UNITED STATES  

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 6-K

 

REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO RULE 13a-16 OR 15d-16 UNDER THE SECURITIES EXCHANGE ACT OF 1934

 

For the month of August, 2019 

 

Commission File Number: 001-38673

 

Arco Platform Ltd.

(Exact name of registrant as specified in its charter)

 

Rua Augusta 2840, 9th floor, suite 91

Consolação, São Paulo – SP

01412-100, Brazil
+55 (11) 3047-2655

(Address of principal executive office)

 

Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F:

 

Form 20-F

X

  Form 40-F  

 

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):

 

Yes     No

X

 

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):

 

Yes     No

X

 

 

 

 

 

TABLE OF CONTENTS

 

ITEM  
1. Unaudited Interim Condensed Consolidated Financial Statements as of and for the six months ended June 30, 2019
   

 

 

 

Item 1

 

 

 

 

 

 

 

 

 

 

 

Arco Platform Limited

 

Unaudited interim condensed

consolidated financial statements

 

June 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Arco Platform Limited

 

Unaudited interim condensed consolidated statements of financial position

As of June 30, 2019 and December 31, 2018 

(In thousands of Brazilian reais)

 

   Notes 

June 30, 2019

  December 31, 2018
Assets     (unaudited)   
Current assets         
Cash and cash equivalents  4   8,530    12,301 
Financial investments  5   869,141    806,789 
Trade receivables  6   142,943    136,611 
Inventories  7   14,598    15,131 
Recoverable taxes  8   20,690    11,227 
Other assets      12,838    6,091 
Total current assets      1,068,740    988,150 
Non current assets             
Financial instruments from acquisition of interests  14   21,261    26,630 
Deferred income tax  22   133,419    99,460 
Recoverable taxes  8   1,033    1,033 
Financial investments  5   4,473    4,370 
Loans to related parties  9   15,631    1,226 
Other assets      6,027    1,060 
Investments and interests in other entities  10   58,113    11,862 
Property and equipment  11   15,959    13,347 
Right-of-use assets  12   17,593    - 
Intangible assets  13   157,960    187,740 
Total non current assets      431,469    346,728 
              
Total assets      1,500,209    1,334,878 
              
Liabilities             
Current liabilities             
Trade payables      13,991    14,845 
Labor and social obligations      31,786    15,888 
Advances from customers      20,506    5,997 
Lease liabilities  12   4,736    - 
Loans and financing      161    - 
Taxes and contributions payable      1,509    2,555 
Income taxes payable      26,731    17,294 
Financial instruments from acquisition of interests  14   15,562    51 
Accounts payable to selling shareholders  15   90,829    830 
Other liabilities      138    428 
Total current liabilities      205,949    57,888 
 Non current liabilities             
Labor and social obligations      2,064    - 
Lease liabilities  12   16,752    - 
Loans and financing      376    - 
Financial instruments from acquisition of interests  14   49,242    25,046 
Accounts payable to selling shareholders  15   106,931    180,551 
Provision for legal proceedings  26   342    131 
Deferred income tax  22   1,560    1,378 
Other liabilities      125    - 
Total non current liabilities      177,392    207,106 
Total liabilities      383,341    264,994 
Equity             
Share capital  17   10    10 
Capital reserve      1,066,710    1,089,505 
Share-based compensation reserve      81,783    67,350 
Accumulated losses      (31,635)   (86,687)
Equity attributable to equity holders of the parent      1,116,868    1,070,178 
Non-controlling interests      -    (294)
Total equity      1,116,868    1,069,884 
              
Total liabilities and equity      1,500,209    1,334,878 

 

The accompanying notes are part of the unaudited interim condensed consolidated financial statements.

 

F-2

 

Arco Platform Limited

 

Unaudited interim condensed consolidated statements of income and comprehensive income

For the three- and six-month periods ended June 30, 2019 and 2018 

(In thousands of Brazilian reais, except earnings per share)

 

      Three-month period ended  Six-month period ended
   Notes  June 30, 2019  June 30, 2018  June 30, 2019  June 30, 2018
      (unaudited)  (unaudited)  (unaudited)  (unaudited)
                
Net revenue  19   137,566    81,436    254,621    195,070 
Cost of sales  20   (25,827)   (16,862)   (47,696)   (42,702)
                        
Gross profit      111,739    64,574    206,925    152,368 
                        
Selling expenses  20   (39,315)   (24,074)   (75,450)   (48,386)
General and administrative expenses  20   (44,926)   (17,033)   (65,758)   (30,728)
Other (expense) income, net      (437)   (1,476)   2,922    2,172 
                        
Operating profit      27,061    21,991    68,639    75,426 
                        
Finance income  21   13,961    3,582    30,917    7,291 
Finance costs  21   (12,374)   (3,840)   (28,855)   (7,765)
Finance result  21   1,587    (258)   2,062    (474)
                        
Share of loss of equity-accounted investees  10   (667)   (229)   (1,159)   (294)
                        
Profit before income taxes      27,981    21,504    69,542    74,658 
 Income taxes - income (expense)                       
 Current      (10,899)   (6,071)   (29,151)   (20,879)
 Deferred      8,617    (1,517)   16,149    528 
   22   (2,282)   (7,588)   (13,002)   (20,351)
                        
Profit for the period      25,699    13,916    56,540    54,307 
                        
Other comprehensive income for the period      -    -    -    - 
Total comprehensive income for the period      25,699    13,916    56,540    54,307 
                        
Profit (loss) attributable to                       
Equity holders of the parent      25,699    14,143    56,540    54,682 
Non-controlling interests      -    (227)   -    (375)
                        
Basic earnings per share - in Brazilian reais  18                    
   Class A      0.51    0.28    1.12    1.09 
   Class B      0.51    0.28    1.12    1.09 
Diluted earnings per share - in Brazilian reais  18                    
   Class A      0.49    0.27    1.09    1.04 
   Class B      0.50    0.27    1.10    1.05 

 

The accompanying notes are part of the unaudited interim condensed consolidated financial statements.

 

F-3

 

Arco Platform Limited

 

Unaudited interim condensed consolidated statements of changes in equity

For the three- and six-month periods ended June 30, 2019 and 2018

(In thousands of Brazilian reais, unless otherwise stated)

 

      Attributable to equity holders of the parent      
              Earnings reserves                          
    Share capital    Capital reserve    Legal reserve    Retained earnings reserve    Share-based compensation reserve    Retained earnings    Total    Non-controlling interests    Total equity 
Balances at March 31, 2018 (unaudited)   55,897    160,682    8,165    73,827    7,396    36,232    342,199    41    342,240 
                                              
Profit for the period   -    -    -    -    -    14,143    14,143    (227)   13,916 
Total comprehensive income   -    -    -    -    -    14,143    14,143    (227)   13,916 
Non-controlling interest increase   -    -    -    -    -    -    -    17    17 
Share-based compensation plan   -    -    -    -    344    -    344    -    344 
Distribution of dividends   -    -    -    (73,827)   -    (712)   (74,539)   -    (74,539)
Balances at June 30, 2018 (unaudited)   55,897    160,682    8,165    -    7,740    49,663    282,147    (169)   281,978 

 

 

      Attributable to equity holders of the parent      
              Earnings reserves                          
    Share capital    Capital reserve    Legal reserve    Retained earnings reserve    Share-based compensation reserve    Retained earnings    Total    Non-controlling interests    Total equity 
Balance at December 31, 2017   55,897    160,682    8,165    73,827    7,053    -    305,624    111    305,735 
    Change in accounting policy – IFRS 9   -    -    -    -    -    (4,307)   (4,307)   -    (4,307)
                                              
Profit for the period   -    -    -    -    -    54,682    54,682    (375)   54,307 
Total comprehensive income   -    -    -    -    -    54,682    54,682    (375)   54,307 
Non-controlling interest increase   -    -    -    -    -    -    -    95    95 
Share-based compensation plan   -    -    -    -    687    -    687    -    687 
Distribution of dividends   -    -    -    (73,827)   -    (712)   (74,539)   -    (74,539)
Balances at June 30, 2018 (unaudited)   55,897    160,682    8,165    -    7,740    49,663    282,147    (169)   281,978 

F-4

 

      Attributable to equity holders of the parent      
   Share capital  Capital reserve  Share-based compensation reserve  Accumulated losses  Total  Non-controlling interests  Total equity
                      
Balances at March 31, 2019 (unaudited)   10    1,081,261    67,487    (57,334)   1,091,424    -    1,091,424 
                                    
Profit for the period   -    -    -    25,699    25,699    -    25,699 
Total comprehensive income   -    -    -    25,699    25,699    -    25,699 
Capital increase (Note 17)   -    12,611    -    -    12,611    -    12,611 
Corporate restructuring (Note 2.2)   -    (27,162)   -    -    (27,162)   -    (27,162)
Restricted stock units (Note 16)   -    -    14,158    -    14,158    -    14,158 
Share-based compensation plan - International School   -    -    138    -    138    -    138 
                                    
Balances at June 30, 2019 (unaudited)   10    1,066,710    81,783    (31,635)   1,116,868    -    1,116,868 

 

 

      Attributable to equity holders of the parent      
   Share capital  Capital reserve  Share-based compensation reserve  Accumulated losses  Total  Non-controlling interests  Total equity
                      
Balances at December 31, 2018   10    1,089,505    67,350    (86,687)   1,070,178    (294)   1,069,884 
Change in accounting policy – IFRS 16 (Note 2.3)   -    -    -    (1,488)   (1,488)   -    (1,488)
                                    
Profit for the period   -    -    -    56,540    56,540    -    56,540 
Total comprehensive income   -    -    -    56,540    56,540    -    56,540 
Capital increase (Note 17)   -    13,829    -    -    13,829    -    13,829 
Corporate restructuring (Note 2.2)   -    (36,624)   -    -    (36,624)   -    (36,624)
Restricted stock units (Note 16)   -    -    14,158    -    14,158    -    14,158 
Non-controlling interest   -    -    -    -    -    294    294 
Share-based compensation plan - International School   -    -    275    -    275    -    275 
                                    
Balances at June 30, 2019 (unaudited)   10    1,066,710    81,783    (31,635)   1,116,868    -    1,116,868 


The accompanying notes are part of the unaudited interim condensed consolidated financial statements.

