Brazil to pay a minimum dividend equal to 25% of its net profit for the year) which was declared by the management of EAS Brazil was approved at the EAS Shareholders’ Meeting, and paid to the shareholders of EAS Brazil on June 25, 2018. In addition, EAS Brazil approved an additional dividend of R$74.5 million on June 7, 2018, which was paid to the shareholders of EAS Brazil on June 25, 2018.

 

Certain Cayman Islands and Brazilian Legal Requirements Related to Dividends

 

Under the Companies Law and our Articles of Association, a Cayman Islands company may pay a dividend out of either its profit or share premium account, but a dividend may not be paid if this would result in the company being unable to pay its debts as they fall due in the ordinary course of business. According to our Articles of Association, dividends can be declared and paid out of funds lawfully available to us, which include the share premium account. Dividends, if any, would be paid in proportion to the number of common shares a shareholder holds. For further information, see “Item 10. Additional Information—E. Taxation—Cayman Islands Tax Considerations.”

 

Additionally, please refer to “Item 3. D. Risk Factors—Certain Factors Relating to Our Business and Industry—We depend on dividend distributions by our subsidiaries, and we may be adversely affected if the performance of our subsidiaries is not positive or if Brazil imposes legal restrictions on dividend distributions by subsidiaries.” Our ability to pay dividends is directly related to positive and distributable net results from our

 

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Brazilian subsidiaries. If, for any legal reasons due to new laws or bilateral agreements between countries, they are unable to pay dividends to Cayman Islands companies, or if a Cayman Islands company becomes incapable of receiving them, we may not be able to make any dividend payments in the future.

 

Legal proceedings

 

We are, and may be from time to time, involved in disputes that arise in the ordinary course of our business. Claims against us can be time-consuming, result in costly litigation, require significant management time and result in the diversion of significant operational resources.

 

In particular, we are subject to a number of judicial and administrative proceedings in the Brazilian court systems, including civil, labor and tax law claims and other proceedings. We recognize provisions for legal proceedings in our financial statements when (i) it is probable that an outflow of resources will be required to settle the obligation, and (ii) a reliable estimate can be made of the amount of the obligation. The assessment by our management of the likelihood of loss includes analysis by outside counsel of available evidence, the hierarchy of laws, available case law, recent court rulings and their relevance in the Brazilian legal system. Our provisions for probable losses arising from these matters are estimated and periodically adjusted by management. In making these adjustments, our management relies on the opinions of our external legal advisors.

 

As of December 31, 2018, we had a provision for legal proceedings of R$131,000 recorded in our financial statements in connection with legal proceedings, based on the advice of our external legal counsel that the likelihood of loss in connection with such proceedings was not probable. However, legal proceedings are inherently unpredictable and subject to significant uncertainties. If one or more cases were to result in a judgment against us in any reporting period for amounts that exceeded our management’s expectations, the impact on our operating results or financial condition for that reporting period could be material. See ‘‘Item 3. Key Information—D. Risk Factors—Certain Factors Relating to Our Business and Industry—Unfavorable decisions in our legal, arbitration or administrative proceedings may adversely affect us.”

 

Civil Matters

 

As of December 31, 2018, we were party to approximately 16 judicial and administrative proceedings of a civil nature for which we did not record any provision based on the advice of our external legal counsel that the likelihood of loss in connection with these proceedings was not probable. The civil claims to which we are a party generally relate to consumer claims, including those related to the early termination of certain of our agreements, among others. We believe these proceedings are unlikely to have a material adverse impact, individually, or in the aggregate, on our results of operations or financial condition.

 

In 2018, we were party to four administrative proceedings filed by each of the prosecutor’s offices in the State of Ceará, in the State of Rio de Janeiro, in the Municipality of Lavras, State of Minas Gerais and in the State of Paraiba, for which the proceedings in the State of Ceará and State of Rio de Janeiro are still under discussion as of December 31, 2018. Each proceeding stems from a complaint filed by either parents of students in one of our partner schools or by lawyers on behalf of students in one of our partner schools. Each complaint alleges that the students in their respective partner schools are required to purchase our educational material from such partner schools at prices higher than those charged by certain of our other partner schools, with no option to purchase such educational material at bookstores or other points of sale. In each of the proceedings in the State of Ceará and the State of Rio de Janeiro, we have filed our defenses, which are currently under review.

 

Regarding the proceeding in the State of Paraiba, we have filed our defense and on November 19, 2018, the prosecutor’s office decided not to proceed with the administrative proceeding as it did not identify any consumer rights violations. The parents did not appeal in the permitted period and the case was closed.

 

In the proceeding in the Municipality of Lavras, the prosecutor’s office analyzed the complaint along with the defenses presented and decided not to proceed with the administrative proceeding as it did not identify any consumer rights violations. The parents then filed an appeal, and on September 29, 2018, the prosecutor’s office decided not to proceed with the case as it did not identify any consumer rights violations.

 

To the extent the prosecutors’ offices decide to proceed with the administrative proceedings in the State of Ceará and in the State of Rio de Janeiro, they may file a public civil claim or require the parties to enter into a settlement agreement (Termo de Ajustamento de Conduta - TAC), requiring the partner schools to adjust their commercial practices as they relate to the sale of educational material. As of December 31, 2018, we cannot estimate the amount of any eventual fine or any claim for damages, or collective non material damages that may be imposed on us as a result of these proceedings.

 

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Labor Matters

 

As of December 31, 2018, we were party to approximately 10 labor-related judicial and administrative proceedings for which we did not record any provision based on the advice of our external legal counsel that the likelihood of loss in connection with these proceedings was not probable. In general, the labor claims to which we are a party were filed by former employees or third-party employees seeking our joint and/or subsidiary liability for the acts of our suppliers and service providers. The principal claims involved in these labor suits relate to overtime, salary equalization termination fees, and indemnities based on Brazilian labor laws. We believe these proceedings are unlikely to have a material adverse impact, individually or in the aggregate, on our results of operations or financial condition.

