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 November, 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 nine months ended September 30, 2019
   

 

Item 1

Arco Platform Limited

 

Unaudited interim condensed

consolidated financial statements

 

September 30, 2019

 

 

 

Arco Platform Limited

 

Unaudited interim condensed consolidated statements of financial position

As of September 30, 2019 and December 31, 2018 

(In thousands of Brazilian reais)

 

   Notes 

September 30,

2019

  December 31, 2018
Assets     (unaudited)   
Current assets         
Cash and cash equivalents  4   2,568    12,301 
Financial investments  5   894,938    806,789 
Trade receivables  6   87,461    136,611 
Inventories  7   25,175    15,131 
Recoverable taxes  8   28,471    11,227 
Financial instruments from acquisition of interests  14   2,004    - 
Loans to related parties  9   1,282    - 
Other assets      9,228    6,091 
Total current assets      1,051,127    988,150 
Non-current assets             
Financial instruments from acquisition of interests  14   21,374    26,630 
Deferred income tax  22   178,163    99,460 
Recoverable taxes  8   946    1,033 
Financial investments  5   4,579    4,370 
Loans to related parties  9   14,613    1,226 
Other assets      8,466    1,060 
Investments and interests in other entities  10   58,505    11,862 
Property and equipment  11   16,726    13,347 
Right-of-use assets  12   19,684    - 
Intangible assets  13   157,467    187,740 
Total non-current assets      480,523    346,728 
              
Total assets      1,531,650    1,334,878 
              
Liabilities             
Current liabilities             
Trade payables      21,824    14,845 
Labor and social obligations      52,183    15,888 
Advances from customers      3,171    5,997 
Lease liabilities  12   5,453    - 
Loans and financing      157    - 
Taxes and contributions payable      2,018    2,555 
Income taxes payable      29,891    17,294 
Financial instruments from acquisition of interests  14   22,576    51 
Accounts payable to selling shareholders  15   112,548    830 
Other liabilities      125    428 
Total current liabilities      249,946    57,888 
 Non-current liabilities             
Labor and social obligations      5,535    - 
Lease liabilities  12   18,131    - 
Loans and financing      353    - 
Financial instruments from acquisition of interests  14   54,861    25,046 
Accounts payable to selling shareholders  15   175,220    180,551 
Provision for legal proceedings  26   231    131 
Deferred income tax  22   871    1,378 
Other liabilities      122    - 
Total non-current liabilities      255,324    207,106 
Total liabilities      505,270    264,994 
Equity             
Share capital  17   10    10 
Capital reserve      1,066,710    1,089,505 
Share-based compensation reserve      99,781    67,350 
Accumulated losses      (140,121)   (86,687)
Equity attributable to equity holders of the parent      1,026,380    1,070,178 
Non-controlling interests      -    (294)
Total equity      1,026,380    1,069,884 
              
Total liabilities and equity      1,531,650    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 nine-month periods ended September 30, 2019 and 2018 

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

 

      Three-month period ended  Nine-month period ended
   Notes  September 30, 2019  September 30, 2018  September 30, 2019  September 30, 2018
      (unaudited)  (unaudited)  (unaudited)  (unaudited)
                
Net revenue  19   70,572    64,902    325,193    259,972 
Cost of sales  20   (14,188)   (14,126)   (61,884)   (56,828)
                        
Gross profit      56,384    50,776    263,309    203,144 
                        
Selling expenses  20   (47,639)   (29,683)   (123,089)   (78,069)
General and administrative expenses  20   (69,515)   (77,016)   (135,273)   (107,744)
Other (expense) income, net      (471)   2,342    2,451    4,514 
                        
Operating profit      (61,241)   (53,581)   7,398    21,845 
                        
Finance income  21   16,187    6,492    47,104    13,783 
Finance costs  21   (104,968)   (8,241)   (133,823)   (16,006)
Finance result  21   (88,781)   (1,749)   (86,719)   (2,223)
                        
Share of loss of equity-accounted investees  10   (794)   (255)   (1,953)   (549)
                        
Income (loss) before income taxes      (150,816)   (55,585)   (81,274)   19,073 
Income taxes - income (expense)                       
Current      (3,103)   (2,370)   (32,254)   (23,249)
Deferred      45,433    (2,379)   61,582    (1,851)
   22   42,330    (4,749)   29,328    (25,100)
                        
Loss for the period      (108,486)   (60,334)   (51,946)   (6,027)
                        
Other comprehensive income for the period      -    -    -    - 
Total comprehensive loss for the period      (108,486)   (60,334)   (51,946)   (6,027)
                        
Loss attributable to                       
Equity holders of the parent      (108,486)   (60,243)   (51,946)   (5,561)
Non-controlling interests      -    (91)   -    (466)
                        
Basic loss per share - in Brazilian reais  18                    
Class A      (2.11)   (1.20)   (1.02)   (0.11)
Class B      (2.11)   (1.20)   (1.02)   (0.11)
Diluted loss per share - in Brazilian reais  18                    
Class A      (2.11)   (1.20)   (1.02)   (0.11)
Class B      (2.11)   (1.20)   (1.02)   (0.11)

 

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 nine-month periods ended September 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  Accumulated losses  Total  Non-controlling interests  Total equity
Balances at June 30, 2018 (unaudited)   55,897    160,682    8,165    -    7,740    49,663    282,147    (169)   281,978 
                                              
Loss for the period   -    -    -    -    -    (60,243)   (60,243)   (91)   (60,334)
Total comprehensive loss   -    -    -    -    -    (60,243)   (60,243)   (91)   (60,334)
Corporate reorganization   (55,890)   63,444    (8,165)   -    -    712    101    -    101 
GA Holding – tax benefit on tax deductible goodwill   -    46,314    -    -    -    -    46,314    -    46,314 
Capital increase – Alfaco   -    3,091    -    -    -    -    3,091    -    3,091 
Issuance of common shares in initial public offering   3    895,179    -    -    -    -    895,182    -    895,182 
Share issuance costs   -    (78,094)   -    -    -    -    (78,094)   -    (78,094)
Non-controlling interest   -    -    -    -    -    -    -    18    18 
Share-based compensation plan   -    -    -    -    59,472    -    59,472    -    59,472 
Balances at September 30, 2018 (unaudited)   10    1,090,616    -    -    67,212    (9,868)   1,147,970    (242)   1,147,728 