 

F-5

 

Arco Platform Limited

 

Unaudited interim condensed consolidated statements of cash flows

For the six-month periods ended June 30, 2019 and 2018

(In thousands of Brazilian reais)

 

 

  June 30, 2019  June 30, 2018
Operating activities   (unaudited)    (unaudited) 
Profit before income taxes for the period   69,542    74,658 
Adjustments to reconcile profit before income taxes          
Depreciation and amortization   16,343    8,902 
Inventory reserves   3,560    3,242 
Allowance for doubtful accounts   2,203    3,137 
Residual value of property and equipment and intangible assets disposed   131    138 
Changes in fair value of derivative instruments   1,866    (1,974)
Share of loss of equity-accounted investees   1,159    294 
Share-based compensation plan   275    687 
Restricted stock units   14,158    - 
Provision for payroll taxes (restricted stock units)   6,518    - 
Accrued interest   14,440    4,052 
Interest in lease liabilities   782    - 
Provision for legal proceedings   211    76 
Foreign exchange results, net   516    - 
Alienation of investment   (3,286)   - 
Other financial cost/revenue, net   (1,202)   - 
Changes in assets and liabilities          
Trade receivables   (8,409)   3,087 
Inventories   (2,031)   (947)
Recoverable taxes   (5,373)   (1,190)
Other assets   (7,826)   (8,556)
Trade payables   659    1,574 
Labor and social obligations   11,354    3,757 
Taxes and contributions payable   (1,047)   639 
Advances from customers   14,998    7,645 
Other liabilities   (354)   (911)
           
Cash generated from operations   129,187    98,310 
           
Income taxes paid   (23,210)   (21,031)
Interest paid on lease liabilities   (220)   - 
Net cash flows from operating activities   105,757    77,279 
           
Investing activities          
Acquisition of property and equipment   (5,829)   (2,158)
Payment of investments and interests in other entities   (4,200)   - 
Acquisition of subsidiaries, net of cash acquired   (16,137)   (13,820)
Acquisition of intangible assets   (18,379)   (4,911)
Financial investments   (62,529)   33,470 
Loans to related parties   (14,000)   - 
Net cash flows from (used in) investing activities   (121,074)   12,581 

Financing activities

 

          
Capital increase   13,829    - 
Share issuance costs   (673)   - 
Payment of lease liabilities   (1,080)   - 
Payment of loans and financing   (14)   - 
Dividends paid   -    (85,050)
Net cash flows from (used in) financing activities   12,062    (85,050)
           
Foreign exchange effects on cash and cash equivalents   (516)   - 
           
Increase (decrease) in cash and cash equivalents   (3,771)   4,810 
           
Cash and cash equivalents at the beginning of the period   12,301    834 
Cash and cash equivalents at the end of the period   8,530    5,644 
Increase (decrease) in cash and cash equivalents   (3,771)   4,810 

 

The accompanying notes are part of the unaudited interim condensed consolidated financial statements.

 

F-6

 

Notes to the unaudited interim condensed consolidated financial statements

Expressed in thousands of Brazilian reais, unless otherwise stated

 

1Corporate information

 

Arco Platform Limited (“Arco”) is a holding company incorporated under the laws of the Cayman Islands on April 12, 2018. Arco and its subsidiaries are collectively referred to as the Company. Arco became the parent company of Arco Educação S.A. (“Arco Brazil”) through the completion of the corporate reorganization described in Note 1 Corporate reorganization and initial public offering of the Company´s consolidated financial statements for the year ended December 31, 2018.

 

Arco Brazil is the holding company of the operating subsidiaries, including EAS Educação S.A. (“EAS”), which provides educational content from basic to secondary education (“K-12 curriculum”). Since 2015, the Company has been investing in technology and its printed methodology evolved to an educational platform, capable of delivering the entire K-12 curriculum content.

 

The Company offers a complete pedagogical methodology using technology features to deliver educational content to improve the learning process. The Company’s activities comprise the editing, publishing, advertising and sale of educational content for private schools.

 

The address of the Company’s principal executive office is 2840 Rua Augusta, 11th Floor, Consolação, São Paulo, Brazil. The Company is listed on the NASDAQ Global Select Market (Symbol: ARCE).

 

These unaudited interim condensed consolidated financial statements were authorized for issue by the Board of Directors on August 27, 2019.

 

Acquisition of Sistema Positivo de Ensino (“Positivo”)

 

On May 7, 2019, the Company announced that it entered into a definitive agreement to acquire Sistema Positivo de Ensino (Positivo), one of the largest K-12 content providers to private schools in Brazil.

 

Under terms of the agreement, Arco will acquire Positivo for R$1,650 million in cash, with 50% due at the time of closing. The remaining 50% will be paid over 5 years, 20% payable in 2021 and 2022, and 30% payable in 2023 and 2024, all adjusted by the Brazilian Interbank Certificate of Deposit rate (CDI). The acquisition has been approved by the Boards of Directors of both Arco and Positivo. The transaction is not subject to any shareholder approval, but is subject to customary closing conditions, including antitrust and other regulatory approvals in Brazil, and accordingly, the Company does not have control of Positivo and has not consolidated it as of June 30, 2019.

 

F-7

 

2Significant accounting policies

 

2.1Basis for preparation and presentation of the unaudited interim condensed consolidated financial statements

 

These interim condensed consolidated financial statements have been prepared in accordance with IAS 34 Interim Financial Reporting ("IAS 34") as issued by the International Accounting Standards Board (“IASB”). Accordingly, certain disclosures included in the Company’s annual consolidated financial statements prepared in accordance with International Financial Reporting Standards (“IFRSs”) as issued by the IASB have been condensed or omitted. These interim condensed consolidated financial statements should be read in conjunction with the Company’s last annual consolidated financial statements for the year ended December 31, 2018, which include information necessary or useful to understanding the Company’s business and financial statement presentation. In particular, the Company’s significant accounting policies were presented in Note 2 Significant accounting policies to the consolidated financial statements for the year ended December 31, 2018.

 

The accounting policies applied in the preparation of these interim condensed consolidated financial statements are consistent with those applied and disclosed in the Company’s consolidated financial statements for the year ended December 31, 2018, with the exception of the application of certain new and amended IFRSs issued by the IASB, which were effective from January 1, 2019. Those new and amended IFRSs that had a significant impact on the Company’s interim condensed consolidated financial statements are described in Note 2.3 Changes in accounting policies and disclosures.

 

In preparing these interim condensed consolidated financial statements, management has made judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets and liabilities, revenue and expenses. Actual results may differ from these estimates. The critical judgements made by management in applying the Company’s accounting policies and the key sources of estimation uncertainty were the same as those applied and disclosed in Note 3 Significant accounting estimates and assumptions to the Company’s consolidated financial statements for the year ended December 31, 2018.

 

The unaudited interim condensed consolidated financial statements are presented in Brazilian reais (“BRL” or “R$”), which is the Company’s functional and presentation currency. All amounts are rounded to the nearest thousand, except when otherwise indicated.

 

2.2Changes in the Company’s subsidiaries

 

During the six-month period ended June 30, 2019, the Company had the following changes in the corporate organization:

 

F-8

 

On January 2, 2019, the Company entered in an agreement to sell its participation of 69.9% of Escola de Aplicação São José dos Campos Ltda. to its minority shareholders, which is part of the Company’s Core segment. The transaction price of R$ 3,741 will be received in 16 quarterly installments from January 2022 to October 2025, adjusted by the IGP-M (Brazilian general market price index issued by the FGV – “Fundação Getúlio Vargas”).

 

On February 1, 2019 because of a corporate restructuring, EAS spun-off its investment in SAE Digital to a new holding company, which was subsequently merged by SAE Digital and its shares were issued to Arco Brazil. When EAS acquired SAE Digital, goodwill was treated as not deductible; however, after this transaction SAE Digital has the tax benefit of the deductibility of the goodwill, which generates a future benefit and has recorded a deferred tax asset of R$ 5,135. The goodwill of this transaction is R$ 14,597. This deferred tax asset and the write off of the goodwill, have a net effect of R$ 9,462 and were accounted in equity.

 

Novagaúcha Editora e Livraria Ltda. was merged by Barra Américas Editora Ltda. on March 31, 2019. The goodwill of this transaction is R$ 4,330 and was written of to equity, no tax benefit was generated in this transaction.

 

On May 1, 2019, continuing the corporate restructuring, SAE Digital merged NS Educação Ltda. (“NS Educação”) and NS Ventures Participações S.A. (“NS Ventures”). In 2017, when NS Ventures acquired 30% interest in SAE Digital and 100% interest in NS Educação, the goodwill was treated as not deductible; however, after this transaction, SAE Digital has the tax benefit of the deductibility of the goodwill, which generates a future tax benefit and has recorded a deferred tax asset of R$ 11,762. The goodwill of this transaction is R$ 34,594. This deferred tax asset and the write off of the goodwill, have a net effect of R$ 22,832 and were accounted in equity.

 

2.3Changes in accounting policies and disclosures

 

New standards, interpretations and amendments adopted by the Company

 

On January 1, 2019, the Company adopted IFRS 16 Leases. The nature and effect of the initial adoption of this new standard are disclosed below.

 

Other amendments and interpretations apply for the first time in 2019, but do not have an impact on the unaudited interim condensed consolidated financial statements of the Company.

 

IFRS 16 - Leases

 

IFRS 16 supersedes IAS 17 Leases, IFRIC 4 Determining whether an Arrangement contains a Lease, SIC-15 Operating Leases-Incentives and SIC-27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease. The standard sets out the principles for the recognition, measurement, presentation and disclosure of leases and requires lessees to account for all leases under a single on-balance sheet model.

 

F-9

 

The Company adopted IFRS 16 using the modified retrospective method of adoption with the date of initial application of January 1, 2019. Under this method, the standard is applied retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application. The Company elected to use the transition practical expedient allowing the standard to be applied only to contracts that were previously identified as leases applying IAS 17 and IFRIC 4 at the date of initial application. The Company also elected to use the recognition exemptions for lease contracts that, at the commencement date, have a lease term of 12 months or less and do not contain a purchase option (‘short-term leases’), and lease contracts for which the underlying asset is of low value (‘low-value assets’, i.e., below US$ 5,000).

 

The effects of adoption of IFRS 16 as at January 1, 2019 is as follows:

 

Assets   
 Right-of-use assets   20,102 
 Deferred tax assets   731 
Total assets   20,833 
      
Liabilities     
 Lease liabilities   22,321 
Total liabilities   22,321 
      
Total adjustment on equity:     
 Retained earnings   (1,488)

 

a)Nature of the effect of adoption of IFRS16

 

The Company has lease contracts for properties. Before the adoption of IFRS 16, the Company classified each of its leases (as lessee) at the inception date as either a finance lease or an operating lease. The Company did not have finance leases as of December 31, 2018. In an operating lease, the leased property was not capitalized, and the lease payments were recognized as rent expense in profit or loss on a straight-line basis over the lease term. Any prepaid rent and accrued rent were recognized under Other assets and Trade payables, respectively. Upon adoption of IFRS 16, the Company applied a single recognition and measurement approach for all leases, except for short-term leases and leases of low-value assets. The standard provides specific transition requirements and practical expedients, which have been applied by the Company.

