Annual and Transition Report (foreign Private Issuer) (20-f)

Date : 04/30/2019 @ 9:04PM
Source : Edgar (US Regulatory)
Stock : Netshoes (Cayman) Limited (NETS)
Quote : 3.7  0.0 (0.00%) @ 12:00AM
Netshoes (Cayman) Limited share price Chart

Annual and Transition Report (foreign Private Issuer) (20-f)

 

 

As filed with the Securities and Exchange Commission on April 30 , 2019.

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 20-F

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

OR

x            ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2018
OR

¨             TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

¨             SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-38055

NETSHOES (CAYMAN) LIMITED

(Exact Name of Registrant as Specified in its charter)

N/A

(Translation of Registrant’s name into English)

The Cayman Islands
(Jurisdiction of Incorporation or Organization)

Rua Vergueiro 961, Liberdade
01504-001 São Paulo, São Paulo, Brazil

São Paulo – SP, Brazil
(Address of principal executive offices)

Marcio Kumruian

Chief Executive Officer
Tel.:   +55 11 3028-8298, Email:
ir@netshoes.com
Rua Vergueiro 961, Liberdade
01504-001 São Paulo, São Paulo, Brazil

São Paulo – SP, Brazil
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

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

Title of each class:

Name of each exchange on which registered:

 

Common Shares, nominal value of US$0.0033

 

The New York Stock Exchange

____________________

 

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

                                                                                                                                                                                                                                                                                                                       


 
 

None

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

None

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

At December 31, 2018

31,056,244 shares of common stock

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ¨    No x

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes ¨    No x

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x   No ¨

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

Large accelerated filer   ¨

Accelerated filer   ¨

Non-accelerated filer   x

Emerging growth company    x

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

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

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

¨   U.S. GAAP

x     International Financial Reporting Standards as issued by the International Accounting Standards Board

¨   Other

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

Item 17 ¨    Item 18 ¨ .

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

Yes ¨    No x

                                                                                                                                                                                                                                                                                                                       


 
 

TABLE OF CONTENTS

Page

PART I INTRODUCTION

 

1

ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

6

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

6

ITEM 3.

KEY INFORMATION

7

A.

Selected Financial Data

7

B.

Capitalization and Indebtedness

14

C.

Reasons for the Offer and Use of Proceeds

14

D.

Risk Factors

14

ITEM 4.

INFORMATION ON THE COMPANY

44

A.

History and Development of the Company

44

B.

Business Overview

44

C.

Organizational Structure

58

D.

Property, Plant and Equipment

58

ITEM 4A.

UNRESOLVED STAFF COMMENTS

60

ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

60

A.

Operating Results

60

B.

Liquidity and Capital Resources

76

C.

Research and Development, Patents and Licenses

82

D.

Trend Information

82

E.

Off-Balance Sheet Arrangements

83

F.

Tabular Disclosure of Contractual Obligations

83

G.

Safe Harbor

83

ITEM 6.

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

83

A.

Directors and Senior Management

83

B.

Compensation of Directors and Officers

85

C.

Board Practices

88

D.

Employees

91

E.

Share Ownership

92

ITEM 7.

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

92

A.

Major Shareholders

92

B.

Related Party Transactions

95

C.

Interests of Experts and Counsel

97

ITEM 8.

FINANCIAL INFORMATION

97

A.

Consolidated Statements and Other Financial Information

97

B.

Significant Changes

99

                                  

i

 


 
 

 

ITEM 9.

THE OFFER AND LISTING

99

A.

Offer and Listing Details

99

B.

Plan of Distribution

101

C.

Markets

101

D.

Selling Shareholders

101

E.

Dilution

101

F.

Expenses of the Issue

101

ITEM 10.

ADDITIONAL INFORMATION

101

A.

Share Capital

101

B.

Memorandum and Articles of Association

101

C.

Material Contracts

114

D.

Exchange Controls

116

E.

Taxation

116

F.

Dividends and Paying Agents

121

G.

Statement by Experts

121

H.

Documents on Display

121

I.

Subsidiary Information

121

ITEM 11.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

121

ITEM 12.

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

123

A.

Debt Securities

123

B.

Warrants and Rights

123

C.

Other Securities

123

D.

American Depositary Shares

123

PART II

 

123

ITEM 13.

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

123

ITEM 14.

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

123

ITEM 15.

CONTROLS AND PROCEDURES

123

A.

Disclosure Controls and Procedures

123

B.

Management’s Annual Report on Internal Control Over Financial Reporting

123

C.

Attestation Report of the Registered Public Accounting Firm

125

D.

Changes in Internal Control Over Financial Reporting

125

ITEM 16.

RESERVED

125

ITEM 16A.

AUDIT COMMITTEE FINANCIAL EXPERT

125

ITEM 16B. CODE OF ETHICS

 

  126

ITEM 16C.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

126

ITEM 16D.

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

126

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PART I
INTRODUCTION

Certain Definitions

Unless otherwise indicated, all references herein to “Netshoes,” “we,” “us” and “our company” refer to Netshoes (Cayman) Limited, an exempted company with limited liability incorporated under the laws of the Cayman Islands, and its consolidated subsidiaries. References to “NS2” are to our subsidiary NS2.com Internet S.A., a corporation ( sociedade anônima ) incorporated under the laws of Brazil. References to “common shares” refer to the common shares of Netshoes (Cayman) Limited, except where the context requires otherwise. The term “Brazil” refers to the Federative Republic of Brazil, and the phrase “Brazilian government” refers to the federal government of Brazil. All references to “ real ,” “ reais ,” “Brazilian real ,” “Brazilian reais ,” or “R$” are to the Brazilian real , the official currency of Brazil; all references to “U.S. dollar,” “U.S. dollars,” or “US$” are to U.S. dollars, the official currency of the United States, and all references to “Argentine peso ,” or “AR$” are to the Argentine peso , the official currency of Argentina.

Financial Information

The financial information contained in this annual report on Form 20-F, or annual report, derives from our audited consolidated financial statements as of December 31, 2017 and 2018 and for the fiscal years ended December 31, 2016, 2017 and 2018. These financial statements and related notes included elsewhere in this annual report are collectively referred to as our audited consolidated financial statements herein and throughout this annual report. Our audited consolidated financial statements are prepared in accordance with International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board, or IASB. Our fiscal year ends on December 31 of each year, so all references to a particular fiscal year are to the applicable year ended December 31.

Although our audited consolidated financial statements were prepared assuming that we will continue as a going concern, we have determined that there is substantial doubt about our ability to continue as a going concern, meaning that we may not be able to continue in operation for the foreseeable future or be able to realize assets and discharge liabilities in the ordinary course of operations, and our independent registered public accounting firm has included an explanatory paragraph relating to our ability to continue as a going concern in its report on our audited consolidated financial statements included in this annual report. For further information, see “Item 5. Operating and Financial Review and Prospects —B. Liquidity and Capital Resources—Going Concern.”

Our consolidated financial statements also reflect the discontinuation of our operations in Mexico in September 2018, in line with our strategy of focusing on our core Brazilian operations.  In accordance with IFRS, in periods where we have either disposed of an operation, we are also required to disclose in the current period those operations’ results as discontinued operations. When such conditions exist, we are required to (a)(i) present the results of operations of the discontinued business and (ii) any gain on sale of a discontinued business as a single item in our statement of profit or loss separate from our continuing operations for the current period, (b) re-present the comparative period statement of profit or loss on a similar basis. As a result, our statement of profit or loss, and other comprehensive income for the years ended December 31, 2016 and 2017 included in our audited consolidated financial statements (as well as financial information for the years ended December 31, 2014 and 2015 included in this annual report) have been re-presented to treat the our operations in Mexico as discontinued operations in accordance with the requirements of “IFRS 5: Non-current assets held for sale and discontinued operations” for comparability purposes. Therefore, our statement of profit or loss includes the separate required disclosures relating to our discontinued operations in Mexico under “net loss from discontinued operations” and has been restated accordingly. Our statement of cash flows has also been re-presented to reflect the discontinuation of our operations in Mexico. See note 3(ii)(a) to our audited consolidated financial statements included elsewhere in this annual report for additional information.

On April 26, 2019, we effected the sale of our operations in Argentina. Financial data included in this annual report and our audited consolidated financial statements included elsewhere in this annual report do not reflect the discontinuation of such operations in Argentina although as a result of this divestment we included in this annual report pro forma information that give effect to such divestment as if it had occurred as of January 1, 2018. See “Item 3. Key Information––A. Selected Financial Data–– Pro Forma Financial Information.”

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Convenience Translation

The reporting currency for our audited consolidated financial statements is the Brazilian real and, solely for the convenience of the reader, we have provided convenience translations into U.S. dollars using the selling exchange rates published by the Brazilian Central Bank ( Banco Central do Brasil ), or Central Bank, on its website. Unless otherwise indicated, convenience translations from reais into U.S. dollars in this annual report use the Brazilian Central Bank offer exchange rate published on December 31, 2018, which was R$3.8748 per US$1.00. No representation is made that the Brazilian reais amounts referred to could have been, or could be, converted into U.S. dollars at any particular rate. See “Item 3. Key Information––A. Selected Financial Data––Exchange Rates” for information regarding historical exchange rates of reais to U.S. dollars.

Market Data

This annual report includes statistical and other industry and market data that we obtained from industry publications and research, government and non-government organization reports, surveys and studies conducted by third parties, including data and information we obtained from Claims Pages, e-Bit, Euromonitor International among others, and data derived from management’s knowledge and our experience in the industries in which we operate. Industry publications and third-party research, surveys and studies generally indicate that their information has been obtained from sources believed to be reliable, although they do not guarantee the accuracy or completeness of such information. Information derived from management’s knowledge and our experience is presented on a reasonable, good faith basis. Estimates of market and industry data are based on statistical models, key assumptions and limited data sampling, and actual market and industry data may differ significantly from estimated industry data.

Rounding

Certain figures included in this annual report have been subject to rounding adjustments. Accordingly, figures shown as totals in certain tables may not be exact arithmetic aggregations or percentages of the figures that precede them.

Emerging Growth Company Status

We are an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended, or the Securities Act, as modified by the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the date of our first sale of our common equity securities pursuant to an effective registration statement under the Securities Act, (b) in which we have total annual revenues of at least US$1.07 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common shares that is held by non-affiliates exceeds US$700.0 million as of the prior June 30, and (2) the date on which we have issued more than US$1.0 billion in non-convertible debt during the prior three-year period. As an emerging growth company, we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, exemptions from the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and any Public Company Accounting Oversight Board, or PCAOB, rules, including any future audit rule promulgated by the PCAOB (unless the SEC determines otherwise). Accordingly, the information about us available to you will not be the same as, and may be more limited than, the information available to shareholders of a non-emerging growth company.

Forward-Looking Statements

This annual report contains information that constitute forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act, that are not based on historical facts and are not assurances of future results. The forward-looking statements contained in this annual report, which address our expected business and financial performance, among other matters, contain words such as “believe,” “expect,” “estimate,” “anticipate,” “intend,” “plan,” “aim,” “will,” “may,” “should,” “could,” “would,” “likely,” “potential” and similar expressions. We have made forward-looking statements that address, among other things our current expectations, plans, forecasts, projections and strategies about future events and financial trends that affect, or may affect, our business, industry, market share, reputation, financial condition, results of operations, margins, cash flow and/or the market price of our common shares, all of which are subject to known and unknown risks and uncertainties. Our actual results could differ materially from those expressed or forecast in any forward-looking statements as a result of a variety of assumptions and factors. These factors include, but are not limited to, the following:

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·          our ability to appropriately manage our working capital needs and continue as a going concern;

·          our ability to record profits and positive operating cash flows;

·          our ability to attract and retain qualified personnel;

·          current competition and the emergence of new market participants in our industry;

·          the inherent risks related to eCommerce, such as the interruption or failure of our computer or information technology systems;

·          the growth of eCommerce;

·          reliance on one third-party data hosting service providers;

·          litigation, such as class actions or enforcement or other proceedings brought by governmental and regulatory agencies;

·          the effectiveness of our risk management policies and procedures, including our internal control over financial reporting;

·          the efficient operation of our distribution centers;

·          our dependence on key suppliers and third-party couriers;

·          logistics and transportation challenges;

·          the inherent risks of the lines of business into which we are expanding;

·          our ability to innovate and respond to technological advances and changing customer demands and shopping patterns;

·          the maintenance of tax incentives;

·          failure to enhance our brand recognition or maintain a positive public image;

·          failure to protect our intellectual property rights;

·          the occurrence of natural disasters that could have a material adverse effect on our business;

·          impacts of future legislation changes on our business;

·          the macroeconomic, political and business environment in the countries where we operate and their impact on our business, notably with respect to inflation, exchange rates, interest rates;

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·          our ability to maintain our classification as an emerging growth company under the JOBS Act; and

·          the other factors discussed under section “Risk factors” in this annual report.

Additionally, factors that could cause actual results to differ from our expectations or projections include, but are not limited to, with respect to the proposed Merger (as defined below), among other things, the following: (1) we may not be able to satisfy all of the conditions to the closing of the Merger Agreement (as defined below) and other related and concurrent transactions contemplated thereunder; (2) the Merger may involve unexpected costs, liabilities or delays, (3) the outcome of any eventual legal proceedings related to the Merger; (4) the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger; (6) other risks to the consummation of the Merger, including the risk that the Merger will not be consummated within the expected time period at all; and (7) the potential requirement that we pay a termination fee in connection with our failure to consummate the Merger.

Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those in the forward-looking statements.  The accompanying information contained in this annual report, including without limitation the information set forth under the heading “Item 5. Operating and Financial Review and Prospects,” identifies important factors that could cause such differences. In light of the risks, uncertainties and assumptions associated with forward-looking statements, you should not place undue reliance on any forward-looking statements. Additional risks that we may currently deem immaterial or that are not presently known to us could also cause the forward-looking events discussed in this annual report not to occur.

Our forward-looking statements speak only as of the date of this annual report or as of the date they are made, and except as otherwise required by applicable securities laws, we undertake no obligation to publicly update any forward-looking statement, whether because of new information, future events or otherwise.

Glossary of Certain Terms Used in this Annual Report

Unless the context otherwise requires, references in this annual report to:

·          “active customers” mean customers who made purchases online with us during the preceding twelve months as of the relevant dates;

·          “average basket size” mean the sum of total order value from online purchases with us and in our brick-and-mortar store divided by the number of total orders for the relevant period;

·          “business-to-business operation” or “B2B operation” mean our offline sales of products to other businesses;

·          “eCommerce” mean product purchases using desktops, tablets or mobile devices;

·          “GMV” mean the sum of net sales, returns, GMV from marketplace and net sales taxes, less marketplace and NCard activation commission fees;

·           “our brick-and-mortar store” mean our omni-channel store for fashion and beauty products located in the city of São Paulo, Brazil; 

·          “our sites” mean www.netshoes.com.br, www.netshoes.com.ar, www.zattini.com.br , www.freelace.com.br and www.shoestock.com.br ;

·          “mCommerce” mean product purchases using only mobile sites and applications;

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·         “Merger Agreement” means the Agreement and Plan of Merger, dated as of April 29, 2019, by and among the Company, Magazine Luiza S.A., a Brazilian sociedade anônima incorporated under the laws of the Federal Republic of Brazil, and Magazine Luiza Cayman Ltd, an exempted company with limited liability incorporated under the laws of the Cayman Islands;

·          “purchases online with us,” “online purchases with us,” “business-to-consumer online operation,” or “B2C operation” in the context of our active customers, average basket size and GMV, mean product sales through our sites (including those sales effected through our marketplace) and the third-party sites that we manage;

·          “third-party sites that we manage” mean all partner-branded online stores that we manage. See “Item 4. Information on the Company—B. Business Overview—Our Additional Sources of Revenues—Partner-Branded Stores”; 

·          “total orders” mean the total number of orders invoiced to active customers during the relevant period; and

·          “total order value” mean the total amount invoiced to a customer in connection with a product sale (including shipping fees and taxes).

Recent Developments

Merger Agreement

On April 29, 2019, we entered into a Merger Agreement with Magazine Luiza S.A. and Magazine Luiza Cayman Ltd, a wholly-owned subsidiary of Magazine Luiza S.A.. Pursuant to the Merger Agreement, Magazine Luiza S.A. will acquire us by way of statutory merger pursuant to the laws of the Cayman Islands, such that, at the effective time of the Merger (the “effective time”), Magazine Luiza Cayman Ltd will merge with and into us (the “Merger”), with Netshoes continuing after the Merger as the surviving company (the “surviving company”) and as a wholly-owned subsidiary of Magazine Luiza S.A.. Subject to the terms and conditions of the Merger Agreement, each of our shareholders will receive US$2.00 per share in cash for each common share (the “merger consideration”). 

We have entered into the Merger Agreement after an extensive process in which we evaluated our prospects as an independent company and reviewed, with the assistance of Goldman Sachs & Co., as financial advisor, opportunities to protect shareholder value through a sale transaction. While we have worked to meet our market opportunity as an independent company, our recent financial results and increasing pressure on our working capital position caused us to reevaluate our prospects and resulted in our decision to enter into the Merger Agreement.

The Merger is subject to the approval of two-thirds (2/3) of the votes cast by the shareholders entitled to vote who are present in person or by proxy at a general meeting. Three of our shareholders, holding an aggregate of 48% of the common shares, have agreed to vote in favor of the Merger. We have agreed to give notice of a meeting to our shareholders for the purpose of approving, ratifying, confirming and adopting the transactions in connection with the consummation of the Merger by no later than May 9, 2019 and will be providing an information statement related to the matters to be considered at that meeting.

Our board of directors has recommended a vote to approve the Merger. See “Item 3. Key Information—D. Risk Factors—Risks Related to the Merger” and “Item 10. Additional Information—C. Material Contracts.”

Divestments of our operations in Argentina

On April 26, 2019, we effected the sale of our operations in Argentina. Pursuant to terms of this transaction, we have granted to NS3 Internet S.A. a license for the period of eighteen months from April 26, 2019 to use in Argentina our brand and e-commerce platform and contributed AR$106.308.088 (approximately US$2.4 million) into NS3 Internet S.A. at closing.  We divested our loss-making operations in Argentina in line with our strategy of focusing on our core Brazilian operations. We included in this annual report pro forma information that give effect to such divestment as if it had occurred as of January 1, 2018. See “Item 3. Key Information––A. Selected Financial Data–– Pro Forma Financial Information.”

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Financial and Liquidity Position

We experienced net losses and significant cash outflows from cash used in operating activities in 2018, and our business performance and financial condition has faced increasing pressure since December 31, 2018.  We are currently engaged in preserving our cash, liquidity and financial position and obtain access to alternative sources of capital necessary to meet our ongoing liquidity needs.  We have engaged financial and other advisors to assist us in that effort.  Although our management has a reasonable expectation that we have adequate resources to continue in operational existence for the foreseeable future, there can no assurance that we will be able to meet our funding requirements and have the ability to gain continued access to short-term financing. If for any reason we are unable to continue as a going concern, this could have an impact on our ability to realize assets at their recognized values, and to settle liabilities in the ordinary course of business (including with suppliers and creditors) at the amounts stated in our audited consolidated financial statements, resulting in defaults in agreements with our creditors and suppliers and may experience additional defaults in the future, including as a result of cross-defaults. Most of our financing agreements are subject to termination in the event of default, and our indebtedness may be accelerated in the event of continuing default. For further information, see “Item 5. Operating and Financial Review and Prospects —B. Liquidity and Capital Resources.”

ITEM 1.             IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2.             OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

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ITEM 3.             KEY INFORMATION

A.                   Selected Financial Data

The following selected financial data, as of December 31, 2017 and 2018 and for the years ended December 31, 2016, 2017 and 2018 have been derived from our audited consolidated financial statements included elsewhere in this annual report. December 31, 2014 and 2015 figures have been provided in the disclosure documents for our initial public offering.

As a result of the discontinuation of our operations in Mexico in September 2018, approved by the board of directors on August 6, 2018, our consolidated statements of profit or loss and cash flow for the years ended December 31, 2014, 2015, 2016 and 2017 included in the table below were restated for the purposes of applying IFRS 5 “Non-current assets held for sale and discontinued operations” for comparability purposes. See “Introduction––Financial Information.”

The following selected financial and other data is qualified by reference to and should be read in conjunction with our audited consolidated financial statements and the notes thereto contained in this annual report, as well as the information set forth under the heading “Item 5. Operating and Financial Review and Prospects.”

Consolidated Statements of Profits or Loss

 

Years Ended December 31,

 

2014
(Restated)

2015
(Restated)

2016
(Restated)

2017
(Restated)

2018

2018

(In thousands, except per share data) (1)

R$

R$

R$

R$

R$

US$ (2)

Net sales

1,086,784

1,453,685

1,685,151

1,835,212

1,808,064

466,621

Cost of sales

(720,107)

(967,823)

(1,144,231)

(1,247,014)

(1,389,842)

(358,687)

Gross profit

 366,677

485,862

540,920

588,198

418,222

107,934

Operating expenses:

 

 

 

 

 

 

Selling and marketing expenses

(312,074)

(383,673)

(431,065)

(495,190)

(480,206)

(123,931)

General and administrative expenses

(137,129)

(144,455)

(162,338)

(143,253)

(191,695)

(49,472)

Other operating expense, net

(4,736)

(3,503)

(5,251)

(3,933)

(9,312)

(2,403)

Total operating expenses

(453,939)

(531,631)

(598,654)

(642,376)

(681,213)

(175,806)

Operating loss

(87,262)

(45,769)

(57,734)

(54,178)

(262,991)

(67,872)

Financial income

32,399

61,144

28,285

28,996

15,026

3,878

Financial expense

(72,539)

(93,619)

(104,795)

(129,040)

(83,223)

(21,478)

Monetary position (loss) gain, net

9,595

2,476

Loss before income tax

(127,402)

(78,244)

(134,244)

(154,222)

(321,593)

(82,996)

Income tax expense

(202)

(52)

Net loss from continuing operations

(127,402)

(78,244)

(134,244)

(154,222)

(321,795)

(83,048)

Net loss from discontinued operations (3)

(16,973)

(21,269)

(17,652)

(16,123)

(10,579)

(2,730)

Net loss……………………..

(144,375)

(99,513)

(151,896)

(170,345)

(332,374)

(85,778)

Net loss attributable to:

 

 

 

 

 

 

Owners of the Parent from continuing operations

(126,993)

(77,407)

(133,422)

(153,623)

(321,166)

(82,886)

Owners of the Parent from discontinuing operations

(16,973)

(21,269)

(17,652)

(16,123)

(10,579)

(2,730)

Non-controlling interests

(409)

(837)

(822)

(599)

(629)

(159)

Loss per share attributable to owners of the Parent Basic and Diluted (4)

(7.54)

(4.66)

(7.05)

(5.95)

(10.68)

(2.76)

 

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(1)     For comparison purposes, the financial information provided in the table above reflects a restatement of such financial information for the years ended December 31 2014, 2015, 2016 and 2017 as a result of the discontinuation of our operations in Mexico in September 2018, which has been made in accordance with IFRS 5. Our audited consolidated financial statements included elsewhere also reflects a restatement as a result of the discontinuation of our operations in Mexico, which has been made in accordance with IFRS 5. See “Introduction––Financial Information.”

(2)     Solely for the convenience of the reader, real amounts as of and for the year ended December 31, 2018 have been translated into U.S. dollars at the selling rate reported by the Central Bank at December 31, 2018 of R$3.8748 to US$1.00. See “Item 3. Key Information––A. Selected Financial Data––Exchange Rates” for information regarding historical exchange rates of reais to U.S. dollars.

(3)     Relates to our operations in Mexico which were discontinued in September 2018.

(4)     Basic loss per common share is calculated based on the weighted average number of common shares for the relevant period. Diluted loss per common share reflects, for each period, the potential dilution of share options that could be exercised or converted into common shares, and is computed by dividing net loss attributable to the owners of the Parent by the weighted average number of common shares outstanding plus the potentially dilutive effect of all of our share options. Earnings per common share data for all periods have been calculated after giving effect to the share split that occurred on April 18, 2017 in connection with the completion of our initial public offering.  When we report net loss attributable to the owners of the Parent, the diluted loss per common share is equal to the basic loss per common share due to the anti-dilutive effect of the outstanding share options.

Consolidated Statements of Financial Position

 

As of December 31,

 

2014

2015

2016

2017

2018

2018

(In thousands)

R$

R$

R$

R$

R$

US$ (1)

Selected Statements of Financial Position Data

 

   

 

 

 

Cash and cash equivalents

242,372

249,064

111,304

395,962

67,321

17,374

Total current assets (2)

743,408

938,358

824,711

1,113,558

582,070

150,220

Total assets

861,956

1,113,568

1,113,722

1,497,125

994,332

256,616

Total current liabilities

378,416

523,271

616,695

796,330

605,751

156,331

Total long-term debt (3)

335,410

333,993

387,382

285,971

228,879

59,069

Share-based payment liability

30,113

35,978

30,139

Total liabilities

616,949

824,566

989,697

1,013,776

837,782

216,214

Total shareholders equity

245,007

289,002

124,025

483,349

156,550

40,402

 

 

(1)     Solely for the convenience of the reader, real amounts as of and for the year ended December 31, 2018 have been translated into U.S. dollars at the selling rate reported by the Central Bank at December 31, 2018 of R$3.8748 to US$1.00. See “Item 3. Key Information––A. Selected Financial Data––Exchange Rates” for information regarding historical exchange rates of reais to U.S. dollars.

(2)     Includes cash and cash equivalents.

(3)     Includes current portion of long-term debt. See note 18 to our audited consolidated financial statements included elsewhere in this annual report.

Selected Operating Data

 

Years Ended December 31,

 

2014

2015

2016

2017

2018

Operating data from continuing operations (1)

 

 

 

 

 

Active customers (in thousands) (2)

3,662

4,567

5,432

6,516

6,805

Total orders (in thousands) (3)

6,642

8,273

10,005

12,037

12,624

% of total orders placed from mobile devices (4)

11.6%

20.8%

32.8%

45.9%

58.7%

Average basket size (5)

R$ 211.0

217.4

R$ 205.5

R$ 202.6

R$ 203.9

 

 

(1)     Does not consider operating data from our Mexican operations, which were discontinued in September 2018 but considers operating data from our operations in Argentina, which were discontinued as of April 2019.

(2)     Customers who made purchases online with us during the preceding twelve months as of the relevant dates.

(3)     Total number of orders invoiced to active customers during the relevant period.

(4)     The sum of total orders placed by active customers through our mobile site and applications as a percentage of total orders placed by active customers for the relevant period. This operational metric is especially relevant as sales made on mobile devices have become an important part of our business.

(5)     The sum of total order value from online purchases with us divided by the number of total orders for the relevant period.

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Non-IFRS Financial Measures

We use non-IFRS financial measures for financial and operational decision-making purposes. To provide investors and others with additional information regarding our financial results and operating performance, we have disclosed in the tables below and within this annual report our EBITDA from continuing operations and EBITDA Margin from continuing operations and GMV which are non-IFRS financial measures.

EBITDA from Continuing Operations and EBITDA Margin from Continuing Operations

We define: (1) “EBITDA from Continuing Operations” as net income (loss) from continuing operations plus interest income/expense, net (which includes interest income, imputed interest on installment sales, interest expenses related to debt, imputed interest on credit purchases and debt issuance costs), income tax, depreciation and amortization expenses and monetary gain (loss), net; and (2) “EBITDA Margin from Continuing Operations” as EBITDA from Continuing Operations divided by net sales for the relevant period, expressed as a percentage. EBITDA from Continuing Operations and EBITDA Margin from Continuing Operations are not measures of financial performance in accordance with IFRS and should not be considered as a substitute for other measures of financial performance reported in accordance with IFRS. These measurements assist our management and may be useful to investors in comparing our operating performance consistently over time as they eliminate the impact of our capital structure (primarily interest charges), asset base (primarily depreciation and amortization) and items outside the control of our management (primarily taxes). These measurements have limitations as analytical tools, including:

·          EBITDA from Continuing Operations does not reflect changes in, or cash requirements for, our working capital needs or contractual commitments;

·          EBITDA from Continuing Operations does not reflect our tax expense or the cash requirements to pay our taxes;

·          Although depreciation and amortization are non-cash charges, the assets being depreciated or amortized will often need to be replaced in the future, and EBITDA from Continuing Operations does not reflect any cash requirements for these replacements; and

·          Other companies may calculate EBITDA from Continuing Operations differently than we do, and therefore this presentation of EBITDA from Continuing Operations may not be comparable to other similarly titled measures used by other companies.

Because of these limitations, you should consider EBITDA from Continuing Operations and EBITDA Margin from Continuing Operations alongside other financial performance measures, like net income (loss) and our other IFRS results. The following table reflects the reconciliation of our net loss from continuing operations to EBITDA from Continuing Operations and EBITDA Margin from Continuing Operations for each of the periods indicated:

 

Years Ended December 31,

(In thousands)

2014

(Restated)

2015

(Restated)

2016

(Restated)

2017

(Restated)

2018
 

R$

R$

R$

R$

R$

Net loss from continuing operations

 (127,402)

 (78,244)

 (134,244)

 (154,222)

 (321,795)

Add (subtract):

 

   

 

 

Interest income/expense, net (1)

26,941

30,524

74,175

93,047

54,097

Depreciation and amortization

15,965

19,892

30,738

31,487

58,022

Income tax expense

202

Monetary gain (loss), net

(9,595)

EBITDA from continuing
operations

(84,496)

(27,828)

(29,332)

(29,688)

(219,069)

Net Sales (2)

1,086,784

1,453,685

1,685,151

1,835,212

1,808,064

EBITDA Margin from continuing operations

(12.7)%

(6.1)%

(10.5)%

(1.6)%

(12.1)%

 

 

(1)     Includes interest income, imputed interest on installment sales, interest expenses related to debt, imputed interest on credit purchases and debt issuance costs.

(2)     Does not consider net sales from our Mexican operations, which were discontinued in September 2018 but considers net sales from our operations in Argentina, which was sold by us on April 26, 2019. See “Introduction––Financial Information” and Item 5. Operating and Financial Review and Prospects––A. Operations Results––Our Business Segments.”

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GMV

We define “GMV” as the sum of net sales, returns, GMV from marketplace and net sales taxes, less marketplace and NCard activation commission fees. GMV is a metric useful to investors as it provides an indication of the total volume of product sales (in terms of gross merchandise value) transacted in online and offline purchases with us as well as the growth trend of our marketplace, which has become an increasingly important part of our business. GMV is not a measure of financial performance in accordance with IFRS and should not be considered as a substitute for other measures of financial performance reported in accordance with IFRS. Because of these limitations, you should consider GMV alongside other financial performance measures, like net sales and our other IFRS results. The following table reflects the reconciliation of our net sales to GMV for each of the periods indicated:

 

Years Ended December 31,

 

2014
(Restated)

2015
(Restated)

2016
(Restated)

2017
(Restated)

2018

 

(In thousands) (1)

 

 

 

 

 

Net sales (2)

R$1,086,784

R$1,453,685

R$1,685,151

R$1,835,212

R$1,808,064

Add (subtract):

 

 

 

 

 

Net sales taxes (3)

241,378

251,714

282,944

327,723

381,818

Returns (4)

73,210

98,543

139,751

197,232

140,277

Marketplace commission fees (5)

(9,086)

(38,858)

(64,307)

NCard activation commission fees (6)

(375)

(1,974)

(2,532)

Sub-Total:

R$ 1,401,372

R$ 1,803,942

R$ 2,098,385

R$ 2,319,335

R$ 2,263,320

GMV from marketplace (7)

 

 

38,288

199,626

333,542

GMV

R$ 1,401,372

R$ 1,803,942

R$ 2,136,673

R$ 2,518,961

R$ 2,596,861

 

 

(1)     For comparison purposes, the financial information provided in the table above reflects a restatement of such financial information for the years ended December 31 2014, 2015, 2016 and 2017 as a result of the discontinuation of our operations in Mexico in September 2018, which has been made in accordance with IFRS 5. Our audited consolidated financial statements included elsewhere also reflects a restatement as a result of the discontinuation of our operations in Mexico, which has been made in accordance with IFRS 5. See “Introduction––Financial Information.” The financial information provided above still considers our operations in Argentina, which was sold by us on April 26, 2019.

(2)     Net sales includes revenue from product sales and other revenues, net of promotional discounts, returns and net sales taxes. See Item 5. Operating and Financial Review and Prospects—A. Operating Results—Components of our Results of Operations.”

(3)     Value added taxes added in our product sales, net of value added taxes incentives granted to us and recorded in our net sales. For further discussion regarding the tax incentives applicable to us, see notes 6 and 8 to our audited consolidated financial statements included elsewhere in this annual report.

(4)     Represents revenue from product sales that are returned by our customers.

(5)     Represents the commission revenue arising from product sales of qualified third-party business-to-consumer, or B2C, vendors through our marketplace, launched in February 2016, that we record as net sales on a net basis. For further information, see “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Components of our Results of Operations.”

(6)     Represents the commission revenue generated by customers’ activation of NCards, an initiative launched in April 2016. For further information, see “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Components of our Results of Operations.”

(7)     Means the gross merchandise value of product sales through our online marketplace, launched in February 2016.  

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Exchange Rates

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

In the past, the Central Bank has intervened occasionally to control unstable movements in foreign exchange rates.  We cannot predict whether the Central Bank or the Brazilian government will continue to permit the real to float freely or will intervene in the exchange rate market through the return of a currency band system or otherwise.  The real may depreciate or appreciate against the U.S. dollar and other currencies substantially.  Furthermore, Brazilian law provides that, whenever there is a serious imbalance in Brazil’s balance of payments or there are serious reasons to foresee a serious imbalance, temporary restrictions may be imposed on remittances of foreign capital abroad.  We cannot assure you that such measures will not be taken by the Brazilian government in the future.  See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in Brazil—Exchange rate instability may adversely increase our costs and affect our financial condition and results of operations.”

The following table shows the selling rate for U.S. dollars for the periods and dates indicated.  The information in the “Average” column represents the average of the daily exchange rates during the periods presented.  The numbers in the “Period End” column are the quotes for the exchange rate as of the last business day of the period in question.

 

Reais per U.S. Dollar

Year

High

Low

Average

Period End

2014

2.7403

2.1974

2.3547

2.6562

2015

4.1949

2.5754

3.3387

3.9048

2016

4.1558

3.1193

3.4833

3.2591

2017

3.3807

3.0510

3.1925

3.3080

2018

4.1879

3.1391

3.6558

3.8748

 

 

 

Reais per U.S. Dollar

Month

High

Low

October 2018

4.0273

3.6368

November 2018

3.8925

3.6973

December 2018

3.9330

3.8285

January 2019

3.8595

3.6519

February 2019

3.7756

3.6519

March 2019

3.9682

3.7762

April (through April 26, 2019)

3.9725

3.8345

 

 

Source: Central Bank.

The exchange rate on December 31, 2018 was R$3.8748 per US$1.00 and on April 26, 2019 was 3.9353 per US$1.00.

Pro Forma Financial Information for the Sale of our Operations in Argentina

On April 26, 2019, we effected the sale of our operations in Argentina to BT8 S.A. Pursuant to terms of this transaction, we have granted to NS3 Internet S.A. a license for the period of eighteen months from the date hereof to use in Argentina our brand and e-commerce platform and contributed AR$106.308.088 (approximately US$2.4 million) into NS3 Internet S.A. at closing.  Pro forma financial information that gives effect to such divestment as if it had occurred as of January 1, 2018 is below:

 

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Pro Forma Consolidated Statements of Profit or Loss

 

For the year ended December 31, 2018

 

Historical (1)

Pro Forma Adjustments (2)

Pro forma

 

R$

R$

R$

 

 

 

 

(in thousands, except per share data)

 

 

 

Net Sales

         1,808,064

(126,101)

         1,681,963

Cost of sales

(1,389,842)

109,465

(1,280,377)

Gross profit

418,222

(16,636)

401,586

Operating expenses:

 

 

 

Selling and marketing expenses

(480,206)

39,664

(440,542)

General and administrative expenses

(191,695)

10,005

(181,690)

Other operating expenses, net

(9,312)

1,803

(7,509)

Total operating expenses

(681,213)

51,472

(629,741)

Operating loss

(262,991)

34,836

(228,155)

Financial income

15,026

(427)

14,599

Financial expenses

(83,223)

12,684

(70,539)

Monetary position (loss) gain, net

9,595

(9,595)

Loss before income tax

(321,593)

37,498

(284,095)

Income tax expense

(202)

202

Net loss from continuing operations

           (321,795)

              37,700

           (284,095)

Net loss from discontinued operations

(10,579)

(47,568)

(58,147)

Net loss

(332,374)

(9,868)

(342,242)

 

 

 

 

Net loss attributable to:

 

 

 

Owners of the Parent from continuing operations

           (321,166)

              37,700

           (283,466)

Owners of the Parent from discontinued operations

(10,579)

(47,568)

(58,147)

Non-controlling interests

(629)

(629)

 

 

 

 

Loss per share attributable to owners of the Parent

 

 

 

Basic and diluted

                    (10.68)

                      (0.32)

                    (11.00)

 

 

(1)     Financial data derived from our audited consolidated financial statements for the year ended December 31, 2018 included elsewhere in this annual report.

(2)     Pro forma adjustments to give effect to the discontinuation of our operations in Argentina as if such divestment had occurred as of January 1, 2018. As a result, it represents the elimination of statement of profit or loss line items associated with our operations in Argentina.

 

 

Pro Forma Consolidated Statements of Financial Position

 

For the year ended December 31, 2018

 

Historical (1)

Pro Forma Adjustments (2)

Pro Forma

 

R$

R$

R$

Assets

 

 

 

Current assets:

 

 

 

Cash and cash equivalents

                 67,321

                     (732)

                 66,589

Restricted cash

2,996

2,996

Derivative financial instruments

Trade accounts receivables, net

163,807

(2,375)

161,432

Inventories, net

268,594

(13,509)

255,085

Recoverable taxes

59,214

(1,238)

57,976

Prepaid expenses and other current assets

20,138

(388)

19,750

Total current assets

582,070

(18,242)

563,828

Non-current assets:

 

 

 

Restricted cash

18,533

18,533

Judicial deposits

119,717

119,717

Recoverable taxes

40,033

40,033

Other assets

14,166

14,166

Due from related parties

7

7

Property and equipment, net

76,489

76,489

Intangible assets, net

143,317

143,317

Total non-current assets

412,262

412,262

Total assets

               994,332

                (18,242)

               976,090

 

 

(1)     Financial data derived from our audited consolidated financial statements for the year ended December 31, 2018 included elsewhere in this annual report.

(2)     Pro forma adjustments to give effect to the discontinuation of our operations in Argentina as if such divestment had occurred as of January 1, 2018. As a result, it represents the elimination of statement of financial position line items associated with our operations in Argentina.

 

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For the year ended December 31, 2018

 

 

Historical (1)

Pro Forma Adjustments (2)

Pro Forma

 

R$

R$

R$

Liabilities and Shareholders’ Equity

 

 

 

Current liabilities:

 

 

 

Trade accounts payable

                           337,120

                            (10,753)

                           326,367

Reverse factoring

45,276

45,276

Current portion of long-term debt

38,473

38,473

Taxes and contributions payable

18,467

(842)

17,625

Deferred revenue

3,983

3,983

Accrued expenses

136,721

(6,881)

129,840

Other current liabilities

25,711

9,252

34,963

Total current liabilities

605,751

(9,224)

596,527

Non-current liabilities:

 

 

 

Long-term debt, net of current portion

190,406

190,406

Provision for labor, civil and tax risks

19,935

19,935

Deferred revenue

21,690

21,690

Total non-current liabilities

232,031

232,031

Total liabilities

837,782

(9,224)

828,558

Shareholders’ equity:

 

 

 

Share capital

244

244

Additional-paid in capital

1,347,581

1,347,581

Treasury shares

(1,533)

(1,533)

Accumulated other comprehensive loss

(11,022)

(11,022)

Accumulated losses

(1,178,464)

(9,274)

(1,187,738)

Equity attributable to owners of the parent

156,806

(9,274)

147,532

Equity attributable to non-controlling interests

(256)

256

Total shareholders’ equity

156,550

(9,018)

147,532

Total liabilities and shareholders’ equity

                           994,332

                            (18,242)

                           976,090

 

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(1)     Financial data derived from our audited consolidated financial statements for the year ended December 31, 2018 included elsewhere in this annual report.

(2)     Pro forma adjustments to give effect to the discontinuation of our operations in Argentina as if such divestment had occurred as of January 1, 2018. As a result, it represents the elimination of statement of financial position line items associated with our operations in Argentina.

 

 

 

These pro forma c onsolidated statements of profit or loss and consolidated statement of financial position have been prepared by us for illustrative purposes and are not intended to represent our results of operations or financial position in future periods or what our results of operations or financial position actually would have been had we completed this divestment during the specified period or as of a specified date.

B.                   Capitalization and Indebtedness

Not applicable.

C.                   Reasons for the Offer and Use of Proceeds

Not applicable.

D.                   Risk Factors

Risks Related to Our Business and Industry

We have determined that there is substantial doubt about our ability to continue as a going concern and our independent registered public accounting firm has included an explanatory paragraph relating to our ability to continue as a going concern in its report on our audited consolidated financial statements included in this annual report.

Our audited consolidated financial statements were prepared assuming that we will continue as a going concern. However, as set out in note 1.4 of our audited consolidated financial statements we have concluded that we will need to explore financing alternatives to meet our obligations within one year from the date of issue of our audited consolidated financial statements and there is no assurance that we will be able to meet our funding requirements and have the ability to gain continued access to short-term financing.  We have incurred operating losses, negative cash flow from operating activities and have a working capital deficiency that raise substantial doubt about our ability to continue as a going concern. In recognition of this, the report of our independent registered public accounting firm included elsewhere in this annual report contains an explanatory paragraph stating there is substantial doubt about our ability to continue as a going concern.

Although our management is currently exploring alternatives to obtain access to other sources of capital necessary to meet our ongoing liquidity needs and is taking measures to improve our operating performance and cash, liquidity and financial position , our plan to improve our operating performance and financial position may not be successful and we may not be able to obtain additional financing when needed on commercially reasonable terms, or at all. The perception that we may not be able to continue as a going concern may also make it more difficult to raise additional funds or operate our business due to concerns about our ability to meet our contractual obligations. For further information regarding such measures taken by our management, see “Item 5. Operating and Financial Review and Prospects —B. Liquidity and Capital Resources.”

We may not be able to maintain adequate liquidity, and our cash flows from operations may not be sufficient to meet our current obligations with financial creditors and suppliers unless we improve our operating performance and cash, liquidity and financial position and obtain access to alternative sources of capital necessary to meet our ongoing liquidity needs.

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We experienced net losses and significant cash outflows from cash used in operating activities for the year ended December 31, 2018. As of and for the year ended December 31, 2018, we had accumulated losses of R$1,180.9 million (compared to R$847.1 million as of December 31, 2017), net loss of R$332.4 million (compared to R$170.3 million in 2017) and net cash used in operating activities of R$102.5 million (compared to R$43.5 million of net cash provided in operating activities in 2017). As of December 31, 2018, we recorded R$23.7 million of net current liabilities (compared to R$317.3 million of net current assets as of December 31, 2017). Our business performance and financial condition has faced increasing pressure since December 31, 2018.

We may be able to meet our funding requirements and have the ability to gain continued access to short-term financing. If for any reason we are unable to continue as a going concern, then this could have an impact on our ability to realize assets at their recognized values, and to settle liabilities in the ordinary course of business (including with suppliers and creditors) at the amounts stated in our audited consolidated financial statements, resulting in defaults in agreements with our creditors and suppliers and may experience additional defaults in the future, including as a result of cross-defaults. Most of our financing agreements are subject to termination in the event of default, and our indebtedness may be accelerated in the event of continuing default. For further information, see Item 5. Operating and Financial Review and Prospects —B. Liquidity and Capital Resources.”

Failure to maintain sufficient working capital could harm our business, financial condition and results of operations.

We have significant working capital requirements primarily driven by payment terms agreed with our suppliers and extended payment terms that we offer our customers. For the year ended December 31, 2018, 56.5% of our product sales were paid in installments by our customers. Differences between the date when we pay our suppliers and the date when we receive payments from customers may negatively affect our liquidity and our cash flows. In addition, we expect our working capital needs to increase as our total number of products sold increases. In order to finance our working capital needs, we enter into financing arrangements to decrease the amount of time it takes for us to collect our trade accounts receivable, or factoring, and to increase the amount of time we have to pay our trade accounts payable, or reverse factoring. For the year ended December 31, 2018, our volume of factoring of trade accounts receivable with financial institutions reached R$1,509.7 million (compared to R$1,113.8 million for the year ended December 31, 2017). There can be no assurance that these types of financing arrangements will continue to be available to us on acceptable terms, or at all, particularly if we are not able to maintain adequate liquidity and continue as a going concern. If we do not have sufficient working capital, we may not be able to respond to competitive pressures or fund key strategic initiatives, such as the development of our sites, which may adversely affect our business, financial condition and results of operations.

Since our inception, we have never recorded profits in a fiscal year.

Since our inception, we have not recorded profits on a consolidated basis and are most likely not be able to record profits on a consolidated basis in the near future. If our operating activities are not profitable and provide us with sufficient cash flows to meet our operational and investment needs, we may be required to seek additional sources of capital, which could include equity, equity-linked and debt financing. Equity financing would have a dilutive effect on our common shares, and new investors in any subsequent transactions could gain rights, preferences and privileges senior to those of our common shareholders. Debt financing, if available, may involve restrictive covenants and could reduce our operational flexibility and profitability. We cannot assure you that any additional financing will be available to us on acceptable terms, if at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to fund our expansion, take advantage of acquisition opportunities, develop or enhance services or products or respond to competitive pressures. These inabilities may have a material adverse effect on our business, results of operations and financial condition.

We are partially dependent upon a select number of prime brands manufactured by certain retail companies. We do not have long-term agreements with our suppliers, and they can cease or limit our access to their products at any time, which could adversely impact our results depending on the importance of the supplier.

Our business partially depends on a select number of prime brands. For instance, for the years ended December 31, 2015, 2016, 2017 and 2018, Nike, Adidas, Mizuno and Asics made up approximately 45.3%, 34.8%, 34.8% and 37.8%, respectively, of our net sales. We currently do not have long-term agreements with our suppliers. If any of these suppliers choose not to sell their products to us or limit our access to their products (for example, by entering into exclusive distribution arrangements with other retailers), whether or not resulting from inability to settle liabilities with them in the ordinary course of our business, our capacity to grow, our market share and our financial results could be adversely impacted. In view of recent issues relating to our ability to continue as a going concern, we have recently delayed payments to certain suppliers. Also, to the extent that the increase in the sales of our private label products on our sites negatively affects the sales of our suppliers’ products, our relationship with certain of them could be adversely impacted.

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In addition, our suppliers participate in an extremely competitive market with few global brands having the majority of the market share. In order to gain scale or market share, these brands could merge or acquire competitors. The further concentration of our suppliers could negatively impact our ability to negotiate with them and limit the number of companies that could act as our main suppliers.

The eCommerce market in Brazil is developing, and our business depends on the continued growth of eCommerce, as well as increased availability, quality and usage of the Internet in Brazil.

Our future sales depend substantially on consumers’ widespread acceptance and use of the Internet as a way to conduct commerce. Rapid growth in the use of the Internet (particularly as a way to provide and purchase products and services) is a relatively recent phenomenon in Brazil, and we cannot assure you that this acceptance and use will continue or increase. In order to grow our customer base successfully, consumers who have historically used physical channels of commerce to purchase lifestyle, sporting, fashion and beauty goods must accept and use new ways of conducting business and exchanging information. Furthermore, if the penetration of Internet access in Brazil does not increase quickly, that may limit our potential growth, particularly in regions with low levels of Internet quality and access and/or low levels of income.

The Internet penetration in Brazil may never reach a percentage similar to more developed countries for reasons that are beyond our control, including the lack of necessary network infrastructure or delayed development of enabling technologies, performance improvements and security measures. The infrastructure for the Internet in Brazil may not be able to support continued growth in the number of users, their frequency of use or their bandwidth requirements. In addition, Internet reliability may not improve in Brazil due to delays in telecommunications, infrastructure development or other technology shortfalls, or due to increased government regulation. If telecommunications services are not sufficiently available to support the growth of the Internet in Brazil, response times could be slower, which would adversely affect the use of the Internet and our services in particular.

Furthermore, the price of Internet access and Internet-connected devices, such as personal computers, tablets, mobile phones and other portable devices, may limit our potential growth in parts of Brazil with low levels of income. Given the comparatively low level of income in Brazil, the penetration rate for Internet-connected devices is significantly lower in Brazil than it is in the United States and many other more developed countries, and the cost of Internet access is still relatively high as compared with other more developed countries. In addition, there may be increases in Internet access fees or telecommunication fees in Brazil. If that happens, our potential number of customers may decrease, which in turn may adversely affect our sales.

The online retail industry is intensely competitive, and we may not compete successfully against new and existing competitors, which may materially and adversely affect our results of operations.

The retail market for the products we sell is intensely competitive. Consumers have many choices online and offline, including global, regional and local retailers. Our current and potential competitors include brick-and-mortar retailers specializing in sporting goods, fashion and beauty, general brick-and-mortar retailers and pure-play eCommerce players, such as other B2C eCommerce retailers. In the future, we may also face competition from new entrants, the consolidation of existing competitors or companies spun off from our larger competitors.

We face a variety of competitive challenges, including: sourcing products efficiently, pricing the products we sell competitively, maintaining optimal inventory levels, selling products effectively, maintaining the quality of the products we sell, building our customer base, conducting effective marketing activities, anticipating and responding quickly to changing consumer demands and preferences (which is especially true for the fashion and beauty segments), attracting visitors to our sites and maintaining favorable brand recognition. In addition, as we further develop our business, we will face increasing challenges to compete for and retain high quality suppliers. If we cannot properly address these challenges, our business and prospects would be materially and adversely affected. Other online retailers may be acquired by, receive investments from or enter into strategic relationships with well-established and well-funded companies or investors, which would help enhance their competitive positions. Certain of our competitors may be able to secure more favorable terms with suppliers, devote greater resources to marketing campaigns, adopt more aggressive pricing or inventory policies and devote substantially more resources to infrastructure and logistics development. Increased competition may reduce our sales performance, product margins, market share and brand recognition.

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We cannot assure you that we will be able to compete successfully against current and future competitors, and competitive pressures may materially and adversely affect our business, financial condition and results of operations.