 

Tax and Social Security Matters

 

As of December 31, 2018, we were party to 4 administrative tax and social security proceeding for which we did not record any provision based on the advice of our external legal counsel that the likelihood of loss in connection with this proceeding was not probable.

 

B.Significant changes

 

None.

 

 

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ITEM 9. THE OFFER AND LISTING

 

A.Offering and listing details

 

Not applicable.

 

B.Plan of distribution

 

Not applicable.

 

C.Markets

 

On September 28, 2018, we completed our initial public offering. Our common shares have been listed on the Nasdaq Global Select Market since September 26, 2018 under the symbol “ARCE.”

 

The table below presents, for the periods indicated, the high and low closing prices of our Class A common shares on Nasdaq.

 

   Class A Common Shares
   High  Low
   (U.S.$ per share)
MONTHLY PRICE HISTORY      
September 2018    25.59    22.23 
October 2018    24.00    20.20 
November 2018    24.50    20.50 
December 2018    24.80    17.68 
January 2019    26.47    20.35 
February 2019    27.47    22.41 
March 2019    32.29    23.43 
April 2019 (through April 15, 2019)

   33.42    31.30 

 

D.Selling shareholders

 

Not applicable.

 

E.Dilution

 

Not applicable.

 

F.Expenses of the issue

 

Not applicable.

 

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ITEM 10. ADDITIONAL INFORMATION

 

A.Share capital

 

Not applicable.

 

B.Memorandum and articles of association

 

Our shareholders adopted the Articles of Association included as Exhibit 3.1 to the Amendment No. 1 to our registration statement on Form F-1 (File no. 333-227007), filed with the SEC on September 12, 2018.

 

Share Capital

 

The Memorandum and Articles of Association authorize two classes of common shares: Class A common shares, which are entitled to one vote per share, and Class B common shares, which are entitled to 10 votes per share and to maintain a proportional ownership interest in the event that additional Class A common shares are issued. Any holder of Class B common shares may convert his or her shares at any time into Class A common shares on a share-for-share basis. The rights of the two classes of common shares are otherwise identical, except as described below. The implementation of this dual class structure was required by Oto Brasil de Sá Cavalcante and Ari de Sá Cavalcante Neto, our principal shareholders, as a condition of undertaking an initial public offering of our common shares. See “—Anti-Takeover Provisions in our Articles of Association—Two Classes of Shares.”

 

As of December 31, 2018, Arco had a total issued share capital of US$2,513.05, divided into 50,261,027 common shares. Those common shares are divided into 22,602,737 issued Class A common shares and 27,658,290 Class B common shares.

 

Treasury Shares

 

As of December 31, 2018, Arco had no shares in treasury.

 

Issuance of Shares

 

Except as expressly provided in Arco’s Articles of Association, Arco’s board of directors has general and unconditional authority to allot, grant options over, offer or otherwise deal with or dispose of any unissued shares in the company’s capital without the approval of our shareholders (whether forming part of the original or any increased share capital), either at a premium or at par, with or without preferred, deferred or other special rights or restrictions, whether in regard to dividend, voting, return of capital or otherwise and to such persons, on such terms and conditions, and at such times as the directors may decide, but so that no share shall be issued at a discount, except in accordance with the provisions of the Companies Law. In accordance with its Articles of Association, Arco shall not issue bearer shares.

 

Arco’s Articles of Association provide that at any time that there are Class A common shares in issue, additional Class B common shares may only be issued pursuant to (1) a share split, subdivision of shares or similar transaction or where a dividend or other distribution is paid by the issue of shares or rights to acquire shares or following capitalization of profits, (2) a merger, consolidation, or other business combination involving the issuance of Class B common shares as full or partial consideration, or (3) an issuance of Class A common shares, whereby holders of the Class B common shares are entitled to purchase a number of Class B common shares that would allow them to maintain their proportional ownership interests in Arco (following an offer by Arco to each holder of Class B common shares to issue to such holder, upon the same economic terms and at the same price, such number of Class B common shares as would ensure such holder may maintain a proportional ownership interest in Arco pursuant to Arco’s Articles of Association). In light of: (a) the above provisions; (b) the fact that future transfers by holders of Class B common shares will generally result in those shares converting to Class A common shares, subject to limited exceptions as provided in the Memorandum and Articles of Association; and (c) the ten-to-one voting ratio between our Class B common shares and Class A common shares, means that holders of our Class B common shares will in many situations continue to maintain control of all matters requiring shareholder approval. This concentration of ownership and voting power will limit or preclude your ability to influence corporate matters for the foreseeable future. For more information see “—Preemptive or Similar Rights.”

 

Arco’s Articles of Association also provide that the issuance of non-voting common shares requires the affirmative vote of a majority of the of then-outstanding Class A common shares.

 

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Fiscal Year

 

Arco’s fiscal year begins on January 1 of each year and ends on December 31 of the same year.

 

Voting Rights

 

The holders of the Class A common shares and Class B common shares have identical rights, except that (i) the holder of Class B common shares is entitled to 10 votes per share, whereas holders of Class A common shares are entitled to one vote per share, (ii) Class B common shares have certain conversion rights and (iii) the holder of Class B common shares is entitled to maintain a proportional ownership interest in the event that additional Class A common shares are issued. For more information see “—Preemptive or Similar Rights” and “—Conversion.” The holders of Class A common shares and Class B common shares vote together as a single class on all matters (including the election of directors) submitted to a vote of shareholders, except as provided below and as otherwise required by law.

 

Arco’s Articles of Association provide as follows regarding the respective rights of holders of Class A common shares and Class B common shares:

 

(i)Class consents from the holders of Class A common shares or Class B common shares, as applicable, shall be required for any variation to the rights attached to their respective class of shares, however, the Directors may treat any two or more classes of shares as forming one class if they consider that all such classes would be affected in the same way by the proposal;

 

(ii)the rights conferred on holders of Class A common shares shall not be deemed to be varied by the creation or issue of further Class B common shares and vice versa; and

 

(iii)the rights attaching to the Class A common shares and the Class B common shares shall not be deemed to be varied by the creation or issue of shares with preferred or other rights, including, without limitation, shares with enhanced or weighted voting rights.