 

The Company recognized right-of-use assets and lease liabilities for those leases previously classified as operating leases, except for short-term leases and leases of low-value assets. The right-of-use assets for most leases were recognized based on the carrying amount as if the standard had always been applied. Lease liabilities were recognized based on the present value of the remaining lease payments, discounted using the incremental borrowing rate at the date of initial application.

 

F-10

 

The Company also applied the available practical expedients wherein it:

 

üUsed an intrinsic discount rate, according to the characteristics for each lease;

 

üRelied on its assessment of whether leases are onerous immediately before the date of initial application;

 

üApplied the short-term leases and low-value assets exemptions to leases at the date of initial application;

 

üExcluded the initial direct costs from the measurement of the right-of-use asset at the date of initial application;

 

üUsed hindsight in determining the lease term where the contract contains options to extend or terminate the lease.

 

Based on the foregoing, as at January 1, 2019:

 

üRight-of -use assets of R$ 20,102 were recognized and presented separately in the consolidated statement of financial position.

 

üLease liabilities of R$ 22,321 were recognized and presented separately in the consolidated statement of financial position;

 

üDeferred tax assets increased by R$ 731 because of the deferred tax impact of the changes in assets and liabilities;

 

üThe net effect of these adjustments had been adjusted to accumulated losses (R$ 1,488).

 

The lease liabilities as at January 1, 2019 can be reconciled to the operating lease commitments as at December 31, 2018 as follows:

 

Operating lease commitments as at December 31, 2018   27,397 
Weighted average incremental borrowing rate as at January 1, 2019   7.35%
Discounted operating lease commitments at January 1, 2019   22,874 
Less:     
Commitments related to sale of Escola de Aplicação São José dos Campos Ltda.   (553)
Lease liabilities as at January 1, 2019   22,321 

 

b)Summary of new accounting policies

 

Set out below are the new accounting policies of the Company upon adoption of IFRS 16, which have been applied from the date of initial application:

 

üRight-of-use assets

 

The Company recognizes right-of-use assets at the commencement date of the lease (i.e., the date the underlying asset is available for use). Right-of-use assets are measured at cost, less any accumulated depreciation and impairment losses, and adjusted for any remeasurement of lease liabilities. The cost of right-of-use assets includes the amount of lease liabilities recognized, initial direct costs incurred, and lease payments made at or before the commencement date less any lease incentives received. Unless the Company is reasonably certain to obtain ownership of the leased asset at the end of the lease term, the recognized right-of-use assets are depreciated on a straight-line basis over the shorter of its estimated useful life and the lease term. Right-of use assets are subject to impairment.

 

F-11

 

üLease liabilities

 

At the commencement date of the lease, the Company recognizes lease liabilities measured at the present value of lease payments to be made over the lease term. The lease payments include fixed payments (including in-substance fixed payments) less any lease incentives receivable, variable lease payments that depend on an index or a rate, and amounts expected to be paid under residual value guarantees. The lease payments also include the exercise price of a purchase option reasonably certain to be exercised by the Company and payments of penalties for terminating a lease, if the lease term reflects the Company exercising the option to terminate. The variable lease payments that do not depend on an index or a rate are recognized as expense in the period on which the event or condition that triggers the payment occurs.

 

In calculating the present value of lease payments, the Company uses the incremental borrowing rate at the lease commencement date if the interest rate implicit in the lease is not readily determinable. After the commencement date, the lease liabilities are measured at amortized cost using the effective interest method. The lease liabilities are remeasured when there is a change in future lease payments arising from a change in an index or rate, if there is a change in the Company's estimate of the amount expected to be payable under a residual value guarantee or if the Company changes its assessment of whether it will exercise a purchase, extension or termination option. When the lease liabilities are remeasured in this way, a corresponding adjustment is made to the carrying amount of the right-of-use asset or is recorded in profit or loss if the carrying amount of the right-of-use asset has been reduced to zero.

 

üShort-term leases and leases of low-value assets

 

The Company applies the short-term lease recognition exemption to its short-term leases of properties (i.e., those leases that have a lease term of 12 months or less from the commencement date and do not contain a purchase option). It also applies the lease of low-value assets recognition exemption to leases of office equipment that are considered of low value. Lease payments on short-term leases and leases of low-value assets are recognized as expense on a straight-line basis over the lease term.

 

üSignificant judgement in determining the lease term of contracts with renewal options

 

The Company determines the lease term as the non-cancellable term of the lease, together with any periods covered by an option to extend the lease if it is reasonably certain to be exercised, or any periods covered by an option to terminate the lease, if it is reasonably certain not to be exercised.

 

F-12

 

The Company has the option, under some of its leases to lease the assets for additional terms. The Company applies judgement in evaluating whether it is reasonably certain to exercise the option to renew. That is, it considers all relevant factors that create an economic incentive for it to exercise the renewal. After the commencement date, the Company reassesses the lease term if there is a significant event or change in circumstances that is within its control and affects its ability to exercise (or not to exercise) the option to renew (e.g., a change in business strategy).

 

IFRIC Interpretation 23 - Uncertainty over Income Tax Treatment

 

The Interpretation addresses the accounting for income taxes when tax treatments involve uncertainty that affects the application of IAS 12 Income Taxes. It does not apply to taxes or levies outside the scope of IAS 12, nor does it specifically include requirements relating to interest and penalties associated with uncertain tax treatments. The Interpretation specifically addresses the following:

 

• Whether an entity considers uncertain tax treatments separately

 

• The assumptions an entity makes about the examination of tax treatments by taxation authorities

 

• How an entity determines taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates

 

• How an entity considers changes in facts and circumstances

 

An entity must determine whether to consider each uncertain tax treatment separately or together with one or more other uncertain tax treatments. The approach that better predicts the resolution of the uncertainty should be followed.

 

The Company applies significant judgement in identifying uncertainties over income tax treatments.

 

Upon adoption of the Interpretation, the Company considered whether it has any uncertain tax positions. The Company applied the interpretation and concluded that it did not have a significant impact on the unaudited interim condensed consolidated financial statements.

 

3Business combination

 

(a)EEM Licenciamento de Programas Educacionais S.A. (“Escola em Movimento”)

 

On April 29, 2019, the Company entered into an agreement to acquire control of Escola em Movimento, by acquiring 100% of its outstanding ordinary shares and voting interests. The Company acquired Escola em Movimento to expand both its existing product portfolio and customer base. The acquisition was subject to CADE’s approval, the Brazilian anti-trust agency, which was a condition precedent for closing the acquisition. CADE approved the acquisition in May 2019, and the transaction closing date occurred on June 4, 2019.

 

F-13

 

Escola em Movimento is an application developer that enhances communication between schools and parents.

 

The purchase consideration transferred was R$ 18,285. The amount of R$ 16,095 was paid on the acquisition date; R$260 was paid on June 29, 2019 and a deferred payment in the amount of R$ 1,930, which has been retained in an escrow account for the period of 2 years as a guarantee for the payment of any contingent liabilities that may arise. Any remaining balance will be transferred to the former owners of the acquired entity. The amount will be released in two annual installments adjusted by the Brazilian basic interest rate (SELIC).

 

The fair value of the identifiable assets and liabilities as of the date of the acquisition was:

 

   Escola em Movimento
Assets     
Cash and cash and equivalents   218 
Trade receivables   126 
Recoverable taxes   12 
Other assets   13 
Property and equipment   83 
Intangible assets   5,865 
    6,317 
      
Liabilities     
Trade payables   48 
Labor and social obligations   200 
Taxes and contributions payable   149 
Loans and financing   547 
Other liabilities   157 
    1,101 
Total identifiable net assets at fair value   5,216 
      
Goodwill arising on acquisition   13,069 
Purchase consideration transferred   18,285 
Cash paid   16,355 
Escrow payments   1,930 
Analysis of cash flows on acquisition:     
Transaction costs of the acquisition (included in cash flows from operating activities)   (306)
Cash paid and subscribed capital net of cash acquired with the subsidiary (included in cash flows from investing activities)   (16,137)

 

Goodwill

 

The goodwill recorded on the acquisition was R$ 13,069 and it is expected to be deductible for tax purposes after the Company merges the acquiree. For the purpose of impairment testing, the goodwill has been allocated to the Supplemental operating segment.

 



 

F-14

 

The goodwill recognized is primarily attributable to the expected synergies and other benefits from combining the assets and activities of Escola em Movimento with those of the Company. The goodwill paid is based on the Business Plan prepared for purposes of the acquisition, and the principal business assumptions used were considered by the administration as appropriate

 

Transaction costs

 

Transaction costs of R$ 306 were expensed and are included in general and administrative expenses for the six-month period ended June 30, 2019.

 

Measurement of fair value

 

The valuation techniques used for measuring the fair value of separate identified intangible assets acquired were as follows:

 

Asset acquired Valuation technique
Customer list

Multi-period excess earning method

The method considers the present value of net cash flows expected to be generated by customer relationship, by excluding any cash flows related to contributory assets.

 

Software

Replacement cost 

The method considers the amount that an entity would have to pay to replace at the present time, according to its current worth.

 

Trademarks

Relief-from-royalty method

The relief-from-royalty method considers the discount estimated royalty payments that are expected to be avoided as a result of the trademarks being owned.

 

Non-compete agreement

With-and-without method 

The With-and-Without method consists of estimating the fair value of an asset by the difference between the value of this asset in two scenarios: a scenario considering the existence of the asset in question and another, considering its non-existence.

 

 

From the date of acquisition to June 30, 2019, Escola em Movimento had revenues of R$ 335 and a loss before income taxes of R$ 250. If the combination had taken place at the beginning of the six month period ended June 30, 2019, net revenue of the Company would have been R$ 256,175 and profit before income taxes would have been R$ 68,980.

 

F-15

 

4Cash and cash equivalents

 

 

   June 30, 2019    December 31, 2018  
    (unaudited)      
Cash and bank deposits   245    366 
Bank deposits in foreign currency (a)   4,124    3,615 
Cash equivalents (b)   4,161    8,320 
    8,530    12,301 

 

(a)Short-term deposits (mainly IPO proceeds) maintained in U.S. dollar.