 

      Attributable to equity holders of the parent      
         Earnings reserves               
   Share capital  Capital reserve  Legal reserve  Retained earnings reserve  Share-based compensation reserve  Accumulated losses  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)
                                              
Loss for the period   -    -    -    -    -    (5,561)   (5,561)   (466)   (6,027)
Total comprehensive loss   -    -    -    -    -    (5,561)   (5,561)   (466)   (6,027)
Corporate reorganization   (55,890)   63,444    (8,165)   (73,827)   -    -    (74,438)   -    (74,438)
GA Holding – tax benefit on tax deductible goodwill   -    46,314    -    -    -    -    46,314    -    46,314 
Capital increase - Alfaco   -    3,091    -    -    -    -    3,091    -    3,091 
Issuance of common shares in initial public offering   3    895,179    -    -    -    -    895,182    -    895,182 
Share issuance costs   -    (78,094)   -    -    -    -    (78,094)   -    (78,094)
Non-controlling interest   -    -    -    -    -    -    -    113    113 
Share-based compensation plan   -    -    -    -    60,159    -    60,159    -    60,159 
Balances at September 30, 2018 (unaudited)   10    1,090,616    -    -    67,212    (9,868)   1,147,970    (242)   1,147,728 

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 June 30, 2019 (unaudited)   10    1,066,710    81,783    (31,635)   1,116,868    -    1,116,868 
                                    
Loss for the period   -    -    -    (108,486)   (108,486)   -    (108,486)
Total comprehensive loss   -    -    -    (108,486)   (108,486)   -    (108,486)
Restricted stock units (Note 16)   -    -    17,861    -    17,861    -    17,861 
Share-based compensation plan - International School   -    -    137    -    137    -    137 
                                    
Balances at September 30, 2019 (unaudited)   10    1,066,710    99,781    (140,121)   1,026,380    -    1,026,380 
                                    
      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)
                                    
Loss for the period   -    -    -    (51,946)   (51,946)   -    (51,946)
Total comprehensive loss   -    -    -    (51,946)   (51,946)   -    (51,946)
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)   -    -    32,019    -    32,019    -    32,019 
Non-controlling interest   -    -    -    -    -    294    294 
Share-based compensation plan - International School   -    -    412    -    412    -    412 
                                    
Balances at September 30, 2019 (unaudited)   10    1,066,710    99,781    (140,121)   1,026,380    -    1,026,380 
                                    


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 nine-month periods ended September 30, 2019 and 2018 

(In thousands of Brazilian reais)

  

    September 30, 2019    September 30, 2018 
Operating activities   (unaudited)    (unaudited) 
Income (loss) before income taxes for the period   (81,274)   19,073 
Adjustments to reconcile income (loss) before income taxes          
Depreciation and amortization   24,449    13,859 
Inventory reserves   4,203    2,377 
Allowance for doubtful accounts   9,489    5,713 
Residual value of property and equipment and intangible assets disposed   593    138 
Changes in fair value of derivative instruments   10,349    (2,902)
Changes in accounts payable to selling shareholders   81,781    - 
Share of loss of equity-accounted investees   1,953    549 
Share-based compensation plan   412    60,159 
Restricted stock units   32,019    - 
Provision for payroll taxes (restricted stock units)   23,399    - 
Accrued interest   24,710    6,326 
Interest in lease liabilities   1,231    - 
Provision for legal proceedings   100    141 
Foreign exchange results, net   (16)   - 
Sale of investment   (3,252)   - 
Other financial cost/revenue, net   (1,481)   - 
Changes in assets and liabilities          
Trade receivables   39,786    26,420 
Inventories   (10,968)   (5,039)
Recoverable taxes   (7,550)   (18)
Other assets   (6,659)   (2,723)
Trade payables   8,492    4,836 
Labor and social obligations   18,340    5,329 
Taxes and contributions payable   (540)   438 
Advances from customers   (2,337)   (1,929)
Other liabilities   (380)   (5,164)
           
Cash generated from operations   166,849    127,583 
           
Income taxes paid   (28,640)   (25,465)
Interest paid on lease liabilities   (397)   - 
Net cash flows from operating activities   137,812    102,118 
           
Investing activities          
Acquisition of property and equipment   (7,609)   (4,047)
Payment of investments and interests in other entities   (5,418)   (2,000)
Acquisition of subsidiaries, net of cash acquired   (16,137)   (13,820)
Acquisition of intangible assets   (26,361)   (9,848)
Financial investments   (88,432)   28,522 
Loans to related parties   (14,000)   - 
Net cash flows used in investing activities   (157,957)   (1,193)
           

Financing activities

          
Capital increase   13,829    3,091 
Proceeds from initial public offering   -    895,182 
Share issuance costs   (673)   (65,577)
Payment of lease liabilities   (2,709)   - 
Payment of loans and financing   (52)   - 
Dividends paid   -    (85,000)
Net cash flows from financing activities   10,395    747,696 
           
Foreign exchange effects on cash and cash equivalents   17    - 
           
Increase (decrease) in cash and cash equivalents   (9,733)   848,621 
Cash and cash equivalents at the beginning of the period   12,301    834 
Cash and cash equivalents at the end of the period   2,568    849,455 
Increase (decrease) in cash and cash equivalents   (9,733)   848,621 

 

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 November 21, 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 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 thousands, except when otherwise indicated.