 

As set forth in the Articles of Association, the holders of Class A common shares and Class B common shares, respectively, do not have the right to vote separately if the number of authorized shares of such class is increased or decreased. Rather, the number of authorized Class A common shares and Class B common shares may be increased or decreased (but not below the number of shares of such class then outstanding) by the affirmative vote of the holders of a majority of the voting power of the issued and outstanding Class A common shares and Class B common shares, voting together in a general meeting.

 

Preemptive or Similar Rights

 

The Class A common shares and Class B common shares are not entitled to preemptive rights upon transfer and are not subject to conversion (except as described below under “—Conversion”), redemption or sinking fund provisions.

 

The Class B common shares are entitled to maintain a proportional ownership interest in the event that additional Class A common shares are issued. As such, except for certain exceptions, if Arco issues Class A common shares, it must first make an offer to each holder of Class B common shares to issue to such holder, upon the same economic terms and at the same price, such number of Class B common shares as would ensure such holder may maintain a proportional ownership interest in Arco. This right to maintain a proportional ownership interest may be waived by the holders of a majority of the Class B common shares.

 

Conversion

 

The outstanding Class B common shares are convertible at any time as follows: (1) at the option of the holder, a Class B common share may be converted at any time into one Class A common share or (2) upon the election of the holders of a majority of the then outstanding Class B common shares, all outstanding Class B common shares may be converted into a like number of Class A common shares. In addition, each Class B common share will convert automatically into one Class A common share upon any transfer, whether or not for value, except for certain transfers described in the Articles of Association, including transfers to affiliates, transfers to and between the Founding Shareholders, their family members and their respective heirs and successors, trusts solely for the benefit of the shareholder or their affiliates, and partnerships, corporations and other entities exclusively owned by the shareholder or their affiliates and certain transfers to organizations that are exempt from taxation under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended. Furthermore, each Class B common share will convert automatically into one Class A common share and no Class B common shares will be issued thereafter if, at any time, the total number of the issued and outstanding Class B common shares is less than 10% of the total number of shares outstanding.

 

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No class of Arco’s common shares may be subdivided or combined unless the other class of common shares is concurrently subdivided or combined in the same proportion and in the same manner.

 

Equal Status

 

Except as expressly provided in Arco’s Articles of Association, Class A common shares and Class B common shares have the same rights and privileges and rank equally, share ratably and are identical in all respects as to all matters. In the event of any merger, consolidation, scheme, arrangement or other business combination requiring the approval of our shareholders entitled to vote thereon (whether or not Arco is the surviving entity), the holders of Class A common shares shall have the right to receive, or the right to elect to receive, the same form of consideration as the holders of Class B common shares, and the holders of Class A common shares shall have the right to receive, or the right to elect to receive, at least the same amount of consideration on a per share basis as the holders of Class B common shares. In the event of any (1) tender or exchange offer to acquire any Class A common shares or Class B common shares by any third-party pursuant to an agreement to which Arco is a party, or (2) any tender or exchange offer by Arco to acquire any Class A common shares or Class B common shares, the holders of Class A common shares shall have the right to receive, or the right to elect to receive, the same form of consideration as the holders of Class B common shares, and the holders of Class A common shares shall have the right to receive, or the right to elect to receive, at least the same amount of consideration on a per share basis as the holders of Class B common shares.

 

Record Dates

 

For the purpose of determining shareholders entitled to notice of, or to vote at any general meeting of shareholders or any adjournment thereof, or shareholders entitled to receive dividend or other distribution payments, or in order to make a determination of shareholders for any other purpose, Arco’s board of directors may set a record date which shall not exceed forty (40) clear days prior to the date where the determination will be made.

 

General Meetings of Shareholders

 

As a condition of admission to a shareholders’ meeting, a shareholder must be duly registered as a shareholder of Arco at the applicable record date for that meeting and, in order to vote, all calls or installments then payable by such shareholder to Arco in respect of the shares that such shareholder holds must have been paid.

 

Subject to any special rights or restrictions as to voting then attached to any shares, at any general meeting every shareholder who is present in person or by proxy (or, in the case of a shareholder being a corporation, by its duly authorized representative not being himself or herself a shareholder entitled to vote) shall have one vote per Class A common share and 10 votes per Class B common share.

 

As a Cayman Islands exempted company, Arco is not obliged by the Companies Law to call annual general meetings; however, the Articles of Association provide that in each year the company will hold an annual general meeting of shareholders, at a time determined by the board of directors, provided that the board of directors of Arco has the discretion whether or not to hold an annual general meeting in 2018. For the annual general meeting of shareholders the agenda will include, among other things, the presentation of the annual accounts and the report of the directors. In addition, the agenda for an annual general meeting of shareholders will only include such items as have been included therein by the board of directors.

 

Also, Arco may, but is not required to (unless required by the laws of the Cayman Islands), hold other extraordinary general meetings during the year. General meetings of shareholders are generally expected to take place in São Paulo, Brazil, but may be held elsewhere if the directors so decide.

 

The Companies Law provides shareholders a limited right to request a general meeting, and does not provide shareholders with any right to put any proposal before a general meeting in default of a company’s Articles of Association. However, these rights may be provided in a company’s Articles of Association. Arco’s Articles of Association provide that upon the requisition of one or more shareholders representing not less than one-third of the voting rights entitled to vote at general meetings, the board will convene an extraordinary general meeting and put the resolutions so requisitioned to a vote at such meeting. The Articles of Association provide no other right to put any proposals before annual general meetings or extraordinary general meetings.