 

(b)Cash equivalents correspond to financial investments in Bank Certificates of Deposit (“CDB”) of highly rated financial institutions. As of June 30, 2019, the average interest on these CDB are equivalent to 64.5% (December 31, 2018: 61.7%) of the Interbank Certificates of Deposit (“CDI”). These funds are available for immediate use and have insignificant risk of changes in value.

 

5Financial investments

 

   June 30, 2019    December 31, 2018  
    (unaudited)      
Financial investments (a)   860,746    810,812 
Financial investments in foreign currency   12,517    - 
Other   351    347 
    873,614    811,159 
Current   869,141    806,789 
Non-current   4,473    4,370 

 

(a)Financial investments correspond to investments in funds managed by highly rated financial institutions. As of June 30, 2019, the average interest on these funds are equivalent to 101.6% (December 31, 2018: 100.9%) of the CDI.

 

6Trade receivables

 

  

June 30, 2019

  December 31, 2018
   (unaudited)   
From sales of educational content   156,236    146,114 
From related parties (Note 9)   1,523    3,916 
    157,759    150,030 
(-) Allowance for doubtful accounts   (14,816)   (13,419)
    142,943    136,611 

F-16

 

As of June 30, 2019, and December 31, 2018, the aging of trade receivables was as follows:

 

   June 30, 2019  December 31, 2018
   (unaudited)   
Neither past due nor impaired   132,947    127,387 
Past due   24,812    22,643 
           
1 to 60 days   13,033    8,931 
61 to 90 days   2,997    3,868 
91 to 120 days   2,150    1,978 
121 to 180 days   1,632    3,173 
More than 180 days   5,000    4,693 
    157,759    150,030 

 

The movement in the allowance for doubtful accounts for the six-month periods ended June 30, 2019 and 2018, was as follows:

 

   June 30, 2019  June 30, 2018
   (unaudited)  (unaudited)
Balance at beginning of the period   (13,419)   (4,533)
Change in accounting policy – IFRS 9   -    (5,757)
Additions   (2,203)   (3,137)
Receivables written off during the period as uncollectible   806    1,346 
Balance at end of period   (14,816)   (12,081)

 

7Inventories

 

  

June,  2019

  December 31, 2018
   (unaudited)   
Educational content   5,400    8,335 
Educational content in progress (a)   7,909    6,205 
Consumables and supplies   644    286 
Inventories held by third parties   645    305 
    14,598    15,131 

 

(a)Costs being incurred to develop educational content. These costs include incurred personnel costs and third-party services for editing educational content and related activities (graphic design, editing, proofreading and layout, among others).

 

Educational content is presented net of inventory reserve. The movement in the inventory reserve for the six-month periods ended June 30, 2019 and 2018 was as follows:

 

   June 30, 2019  June 30, 2018
   (unaudited)  (unaudited)
Balance at beginning of the period   (4,403)   (2,047)
Inventory reserve   (3,560)   (3,242)
Write-off of inventories against reserve   3,505    - 
Balance at end of the period   (4,458)   (5,289)

F-17

 

8Recoverable taxes

 

   June 30, 2019  December 31, 2018
   (unaudited)   
Withholding Income Tax (IRRF) on financial investments   8,178    5,291 
Recoverable IRPJ and CSLL   11,566    5,520 
Recoverable PIS and COFINS   1,280    1,223 
Other recoverable taxes   699    226 
    21,723    12,260 
Current   20,690    11,227 
Non current   1,033    1,033 

 

Withholding income tax (IRRF) will be utilized to offset federal taxes payable.

 

9Related parties

 

The table below summarizes the balances and transactions with related parties:

 

   June 30, 2019  December 31, 2018
Assets  (unaudited)   
Trade receivables      
Livraria ASC Ltda. and Educadora ASC Ltda. (a)   1,523    3,916 
    1,523    3,916 
           
Loans to related parties          
WPensar S.A. (b)   1,263    1,226 
Loans - Geekie (c)   4,106    - 
Debentures – Geekie (c)   10,262    - 
    15,631    1,226 
           
Advances from customers          
Livraria ASC Ltda. and Educadora ASC Ltda. (a)   (918)   - 
    (918)   - 
           
           
    June 30, 2019    June 30, 2018 
Net revenue   (unaudited)    (unaudited) 
Livraria ASC Ltda. and Educadora ASC Ltda. (a)   3,585    3,718 
           
Expenses          
ASC Empreendimentos Ltda. and OSC Empreendimentos Ltda. (d)   (4)   (10)

 

(a) SAS Desenvolvimento Educacional Ltda. and International School sell educational content to Livraria ASC Ltda. and Educadora ASC Ltda., entities under common control of the Company’s controlling shareholder. The transactions are priced based on contract price at the sales date.

 

(b) The amounts receivable from joint venture are monetarily indexed to the Brazilian Sistema Especial de Liquidação e Custódia (SELIC) interest rate and have due date in July 2020.

 

F-18

 

(c) On January 17, 2019, the Company entered into an agreement with its associated company, Geekie Desenvolvimento de Softwares S.A. (“Geekie”) buying 100,000 debentures issued at same date at par value of R$ 100.00 (hundred reais) each, totaling R$ 10,000. The debentures are due in June 2022 and bear interest of 110% of the CDI. The debentures are convertible at the option of Arco on maturity at the same mechanics of the call and put options presented in the investment agreement.

 

On the same date, the Company lent R$ 4,000 to Geekie Partners S.A., the controlling shareholder of Geekie, through a loan agreement with payment in June 2022, interest of 110% of the CDI, and with their entire interest on Geekie’s shares as collateral to the transaction.

 

The transactions totaled R$ 14,000 and are intended to support Geekie’s working capital needs.

 

(d) SAS Sistema de Ensino Ltda. had leased a facility from ASC Empreendimentos Ltda., which agreement was terminated in June 2018; SAS Livrarias Ltda. had leased a facility from OSC Empreendimentos Ltda., which agreement was also terminated in June 2018; and SAS Desenvolvimento Educacional Ltda. leases a facility from OSC Empreendimentos Ltda., which are entities under common control of the Company’s controlling shareholder.

 

Key management personnel compensation

 

Key management personnel compensation comprised the following:

 

   June 30, 2019  June 30, 2018
   (unaudited)  (unaudited)
Short-term employee benefits   6,527    3,888 
Share-based compensation plan   -    412 
Restricted stock units   20,676    - 
    27,203    4,300 

 

 

For the six-month period ended June 30, 2019, there was no recognition of expenses for Arco's stock option plan, since it is fully vested (see note 16.b).

 

The expense of restricted stock units (“RSUs”) represents the grant of new awards (see note 16.b).

 

Compensation of the Company’s key management includes short-term employee benefits comprised by salaries, bonuses, labor and social charges, and other ordinary short-term employee benefits.

 

F-19

 

10Investments and interests in other entities

 

(a)Investments

 

Nave à Vela Ltda. (“Nave”)

 

On May 13, 2019, the selling shareholders of Nave, a developer of competence-based learning content and methodology, approved a capital increase from SAS Desenvolvimento Educacional Ltda. (“SAS Desenvolvimento”) through the issuance of 760 new common shares, registered and without par value, for the total subscription price of R$ 4,200, corresponding to a minority interest of 13.2% of the total amount of shares issued. Nave will be managed by Directors, subject to the guidelines of the Consulting Board, composed of three members, which one member will be indicated by SAS Desenvolvimento and the others by the sellers and, accordingly, as of June 30, 2019, SAS Desenvolvimento does not control Nave.

 

The acquisition of the remaining 86.8% of the total capital will occur over the next three years (subject to price adjustments, net of debt at each closing date) and was accounted as forward contract.

 

(i) First tranche: It will be paid on February 15, 2020 or within 15 days after the final and definitive determination of the acquisition price relating to this tranche, whichever occurs last. SAS Desenvolvimento will acquire 37.8% interest, for the amount of 37.8% of Nave’s revenues from October 1, 2018 to September 30, 2019 multiplied by 6.5, net of debt. As from the closing date of the first tranche, Nave will be managed by the Board of Directors, and SAS Desenvolvimento will indicate two members.

 

(ii) Second tranche: It will be paid on February 15, 2021 or within 15 days after the final and definitive determination of the acquisition price relating to this tranche, whichever occurs last. SAS Desenvolvimento will acquire 24% interest, for the amount of 24% of Nave’s revenues from October 1, 2019 to September 30, 2020 multiplied by 5.3, net of debt;

 

(iii) Third tranche: It will be paid on February 15, 2022 or within 15 days after the final and definitive determination of the acquisition price relating to this tranche, whichever occurs last. SAS Desenvolvimento will acquire the remaining 25% interest, for the amount of 25% of the Nave’s revenues from October 1, 2020 to September 30, 2021 multiplied by 3, net of debt.

 

F-20

 

(i)Investments and interests in other entities

 

Reconciliation of carrying amount:

 

   June 30, 2019  June 30, 2018
   (unaudited)  (unaudited)
   WPensar  Geekie  Nave  Total  Total
At beginning of the period   3,237    8,625    -    11,862    12,654 
Capital contributions   -    -    4,200    4,200    - 
Forward contract (Note 10a)   -    -    43,210    43,210    - 
Share of profit (loss) of equity-accounted investees   14    (887)   (286)   (1,159)   (294)
At end of the period   3,251    7,738    47,124    58,113    12,360 
                          
Percentage of ownership   25.0%   8.05%   13.2%          

 

 

(ii)Selected financial information for associates and joint ventures

 

   Geekie  WPensar  Nave
June 30, 2019 (unaudited)               
Current assets   5,209    1,697    6,511 
Non-current assets   13,851    1,573    242 
Current liabilities   4,391    302    1,608 
Non-current liabilities   10,277    1,206    398 
Equity   4,392    1,762    4,747 
Net revenue   5,554    2,482    93 
Costs and expenses (*)   (12,426)   (2,303)   (1,136)
Profit (loss) for the period   (6,872)   179    (1,043)
June 30, 2018 (unaudited)               
Net revenue   3,902    1,945    - 
Costs and expenses (*)   (8,422)   (1,726)   - 
Profit (loss) for the period   (4,520)   219    - 
December 31, 2018               
Current assets   5,215    1,625    - 
Non-current assets   12,174    1,414    - 
Current liabilities   7,681    286    - 
Non-current liabilities   -    1,170    - 
Equity   9,708    1,583    - 

 

(*)Comprise costs, selling and administrative expenses, finance result, other expenses and income tax and social contribution.

