NETS Netshoes (Cayman) Limited

NETSHOES (CAYMAN) LIMITED

Unaudited condensed consolidated interim financial statements

as of March 31, 2019, and for the three-month periods ended March 31, 2018 and 2019

1.               Organization and background

1.1       Nature of Operations

Netshoes (Cayman) Limited (“NSC” or the “Parent") was incorporated in the Cayman Islands on April 12, 2011. NSC is a holding company and conducts its business primarily through its subsidiaries (together with NSC, the “Company”, “we” or “us”). The Company’s registered office is at Willow House, Cricket Square, George Town, KY 1-1104, Cayman Islands. Major shareholders of the Company include Tiger Global Private Investment Partners V, L.P. (“Tiger Global V”), Tiger Global Private Investment Partners V, L.P. (“Tiger Global V”), Tiger Global Private Investment Partners VI, L.P. (“Tiger Global VI”), Ruane Cunniff & Goldfarb LP, CDK Net Fund IC and HCFT Holdings.

The Company is a sports and lifestyle ecommerce destination in Brazil. The Company’s core business is to offer to its customers a reliable and convenient online shopping experience with a wide selection of products including athletic shoes, jerseys, apparel, accessories and sporting equipment from leading international, local and private brands as well as fashion and beauty. The Company conducts its business mainly through its ecommerce websites (Netshoes, Zattini, Shoestock and Freelace).

In August 2018, the Company entered into an agreement with the Grupo Sierra Capital (“Sierra”) to sell the entirety of its Mexico operations. On October 11, 2018 the Company and Sierra concluded the transaction, which was preceded by final adjustments agreed by the parties under the original terms and conditions of the negotiation (see note 3).

In January 2019, the Company decided to divest Argentina operations and in April 2019 the Company entered into an agreement with BT8 S.A. to sell the entirety of its Argentina operations (see note 3).

The Company’s shares are offered, sold and registered under the Securities Act of 1933, as amended, pursuant to the Company’s Registration Statement on Form F-1 (Registration No.333-216727), which was declared effective by the Securities and Exchange Commission on April 12, 2017. The common stock began trading on the New York Stock Exchange on April 12, 2017 under the symbol "NETS".

1.2     Going concern considerations

The Company recorded a net loss and a significant negative operating cash flow in the year ended December 31, 2018 and in the three-month period ended March 31, 2019. As of and for the period ended March 31, 2019, the Company had accumulated losses of R$ 1,245,338 (compared to R$1,178,464 as of December 31, 2018), net loss of R$66,917 (compared to R$61,300 for the period ended March 31, 2018) and net cash used in operating activities of R$4,341 (compared to  R$241,820 for the period ended March 31, 2018). In addition, the Company has a working capital deficiency as of March 31, 2019 with R$ 132,220 of net current liabilities (compared to R$ 23,681 as of December 31, 2018).

The Company expects to continue to incur net losses for at least the next twelve-months following the issue of these condensed consolidated financial statements. Although the Company continues to take action to improve its operating performance and expects to generate positive net operating cash flow over the next twelve-months, this positive cash flow from operating activities by itself may not be sufficient to meet the Company’s cash requirements in the same period arising from its financing activities. As such, Management has concluded that financing alternatives will be necessary to meet its obligations within one year from the date of issue of these condensed consolidated financial statements. However, there can be no assurance that the Company’s plan to improve its operating performance and financial position will be successful or that the Company will be able to obtain additional financing on commercially reasonable terms, or at all.

The Company is currently exploring alternatives to obtain access to other sources of capital necessary to meet its ongoing liquidity needs, such as obtaining new lines of credit, and is taking measures to improve its operating performance and cash, liquidity and financial position. Such measures include, among others, the following:

·          continuing to implement cost-saving initiatives across the Company;

·          negotiating alternative payment terms with suppliers;

·          seeking with current creditors the partial release of collateral provided under certain of the Company’s financing arrangements (basically restricted cash and cash equivalents, which as of March 31, 2019 amounted to R$65,594); and

·          assessing ways of monetizing the Company’s PIS/COFINS judicial deposits, following a favorable decision in its judicial disputes challenging the tax authorities’ interpretation of the calculation basis for PIS/COFINS taxes over products sold by the Company (such tax credits amounted to R$ 103,595 as of March 31, 2019). Following the favorable decision, the Company expects these deposits to be released, however authorization for release is subject to government approval, the timing of which is currently unknown.