 

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Subject to regulatory requirements, the annual general meeting and any extraordinary general meetings must be called by not less than ten (10) clear days’ notice prior to the relevant shareholders meeting and convened by a notice discussed below. Alternatively, upon the prior consent of all holders entitled to receive notice, with regards to the annual general meeting, and the holders of 95% in par value of the shares entitled to attend and vote at an extraordinary general meeting, that meeting may be convened by a shorter notice and in a manner deemed appropriate by those holders.

 

Arco will give notice of each general meeting of shareholders by publication on its website and in any other manner that it may be required to follow in order to comply with Cayman Islands law, Nasdaq and SEC requirements. The holders of registered shares may be given notice of a shareholders’ meeting by means of letters sent to the addresses of those shareholders as registered in our shareholders’ register, or, subject to certain statutory requirements, by electronic means.

 

Holders whose shares are registered in the name of DTC or its nominee, which we expect will be the case for all holders of Class A common shares, will not be a shareholder or member of the company and must rely on the procedures of DTC regarding notice of shareholders’ meetings and the exercise of rights of a holder of the Class A common shares.

 

A quorum for a general meeting consists of any one or more persons holding or representing by proxy not less than one-third of the aggregate voting power of all shares in issue and entitled to vote upon the business to be transacted.

 

A resolution put to a vote at a general meeting shall be decided on a poll. An ordinary resolution to be passed by the shareholders at a general meeting requires the affirmative vote of a simple majority of the votes cast by, or on behalf of, the shareholders entitled to vote, present in person or by proxy and voting at the meeting. A special resolution requires the affirmative vote on a poll of no less than two-thirds of the votes cast by the shareholders entitled to vote who are present in person or by proxy at a general meeting. Both ordinary resolutions and special resolutions may also be passed by a unanimous written resolution signed by all the shareholders of our Company, as permitted by the Companies Law and our Articles of Association.

 

Pursuant to Arco’s Articles of Association, general meetings of shareholders are to be chaired by the chairman of our board of directors or in his absence the vice-chairman of the board of directors. If the chairman or vice-chairman of our board of directors is absent, the directors present at the meeting shall appoint one of them to be chairman of the general meeting. If neither the chairman nor another director is present at the general meeting within 15 minutes after the time appointed for holding the meeting, the shareholders present in person or by proxy and entitled to vote may elect any one of the shareholders to be chairman. The order of business at each meeting shall be determined by the chairman of the meeting, and he or she shall have the right and authority to prescribe such rules, regulations and procedures and to do all such acts and things as are necessary or desirable for the proper conduct of the meeting, including, without limitation, the establishment of procedures for the maintenance of order and safety, limitations on the time allotted to questions or comments on the affairs of the Company, restrictions on entry to such meeting after the time prescribed for the commencement thereof, and the opening and closing of the polls.

 

Liquidation Rights

 

If Arco is voluntarily wound up, the liquidator, after taking into account and giving effect to the rights of preferred and secured creditors and to any agreement between Arco and any creditors that the claims of such creditors shall be subordinated or otherwise deferred to the claims of any other creditors and to any contractual rights of set-off or netting of claims between Arco and any person or persons (including without limitation any bilateral or any multi-lateral set-off or netting arrangements between the company and any person or persons) and subject to any agreement between Arco and any person or persons to waive or limit the same, shall apply Arco’s property in satisfaction of its liabilities pari passu and subject thereto shall, subject to the rights attaching to any share, distribute the property pari passu amongst the shareholders in proportion to the capital paid up at the commencement of the winding up on the shares held by them respectively.

 

Changes to Capital

 

Pursuant to the Articles of Association, Arco may from time to time by ordinary resolution:

 

·increase its share capital by such sum, to be divided into shares of such amount, as the resolution shall prescribe;

 

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·consolidate and divide all or any of its share capital into shares of a larger amount than its existing shares;

 

·convert all or any of its paid-up shares into stock and reconvert that stock into paid-up shares of any denomination;

 

·subdivide its existing shares or any of them into shares of a smaller amount, provided that in the subdivision the proportion between the amount paid and the amount, if any, unpaid on each reduced share shall be the same as it was in the case of the share from which the reduced share is derived; or

 

·cancel any shares which, at the date of the passing of the resolution, have not been taken or agreed to be taken by any person and diminish the amount of its share capital by the amount of the shares so canceled.

 

Arco’s shareholders may by special resolution, subject to confirmation by the Grand Court of the Cayman Islands on an application by the Company for an order confirming such reduction, reduce its share capital or any capital redemption reserve in any manner permitted by law.

 

In addition, subject to the provisions of the Companies Law and our Articles of Association, Arco may:

 

·issue shares on terms that they are to be redeemed or are liable to be redeemed;

 

·purchase its own shares (including any redeemable shares); and

 

·make a payment in respect of the redemption or purchase of its own shares in any manner authorized by the Companies Law, including out of its own capital.

 

Transfer of Shares

 

Subject to any applicable restrictions set forth in the Articles of Association, any shareholder of Arco may transfer all or any of his or her common shares by an instrument of transfer in the usual or common form or in the form prescribed by the Nasdaq or any other form approved by the Company’s board of directors.

 

The Class A common shares are traded on the Nasdaq in book-entry form and may be transferred in accordance with Arco’s Articles of Association and Nasdaq’s rules and regulations.

 

However, Arco’s board of directors may, in its absolute discretion, decline to register any transfer of any common share which is either not fully paid up to a person of whom it does not approve or is issued under any share incentive scheme for employees which contains a transfer restriction that is still applicable to such common share. The board of directors may also decline to register any transfer of any common share unless:

 

·a fee of such maximum sum as the Nasdaq may determine to be payable or such lesser sum as the board of directors may from time to time require is paid to Arco in respect thereof;

 

·the instrument of transfer is lodged with Arco, accompanied by the certificate (if any) for the common shares to which it relates and such other evidence as our board of directors may reasonably require to show the right of the transferor to make the transfer;

 

·the instrument of transfer is in respect of only one class of shares;

 

·the instrument of transfer is properly stamped, if required;

 

·the common shares transferred are free of any lien in favor of Arco; and

 

·in the case of a transfer to joint holders, the transfer is not to more than four joint holders.

 

If the directors refuse to register a transfer they are required, within two months after the date on which the instrument of transfer was lodged, to send to the transferee notice of such refusal.

 

Share Repurchase

 

The Companies Law and the Articles of Association permit Arco to purchase its own shares, subject to certain restrictions. The board of directors may only exercise this power on behalf of Arco, subject to the Companies Law, the Articles of Association and to any applicable requirements imposed from time to time by the SEC, the Nasdaq, or by any recognized stock exchange on which our securities are listed.

 

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Dividend Rights

 

See “Item 8A. Consolidated Statements and Other Financial Information—Dividends and Dividend Policy” for further information regarding dividend rights.

 

Appointment, Disqualification and Removal of Directors

 

Arco is managed by its board of directors. The Articles of Association provide that, unless otherwise determined by a special resolution of shareholders, the board of directors will be composed of four to 11 directors, with the number being determined by a majority of the directors then in office. There are no provisions relating to retirement of directors upon reaching any age limit. The Articles of Association also provide that, while Arco’s shares are admitted to trading on Nasdaq, the board of directors must always comply with the residency and citizenship requirements of the U.S. securities laws applicable to foreign private issuers.

 

The Articles of Association provide that directors shall be elected by an ordinary resolution of our shareholders, which requires the affirmative vote of a simple majority of the votes cast on the resolution by the shareholders entitled to vote who are present, in person or by proxy, at the meeting. Each director shall be appointed and elected for such term as the resolution appointing him or her may determine or until his or her removal or vacation of office in accordance with the Articles of Association.

 

Any vacancies on the board of directors that arise other than upon the removal of a director by resolution passed at a general meeting can be filled by the remaining directors (notwithstanding that they may constitute less than a quorum). Any such appointment shall be as an interim director to fill such vacancy until the next annual general meeting of shareholders.

 

Additions to the existing board (within the limits set pursuant to the Articles of Association) may be made by ordinary resolution of the shareholders.

 

Upon the completion of the offering, the board of directors will have in place an audit committee. See “Item 6. Directors, Senior Management and Employees—C. Board practices—Committees of the Board of Directors—Audit Committee.”

 

Grounds for Removing a Director

 

A director may be removed with or without cause by ordinary resolution. The notice of general meeting must contain a statement of the intention to remove the director and must be served on the director not less than ten calendar days before the meeting. The director is entitled to attend the meeting and be heard on the motion for his removal.

 

The office of a director will be vacated automatically if he or she (1) becomes prohibited by law from being a director, (2) becomes bankrupt or makes an arrangement or composition with his creditors, (3) dies or is in the opinion of all his co-directors, incapable by reason of mental disorder of discharging his duties as director, (4) resigns his office by notice to us or (5) has for more than six months been absent without permission of the directors from meetings of the board of directors held during that period, and the remaining directors resolve that his or her office be vacated.

 

Proceedings of the Board of Directors

 

The Articles of Association provide that Arco’s business is to be managed and conducted by the board of directors. The quorum necessary for the board meeting shall be a simple majority of the directors then in office (subject to there being a minimum of two directors present) and business at any meeting shall be decided by a majority of votes. In the case of an equality of votes, the chairman shall have a casting vote.

 

Subject to the provisions of the Articles of Association, the board of directors may regulate its proceedings as they determine is appropriate. Board meetings shall be held at least once every calendar quarter and shall take place either in São Paulo, Brazil or at such other place as the directors may determine.

 

Subject to the provisions of the Articles of Association, to any directions given by ordinary resolution of the shareholders and the listing rules of the Nasdaq, the board of directors may from time to time at its discretion exercise all powers of Arco, including, subject to the Companies Law, the power to issue debentures, bonds and other securities of the company, whether outright or as collateral security for any debt, liability or obligation of our company or of any third-party.

 

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Inspection of Books and Records

 

Holders of Arco shares will have no general right under Cayman Islands law to inspect or obtain copies of the list of shareholders or corporate records of the Company. However, the board of directors may determine from time to time whether and to what extent Arco’s accounting records and books shall be open to inspection by shareholders who are not members of the board of directors. Notwithstanding the above, the Articles of Association provide shareholders with the right to receive annual financial statements. Such right to receive annual financial statements may be satisfied by publishing the same on the company’s website or filing such annual reports as we are required to file with the SEC.

 

Register of Shareholders

 

The Class A common shares are held through DTC, and DTC or Cede & Co., as nominee for DTC, will be recorded in the shareholders’ register as the holder of our Class A common shares.

 

Under Cayman Islands law, Arco must keep a register of shareholders that includes:

 

·the names and addresses of the shareholders, a statement of the shares held by each member, and of the amount paid or agreed to be considered as paid, on the shares of each member;

 

·the date on which the name of any person was entered on the register as a member; and

 

·the date on which any person ceased to be a member.

 

Under Cayman Islands law, the register of shareholders of Arco is prima facie evidence of the matters set out therein (i.e. the register of shareholders will raise a presumption of fact on the matters referred to above unless rebutted) and a shareholder registered in the register of shareholders is deemed as a matter of Cayman Islands law to have prima facie legal title to the shares as set against his or her name in the register of shareholders. Once the register of shareholders has been updated, the shareholders recorded in the register of shareholders should be deemed to have legal title to the shares set against their name.

 

If the name of any person is incorrectly entered in or omitted from the register of shareholders, or if there is any default or unnecessary delay in entering on the register the fact of any person having ceased to be a shareholder of Arco, the person or member aggrieved (or any shareholder of Arco, or Arco itself) may apply to the Cayman Islands Grand Court for an order that the register be rectified, and the Court may either refuse such application or it may, if satisfied of the justice of the case, make an order for the rectification of the register.