 

F-21

 

11Property and equipment

 

Reconciliation of carrying amount:

 

  

June 30, 2019

(unaudited)

 

June 30,2018

(unaudited)

   Machinery and equipment  Vehicles 

Furniture and

fixtures

  IT equipment  Facilities 

Leasehold

improvements

  Others  Total  Total
                            
Cost                           
At beginning of the period   896    191    2,296    5,080    325    4,638    6,199    19,625    12,926 
Additions   34    -    388    977    -    3,569    861    5,829    2,158 
Disposals   (17)   -    -    (27)   -    (23)   (1,055)   (1,122)   (155)
Business combination   17    -    21    45    -    -    -    83    - 

Sale of Escola de Aplicação 

São José dos Campos Ltda. 

   (50)   -    (201)   (51)   -    (710)   -    (1,012)   - 
Write-offs   -    -    -    -    -    -    (792)   (792)   - 
At end of the period   880    191    2,504    6,024    325    7,474    5,213    22,611    14,929 
                                              
Depreciation                                             
At beginning of the period   (254)   (144)   (527)   (1,910)   (100)   (1,274)   (2,069)   (6,278)   (3,847)
Depreciation charge for the period   (41)   (13)   (110)   (497)   (17)   (260)   (638)   (1,576)   (1,146)
Depreciation of disposals   -    -    -    -    11    46    934    991    17 

Sale of Escola de Aplicação 

São José dos Campos 

   10    -    34    17    -    150    -    211    - 
At end of the period   (285)   (157)   (603)   (2,390)   (106)   (1,338)   (1,773)   (6,652)   (4,976)
                                              
Net book value                                             
As of December 31   642    47    1,769    3,170    225    3,364    4,130    13,347    9,079 
As of June 30 (unaudited)   595    34    1,901    3,634    219    6,136    3,440    15,959    9,953 
                                              
Annual depreciation rates   10%   20%   10%   20%   10%   10% to 30%    33%          

 

(*) The additions of leasehold improvements during the six-month period ended June 30, 2019 refers to the construction of a new corporate headquarter.

 

The Company assesses, at each reporting date, whether there is an indication that a property and equipment asset may be impaired. If any indication exists, the Company estimates the asset’s recoverable amount. There were no indications of impairment of property and equipment for the six-month periods ended June 30, 2019 and 2018.

 

12Leases

 

The balance sheet shows the following amounts relating to leases:

 

   June 30, 2019
   (unaudited)
Right-of-use assets   
Properties   17,593 
    17,593 

 

 

   June 30, 2019
   (unaudited)
Lease liabilities *   
Current   (4,736)
Non-current   (16,752)
    (21,488)

 

* For the adjustments recognized on adoption of IFRS 16 on January 1, 2019, see Note 2.3.

 

F-22

 

Set out below, are the carrying amounts of the Company’s right-of-use assets and lease liabilities and the movements during the period:

 

   Right-of-use assets – Properties  Lease
Liabilities
As at January 1, 2019   20,102    (22,321)
Lease modification   (315)   315 
Depreciation expense   (2,194)   - 
Interest expense   -    (782)
Payments of lease liabilities   -    1,080 
Interest paid   -    220 
As at June 30, 2019   17,593    (21,488)
           
Average annual depreciation rate   18%     

 

The Company recognized rent expense from short-term leases and low-value assets of R$ 1,506 for the six-month period ended June 30, 2019.

 

There were no additions to the right-of-use assets during the six-month period ended June 30, 2019.

 

F-23

 

13Intangible assets

 

  

June 30, 2019

(unaudited)

 

June 30, 2018

(unaudited)

   Goodwill  Rights on contracts  Customer relationships  Educational system 

Copyrights

  Software license  Trademarks  Educational platform  Non- compete agreement 

In

Progress

  Total  Total
                                     
                                     
Cost                                    
At the beginning of the period   89,634    15,263    23,045    36,656    12,692    2,808    19,141    21,911    1,097    2,249    224,496    195,093 
Corporate restructuring (Note 2.2)   (53,521)   -    -    -    -    -    -    -    -    -    (53,521)   - 
Acquisitions   -    -    -    -    4,107    1,024    -    10,539    -    2,709    18,379    4,911 
Business combination   13,069    -    1,218    -    -    3,029    1,161    -    457    -    18,934    - 
At end of the period   49,182    15,263    24,263    36,656    16,799    6,861    20,302    32,450    1,554    4,958    208,288    200,004 
                                                             
Amortization                                                            
At the beginning of the period   -    (3,949)   (7,560)   (12,716)   (3,939)   (648)   (3,810)   (3,860)   (274)   -    (36,756)   (19,610)
Amortization   -    (671)   (1,203)   (3,275)   (2,788)   (474)   (797)   (4,245)   (119)   -    (13,572)   (7,756)
At end of the period   -    (4,620)   (8,763)   (15,991)   (6,727)   (1,122)   (4,607)   (8,105)   (393)   -    (50,328)   (27,366)
                                                             
Net book value                                                            
At the beginning of the period   89,634    11,314    15,485    23,940    8,753    2,160    15,331    18,051    823    2,249    187,740    175,483 
At end of the period (unaudited)   49,182    10,643    15,500    20,665    10,072    5,739    15,695    24,345    1,161    4,958    157,960    172,638 
                                                             
Average annual amortization rates   -    10%   13%   17%   33%   33%   10%   33%   21%   -           

F-24

 

(a)Goodwill

 

The carrying amount of goodwill by operating segment was:

 

  

June 30, 2019

(unaudited)

  December 31, 2018
       
Core   8,515    62,036 
Supplemental   40,667    27,598 
    49,182    89,634 

 

Impairment test for goodwill

 

There were no indications of impairment for the six-month periods ended June 30, 2019 and 2018.

 

(a)Other intangible assets

 

Intangible assets, other than goodwill, are valued separately for each acquisition and are amortized over their expected useful lives. The useful lives and methods of amortization of other intangibles are reviewed at each financial year end and adjusted prospectively, if appropriate.

 

For the six-month periods ended June 30, 2019 and 2018 there were no indications that the Company’s other intangible assets with definite lives might be impaired.

 

14Financial instruments from acquisition of interests

 

The breakdown of derivative instruments related to business combinations and acquisition of investments in associates and joint ventures is as follows:

 

   June 30, 2019  December 31, 2018
Assets  (unaudited)   
Derivative financial instruments (*)      
Call option in Geekie   19,456    23,346 
Call option in WPensar   1,805    3,284 
    21,261    26,630 
Current   -    - 
Non current   21,261    26,630 

F-25

 

Liabilities  June 30, 2019  December 31, 2018
Derivative financial instruments  (unaudited)   
Put option in Geekie   (19,767)   (22,037)
Put option in WPensar   (1,827)   (3,006)
Deferred revenue in Escola de Aplicação São José dos Campos Ltda.   -    (54)
           
Forward contract          
Investment in Nave (Note 10a)   (43,210)   - 
           
    (64,804)   (25,097)
           
Current   (15,562)   (51)
Non current   (49,242)   (25,046)

 

(*) Refer to Note 11 of the consolidated financial statements ate December 31, 2018 for a description of the terms and condition of the call and put options.

 

15Accounts payable to selling shareholders

 

   June 30, 2019  December 31, 2018
   (unaudited)   
Accounts payable to selling shareholders      
Acquisition of International School (a)   (188,637)   (174,410)
Acquisition of NS Educação Ltda. (b)   (7,186)   (6,971)
Acquisition of Escola em Movimento (c)   (1,937)   - 
    (197,760)   (181,381)
Current   (90,829)   (830)
Non-current   (106,931)   (180,551)

 

(a)Upon acquiring control of International School, the shareholders entered into an agreement with put and call options over the remaining interest. Because the terms of the put and call options are symmetrical, the Company concluded that it is virtually certain that either the parent or the non-controlling shareholder will exercise the option because it will be in the economic interests of one of them to do so. The financial liability is recorded at the present value of the estimated amount payable to the non-controlling shareholder upon the exercise of the put option and discounted to present value using an estimated interest rate of 17,6%.

 

(b)This amount was retained as an escrow for any losses, which will be released in annual installments from December 30, 2018 to December 30, 2022.

 

(c)This amount was retained as an escrow for any losses, which will be released in two annual installments on the first and second anniversary of the acquisition. The amount is being adjusted by the basic interest rate (SELIC).

 

F-26

 

16Labor and social obligations

 

(a)Variable remuneration (bonuses)

 

The Company recorded bonuses related to variable remuneration of employees and management in cost of sales, selling and administrative expenses in the amount of R$ 7,642 and R$ 2,420 for the six-month periods ended June 30, 2019 and 2018, respectively.

 

(b)Share-based compensation plan

 

Arco Plan

 

Members of the Company’s Management participate in a share-based compensation plan. In 2019, all directors exercised their stock options.

 

As of June 30, 2019, there were no outstanding share options (December 31, 2018: 1,091,039).

 

There was no share-based compensation expense for the six-month period ended June 30, 2019.

 

The following table illustrates the number and movements of share options during the period:

 

   Number of share options  Average exercise price per share option
Outstanding at December 31, 2018   1,091,039    12.56 
Granted   -    - 
Forfeited   -    - 
Exercised   (1,091,039)   12.68 
Expired   -    - 
Outstanding at June 30, 2019   -    - 

 

International School plan

 

There were no share options granted, forfeited, exercised and expired for the six-month period ended June 30, 2019.

 

The share-based compensation expense for the International School Plan recognized in the statement of income for the six-month period ended June 30, 2019 was R$ 275 (R$ 275 in 2018).

 

Restricted stock units

 

On April 30, 2019, the Company granted 566,890 restricted stock units (RSUs), which will be available for sale by the beneficiaries annually, over three years, on each date of the anniversary of the IPO. The related compensation expense will be recognized over a period of three years. The total compensation expense for the six-month period

 

F-27

 

ended June 30, 2019, including taxes and social charges, was R$ 20,676. These awards are classified as equity.

 

After the vesting period, the restricted shares have the same rights and privileges as any shareholder. The condition for the employee to receive the restricted shares is to continue working at the Company during the vesting period.

 

17Equity

 

Share capital

 

As of June 30, 2019, the Company’s share capital is represented by 51,352,066 common shares (December 31, 2018: 50,261,027) of par value of US$ 0.00005 each, comprised by 27,658,290 Class B common shares (December 31, 2018: 27,658,290) and 23,693,776 Class A common shares (December 31, 2018: 22,602,737).

 

In 2019, the directors exercised their stock options, resulting in a capital increase of R$13,829 and 1,091,039 of Class A common shares.

 

18Earnings per share (EPS)

 

Basic

 

Basic EPS is calculated by dividing profit attributable to the equity holders of the parent by the weighted average number of Class A and Class B common shares outstanding during the period.