The Company has also engaged financial and other advisors to assist it in those efforts.

Given the above, management acknowledges there is a material uncertainty which may cast substantial doubt on the Company’s ability to continue as a going concern.

The financial statements of the Company have been prepared assuming the Company’s ability to continue as a going concern as management has a reasonable expectation that the Company has adequate resources to continue in operational existence for the foreseeable future based on the projections and measures being taken.  If for any reason the Company is unable to continue as a going concern, then this could have an impact on the Company’s ability to realize assets at their recognized values, and to settle liabilities in the ordinary course of business at the amounts stated in the condensed consolidated financial statements. The condensed consolidated interim financial statements do not include any adjustments that might result from this uncertainty.

1.3     Merger agreement – subsequent event

The Company announced, on April 29, 2019, that it has entered into an Agreement and Plan of Merger (“Merger Agreement”) with Magazine Luiza S.A. and its wholly-owned subsidiary located in the Cayman Islands (“Merger Sub”). Pursuant to the Merger Agreement, Magazine Luiza S.A. will acquire the Company, such that, at the effective time of the transaction, Merger Sub will merge with and into the Company (the “Merger”), with the Company continuing after the Merger as the surviving company and a wholly-owned subsidiary of Magazine Luiza S.A. Subject to the terms and conditions of the Merger Agreement, each of Company´s shareholders will receive US$2.00 per share in cash for each common share.

The Merger is subject to the satisfaction of certain conditions precedent established in the Agreement and Plan of Merger, including, among others, its approval by two-thirds (2/3) of the votes cast by the shareholders entitled to vote who are present in person or by proxy at a Company’s general meeting, and by the Administrative Council for Economic Defense (Conselho Administrativo de Defesa Econômica – CADE), the Brazilian anti-trust agency.

In addition, on April 29, 2019, Magazine Luiza S.A. announced that it has entered into a voting and support agreement, with shareholders representing 47.9% of Company’s capital stock, pursuant to which, among other things, each such shareholder has agreed to vote all common shares beneficially owned by such shareholder in favor of the adoption of the Merger Agreement and the approval of the Merger and the other transactions contemplated by the Merger Agreement.

2.               Summary of Significant Accounting Policies

2.1.           Statement of Compliance

These condensed consolidated interim financial statements have been prepared in accordance with International Accounting Standard 34, “Interim Financial Reporting” and should be read in conjunction with the Company’s last annual consolidated financial statements as at and for the year ended December 31, 2018 (“last annual financial statements”). These interim financial statements, which are unaudited, do not include all of the information required for a complete set of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”). However, selected explanatory notes are included to explain events and transactions that are significant to

an understanding of the changes in the Company’s financial position and performance since the last annual financial statements.

These condensed consolidated interim financial statements as of and for the three-month period ended March 31, 2019 were authorized for issuance by the Board of Directors on May 10, 2019.

2.2.           Basis of Presentation

The functional currency of the Company is US$ and the reporting currency is Brazilian Real (“R$”) as this currency better reflects the underlying operations of the consolidated entities. The Company’s subsidiaries with operations in Brazil, Argentina and Mexico (last two presented as discontinued operations, as described in note 3) use their respective currencies as their functional currencies.

Translations of balances in the condensed consolidated statement of financial positions, condensed consolidated statement of profit or loss, condensed consolidated statement of comprehensive income (loss) and condensed consolidated statement of cash flows from R$ into US$ are solely for the convenience of the readers and have been calculated at the rate of US$1.00 = R$ 3.8967, representing the exchange rate set forth by the Banco Central do Brasil (Central Bank of Brazil) on March 31, 2019. No representation is made that the R$ amounts could have been, or could be, converted, realized or settled into US$ at that rate on March 31, 2019, or at any other rate. All values have been rounded to the nearest thousands of R$ and US$, except where noted.