 

Exempted Company

 

Arco is an exempted company with limited liability under the Companies Law. The Companies Law distinguishes between ordinary resident companies and exempted companies. Any company that is registered in the Cayman Islands but conducts business mainly outside of the Cayman Islands may apply to be registered as an exempted company. The requirements for an exempted company are essentially the same as for an ordinary company except for the exemptions and privileges listed below:

 

·an exempted company does not have to file an annual return of its shareholders with the Registrar of Companies;

 

·an exempted company’s register of shareholders is not open to inspection;

 

·an exempted company does not have to hold an annual general meeting;

 

·an exempted company may obtain an undertaking against the imposition of any future taxation (such undertakings are usually given for 20 years in the first instance);

 

·an exempted company may register by way of continuation in another jurisdiction and be deregistered in the Cayman Islands;

 

·an exempted company may register as a limited duration company; and

 

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·an exempted company may register as a segregated portfolio company.

 

“Limited liability” means that the liability of each shareholder is limited to the amount unpaid by the shareholder on the shares of the company (except in exceptional circumstances, such as involving fraud, the establishment of an agency relationship or an illegal or improper purpose or other circumstances in which a court may be prepared to pierce or lift the corporate veil).

 

Arco is subject to reporting and other informational requirements of the Exchange Act, as applicable to foreign private issuers. Except as otherwise disclosed in this annual report, Arco intends to continue to comply with the Nasdaq rules in lieu of following home country practice.

 

Anti-Takeover Provisions in our Articles of Association

 

Some provisions of the Articles of Association may discourage, delay or prevent a change in control of Arco or management that shareholders may consider favorable. In particular, the capital structure of Arco concentrates ownership of voting rights in the hands of the Founding Shareholders. These provisions, which are summarized below, are expected to discourage coercive takeover practices and inadequate takeover bids. These provisions are also designed to encourage persons seeking to acquire control of Arco to first negotiate with the board of directors. However, these provisions could also have the effect of discouraging others from attempting hostile takeovers and, as a consequence, they may also inhibit temporary fluctuations in the market price of the Class A common shares that often result from actual or rumored hostile takeover attempts. These provisions may also have the effect of preventing changes in the management of Arco. It is possible that these provisions could make it more difficult to accomplish transactions that shareholders may otherwise deem to be in their best interests.

 

Two Classes of Common Shares

 

The Class B common shares of Arco are entitled to 10 votes per share, while the Class A common shares are entitled to one vote per share. Since it owns of all of the Class B common shares of Arco, the Founding Shareholders currently have the ability to elect all directors and to determine the outcome of most matters submitted for a vote of shareholders. This concentrated voting control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other shareholders may view as beneficial.

 

So long as the Founding Shareholders have the ability to determine the outcome of most matters submitted to a vote of shareholders as well as the overall management and direction of Arco, third parties may be deterred in their willingness to make an unsolicited merger, takeover, or other change of control proposal, or to engage in a proxy contest for the election of directors. As a result, the fact that Arco has two classes of common shares may have the effect of depriving you as a holder of Class A common shares of an opportunity to sell your Class A common shares at a premium over prevailing market prices and make it more difficult to replace the directors and management of Arco.

 

Preferred Shares

 

Arco’s board of directors is given wide powers to issue one or more classes or series of shares with preferred rights. Such preferences may include, for example, dividend rights, conversion rights, redemption privileges, enhanced voting powers and liquidation preferences.

 

Despite the anti-takeover provisions described above, under Cayman Islands law, Arco’s board of directors may only exercise the rights and powers granted to them under the Articles of Association, for what they believe in good faith to be in the best interests of Arco.

 

Protection of Non-Controlling Shareholders

 

The Grand Court of the Cayman Islands may, on the application of shareholders holding not less than one-fifth of the shares of Arco in issue, appoint an inspector to examine the Company’s affairs and report thereon in a manner as the Grand Court shall direct.

 

Subject to the provisions of the Companies Law, any shareholder may petition the Grand Court of the Cayman Islands which may make a winding-up order, if the court is of the opinion that this winding up is just and equitable.

 

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Notwithstanding the U.S. securities laws and regulations that are applicable to Arco, general corporate claims against Arco by its shareholders must, as a general rule, be based on the general laws of contract or tort applicable in the Cayman Islands or their individual rights as shareholders as established by Arco’s Articles of Association.

 

The Cayman Islands courts ordinarily would be expected to follow English case law precedents, which permit a minority shareholder to commence a representative action against Arco, or derivative actions in Arco’s name, to challenge (1) an act which is ultra vires or illegal, (2) an act which constitutes a fraud against the minority and the wrongdoers themselves control Arco, and (3) an irregularity in the passing of a resolution that requires a qualified (or special) majority.

 

C.Material Contracts

 

See “Item 7. Major Shareholders and Related Party Transactions – B. Related party transactions.” Except as otherwise disclosed in this annual report on Form 20-F (including the Exhibits), we are not currently, and have not been in the last two years, party to any material contract, other than contracts entered into in the ordinary course of business.

 

D.Exchange Controls

 

The Cayman Islands currently has no exchange control restrictions.

 

E.Taxation

 

The following summary contains a description of certain Cayman Islands and U.S. federal income tax consequences of the acquisition, ownership and disposition of our Class A common shares. It does not purport to be a comprehensive description of all the tax considerations that may be relevant to a decision to purchase the Class A common shares, is not applicable to all categories of investors, some of which may be subject to special rules, and does not address all of the Cayman Islands and U.S. federal income tax considerations applicable to any particular holder. The summary is based upon the tax laws of the Cayman Islands and regulations thereunder and on the United States and regulations thereunder as of the date hereof, which are subject to change.

 

Prospective purchasers of our Class A common shares should consult their own tax advisors about the particular Cayman Islands and U.S. federal, state, local and other tax consequences to them of the acquisition, ownership and disposition of our Class A common shares.

 

Cayman Islands Tax Considerations

 

The Cayman Islands laws currently levy no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty or withholding tax applicable to us or to any holder of Class A common shares. There are no other taxes likely to be material to us levied by the government of the Cayman Islands except for stamp duties which may be applicable on instruments executed in, or after execution brought within the jurisdiction of the Cayman Islands. No stamp duty is payable in the Cayman Islands on transfers of shares of Cayman Islands companies except those which hold interests in land in the Cayman Islands. The Cayman Islands is not party to any double tax treaties which are applicable to any payments made by or to our company. There are no exchange control regulations or currency restrictions in the Cayman Islands.

 

As a Cayman Islands exempted company with limited liability, we have received an undertaking as to tax concessions pursuant to Section 6 of the Tax Concessions Law (2018 Revision). This undertaking provides that, for a period of 20 years from the date of issue of the undertaking (April 16, 2018), no law thereafter enacted in the Cayman Islands imposing any taxes to be levied on profits, income, gains or appreciation will apply to us or our operations.

 

Payments of dividends and capital in respect of our Class A common shares will not be subject to taxation in the Cayman Islands and no withholding will be required on the payment of a dividend or capital to any holder of our Class A common shares, nor will gains derived from the disposal of our Class A common shares be subject to Cayman Islands income or corporation tax.

 

There is no income tax treaty or convention currently in effect between the United States and the Cayman Islands.

 

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Material U.S. Federal Income Tax Considerations for U.S. Holders

 

In the opinion of Davis Polk & Wardwell, the following summary describes the material U.S. federal income tax consequences of the acquisition, ownership and disposition of our Class A common shares, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular person’s decision to acquire such securities.

 

This summary applies only to U.S. Holders (as defined below) that hold our Class A common shares as capital assets for tax purposes. In addition, it does not describe all of the tax consequences that may be relevant in light of a U.S. Holder’s particular circumstances, including alternative minimum tax consequences, the potential application of the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), known as the Medicare contribution tax, and tax consequences applicable to U.S. Holders subject to special rules, such as:

 

·certain financial institutions;

 

·insurance companies;

 

·real estate investment trusts or regulated investment companies;

 

·dealers or traders in securities that use a mark-to-market method of tax accounting;

 

·persons holding common shares as part of a hedging transaction, straddle, wash sale, conversion transaction or other integrated transaction or persons entering into a constructive sale with respect to the common shares;

 

·persons whose functional currency for U.S. federal income tax purposes is not the U.S. dollar;

 

·tax-exempt entities, including an “individual retirement account” or “Roth IRA”;

 

·persons that own or are deemed to own ten percent or more of our Class A common shares, by vote or value;

 

·persons holding our Class A common shares in connection with a trade or business conducted outside of the United States; or

 

·partnerships or other entities or arrangements treated as partnerships for U.S. federal income tax purposes.

 

If an entity that is classified as a partnership for U.S. federal income tax purposes holds our Class A common shares, the U.S. federal income tax treatment of a partner will generally depend on the status of the partner and the activities of the partnership. Partnerships holding our Class A common shares and partners in such partnerships should consult their tax advisers as to the particular U.S. federal income tax consequences of owning and disposing of the Class A common shares.

 

This discussion is based on the Code, administrative pronouncements, judicial decisions, final, temporary and proposed Treasury regulations, all as of the date hereof, any of which is subject to change or differing interpretations, possibly with retroactive effect.

 

A “U.S. Holder” is a holder who, for U.S. federal income tax purposes, is a beneficial owner of our Class A common shares and is:

 

·an individual that is a citizen or resident of the United States;

 

·a corporation, or other entity taxable as a corporation, created or organized in or under the laws of the United States, any state therein or the District of Columbia; or

 

·an estate or trust the income of which is subject to U.S. federal income taxation regardless of its source.

 

U.S. Holders should consult their tax advisers concerning the U.S. federal, state, local and non-U.S. tax consequences of owning and disposing of our Class A common shares in their particular circumstances.

 

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This discussion assumes that we are not, and will not become, a passive foreign investment company (a “PFIC”), as described below.

 

Taxation of Distributions

 

As discussed under “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Dividends and Dividend Policy”, we do not currently intend to pay dividends. In the event that we do pay dividends, and subject to the discussion below under “—Passive Foreign Investment Company Rules”, distributions paid on our Class A common shares, other than certain pro rata distributions of common shares, will be treated as dividends to the extent paid out of our current or accumulated earnings and profits (as determined under U.S. federal income tax principles). Because we do not maintain calculations of our earnings and profits under U.S. federal income tax principles, we expect that distributions generally will be reported to U.S. Holders as dividends. Subject to applicable limitations, dividends paid to certain non-corporate U.S. Holders may be eligible for taxation as “qualified dividend income” and therefore may be taxable at rates applicable to long-term capital gains so long as our Class A common shares are listed and trade on Nasdaq or are readily tradable on another established securities market in the United States. U.S. Holders should consult their tax advisers regarding the availability of the reduced tax rate on dividends in their particular circumstances.

 

The amount of the dividend will generally be treated as foreign-source dividend income to U.S. Holders and will not be eligible for the dividends-received deduction generally available to U.S. corporations under the Code. Dividends will be included in a U.S. Holder’s income on the date of the U.S. Holder’s receipt of the dividend.

 

Sale or Other Disposition of Common Shares

 

Subject to the discussion below under “—Passive Foreign Investment Company Rules”, for U.S. federal income tax purposes, gain or loss realized on the sale or other disposition of our Class A common shares will be capital gain or loss, and will be long-term capital gain or loss if the U.S. Holder held the Class A common shares for more than one year. The amount of the gain or loss will equal the difference between the U.S. Holder’s tax basis in the Class A common shares disposed of and the amount realized on the disposition, in each case as determined in U.S. dollars. This gain or loss will generally be U.S.-source gain or loss for foreign tax credit purposes. The deductibility of capital losses is subject to various limitations.

 

Passive Foreign Investment Company Rules

 

A non-U.S. corporation will be a PFIC for any taxable year in which either (i) 75% or more of its gross income consists of “passive income,” or (ii) 50% or more of the average quarterly value of its assets consist of assets that produce, or are held for the production of, “passive income.” For this purpose, subject to certain exceptions, passive income includes interest, dividends, rents, and gains from transactions in commodities. A non-U.S. corporation will be treated as owning its proportionate share of the assets and earning its proportionate share of the income of any other corporation in which it owns, directly or indirectly, more than 25% (by value) of the stock.

 

Based on our current operations, income, assets and certain estimates and projections, including as to the relative values of our assets, we believe that we were not a PFIC for U.S. federal income tax purposes for our taxable year ended December 31, 2018. However, because PFIC status depends on the composition of a company’s income and assets and the market value of its assets from time to time, there can be no assurance that we will not be a PFIC for any taxable year. If we were a PFIC for any year during which a U.S. Holder holds our Class A common shares, we generally would continue to be treated as a PFIC with respect to that U.S. Holder for all succeeding years during which the U.S. Holder holds the Class A common shares, even if we ceased to meet the threshold requirements for PFIC status.

 

If we were a PFIC for any taxable year during which a U.S. Holder held our Class A common shares (assuming such U.S. Holder has not made a timely election described below), gain recognized by a U.S. Holder on a sale or other disposition (including certain pledges) of the common shares would be allocated ratably over the U.S. Holder’s holding period for the common shares. The amounts allocated to the taxable year of the sale or other disposition and to any year before we became a PFIC would be taxed as ordinary income. The amount allocated to each other taxable year would be subject to tax at the highest rate in effect for individuals or corporations, as appropriate, for that taxable year, and an interest charge would be imposed on the tax on such amount. Further, to the extent that any distribution received by a U.S. Holder on its common shares exceeds 125% of the average of the annual distributions on the common shares received during the preceding three years or the U.S. Holder’s holding period, whichever is shorter, that distribution would be subject to taxation in the same manner as gain, described immediately above. If we are a PFIC in any year, certain elections may be

 

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available that would result in alternative tax consequences (such as mark-to-market treatment) of owning and disposing the common shares. U.S. Holders should consult their tax advisers to determine whether any of these elections would be available and, if so, what the consequences of the alternative treatments would be in their particular circumstances.

 

In addition, if we were a PFIC or, with respect to a particular U.S. Holder, were treated as a PFIC for the taxable year in which we paid a dividend or for the prior taxable year, the preferential dividend rates discussed above with respect to dividends paid to certain non-corporate U.S. Holders would not apply.

 

If a U.S. Holder owns common shares during any year in which we are a PFIC, the holder generally must file an annual report containing such information as the U.S. Treasury may require on IRS Form 8621 (or any successor form) with respect to us, generally with the holder’s federal income tax return for that year.

 

U.S. Holders should consult their tax advisers concerning our potential PFIC status and the potential application of the PFIC rules.

 

Information Reporting and Backup Withholding

 

Payments of dividends and sales proceeds that are made within the United States or through certain U.S.-related financial intermediaries generally are subject to information reporting, and may be subject to backup withholding, unless (i) the U.S. Holder is a corporation or other exempt recipient or (ii) in the case of backup withholding, the U.S. Holder provides a correct taxpayer identification number and certifies that it is not subject to backup withholding.

 

Backup withholding is not an additional tax. The amount of any backup withholding from a payment to a U.S. Holder will be allowed as a credit against such holder’s U.S. federal income tax liability and may entitle it to a refund, provided that the required information is timely furnished to the IRS. U.S. Holders should consult their tax advisers regarding the application of the U.S. information reporting and backup withholding rules.

 

Information with Respect to Foreign Financial Assets

 

Certain U.S. Holders who are individuals (and, under recent Treasury regulations, certain entities) may be required to report information on their U.S. federal income tax returns relating to an interest in our common shares, subject to certain exceptions (including an exception for common shares held in accounts maintained by certain U.S. financial institutions). U.S. Holders should consult their tax advisers regarding the effect, if any, of this requirement on their ownership and disposition of the common shares.

 

F.Dividends and Paying Agents

 

Not applicable.

 

G.Statement by Experts

 

Not applicable.

 

H.Documents on Display

 

We are subject to the informational requirements of the Exchange Act. Accordingly, we are required to file reports and other information with the SEC, including annual reports on Form 20-F and reports on Form 6-K. You may inspect and copy reports and other information filed with the SEC at the Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet website that contains reports and other information about issuers, like us, that file electronically with the SEC. The address of that website is www.sec.gov.

 

I.Subsidiary information

 

Not applicable.

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to market risks associated with foreign exchange and interest rates. In accordance with our policies, we seek to manage our exposure to these various market-based risks.

 

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We monitor market, credit and operational risks in line with the objectives in capital management, supported by the oversight of our Board of Directors, in decisions related to capital management and to ensure their consistency with our objectives and assessment of risks. Information relating to quantitative and qualitative disclosures about these market risks is described below.

 

Foreign Exchange Risk

 

Our results are not subject to significant fluctuations resulting from the effects of the volatility of any exchange rate. As of December 31, 2018, we have cash and cash equivalents denominated in U.S. dollars in the amount of R$3.6 million.

 

Interest Rate Risk

 

Interest rate risk represents the chance that the fair value or future cash flows of a financial instrument will fluctuate due to changes in market interest rates. Our exposure to this risk relates primarily to our investments with floating interest rates. We are primarily exposed to fluctuations in CDI interest rates on financial investments. Our exposure to cash and cash equivalents and financial investments indexed to the CDI totaled R$819.5 million as of December 31, 2018. See note 25 to our audited consolidated financial statements for a sensitivity analysis of the impact of a hypothetical 10% change in the CDI on our cash and cash equivalents and financial investments as of December 31, 2018.

 

For further information on our market risks, see note 25 to our audited consolidated financial statements.

 

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

 

A.Debt securities

 

Not applicable.

 

B.Warrants and rights

 

Not applicable.

 

C.Other securities

 

Not applicable.

 

D.American Depositary Shares

 

Not applicable.