 

Diluted

 

Diluted EPS is calculated by dividing profit attributable to the equity holders of the parent by the weighted average number of Class A and Class B common shares outstanding during the period plus the weighted average number of common shares that would be issued on conversion of all potential common shares with dilutive effects.

 

The following table reflects the profit attributable to equity holders of the parent and the share data used in the basic and diluted EPS computations:

 

F-28

 

   Three-month period ended  Three-month period ended
   June 30, 2019 (unaudited)  June 30, 2018 (unaudited)
   Class A  Class B  Total  Class A  Class B  Total
                   
Profit attributable to equity holders of the parent   11,857    13,842    25,699    6,360    7,783    14,143 
Weighted average number of common shares outstanding (thousand)   23,397    27,312    50,709    22,603    27,658    50,261 
Effects of dilution from:                              
Share-based compensation plan (thousands)   567    -         981    -      
                               
Basic earnings per share - R$   0.51    0.51         0.28    0.28      
Diluted earnings per share - R$   0.49    0.50         0.27    0.27      

 

 

   Six-month period ended  Six-month period ended
   June 30, 2019 (unaudited)  June 30, 2018 (unaudited)
   Class A  Class B  Total  Class A  Class B  Total
                   
Profit attributable to equity holders of the parent   26,087    30,453    56,540    24,591    30,091    54,682 
Weighted average number of common shares outstanding (thousand)   23,303    27,202    50,505    22,603    27,658    50,261 
Effects of dilution from:                              
Share-based compensation plan (thousands)   567    -         981    -      
                               
Basic earnings per share - R$   1.12    1.12         1.09    1.09      
Diluted earnings per share - R$   1.09    1.10         1.04    1.05      

 

The number of Class A and Class B common shares outstanding was retrospectively adjusted due to the issuance of new shares as a result of the IPO and the corporate reorganization, described in Note 1.

 

Diluted earnings per share is calculated by the weighted average number of outstanding shares, in order to assume the conversion of all potential dilutive shares. Diluted result per share is calculated considering the instruments that may have a potential dilutive effect in the future, such as share-based payment instruments, using the treasury shares method when the effect is dilutive.

 

F-29

 

19Revenue

 

The Company’s net revenue is as follows:

 

   Three-month period ended  Six-month period ended
   June 30, 2019  June 30, 2018  June 30, 2019  June 30, 2018
   (unaudited)  (unaudited)  (unaudited)  (unaudited)
Educational content   146,919    88,293    275,824    205,527 
Other   356    695    356    1,742 
Returns   (5,913)   (5,298)   (12,889)   (5,913)
Discounts   (3,775)   (2,247)   (8,649)   (6,256)
Taxes   (21)   (7)   (21)   (30)
Net revenue   137,566    81,436    254,621    195,070 

 

 

   For the six-month period ended 30 June 2019  For the six-month period ended 30 June 2018
Segments  Core  Supplemental  Total  Core  Supplemental  Total
Type of goods or service  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)
     Educational content   199,982    54,304    254,286    160,236    33,140    193,376 
     Other   -    335    335    1,694    -    1,694 
Total net revenue from contracts with customers   199,982    54,639    254,621    161,930    33,140    195,070 
Timing of revenue recognition                              
Transferred at a point in time   199,982    54,639    254,621    161,930    33,140    195,070 
Total net revenue from contracts with customers   199,982    54,639    254,621    161,930    33,140    195,070 

 

 

   For the three-month period ended 30 June 2019  For the three-month period ended 30 June 2018
Segments  Core  Supplemental  Total  Core  Supplemental  Total
Type of goods or service  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)
     Educational content   100,832    36,399    137,231    62,482    18,271    80,753 
     Other   -    335    335    683    -    683 
Total net revenue from contracts with customers   100,832    36,734    137,566    63,165    18,271    81,436 
Timing of revenue recognition                              
Transferred at a point in time   100,832    36,734    137,566    63,165    18,271    81,436 
Total net revenue from contracts with customers   100,832    36,734    137,566    63,165    18,271    81,436 

 

The Company’s revenues from contracts with customers are all in Brazil.

 

F-30

 

The Company recognized impairment losses on trade receivables arising from contracts with customers, included under selling expenses in the statement of income, of R$ 2,203 and R$ 3,137 for the six-month periods ended June 30, 2019 and 2018, respectively.

 

Revenues tax benefits

 

The Company is not subjected to the payment of 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 printed and digital books is also exempt from the Brazilian municipal taxes and from the Brazilian value added tax (Imposto sobre Operações relativas à Circulação de Mercadorias e sobre Prestações de Serviços de Transporte Interestadual e Intermunicipal e de Comunicação, or ICMS).

 

20Expenses by nature

 

   Three-month period ended  Six-month period ended
   June 30, 2019  June 30, 2018  June 30, 2019  June 30, 2018
   (unaudited)  (unaudited)  (unaudited)  (unaudited)
             
Content providing   11,272    5,108    22,480    20,994 
Operations personnel   3,651    5,192    5,974    9,334 
Inventory reserves   1,332    1,146    3,560    3,242 
Freight   4,387    2,931    7,481    3,790 
Depreciation and amortization   4,068    1,303    6,611    2,158 
Other   1,117    1,182    1,590    3,184 
Cost of sales   25,827    16,862    47,696    42,702 
                     
Sales personnel   17,972    11,107    37,444    21,884 
Depreciation and amortization   3,388    2,849    6,483    5,900 
Sales & marketing   7,556    4,439    10,626    5,886 
Customer support   7,875    4,438    14,885    8,419 
Allowance for doubtful accounts   550    (397)   2,203    3,137 
Real estate rentals   381    433    944    880 
Other   1,593    1,205    2,865    2,280 
Selling expenses   39,315    24,074    75,450    48,386 
                     
Corporate personnel   10,298    9,219    22,735    16,040 
Third party services   8,265    4,581    12,323    7,349 
Real estate rents   928    775    1,506    1,703 
Travel expenses   649    629    1,218    1,162 
Tax expenses   365    366    1,088    916 
Software licenses   109    262    298    721 
Share-based compensation plan, restricted stock units and payroll taxes   20,814    343    20,951    687 
Depreciation and amortization   1,647    424    3,249    844 
Other   1,851    434    2,390    1,306 
General and administrative expenses   44,926    17,033    65,758    30,728 
                     
Total   110,068    57,969    188,904    121,816 

F-31

 

21Finance result

 

   Three-month period ended    Six-month period ended  
   June 30, 2019    June 30, 2018    June 30, 2019    June 30, 2018  
   (unaudited)    (unaudited)    (unaudited)    (unaudited)  
Income from financial investments   8,781    261    20,844    577 
Changes in fair value of financial investments (a)   4,383    1,606    4,661    2,889 
Changes in fair value of derivative instruments (b)   -    1,203    3,449    3,083 
Foreign exchange gains   65    -    377    - 
Other   732    512    1,586    742 
Finance income   13,961    3,582    30,917    7,291 
                     
Changes in fair value of derivative instruments (b)   -    (836)   (5,369)   (1,109)
Interest expenses (c)   (6,916)   (2,326)   (14,440)   (4,824)
Financial discounts granted   (1,316)   (230)   (2,382)   (933)
Bank fees   (1,094)   (89)   (2,174)   (169)
Interest on lease expenses   (387)   -    (782)   - 
Foreign exchange loss   (893)   -    (893)   - 
Other   (1,768)   (359)   (2,815)   (730)
Finance costs   (12,374)   (3,840)   (28,855)   (7,765)
                     
Finance result   1,587    (258)   2,062    (474)

 

(a)Refers to gains on financial investments measured at FVPL.

 

(b)Refers to changes in the fair value of derivative financial instruments, comprised of the put and call options from business acquisitions and investments in associates and joint ventures.

 

(c)Refer to interest expense on liabilities related to business combinations and investments in associates.

 

F-32

 

22Income taxes

 

(a)Reconciliation of income taxes expense

 

   Three-month period ended    Six-month period ended  
   June 30, 2019    June 30, 2018    June 30, 2019    June 30, 2018  
   (unaudited)    (unaudited)    (unaudited)    (unaudited)  
             
Profit before income taxes   27,981    21,504    69,542    74,658 
Combined statutory income taxes rate - %   34%   34%   34%   34%
    (9,513)   (7,311)   (23,644)   (25,384)
Income taxes at statutory rates                    
Reconciliation adjustments:                    
  Share of loss of equity-accounted investees (a)   (227)   (78)   (394)   (100)
   Effect of presumed profit of subsidiaries (b)   3,429    (79)   8,167    5,444 
   Other additions (exclusions), net   4,029    (120)   2,869    (311)
Income taxes expense   (2,282)   (7,588)   (13,002)   (20,351)
                     
Current   (10,899)   (6,071)   (29,151)   (20,879)
Deferred   8,617    (1,517)   16,149    528 
Income taxes expense   (2,282)   (7,588)   (13,002)   (20,351)
                     
Effective rate   8.2%   35.3%   18.7%   27.3%
                     
(a)Refers to the effect of 34% on the share of profit of investees for the year.

 

(b)Brazilian tax law establishes that companies that generate gross revenues of up to R$ 78,000 in the prior fiscal year may calculate income taxes as a percentage of gross revenue, using the presumed profit income tax regime. The Company’s subsidiaries adopted this tax regime and the effect of the presumed profit of subsidiaries represents the difference between the taxation based on this method and the amount that would be due based on the statutory rate applied to the taxable profit of the subsidiaries. The variance between for the six-month periods ended June 30, 2019   and 2018 is due to the effect of presumed profit taxation of certain subsidiaries, which have a lower income tax rate but had a higher profit before income tax.

 

F-33

 

(b)Deferred income taxes

 

The changes in the deferred tax assets and liabilities are as follows:

 

   As of December 31, 2018  Change in accounting practice  Recognized in profit or loss  Recognized in equity  As of June 30, 2019  
Deferred tax assets              (unaudited)  
Tax losses carryforward   4,364    -    (1,178)   -    3,186 
Temporary differences                         
Financial instruments from acquisition of interests   59,166    -    6,703    -    65,869 
Other temporary differences   6,585    731    5,103    -    12,419 
Tax benefit from tax deductible goodwill (a)   46,314    -    (166)   16,897    63,045 
Amortization of intangible assets   1,282    -    1,756    -    3,038 
Restricted stock units   -    -    6,571    -    6,571 
Total deferred tax assets   117,711    731    18,789    16,897    154,128 
Deferred tax liabilities                         
Financial instruments from acquisition of interests   (18,166)   -    (1,140)   -    (19,306)
Other temporary differences   (1,463)   -    (1,500)   -    (2,963)
Total deferred tax liabilities   (19,629)   -    (2,640)   -    (22,269)
Deferred tax assets (liabilities), net   98,082    731    16,149    16,897    131,859 
                          
Deferred tax assets – non current   99,460                   133,419 
Deferred tax liabilities – non current   (1,378)                  (1,560)

 

(a)Refers to R$ 46,314 of tax benefit generated from the goodwill in the acquisition of EAS interest by GA Holding and R$ 16,897 to tax benefits generated from the corporates restructuring described in Note 2.2.

 

As of June 30, 2019, the Company had unrecognized deferred income tax assets in the amount of R$ 85 (December 31, 2018: R$ 3,228) with respect to tax loss carryforward. The net operating losses carried forwards do not expire, however, their compensation is limited to 30% of the annual taxable income. The recognition of the deferred income tax assets is supported by the Company’s forecasts of the future profitability and historical results.

 

23Segment information

 

Segment information is presented consistently with the internal reports provided to the Company’s main key executives. They are responsible for allocating resources, assessing the performance of the operating segments, and making the Company’s strategic decisions.

 

The Executive Officers have defined the operating segments based on the reports used to make structured strategic decisions, which allow for decision-making based on these structures:

 

(i)Core: The Core Curriculum business segment provides solutions that address the Brazilian 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 formats that are aligned with the daily curriculum of their classes;

 

F-34

 

(ii)Supplemental: The Supplemental Solutions business segment provide additional value-added content that private schools can opt in for, in addition to the Core Curriculum solution. Currently, the Company’s primary Supplemental product is an English as a second language (ESL) bilingual teaching program.

 

The Executive Officers do not make strategic decisions or evaluate performance based on geographic regions. Currently, the Company operates solely in Brazil and all the assets, liabilities and results are allocated in Brazil. Also, based on the agreements signed with schools as of June 30, 2019  , none of our customers individually represented more than 5% of our total revenue.

 

Seasonality of operations

 

The Company typically delivers Core Curriculum content four times each year: in March, June, August and December. Supplemental Solutions content is delivered twice each year in June and December, typically two to three months prior to the start of each school quarter. This allows the private schools and their teachers to prepare classes in advance of each school quarter. Because revenue is recognized at the moment of delivery of the educational content, the fourth quarter results reflect the growth in the number of students from one school year to another. Consequently, the Company generally have higher revenues in the fourth quarter of the year compared to the preceding quarters.

 

F-35

 

   Six-month period ended June 30, 2019   (unaudited)  
   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
Net revenue   199,982    54,639    254,621    -    254,621 
Cost of sales   (40,274)   (7,422)   (47,696)   -    (47,696)
Gross profit   159,708    47,217    206,925    -    206,925 
Selling expenses   (57,738)   (17,712)   (75,450)   -    (75,450)
Segment profit   101,970    29,505    131,475    -    131,475 
General and administrative expenses                       (65,758)
Other income, net                       2,922 
Operating profit                       68,639 
Finance income                       30,917 
Finance costs                       (28,855)
Share of loss of equity-accounted investees                       (1,159)
Profit before income taxes                       69,542 
Income taxes expense                       (13,002)
Profit for the period                       56,540 
                          
Other disclosures                         
Depreciation and amortization   14,414    1,929    16,343    -    16,343 
Investments in associates and joint ventures   58,113    -    58,113    -    58,113 
Capital expenditures   6,417    17,791    24,208         24,208 

F-36

 

   Six-month period ended June 30, 2018   (unaudited)  
   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
Net revenue   161,930    33,140    195,070    -    195,070 
Cost of sales   (37,332)   (5,370)   (42,702)   -    (42,702)
Gross profit   124,598    27,770    152,368    -    152,368 
Selling expenses   (39,241)   (9,145)   (48,386)   -    (48,386)
Segment profit   85,357    18,625    103,982    -    103,982 
General and administrative expenses                       (30,728)
Other income, net                       2,172 
Operating profit                       75,426 
Finance income                       7,291 
Finance costs                       (7,765)
Share of loss of equity-accounted investees                       (294)
Profit before income taxes                       74,658 
Income taxes expense                       (20,351)
Profit for the period                       54,307 
                          
Other disclosures                         
Depreciation and amortization   8,156    746    8,902    -    8,902 
Investments in associates and joint ventures   12,360    -    12,360    -    12,360 
Capital expenditures   6,223    846    7,069    -    7,069 

 

F-37

 

 

 

 

   Three-month period ended June 30, 2019   (unaudited)  
   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
Revenue   100,832    36,734    137,566    -    137,566 
Cost of sales   (20,589)   (5,238)   (25,827)   -    (25,827)
Gross profit   80,243    31,496    111,739    -    111,739 
Selling expenses   (28,602)   (10,713)   (39,315)   -    (39,315)
Segment profit   51,641    20,783    72,424    -    72,424 
General and administrative expenses                       (44,926)
Other expenses, net                       (437)
Operating profit                       27,061 
Finance income                       13,961 
Finance costs                       (12,374)
Share of loss of equity-accounted investees                       (667)
Profit before income taxes                       27,981 
Income taxes expense                       (2,282)
Profit for the period                       25,699 
                          

 

 

   Three-month period ended June 30, 2018   (unaudited)  
   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
Revenue   63,165    18,271    81,436    -    81,436 
Cost of sales   (13,773)   (3,089)   (16,862)   -    (16,862)
Gross profit   49,392    15,182    64,574    -    64,574 
Selling expenses   (19,645)   (4,429)   (24,074)   -    (24,074)
Segment profit   29,747    10,753    40,500    -    40,500 
General and administrative expenses                       (17,033)
Other expenses, net                       (1,476)
Operating profit                       21,991 
Finance income                       3,582 
Finance costs                       (3,840)
Share of loss of equity-accounted investees                       (229)
Profit before income taxes                       21,504 
Income taxes expense                       (7,588)
Profit for the period                       13,916 

F-38

 

Capital expenditures consist of additions of property and equipment and intangible assets. There were no inter-segment revenues in the six-month periods ended June 30, 2019 and 2018.

 

Segment performance is evaluated based on segment profit or loss and is measured consistently with profit or loss in the consolidated financial statements. General and administrative expenses, other income (expenses) net, finance result, share of profit (loss) of equity-accounted investees and income taxes are managed on a Company basis and are not allocated to operating segments.

 

Segment profit or loss excludes general and administrative expenses, other income (expenses), net, finance result, share of profit (loss) of equity-accounted investees and income taxes in order to demonstrate the results without the influence of shared service center expenses or significant items of income and expenses which may have an impact on the quality of earnings such as restructuring costs, legal expenses, and impairments.

 

There were no adjustments or eliminations in the profit or loss between segments. Segment assets and liabilities are measured in the same way as in the financial statements. These assets and liabilities are allocated based on the operations of the segment.

 

   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
As of June 30, 2019   (unaudited)                           
Total assets   1,407,331    95,645    1,502,976    (2,767)   1,500,209 
Total liabilities   362,436    23,672    386,108    (2,767)   383,341 
                          
As of December 31, 2018                         
Total assets   1,273,107    62,006    1,335,113    (235)   1,334,878 
Total liabilities   254,744    10,485    265,229    (235)   264,994 

 

 

24Financial instruments

 

The Company holds the following financial instruments:

 

Financial assets  Assets at FVPL  Assets at amortized cost  Total
June 30, 2019   (unaudited)                 
Cash and cash equivalents   8,530    -    8,530 
Financial investments   413,756    459,858    873,614 
Trade receivables   -    142,943    142,943 
Financial instruments from acquisition of interests   21,261    -    21,261 
    443,547    602,801    1,046,348 

F-39

 

Financial assets

  Assets at FVPL  Assets at amortized cost  Total
December 31, 2018         
Cash and cash equivalents   12,301    -    12,301 
Financial investments   2,370    808,789    811,159 
Trade receivables   -    136,611    136,611 
Financial instruments from acquisition of interests   26,630    -    26,630 
    41,301    945,400    986,701 

 

Financial liabilities  Liabilities at FVPL  Liabilities at amortized cost  Total
June 30, 2019   (unaudited)           
Trade payables   -    13,991    13,991 
Financial instruments from acquisition of interests   64,804    -    64,804 
Accounts payable to selling shareholders   197,760    -    197,760 
Lease liabilities   -    21,488    21,488 
Loans and financing   -    537    537 
    262,564    36,016    298,580 

 

Financial liabilities  Liabilities at FVPL  Liabilities at amortized cost  Total
December 31, 2018         
Trade payables   -    14,845    14,845 
Financial instruments from acquisition of interests   25,097    -    25,097 
Accounts payable to selling shareholders   -    181,381    181,381 
    25,097    196,226    221,323 

 

The Company’s exposure to certain risks associated with the financial instruments is discussed in Note 25.

 

The maximum exposure to credit risk at the end of the reporting period is the carrying amount of each class of financial assets mentioned above.

 

(a) Financial instruments at fair value through profit or loss

 

Financial investments

 

The Company designated part of its financial investments as financial assets at fair value through profit or loss.

 

F-40

 

Derivative instruments

 

The Company acquired entities under business combinations and through the acquisition of interests in associates and joint ventures. The share purchase agreements contain put and call options and forward contracts that are also measured at fair value through profit or loss.

 

As of and for the six-month periods ended June 30, 2019   and 2018 none of the Company’s derivatives have been designated as hedges for accounting purposes.

 

(ii) Amounts recognized in profit or loss

 

Changes in fair values of financial instruments at fair value through profit or loss are recorded in finance income (costs) in profit or loss (loss of R$ 1,866 and gain of R$ 1,974 for the six-month periods ended in June 30, 2019 and 2018, respectively).

 

(b) Recognized fair value measurements

 

(i) Fair value hierarchy

 

The table below explains the judgements and estimates made in determining the fair values of the financial instruments that are recognized and measured at fair value through profit or loss in the consolidated financial statements. To provide an indication about the reliability of the inputs used in determining fair value, the Company has classified its financial instruments into the three levels.

 

Assets and liabilities are measured and recognized at fair value as follows:

 

   Hierarchy  June 30, 2019    December 31, 2018
Financial assets             
Cash and cash equivalents  Level 2   8,530    12,301 
Financial investments  Level 2   413,756    2,370 
Derivative financial instruments  Level 3   21,261    26,630 
              
Financial liabilities             
Derivative financial instruments and forward contracts  Level 3   64,804    25,097 
Accounts payable to selling shareholders  Level 3   197,760    - 

 

As of June 30, 2019, and December 31, 2018, the Company assessed the fair values of its financial instruments. This assessment does not indicate fair values significantly different from the carrying amounts. The estimated realizable values of financial assets and liabilities were determined based on available market information and appropriate valuation methodologies.

 

The Company’s policy is to recognize transfers into and transfers out of fair value hierarchy levels as at the end of the reporting period.

 

F-41

 

There were no transfers between levels for recurring fair value measurements during the financial statement period.

 

(ii) Valuation techniques used to determine fair values

 

Specific valuation techniques used to value financial instruments include:

 

·the use of quoted market prices or dealer quotes for similar instruments;

 

·the fair value of derivatives is calculated with Black & Scholes; and

 

·the fair value of the remaining financial instruments is determined using discounted cash flow analysis.

 

All the resulting fair value estimates are included in level 2 except for contingent consideration and certain derivative contracts, where the fair values have been determined based on present values and the discount rates used were adjusted for counterparty or own credit risk.

 

If the inputs used to measure the fair value of an asset or a liability fall into different levels of the fair value hierarchy, then the fair value measurement is categorized in its entirety in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement.

 

(iii) Fair value measurements using significant unobservable inputs (level 3)

 

The following table presents the changes in level 3 items for the six-month periods ended June 30, 2019   and 2018.

 

Recurring fair value measurements  Financial instruments from acquisition of interests (assets)  Financial instruments from acquisition of interests (liabilities)  Accounts payable to selling shareholders
Balances as of December 31, 2017   12,511    (13,637)   - 
Deferred revenue in Escola de Aplicação São José dos Campos Ltda.   -    25    - 
Gains recognized in statement of income   1,782    167    - 
Balances as of June 30, 2018   (unaudited)     14,293    (13,445)   - 
                
Balances as of December 31, 2018   26,630    (25,097)   181,381 
Acquisition of Escola em Movimento   -    -    1,929 
Forward contract of Nave   -    (43,210)     
Interest expense   -    -    14,450 
Deferred revenue in Escola de Aplicação São José dos Campos Ltda.   -    54    - 
Gains (loss) recognized in statement of income   (5,369)   3,449    - 
Balances as of June 30, 2019   (unaudited)     21,261    (64,804)   197,760 

 

(iv) Transfers between levels 2 and 3

 

In the six-month periods ended June 30, 2019 and 2018, the Company did not transfer any financial instruments from level 2 into level 3.

 

F-42

 

(v) Valuation processes

 

The finance department of the Company performs and reviews the valuations of items required for financial reporting purposes, including level 3 fair values. Discussions of valuation processes and results conform with the Company’s yearly reporting periods. Also, the Company hires specialists to measure fair value of certain financial assets independently.

 

The main level 3 inputs used by the Company are derived and evaluated as follows:

 

·Discount rates for financial assets and financial liabilities are determined using a capital asset pricing model to calculate a pre-tax rate that reflects current market assessments of the time value of money and the risk specific to the asset.

 

·Risk adjustments specific to the counterparties (including assumptions about credit default rates) are derived from observable market data of credit risk grading.

 

·Earnings growth factors for unlisted equity securities are estimated based on market information for similar types of companies.

 

·Contingent consideration – expected cash outflows are estimated based on the terms of the business combinations and the entity’s knowledge of the business as well as how the current economic environment is likely to impact it.

 

25Risk

 

(a)Financial risk management

 

The Company monitors market, credit and operational risks in line with the objectives in capital management and counts with the support, monitoring and oversight of the Board of Directors in decisions related to capital management and its alignment with the objectives and risks. The Company monitors the effectiveness of the Company’s risk management.

 

The sensitivity analyses in the following sections relate to the position as of June 30, 2019  .

 

Capital management

 

The Company’s objectives when managing capital are to:

 

·maximize shareholder value;

 

·safeguard its ability to continue as a going concern, so that it can continue to provide returns for shareholders and benefits for other stakeholders; and

 

·maintain an optimal capital structure to reduce the cost of capital.

 

In order to maintain or alter the capital structure, the Company may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debt.

 

F-43

 

No changes were made in the objectives, policies or processes for managing capital during the six-month period ended June 30, 2019.

 

(i)Foreign exchange risk

 

Exposure

 

The Company’s exposure to foreign currency risk as of June 30, 2019 and December 31, 2018, was as follows:

 

   June 30, 2019    December 31, 2018
Cash and cash equivalents   4,124    3,615 
Financial investments   12,517    - 

 

The Company does not operate outside Brazil and does not have exposure to foreign exchange risk on commercial transactions, i.e., revenues or expenses.

 

Sensitivity analysis

 

The sensitivity analysis as of June 30, 2019 consider three scenarios of U.S. dollar exchange rate variation, as follows:

 

·Base scenario - exchange rate as of June 30, 2019 of R$ 3.8322 per US$ 1.00;

 

·Scenario I - a 10% increase in the U.S. dollar exchange rate, to R$ 4.2154; and

 

·Scenario II - a 10% decrease in the U.S. dollar exchange rate, to R$ 3.4490.

 

The table below set forth the sensitivity analysis as of June 30, 2019, for the amount of cash and cash equivalents and financial investments denominated in U.S. dollar of US$ 4,342 thousand:

 

Base scenario 

Scenario I 

Scenario II 

 

Exchange rate:

R$ 3.8322

Exchange rate:
R$ 4.2154
Exchange rate:
R$ 3.4490
Finance income (costs)   R$ 1,664 R$ (1,664)

 

(ii)Liquidity risk

 

Management of the Company has responsibility for mitigating liquidity risk. In order to achieve their goals, management regularly reviews the risk and maintains appropriate reserves, including bank credit facilities with first tier financial institutions. Management also continuously monitors projected and actual cash flows and the combination of the maturity profiles of the financial assets and liabilities.

 

The main requirements for financial resources used by the Company arise from the need to make payments for printing educational content, freight expenses, operating expenses, labor and social obligations and other operating disbursements.

 

F-44

 

The table below summarizes the maturity profile of the Company’s financial liabilities based on contractual undiscounted amounts:

 

As of June 30, 2019   (unaudited)

 

  On demand  Less than 3 months  3 to 12 months  1 to 5 years  More than 5 years  Total
Trade payables   -    13,991    -    -    -    13,991 
Lease liabilities   269    1,031    3,436    16,752    -    21,488 
Loans and financing   -    40    121    376    -    537 
Financial instruments from 
acquisition of interests
   -    -    15,562    49,242    -    64,804 
Accounts payable to selling 
shareholders
   -    -    90,829    106,931    -    197,760 
    269    15,062    109,948    173,301    -    298,580 

 

(iii)Financial counterparty risk

 

This risk arises from the possibility that the Company may incur losses due to the default of its counterparties. To mitigate these risks, the Company adopts as practice the analysis of the financial and equity situation of its counterparties.

 

Counterparty credit limits, which take published credit ratings and other factors into account, are set to cover the Company’s total aggregate exposure to a single financial institution. Exposures and limits applicable to each financial institution are approved by our treasury within guidelines approved by the board and are reviewed on a regular basis.

 

(iv)Interest rate risk

 

Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company’s exposure to the risk of changes in market interest rates relates primarily to the Company’s investments with floating interest rates. The Company is mainly exposed to fluctuations in CDI interest rates on financial investments.

 

Sensitivity analysis

 

The Company has a significant portion of its financial investments indexed to the CDI variation. According to the reference rates obtained from the website of the Brazilian Stock Exchange – B3 S.A. - Brasil, Bolsa, Balcão (“B3”) and projected for 12 months, as of June 30, 2019 the CDI rate was 6.40%.

 

F-45

 

As of June 30, 2019, the Company’s management estimated two scenarios of the CDI rates at +10% and -10%, which were used as a basis for the possible and remote scenarios, respectively. The table below shows a summary of the scenarios estimated by Management and the effect on profit before income taxes:

 

    Exposure    +10%    -10%
June 30, 2019   (unaudited)                 
Cash, bank deposits and cash equivalents   4,406    28    (28)
Financial investments   861,097    5,511    (5,511)

 

The Company has derivatives (calls and put options) on non-controlling interests in associates and joint ventures acquired. The fair value of these derivatives is calculated using multiple scenarios and intrinsic methods. The major inputs are: exercise price, exercise date, volatility and gross profit of the associates and joint ventures.

 

The Company performed evaluation of their fair value at the end of each period in order to account for any changes to it, as disclosed in Note 24. These derivatives, which are not publicly traded, have specific conditions that do not enable us to present a sensitivity analysis in relation to specific interest rates or market indexes. Also, these derivatives are part of the Company’s strategy to acquire companies directly related to its continuous growth and are considered by the Company as a deferred payment to the previous shareholders of the acquirees.

 

26Commitments and contingencies

 

(i)Legal proceedings

 

The Company is party to labor and tax litigation in progress, which arise during the ordinary course of business. The provisions for probable losses arising from these matters are estimated and periodically adjusted by Management, supported by the opinion of its external legal advisors.

 

   Labor  Taxes  Total
    (unaudited)    (unaudited)    (unaudited) 
                
Balances at December 31, 2018   17    114    131 
Additions   213    -    213 
Reversals   (2)   -    (2)
Balances at June 30, 2019     228    114    342 

 

As of June 30, 2019, the Company was party to lawsuits classified as possible losses totaling R$ 5,496 (R$ 5,170 as of December 31, 2018), as shown below:

 

F-46

 

   June 30, 2019    December 31, 2018
   (unaudited)     
Civil (a)   4,919    4,425 
Labor (b)   577    745 
Total   5,496    5,170 

 

(a)The civil proceedings relate mainly to customer claims, including those related to the early termination of certain agreements, among others.

 

(b)The labor proceedings to which the Company is a party were filed by former employees or suppliers and third-party service providers’ employees seeking joint liability for the acts of the Company’s suppliers and service providers.

 

27Transactions not involving cash

 

The Company carried out the non-cash activities in the six-month period ended June 30, 2019  , which are not reflected in the statement of cash flows, mainly related to the corporate restructuring described in Note 2.2, the recognition of right-of-use asses and lease liabilities as a result of the adoption of IFRS 16, the forward contract (Note 10 and Note 14) and the escrow account described in note 3 (Business combination)

 

***

 

 

 

 

F-47

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    Arco Platform Ltd.
     
     
      By: /s/ Ari de Sá Cavalcante Neto
        Name: Ari de Sá Cavalcante Neto
        Title: Chief Executive Officer

Date: August 27, 2019