If the Internet or the markets for our Internet-based services in Brazil fail to grow as anticipated, such lack of growth may have a material adverse impact on our business prospects, results of operations and financial condition.

We operate in a rapidly evolving market. Accordingly, we may be unable to accurately forecast net sales or earnings and appropriately plan our future expenditures.

Considering the emerging nature of the markets in which we compete, the rapidly evolving nature of our business, the relative newness of eCommerce in Brazil, our business diversification and continuous innovation and the general economic and business conditions in Brazil, it is particularly difficult for us to forecast our net sales or earnings accurately. Our current and future expenditure levels are based largely on our investment plans and are, to a large extent, fixed. We may not be able to adjust spending in a timely manner to compensate for any unexpected net sales shortfalls arising from the rapidly evolving nature of our business or other conditions that affect our business. Accordingly, any significant shortfall in net sales relative to our planned expenditures would have an immediate adverse effect on our business, results of operations and financial condition.

We depend on search engines, e-mail, and other messaging services to attract a substantial portion of the customers who visit our sites, and changes in search engine logic, or any restrictions on the sending of emails or messages or an inability to timely deliver such communications could adversely affect our business and results of operations.

Our site traffic is generated by different advertising channels. A portion is generated by customers clicking on search results displayed by search engines, such as Google, Facebook, Yahoo or Bing. These search engines typically provide two types of results: algorithmic and purchased listings. Algorithmic listings cannot be purchased and instead are determined and displayed solely by a set of formulas designed by the search engine provider. Purchased listings can be purchased by companies and other entities in order to attract users to their sites. We rely on both algorithmic and purchased listings to attract a substantial portion of the customers that we serve. The cost of purchased search listing advertising may increase as demand for such advertising channels grows, and further increases may have a negative impact on our ability to maintain or increase profitability. Further, search engines revise their algorithms from time to time in an attempt to optimize their search result listings and to maximize the advertising revenue generated by those listings. Search engines may also place websites on a “blacklist” or remove them from their indexes. We cannot guarantee that a removal by Google, Facebook, Yahoo, Bing or another search engine will not happen to us in the future or that we will be able to adapt to changes in their algorithms in a timely manner.

If the search engines on which we rely for site traffic remove us from their indices or otherwise modify their algorithms such that we have less favorable placement or do not appear among search results, our business will be adversely affected. Such circumstances may result in fewer customers clicking through to our sites, requiring us to resort to other more costly resources to attempt to replace that traffic, and this may reduce our net sales and harm our business. We may also be unable to purchase listings on alternative search engines and if we are able to purchase listings from such alternative search engines, those companies may charge higher prices for advertising or have fewer users.

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Also, our business partially relies on email and other messaging services for promoting our sites and product offerings. We provide promotional emails to consumers in our database and we rely on a third-party service for the delivery of all our emails. Delays or errors in the delivery of such emails or other messaging we send may occur and are beyond our control. From time to time, Internet service providers or other third parties may block bulk email transmissions or otherwise experience technical difficulties that result in our inability to successfully deliver emails or other messages to our customers. Changes in the laws or regulations that limit our ability to send such communications or impose additional requirements upon us in connection with sending such communications could also materially and adversely impact our business. In addition, changes in how webmail applications organize and prioritize email may reduce the number of our emails being opened, including if our email messages are delivered to “spam” or similar folders. Actions by third parties to block, impose restrictions on or charge for the delivery of emails or other messages or delays in the distribution of such messages could materially and adversely impact our business. We also use social media services and other retargeting channels to send communications and product offerings to our customers. Changes in the terms of use of social media services and other retargeting channels that would limit our ability to send promotional communications or our customers’ ability to receive communications, disruptions or downtime experienced by these services or a decline in the use of or engagement with social media by customers and potential customers could harm our business.

Our success depends in part on our ability to increase our net sales per active customer. If our efforts to increase customer loyalty and repeat purchasing and to maintain high levels of customer engagement and the average basket size of our customers are not successful, our prospects and net sales will be materially adversely affected.

Our ability to grow our business depends on our ability to retain our existing customer base, generate increased sales and repeat purchases from this customer base, and maintain high levels of customer engagement. To do this, we must continue to provide our customers and potential customers with an intuitive, convenient, efficient and differentiated shopping experience and to continue to offer products that our customers find compelling. If we fail to increase net sales per active customer, generate repeat purchases or maintain high levels of customer engagement and average basket size, our growth prospects, operating results and financial condition could be materially adversely affected.

If we are unable to predict or effectively react to changes in consumer demand or shopping patterns, we may face significant inventory risk or lose customers and our sales may decline.

Our success depends in part on our ability to anticipate and respond in a timely manner to changing consumer demands and preferences and shopping patterns and seasonality regarding sporting, lifestyle, fashion and beauty goods. The products we sell must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to change. Sudden changes in consumer spending patterns, consumer demands and preferences are especially likely in fashion and beauty, markets in which we recently began operating and have limited experience. Also, consumer preferences could shift rapidly and our future success depends in part on our ability to select and offer products in a way that anticipates and responds to those changes. If we misjudge the market for our merchandise and do not forecast consumer demand accurately, our sales may decline significantly.

We may experience excess inventory levels (for example, if we overstock unpopular products) and be forced to take significant inventory markdowns, which could have a negative impact on our profitability. Conversely, shortages of products that prove popular could negatively impact our net sales. In addition, a major shift in consumer demand away from sporting, fashion or beauty goods could have a material adverse effect on our business, results of operations and financial condition. We often agree to purchase products from our suppliers several months in advance of the proposed delivery; however, product demand can change significantly between the time we commit to buy a product and its expected date of sale. Also, we carry a broad selection of products—some at significant inventory levels—and we may be unable to sell products in sufficient quantities or during the selling seasons. Any one of these inventory risks may adversely affect our operating results.

For instance, in the second half 2017, after remodeling our B2B operation, as of December 31, 2017, we had R$117.7 million of nutritional supplement products stored in our inventories and during the course of 2018 the  venture with Midway Labs to sell nutritional supplement products continued to generate lower than expected results and a high level of inventory of nutrition supplements. In light of that, and as part of our continuing move to streamline our operations and focus on our core B2C operation, we announced in October 2018 that we have decided to discontinue our B2B operation dedicated to sales of Midway’s nutrition supplements and vitamins. In order to minimize further negative results, we adjusted the margins of nutrition supplements products, accelerating sales through our B2C channel. This resulted in a write-down of about R$60 million in existing Midway’s nutrition supplement inventory in September 2018. As of December 31, 2018, we had R$24.7 million of Midway’s nutritional supplement products stored in our inventories. There can be no assurance that we will be able to sell them in sufficient quantities prior to their expiration date.

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A number of factors, many of which are outside our control, may affect consumer demand, shopping patterns or the predictability of our inventory levels, including: general economic conditions; lockouts or strikes involving professional sports teams; the retirement of sports or other celebrities used in marketing for the various products we sell; sports scandals or scandals involving celebrities we use in campaigns to advertise our sites; litigation; and pricing and other actions taken by our competitors.

Failure to anticipate and respond to changing consumer preferences and shopping patterns in a timely manner could lead to, among other things, lower sales and excess inventory levels.

Our business is subject to substantial fluctuation as a result of the seasonal buying patterns of our customers.

We experience seasonal fluctuations in our net sales and operating results, both of which may vary from quarter-to-quarter in the future. We have historically generated significantly higher net sales in the fourth quarter, which includes the Black November period and the holiday selling season. Accordingly, a reduction in consumer confidence during the holiday season would have a significant impact on our business. Further, in the fourth quarter we generally have increased expenses for personnel and advertising, due to anticipated higher purchase and sales volumes. Seasonality also influences our buying patterns since we purchase merchandise for seasonal activities in advance of a season, which directly impacts our inventory and accounts payable levels and cash flows. If we miscalculate the demand for the amount of products we will sell or for the product mix during the fourth quarter, our net sales can decline, which can harm our financial performance. If fourth quarter net sales are not high enough to allow us to fully recoup our personnel and advertising expenses or are lower than the targets used to determine our inventory levels, this shortfall can negatively impact our results of operations. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Seasonality and Quarterly Results of Operations.”

Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including, among other things, the timing of the introduction of and advertising for new products and changes in our product mix. As a result of these seasonal and quarterly fluctuations, we believe that comparisons of our operating results between different quarters within a single year are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of our future performance. Any seasonal or quarterly fluctuations that we report in the future may not match the expectations of market analysts and investors. This could cause the price of our common shares to fluctuate significantly.

We derive our net sales from product categories that represent discretionary spending, and changes in global macroeconomic conditions may decrease the demand for the products we sell and adversely affect our growth strategies and business prospects.

Our operating results are affected by the relative condition of the economy. Our business and financial performance may be adversely affected by current and future economic conditions that cause a decline in business and consumer spending, including a reduction in the availability of credit, increased unemployment levels, higher energy and fuel costs, rising interest rates, financial market volatility and recession. Additionally, we may experience difficulties in operating and growing our operations as a result of economic pressures.

As a business that depends on consumer discretionary spending, we may be adversely affected if our customers reduce their purchases due to continued job losses, foreclosures, bankruptcies, higher consumer debt and interest rates, reduced access to credit, lower consumer confidence, uncertainty or changes in tax policies and tax rates. Decreases in customer traffic or average value per transaction negatively affect our financial performance, and a prolonged period of depressed consumer spending could have a material adverse effect on our business. Promotional activities and decreased demand for consumer products, particularly higher-end products, could affect profitability and margins. The timing and duration of the different economic cycles in Brazil are difficult to forecast and mitigate. As a consequence, our sales, operating and financial results for a particular period are difficult to predict, and, therefore, it is difficult to forecast future results. Any of the foregoing could have a material adverse effect on our business, results of operations and financial condition and could adversely affect our share price.

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A continued or future slowdown in Brazil or the global economy or a negative economic outlook could materially adversely affect consumer spending habits and potentially our future operating results.

If we are unable to appropriately address new market risks or the inherent risks in the lines of business into which we are expanding, our growth potential, reputation and results of operations could be materially and adversely affected.

We are engaged in an effort to expand our operations into other products and services in order to monetize our user traffic and distribution capabilities. Our ability to monetize our user traffic is critical to our envisioned plans for growth. As we expand into new business segments or regions, such as fashion and beauty, we will face new risks associated with lines of business in which we have limited or no experience and in which we may be less well-known. We may be unable to attract a sufficient number of customers, fail to anticipate competitive conditions or face difficulties in operating effectively in these new segments. In addition, profitability, if any, in our newer activities may be lower than in our more mature lines of business, and we may not be successful enough to recover our investments in them. For instance, in September 2018 and in April 2019, respectively we divested from our operations in Mexico and Argentina, both as a result of our strategy of focusing on our core Brazilian operations.

Most of our new lines of business are subject to risks similar to those that our sporting goods business is subject, such as changes in consumer demands or shopping patterns, risks related to our suppliers and private label brands, seasonality and distribution risks. However, some of them are subject to their own set of inherent risks. For instance, we launched an online marketplace in February 2016, and maintaining a trusted status for its operations will be critical to its success. Any damage to our reputation related to, or loss of trust in, our online marketplace operations could have a negative impact on our business and result in consumers, merchants and other participants choosing not to carry out transactions or reducing their activity level on our online marketplace, which could limit our potential for growth. The success of our online marketplace will depend on, among other things, our ability to (1) attract both consumers and merchants to our online marketplace, (2) offer a secure and reliable transactional environment (including payment services) for both consumers and merchants, (3) create an effective set of rules governing our online marketplace, that is perceived as fair, (4) restrict access to our online marketplace for merchants who are not reliable or do not offer high-quality products and (5) ensure that third-party couriers used by merchants will be able to provide reliable logistics services in order to deliver products to customers within the agreed-upon timeframe.

Interruption or failure of our information technology and communications systems could impair our operations, which could damage our reputation and harm our results of operations. Specifically, we rely on certain third-party providers to provide us with Internet data centers to host our sites and back-office end systems and keep them fully operational. Disruptions with this provider or in the services it provides to us could materially affect our reputation, operations or financial results.

Our success and ability to sell products online and provide high quality customer service depend on the efficient and uninterrupted operation of our computer and information technology systems. Any failure of our computer systems and information technology to operate effectively or to integrate with other systems, performance inadequacy or breach in security may cause interruptions in the availability of our sites, delays in product fulfillment and reduced efficiency of our operations. We experience service disruptions from time to time and on occasion, our site has not properly displayed promotions as marketed. Any failures, problems or security breaches may adversely affect the number of customers willing to purchase the products we offer in the future. Factors that could occur and significantly disrupt our operations include: system failures and outages caused by fire, floods, earthquakes, power loss, telecommunications failures, sabotage, vandalism, terrorist attacks and similar events; software errors; computer viruses, worms, physical or electronic break-ins and similar disruptions from unauthorized tampering with our computer systems and data centers; and security breaches related to the storage and transmission of proprietary information or customer information, such as credit card numbers or other personal information. Also, if too many customers access our sites within a short period of time due to increased holiday demand or any other reason, like one we had in the past we may in the future experience system interruptions that make our sites unavailable or prevent us from efficiently fulfilling orders, which may reduce the volume of goods we sell and the attractiveness of our products and services. We cannot assure you that such events will not occur and while we have backup systems and contingency plans for certain aspects of our operations and business processes, our planning does not account for all possible scenarios.

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Specifically, we rely on certain technologies that we license from third parties, such as UoL Diveo, to host our eCommerce sites in cloud and keep them operational and to provide us with two data centers to host our back-office end systems. Failure by Uol Diveo to adequately keep our sites fully operational, including any prolonged or unscheduled service disruption that affects our customers’ ability to utilize our sites and effect purchases therein, could result in the loss of sales and customers and/or increased costs, which could materially affect our reputation, operations or financial results. In addition, we rely on Uol Diveo to advise us of any security breaches, and if they do not provide notice on a timely basis, our reputation and results of operations may be adversely affected. We may have limited access to alternative services and may not be able to timely replace Uol Diveo, or find a replacement on a cost-efficient basis, in the event of termination of these agreements, disruptions, failures to provide services or other issues with them that may adversely affect our business. See “Item 10. Additional Information—C. Material Contracts.”

Any disruptions or service interruptions that affect our sites could damage our reputation, require us to spend significant capital and other resources and expose us to a risk of loss or litigation and possible liability. We do not carry any business interruption insurance to compensate for losses that may occur as a result of any of these events and our agreements with third-party service providers do not require those providers to indemnify us for any losses resulting from any disruption in service. Accordingly, our results of operations may be adversely affected if any of the above disruptions should occur.

Our business may be harmed if we are unable to secure licenses for third-party technologies on which we rely.

We rely on licenses to utilize certain technology provided by third parties, such as our key database technology, our eCommerce platform, operating systems for our servers and other computers and components for our servers. These third-party technology licenses may cease to be available to us on commercially reasonable terms, or at all. If we are unable to obtain licenses for, or otherwise make use of this technology, we would need to obtain substitute technology, which may not be available. If substitute technology is available, it may be of lower quality or have lower performance standards or may only be available at a greater cost, any of which could materially adversely affect our business, results of operations and financial condition.

Also, because we often depend upon the successful operation of third-party products in conjunction with our software, any errors in these third-party products, which may be outside our control, may prevent the implementation or impair the functionality of our software and Internet-based services, delay the introduction of new services and harm our reputation.

If we are not able to continue to innovate and adapt to changes in technology or in our industry, our business, financial condition and results of operations would be materially and adversely affected.

The Internet is characterized by rapidly changing technology, evolving industry standards, new mobile apps, protocols and technologies, new service and product introductions, triggering further changes in customer demands and shopping patterns. Our failure to innovate and adapt to these changes would have a material adverse effect on our business, financial condition and results of operations. For example, total orders placed from mobile devices are growing at a fast pace. In the year ended December 31, 2018, orders placed by our customers from mobile devices represented approximately 58.7% of our total orders (compared to 45.9% in the year ended December 31, 2017, 32.2% in the year ended December 31, 2016 and 20.2% in the year ended December 31, 2015). The variety of technical and other configurations across different mobile devices and platforms increases the challenges associated with this environment. If we are unable to continue to (1) attract new mobile consumers and increase or maintain levels of mobile engagement or (2) to rapidly adapt to future changes in technology, our ability to maintain or grow our business would be materially and adversely affected.

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We rely on a small number of third-party couriers to deliver the products we sell to our customers, and their failure to provide high quality delivery services or our failure to effectively manage our relationships with them may materially and adversely affect our business, financial condition and results of operations.

We currently rely on a small number of third-party courier companies to deliver products to our consumers, and any failure by our key third-party service couriers to perform or any adverse change to their financial conditions could have a material adverse effect on our reputation and results of operations. In particular, we rely significantly on Total Express, Transfolha and the Brazilian official post office ( Correios ), which together delivered 55.9% of the purchase orders shipped to our customers for the year ended December 31, 2018. Our third-party couriers may offer us less favorable terms in the future, which may increase our shipping costs and materially and adversely affect our financial condition and results of operation. For instance, in 2018 Correios announced a general increase in the prices it charges for the shipment of products, and this increase in cost may be particularly damaging to the qualified third-party B2C vendors selling products through our marketplace (and consequently to the successful development of our marketplace) if they are not capable of either absorbing this increased cost or passing on this additional cost to customers without affecting overall sales volumes. Further, most of our agreements with third-party couriers can be terminated upon delivery of thirty days’ prior written notice by any of the parties. If any of these agreements are terminated, there can be no assurance that we will be able to successfully substitute another service provider to provide delivery services on the same terms, in a timely manner or at all.

Additionally, interruptions to or failures in these third parties’ shipping services could prevent the timely or successful delivery of our products and adversely affect our operations. These interruptions may be due to unforeseen events such as inclement weather, natural disasters, pressure from unions, labor unrest or a strike, which are all beyond our control or the control of these third-party couriers. For example, our distribution network is sensitive to fluctuation in oil prices, which may result in increased shipping costs for third-party courier companies (as well as our suppliers’ transportation costs), which may, in turn, increase the prices of the products we sell and make us less competitive.

Additionally, in May 2018, Brazil experienced a national truck drivers’ strike that severely impacted the logistics operations of many companies throughout Brazil, including us, resulting in a temporary reduction in the volume of new orders from customers as a result of uncertainty regarding delivery time and also led us to take longer than usual to deliver the orders that were already in transit. Also, products may not be delivered to certain limited regions impacted by urban violence, which may prevent us from delivering our products to our customers’ homes.

If we do not deliver products in a timely manner or if we deliver damaged products, our customers may refuse to accept them and lose confidence in us. Many of the products we sell may be especially sensitive to delivery delays given that they are often purchased in anticipation of a specific date. Other products have a limited shelf-life and become quickly outdated. Any inability to promptly and successfully deliver the products we sell to customers, may result in the loss of their business and a material and adverse effect on our financial condition and reputation.

If we are unable to successfully manage the logistical challenge of expanding our operations, including the requisite technological capabilities, our results of operations and business could be materially and adversely affected.

We have expanded our operations rapidly since our inception and our net sales have increased from R$252.9 million in 2010 to R$1,808.1 million in 2018 (a compound annual growth rate, or CAGR, of 27.9%). Our substantial growth has placed, and is expected to continue to place, a significant strain on our management, operational and financial resources. If our operations continue to grow, we will be required to continue to expand our sales and marketing and distribution functions, upgrade our management information systems and other processes and technology, and obtain more space for our expanding workforce. This expansion could increase the strain on our resources, and we could experience serious operating difficulties, including difficulties in hiring, training and managing an increasing number of employees, difficulties in obtaining sufficient suppliers, and delays in shipments. These difficulties would likely result in the erosion of our brand image and a resulting decrease in net sales and the price of our common shares.

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As a result of expansion efforts, we must consistently add new hardware, update software, enhance our billing and transaction systems, and add and train new engineering and other personnel to support the increased use of our sites and the new products and features we regularly introduce. This upgrade process is expensive, and the increasing complexity and enhancement of our sites results in higher costs. Failure to upgrade our technology, transaction processing systems, security infrastructure, or network infrastructure to accommodate increased traffic or transaction volume could harm our business. Adverse consequences could include unanticipated system disruptions, slower response times, degradation in levels of customer support, impaired quality of users’ experiences of our services and delays in reporting accurate financial information. Also, our net sales depend on prompt and accurate billing processes. Our failure to grow our transaction-processing capabilities to accommodate the increasing number of transactions that must be billed on our sites would harm our business and our ability to collect revenue.

Furthermore, we may need to enter into relationships with various strategic partners, sites and other online service providers and other third parties necessary to our business. The increased complexity of managing multiple commercial relationships could lead to execution problems that can affect current and future sales and operating margins. Our current and planned systems, procedures and controls, personnel and third-party relationships may not be adequate to support our future operations. Our failure to manage growth effectively could have a material adverse effect on our business, results of operations and financial condition.

We rely on third-party suppliers for the products we sell and any deterioration in those business relationships, the quality of their products or their reputation, especially in the case of any infringement by them on the intellectual property rights of others, may materially and adversely affect our reputation, business, financial condition and results of operations.

We source the products we sell (including our private label products) from over 500 suppliers. Our continued growth resulting from increased demand for the products we sell will require us to increase our ability to source commercial-quality products on reasonable terms.

Our suppliers (including those manufacturing our private label products) may:

·          cease selling merchandise on terms acceptable to us or at all in particular in view of recent issues relating to our ability to continue as a going concern;

·          fail to deliver goods that meet consumer demands;

·          encounter financial difficulties;

·          terminate our relationships and enter into agreements with our competitors on more favorable terms;

·          have economic or business interests or goals that are inconsistent with ours and take actions contrary to our instructions, requests or objectives;

·          decide to initiate their own eCommerce operations, thereby directly competing with us;

·          be unable or unwilling to fulfill their obligations, including their obligations to meet our production deadlines, quality standards and product specifications;

·          fail to expand their production capacities to meet our growing demands;

·          encounter raw material or labor shortages or increases in raw material or labor costs, which may impact our costs; or

·          engage in other activities or employment practices that may harm our reputation.

Furthermore, agreements with our suppliers do not typically establish a fixed price for the purchase of products. As a result, we may be subject to price fluctuations based on changes in our suppliers’ businesses, cost structures or other factors. The occurrence of any of these events, alone or together, may have a material and adverse effect on our business, financial condition and results of operations. In addition, most of our agreements with suppliers do not contain non-compete or exclusivity clauses that would prevent those suppliers from producing similar products for any other third party. Any disruption in our relationships with suppliers or our failure to resolve disputes with or complaints from our suppliers in a timely manner, could materially and adversely affect our business, financial condition and results of operations.

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Also, our suppliers may sell products that infringe on the intellectual property rights of third parties. As a result, in addition to product delays, we may be subject to claims or proceedings resulting from our suppliers’ infringement. We may also be involved in intellectual property rights claims for sports, fashion or beauty apparel or products sold on our sites that may contain unauthorized logos or brands. In case we have determined that products sold on our sites are infringing on the intellectual property rights of third parties, we will remove them from our sites; however, we could incur significant costs and efforts in defending against or settling such claims. If there is a successful claim against us, we may be required to refrain from further sales of these products, enter into royalty or licensing agreements with other third parties or pay substantial damages, and we may be unable to recoup any losses from our suppliers. Any of these events could have a material adverse effect on our business, financial condition and results of operations.

Failure to renew our current leases or locate desirable alternatives for our facilities could materially and adversely affect our business.

All of our offices and distribution centers are currently located on leased premises. At the end of each lease term, we may be unable to negotiate an extension of our leases or renew them on commercially acceptable terms. This could disrupt our operations and adversely affect our operating results. We compete with other businesses for premises at certain locations or of desirable sizes, and some landlords may have entered into long-term leases with other companies for our preferred premises. As a result, we may not be able to obtain new leases at desirable locations or renew our existing leases on acceptable terms or at all, which could materially and adversely affect our business.

We believe the interplay between the location of our distribution centers and our distribution network is an essential part of our business strategy. As we expand our operations, we cannot assure you that we will be able to lease suitable facilities on commercially acceptable terms in accordance with our growth strategy. The expansion of our logistics centers and distribution network, which could come in the form of expanding existing facilities or opening alternative or additional facilities, could put pressure on our managerial, financial, operational and other resources. If we are unable to secure new facilities or effectively manage our expanded logistical operations and control increasing costs, our growth potential, results of operations and business could be materially and adversely affected.

We operate three distribution centers in Brazil, and if we fail to operate them efficiently, or if there is a serious disruption at one of these facilities, we may lose merchandise and be unable to effectively deliver it to our customers.

We currently operate three distribution centers in Brazil with approximately 63,000 square meters in total. One of these distribution centers is in Barueri, in the State of São Paulo, Brazil, one is in Extrema, in the State of Minas Gerais, Brazil, and one is in Jaboatão dos Guararapes, in the State of Pernambuco, Brazil. The operation, management and expansion of our distribution centers are key to our business and growth. If we fail to operate our distribution centers successfully and efficiently or there is a serious service disruption in one of these facilities, our deliveries could be delayed, a significant portion of our inventory could be damaged or our ability to adequately stock the products we sell and process returns of products to our suppliers could be impaired.

We have designed and built our own logistics infrastructure, including inbound receipt of items for sale, storage systems, packaging, outbound freight and the receipt, screening and handling of returns. These processes are complex and depend on sophisticated know-how and computerized systems which we have tailored to meet the specific needs of our business. Any failure or interruption, partial or complete, of these systems, for example as a result of software malfunctions or other serious disruptions, could impair our ability to timely deliver our customers’ purchases and harm our reputation. If we continue to add distribution capabilities, add new businesses or categories with different logistical requirements or change the mix of products that we sell, our logistics infrastructure will become increasingly complex and operating it will become even more challenging. We might encounter operational difficulties which could result in shipping delays and customer dissatisfaction or cause our logistical costs to become high and uncompetitive. Any failure to successfully address these challenges in a cost-effective and timely manner could severely disrupt our business and harm our reputation.

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Our product delivery times can vary due to a variety of factors such as the location, our capacity to adequately manage and process multiple orders placed by our customers, the type of product sold, as well as the shipping option chosen by our customer. Our distribution capacity is dependent on the timely performance of services by third parties, including the shipping of products to and from our distribution facilities. Also, customers may expect or demand faster delivery times than we can provide in the future. If we are unable to meet customer expectations or demands in respect of delivery times or convenience, or if our competitors are able to deliver the same or equivalent products faster, more conveniently or for a lower cost, we could lose current or potential customers, our brand and reputation could suffer, and we could experience shortfalls in net sales.

Because many of the products that we sell are manufactured abroad, we may face delays, increased cost or quality control deficiencies in the importation of these products, which could reduce our net sales and profitability.

Although our direct imports of products represent 6.2% of the products we sold in 2018, like many other sporting, fashion and beauty goods retailers, a significant portion of the products that we purchase for resale is manufactured abroad in countries such as the U.S.A, China, Taiwan and South Korea. For the year ended December 31, 2018, 36.9% of the products we sold were imported. Foreign imports subject us to the risks of changes in import duties or quotas, new restrictions on imports, work stoppages, delays in shipment, freight cost increases, product cost increases due to foreign currency fluctuations or revaluations and economic uncertainties (including the imposition of antidumping or countervailing duty orders, safeguards, remedies or compensation and retaliation due to illegal foreign trade practices). If any of these or other factors were to cause a disruption of trade from the countries in which the suppliers of our vendors are located, we may be unable to obtain sufficient quantities of products to satisfy our requirements or our cost of obtaining products may increase.

In addition, we do not control our suppliers or the manufacturers of our private label products. To the extent that any foreign manufacturers that supply products to us directly or indirectly utilize quality control standards, production methods, labor practices or other practices that vary from those legally mandated, expected by our customers or commonly accepted in the world, we could be hurt by any resulting negative publicity or, in some cases, face potential liability. Historically, instability in the political and economic environments of the countries in which our suppliers or we operate has not had a material adverse effect on our operations. However, we cannot predict the effect that future changes in economic or political conditions in the foreign countries where our supplying manufacturers are located may have on our operations. In the event of disruptions or delays in supply due to economic or political conditions in foreign countries, those disruptions or delays could adversely affect our results of operations unless and until alternative supply arrangements are made. In addition, merchandise purchased from alternative sources may be of lesser quality or more expensive than the merchandise we currently purchase abroad.

Failure to maintain and further develop our brand recognition and maintain a positive public image could have a material adverse effect on our business and results of operations.

We believe developing our brand recognition is important to our sales and marketing efforts. If we fail to enhance the recognition of our brand, it could have a material adverse effect on our ability to sell products and, in turn, our business and results of operations. If we fail to maintain and develop a positive public image and reputation, our existing business with our customers could decline and we may fail to attract new customers, which could, in turn, adversely affect our prospects and results of operations.

For instance, complaints from customers or negative publicity about the products we sell (especially our private label products), the prices we charge or customer service have, from time to time, had a negative effect on our reputation in the past and could in the future reduce consumer confidence and the use of our services and adversely affect our business. In addition, some of the products we sell may expose us to product liability claims relating to personal injury, death, or property damage, and may require product recalls or other actions. To maintain good customer relations, we need prompt and accurate customer service to resolve irregularities and disputes. Effective customer service requires significant personnel expense and investment in developing programs and technology infrastructure to help customer service representatives carry out their functions. These expenses, if not managed properly, could significantly impact our profitability. Failure to manage or train our customer service representatives properly could compromise our ability to handle customer complaints effectively. If we do not handle customer complaints effectively, our reputation may suffer and we may lose our customers’ confidence.

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In addition, from time to time we execute advertisement contracts with celebrities to promote our sites and brands in marketing campaigns. Harm to those celebrities’ reputations, even if not associated with our sites and brands, could also harm our brand image and result in a material decrease in our net sales, which could have a material adverse effect on our business, results of operations and financial condition.

Changes in tax laws, tax incentives, benefits or differing interpretations of tax laws may adversely affect our results of operations.

Changes in tax laws, regulations, related interpretations and tax accounting standards in, Brazil the Cayman Islands and the United States may result in a higher tax rate on our earnings, which may result in a significant negative impact on our profits and cash flows from operations. Also, our results of operations and financial condition may be affected if certain tax incentives are not retained or renewed. For example, the ICMS ( Imposto sobre Circulação de Mercadorias e Serviços ) is a Brazilian state value-added tax with nominal rates of 4% to 25% depending on each state’s tax legislation. Sales to purchasers outside of the State of Pernambuco originating from our distribution center located in the city of Recife (State of Pernambuco, Brazil) currently enjoy Pernambuco State ICMS tax rates ranging from 0.5% to 1.0%, depending on the type of product offered. Also, sales to purchasers outside of the State of Minas Gerais originating from our distribution center located in the city of Extrema (State of Minas Gerais, Brazil) currently enjoy a Minas Gerais State ICMS tax rate of 1.0%. These ICMS tax benefits can be suspended or cancelled by the States of Pernambuco and Minas Gerais at any time. Benefits can also be suspended or cancelled by Brazilian judicial courts in the event of lawsuits filed by other States or legitimate parties challenging their constitutionality, and any loss of these incentives would result in increased taxes for the upcoming fiscal years and adversely affect our results if we are not able to pass this tax increase on to our customers. In 2015, our average ICMS tax burden was 3.6%, mainly as a result of tax reductions and incentives. As a result of an amendment to the Brazilian constitution occurred in 2016, which changed the rules about the allocation of ICMS taxes collected in interstate sales between the state of origin of the products sold and the state where the final customer is located, we expect that our average ICMS tax burden will increase to 10.1% by 2019, as these changes are expected to partially offset the benefits we currently experience from these tax incentives. For further information regarding the changes prompted by this constitutional amendment and its impact on us, see “Item 4. Information on the Company— B. Business Overview—Regulation.” If we are not capable of optimizing our cost structure to offset this tax increase or if we are not capable of passing on this tax increase to our customers, our financial condition, results of operations and cash flows could be adversely impacted.

In addition, governments are increasingly considering tax law changes as a means to cover budgetary shortfalls resulting from the recent downturn of the economic environment in Brazil. If such proposals were enacted, or if modifications were to be made to certain existing tax benefits or treaties, the consequences may have a material adverse impact on us, including increasing our tax burden, increasing costs of our tax compliance or otherwise adversely affecting our financial condition, results of operations and cash flows.

Additionally, tax laws and regulations may be interpreted differently by tax authorities, which may impact our operations if the interpretation of the tax authorities differs from our interpretation.  For further information regarding ongoing relevant disputes between us and tax authorities, see “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings —Legal and Administrative Proceedings—Tax and Social Security Matters.”

We may be or become a passive foreign investment company, which could result in adverse United States tax consequences to United States investors.

Based on the past and projected composition of our income and assets, and the valuation of our assets, and taking into account the value of our goodwill calculated based on the current value of our common shares, we do not believe we were a passive foreign investment company (a “PFIC”) for our most recent taxable year, and we do not expect to become a PFIC in the current taxable year or the foreseeable future. However, the determination of whether or not we are a PFIC is made on an annual basis and will depend on the composition of our income and assets from time to time. Specifically, for any taxable year we will be classified as a PFIC for United States federal income tax purposes if either (i) at least 75% of our gross income in that taxable year is passive income or (ii) at least 50% of the value (determined based on a quarterly average) of our assets is attributable to assets that produce or are held for the production of passive income. The calculation of the value of our assets will be based, in part, on the quarterly market value of our common shares, which is subject to change. See “Item 10. Additional Information—E. Taxation—Certain U.S. Federal Income Tax Consequences—Passive Foreign Investment Company.”

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If we are a PFIC for any taxable year during which you hold our common shares, such characterization could result in adverse United States federal income tax consequences to you if you are a United States Holder, as defined under “Item 10. Additional Information—E. Taxation—Certain U.S. Federal Income Tax Consequences.” For example, if we are or become a PFIC, you may become subject to increased tax liabilities under United States federal income tax laws and regulations, and will generally become subject to burdensome reporting requirements. We cannot assure you that we are not a PFIC for our current taxable or that we will not be a PFIC for any future taxable year. For more information, see “Item 10. Additional Information—E. Taxation—Certain U.S. Federal Income Tax Consequences —Passive Foreign Investment Company.”

The expansion of our business partially depends on increased availability of credit and credit cards to our customers, and we are subject to payments-related risks.

Our business is highly dependent on credit cards as the preferred payment method of our customers. As of December 31, 2018, 76.7% of our net sales were derived from payments effected through credit cards. As a result, the continued growth of our business is also partially dependent on the expansion of credit card penetration in Brazil, which may never reach a percentage similar to more developed countries for reasons that are beyond our control, such as low credit availability for a relevant portion of the population in such countries.

In addition to credit cards, we accept payments using a variety of methods, including bank payment slips, electronic payment platforms (such as PayPal) and consumer invoicing. As we offer new payment options to our customers, we may be subject to additional regulations, compliance requirements, and additional fraud-related risks. For certain payment methods, including credit cards, we pay transaction and other fees, which may increase over time and raise our operating costs, lowering profitability. We rely on third parties to provide payment processing services and it could disrupt our business if these companies become unwilling or unable to provide these services to us or if their data security systems are breached or compromised. If we fail to comply with these third-party servicers’ rules or requirements, or if our data security systems are breached or compromised (similar to the increase in fraud attempts we experienced in 2016 and the cybersecurity incident experienced in December 2017), we may be liable for chargebacks, credit card issuing banks’ costs, fines and higher transaction fees and we may lose our ability to accept credit card payments from our customers, process electronic funds transfers, or facilitate other types of online payments. Additionally, consumers and merchants in Brazil can bring claims against us for credit card and other losses due to third-party fraud on our marketplace platform. If any of these situations were to occur, our business and operating results could be adversely affected.

In addition, as secure methods of payment for eCommerce transactions have not been widely adopted in certain emerging markets, consumers and other merchants may have relatively low confidence in the integrity of eCommerce transactions and remote payment mechanisms, which may have a material and adverse effect on our business prospects or limit our growth.

Our costs may change as a result of currency exchange rate fluctuations or inflation in the cost of merchandise manufactured and purchased abroad.

We source goods from various countries (mainly from the United States of America, Taiwan and China) in currencies other than the Brazilian real (mainly the U.S. dollar). As a result, changes in the value of the U.S. dollar or in the functional currencies in which our subsidiaries operate compared to other currencies, or inflation affecting foreign labor and raw material costs, may affect the cost of goods that we purchase. If the cost of goods that we purchase increases, we may not be able to similarly increase the retail prices that we charge consumers without impacting our sales and our results of operations may suffer. If we do increase our retail prices, our reputation may suffer, which may also negatively impact our results of operations.

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We depend on key management personnel, and the loss of our management or the inability to attract and retain other key personnel could harm our business.

Our future success depends largely on the skills and efforts of our senior management team, and in particular, Marcio Kumruian, one of our founders, and currently chairman of our board of directors and chief executive officer. The loss of members of our management could disrupt our operations and have an adverse effect on our business. If members of our senior management team resign, we may not be able to sustain our existing culture or replace them with individuals of the same experience and qualification. In particular, our business model was designed by Marcio Kumruian, and we believe that we will continue to be heavily dependent on his insights and experience for our continuing success.

Our future success also depends on our ability to identify, attract, hire, train, retain, motivate and manage other highly skilled technical, managerial, information technology, marketing and customer service personnel. Competition for these personnel is intense, and we may not be able to successfully attract, hire, train, retain, motivate and manage sufficiently qualified personnel.

We are susceptible to illegal uses of our platform, and we could potentially face liability for any illegal use of our platform.

We, like our platforms, are susceptible to potentially illegal or improper uses, including, fraudulent and illicit sales on the payment methods accepted by us and bank fraud. In addition, our services could be subject to unauthorized credit card use, identity theft, employee fraud or other internal security breaches. We may incur significant costs to protect against the threat of information security breaches or to respond to or alleviate problems caused by any breaches. Laws may require notification to regulators, customers or employees and we may be required to reimburse customers or credit card companies for any funds stolen as a result of any breaches or to provide credit monitoring or identity theft protection in the event of a privacy breach. These requirements, as well as any additional restrictions that may be imposed by credit card companies, could raise our costs significantly and reduce our attractiveness.

In addition to the direct costs of such losses, if they are related to credit card transactions and become excessive they could result in us losing the right to accept credit cards for payment. If we are unable to accept credit cards, our business will be adversely affected given that credit cards are the most widely used method for our customers to pay for the products we sell.

Requirements associated with being a public company in the United States will require significant company resources and management attention.

We are subject to certain reporting requirements of the Exchange Act, and the other rules and regulations of the SEC and the NYSE. We are also subject to various other regulatory requirements, including the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. These rules and regulations increase our legal, accounting and financial compliance costs and make some activities more time-consuming and costly. For example, these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantial costs to maintain the same or similar coverage. New rules and regulations relating to information disclosure (including cybersecurity risk), financial reporting and controls and corporate governance, which could be adopted by the SEC, the NYSE or other regulatory bodies or exchange entities from time to time, could result in a significant increase in legal, accounting and other compliance costs and make certain corporate activities more time-consuming and costly, which could materially affect our business, financial condition and results of operations. These rules and regulations may also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers.

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These new obligations may also require substantial attention from our senior management and could divert their attention away from the day-to-day management of our business. Given that most of the individuals who now constitute our management team have limited experience managing a publicly traded company and complying with the increasingly complex laws pertaining to public companies, initially, these new obligations could demand even greater attention. These cost increases and the diversion of management’s attention could materially and adversely affect our business, financial condition and operation results.

Our management has identified material weaknesses in our internal control over financial reporting, and has concluded that our internal control over financial reporting was not effective at December 31, 2018, which may have a material adverse result on our results of operation and financial condition.

Our management identified a number of material weaknesses in our internal control over financial reporting in 2018. For further information on the material weaknesses identified by our management, see “Item 15. “Controls and Procedures—B. Management’s Annual Report on Internal Control Over Financial Reporting.” As a result, due to the identified material weaknesses, our management concluded that our internal control over financial reporting was not effective as of December 31, 2018. Although we have developed and implemented several measures to remedy these material weaknesses, we cannot be certain that there will be no other material weaknesses in our internal control over financial reporting in the future.

If our efforts to remediate the material weaknesses are not successful, we may be unable to report our results of operations for future periods accurately and in a timely manner and make our required filings with government authorities, including the SEC. There is also a risk that there could be accounting errors in our financial reporting, and we cannot be certain that in the future additional material weaknesses will not exist or otherwise be discovered. Any of these occurrences could adversely affect our business and operating results, resulting in fines and enforcement actions against us and could generate negative market reactions, potentially leading to a decline in the price of our common shares.

Our holding company structure makes us dependent on the operations of our subsidiaries.

We are a Cayman Islands exempted company with limited liability. Our material assets are our direct and indirect equity interests in our subsidiaries, particularly our Brazilian subsidiary. We are, therefore, dependent upon payments, dividends and distributions from our subsidiaries for funds to pay our holding company’s operating and other expenses and to pay future cash dividends or distributions, if any, to holders of our common shares, and we may have tax costs in connection with any dividend or distribution. Furthermore, exchange rate fluctuation will affect the U.S. dollar value of any distributions our subsidiaries make with respect to our equity interests in those subsidiaries. See “—Risks Related to Doing Business in Brazil —The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. This involvement, as well as Brazilian political and economic conditions, could have an adverse effect on us and the market price of our common shares,” “—Risks Related to our Common Shares—It is unlikely that we will declare any dividends on our common shares” and “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Dividends and Dividend policy.”

An occurrence of a natural disaster, widespread health epidemic or other outbreaks could have a material adverse effect on our business, financial condition and results of operations.

Our business could be materially and adversely affected by natural disasters, such as fires or floods, the outbreak of a widespread health epidemic, or other events, such as wars, acts of terrorism, environmental accidents, power shortages or communication interruptions. The occurrence of a disaster or similar event could materially disrupt our business and operations. These events could also cause us to close our operating facilities temporarily, which would severely disrupt our operations and have a material adverse effect on our business, financial condition and results of operations. In addition, our net sales could be materially reduced to the extent that a natural disaster, health epidemic or other major event harms the economy of Brazil. Our operations could also be severely disrupted if our consumers, merchants or other participants were affected by natural disasters, health epidemics or other major events.

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Our business is subject to cyberattacks and security and privacy breaches. Unauthorized disclosure of sensitive or confidential customer information or our failure or the perception by our customers that we failed to comply with privacy laws or properly address privacy concerns could harm our business and standing with our customers.

We collect, store, process, and use certain personal information and other user data in our business. A significant risk associated with eCommerce and communications is the secure transmission of confidential information over public networks.

An increasing number of organizations, including large businesses, financial institutions and government institutions, have disclosed breaches of their information technology and information security systems, some of which have involved sophisticated and highly targeted attacks, including on portions of their websites or infrastructure. The techniques used to obtain unauthorized, improper or illegal access to systems, data or our customers’ data, to disable or degrade service, or to sabotage systems are constantly evolving, may be difficult to detect quickly, and often are not recognized until launched against a target.  Unauthorized parties may attempt to gain access to our systems or facilities through various means, including, among others, hacking into our systems or those of our customers, partners or vendors, or attempting to fraudulently induce our employees, customers, partners, vendors or other users of our systems into disclosing user names, passwords, payment card information or other sensitive information, which may in turn be used to access our information technology systems.  Certain efforts may be supported by significant financial and technological resources, making them even more sophisticated and difficult to detect.

The perception of privacy concerns, whether or not valid, may adversely affect our business and results of operations. We must ensure that any processing, collection, use, storage, dissemination, transfer and disposal of data for which we are responsible complies with relevant data protection and privacy laws. The protection of our customer, employee and company data is critical to us. Currently, a number of our users authorize us to bill their credit card accounts directly. We rely on commercially available systems, software, tools and monitoring to provide secure processing, transmission and storage of confidential customer information, such as credit card and other personal information.

Despite the security measures we have in place, our facilities and systems, and those of our third-party service providers, may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors, or other similar events. Any security breach, or any perceived failure involving the misappropriation, loss or other unauthorized disclosure of confidential information, distributed denial of service attacks into our web-sites as well as any failure or perceived failure to comply with laws, policies, legal obligations or industry standards regarding data privacy and protection, whether by us or our vendors, could damage our reputation, expose us to litigation risk and liability, subject us to negative publicity, disrupt our operations and harm our business.

For instance, in December 2017 we experienced a cybersecurity incident in our operations in Brazil, in which specified non-banking personal data (no passwords or credit card data) from certain of our customers were disclosed to unauthorized third-parties. In this context, we reached an agreement ( Termo de Ajustamento de Conduta ) with the Brazilian Federal District State Attorney’s Office ( Ministério Público Estadual do Distrito Federal e Territórios ), ratified by Brazilian courts on February 12, 2019, pursuant to which we agreed to pay a fine in the amount of R$500,000.00. In return, the Brazilian Federal District State Attorney’s Office terminated its administrative legal proceeding related to this incident. Although after the conclusion of an internal investigation carried out by an independent specialized cybersecurity company there is no indication that our IT infrastructure has been compromised, we cannot assure you that our security measures in place are sufficient to prevent future security breaches or that our failure to prevent them will not have a material adverse effect on our business. Further, we do not carry and we do not require our vendors to carry cybersecurity insurance to compensate for any losses that may result from any breach of security. Therefore, our results of operations or financial condition may be materially adversely affected if our existing general liability policies did not cover a security breach.

Our inability or failure to protect our intellectual property and any intellectual property infringement against us could have a negative impact on our operating results.

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Our trademarks, service marks, copyrights, trade secrets, domain names and other intellectual property (including those related to our private label products) are valuable assets that are critical to our success. In particular, the protection of our trademarks and service marks is an important factor in product recognition and in our ability to maintain or increase market share. If we do not adequately protect our rights in our various trademarks and service marks, unauthorized reproduction or other misappropriation of our intellectual property may arise. Such infringement of our intellectual property rights could diminish the value of our brands or goodwill and cause a decline in our sales. As a result, any failure to protect our intellectual property could have an adverse effect on our operating results.

Effective trademark and other intellectual property protection may not be available in Brazil and we cannot guarantee that we will be able to adequately protect our intellectual property from misappropriation or unauthorized use. The process of seeking intellectual property protection is expensive and time-consuming. While we aim to acquire adequate protection of our brand through trademark registrations in key markets, occasionally third parties may have already registered or otherwise acquired rights to identical or similar marks for products or solutions that address our market. Policing unauthorized use of intellectual property is also difficult. Additionally, costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and our failure to successfully defend our proprietary rights could adversely affect our business.

Cayman Islands economic substance legislation may adversely impact us or our operations.

The Cayman Islands, together with several other non-European Union jurisdictions, have recently introduced legislation aimed at addressing concerns raised by the Council of the European Union as to offshore structures engaged in certain activities which attract profits without real economic activity. With effect from January 1, 2019, the International Tax Co-operation (Economic Substance) Law, 2018 (the “Economic Substance Law”) came into force in the Cayman Islands, introducing certain economic substance requirements for in-scope Cayman Islands entities which are engaged in “relevant activities,” which in the case of exempted companies incorporated before January 1, 2019, will apply from July 1, 2019. However, it is anticipated that we may remain out of scope of the Economic Substance Law or be subject to limited substance requirements thereunder. Although it is presently anticipated that the Economic Substance Law will have little material impact on us or our operations, as the legislation is new and remains subject to further clarification and interpretation, it is not currently possible to ascertain the precise impact of these legislative changes on us.

Risks Related to Doing Business in Brazil

The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. This involvement, as well as Brazilian political and economic conditions, could have an adverse effect on us and the market price of our common shares.

We conduct a substantial amount of our operations in Brazil, and we sell a substantial portion of our products to customers in the domestic market. For the year ended December 31, 2018, 93.0% of our net sales (excluding net sales from our operations in Mexico, which were discontinued in September 2018) were derived from Brazil. Accordingly, our results of operations are substantially dependent on the economic conditions in Brazil. Brazil’s gross domestic product, or GDP, in real terms, grew by 0.1% in 2014, shrank by 3.8% in 2015 and by 3.6% in 2016, grew again by 1.0% in 2017, and 1.1% in 2018. In 2016, the real has fluctuated significantly, primarily as a result of Brazil’s political instability, and it has generally appreciated against the U.S. dollar since March 2016. In 2017, the real has generally stabilized, and in 2018 it depreciated against the U.S. dollar back to the level seen in the end of 2015 (to approximately R$3.90). In addition, the credit rating of the Brazilian federal government has been downgraded in 2015 and 2016 by all major credit rating agencies and is no longer investment grade. In January 2018, S&P further lowered its long-term rating for Brazil’s sovereign credit from BB to BB-minus, with a stable outlook, citing less timely and effective reform policymaking.  In February 2018, Fitch lowered its long-term rating for Brazil’s sovereign credit from BB to BB-minus, with a stable outlook. We cannot assure that Brazil’s GDP will increase or stabilize in the future. Future developments in the Brazilian economy may affect Brazil’s growth rates, employment rates, the availability of credit and average wages in Brazil and, consequently, the consumption level of the products we sell. As a result, these developments could impair our business strategies, results of operations or financial condition.

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The Brazilian government frequently intervenes in the Brazilian economy and occasionally makes significant changes in policy and regulations. The Brazilian government’s actions to control inflation and implement other policies and regulations have often involved, among other measures, increases in interest rates, changes in tax policies, wage and price controls, currency devaluations, capital controls and limits on imports. Our business, financial condition, results of operations, trading price of the common shares and prospects may be adversely affected by changes in government policies or regulations, involving or affecting factors such as:

·          interest rates;

·          exchange rates and exchange control policies;

·          restrictions on remittances abroad;

·          currency fluctuation;

·          inflation rates;

·          tariff and export/import control policies;

·          economic and social instability;

·          liquidity of domestic financial and capital markets;

·          electricity rationing and energy shortage;

·          international trade policy;

·          tax policies;

·          regulatory framework governing our industry; and

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

Historically, the Brazilian currency has suffered frequent devaluations against the U.S. dollar. Throughout the periods of currency depreciation, the Brazilian government has implemented certain measures and various economic plans for exchange controls. For instance, Brazilian law provides that whenever there is a serious imbalance in Brazil’s balance of payments or reason to foresee a serious imbalance, the Brazilian government may impose temporary restrictions on the remittance to foreign investors of the proceeds of their investments in Brazil. For example, for approximately six months in 1989 and early 1990, the Brazilian government froze all dividend and capital repatriations that were owed to foreign equity investors and held by the Central Bank in order to conserve Brazil’s foreign currency reserves. These amounts were subsequently released in accordance with Brazilian governmental directives. We cannot assure you that the Brazilian government will not take similar measures in the future. As a result, we may not be able to receive dividends or distributions from our Brazilian subsidiary in currencies other than reais and consequently be unable to pay dividends to our shareholders. The likelihood that the Brazilian government would impose such restrictions may be affected by the extent of Brazil’s foreign currency reserves, the availability of foreign currency in the foreign exchange markets on the date a payment is due, the size of Brazil’s debt service burden relative to the economy as a whole, and other factors.

Furthermore, the Brazilian economy has experienced a sharp downturn in recent years due, in part, to the interventionist economic and monetary policies of the Brazilian government and the global drop in commodity prices. It is expected from current Brazilian federal government to propose the general terms of a fiscal reform to stimulate the economy and reduce the forecasted budget deficit for 2019, but it is uncertain whether the Brazilian government will be able to gather the required support in the Brazilian Congress to pass additional specific reforms. As of the date of this annual report, many of the proposed public expenses in Brazil’s budget have been maintained and it is not clear whether other expenses will be reduced or entirely eliminated. If some or all of these public expenses are maintained, Brazil will continue to run a budget deficit for 2019 and the years going forward. We cannot predict the effects of this budget deficit on the Brazilian economy. We cannot predict which policies the Brazilian federal government may adopt or change or the effect that any such policies might have on our business and on the Brazilian economy. Any such new policies or changes to current policies may have a material adverse impact on our business, results of operations, financial condition and prospects.

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Uncertainty as to whether the Brazilian government will implement changes in policy or regulations affecting these or other factors in the future may contribute to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets and the securities issued by Brazilian companies.

Operation Lava Jato or similar investigations and political instability resulting therefrom may adversely affect our business and results of operations and the price of the securities issued by subsidiaries of companies with substantial operations in Brazil. Additionally, such investigations may result in reputational risks.

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

Brazilian markets have been experiencing heightened volatility due to uncertainties derived from the ongoing Lava Jato investigation, which is being conducted by the Office of the Brazilian Federal Prosecutor, and its impact on the Brazilian economy and political environment. As a result of the ongoing Lava Jato investigation, a number of senior politicians, including current and former congressmen and officers of some of the major state-owned companies in Brazil have resigned or been arrested. Other senior elected officials and other public officials in Brazil are being investigated for allegations of unethical and illegal conduct identified during the Lava Jato investigation. The matters that have come, and may continue to come, to light as a result of, or in connection with the Lava Jato investigation and related anti-corruption inquiries have adversely affected and we expect that they will continue to adversely affect the Brazilian economy, markets and trading prices of securities issued by issuers with Brazilian operating subsidiaries in the near future.

The potential outcome of the investigations related to the Lava Jato operation is uncertain, but they have already had an adverse impact on the image and reputation of the implicated companies, and on the general market perception of the Brazilian economy. We cannot predict whether the allegations will lead to further political and economic instability or whether new allegations against government officials will arise in the future.  In addition, we cannot predict the outcome of any such allegations nor their effect on the Brazilian economy. The development of the cases could adversely affect us.

Amidst this background of political uncertainty, in August 2016, the Brazilian Senate approved the removal from office of Brazil’s then-President, Dilma Rousseff, following a legal and administrative impeachment process for infringement of budgetary laws. Michel Temer, the former Vice-President, who assumed the presidency of Brazil following Rousseff’s ouster, is also under investigation on corruption allegations. In addition, the former President, Luiz Inacio Lula da Silva, began serving a 12-year prison sentence on corruption and money laundering charges in April 2018 yet had led for a while the polls as a top contender to win the 2018 presidential election. On October 28, 2018, Jair Bolsonaro, a former member of the military and three-decade congressman, was elected the president of Brazil and took office on January 1, 2019. During his presidential campaign, Bolsonaro was reported to favor the privatization of state-owned companies, economic liberalization, and social security and tax reforms. However, there is no guarantee that Bolsonaro will be successful in executing his campaign promises or passing certain favored reforms fully or at all, particularly when confronting a fractured congress. In February 2019, the Brazilian federal government presented to the Congress a bill proposing a large and comprehensive change of Brazil’s public social security system. If some or all of these public expenses are maintained and the required reforms are not passed, Brazil will continue to run a budget deficit for 2019 and the years going forward. We cannot predict the effects of this budget deficit on the Brazilian economy. We cannot predict which policies the Brazilian federal government may adopt or change or the effect that any such policies might have on our business and on the Brazilian economy. Any such new policies or changes to current policies may have a material adverse impact on our business, results of operations, financial condition and prospects. In addition, his current minister of the economy, Paulo Guedes, proposed during the presidential campaign the revocation of income tax exemption over payment of dividends, which, if enacted, would increase the tax expenses associated with any dividend or distribution by Brazilian companies, which could impact our capacity to receive, from our subsidiaries, future cash dividends or distributions net of taxes.  Moreover, Bolsonaro was generally a polarizing figure during his campaign for presidency, particularly in relation to certain of his behavioral views, and we cannot predict the ways in which a divided electorate may continue to impact his presidency and ability to implement policies and reforms, all of which could have a negative impact on our business and the price of our common shares.

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Inflation and efforts by the Brazilian government to combat inflation may contribute significantly to economic uncertainty in Brazil and could have an adverse effect on us and the market price of our common shares.

Brazil has historically experienced high rates of inflation. Inflation, as well as governmental measures put in place to combat inflation, have had a material adverse effect on the Brazilian economy. Inflationary pressures persist, and actions taken in an effort to curb inflation, coupled with public speculation about possible future governmental actions, have in the past contributed to economic uncertainty in Brazil and heightened volatility in the Brazilian securities market. The inflation rate in Brazil, as reflected by the Broad Consumer Price Index ( Índice Nacional de Preços ao Consumidor Amplo , or IPCA), published by the Brazilian Institute for Geography and Statistics ( Instituto Brasileiro de Geografia e Estatística , or IBGE), was 10.67% in 2015, 6.29% in 2016, 2.95% in 2017 and 3.75% in 2018.

As a result of inflationary pressures and macroeconomic instability, the Brazilian government historically has adopted monetary policies that have resulted in Brazil’s interest rates being among the highest in the world. The Central Bank sets the base interest rates generally available to the Brazilian banking system, based on the expansion or contraction of the Brazilian economy, inflation rates and other economic indicators. In August 2012, the base interest rate ( Sistema Especial de Liquidação e Custódia , or SELIC rate) set by the Central Bank was 7.50%. To control inflation during 2013, the Central Bank gradually raised the SELIC rate to 8.50% in July, 9.00% in August, 9.50% in October, and 10.00% in December. In 2014, the Central Bank raised the SELIC rate to 11.00% in April, 11.25% in October and 11.75% in December. In 2015, it was raised again to 12.25% in January, 12.75% in March, 13.25% in May and 14.25% in July. From July 2015 to September 2016 it remained at 14.25% and mostly following lower inflationary pressures it was reduced to 14% in October 2016, 13.75% in November 2016, 13% in January 2017, 12.25% in February 2017, 11.25% in April 2017, 10.25% in May 2017, 9.25% in July 2017, 8.25% in September 2017, 7.50% in October 2017, 7.00% in December 2017 and 6.5% in April 2018. As of April 26, 2019, the SELIC rate was 6.5%. Brazilian interest rates remain relatively high and any increase in interest rates could negatively affect our profitability and results of operations and would increase the costs associated with financing our operations.

Inflation and government measures to combat inflation, along with speculation about possible future governmental measures, have had and are expected to continue to have significant negative effects on the Brazilian economy, including heightened volatility in the Brazilian securities market. In addition, measures to control inflation have often included maintaining a tight monetary policy with high interest rates, thereby restricting the availability of credit and limiting economic growth. On the other hand, these policies may be incapable of preventing increases in the inflation rate. Furthermore, the absence of such policies may trigger increases in the inflation rate and thereby adversely affect economic stability. In the event of an increase in inflation, we may not be able to adjust the prices we charge our customers to offset the effects of inflation on our cost structure, which may adversely affect our business, results of operations and the market price of our common shares.

Exchange rate instability may adversely increase our costs and affect our financial condition and results of operations.

The Brazilian currency has historically experienced frequent, sometimes significant, fluctuations relative to the U.S. dollar and other foreign currencies. On December 31, 2012 the real /U.S. dollar exchange rate was R$2.04 per US$1.00. During 2013, the real depreciated against the U.S. dollar, and on December 31, 2013, the exchange rate was R$2.34 per US$1.00. The real continued its decline against the U.S. dollar in 2014, reaching R$2.66 per US$1.00 on December 31, 2014. In 2015, the real further depreciated against the U.S. dollar, reaching R$3.90 per US$1.00 on December 31, 2015. In 2016,  the real appreciated against the U.S. dollar, reaching R$3.26 per US$1.00 on December 31, 2016. In 2017,  the real remained relatively stable against the U.S. dollar, reaching R$3.31 per US$1.00 on December 31, 2017. On December 31, 2018 the real /U.S. dollar exchange rate was R$3.87 per US$1.00 and on April 26, 2019, the real /U.S. dollar exchange rate was R$3.94 per US$1.00.

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

On the other hand, an appreciation of the real relative to the U.S. dollar and other foreign currencies may deteriorate the Brazilian foreign exchange current accounts. Many of the goods we purchase are manufactured abroad, and the prices charged by foreign manufacturers may be affected by the fluctuation of their local currency against the U.S. dollar. We source goods from various countries, including China, and thus changes in the value of the U.S. dollar compared to other currencies may affect the costs of goods that we purchase. Depending on the circumstances, either devaluation or appreciation of the real relative to the U.S. dollar and other foreign currencies could adversely affect the growth of the Brazilian economy, as well as our business, results of operations and profitability.

Deterioration in general economic and market conditions or the perception of risk in other countries, especially the United States and emerging market countries, may adversely affect Brazil, the market price of our common shares, our access to the international capital markets and, accordingly, our results of operation and financial condition.

The market price of securities issued by Brazilian companies or holding companies with Brazilian subsidiaries is affected to varying degrees by economic and market conditions in other countries, including the United States and other Latin American and emerging market countries. Factors such as higher interest rates, higher fuel and energy costs, weakness in overall market conditions, higher levels of inflation and unemployment, decreases in consumer disposable income, unavailability of consumer credit or credit restrictions imposed by credit card companies, higher consumer debt levels and tax rates, among others, may adversely affect consumer demand for sporting, fashion and beauty goods, and significantly affect our business. Although economic conditions in certain countries may differ significantly from economic conditions in Brazil, investors’ reactions to developments in other countries may have an adverse effect on companies with operations in Brazil. For example, the popular referendum that approved the United Kingdom’s withdrawal from the European Union and the election of the current president of the United States, may have an adverse effect on the market value of securities of Brazilian issuers, or companies with significant operations in Brazil. Crises or investors’ perceptions of events in the United States and other emerging market countries or changes in economic policies of other countries may substantially affect capital flows into these countries and the market value of securities from issuers in other countries, and may especially impact the demand for securities of Brazilian issuers or issuers with Brazilian operating subsidiaries, including ours. Any of these factors could adversely affect the market price of our securities and restrict our ability to access international capital markets at all or on acceptable terms and finance our operations.

In the past, adverse economic conditions in other emerging markets resulted in a significant outflow of funds and a decrease in the quantity of foreign capital invested in Brazil. The financial crisis that began in the United States during the third quarter of 2008 contributed to a global recession. This had direct and indirect adverse effects in the Brazilian economy and capital markets. These effects included fluctuations in the trading prices of listed securities, scarcity of credit, cost-cutting measures, general worldwide recession, exchange rate instability and inflationary pressures. Any of these events could adversely affect the market price of our common shares and limit our access to capital markets. As a result, we may be unable to finance our operations in the future on acceptable terms or at all.

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To the extent that economic problems in emerging market countries or elsewhere adversely affect Brazil, our business and the market value of our common shares could be adversely affected. Furthermore, we cannot assure you that, in the event of adverse developments in emerging market economies, the international capital markets will remain open to companies with significant Brazilian operations or that the resulting interest rates in such markets will be advantageous to us. Decreased foreign investment in Brazil may negatively affect growth and liquidity in the Brazilian economy, which in turn may have a negative impact on our business.

Internet regulation in Brazil is recent and still limited and several legal issues related to the Internet are uncertain.

In 2014, Brazil enacted a law setting forth principles, guarantees, rights and duties for the use of the internet in Brazil, including provisions about Internet service provider liability, Internet user privacy and internet neutrality, or the Internet Act. In May 2016, further regulations were passed in connection with the Internet Act. However, unlike in the United States, little case law exists around the Internet Act and existing jurisprudence has not been consistent. Legal uncertainty arising from the limited guidance provided by current laws in force allows for different judges or courts to decide very similar claims in different ways and establish contradictory jurisprudence. This legal uncertainty allows for rulings against us and could set adverse precedents, which individually or in the aggregate could have a material adverse effect on our business, results of operations and financial condition. In addition, legal uncertainty may negatively affect our customers’ perception and use of our services.

We are subject to costs and risks associated with increased or changing laws and regulations affecting our business, including those relating to the sale of consumer products. Specifically, developments in data protection and privacy laws could have a material adverse effect on our business, financial condition or results or operations.

We operate in a complex regulatory and legal environment that exposes us to compliance and litigation risks and that could materially affect our operations and financial results. These laws may change, sometimes significantly, as a result of political, economic or social events. Some of the federal, state or local laws and regulations that affect us include: those relating to consumer products, product liability or consumer protection; those relating to the manner in which we advertise, market or sell products; labor and employment laws, including wage and hour laws; tax laws or interpretations thereof; data protection and privacy laws and regulations; customs or import laws and regulations; and securities and exchange laws and regulations.

For instance, on August 14, 2018, the President of Brazil approved Law No. 13,709/2018, a comprehensive data protection law establishing general principles and obligations that apply across multiple economic sectors and contractual relationships ( Lei Geral de Proteção de Dados ), or the LGPD. The LGPD establishes detailed rules for the collection, use, processing and storage of personal data and will affect all economic sectors, including the relationship between customers and suppliers of goods and services, employees and employers and other relationships in which personal data is collected, whether in a digital or physical environment. The obligations established by LGPD will become effective within 24 months from the date of publication of the law (August 2020), by which date we will be required to adapt our data processing activities to these new rules. A comprehensive understanding of personal data flows and, as a consequence, the review of internal documents and procedures, as well as the negotiation of contractual amendments are examples of adaptations required for compliance with the LGPD. There can be no guarantee that we will have sufficient financial resources to comply with this regulation and any  new regulations or successfully compete in the context of a shifting regulatory environment. Any additional privacy laws or regulations enacted or approved in Brazil or in other jurisdictions in which we may operate in the future could materially adversely affect our business, financial condition or results of operations.

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

Brazil has a series of strict consumer protection statutes, or collectively the Consumer Protection Code ( Código de Defesa do Consumidor ), that are intended to safeguard consumer interests and that apply to all companies in Brazil that supply products or services to Brazilian consumers. These consumer protection provisions include protection against misleading and deceptive advertising, protection against coercive or unfair business practices and protection in the formation and interpretation of contracts, usually in the form of civil liabilities and administrative penalties for violations. These penalties are often levied by the Brazilian Consumer Protection Agencies ( Fundação de Proteção e Defesa do Consumidor , or PROCONs), which oversee consumer issues on a district-by-district basis. Companies that operate across Brazil may face penalties from multiple PROCONs, as well as the National Secretariat for Consumers ( Secretaria Nacional do Consumidor , or SENACON). Companies may settle claims made by consumers via PROCONs by paying compensation for violations directly to consumers and through a mechanism that allows them to adjust their conduct, called a conduct adjustment agreement ( Termo de Ajustamento de Conduta , or TAC). Brazilian Public Prosecutor Offices may also commence investigations related to consumer rights violations and this TAC mechanism is also available for them. Companies that violate TACs face potential automatic fines. Brazilian Public Prosecutor Offices may also file public civil actions against companies in violation of consumer rights, seeking strict observation to the consumer protection law provisions and compensation for the damages consumers may have suffered.

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As of December 31, 2018, we had approximately 2,000 active proceedings with PROCONs and small claims courts relating to consumer rights. Most of these disputes are related to delays in the delivery of products, chargeback disputes, and product returns. To the extent consumers file such claims against us in the future, we may face reduced revenue due to refunds and fines for non-compliance that could negatively impact our results of operations.

Risks Related to our Common Shares

The price of our common shares may fluctuate substantially, and your investment may decline in value.

The trading price of our common shares is likely to be highly volatile and may be subject to wide fluctuations in response to factors, many of which are beyond our control, including those described above under “—Risks Related to our Business and Industry” and “—Risks Related to Doing Business in Brazil.” The stock markets in general, and the NYSE and the market for Internet-related and technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the companies involved. We cannot assure you that trading prices and valuations will be sustained. These broad market and industry factors may materially adversely affect the market price of our common shares, regardless of our operating performance. Market fluctuations, as well as general political and economic conditions in the markets in which we operate, such as recession or currency exchange rate fluctuations, may also adversely affect the market price of our common shares. Following periods of volatility in the market price of a company’s securities, that company may often be subject to securities class-action litigation. For further information about the high and low closing sales prices for our common shares on the NYSE, see “Item 9. —A. Offer and Listing Details—Price History of Our Common Shares.” This kind of litigation may result in substantial costs and a diversion of management’s attention and resources, which would have a material adverse effect on our business, results of operations and financial condition. For instance, two purported shareholder class actions under the Securities Act were filed in the Supreme Court of New York, claiming that we, among other defendants, made alleged material misstatements or omissions in the registration statement and prospectus issued in connection with our initial public offering. The plaintiffs have not specified an amount of alleged damages in the actions. A court order consolidating these actions was entered on September 14, 2018. Because this lawsuit is in its early stage, the possible loss or range of losses, if any, arising from the litigation cannot be estimated and consequently we have made no provisions with respect to this litigation.  In the event that this litigation is decided against us, or we enter into an agreement to settle such matters, we may be required to pay substantial amounts. Depending on the outcome, such litigation could also result in restrictions on our operations and have a material adverse effect on our business.  We have engaged a U.S. firm as legal counsel and intend to defend vigorously against the allegations made in the context of these actions. See Item 8. “Financial Information—Legal and Administrative Proceedings—U.S. Class Action” for a description of the U.S. securities class action litigation against us.

Our largest shareholders and their affiliates, in the aggregate, own 71.26% of our outstanding common shares and, to the extent they act together, will control all matters requiring shareholder approval. This concentration of ownership limits your ability to influence corporate matters.

Our largest shareholders and their affiliates own 71.26% of our common shares. See “Item 7. Major Shareholders and Related Party Transactions—A. Major Shareholders.” Despite the termination of our shareholders’ agreement upon completion of our initial public offering in April 2017, these entities, to the extent they act together, will control a substantial majority of our voting power and will have the ability to control matters affecting, or submitted to a vote of, our shareholders. As a result, these shareholders may be able to elect all or a substantial majority of the members of our board of directors and set our management policies and exercise overall control over us. See “Item 6. Directors, Senior Management and Employees” and “Item 7. Major Shareholders and Related Party Transactions — A. Major Shareholders” for more information.

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The interests of these shareholders may conflict with, or differ from, the interests of other holders of our common shares. For example, these shareholders may cause us to make acquisitions that increase the amount of our indebtedness or outstanding common shares, sell revenue-generating assets or inhibit change of control transactions that benefit other shareholders. They may also pursue acquisition opportunities for themselves that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. So long as these shareholders continue to own a substantial number of our common shares, they will significantly influence all our corporate decisions and together with other shareholders they may be able to effect or inhibit changes in the control of our company.

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

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

If securities or industry analysts do not publish research or reports about our business, or publish unfavorable research or reports, our share price and trading volume may decline.

The trading market for our common shares will depend in part on the research and reports that securities or industry analysts publish about us, our business, our market or our competitors. In the event one or more of the analysts who covers us downgrades us or releases negative publicity about our common shares, our share price would likely decline. Further, as we are not required to publish quarterly financial information, if we cease to publish that information, any analysts covering us may not have enough information to compare us to our peers on a regular basis and may choose to cease coverage. If one or more of these analysts ceases to cover us or fails to regularly publish reports on us, interest in our common shares may decrease, which may cause our share price or trading volume to decline.

It is unlikely that we will declare any dividends on our common shares in the foreseeable future and therefore, you must rely on price appreciation of our common shares for a return on your investment.

We do not anticipate paying any dividends in the foreseeable future. Instead, we intend to retain earnings, if any, for future operations and expansion. Any decision to declare and pay dividends in the future will be made at the discretion of our general meeting of shareholders, acting pursuant to a proposal by our board of directors, and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our general meeting of shareholders or board of directors may deem relevant. Accordingly, investors will most likely have to rely on sales of their common shares, which may increase or decrease in value, as the only way to realize cash from their investment. There is no guarantee that the price of our common shares will ever exceed the price that you pay.

Common shares eligible for future sale may cause the market price of our common shares to drop significantly, even if our business is doing well.

The market price of our common shares may decline as a result of sales of a large number of our common shares in the market or the perception that these sales may occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

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We currently have 31,056,244 common shares outstanding that except as set forth below, are freely tradable without restriction or further registration under the Securities Act by persons other than our affiliates within the meaning of Rule 144 of the Securities Act.

Our shareholders or entities controlled by them or their permitted transferees will be able to sell their shares in the public market from time to time without registering them, subject to certain limitations on the timing, amount and method of those sales imposed by regulations promulgated by the SEC. If any of our shareholders, the affiliated entities controlled by them or their respective permitted transferees were to sell a large number of their shares, the market price of our common shares may decline significantly. In addition, the perception in the public markets that sales by them might occur may also adversely affect the market price of our common shares.

From time to time we may grant share based compensation to our board members, executives and employees, which may cause their interests to become excessively tied to the trading price of our common shares.

We have created a share option plan, which is in the process of being fully vested and exercised. From time to time, we may grant additional share options to our board members, executives and employees under this plan. For instance, during the course of 2018 we granted 724,500 additional share options and expect to continue granting share options to our management and employees from time to time. We may also introduce new share option plans for our senior management and employees in order to further increase their efficiency, align their interests with the interests of our shareholders and retain executives who commit to long-term earnings and short-term performance.

If our board of directors approve the issuance of new share option plans (or the issuance of additional share options under the existing share option plan), you may be diluted in the event that the exercise price under such share option plan is lower than the trading price of our common shares. In addition, new share option plans may cause the interests of our management to become excessively tied to the trading price of our common shares, which may have an adverse impact on our business and financial condition. For more information about our share based compensation, see “Item 5. Operating and Financial Review and Prospects—A. Operating Results— Critical Accounting Policies and Estimates—Share-based Payments” and “Item 6. Directors, Senior Management and Employees—B. Compensation of Directors and Officers—2012 Share Plan.”

We are a Cayman Islands exempted company with limited liability. The rights of our shareholders may be different from the rights of shareholders governed by the laws of U.S. jurisdictions.

We are a Cayman Islands exempted company with limited liability. Our corporate affairs are governed by our amended and restated memorandum and articles of association and by the laws of the Cayman Islands. The rights of shareholders and the responsibilities of members of our board of directors may be different from the rights of shareholders and responsibilities of directors in companies governed by the laws of U.S. jurisdictions. In the performance of its duties, the board of directors of a solvent Cayman Islands exempted company is required to consider the company’s interests, and the interests of its shareholders as a whole, which may differ from the interests of one or more of its individual shareholders. See “Item 16G. Corporate Governance.”

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

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

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

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

The JOBS Act contains provisions that, among other things, relax certain reporting requirements for emerging growth companies. Under this act, as an emerging growth company, we will not be subject to the same disclosure and financial reporting requirements as non-emerging growth companies. For example, as an emerging growth company we are permitted to, and intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. Also, we will not have to comply with future audit rules promulgated by the PCAOB (unless the SEC determines otherwise) and our auditors will not need to attest to our internal controls under Section 404(b) of the Sarbanes-Oxley Act. We may follow these reporting exemptions until we are no longer an emerging growth company. As a result, our shareholders may not have access to certain information that they deem important. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of our first sale of our common equity securities pursuant to an effective registration statement under the Securities Act, (b) in which we have total annual revenues of at least US$1.07 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common shares that is held by non-affiliates exceeds US$700.0 million as of the prior June 30 th , and (2) the date on which we have issued more than US$1.0 billion in non-convertible debt during the prior three-year period. Accordingly, the information about us available to you will not be the same as, and may be more limited than, the information available to shareholders of a non-emerging growth company.

We cannot predict if investors will find our common shares less attractive because we will rely on these exemptions. If some investors find our common shares less attractive as a result, there may be a less active trading market for our common shares and our share price may be more volatile.

We are a foreign private issuer and, as a result, in accordance with the listing requirements of the NYSE we will rely on certain home country governance practices from the Cayman Islands, rather than the corporate governance requirements of the NYSE.

We report under the Exchange Act as a non-U.S. company with foreign private issuer status. The NYSE rules provide that foreign private issuers are permitted to follow home country practice in lieu of certain NYSE corporate governance standards. The standards applicable to us are considerably different than the standards applied to U.S. domestic issuers. For instance, we are not required to:

·          have a majority of the board be independent (other than as may result from the requirements for the audit committee member independence under the Exchange Act);

·          have a compensation committee or a nominating and corporate governance committee; or

·          have regularly scheduled executive sessions with only independent directors;

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Although we may have certain corporate governance practices that generally follow NYSE corporate governance standards, as a foreign private issuer, we may follow home country practice from the Cayman Islands in lieu of the above requirements. Therefore, our board of director’s approach to governance may be different from that of a board of directors consisting of a majority of independent directors, and, as a result, our management oversight may be more limited than if we were subject to all of the NYSE corporate governance standards. Accordingly, you may not have the same protections afforded to shareholders of companies that are not foreign private issuers. For further information regarding our corporate governance practices, see “Item 16G. Corporate Governance.”

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

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

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

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

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

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

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

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

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

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

Risks Related to the Merger

Failure to complete the Merger could negatively impact our share price, business, financial condition, results of operations or prospects.

The Merger is subject to the satisfaction or waiver of certain closing conditions set forth in the Merger Agreement, including, among others, that:

·         the Merger must have been approved by shareholders of Netshoes representing at least two-thirds (2/3) of votes cast by the shareholders entitled to vote who are present in person or by proxy at a general meeting;

·         no governmental authority of competent jurisdiction has enacted, entered, promulgated or enforced any law, statute, rule, regulation, executive order, decree, ruling injunction or other order (whether temporary, preliminary or permanent) which prohibits, restrains or enjoins the consummation of the Merger; and

·         clearance from Brazilian anti-trust authorities.

In addition, each party’s obligation to complete the Merger is subject to the truthful and correctness of the other parties’ representations and warranties in the Merger Agreement (subject in most cases to materiality and knowledge qualifications), and the other parties’ compliance with their respective covenants and agreements in the Merger Agreement in all material respects.

No assurance can be given that each of the conditions will be satisfied. In addition, the Merger Agreement may be terminated under the circumstances set forth in the Merger Agreement, including by mutual decision of the parties thereto. If the conditions are not satisfied or waived in a timely manner and the Merger is delayed, payment of the merger consideration will also be delayed. If the Merger is not completed (including in the case the Merger Agreement is terminated), our ongoing business will be materially adversely affected.

We also could be subject to litigation related to any failure to complete the Merger. If the Merger is not completed, these risks may materialize and may materially adversely affect the price of our common shares, our business, financial condition, results of operations or prospects.

Our CEO and chairman of the board of directors has interests that may differ from the interests of our shareholders.

 

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Our CEO and chairman of the board of directors, Marcio Kumruian, may have interests that differ from, or are in addition to, his interests as shareholder in connection with the approval of the proposals at the shareholders’ extraordinary general meeting. Even though he did not vote as a director in connection with approving the execution of the Merger Agreement and recommending to shareholders to approve the Merger, these interests could cause members of our board of directors to have, or be perceived to have, a conflict of interest in approving the proposals at the shareholders’ extraordinary general meeting.

The fact that there is a Merger pending could harm our business and results of operations.

While the Merger is pending, we are subject to a number of risks that may harm our business and results of operations, including:

·         the diversion of management and employee attention from our business may detract from our ability to operate efficiently, capitalize on new opportunities and commence new initiatives;

·         we may be unable to respond effectively to competitive pressures, industry developments and future opportunities;

·         we could be subject to costly litigation associated with the Merger;

·         our current and prospective employees may be uncertain about their future roles and relationships with Parent during and following completion of the Merger, and this uncertainty may adversely affect our ability to attract, retain and motivate key personnel;

·         the Merger Agreement contains certain covenants restricting the conduct of our business between the date of the Merger Agreement and the earlier to occur of (i) the termination of the Merger Agreement pursuant to its terms and (ii) the effective time, the waiver of which is subject to the consent of the other parties. These covenants may limit our freedom to operate our business in potentially adverse ways.

Our obligation to pay a termination fee under certain circumstances and the restrictions on our ability to solicit or engage in negotiations with respect to other acquisition proposals may discourage other transactions that may be favorable to our shareholders.

Until the Merger is completed or the Merger Agreement is terminated, with limited exceptions, the Merger Agreement generally prohibits us from initiating, soliciting, facilitating or knowingly encouraging any inquiries with respect to, any acquisition inquiry or acquisition proposal, or executing or entering into any agreement in connection with any acquisition proposal. We may be required to pay to Magazine Luiza S.A. a termination fee equal to US$1,800,000.00 under certain circumstances. For more details, see “Item 10. Additional Information—C. Material Contracts.”

We may be the target of securities class action and derivative lawsuits which could result in substantial costs and may delay or prevent the Merger from being completed.

Securities class action lawsuits and derivative lawsuits are often brought against public companies that have entered into merger agreements. Even if the lawsuits are without merit, defending against these claims can result in substantial costs and divert management time and resources. An adverse judgment could result in monetary damages, which could have a negative impact on our liquidity and financial condition. Additionally, if a plaintiff is successful in obtaining an injunction prohibiting completion of the Merger, then that injunction may delay or prevent the Merger from being completed, which may adversely affect our or, if the Merger is completed but delayed, the combined company’s business, financial position and results of operations.

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ITEM 4.             INFORMATION ON THE COMPANY

A.                   History and Development of the Company

Netshoes (Cayman) Limited is a publicly-held company listed on the New York Stock Exchange since April, 2017, and therefore subject to certain reporting requirements of the Exchange Act.

We were founded in January 2000 when our founders Marcio Kumruian and Hagop Chabab opened a physical shoe store in São Paulo, Brazil, and our business has transformed substantially since then. In 2007, we closed our brick-and-mortar retail stores, shifted our focus to eCommerce retail and launched Netshoes.com, our online store specialized in sports and active lifestyle goods.

Our principal executive office is located at Rua Vergueiro 961, Liberdade, Zip Code 01504-001, in the city of São Paulo, State of São Paulo, Brazil. We were incorporated in the Cayman Islands as an exempted company with limited liability. Our registered office is located at Floor 4, Willow House, Cricket Square, Grand Cayman, KY1-9010, Cayman Islands. The telephone number of our investor relations department is +(55-11) 3028-8298. Our corporate investor relations website can be found at www.netshoes.com/institucional. Information contained on our website is not incorporated by reference into this annual report, and you should not consider information contained on our website to be part of this annual report or in deciding whether to invest in our common shares.

On April 29, 2019, we entered into the Merger Agreement. See “Item 10. Additional Information—C. Material Contracts.” See “Item 3. Key Information—D. Risk Factors—Risks Related to the Merger” and “Item 10. Additional Information—C. Material Contracts.”

Principal Capital Expenditures

Our capital expenditures (consisting of purchase of property and equipment and intangible assets) represented 4.3%, 3.1% and 5.2% of our net sales in 2016, 2017 and 2018, respectively . In 2018, expenditures were mainly concentrated in the acquisition and in-house development of software. For 2019, we have budgeted capital expenditures of R$45 million, including the acquisition of property and equipment and intangible assets, which will be funded through our operating activities and debt financing.

B.                   Business Overview

Since our launch, we have sold to more than 17.6 million customers across our sites (representing a 16.9% year-over-year growth from 2017), solidifying our position as one of the few scaled online retailers in Brazil and creating a foundation of audience, brand and capabilities on top of which we are building a digital ecosystem capable of delivering increasing and significant value to customers and partners in the future. Through our desktop and mobile websites and applications, which we refer to as our “sites,” we deliver our customers a convenient and intuitive online shopping experience across our two core brands, Netshoes and Zattini. We believe that Zattini, a site we launched in December 2014, is quickly becoming a leading online brand for fashion and beauty in Brazil in terms of consumer recognition.

We were founded in January 2000 by Marcio Kumruian and Hagop Chabab as a single physical shoe store in São Paulo, Brazil. In 2007, we closed our brick-and-mortar stores and shifted to an online business to reach more customers across Brazil. We have also selectively introduced new product categories, maintaining our core strategy of focusing on product verticals with higher margins that have short replacement cycles and are easy to ship.

We have a relentless focus on delivering a superior customer experience across Brazil, including remote locations not typically served by traditional retailers. As one of the first companies in Latin America to provide online retail offerings, we have emphasized the importance of customer service, including introducing short delivery times (with same-day delivery in capital cities of each of the countries in which we operate and certain other densely populated areas in Brazil), free return shipping for the first return or exchange, one-click purchasing, secure payment options and post-sales support. We have also developed technology that personalizes the shopping experience for our customers, and our sites have advanced features including enhanced search capabilities, easy navigation, product recommendations and customized ordering.

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Our sites are also optimized for mobile shopping, and to facilitate our customers’ access to our sites. Despite Latin America’s relatively low smartphone penetration rate, in the year ended December 31, 2018, 58.7% of the total orders placed by our active customers came from mobile devices (in Brazil, mobile commerce accounted for 29% of eCommerce sales in 2018, according to Euromonitor 1 ).

We are also a trusted partner and the go-to channel for the most important brands in sports and lifestyle retail in Brazil, and are increasingly establishing similar partnerships with fashion and beauty brands. We offer over 320,000 stock keeping units, or SKUs, from over 500 brands, including Nike, Adidas, Mizuno, Tommy Hilfiger, Ralph Lauren and Lacoste and work closely with our suppliers to promote and protect their brands and help manage product selection. We believe we are one of the largest distribution channels for these brands in Brazil. We have also begun to develop our private label brands to supplement our existing supplier relationships in key categories.

Our success has been dependent on our consistent ability to build a solid infrastructure network to support our operations, as well as our scalable and customized logistics capabilities. We have created a highly automated picking, packing and inventory management system, built to efficiently handle the products in which we specialize — easy-to-ship items with high margins and short replacement cycles. Today, we have three automated distribution centers in Brazil. We have also established innovative partnerships with over 10 local companies, across all of our operations, including Correios , the largest shipping provider in Brazil which has established shipping centers within our distribution centers to facilitate more efficient distribution. Also, since September 2017, we offer customers the option of collecting their purchases directly at Correios’ branches, with over 7,000 pick-up points in Brazil.  We are able to ship over one million orders a month, and on average, process the orders we receive within eight hours after confirmation, achieving an on-time delivery rate of approximately 97.0% of total processed orders. Having built scale in logistics has enabled us to offer the benefits of this scale to our third-party marketplace sellers. Today more than 50% of our marketplace sellers are using “Netshoes Entregas,” benefiting from cheaper, more agile and controlled delivery options using our courriers .

We have achieved the following significant milestones as of and for the year ended December 31, 2018 (excluding data from our Mexican operations, which were discontinued in September 2018):

·          6.8 million active customers, an increase of 4.4% from the 6.5 million active customers we had as of December 31, 2017;

·          12.6 million total orders on our sites, an increase of 4.9% from the 12.0 million total orders for the year ended December 31, 2017;

·          58.7% of our total orders were placed by customers on a mobile device, an increase of 12.7 percentage points from 45.9% for the year ended December 31, 2017; and

Also, for the years ended December 31, 2017 and 2018, excluding the results of our Mexican operations, which were discontinued in September 2018, we reported:

·          Net sales of R$ 1,835.2 million and R$1,808.1 million, respectively, representing a decrease of 1.5% in 2018;

·          Net loss of R$170.3 million and R$332.4 million, respectively; and

·          R$29.7 million and R$219.1 million in negative EBITDA from Continuing Operations, respectively.

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1 Source: Euromonitor International Limited; Retailing 19ed; per Retailing, Internet Retailing, Mobile Internet Retailing; retail value sales, RSP, excl. Sales tax, current prices, local currency; 2018 data.


 
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For information on how we define and calculate active customers, total orders, total orders placed from mobile devices and EBITDA from Continuing Operations, and for a reconciliation of our non-IFRS figures to their IFRS equivalents, see the section of this annual report captioned “Item 3. Key Information—A. Selected Financial Data Selected Operating Data.”

Our Industry

We believe eCommerce is becoming the universal solution for consumers to access products, anytime, anywhere.

In Brazil in particular, eCommerce presents a significant opportunity, with a number of factors supporting its expansion: increasing online penetration and mobile adoption, the emergence of new payment methods, and better network and logistics infrastructure, amongst others.

Additionally, despite recent macroeconomic volatility in Brazil, eCommerce in the country has grown at an attractive CAGR of 18.6% from 2012 to 2018, according to Euromonitor. In the mid- to long-term, we expect strong macro tailwinds due to an expanding middle class, increased disposable income, and reduced unemployment and interest rates, among others.

Overview of our market and the opportunity

Large and growing online audience in Brazil

·          Brazil alone has the fourth largest online audience in the world . As of December 31, 2018, Brazil had 138 million Internet users (representing a 70.5% penetration in the country). According to Euromonitor 2 , the portion of Brazil’s population that is connected to the Internet in Brazil is expected to grow at a 4.3% CAGR between 2018 and 2022, compared to 3.3% for the United States, which had 239.4 million Internet users as of December 31, 2018.

Our market verticals, in particular, represent a large opportunity, driven by an increased use of technology

·          Sports, fashion and beauty represent a significant opportunity in Brazil. We operate in the sports, fashion and beauty categories, which represent a significant opportunity in the countries where we are present. For instance, in Brazil, these categories reached, according to our estimates, US$2.4 billion in 2018, representing 12.8% of the country’s total online sales 3 .

·          Online retail penetration is low, but accelerating. With only 7.2% share of the total retail market in 2018, eCommerce in Brazil has significant potential vis-à-vis developed economies such as the United States, at a 13.7% market share, according to Euromonitor.

·          New technology-enabled business models empowering online consumption. We believe the continued evolution of both web and mobile technology is enabling the emergence of new business models that better address customer needs. These new business models are creating new and innovative ways to interact more closely with consumers, providing them with access to a larger assortment of goods, and higher levels of service and convenience that were previously not achievable. We believe that consumers now have access to more brands and more retail channels than ever before, and brands are in turn increasingly using online retail channels to gain access to a broader set of consumers.

Mobile becoming more prevalent and rapidly gaining share in eCommerce

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2 Source: Euromonitor International Limited; Digital Consumer 19ed.; per Internet Users and Percentage of Population Using the Internet definitions; 2018 data.

3 Source: Company’s estimates based on Euromonitor’s data. Source: Euromonitor International Limited; Retailing 19ed; per Apparel and Footwear through Internet Retailing, Beauty and Personal Care Internet Retailing, Consumer Health Internet Retailing and Personal Accessories and Eyewear through Internet Retailing and  Internet Retailing definitions; retail value sales, RSP, excl sales tax, current prices; 2018 data.


 
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·          Smartphone adoption is high and rapidly growing . The possession of smartphones has achieved rapid adoption in households in Brazil, with rates of 96.5%, compared to 94.2% in the United States for the year ended 2018, according to Euromonitor 4 . In 2022, Smartphone penetration in households are expected to reach 98.6% in Brazil.

·          Mobile commerce is growing and gaining share . The growth and proliferation of smartphones and tablets has made mobile commerce one of the fastest growing retail channels in Brazil. Based on data from Euromonitor 5 , mobile commerce accounted for 29% of eCommerce sales in Brazil in 2018, increasing from 4.5% in 2013, compared to 27.2% in the United States in 2018.

Greater focus on sports, apparel, accessories, footwear, fashion and beauty, which are the most attractive categories in online retail

·          Increasing focus on active lifestyles and sports, resulting in a very attractive business opportunity. We believe that there has been an increased focus on education and health in Brazil, which is translating into more active lifestyles and participation in sports. While soccer remains the most popular sport in Brazil, other sports including running, volleyball, mixed martial arts, basketball, tennis and motor sports have become increasingly popular. Overall, we believe that sports are a very attractive category to operate in.

·          Sports, fashion, beauty and footwear are among the retail categories with the highest gross margins in the retail sector. Sporting goods, clothing, beauty and footwear retailers have some of the highest gross margins among retail businesses in the United States, a trend which we believe also applies to Brazil.

·          Short replacement cycles. We believe that these retail categories are highly attractive due to their relatively short replacement cycles compared to other product categories. For instance, in the United States, according to Claims Pages, sneakers and clothes have on average 1 and 4 years of useful life, respectively, compared to 15 years for houseware and electronics. As a result, there are opportunities for recurring purchases of these goods. In addition, by having shorter replacement cycles, these product categories have higher inventory turnover, which in turn leads to lower inventory levels and capital requirements.

Dynamics in Brazilian eCommerce

Unique dynamics driving eCommerce adoption

·          Low but growing penetration of credit cards and evolution of online payment methods. According to the Bank of International Settlements and data from the World Bank, payment with card use remains relatively low in Brazil compared to more developed markets. Debit and credit card payments accounted for 28.4% of the Brazilian household consumption in 2015, compared with 45.0% in the United States. In addition, other payment alternatives have emerged in Brazil, such as PagSeguro, PayPal and MercadoPago, among other alternatives. We believe the emergence of these payment alternatives, along with the increasing penetration of credit cards, is driving the adoption of online payments and enabling more consumers to transact online securely.

·          Installment payments as an important method in Brazil. According to e-Bit, 50.2% of eCommerce payments in Brazil were made with extended payment terms during 2017 As a result, the ability to manage net working capital dynamics through the asymmetric payment cycle is an important local expertise needed to operate in the Brazilian market.

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4 Source: Euromonitor International Limited 19ed.; Digital Consumer; per Possession of Mobile Phone definitions; 2018 data.

5 Source: Euromonitor International Limited; Retailing 19ed; per Retailing, Internet Retailing, Mobile Internet Retailing; retail value sales, RSP, excl. Sales tax, current prices, local currency; 2018 data.


 
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·          Increasing trust and confidence in online retailers. In the past, online retailing in Brazil suffered from consumer lack of confidence due to a lack of secure payment options and low visibility in the delivery of products, among other factors. However, we believe that the emergence of more secure online payment methods, coupled with the higher reliability of mail networks for delivery, is making consumers more confident in purchasing through online retailers, particularly for small-volume goods.

·          eCommerce as a unique solution to a geographically disperse universe of customers. We believe eCommerce is particularly well suited to Brazil. With expanding and geographically dispersed population, brick-and-mortar retailers have difficulties in serving a large portion of consumers in Brazil. Brick-and-mortar retailers tend to concentrate in specific cities or regions, leaving large percentages of the population without convenient access to their products. For this reason, we believe that eCommerce provides a unique solution to consumers who are looking to access a variety of goods from various brands, irrespective of their location.

Our Competition

eCommerce in Brazil includes a number of local players and a few global companies focused on a wide variety of categories. Based on management’s experience in, and knowledge of, the industry, we do not believe we have a relevant direct competitor in the eCommerce sports category in Brazil ( we are a leader in this country), and while we face competition in our fashion and beauty categories, in just four years of operation we believe we have become a clear contender for the market leader in Brazil. Our current or potential competitors include the following:

·          Brick-and-mortar stores: We face competition from brick-and-mortar retailers specialized in sporting goods, fashion and beauty and general brick-and-mortar retailers, some of which currently also sell, or in the future may sell, their products online. Based on management’s experience in, and knowledge of, the industry, we believe that most existing brick and mortar retail players in Brazil have limited eCommerce presence and are often focused on specific categories which, in general, are not core to us; such as electronics and household appliances. We believe that most retailers’ constraint to physical locations results in limited product offerings and restricts their operations to narrower geographies. In summary, we believe, based on management’s experience in, and knowledge of, the industry, that the nature of the eCommerce platforms developed by most brick-and-mortar stores is more of a complementary service rather than a priority for their business. We believe our platform, on the other hand, provides a unique solution to customers and focuses on more attractive product categories with a team of professionals solely dedicated to delivering a best-in-class customer service; and

·           Pure-play eCommerce players: We face competition from (a) other B2C eCommerce retailers; (b) retailers and other sellers that conduct commerce through online marketplaces; and (c) a number of indirect competitors, including Internet portals and Internet search engines that are involved in online commerce, either directly or in collaboration with other retailers. We believe that, based on management’s experience in, and knowledge of, the industry, pure-play sports eCommerce players are fragmented in Brazil with no company having achieved scale other than us. Moreover, no consolidation strategy has been deployed by any local or global player.

We believe our 6.9% growth in consolidated B2C GMV in Brazil - which includes marketplace sales - for the year ended December 31, 2018 was above the average of retail industries in Brazil. According to Euromonitor 6 , in 2018 the total retail market in Brazil grew by 5.1%.

Our Customers

With 6.8 million active customers as of December 31, 2018, a highly recognized consumer brand and a large selection of verticals and products, we attract a highly diversified customer base as measured across multiple attributes: gender, age and income. In particular, the launch of Zattini in December 2014, with new categories such as fashion and beauty, introduced our sites to a larger number of women. The launch of Zattini has also helped create a cycle where Netshoes customers are expanding into Zattini and Zattini is bringing a new customer base onto the Netshoes platform. For example, for the year ended December 31, 2018, approximately 53.8% of Zattini customers in Brazil were originally Netshoes customers.

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6 Source: Euromonitor International Limited; Retailing 19ed; per Retailing definitions; retail value sales, RSP, excl sales tax, current prices, local currency; 2018 data.


 
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Our customer base is also diversified in terms of age, income and geographic dispersion. As of December 31, 2018, our customer base was comprised of 27.3% customers under 25 years of age, 36.2% between 26 and 35 years, 22.5% between 36 and 45 years and 14.1% over 45 years of age, showing no significant concentration within any specific age group. In addition, our customer base spans across all levels of income, from low (54%), to middle-  (33%) and high-end customers (13%). Our customers are distributed nationwide and our solid infrastructure network allows us to reach customers in all zip codes of Brazil.

In order to improve traffic, attract more customers to our sites and increase conversion rates, we actively use data analytics and other technology tools. The insights collected from our customers’ engagement with our sites and marketing are used to improve customer experience, enhance conversion, and increase repeat purchases by further personalizing marketing and communication campaigns. Given our practice to analyze consumer behavior and engagement with our sites (including browsing and purchasing activities), we believe we are in a better position than brick-and-mortar stores to predict and react to any changes in consumer demand and shopping patterns and to recommend to our customers specific products that might be of interest to them based on their behavior.

Our Partner Suppliers

We are a trusted partner for the most important brands in the sports and lifestyle retail industry in Brazil, with a network of partner suppliers spanning over 500 brands, including Nike, Adidas, Mizuno, Tommy Hilfiger, Ralph Lauren and Lacoste. We are the go-to-channel for global sports brands to reach customers in Brazil, and we are increasingly establishing similar partnerships with fashion and beauty brands.

Different from many of our competitors whose operations rely on a smaller number of suppliers, our diversified network of partner suppliers allows us to offer our customers a comprehensive product portfolio while reducing operational risk and dependency on specific suppliers. For the year ended December 31, 2018, our top 10 partner suppliers represented 54.0% of our net sales, the same share recorded for the year ended December 31, 2017. As of December 31, 2018, we had expanded our sporting and lifestyle product offerings to more than 320,000 SKUs compared to approximately 111,000 SKUs as of December 31, 2014, reflecting our diversified product offerings achieved through broadening our network of partner suppliers.

In order to continuously improve our relationship with partner suppliers, further developing brand recognition and streamlining processes, we have a fully dedicated team responsible for the constant management and evaluation of our partner suppliers. The results of these measurements are periodically shared with our partner suppliers in an effort to promote higher efficiency and profitability.

Our Private Labels

In November 2014, we began offering private label sports brands on the Netshoes site, and in 2016, we started to offer private label brands on our fashion and beauty site, Zattini. Our private label brands span product categories in which we believe we can compete to provide online shoppers lower cost, high quality options. Our private label products are higher margin items and our seven brands cover the majority of the categories we currently offer. For the year ended December 31, 2018, the sales of private label products accounted for 9% of the net sales of our operations in Brazil and for 8% of our net sales on a consolidated basis.

“Gonew,” our first private label brand was created in September 2014 and today is our sixth largest brand in terms of net sales, currently selling over 2,700 SKUs within the sports apparel, equipment and footwear categories. We also have private labels such as, “Mood,” “Burn” and “Treebo” covering apparel, equipment and footwear for Surfing & Skating activities and other casual shoes and clothes labels, such as “Shoestock” and “Drezzup” covering fashion shoes and clothing, and “Zeep!”, designed to offer shoes and clothes for kids. We outsource the production of 100% of our private label products from qualified national and international third-party suppliers.

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Our Sites

We currently operate under three brands: Netshoes, Zattini and Free Lace. Although we connect the brands through cross promotional links and the user interface of our sites, each brand has a unique identity and product set to cater to specific consumer tastes, styles and purchasing goals. Across our brands and sites, we offer the same personalized shopping and rich product selection for which we are known, focusing on delivering an intuitive online experience for all consumers regardless of the brand with which they engage.

Netshoes: Netshoes was our first to market brand and is the leading sporting goods retailer in Brazil. Our website offers consumers a superior and personalized shopping experience for sporting and active lifestyle products and features a user-friendly and intuitive interface designed to allow users to conveniently search for, find, compare and purchase sporting and active lifestyle goods. We are the one stop shop for consumers across sporting goods and active lifestyle products and we operate this business through our websites www.netshoes.com.br and www.netshoes.com.ar.

Currently we offer our customers a wide selection of athletic shoes, jerseys, apparel, accessories and sporting equipment from leading international and local brands, including Nike, Under Armour, Adidas, Puma, Mizuno, Asics, Umbro, New Balance, Olympikus, Fila, Wilson, Topper, Oakley, Timberland and Reebok. In addition, we have licenses to sell a number of exclusive products from brands such as Kappa, Pretorian, Disney, Camaro and Corvette and private label offerings. We also offer personalized products, such as jerseys, footwear and bicycles, where customers can print or engrave words or images on the item. We were the first large scale Brazilian retailer to offer personalized products from Nike, Puma and Adidas online.

Zattini: Launched in December 2014, Zattini is one of the fastest growing fashion and beauty site in Brazil. Our website offers consumers a superior and personalized shopping experience for fashion and beauty products such as shoes, clothes, accessories, fragrances and hair care products, and features a user-friendly and intuitive interface similar to our Netshoes sites. We offer over 200 leading international and local brands (including, among others, Calvin Klein, Revlon, Maybelline, L’Oreal, Joico, Dolce & Gabbana and Carolina Herrera). Also, to capitalize on consumer openness to private label in apparel, in February 2016 we acquired Shoestock, a strong fashion brand in Brazil. Currently we operate Zattini through our websites www.zattini.com and www.zattini.com.br. As of December 31, 2018, our Zattini platform had over 215,000 SKUs offered to our customers.

Free Lace : Launched in September 2018, Free Lace website was developed to connect our clients with the most sophisticated, exclusive and desirable sneakers from the most iconic brands, offering a superior and personalized shopping experience. We operate this business through our website www.freelace.com.br.

The Features of Our Sites

Our sites consist of desktop websites and our mobile websites and applications. We designed our sites to be customer friendly, visually appealing, stable, secure and responsive to customers’ preferences. We manage our desktop sites, mobile websites and mobile applications differently, each optimized for the screens they fit and the way our customers use them.

We are focused on providing consumers the most user-friendly and efficient way to find products that meet their needs and preferences. The central part of our home page is the search tool, where consumers can type in product keywords or brands to search for specific products in our merchandise database. Relevant listings, pictures and custom editorial content are also placed throughout the site.

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Mobile access is a key component of our long-term strategy and we have made significant investments in our mobile functionality. Our mobile website and applications were custom built for our unique needs and are powered by the same core platform that powers our eCommerce sites. mCommerce has grown on our sites as a result of the continued success of our applications, increasing mobile penetration and the launch of programs such as our partnership with local telecommunication service providers to offer free access to the Internet from mobile devices when accessing our sites.

Browsing: Our sites provide users with detailed product information, including a description, rich media images, typically with multiple pictures from different angles, size and color availabilities, sizing charts and customer reviews of products. In addition, for our Netshoes sites, our customers have access to the following features that were designed to optimize their browsing experience: (a) Shop by Sport, (b) Shop by Gender, (c) Shop by Brand, (d) Shop by category, which allows users to browse certain product categories, such as shoes, clothes, accessories, nutritional supplements among others, and (e) Super Discount, which allows users to find products with promotions and discounts.

For Zattini, our customers have access to the following features that were designed to optimize their browsing experience: (a) Shop by Gender, (b) Shop by Brand, (c) Beauty Products, (d) Home and Décor Products, and (e) Super Discount.

Our sites use algorithms across many dimensions, including visits, product margin, revenue and available inventory, to optimize product sorting and search results to rank relevance and test the optimal results for specific customers.

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Site Personalization: We offer a personalized eCommerce experience through product recommendations by enabling our users to build online shopper profiles reflecting their preferences and interests and by tracking users’ browsing and purchase history. Each of our customers has a user name and password, which allows him or her to track order status and previous purchases. Prior to logging into their accounts, our system can typically customize the initial landing page for our customers by reviewing their browsing records. In addition, we analyze each customer’s purchase patterns and send personalized e-mails to our registered members periodically. Our e-mails update our customers on new product arrivals, tailored promotions and other related items that might be of interest based on their preferences.

Product Reviews: We now have a solid customer review database, which helps customers find the right product for their needs and our merchandising team in its buying decisions. Our customers are generally engaged in writing reviews on our website. As of December 31, 2018, approximately 62.1% of the SKUs available on our sites had been reviewed by our clients.           

Our Additional Sources of Revenues

A portion of our net sales is generated from sources other than product sales effected by us directly from our Netshoes and Zattini sites. These sources include our services to customers through our marketplace, as well as products sold through partner-hosted sites, Shoestock site and its omni-channel brick and mortar store, and NCard. These sources allow us to continue to reach a broader consumer base, help us build our brand, improve customer loyalty to the platform and drive incremental net sales.

Online Marketplace: Our marketplace enables customers to purchase products from a multitude of third-party qualified B2C vendors through a seamless purchase experience on our sites. In February 2016, we launched this marketplace service to supplement our direct sales site. Our marketplace collects product photos and merchandise from approved sellers and showcases them on our platform to supplement products we have in inventory. We have focused the marketplace on helping extend our product offering into merchandise for which it is not economical to hold inventory. For example, when a customer searches for a baseball bat and gloves, we can show products from an approved seller, and we leverage our platform for checkout and reviews.

Partner-Branded Stores: In addition to offering merchandise through our sites, we offer and deliver merchandise to our customers through a number of partner-branded store sites managed by us. These include the sub-home of the National Basketball Association, or NBA, in Brazil; the Brazilian online stores of multiple global and local brands including Puma and Olympikus; and the online stores of major soccer clubs including Corinthians, São Paulo, Santos, Internacional, Vasco da Gama, Chapecoense and Cruzeiro, among others. As of December 31, 2018, we managed 14 partner-branded stores.

Shoestock Store: In March 2017, we successfully re-launched Shoestock, a Brazilian fashion brand for shoes and accessories acquired by us in February 2016. With over 30 years of existence, Shoestock is a brand with solid customer awareness in the São Paulo region in Brazil, and augments our private label portfolio in the fashion category. Shoestock products are available to customers nationwide via Zattini site, Shoestock’s own store site and also through its concept brick-and-mortar store – offering a complete omni-channel shopping experience to customers in the city of São Paulo. This store is fully integrated with our online operations and provides significant cross-selling opportunities with other fashion and beauty categories.

NCard: In partnership with Banco Itaú S.A., a major Brazilian financial institution, we offer consumers an International MasterCard on par with credit cards readily available in Brazil. NCards also provide special loyalty rewards and benefits for our customers, which we believe improve customer loyalty. Customers using their NCards receive additional 5% to 10% off throughout most of our sites, free customization on products throughout our sites, among others. We have found that NCard holders visit our sites more often than our average customer, driving their annual purchase value higher.

We continuously analyze the possibility of developing new adjacent businesses, which we believe could generate long-term growth and value to our consumers.

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Our Customer Service

As a result of our efforts to deliver a superior customer experience, we have been widely recognized by our customers and the industry. We have been awarded several prizes, including: the E-award Prize – Best Customer Service ( Braspag , 2015 and 2016) and Modern Consumer Award in Customer Excellence – Company that Most Respects its Customers ( Grupo Padrão , 2013 through 2018).

A key element of our sales strategy is our ability to provide our users with a high level of customer service and support. We believe our rapid growth has been driven in part by our excellence in customer service. By helping consumers navigate our sites, answering their questions and completing their orders, our team helps us to continue building trust with consumers, enhance our reputation and drive sales.

We provide our customers with an array of online self-service features including the ability to track orders and shipment status, review estimated delivery dates, cancel unshipped items, change delivery information and process exchanges or returns. We also respond to 99% of emails sent to our customer service desk within 24 hours, and we are continuing to reduce our contact per order as we implement electronic systems that answer the most frequent questions in our region – delivery timing and order completion.

Our customers can contact our customer service representatives through real-time online chat, our customer service e-mail address or our customer service hotline. As of December 31, 2018, our customer service department had more than 510 in-house employees empowered to keep our customers happy and satisfied. Our decision to have all of our customer service professionals in-house was driven by our relentless focus on customer experience.

We maintain service quality by placing emphasis on selecting personnel carefully and regularly monitoring the performance of our employees. Our employees are trained to have in-depth product knowledge, professional service attitudes and communication skills to best address customer needs and inquiries. Each of our new customer service employees is required to complete a rigorous training program for more than 12 days followed by working alongside a senior customer service professional for one month before having their first direct contact with a customer.

In addition, while we offer our customers the ability to return items, we benefit from low return rates as compared to similar retailers in the United States due to cultural norms and more limited credit availability.

Sales & Marketing

Our sales and marketing efforts are focused on driving organic traffic to our sites and increasing the monetization of our existing traffic. Given that Netshoes is one of the most recognizable brands in Brazil, we have focused on performance marketing for this site to drive measurable customer acquisition. For Zattini, we continue to focus on growing brand awareness as well as performance marketing. We aim to maintain the right balance between marketing across brand-building channels and performance-based customer acquisition strategies.

Our Sales & Marketing is integrated with our business strategy and supported by our technology development efforts. We evaluate each of our marketing initiatives for its return on investment and performance versus our business objectives. Although some of the visitors to our sites make purchases when they first register, we have noticed that visitors may register to receive our emails and “push” communications months before they make their first purchase. We consider 6.8 million (or approximately one-third) of our users to be Prospects (i.e., registered users who have not made purchases yet), and we believe an opportunity exists to convert them to customers. A portion of our marketing spend is meant to target these visitors for whom the conversion to purchasing comes after we have built a substantial relationship with them through regular contact and outreach over time. We also benefit from the breadth of our platform as purchasers often first engage on either Netshoes or Zattini and then move over to the other site. This means we can acquire a member once for either site and benefit continuously across both sites.

Due to our market leadership in Brazil, we have pioneered many new regional marketing programs with third parties, such as Facebook, Google and Criteo, which allow us to deepen our knowledge about online consumer behavior and, consequently, results in a better shopping experience for our customers. We constantly share data analytics about our respective experiences with digital consumers in order to take advantage of new latent opportunities related to our markets.

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We acquire new email-registered members through a diverse set of paid and unpaid marketing channels. Our paid advertising efforts include search engine marketing, display advertising, paid social media, affiliate channels and specific offline marketing channels (such as television ads). Our non-paid advertising efforts include search engine optimization, non-paid social media, mobile “Push” notifications, customer referrals and email. Upon acquiring a customer or a potential customer’s email address, we focus on how to increase their engagement with our platform and drive consistent repeat purchases. This effort to increase engagement and repeat purchasing is primarily accomplished by providing consistent customer service and email marketing efforts. We consistently track our member base across their current activity status—Prospect (as defined above), New Purchaser (customers whose first online purchases with us were in the preceding month prior to the relevant dates), Active (customers who made purchases online with us during the preceding twelve months prior to the relevant dates), Inactive (customers who made purchases online with us between thirteen and twenty four months prior to the relevant date the relevant dates) and Churn (customers who have not made purchases online with us for more than twenty four months prior to the relevant dates)—and we focus on engaging or reengaging each member depending on their current status.

Our Technology

We are proud of our technology leadership in Brazil and were awarded the Sales Innovator of the Year Award in 2016 by eCommerce Brasil and “The Most Innovative Retailer” in 2016 through 2018 by Valor Econômico , a prestigious business and financial newspaper in Brazil. As one of the first online retailers in country, we have adopted a technology-forward and data-driven approach to all aspects of our business.

We use our technology platform to improve the experience of our customers, increase the purchase frequency and average order size placed by our customers and optimize the efficiency of our business operations. We have successfully built an innovative technology culture that is unique in our geography and enables us to attract and retain some of the best technological minds in Brazil. We employ over 236 dedicated technology professionals and our research and development is centralized in São Paulo.

We have organized our technology team into 15 small, nimble and autonomous squads that tackle problems across each of our sites. Our squads are aligned with business goals, such as improving conversion and revenue per visit. Our technology team adopts a continuous improvement, high-frequency testing approach to our business, aimed at improving both traffic and conversion rates. Our site updates several times a day with changing imagery, product descriptions and inventory, based on updated revenue and margin targets. These constant site refreshes also allow our technology professionals to A/B test multiple site features over the course of each day.

Our platform is engineered to provide a personalized experience to our customers. We collect insights from our customers’ interactions through our algorithms and through traditional information retrieval techniques, such as cookies. We then use these insights to customize our sites in real-time for individual customers, with product suggestions and category highlights. These insights also form the basis of our enhanced conversion strategies as we continue to target a customer between 0 – 15 days after they view an item. We use email, social media marketing and retargeting campaigns to remind customers of their searches, items left in carts and items browsed.

We strive to keep customers engaged wherever they are, by providing the functionality of our website in iOS and Android mobile apps. Our mobile apps include search and discovery, personalization and social shopping features similar to those that customers enjoy on our desktop site. In addition, we are also capable of managing significantly higher volumes of site traffic during peak periods, such as those generally experienced during the Black November period. We routinely test and expand the capacity of our servers so we are prepared to provide our customers with uninterrupted access to our sites during periods with high levels of user traffic. We also have in place two redundant data centers and back-up systems located in two different cities designed to ensure the uninterrupted operation of our information technology systems and sites.

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We believe we can continue to scale our technology to accommodate significantly higher volumes of site traffic, customers, orders and the overall growth in our business. We have built a technology stack with a proven record of an ability to scale.

Security and Privacy Policy

We are committed to operating a secure online business. We use various security methods in an effort to protect the integrity of our networks and the confidential data collected and stored on our servers. For example, we use hierarchical levels of firewall technology to protect access to our networks and to our servers and databases on which we store confidential data. We have developed and use internal policies and procedures to protect the personal information of our customers.

We believe that issues relating to privacy and use of personal information relating to Internet users are becoming increasingly important as the Internet and its commercial use continue to grow. We have adopted what we believe is a detailed privacy policy that complies with local legal requirements and outlines the information that we collect concerning our users and how we use it, and the extent to which other registered Netshoes and Zattini users may have access to this information. Users must acknowledge and expressly agree to this policy when registering with our sites. For more information, particularly with respect to a cybersecurity incident experienced by us in December 2017, see “Item 3. Key Information—D. Risk Factors—Risks Related to our Business and Industry—Unauthorized disclosure of sensitive or confidential customer information or our failure or the perception by our customers that we failed to comply with privacy laws or properly address privacy concerns could harm our business and standing with our customers” and “Item 8. Financial Information——A. Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings—Legal and Administrative Proceedings—Civil Matters.”

Although we send marketing communications to our users periodically, we use our best efforts to ensure that they respect users’ notification preferences. When users register with us, they can opt out of receiving marketing e-mails from us. They can modify their notification preferences at any time in the “My Account” section of our sites.

We do not sell or rent any personally identifiable information about our users to any third party. However, for our marketplace operations, we do disclose information to merchants and purchasers so they can complete the transaction (respective names and addresses of purchasers, among other relevant information). We only use information about our users for internal purposes in order to improve marketing and promotional efforts and to improve our content, product offerings and site layout. We may also disclose information about our users in response to legal requirements. All information is stored on our servers located in Brazil.

Billing and Collection

We provide our online customers in Brazil the flexibility to choose from a number of payment options including online payment through all major credit cards and bank payment slips, known as “ boleto ” in Brazil. We offer our credit card paying customers the option to pay in monthly installments (up to 15 for customers using NCard and up to 10 for customers using other types of credit cards), with a minimum installment payment of R$39.90. Paying by credit card in monthly installments is the most popular option among our customers in Brazil. For the year ended December 31, 2018, 56.5% of our product sales were paid in installments by our customers. In conjunction with third-party service providers, we have a dedicated risk department that conducts a rigorous analysis of each transaction to help reduce the risk of fraudulent payments and decrease payment default.

Seasonality

We experience the effects of seasonality throughout the calendar year. Typically, the fourth quarter of the year is the strongest for our sales due to the Black November period in Brazil and the Christmas season in Brazil. The first quarter of the year is our slowest period, as the months of January, February and March correspond to vacation time in Brazil. See “Item 5. Operating and Financial Review and Prospects —B. Liquidity and Capital Resources.”

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Intellectual Property

We rely on a combination of trademark, trade secret and other intellectual property laws as well as confidentiality agreements with our employees and suppliers for the purpose of protecting the proprietary rights associated with the products branded under our private labels. We have also registered the domain names www.netshoes.com, www.netshoes.com.br, www.zattini.com, www.zattini.com.br, www.shoestock.com, www.shoestock.com.br, www.freelace.com.br and their variations. Our “Netshoes” and “Zattini” trademarks and logos have also been registered with the relevant authorities in Brazil and in other countries. Trademark registrations for “Shoestock” have been granted to us in the United States and Brazil. Furthermore, we have applied for the registration of the trademarks and logos of all of our private labels, such as Gonew, Burn, Drezzup and Mood, all of which have been granted in Brazil.

In addition to the protection of our intellectual property, we are focused on ensuring that our product offerings (and especially those products branded under our private labels) do not infringe the intellectual property of others. Generally, our agreements with suppliers of private label products contain provisions to safeguard us against potential intellectual property infringement by our suppliers and impose penalties in the event of any infringement. We reserve the right to refuse to work with or terminate our relationship with suppliers where it comes to our attention that they are violating the intellectual property rights of a third party. For more information, see “Item 3. Key Information—D. Risk Factors—Risks Related to our Business and Industry—Our inability or failure to protect our intellectual property and any intellectual property infringement against us could have a negative impact on our operating results” elsewhere in this annual report.

Insurance We have insurance policies with reputable insurers in amounts considered sufficient by our management to cover potential losses arising from events that may affect our assets, as well as for any indemnities that we may have to pay to third parties as a result of our operations. These policies include insurance covering our distribution centers including equipment, machinery and inventory stored therein (or in transit) and have coverage limits of up to R$288.2 million. We seek coverage against risks that are compatible with our scale and type of operations, considering the nature of our activities, the risks we are exposed to, market practices in our industry, and the advice of our insurance consultants.

The insured amounts are reviewed every year when policies are renewed, to ensure the amounts are consistent with the value of our assets and our liabilities from operations. We do not anticipate having any difficulties in renewing any of our insurance policies.

While we believe our insurance contracts reflect standard market practices, there are certain types of risks that may not be covered by the policies (such as war, terrorism, acts of God and force majeure, liability for certain harm or interruption of certain activities). Therefore, if any of these uncovered events occur, we may be obliged to incur additional costs to remedy the situation, reconstitute our assets and/or indemnify our customers, which may adversely affect us. Furthermore, even in the event that we incur a loss that is covered by our policies, we cannot assure that damages awarded by our insurers will be sufficient to cover the losses arising from the insured event.

Regulation

Our business is subject to a number of laws and regulations that affect companies conducting business on the Internet, many of which are still evolving and could be interpreted in ways that could harm our business. While it is difficult to fully ascertain the extent to which new developments in the field of law will affect our business, there has been a trend towards increased consumer and data privacy protection. It is possible that general business regulations and laws, or those specifically governing the Internet, eCommerce or mCommerce, may be interpreted and applied in a manner that may place restrictions on the conduct of our business. Below is a summary of the most relevant laws that apply to the operations of eCommerce companies in Brazil:

Consumer Protection Laws . Brazil’s consumer Protection Code sets forth the legal principles and requirements applicable to consumer relations in Brazil. This law regulates, among other things, commercial practices, product and service liability, strict liability of the supplier of products or services, reversal of the burden of proof to the benefit of consumers, the joint and several liability of all companies within the supply chain, abuse of rights in contractual clauses, advertising and information on products and services offered to the public. Specifically, as an Internet-based retailer, we are subject to several laws and regulations designed to protect consumer rights — most importantly Law No. 8,078 of September 11, 1990 — known as the Consumer Protection Code, and Decree No 7,962 of March 15, 2013, that regulates eCommerce in Brazil, or the eCommerce Decree. The Consumer Protection Code establishes the legal framework for the protection of consumers, setting out certain basic rights, among which is the right to clear and accurate information about products and services offered in the consumer market, with correct specification of characteristics, structure, quality and price and the risks they pose, and the consumers’ rights to access and modify personal information collected about them and stored in private databases. The eCommerce Decree complements the Consumer Protection Code and sets forth specific rights and obligations of consumers and eCommerce retailers. Pursuant to the eCommerce Decree, online retailers are required to break-down pricing and disclose fees and shipping charges. Online retailers are also required to provide clear and accurate terms and conditions for the sales, including the consumers’ right to cancel a transaction without charges ( direito de arrependimento ) and to return or exchange products. In addition, the eCommerce Decree sets forth general guidelines that must be followed by online retailers’ consumer services. The growth and demand for eCommerce could result in more stringent consumer protection laws that impose additional compliance burdens on online companies. These consumer protection laws could result in substantial compliance costs.

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Data Privacy and Protection . The Internet Act establishes principles, guarantees, rights and duties for the use of the Internet in Brazil, including regulation about data privacy for Internet users. Under Brazilian laws personal data may only be treated (i.e., collected, used, transferred, etc.) upon users’ prior and express consent. Privacy policies of any company must be clear and detailed and include information regarding all contemplated uses for such users’ data and excessively ample or vague consent for data treatment may be deemed invalid in Brazil. Brazilian courts have applied joint and several liability among all entities that shared and/or used personal data subject to a breach. See “Item 3. Key Information—D. Risk Factors—Risks Related to our Business and Industry—Unauthorized disclosure of sensitive or confidential customer information or our failure or the perception by our customers that we failed to comply with privacy laws or properly address privacy concerns could harm our business and standing with our customers.” We are also subject to the LGPD, which establishes detailed rules for the collection, use, processing and storage of personal data and will affect all economic sectors, including the relationship between customers and suppliers of goods and services, employees and employers and other relationships in which personal data is collected, whether in a digital or physical environment. See “Item 3. Key Information—D. Risk Factors—Risks Related to our Business and Industry—We are subject to costs and risks associated with increased or changing laws and regulations affecting our business, including those relating to the sale of consumer products. Specifically, developments in data protection and privacy laws could have a material adverse effect on our business, financial condition or results or operations.”

Recent Changes in Brazilian Laws Relevant for our Business:

Value Added Tax Laws . On April 2015, an amendment to the Brazilian Constitution became effective to change the then-existing rules as to the allocation of ICMS taxes collected in interstate sales between the state of origin of products sold and the state where the final customer is located, or State of Destination. Under the prior rules, ICMS taxes levied on sales to customers characterized as the final customers of certain goods were entirely collected by the state from where the product was shipped and invoiced, or State of Origin. As a result of this constitutional amendment, since 2016 ICMS taxes in interstate sales have been allocated between the States of Origin and States of Destination on the following basis: (a) States of Origin have the right to collect the value corresponding to the ICMS interstate tax rate applicable for the product while (b) the States of Destination have the right to collect the value corresponding to the difference between the ICMS interstate tax rate applicable for the product and the internal ICMS tax rate of such State of Destination applicable for the relevant product (assuming that the internal ICMS tax rate of the State of Destination is higher than the ICMS interest tax rate). While these constitutional changes did not affect the benefits we currently extract from tax incentives in the States of Origin from where we generally ship and invoice our products (i.e., Minas Gerais and Pernambuco), we expect that our average ICMS tax burden will increase from 3.6% in 2015 to 10.1% by 2019 as we are now required to also pay ICMS taxes to States of Destination of our products in which we currently have no tax benefits. See “Item 3. Key Information—D. Risk Factors—Risks Related to our Business and Industry— Changes in tax laws, tax incentives, benefits or differing interpretations of tax laws may adversely affect our results of operations.”

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C.                   Organizational Structure  

The following is a chart of our current corporate structure (which already contemplates divestment from our operations in Argentina):

 

For a complete list of all of our direct and indirect wholly-owned subsidiaries, see note 2.3 to our consolidated financial statements included elsewhere in this annual report.

D.                   Property, Plant and Equipment 

Our Facilities, Logistics and Operations

Fundamental to our success is our custom-built logistics and operations infrastructure. We were recently selected for the Best Logistics award by e-Commerce Brasil, and we believe that we are market leaders in developing a proprietary infrastructure that supports our specific product verticals and regions. We manage all of the key components of our supply chain, including fulfillment and customer service. We monitor each step of our order fulfillment process from the time a product is inspected and stocked, to when the product is delivered to a customer, which we believe enables us to maintain a high level of shipping accuracy and timely delivery.

We currently lease all properties for our operations in Brazil. Our corporate headquarters are located in São Paulo, Brazil. We lease three distribution centers in Brazil, one of which is located in the State of São Paulo (Barueri), one in the State of Minas Gerais (Extrema) and one in the State of Pernambuco (Jaboatão dos Guararapes). We also lease one physical store location for Shoestock in São Paulo, Brazil. We believe that our properties are generally suitable to meet our needs for the foreseeable future, and we will continue to seek additional space as needed to pursue our growth strategy.

The following table sets forth a summary of our distribution centers as of December 31, 2018:

Location

Area (m²)

Storage Capacity (m²)

Agreement Expiration Date

Barueri (State of São Paulo, Brazil) (1)

19,143

45,843

April 1, 2028

Extrema (State of Minas Gerais, Brazil)

28,656

42,316

October 22, 2020

Jaboatão dos Guararapes (State of Pernambuco, Brazil)

15,321

23,915

January 31, 2023

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(1)     The original expiration date of May 31, 2019 was extended by the parties in March 2018.

In Brazil, we have three distribution centers with a total storage capacity of over 110,000 square meters across all floors and a high level of automation. Our distribution centers located in Brazil have the capacity to handle over 9.7 million items at peak capacity and are able to ship products across all 26 Brazilian states and the Federal District of Brazil.

In Brazil, we have a nationwide delivery network consisting of 13 third-party courier companies and were the first retail company to develop an on-site partnership with Brazil’s national post office, Correios , which expedites the delivery of our products. We leverage our large scale of operations and reputation to obtain favorable contractual terms with the courier companies. We monitor and review the courier companies’ performance and its compliance with our contractual terms.

Our distribution centers and delivery network are strategically located and designed for reliable and timely product delivery. In general, orders are automatically allocated to one of our distribution centers for fulfillment. We then process our orders within eight hours after the orders are confirmed on average, and we can deliver on the same day in the main Brazilian urban centers and Buenos Aires. We offer a wide range of delivery options to cater to our customers’ individual requirements and preferences. Our delivery options include normal delivery within four to five days, express delivery within two to three days, super express delivery for same-day delivery, scheduled delivery, and the option to pick-up products from one of the almost 7,000 Correios branches in Brazil. We have an on-time delivery rate of approximately 97.0% of total processed orders. Our infrastructure also includes two data centers that are critical to our operations (see Item 4. Information on the Company—B. Business Overview—Our Technology”).

We also use our distribution centers and delivery network to manage the logistics and distribution of a number of our suppliers’ and partners’ online stores.

We invested in 2018 in the expansion of the storage capacity and in increased automation for our distribution  center located in the municipality of Extrema, State of Minas Gerais, increasing its current storage capacity of 35,431 m 2 to 42,316 m 2 .

 

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ITEM 4A.     UNRESOLVED STAFF COMMENTS

None.

ITEM 5.             OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A.                   Operating Results

Overview

We currently operate in Brazil (having recently divested from our operations in Mexico, in 2018, and Argentina, in 2019) and, since our launch, we have sold to more than 17.6 million customers across our sites (representing a 16.9% year-over-year growth from 2017), solidifying our position as one of the few scaled online retailers in Brazil and creating a foundation of audience, brand and capabilities on top of which we are building a digital ecosystem capable of delivering increasing and significant value to customers and partners in the future. Through our sites, we deliver our customers a convenient and intuitive online shopping experience across our two core brands, Netshoes and Zattini. We believe that Zattini, a site we launched in December 2014, is quickly becoming a leading online brand for fashion and beauty in Brazil in terms of consumer recognition.

Since we were founded in 2000, we have selectively introduced new product categories, maintaining our core strategy of focusing on lifestyle verticals, which we believe are particularly well-suited for distribution online due to the following factors: (1) the vast inventory selection, benefitting customers by providing them with access to varied products in one place; (2) the lightweight nature of most of the products we offer, which makes them easy to ship and drives fast delivery speeds at significant volumes; (3) the high gross margin of these retail categories; and (4) the need for consistent replacement (compared to, for example, household appliances and electronics), which drives repeat purchasing.

We focus on delivering a superior customer experience and providing service across all regions in Brazil, including remote locations not typically served by traditional retailers. As one of the first companies in Brazil to provide online retail offerings, we have emphasized the importance of customer service. We have also developed technology that personalizes the shopping experience for our customers, and our sites have advanced features including enhanced search capabilities, easy navigation, and product recommendations. This core customer focus has driven customer loyalty.

We benefit from our early mover advantage in the Brazilian eCommerce, which has allowed us to capture what we believe is a significant market share in a large addressable market. As our market continues to expand, we believe that we are and will continue to be well-positioned as a leading established player to benefit from these macro-economic trends.

We have achieved the following significant milestones as of and for the year ended December 31, 2018 (excluding data from our Mexican operations, which were discontinued in September 2018):

·          6.8 million active customers, an increase of 4.4% from the 6.5 million active customers we had as of December 31, 2017;

·          12.6 million total orders on our sites, an increase of 4.9% from the 12.0 million total orders for the year ended December 31, 2017;

·          58.7% of our total orders were placed by customers on a mobile device, an increase of 12.7 percentage points from 45.9% for the year ended December 31, 2017; and

Also, for the years ended December 31, 2017 and 2018, excluding the results of our Mexican operations, which were discontinued in September 2018, we reported:

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·          Net sales of R$1,835.2 million and R$1,808.0 million, respectively, representing a decrease of 1.5% in 2018;

·          Net loss of R$170.3 million and R$332.4, respectively;  and

·          R$29.7 million and R$219.1 million in negative EBITDA from Continuing Operations, respectively.

For information on how we define and calculate active customers, total orders, total orders placed from mobile devices and EBITDA from Continuing Operations, and for a reconciliation of our non-IFRS figures to their IFRS equivalents, see the section of this annual report captioned “Item 3. Key Information—A. Selected Financial Data Selected Operating Data.”

Key Trends and Factors Affecting Our Business

We believe that our results of operations and financial performance will be driven by the following trends and factors:

·          Financial and Liquidity Position .  We experienced net losses and significant cash outflows from cash used in operating activities in 2018, and our business performance and financial condition has faced increasing pressure since December 31, 2018.  We are currently engaged in preserving our cash, liquidity and financial position and obtain access to alternative sources of capital necessary to meet our ongoing liquidity needs.  We have engaged financial and other advisors to assist us in that effort.  Although our management has a reasonable expectation that we have adequate resources to continue in operational existence for the foreseeable future, there can no assurance that we will be able to meet our funding requirements and have the ability to gain continued access to short-term financing. If for any reason we are unable to continue as a going concern, this could have an impact on our ability to realize assets at their recognized values, and to settle liabilities in the ordinary course of business (including with suppliers and creditors) at the amounts stated in our audited consolidated financial statements, resulting in defaults in agreements with our creditors and suppliers and may experience additional defaults in the future, including as a result of cross-defaults. Most of our financing agreements are subject to termination in the event of default, and our indebtedness may be accelerated in the event of continuing default. For further information, see “—B. Liquidity and Capital Resources.”

·          Continuous Engagement of our Customers: We benefit from our early mover advantage in the Brazilian eCommerce, which has allowed us to capture what we believe is a significant market share in a large addressable market, but there is still significant room to further expand the customer base for our sites and increase customer loyalty and repeat purchasing. Since our launch, we have used several marketing channels to promote our sites, including television, sponsorship of sport clubs, internet search engines, social media and promotional emails, which has resulted in a substantial increase in the engagement of our customers with our brands.

·          Launch of New Products and Services: Our continuous ability to monetize our user traffic remains critical to our envisioned plans for growth. Our net sales have increased from R$252.9 million in 2010 to R$1,808.1 million in 2018 (a CAGR of 27.9%), and in the same period our GMV grew at a CAGR of approximately 27.7%. We have launched new initiatives that are specifically focused on delivering increased revenue at higher margins, and we expect that the success of these initiatives will play a key role in our long-term growth strategy. In December 2014, we launched Zattini, an online retail store for fashion and beauty products. We have also offered private label apparel to our customers across our Netshoes platform since November 2014 and through our Zattini platform since its launch, and for the year ended December 31, 2018, the sales of those products accounted for 9% of our net sales in Brazil and 8% of our net sales on a consolidated basis. For the year ended December 31, 2018, Zattini accounted for 18.8% of the net sales of our operations in Brazil and 17.5% of our net sales on a consolidated basis. We have developed other initiatives that tie our customers more closely to our sites, such as extended payment terms to our customers through our co-branded credit card with Banco Itaú S.A., which we refer to as “NCard,” launched in April 2016. Our expansion efforts also led us to launch our online marketplace platform in February 2016. In 2018 this platform was responsible for 12.8% of our GMV, increasing its penetration by 11.1 percentage points when compared to 2016. We expect that marketplace and these new initiatives will play a role in our strategy to attract new customers to our sites and increase spending per active customer.

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·          Growth of eCommerce: Our sales depend substantially on consumers’ widespread acceptance and use of the Internet as a way to conduct commerce. Consumers who have historically used physical channels of commerce to purchase sporting, fashion and beauty goods have started to transition to eCommerce, and we expect they will continue to do so. With only a 7.2% share of the total retail market in 2018, online retail penetration in Brazil offers significant potential relative to developed economies such as the United States, which has 13.7% online retail penetration, according to Euromonitor. Despite recent macroeconomic volatility in Brazil, eCommerce has grown at a CAGR of 18.6% from 2012 to 2018 according to Euromonitor. Also, our customers have been increasingly accessing our sites using mobile devices. In the year ended December 31, 2018, orders placed by our customers from mobile devices represented approximately 58.7% of our total orders (compared to 45.9% in the year ended December 31, 2017), and we believe there is room for further growth in mobile commerce. We are focused on the continuous development of our mobile platforms as sales made on mobile devices have become an important part of our business.

·          Changing Customer Demands, Shopping Patterns and Technologies: We believe that the current scale of our business reflects in part our consistent ability to anticipate and respond in a timely manner to changing consumer demands and shopping patterns. We believe that there has been an increased focus on education and health, which is translating into more active lifestyles and higher participation in sports. We have been directing our efforts to address the needs of consumers in this growing market, which we believe is a primary component behind our growth in net sales from R$252.9 million in 2010 to R$1,808.1 million in 2018. Also , our ability to innovate and be at the forefront of technological trends and incorporate technology into all aspects of our business has been key to our success, and we expect to benefit from the growth of eCommerce (which, according to Euromonitor, has grown from 3.6% of the retail market in Brazil in 2012 to 7.2% in 2018).

·          Political Environment and Macroeconomic Conditions in Brazil: All of our business is currently carried out in Brazil. Our results of operations and financial condition are significantly influenced by political and economic developments in Brazil and the effect that these factors have on the availability of credit, employment rates, disposable income and average wages in the country. In the mid- to long-term, we expect strong macro tailwinds due to an expanding middle class, increased disposable income and reduced unemployment and interest rates, among other factors.

Our Business Segments

As of December 31, 2018, we had organized our operations around geographical divisions, and a result we had the following reportable segments: Brazil and Argentina.

·          Brazil: consists of retail sales of consumer products from all of our verticals (which includes sales of sporting goods and related garments as well as fashion and beauty goods) carried out through our sites Netshoes.com.br, Zattini.com.br, Shoestock.com.br, Freelace.com.br and third-party sites that we manage as well as our business to business offline operation.

·          Argentina: consists of retail sales of consumer products (mainly sporting goods and related garments) from our site netshoes.com.ar in Argentina. In line with our strategy of focusing on our core Brazilian operations , we discontinued our operations in Mexico in September 2018. In April 26, 2019, we divested from our operations in Argentina as part of our strategy to focus on our core Brazilian operations. See “Introduction––Recent Developments” and “Item 3. Key Information––A. Selected Financial Data–– Pro Forma Financial Information.”

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Corporate functions and activities (primarily operating expenses, financial income and financial expenses recorded in Netshoes (Cayman) Limited and Netshoes Holding, LLC) are not allocated directly to the reportable segments and are disclosed separately in our audited consolidated financial statements to reconcile our segments to our audited consolidated financial information. For further information, see note 4 to our audited consolidated financial statements included elsewhere in this annual report.

Going forward, we will have only one Business Segment, Brazil, which will be comprised of our operations in Brazil.

Components of Our Results of Operations

The following is a summary of the items comprising our consolidated statements of profit or loss:

Net Sales

Net sales includes revenue from product sales and other revenues, net of promotional discounts and returns. Revenue from product sales arises from online purchases with us (except marketplace) and within our brick-and-mortar store and (ii) offline purchases through our B2B operations (including our B2B operation dedicated to sales of Midway’s nutrition supplements and vitamins which was discontinued in October 2018). Other revenues mainly consist of (i) revenues from shipping services related to our product sales, (ii) commission revenue representing a percentage of the total order value of product sales through our marketplace, where qualified third-party B2C vendors can sell their own products to customers through our sites and (iii) commission revenue generated by customers’ activation of NCards. We launched our marketplace platform in February 2016 and NCard in April 2016. For the year ended December 31, 2018, online purchases with us plus our brick-and-mortar store represented 99.3% of our net sales (which excludes the results from our discontinued operation in Mexico but considers net sales from our operations in Argentina, which was sold by us on April 26, 2019 as part of our strategy to focus on our core Brazilian operations, while offline purchases through our B2B operations and other revenues represented 0.6% and 0.1% of our net sales, respectively.

Our net sales are also recorded net of certain taxes, principally Taxes on Sale of Goods and Services ( Imposto sobre Circulação de Mercadoria e Serviços ), or ICMS. We have received ICMS tax incentives from the States of Pernambuco and Minas Gerais in Brazil, and the impact of these tax incentives is reflected in net sales because the amount of ICMS we pay to those states is lower than the amount we invoice to our customers who order from outside of these states. For further discussion regarding the tax incentives applicable to us, see notes 6 and 8 to our audited consolidated financial statements included elsewhere in this annual report.

Cost of Sales

Cost of sales consists primarily of costs related to our product sales (except marketplace), including the purchase price of goods for resale (net of rebates from suppliers) and related non-recoverable taxes, as well as shipping costs.

Selling and Marketing Expenses

Selling and marketing expenses consist primarily of marketing and advertising costs, personnel expenses for employees engaged in selling, marketing and distribution activities, rental expenses in connection with our distribution centers, credit card fees paid to financial institutions and other expenses. See note 8(ii) to our audited consolidated financial statements included elsewhere in this annual report.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel expenses for management and employees involved in general corporate functions, including finance, accounting, tax, legal, information technology and human resources, and our share option plan granted to key management personnel. General and administrative expenses also include rental expenses incurred in connection with our corporate offices, technology and related infrastructure costs, professional and consulting fees, depreciation costs of equipment used by our corporate departments and insurance expenses. See note 8(iii) to our audited consolidated financial statements included elsewhere in this annual report.

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Other Operating Expenses, Net

Other operating income consists primarily of the income related to our agreement with Banco Itaú S.A. to provide it with exclusive access to our customer database and gains on the disposal of fixed assets and intangible assets. Other operating expense consists primarily of losses on the disposal of fixed assets and provisions for civil and labor risks.

Financial Income

Financial income consists primarily of interest income on cash and cash equivalents, imputed interest income on installment sales and gains on derivative financial instruments. See note 19 to our audited consolidated financial statements included elsewhere in this annual report for further information regarding our derivative financial instruments.

Imputed interest on installment sales represents the interest component of the stated purchase price for goods that the customer pays for in installments. We recognize imputed interest over the payment term offered to our customers paying in installments.

From time to time we enter into derivative financial instruments to protect us against foreign exchange volatility arising from the import of products and debt denominated in U.S. dollars. Since March 2016, we did not enter into new forward foreign exchange contracts in order to hedge our exposure to purchase commitments denominated in U.S. dollars.

Financial Expense

Financial expense consists primarily of interest expense on debt, bank fees and imputed interest expense on credit purchases and losses on derivative financial instruments.

Imputed interest on credit purchases represents the interest component of the stated purchase price when we purchase inventory from our suppliers on extended payment terms. We recognize imputed interest expense over the payment term of the trade account payable.

We enter into derivative financial instruments to protect us against foreign exchange volatility arising from the import of products and debt denominated in U.S. dollars.

Income Tax Expense

Income tax expense consists primarily of current tax. Current income tax is measured as the amount expected to be paid (or recovered, to the extent applicable) to tax authorities based on the taxable profit for the period. We have reported pretax losses, giving rise to substantial tax loss carryforwards in Brazil. We will not recognize deferred tax assets until we begin to experience future sustainable taxable profits and it is probable that we will be able to utilize these tax benefits. See below “—Critical Accounting Policies and Estimates—Income Taxes” and notes 2.27 and 20 to our audited consolidated financial statements included elsewhere in this annual report.

Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements included elsewhere in this annual report.  The following table set forth our results of operations for the periods indicated:

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(In thousands) (1)

Year Ended
December 31,
2016
(Restated)

Year Ended
December 31,
2017
(Restated)

Year Ended
December 31,
2018

 

R$

R$

R$

Net sales

1,685,151

1,835,212

1,808,064

Cost of sales

(1,144,231)

(1,247,014)

(1,389,842)

Gross profit

540,920

588,198

418,222

Operating expenses

 

 

 

Selling and marketing expenses

(431,065)

(495,190)

(480,206)

General and administrative expenses

(162,338)

(143,253)

(191,695)

Other operating expense, net

(5,251)

(3,933)

(9,312)

Total operating expenses

(598,654)

(642,376)

(681,213)

Operating loss

(57,734)

(54,178)

(262,991)

Financial income

28,285

28,996

15,026

Financial expense

(104,795)

(129,040)

(83,223)

Monetary position (loss) gain, net

9,595

Loss before income tax

(134,244)

(154,222)

(321,593)

Income tax expense

(202)

Net loss from continuing operations

(134,244)

(154,222)

(321,795)

Net loss from discontinued operations

(17,640)

(16,121)

(10,579)

Net loss

(151,884)

(170,343)

(332,374)

 

 

(1)     For comparison purposes, the financial information provided in the table above reflects a restatement of such financial information for the years presented herein as a result of the discontinuation of our operations in Mexico in September 2018, which has been made in accordance with IFRS 5. See “Introduction––Financial Information.”

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

The following table sets forth our consolidated financial information ended in 2016 and 2017:

(In thousands) (1)

Year Ended
December 31,
2016
(Restated)

Year Ended
December 31,
2017
(Restated)

% Change

 

R$

R$

 

Net sales

1,685,151

1,835,212

8.9%

Cost of sales

(1,144,231)

(1,247,014)

9.0

Gross profit

540,920

588,198

8.7

Operating expenses:

 

 

 

Selling and marketing expenses

(431,065)

(495,190)

14.9

General and administrative expenses

(162,338)

(143,253)

(11.8)

Other operating expense, net

(5,251)

(3,933)

(25.1)

Total operating expenses

(598,654)

(642,376)

7.3

Operating loss

(57,734)

(54,178)

(6.2)

Financial

28,285

28,996

2.5

Financial expense

(104,795)

(129,040)

23.1

Monetary position (loss) gain, net

Loss before income tax

(134,244)

(154,222)

14.9

Income tax expense

Net loss from continuing operations

(134,244)

(154,222)

14.9

Net loss from discontinued operations

(17,652)

(16,123)

(8.7)

Net loss

(151,896)

(170,345)

12.1%

 

 

(1) For comparison purposes, the financial information provided in the table above reflects a restatement of such financial information for the years presented herein as a result of the discontinuation of our operations in Mexico in September 2018, which has been made in accordance with IFRS 5.

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Net Sales

Total net sales increased by 8.9% from R$1,685.1 million in 2016 to R$1,835.2 million in 2017. The following table sets forth the breakdown of our net sales by segment for the periods indicated:

(In thousands)

Year Ended
December 31,
2016

Year Ended
December 31,
2017

% Change

 

R$

R$

 

Brazil

1,554,405

1,693,467

8.9%

Argentina (1)

130,832

141,745

8.4%

Total

1,685,151

1,835,212

8.9%

 

 

(1)     Does not consider net sales from our Mexican operations, which were discontinued in September 2018 but considers net sales from our operations in Argentina, which was sold by us on April 26, 2019 as part of our strategy to focus on our core Brazilian operations. See “Introduction––Financial Information” and Item 5. Operating and Financial Review and Prospects––A. Operations Results––Our Business Segments.”

Brazil net sales increased by 8.9% from R$1,554.4 million in 2016 to R$1,693.5 million in 2017, primarily due to:

·          a 20.2% increase in the number of total orders placed by our customers in Brazil to 11.3 million in 2017, driven by our successful actions to introduce new products in attractive and profitable verticals, notably Zattini site, the continuous ramp up of our marketplace operation in Brazil (launched in February 2016) and of our private label product assortment (such as Shoestock, launched in March 2017). These offerings represent key growth drivers, and their increasing scale and contribution to results is fueling topline growth;

·          partially offset by a 85.8% decrease in net sales from our B2B operation, from R$65.9 million in 2016 to R$9.4 million in 2017, as our management decided to substantially reduce the scale of this operation to focus on improving the segment’s economics and overall business model. Our B2B operation was launched in early 2016 to complement our core B2C operation and represented 3.8% and 0.5% of our net sales in Brazil in 2016 and 2017, respectively. Our B2B operation dedicated to sales of Midway’s nutrition supplements and vitamins was discontinued in October 2018. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—If we are unable to predict or effectively react to changes in consumer demand or shopping patterns, we may face significant inventory risk or lose customers and our sales may decline.

Argentina net sales increased by 8.4% from R$130.8 million in 2016 to R$141.7 million in 2017 primarily due to a 23.0% increase in the number of total orders placed by our customers, from 0.6 million in 2016 to 0.8 million in 2017, derived mainly from a 18.5% increase in active customers to 385 thousand in 2017, partially offset by a 12.7% decrease in the average basket size per order (from R$297.3 in 2016 to R$259.4 in 2017) as a result of exchange translation effects resulting from the appreciation of the Brazilian real against the Argentine pesos . On a local currency basis, the net sales of our Argentine subsidiary increased  by 31.3% (from AR$560.0 million in 2016 to AR$735.0 million in 2017) primarily attributable to the expansion of our sporting goods operations and inflation in Argentina.

Cost of Sales and Gross Margin

Our cost of sales increased by 9.0% from R$1,144.2 million in 2016 to R$1,247.0 million in 2017. Our cost of sales as a percentage of our net sales remained stable at 67.9% in 2016 and 2017. Our gross margin also remained stable at 32.1% in 2016 and 2017, mainly attributable to our strategy to (1) increase the number of products we sell with promotional discounts to counteract the still challenging economic environment in Brazil which has not yet shown material positive impact in the disposable income of our customers and (2) accelerate the transition to a more favorable mix of GMV coming from our marketplace and private label operations.

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Operating Expenses

Selling and Marketing Expenses

Selling and marketing expenses increased by 14.9% from R$431.1 million in 2016 to R$495.2 million in 2017. As a percentage of our net sales, selling and marketing expenses increased from 25.6% in 2016 to 27.0% in 2017. Key drivers leading to this increase in selling and marketing expenses are discussed in further detail below:

·          Marketing expenses increased by R$31.9 million, resulting primarily from increased investments in marketing campaigns to attract new customers to our sites and increase our active customers by reengaging our registered members. As a percentage of our net sales, marketing expenses increased from 10.2% in 2016 to 11.1% in 2017, mainly as a result of the investments made to foster the development of our marketplace operation;

·          Allowance for doubtful accounts increased from R$6.2 million in 2016 to R$25.4 million in 2017. As a percentage of our net sales, our allowance for doubtful accounts increased from 0.4% in 2016 to 1.4% in 2017. This R$19.2 million increase was primarily attributable to increased credit risk from certain of our B2B customers derived from an increase of overdue receivables in our B2B operations.

·          Personnel expenses increased by R$9.4 million, resulting from (1) higher employee compensation costs attributable to collective bargaining agreements executed in September 2017, which led to an approximate 1.7% average increase in salaries, and (2) an increase in our average headcount, mainly in our distribution centers, to sustain the elevated growth of our operations. As a percentage of our net sales, personnel expenses decreased from 7.9% in 2016 to 7.7% in 2017.

General and Administrative Expenses

General and administrative expenses decreased by 11.8% from R$162.3 million in 2016 to R$143.2 million in 2017. As a percentage of our net sales, general and administrative expenses substantially decreased from 9.6% in 2016 to 7.8% in 2017. The decrease in general and administrative expenses was primarily attributable to a R$30.8 million decrease in personnel expenses, resulting mainly from (i) a R$14.7 million decrease in share-based expenses related to a R$12.9 million positive effect recorded in the first quarter of 2017 resulting from the remeasurement of the value of our then cash-settled stock option liability based on our initial public offering price; and (ii) a R$14.9 million decrease in IT personnel expenses as during the year of 2017, as a great portion of our IT employees were engaged in software development (website, mobile, and marketplace platforms) and their compensation was recognized as intangible assets. The decrease in general and administrative expenses was partially offset by, among others, a R$4.0 million increase in amortization of software expenses, resulting from additional software acquired and developed in 2017.

Financial Income

Financial income increased by 2.5% from R$28.3 million in 2016 to R$29.0 million in 2017. This increase was primarily to a R$5.0 million increase in our interest income on cash and cash equivalents, mostly resulting from an increase in our average monthly balance of cash and cash equivalents from R$88.8 million in 2016 to R$243.2 million in 2017, mainly due to the R$415.6 million (US$134.2 million) received in net proceeds upon the completion of our initial public offering in April 2017, partially offset by a R$3.5 million decrease in imputed interest income on installment sales primarily due to the increase in the use of factoring of trade accounts receivable with financial institutions. For the year ended December 31, 2017, our volume of factoring of trade accounts receivable sold to financial institutions reached R$1,113.8 million (compared to R$789.2 million for the year ended December 31, 2016).

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Financial Expense

Financial expense increased by 23.1% from R$104.8 million in 2016 to R$129.0 million in 2017. This increase was primarily attributable to a R$21.3 million increase in imputed interest expense on credit purchases, which was in line with our strategy to extend our payment terms with suppliers.

Income Tax Expense

We recorded R$0 in deferred income tax assets in 2016 and 2017. See below “—Critical Accounting Policies and Estimates—Income Taxes—Deferred Income Tax” and note 20 to our audited consolidated financial statements included elsewhere in this annual report.

Net Loss from continuing operations

Our net loss increased by 14.9% from R$134.2 million in 2016 to R$154.2 million in 2017 due to the above mentioned factors. As a percentage of our net sales, net loss was 8.0% in 2016 and 8.4% in 2017.

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

The following table sets forth our consolidated financial information ended in 2017 and 2018:

 

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(In thousands) (1)

Year Ended
December 31,
2017

(Restated)

Year Ended
December 31,
2018

% Change

 

R$

R$

 

Net sales

1,835,212

1,808,064

(1.5)%

Cost of sales

(1,247,014)

(1,389,842)

11.5

Gross profit

588,198

418,222

(28.9)

Operating expenses:

 

 

 

Selling and marketing expenses

(495,190)

(480,206)

(3.0)

General and administrative expenses

(143,253)

(191,695)

33.8

Other operating expense, net

(3,933)

(9,312)

136.8

Total operating expenses

(642,376)

(681,213)

6.0

Operating loss

(54,178)

(262,991)

385.4

Financial income

28,996

15,026

(48.2)

Financial expense

(129,040)

(83,223)