Due to the significant inflation in Argentina over the past few years, the three-year cumulative inflation rate in Argentina has exceeded 100% based on data from the national wholesale price index and various available inflation indices in May 2018. As such, Argentina was considered as hyperinflationary economy effective July 1, 2018 and, as from January 1, 2018, the Company was required to apply inflation accounting. Thus, its statement of financial position and statement of profit or loss are adjusted for the changes in the general purchasing power of the local currency, using official indices at the reporting date, before translation into Brazilian Real (“R$”) and, as a result, are stated in terms of the measuring unit current at the reporting date.

These interim condensed consolidated interim financial statements were prepared pursuant to the accounting principles, practices and criteria consistent with those adopted in financial statements for the year ended December 31, 2018 and must be analyzed jointly with the referred to financial statements, except for:

·          the comparative information for the three-month period ended March 31, 2018 which was restated, see note 3 for further information; and

·          the adoption of IFRS 16, see note 2.5 for further information.

The policy for recognizing and measuring income taxes in the interim period is described in note 22.

2.3.           Use of Judgments, Estimates and Assumptions

2.4.           Fair Value Measurements

·          Level 1 — unadjusted quoted prices in active markets for identical assets or liabilities.

·          Level 2 — inputs other than quoted prices included in Level 1 that are observable for the assets or liability, either directly or indirectly

·          Level 3 — inputs for the assets or liability that are not based on observable market data.

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.

The Company recognizes transfers between levels of the fair value hierarchy in the reporting period during which the change has occurred.

Note 20 includes accounting classification and fair value measurement of financial instruments.

2.5.           Changes in accounting policies

The Company applied as of January 1, 2019, IFRS 16 (Leases). The nature and effect of these changes are described below.

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.

Lessor accounting under IFRS 16 is substantially unchanged under IAS 17. Lessors will continue to classify leases as either operating or finance leases using similar principles as in IAS 17.

The Company adopted IFRS 16 using the modified retrospective method of adoption with the date of initial application as 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’).

a.        Nature of the effect of adoption of IFRS 16

The Company has lease contracts on buildings where its distribution centers and administrative headquarters are located with third parties. 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 buildings mentioned were classified as operating leases under IAS 17). A lease was classified as a finance lease if it transferred substantially all of the risks and rewards incidental to ownership of the leased asset to the Company; otherwise it was classified as an operating lease. Finance leases were capitalized at the commencement of the lease at the inception date fair value of the leased property or, if lower, at the present value of the minimum lease payments. Lease payments were apportioned between interest (recognized as finance costs) and reduction of the lease liability. In an operating lease, the leased property was not capitalized, and the lease payments were recognized as rent expense in the statement of profit or loss on a straight-line basis over the lease term. Any prepaid rent and accrued rent were recognized under Prepaid expenses and other current assets and Other current liabilities, 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 has been applied by the Company.

Leases previously accounted for as operating leases

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, apart from the use of incremental borrowing rate at the date of initial application. In some leases, the right-of-use assets were recognized based on the amount equal to the lease liabilities, adjusted for any related prepaid and accrued lease payments previously recognized. 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.

The Company also applied the available practical expedients wherein it:

-           apply the new definition of a lease to all of their contracts;

-           exemptions to short term leases and/or with low values;

-           does not restate its prior-period financial information;

-           calculates lease assets and lease liabilities as at the beginning of the current period using:

o     measures the lease liability at the date of initial application as the present value of the remaining lease payments;

o     measure the right of use assets at an amount equal to the lease liability; and

-           apply a single discount rate to the portfolio of leases with similar characteristics using market rates which reasonable approximates the Company risks.

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

-           Right-of -use assets of R$83,516, recognized in Property and equipment, net, such as Property, were recognized and presented as in the statement of financial position; and

-           Additional lease liabilities of R$83,516 (included in Lease liabilities current and non-current) were recognized.

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:

Right-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.

Lease 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 amount of lease liabilities is increased to reflect the accretion of interest and reduced for the lease payments made. In addition, the carrying amount of lease liabilities is remeasured if there is a modification, a change in the lease term, a change in the in-substance fixed lease payments or a change in the assessment to purchase the underlying asset.

Short-term leases and leases of low-value assets

The Company applies the short-term lease recognition exemption to its short-term leases of machinery and equipment (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.

Significant 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.

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).

The Company recognized rent expense from short-term leases and leases of low-value assets.