 

2.2Changes in the Company’s subsidiaries

 

During the nine-month period ended September 30, 2019, the Company had the following changes in its corporate organization:

 

F-8

 

On January 2, 2019, the Company agreed to sell its shares of Escola de Aplicação São José dos Campos Ltda., which is part of the Company’s Core segment, to its minority shareholders. 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, 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 tax benefit and has recorded a deferred tax asset of R$ 5,135. The deductible goodwill amounts to R$ 14,597. The net effect of R$ 9,462 was accounted for in equity.

 

On March 31, 2019, Novagaúcha Editora e Livraria Ltda. was merged by Barra Américas Editora Ltda.. The goodwill of this transaction is R$ 4,330 and was charged 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 a 30% interest in SAE Digital and a 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 deductibe goodwill amounts to R$ 34,594. The net effect of R$ 22,832 was accounted for 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).

 

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 agreed 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$260 was paid on September 29, 2019 and R$ 1,930 has been retained 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 equal annual installments R$ 965, 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 
Retained payments   1,930 
Analysis of cash flows on acquisition:     
Transaction costs of the acquisition (included in cash flows from operating activities)   (649)
Cash paid and subscribed capital net of cash acquired with the subsidiary (included in cash flows from investing activities)   (16,137)

 

The Company did not recognize deferred taxes related to business combination due to lack of difference between the fiscal and accounting balance sheet.

 

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$ 649 were expensed and are included in general and administrative expenses for the nine-month period ended September 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 September 30, 2019, Escola em Movimento had revenues of R$ 1,346 and a loss before income taxes of R$ 1,472. If the combination had taken place at the beginning of the nine-month period ended September 30, 2019, net revenue of the Company would have been R$ 326,747 and loss before income taxes would have been R$ 81,835.

 

F-15

 

4Cash and cash equivalents

 

   September 30, 2019  December 31, 2018
   (unaudited)   
Cash and bank deposits   445    366 
Bank deposits in foreign currency (a)   41    3,615 
Cash equivalents (b)   2,082    8,320 
    2,568    12,301 

 

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

 

(b)Cash equivalents represent investments in Bank Certificates of Deposit (“CDB”) of highly rated financial institutions. As of September 30, 2019, the average interest on these CDBs are equivalent to 60.8% (December 31, 2018: 61.7%) of the Interbank Certificates of Deposit rate (“CDI”). The average CDI rate during the nine-month period was 0.51% per month. These funds are available for immediate use and have insignificant risk of changes in value.

 

5Financial investments

 

   September 30, 2019  December 31, 2018
   (unaudited)   
Financial investments (a)   895,988    810,812 
Financial investments in foreign currency   3,123    - 
Other   406    347 
    899,517    811,159 
Current   894,938    806,789 
Non-current   4,579    4,370 

 

(a)Financial investments correspond to investments in funds managed by highly rated financial institutions. As of September 30, 2019, the average interest on these funds are equivalent to 101.4% (December 31, 2018: 100.9%) of the CDI. The average CDI rate during the nine-month period was 0.51% per month.

 

6Trade receivables

 

  

September 30,

2019

  December 31, 2018
   (unaudited)   
From sales of educational content   108,296    146,114 
From related parties (Note 9)   879    3,916 
    109,175    150,030 
(-) Allowance for doubtful accounts   (21,714)   (13,419)
    87,461    136,611 

F-16

 

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

 

   September 30, 2019  December 31, 2018
   (unaudited)   
Neither past due nor impaired   66,151    127,387 
Past due   43,024    22,643 
           
1 to 60 days   19,187    8,931 
61 to 90 days   5,758    3,868 
91 to 120 days   4,547    1,978 
121 to 180 days   6,983    3,173 
More than 180 days   6,549    4,693 
    109,175    150,030 

 

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

 

   September 30, 2019  September 30, 2018
   (unaudited)  (unaudited)
Balance at beginning of the period   (13,419)   (4,533)
Change in accounting policy – IFRS 9   -    (5,757)
Additions   (9,489)   (5,713)
Receivables written off during the period as uncollectible   1,194    1,545 
Balance at end of period   (21,714)   (14,458)

 

7Inventories

 

  

September 30,

2019

  December 31, 2018
   (unaudited)   
Educational content   8,169    8,335 
Educational content in progress (a)   13,235    6,205 
Consumables and supplies   861    286 
Inventories held by third parties   2,910    305 
    25,175    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 nine-month periods ended September 30, 2019 and 2018 was as follows:

 

   September 30, 2019  September 30, 2018
   (unaudited)  (unaudited)
Balance at beginning of the period   (4,403)   (2,047)
Inventory reserve   (4,203)   (2,377)
Write-off of inventories against reserve   5,342    1,667 
Balance at end of the period   (3,264)   (2,757)

F-17

 

8Recoverable taxes

 

   September 30, 2019  December 31, 2018
   (unaudited)   
Withholding Income Tax (IRRF) on financial investments   10,560    5,291 
Recoverable IRPJ and CSLL   17,382    5,520 
Recoverable PIS and COFINS   973    1,223 
Other recoverable taxes   502    226 
    29,417    12,260 
Current   28,471    11,227 
Non current   946    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:

 

   September 30, 2019  December 31, 2018
Assets  (unaudited)   
Trade receivables          
Livraria ASC Ltda. and Educadora ASC Ltda. (a)   879    3,916 
    879    3,916 
           
Loans to related parties          
WPensar S.A. (b)   1,282    1,226 
Loans - Geekie (c)   4,174    - 
Debentures – Geekie (c)   10,439    - 
    15,895    1,226 
Current   1,282    - 
Non current   14,613    1,226 
           
Advances from customers          
Livraria ASC Ltda. and Educadora ASC Ltda. (a)   (24)   - 
    (24)   - 
           

 

   September 30, 2019  September 30, 2018
Net revenue  (unaudited)  (unaudited)
Livraria ASC Ltda. and Educadora ASC Ltda. (a)   4,490    4,507 
           
Expenses          
ASC Empreendimentos Ltda. and OSC Empreendimentos Ltda. (d)   (6)   (12)
           
Finance income          
WPensar S.A. (b)   56    - 
Geekie (c)   613    - 
    669    - 

 

(a) SAS Desenvolvimento Educacional Ltda. and International School sell educational content to Livraria ASC Ltda. and Educadora ASC Ltda., entities under common control

 

F-18

 

of the Company’s controlling shareholder. The transactions are priced based on contract price at the sales date.

 

(b) The amounts receivable from WPensar S.A. come from loan agreements and are indexed to the Brazilian Sistema Especial de Liquidação e Custódia (SELIC) interest rate and have a due date in July 2020. During 2019, the Company recognized R$ 56 of finance income.

 

(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. During 2019, the Company recognized R$ 439 of finance income. The debentures are due in June 2022 and bear interest of 110% of the CDI. The debentures are convertible in shares at the option of Arco at maturity similar to same terms 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 due in June 2022, interest of 110% of the CDI, and with their entire interest on Geekie’s shares as collateral to the transaction. During 2019, the Company recognized R$ 174 of finance income.

 

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

 

(d) SAS Sistema de Ensino Ltda. leased a facility from ASC Empreendimentos Ltda., which agreement was terminated in June 2018; SAS Livrarias Ltda. 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:

 

   September 30, 2019  September 30, 2018
   (unaudited)  (unaudited)
Short-term employee benefits   9,565    5,466 
Share-based compensation plan   -    59,747 
Restricted stock units   48,370    - 
    57,935    65,213 

 

For the nine-month period ended September 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 September 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 has been accounted as forward contract.

 

(i) First tranche: Payable 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, in 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: Payable 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, in 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: Payable 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, in 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:

 

   September 30, 2019  September 30, 2018
   (unaudited)  (unaudited)
   WPensar  Geekie  Nave  Total  Total
At beginning of the period   3,237    8,625    -    11,862    12,654 
Capital contributions   -    1,218    4,200    5,418    - 
Forward contract (Note 10a)   -    -    43,210    43,210    - 
Loss of changes in ownership   -    (32)   -    (32)   - 
Share of profit (loss) of equity-accounted investees   (126)   (1,308)   (519)   (1,953)   (549)
At end of the period   3,111    8,503    46,891    58,505    12,105 
                          
Percentage of ownership   25.0%   9.01%   13.2%          

 

(ii) Selected financial information for associates and joint ventures

 

   Geekie  WPensar  Nave
September 30, 2019 (unaudited)         
Current assets   5,192    1,711    4,867 
Non-current assets   14,916    1,650    297 
Current liabilities   8,213    350    1,323 
Non-current liabilities   10,463    1,224    412 
Equity   1,432    1,787    3,429 
Net revenue   7,357    3,231    1,236 
Costs and expenses (*)   (18,363)   (3,026)   (3,587)
Profit (loss) for the period   (11,006)   205    (2,351)
September 30, 2018 (unaudited)               
Net revenue   6,142    934    - 
Costs and expenses (*)   (12,994)   (1,078)   - 
Profit (loss) for the period   (6,852)   (144)   - 
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:

 

  

September 30, 2019

(unaudited)

 

September 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   137    -    443    1,518    -    4,189    1,322    7,609    4,047 
Disposals   (17)   -    -    (16)   -    (19)   (1,053)   (1,105)   (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   983    191    2,559    6,576    325    8,098    5,676    24,408    16,818 
                                              
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   (62)   (18)   (174)   (800)   (14)   (450)   (1,077)   (2,595)   (1,743)
Depreciation of disposals   -    -    -    -    -    42    938    980    17 
Sale of Escola de Aplicação
São José dos Campos
   10    -    34    17    -    150    -    211    - 
At end of the period   (306)   (162)   (667)   (2,693)   (114)   (1,532)   (2,208)   (7,682)   (5,573)
                                              
Net book value                                             
As of December 31   642    47    1,769    3,170    225    3,364    4,130    13,347    9,079 
As of September 30 (unaudited)   677    29    1,892    3,883    211    6,566    3,468    16,726    11,245 
                                              
Annual depreciation rates   10%   20%   10%   20%   10%   10% to 30%    33%          

(*) The additions of leasehold improvements during the nine-month period ended September 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 nine-month periods ended September 30, 2019 and 2018.

 

12Leases

 

The balance sheet shows the following amounts relating to leases:

 

   September 30, 2019
   (unaudited)
Right-of-use assets   
Properties   19,684 
    19,684 

 

   September 30, 2019
   (unaudited)
Lease liabilities *   
Current   5,453 
Non-current   18,131 
    23,584 

 

* 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)
Additions   3,453    (3,453)
Lease modification   (315)   315 
Depreciation expense   (3,556)   - 
Interest expense   -    (1,231)
Payments of lease liabilities   -    2,709 
Interest paid   -    397 
As at September 30, 2019   19,684    (23,584)
           
Average annual depreciation rate   20%     

 

The Company recognized rent expense from short-term leases and low-value assets of R$ 2,019 for the nine-month period ended September 30, 2019.

 

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

 

F-23

 

13Intangible assets

 

     

September 30, 2019

(unaudited)

 

September 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)   9,848 
Acquisitions   -    -    -    -    5,701    2,416    -    14,530    -    3,714    26,361    - 
Disposals   -    -    -    -    -    -    -    (676)   -    -    (676)   - 
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    18,393    8,253    20,302    35,765    1,554    5,963    215,594    204,941 
                                                             
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   -    (1,007)   (1,997)   (4,760)   (4,196)   (1,054)   (1,220)   (7,142)   (203)   -    (21,579)   (12,116)
Amortization of disposals   -    -    -    -    -    -    -    208    -    -    208    - 
At end of the period   -    (4,956)   (9,557)   (17,476)   (8,135)   (1,702)   (5,030)   (10,794)   (477)   -    (58,127)   (31,726)
                                                             
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    10,307    14,706    19,180    10,258    6,551    15,272    24,971    1,077    5,963    157,467    173,215 
                                                             
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:

 

  

September 30, 2019

(unaudited)

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

 

The decrease in goodwill in the nine-month period is due to the write-off to equity resulting from corporate restructuring as mentioned in note 2.2.

 

Impairment test for goodwill

 

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

 

(b)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 nine-month periods ended September 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:

 

   September 30, 2019  December 31, 2018
Assets  (unaudited)   
Derivative financial instruments (*)          
Call option in Geekie   21,374    23,346 
Call option in WPensar   2,004    3,284 
    23,378    26,630 
Current   2,004    - 
Non current   21,374    26,630 

F-25

 

Liabilities  September 30, 2019  December 31, 2018
Derivative financial instruments  (unaudited)   
Put option in Geekie   (21,682)   (22,037)
Put option in WPensar   (2,026)   (3,006)
Deferred revenue in Escola de Aplicação São José dos Campos Ltda.   -    (54)
           
Forward contract          
Investment in Nave (a)   (53,729)   - 
           
    (77,437)   (25,097)
           
Current   (22,576)   (51)
Non current   (54,861)   (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.

 

(a)The forward contract is recorded at the present value using an estimated interest rate of 17,8%. During 2019, the Company recognized R$ 2,033 of interest and changes in fair value of derivative instruments of R$ 8,485.

 

15Accounts payable to selling shareholders

 

   September 30, 2019  December 31, 2018
   (unaudited)   
Accounts payable to selling shareholders          
Acquisition of International School (a)   (278,504)   (174,410)
Acquisition of NS Educação Ltda. (b)   (7,297)   (6,971)
Acquisition of Escola em Movimento (c)   (1,967)   - 
    (287,768)   (181,381)
Current   (112,548)   (830)
Non-current   (175,220)   (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%. During 2019, the Company recognized R$ 22,313 of interest. The amount payable is calculated based on realized EBITDA for the school year of 2019 (first installment) and projected EBITDA for school year of 2020 (second installment), both, net of debts, as determined in the agreement. School year is defined as the twelve-month period starting in October of the previous year to September of the mentioned current year. The first installment will be paid in the first half of 2020 and the second installment in the first half of 2021. The Company performed a review of previous operations projections, because it had a better visibility regarding next year’s contracts revenue with customers (ACV), that

 

F-26

 

resulted in an increase on the projected EBITDA. Based on the new projected numbers, the accounts payable increased by R$ 81,781 and was recorded as financial expense liability. The Company’s review of previous operations projections as described above was performed with no change to the accounting criteria applied to prior financial periods. The operation projections may vary in subsequent financial periods depending on the application of the agreement and the final basis of calculation of its financial liability and will be updated accordingly in its financial statements for future financial periods.

 

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

 

(c)This amount was retained 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-27

 

16Labor and social obligations

 

(a)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 September 30, 2019, there were no outstanding share options (December 31, 2018: 1,091,039).

 

There was no share-based compensation expense for the nine-month period ended September 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 September 30, 2019   -    - 

 

International School plan

 

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

 

The share-based compensation expense for the International School Plan recognized in the statement of income for the nine-month period ended September 30, 2019 was R$ 412 (R$ 412 in 2018).

 

Restricted stock units

 

On April 30, 2019, the Company granted 542,760 restricted stock units (RSUs), with fair value of R$ 126.76, 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.

 

On July 19, 2019, one beneficiary left the Company, reducing by 28,758 the number of restricted stock shares granted. The following table reflects the movements from the grant date until September 30, 2019:

 

F-28

 

   Number of share options
Outstanding at December 31, 2018   - 
Granted   542,760 
Effectively forfeited   (28,758)
Estimated forfeited   (20,560)
Outstanding at September 30, 2019   493,442 

 

The total compensation expense for the nine-month period ended September 30, 2019, including taxes and social charges, was R$ 55,418, net of estimated forfeited. 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 September 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 (loss) per share (EPS)

 

Basic

 

Basic EPS is calculated by dividing profit (loss) 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 (loss) 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 (loss) attributable to equity holders of the parent and the share data used in the basic and diluted EPS computations:

 

F-29

 

   Nine-month period ended  Nine-month period ended
   September 30, 2019 (unaudited)  September 30, 2018 (unaudited)
   Class A  Class B  Total  Class A  Class B  Total
                   
Loss attributable to equity holders of the parent   (23,658)   (28,288)   (51,946)   (2,501)   (3,060)   (5,561)
Weighted average number of common shares outstanding (thousand)   23,132    27,658         22,603    27,658      
Effects of dilution from:                              
Share-based compensation plan (thousands)   -    -         -    -      
                               
Basic loss per share - R$   (1.02)   (1.02)        (0.11)   (0.11)     
Diluted loss per share - R$   (1.02)   (1.02)        (0.11)   (0.11)     

 

   Three-month period ended  Three-month period ended
   September 30, 2019 (unaudited)  September 30, 2018 (unaudited)
   Class A  Class B  Total  Class A  Class B  Total
                   
Loss attributable to equity holders of the parent   (50,055)   (58,431)   (108,486)   (27,092)   (33,151)   (60,243)
Weighted average number of common shares outstanding (thousand)   23,694    27,658         22,603    27,658      
Effects of dilution from:                              
Share-based compensation plan (thousands)   -    -         -    -      
                               
Basic loss per share - R$   (2.11)   (2.11)        (1.20)   (1.20)     
Diluted loss per share - R$   (2.11)   (2.11)        (1.20)   (1.20)     

 

Diluted loss 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. However, due to the losses reported for the three- and nine-month periods ended September 30, 2019 and 2018, these instruments issued have antidilutive effect and, therefore, were not considered in the weighted average number of outstanding shares for the computation of diluted loss per share.

 

F-30

 

19Revenue

 

The Company’s net revenue is as follows:

 

   Three-month period ended  Nine-month period ended
   September 30, 2019  September 30, 2018  September 30, 2019  September 30, 2018
   (unaudited)  (unaudited)  (unaudited)  (unaudited)
Educational content   75,258    67,486    351,082    273,013 
Other   1,078    1,219    1,434    2,961 
Returns   (3,763)   (2,132)   (16,652)   (8,045)
Discounts   (1,934)   (1,614)   (10,583)   (7,870)
Taxes   (67)   (57)   (88)   (87)
Net revenue   70,572    64,902    325,193    259,972 

 

   For the nine-month period ended 30 September 2019  For the nine-month period ended 30 September 2018
Segments  Core  Supplemental  Total  Core  Supplemental  Total
Type of goods or service  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)
     Educational content   267,052    56,795    323,847    223,279    33,830    257,109 
     Other   -    1,346    1,346    2,863    -    2,863 
Total net revenue from contracts with customers   267,052    58,141    325,193    226,142    33,830    259,972 
Timing of revenue recognition                              
Transferred at a point in time   267,052    58,141    325,193    226,142    33,830    259,972 
Total net revenue from contracts with customers   267,052    58,141    325,193    226,142    33,830    259,972 

 

   For the three-month period ended 30 September 2019  For the three-month period ended 30 September 2018
Segments  Core  Supplemental  Total  Core  Supplemental  Total
Type of goods or service  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)
     Educational content   67,070    2,491    69,561    63,043    690    63,733 
     Other   -    1,011    1,011    1,169    -    1,169 
Total net revenue from contracts with customers   67,070    3,502    70,572    64,212    690    64,902 
Timing of revenue recognition                              
Transferred at a point in time   67,070    3,502    70,572    64,212    690    64,902 
Total net revenue from contracts with customers   67,070    3,502    70,572    64,212    690    64,902 

 

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

 

F-31

 

The Company recognized impairment losses on trade receivables arising from contracts with customers, included under selling expenses in the statement of income, of R$ 9,489 and R$ 5,713 for the nine-month periods ended September 30, 2019 and 2018, respectively.

 

Revenues tax benefits

 

The Company is not subject 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  Nine-month period ended
   September 30, 2019  September 30, 2018  September 30, 2019  September 30, 2018
   (unaudited)  (unaudited)  (unaudited)  (unaudited)
             
Content providing   5,976    8,785    28,456    29,779 
Operations personnel   1,870    2,566    7,844    9,147 
Inventory reserves   643    (865)   4,203    2,377 
Freight   2,330    1,673    9,811    5,463 
Depreciation and amortization   2,416    1,460    9,027    3,618 
Other   953    507    2,543    6,444 
Cost of sales   14,188    14,126    61,884    56,828 
                     
Sales personnel   18,564    10,697    56,008    32,581 
Depreciation and amortization   3,659    3,044    10,142    8,944 
Sales and marketing   9,274    5,499    19,900    11,385 
Customer support   5,547    6,073    20,432    14,492 
Allowance for doubtful accounts   7,286    2,576    9,489    5,713 
Real estate rentals   494    514    1,438    1,394 
Other   2,815    1,280    5,680    3,560 
Selling expenses   47,639    29,683    123,089    78,069 
                     
Corporate personnel   12,464    9,770    35,198    25,810 
Third party services   15,400    2,961    27,723    10,310 
Real estate rentals   514    904    2,019    2,607 
Travel expenses   955    952    2,173    2,114 
Tax expenses   490    903    1,578    1,819 
Software licenses   412    189    710    910 
Share-based compensation plan, restricted stock units and payroll taxes   34,878    59,472    55,830    60,159 
Depreciation and amortization   2,029    453    5,278    1,297 
Other   2,373    1,412    4,764    2,718 
General and administrative expenses   69,515    77,016    135,273    107,744 
                     
Total   131,342    120,825    320,246    242,641 

F-32

 

21Finance result

 

   Three-month period ended  Nine-month period ended
   September 30, 2019  September 30, 2018  September 30, 2019  September 30, 2018
   (unaudited)  (unaudited)  (unaudited)  (unaudited)
Income from financial investments   10,407    253    31,251    830 
Changes in fair value of financial investments (a)   3,242    647    7,903    3,536 
Changes in fair value of derivative instruments (b)   260    5,742    3,709    8,825 
Foreign exchange gains   1,209    -    1,586    - 
Interest income   1,358    -    1,358    - 
Other   (289)   (150)   1,297    592 
Finance income   16,187    6,492    47,104    13,783 
                     
Changes in fair value of derivative instruments (b)   (8,689)   (4,814)   (14,058)   (5,923)
Changes in accounts payable to selling shareholders (Note 15)   (81,781)   -    (81,781)   - 
Interest expenses (c)   (10,270)   (2,538)   (24,710)   (7,362)
Financial discounts granted   (554)   (427)   (2,936)   (1,360)
Bank fees   (368)   (98)   (2,542)   (267)
Interest on lease expenses   (449)   -    (1,231)   - 
Foreign exchange loss   (676)   (136)   (1,569)   (136)
Other   (2,181)   (228)   (4,996)   (958)
Finance costs   (104,968)   (8,241)   (133,823)   (16,006)
                     
Finance result   (88,781)   (1,749)   (86,719)   (2,223)

 

(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-33

 

22Income taxes

 

(a)Reconciliation of income taxes expense

 

   Three-month period ended  Nine-month period ended
   September 30, 2019  September 30, 2018  September 30, 2019  September 30, 2018
   (unaudited)  (unaudited)  (unaudited)  (unaudited)
             
Profit (loss) before income taxes   (150,816)   (55,585)   (81,274)   19,073 
Combined statutory income taxes rate - %   34%   34%   34%   34%
    51,277    18,899    27,633    (6,485)
Income taxes at statutory rates                    
Reconciliation adjustments:                    
  Share of loss of equity-accounted investees (a)   (270)   (87)   (664)   (187)
   Effect of presumed profit of subsidiaries (b)   (7,774)   789    393    6,233 
   Permanent differences (c)   -    (22,531)   -    (22,531)
   Other additions (exclusions), net   (903)   (1,819)   1,966    (2,130)
Income taxes benefit (expense)   42,330    (4,749)   29,328    (25,100)
                     
Current   (3,103)   (2,370)   (32,254)   (23,249)
Deferred   45,433    (2,379)   61,582    (1,851)
Income taxes benefit (expense)   42,330    (4,749)   29,328    (25,100)
                     
Effective rate   28.1%   (8.5%)   36.1%   131.6%

 

(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 nine-month periods ended September 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.

 

(c)Refers mainly to permanent differences of non-deductible expenses from share-based compensation plan expenses.

 

F-34

 

(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 September 30, 2019
Deferred tax assets              (unaudited)
Tax losses carryforward   4,364    -    (946)   -    3,418 
Temporary differences                         
Financial instruments from acquisition of interests   59,166    -    37,306    -    96,472 
Other temporary differences   6,585    731    8,615    -    15,931 
Tax benefit from tax deductible goodwill (a)   46,314    -    467    16,897    63,678 
Amortization of intangible assets   1,282    -    347    -    1,629 
Restricted stock units   -    -    17,551    -    17,551 
Total deferred tax assets   117,711    731    63,340    16,897    198,679 
Deferred tax liabilities                         
Financial instruments from acquisition of interests   (18,166)   -    (1,212)   -    (19,378)
Other temporary differences   (1,463)   -    (546)   -    (2,009)
Total deferred tax liabilities   (19,629)   -    (1,758)   -    (21,387)
Deferred tax assets (liabilities), net   98,082    731    61,582    16,897    177,292 
                          
Deferred tax assets – non current   99,460                   178,163 
Deferred tax liabilities – non current   (1,378)                  (871)

 

(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 September 30, 2019, the Company had unrecognized deferred income tax assets in the amount of R$ 937 (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-35

 

(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 September 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.

 

   Nine-month period ended September 30, 2019 (unaudited)
   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
Net revenue   267,052    58,141    325,193    -    325,193 
Cost of sales   (53,236)   (8,648)   (61,884)   -    (61,884)
Gross profit   213,816    49,493    263,309    -    263,309 
Selling expenses   (94,484)   (28,605)   (123,089)   -    (123,089)
Segment profit   119,332    20,888    140,220    -    140,220 
General and administrative expenses                       (135,273)
Other income, net                       2,451 
Operating profit                       7,398 
Finance income                       47,104 
Finance costs                       (133,823)
Share of loss of equity-accounted investees                       (1,953)
Loss before income taxes                       (81,274)
Income taxes expense                       29,328 
Loss for the period                       (51,946)
                          
Other disclosures                         
Depreciation and amortization   21,860    2,587    24,447    -    24,447 
Investments in associates and joint ventures   58,505    -    58,505    -    58,505 
Capital expenditures   23,981    9,989    33,970    -    33,970 

F-36

 

   Nine-month period ended September 30, 2018 (unaudited)
   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
Net revenue   226,142    33,830    259,972    -    259,972 
Cost of sales   (51,159)   (5,669)   (56,828)   -    (56,828)
Gross profit   174,983    28,161    203,144    -    203,144 
Selling expenses   (61,662)   (16,407)   (78,069)   -    (78,069)
Segment profit   113,321    11,754    125,075    -    125,075 
General and administrative expenses                       (107,744)
Other income, net                       4,514 
Operating profit                       21,845 
Finance income                       13,783 
Finance costs                       (16,006)
Share of loss of equity-accounted investees                       (549)
Profit before income taxes                       19,073 
Income taxes expense                       (25,100)
Profit for the period                       (6,027)
                          
Other disclosures                         
Depreciation and amortization   12,824    1,035    13,859    -    13,859 
Investments in associates and joint ventures   12,105    -    12,105    -    12,105 
Capital expenditures   11,824    2,071    13,895    -    13,895 

F-37

 

   Three-month period ended September 30, 2019 (unaudited)
   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
Revenue   67,070    3,502    70,572    -    70,572 
Cost of sales   (12,962)   (1,226)   (14,188)   -    (14,188)
Gross profit   54,108    2,276    56,384    -    56,384 
Selling expenses   (36,746)   (10,893)   (47,639)   -    (47,639)
Segment profit   17,362    (8,617)   8,745    -    8,745 
General and administrative expenses                       (69,515)
Other expenses, net                       (471)
Operating profit                       (61,241)
Finance income                       16,187 
Finance costs                       (104,968)
Share of loss of equity-accounted investees                       (794)
Profit before income taxes                       (150,816)
Income taxes expense                       42,330 
Profit for the period                       (108,486)
                          

 

   Three-month period ended September 30, 2018 (unaudited)
   Core  Supplemental  Total reportable segments  Adjustments and eliminations  Total
Revenue   64,212    690    64,902    -    64,902 
Cost of sales   (13,827)   (299)   (14,126)   -    (14,126)
Gross profit   50,385    391    50,776    -    50,776 
Selling expenses   (22,421)   (7,262)   (29,683)   -    (29,683)
Segment profit   27,964    (6,871)   21,093    -    21,093 
General and administrative expenses                       (77,016)
Other income, net                       2,342 
Operating profit                       (53,581)
Finance income                       6,492 
Finance costs                       (8,241)
Share of loss of equity-accounted investees                       (255)
Profit before income taxes                       (55,585)
Income taxes expense                       (4,749)
Profit for the period                       (60,334)
                          

F-38

 

Capital expenditures consist of additions of property and equipment and intangible assets. There were no inter-segment revenues in the nine-month periods ended September 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 September 30, 2019 (unaudited)                         
Total assets   1,446,129    87,751    1,533,880    (2,230)   1,531,650 
Total liabilities   479,389    28,111    507,500    (2,230)   505,270 
                          
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
September 30, 2019 (unaudited)         
Cash and cash equivalents   2,568    -    2,568 
Financial investments   893,148    6,369    899,517 
Trade receivables   -    87,461    87,461 
Financial instruments from acquisition of interests   23,378    -    23,378 
    919,094    93,830    1,012,924 

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
September 30, 2019 (unaudited)         
Trade payables   -    21,824    21,824 
Financial instruments from acquisition of interests   77,437    -    77,437 
Accounts payable to selling shareholders   287,768    -    287,768 
Lease liabilities   -    23,584    23,584 
Loans and financing   -    510    510 
    365,205    45,918    411,123 

 

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 nine-month periods ended September 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$ 10,349 and gain of R$ 2,902 for the nine-month periods ended in September 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  September 30, 2019  December 31, 2018
Financial assets             
Cash and cash equivalents  Level 2   2,568    12,301 
Financial investments  Level 2   893,148    2,370 
Derivative financial instruments  Level 3   23,378    26,630 
              
Financial liabilities             
Derivative financial instruments and forward contracts  Level 3   77,437    25,097 
Accounts payable to selling shareholders  Level 3   287,768    - 

 

As of September 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 nine-month periods ended September 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)   - 
Payment of capital increase in Geekie   -    2,000    - 
Deferred revenue in Escola de Aplicação São José dos Campos Ltda.   -    37    - 
Gains recognized in statement of income   3,118    (253)   - 
Balances as of September 30, 2018 (unaudited)   15,629    (11,853)   - 
                
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)   - 
Changes in accounts payable to selling shareholders   -    -    (81,781)
Interest expense   -    (2,033)   (22,677)
Deferred revenue in Escola de Aplicação São José dos Campos Ltda.   -    54    - 
Gains (loss) recognized in statement of income   (3,252)   (7,151)   - 
Balances as of September 30, 2019 (unaudited)   23,378    (77,437)   (287,768)

 

(iv) Transfers between levels 2 and 3

 

F-42

 

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

 

(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 September 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.

 

F-43

 

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.

 

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

 

(i) Foreign exchange risk

 

Exposure

 

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

 

   September 30, 2019  December 31, 2018
Cash and cash equivalents   41    3,615 
Financial investments   3,123    - 
           

 

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 September 30, 2019 consider three scenarios of U.S. dollar exchange rate variation, as follows:

 

·Base scenario - exchange rate as of September 30, 2019 of R$ 4.1638 per US$ 1.00;

·Scenario I - a 10% increase in the U.S. dollar exchange rate, to R$ 4.5802; and

·Scenario II - a 10% decrease in the U.S. dollar exchange rate, to R$ 3.7474.

 

The table below set forth the sensitivity analysis as of September 30, 2019, for the amount of cash and cash equivalents and financial investments denominated in U.S. dollar of US$ 760 thousand:

 

 

Base scenario

Scenario I

Scenario II

 

Exchange rate:

R$ 4.1638 

Exchange rate:
R$ 4.5802
Exchange rate:
R$ 3.7474
Finance income (costs)   317 (317)

 

(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.

 

F-44

 

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-45

 

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

 

As of September 30, 2019 (unaudited)

  On demand  Less than 3 months  3 to 12 months  1 to 5 years  More than 5 years  Total
Trade payables   -    21,824    -    -    -    21,824 
Lease liabilities   43    1,230    4,180    18,131    -    23,584 
Loans and financing   -    39    118    353    -    510 
Financial instruments from acquisition of interests   -    -    22,576    54,861    -    77,437 
Accounts payable to selling shareholders   -    867    111,681    175,220    -    287,768 
    43    23,960    138,555    248,565    -    411,123 

 

(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 September 30, 2019 the CDI rate was 5.71%.

 

F-46

 

As of September 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%
September 30, 2019 (unaudited)               
Cash, bank deposits and cash equivalents   2,082    12    (12)
Financial investments   896,394    5,118    (5,118)

 

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   222    2    224 
Reversals   (124)   -    (124)
Balances at September 30, 2019   115    116    231 

 

As of September 30, 2019, the Company was party to lawsuits classified as possible losses totaling R$ 4,046 (R$ 5,170 as of December 31, 2018), as shown below:

 

F-47

 

   September 30, 2019  December 31, 2018
   (unaudited)   
Civil (a)   3,538    4,425 
Labor (b)   508    745 
Total   4,046    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.

 

On September 19, 2019, Mr. Ulisses Borges Cardinot, a 48.52% shareholder in our subsidiary, International School, filed a request for arbitration with the Center for Arbitration and Mediation of the Chamber of Commerce Brazil-Canada in Brazil against Arco Platform Limited, EAS Educação S.A. and Arco Educação S.A. This request for arbitration purporting to assert Mr. Cardinot's rights under the Investment Agreement, is still at an early stage; therefore, it is not possible to confirm which claims will be asserted by Mr. Cardinot in the course of the proceedings or estimate provisions accordingly.

 

27Transactions not involving cash

 

The Company carried out the non-cash activities in the nine-month period ended September 30, 2019, which are not reflected in the statement of cash flows, mainly related to the corporate restructuring in the amount of R$ 3,741 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).

 

28Subsequent events

 

Follow-on public offering

 

On October 29, 2019, Arco completed a follow-on public offering. The public offering of 7,719,503 Class A common shares, consisting of 4,268,847 Class A common shares offered by certain selling shareholders of Arco (the “Selling Shareholders”), including General Atlantic Arco (Bermuda), L.P. (“GA”), and 3,450,656 Class A common shares offered by Arco. In addition, GA expects to grant the underwriters a 30-day option to purchase up to 1,157,925 additional Class A common shares at the public offering price, less underwriting discounts and commissions. Arco will not receive any proceeds from the sale of Class A common shares by the Selling Shareholders.

 

The initial offering price was US$43.00 per common share, for gross proceeds of US$331.9 million, for both, the selling shareholders and the Company. The Company

 

F-48

 

received net proceeds of US$143.9 million (or R$574.6 million), after deducting US$3.7 million (or R$14.7 million) in underwriting discounts and commissions.

 

Restricted Stock Units

 

On October 1, 2019, one beneficiary left the Company, reducing by 8,155 the number of restricted stock shares granted. On October 2, 2019, Arco granted 37,929 new restricted shares. The purpose of the Restricted Shar