Other Clarifications, amendments and interpretations

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

3.               Specific events occurred

3.1            Discontinued operations

(a)      Argentina operation

The subsidiaries (NS2.Com Internet S.A. and NS5 Participações Ltda.) have signed an agreement, on April 26, 2019 (“closing date”), to sell the entirety of its Argentina operations (NS3 Internet S.A.), which belongs to the reportable International segment, through the sale of all shares which they hold.

Pursuant to terms of this transaction, the Company:

- will receive ARS 1 (one Argentinean peso) for the shares that are transferred;

- has granted to the former subsidiary a license for the period of eighteen months from the closing date, in Argentina, for the Company brand and e-commerce platform;

- has agreed to provide certain services relating to IT for the period of eighteen months from the closing date; and

- has agreed to contribute approximately ARS106,000 (approximately USD2,500) into NS3.

The Company estimated a total loss of R$15,100 (USD3,873), including the estimated costs for fulfilling the conditions listed above, which will be recognized in the income statement from discontinued operations in the second quarter of 2019.

As at March 31, 2019 the non-current assets and liabilities held for sale comprises:

The statements of profit or loss and cash flow from discontinued operations of the Argentina Operation for the period ended March 31, 2018 and 2019 are presented below.

(b)      Mexico operation

In August 2018, the Company entered into an agreement with the Grupo Sierra Capital (“Sierra”) to sell the entirety of its Mexico operations. On October 11, 2018 (the “Closing date”) the Company and Sierra concluded the transaction, which was preceded by final adjustments agreed by the parties under the original terms and conditions of the negotiation.

The statements of profit or loss and cash flow from discontinued operations of the Mexico Operation for the period ended March 31, 2018 are presented below.

4.               Seasonality

Like most retail businesses, the Company experiences seasonal fluctuations in its revenues and operating results. Historically, the Company has generated higher revenues in the fourth quarter, which includes Black November period (commercial holiday introduced in 2010 by Brazilian e-commerce websites which is a month-long equivalent to the Black Friday in the United States) and the Christmas season in Brazil, Argentina and Mexico while the first quarter of the year is our slowest period, as the months of January and February correspond to vacation time in Brazil and Argentina.

The amount of cash flows and working capital we require to support our operations fluctuate throughout the year, primarily driven by the seasonality of our business. Typically, we have higher generation of cash flows during the fourth quarter, given the increase in the volume of sales we generally experience in this period, which includes the Black November period and the holiday season. Conversely, our cash flow requirements increase during the first quarter of the year as a result of (1) the maturity of the payment terms with our suppliers for inventory acquired in advance of our peak selling season and (2) a decrease in sales volumes that typically follows such season.

5.               Segment Information

The Company uses the “management approach” to determine its reportable segments. The management approach identifies operating segments based on how the entity is organized and based on how financial information is presented to the chief operating decision maker (“CODM”). The Company concluded that the CODM is the Chief Executive Officer.  

The Company, after past reorganizations and deals, organized around geographical divisions has only one reportable segment, Brazil. Which comprises operating revenues, expenses, financial income and financial expenses recorded in Netshoes (Cayman) Limited Netshoes Holding, LLC and NS2.Com Internet S.A.

The CODM receives individual financial information based on the nature of revenues and expenses incurred. There is no regular reporting of individual financial information for products, services, or major customers.

No information on segment assets or liabilities is relevant for decision-making. There are no inter segment transactions in the internal reporting structure.   

The Company has aggregated its products and services into groups of similar products and provided the supplemental disclosure of revenues below. The Company evaluates whether additional disclosure is appropriate when a product or service category begins to approach a significant level of revenues.

⁽¹⁾ Freight services were allocated to the product revenues that they are related to.

6.               Earnings (Loss) Per Share (“EPS”)

The Company computes basic loss per share by dividing net loss, from continuing operations and from discontinued operations, attributable to the owners of the Parent by the weighted average number of common shares outstanding for the period. Diluted loss per share reflects the potential dilution of share options that could be exercised or converted into common shares, and is computed by dividing net loss, from continuing operations and from discontinued operations, attributable to the owner of the Parent by the weighted average number of common shares outstanding plus the potentially dilutive effect of share options.

The following table sets forth the computation of the Company’s basic and diluted loss, from continuing operations and discontinued operations, per share attributable to the owners of the Parent for the three months ended March 31, 2018 and 2019: