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Edited Transcript of HGTX3.SA earnings conference call or presentation 1-Nov-19 3:00pm GMT

Q3 2019 Cia Hering Earnings Call

Nov 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Cia Hering earnings conference call or presentation Friday, November 1, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Fabio Hering

Cia. Hering - CEO, Advisor, Member of Executive Board & Director

* Rafael Bossolani

Cia. Hering - CFO, DRI & Member of Executive Board

* Thiago Hering

Cia. Hering - COO

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Conference Call Participants

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* Felipe Cassimiro de Freitas

HSBC, Research Division - Analyst of LatAm Retail

* Helena Villares

Banco Bradesco BBI S.A., Research Division - Research Analyst

* Olivia B. Petronilho

JP Morgan Chase & Co, Research Division - Analyst

* Ruben Couto

Santander Investment Securities Inc., Research Division - Research Analyst

* Thiago A. Bortoluci

Goldman Sachs Group Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the conference call to announce the results of the third quarter of 2019 of Cia. Hering. (Operator Instructions) Before continuing, statements made during this conference call relative to the company's business prospects as well as operational and financial projections and goals are forecasted based on the management's expectations. Forward-looking statements are highly dependent on the status of the domestic market and the economic performance of the country and of international markets and, therefore, they are subject to change.

Today with us in São Paulo, we have Mr. Fabio Hering, CEO of the company, Mr. Rafael Bossolani, CFO and IRO; and Mr. Thiago Hering, Executive Business Officer. The executive officers are going to make an initial introduction, and then they're going to answer questions you ask.

Now I would like to turn the conference over to Mr. Hering. Please, Mr. Hering. You may start.

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Fabio Hering, Cia. Hering - CEO, Advisor, Member of Executive Board & Director [2]

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Hello to everyone. You're all most welcome to our earnings conference call. And now we have already completed 3 quarters of the year. And this is a year in which we have been able to have qualitative growth especially even though we have not yet reached the top line growth that is buried deeper.

Now once October is over, the first store with a full package of omni-channel has opened, which is our Morumbi Mall store. And as part of this project, we have evolved very well during 2019. So far, almost entire network has multi-channel mobility implemented. And our goal for the end of the year, and now during the fourth quarter, we went 100% of our chain with omni-channel tools already implemented.

In this manner, I think that we have a positive prospect for our businesses, also including important movements that we had in all our channels, in our brands, in addition to Hering both this arm, with new business plans, both with the opening of its first store with the concept book and trends recently that we've opened recently at Morumbi Mall. So we have many new platforms to start a growth cycle.

And finally, I would also like to add that in that macroeconomic scenario seems to demonstrate the beginning of a recovery though -- although slow, but a more positive scenario in the outlook, considering that, today, if we look at the retail market and the incentives that are being given, for example, the release of the severance funds that may provide better prospects also for the end of the year.

So before turning the conference over to Rafael, who's going to talk to you about our results, I would also like to stress that although we have completed the 3 quarters of the year, the fourth quarter of the year, the last quarter of the year is the most important for our business. And we have a hand on 2 very important events. One is the newest -- is the Black Friday or Black Week that we have in Brazil, something new in Brazil. And then the main one and the season's Christmas and New Year vacation. I think that we are very well prepared, and we have good tools to face this season and to attain good results in the fourth quarter.

And that's it now. I would like to ask Rafael to talk to you about our results. And then the 3 of us, Rafael, Thiago and myself, would be available for the questions-and-answers session. Thank you very much.

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Rafael Bossolani, Cia. Hering - CFO, DRI & Member of Executive Board [3]

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Good afternoon. Thank you, Fabio, and thank you all for being here today for our earnings conference -- earnings results conference.

During the third quarter, we are guiding our efforts to the strategy of the new cycle of growth of our company. As we announced in the beginning of this year, our actions they were present at our main strategic front line related to a better shopping experience, innovation at our product matrix, a continuous search for operational excellence as well as increase the desire to purchase our brands in addition to strengthen our whole line of business.

We have improved our CRM project, thanks to database structure, which now counts on over 8 million registered customers. As to omni-channel, we keep on expanding and integrating new franchise stores as part of the franchise system, where we have over 1,500 stores.

As part of our business units, we keep engaged to allow better operation, replenishment, maintenance of higher levels in compliance to our purchase recommendation. And in addition to that, we have reached over 100 stores that were renowned throughout that cycle of refurbishment and now we anticipate that the launching for the end of this year. All of these and a number of initiatives, they transfer somehow our commitment to keep our business -- to keep a healthy business network according to our satisfaction survey, which we conducted yearly with our consumers since we started our survey back in 2013. We are also -- we also emphasized our omni-channel in a short run. That becomes a challenge, and we are confident to recover our sales throughout that new management model.

Our brands are emphasizing our leverage actions throughout different activities in compliance with our proposal and our target consumers with -- throughout a number of marketing activities. So we feel safe about our strategic choice. And also, we comply with our ability to execute all these actions, and we believe that we'll have a very positive and prospective future.

About results. Now Slide 3, we can see that our gross revenue amounted BRL 452 million. This is an increase in relation to the past year, and a positive performance, especially in the sellout sales channel represented by our own stores as well as web stores, and we see some challenges in the multichannels and franchise channels. Our own store sales, they show 14.2% increase over BRL 82 million, a positive growth, except for PUC, which had its performance impacted as 6 stores closed down in the past 12 months. As part of our new marketing action, this new channel is explained by the growth of same-store sales and productivity growth of a number of stores as a consequence of sales conversion. And that has been motivated by a better execution in the POS.

I also would like to highlight the positive performance of our outlets. We opened 6 new stores in the past year.

Web stores, they had an increased amounting 53.2%, a total of BRL 19 million. That performance is due to investment performance, which collaborated to increase our flows at different levels as well as a better purchase experience as part of the new strategy in our web commerce.

This channel has amounted 4.3% of our revenue, which is responsible for 1.4 percentage points in relation to the past year.

Franchise sales channel selling concepts, over BRL 160 million have dropped off 0.14% versus the past year. Such a performance can be explained due to the decrease in the number of stores despite expanding same-store sales at the same channel.

Let me highlight that the network has health inventory, and there is an alignment reasoning between selling and sell-out, as we had changed our incentive structure based on our last year's new activities.

We had some retraction, 7 -- 5.7%, a total of over BRL 170 million in revenue due to the reduction of sales and some collections that were left over. We have a challenging scenario, but thanks -- and because of a slowly economic recovery, has been one of the reasons of our decrease despite the stability of qualified number of clients that, today, they represent about 30% of our revenue.

Next slide. Hering's network, which we consider brands, Hering and Hering Kids, as the brand both showed an increase in the sell-out of 2.8%, amounting a total of over BRL 227 million. The commerce had some additional benefits during the sales period.

8.3% growth in-store productivity measured by square meters revenue versus those effects related to those stores that closed down. Those stores that are managed by the company as part of this network, they had 13.9% growth, influenced by the higher conversion rate and also due to an increase in the POS. The franchise stores, they were impacted due to the number of stores that were closed down. Still in the same slide, we can tell that same-store sales, they increased 6.6%.

Now going to Slide 5. Our gross profit and gross margin -- the company gross profit reached BRL 174 million in this 3 quarter and an expansion of almost 3 points in gross margin, which reached 45%. That margin expansion happened, thanks to a better sales mix and a higher participation of sellout sales and taxes collection sales reduction. And in addition to that, I'd like to highlight the operational leverage, thanks to a good management of our overhead costs.

Slide 6. EBITDA reached BRL 78.8 million, up to 16.9% in the third quarter, while EBITDA margin reached 20.3%, and an increase of the 28 bps, primarily due to gross margin expansion. Excluding the impact of IFRS 16, EBITDA would total BRL 71.7 million, up to 6.5%, reaching 18.5% of EBITDA margin with an increase of 100 points.

Slide 7, we had a net income and net margin, and then we have had better operational results and also a lower quote for the income tax because of the decision of interest on equity that we have made during the quarter. Once again, excluding the effect of IFRS net income would total BRL 64.5 million, a high of 23.1% and a net margin of 16.6%, an increase of 3 percentage points.

Now moving to Slide #8, where you can see the quarter's investments totaling slightly more than BRL 12 million. We have the development and integrations of CRM systems technology and information systems, in addition to developments in our industrial complex with the acquisition of machinery and automation of some logistics processes in our distribution centers.

And then on Page 9, you see the cash flow with BRL 23 million of free cash, BRL 49 million below last year because of higher investment in working capital with higher inventory levels. An important highlight is that our efforts to have longer terms with vendors as of the second quarter last year led to a high generation of cash in the previous period, So the comparison basis is relevant. It's also worth mentioning that high inventory level is concentrated, especially in finished products of perennial items of collections in effect.

Lastly, on Slide #10, I would just like to highlight that we are still optimistic with the gradual improvement of economic indicators. And a confidence level of consumers as a whole we're still committed and involved in executing our strategic priorities. And we are continuing strengthening our brands, products and distribution network. We continue to have our focus on sustainable sales recovery and also on maintaining a balanced operation and our efforts focused on sustaining same-store sales and, as a consequence, to increase revenue in addition to maintaining healthy levels of our gross margin, which are fundamental factors for the company's performance and results.

Additionally, we want to seek productivity gains, discipline on capital, which will enable us to make the necessary investments in the business and consequently generate shareholder value. We continue to strengthen our business for sustainable construction of the company's results while always looking in the medium and in the long term.

That's it. Now I would like to turn the conference over to the operator, and we may start the Q&A session. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Mr. Villares from Itaú (sic) [Banco Bradesco] -- rather Ms. Villares.

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Helena Villares, Banco Bradesco BBI S.A., Research Division - Research Analyst [2]

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I would like to know more about multi-brand. You mentioned that you are able to identify sellout of 100 customers. Do you have any metrics to share to us -- with us about that? Any surprises? It would be interesting to hear that.

And second is the weather. You have demonstrated very good performance in sales -- or sales, but the weather didn't really help retail in the third quarter. Did you learn anything in the second quarter that you're already able to implement or anything else?

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Thiago Hering, Cia. Hering - COO [3]

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This is Thiago. I'll be answering Helena’s question. Yes, we have implemented some important adjustments related to the weather. This quarter, we are more and more seeking to respond rapidly to what customers want in terms of changing the mix and the assortment and to adapt the life cycle of products in order to mitigate inventory risks. And at the end of our winter sales, and in the intelligent way, without affecting the margins, and I think we were successful in doing that.

And in my understanding, the main adjustments and customizations of products will be applied after the new cycle for the cold season in the beginning of next year. We have good novelties and significant adjustments in our gold market strategies for the collections.

As to multi-brand, this is very much in the beginning the analysis that we have made in terms of a sellout of our 450 customers, what we see the slow evolution in inventory turnover and same-store sales in terms of the sales growth of these customers with some of them we were able to identify the historical basis. They already had a basis of more than 2 years that was in the provider. So we wanted to see the sales curve for this customer.

But even so, the scenario is challenging with a slow but steady evolution. So we want to prove the execution in points of sale to the know-how to help our partners to improve operation, to increase turnover and to start a virtuous cycle.

We have gathered our team. In the past, we were too transactional. And now we have more transformational figures in the point-of-sale to help customers and partners to improve their performance and their productivity in the POS. Thank you very much.

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Operator [4]

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Our next question comes from Gabriel Disselli from Santander.

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Ruben Couto, Santander Investment Securities Inc., Research Division - Research Analyst [5]

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This is Ruben speaking, actually. I have 2 questions, brief questions in terms of multi-brand. I mean, you also talked about the drop and a reduction in the sale of balances. Did you drive the channel to do that in terms of having a slightly healthier response in terms of selling? Was it proactive? Or did the channels do it by itself?

And the second topic regarding the gross margin. So we are going back to the levels that you had before the adjustments that you had along last year. Can we go back to the level of 45% for future quarters?

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Rafael Bossolani, Cia. Hering - CFO, DRI & Member of Executive Board [6]

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As to reduction on sales, yes, that was a proactive measure, as I answered before. All our efforts are towards to enhance the quality of sales at all channels, mainly at the mono brands, where we have a very important revolution in terms of markdown and margin revolution, where we apply the same methodology and some common methodologies also at the multi-brand channel. We may later on invest on -- in strengthening new collection sales to increase our client base and also reducing our sales on the sales products. That will drive a better scenario, but not only. The main effort towards that sense is to have more effective collections to consolidate a push-and-pull model, where we may deliver a better product -- where we can deliver products in a better way to all channels.

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Fabio Hering, Cia. Hering - CEO, Advisor, Member of Executive Board & Director [7]

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Now it's Fabio. Let me just add to it. The third -- the negative third quarter performance as the multi-brand selling channel, if we exclude the sales, I would say that the results would be almost flat, just a little share of negative results. And that can help you to identify how much healthier sales were and sales of quality.

Indeed, in the next quarter, that will happen. Not at the same very level, but during that adjustment, we may see that this additional effort will work at some future seeds exactly. Those initiatives, they converge towards that.

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Ruben Couto, Santander Investment Securities Inc., Research Division - Research Analyst [8]

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How about gross margin, but not specifically for this channel, but 45% into some specific channels and some particular basis in relation to season. But 45% level to the fourth quarter, can we expect that?

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Rafael Bossolani, Cia. Hering - CFO, DRI & Member of Executive Board [9]

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This is Rafael Bossolani. Well, we always say that a health margin to us around 45%, this is what we are after. This is our desire. So the answer is yes. We have a number of efforts to push a better quality of life. And this is linked to the assertivity of the collection. As it was mentioned here, our collection is highly related to its quality. We also have a number of additional efforts for a continued search for productivity gains and operation, our efficiency. And we have some examples like that such as closing down some industrial plants, where we manage to consolidate our procurement and production productivity processes. And for quite a while, we have been investing efforts in search for productivity and new resources that will allow us to reallocate and reinvest in our business. So the answer to that question is, yes, we do keep -- we do want to keep health levels in the quality of sales that will be reflected in our gross margin. Thank you.

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Operator [10]

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Now Olivia Petronilho representing JPMorgan Bank.

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Olivia B. Petronilho, JP Morgan Chase & Co, Research Division - Analyst [11]

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I have 2 questions, actually. First question, from a store review, if you -- what do you expect from now on in terms of the stores that you intended to close other stores? And those that have been closed, are you still considering to take them to own stores?

And second question about the basic shop and the franchise model. Could you update and elaborate a little bit more what to expect from now on?

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Fabio Hering, Cia. Hering - CEO, Advisor, Member of Executive Board & Director [12]

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So this opening and closing stores agenda, this is part of the nature of the business since the first half of the year. And when we look back to the first half reality, and now we are reducing the number of stores which are closing down, and we understand that cleaning the base and the network is almost done.

More recently, we are even reopening at the same sites or close to those sites where we have closed down some previous stores, but this time with a much better format where we are after searching as the franchise, the shell the possibility to explore new formats, the new shapes, would that allow better feet from our regional or cultural perspective to increase the audience? So we have those 2 examples that you mentioned in your question. They are very timely in the life franchise and basic shopping.

We see an acceleration in opening new stores and qualify the retail and multi-brand and light franchise. And the number of this format, we do not have any same-store sales in any stores, but we have a positive indication where most of them, they are exceeding our revenue forecast and what was placed as a top line goal. We have a very positive scenario. There is an increasing interest for multi-brands and franchisees to explore those new formats in regions where that would be not feasible before. And there was some sort of restriction in our menu of business models that would prevent expanding those businesses in some of these regions.

Let me also point out that more recently -- actually, yesterday, we opened a new format. They are like a low CapEx. They are kiosk-like where we wanted to have an incremental -- add some new sites as well as add enough at the same shopping center or at the same business to implement the initial operation of our franchisee in their own store. We might not have conversion of owned stores once they are part of a lower level of revenues. And they have a different sort of fiscal formats, and that represents as well a geographical challenge, whilst we may expect once owned stores performance, they are quite positive and they keep growing in addition of sharing best practice.

So the network, and this is part of our agenda in terms of earnings and results, we can and we might see some type of store conversions. Once that we understand that the investment they have to be high in terms of volume portfolio, only then we'll be able to see an investment as owned stores.

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Operator [13]

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Next question by Felipe Cassimiro from HSBC.

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Felipe Cassimiro de Freitas, HSBC, Research Division - Analyst of LatAm Retail [14]

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So now a follow-up as to the results. First, could you share with us a bit more how much of sales -- in-store sales is related to e-commerce?

And second, you still have quite high inventory levels. So you mentioned that it's more with finished products rather than on-suite products. Could you tell us more about the quality of the inventory?

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Rafael Bossolani, Cia. Hering - CFO, DRI & Member of Executive Board [15]

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Felipe, this is Rafael talking. Well, number one, our inventory coverage has gone up for about 18 days, the impact of about BRL 40 million. But it's important for us to highlight that approximately to 16 days or 90% -- slightly more than 90% are related to good quality finished products. So how do we measure that? You have basic or perennial products. Our products, they're not part of the collection that is out. And so this increase is based on the expectation of supplying demand over the few months, in addition to any changes that we have made in the calendar is something that we advanced, some collections that we launched earlier.

I would also like to mention that when we analyze the products of previous collections, so from the summer backwards, all the products, we had a reduction of more than 7% as compared to last year. So I think that we are going to normalize inventory coverage before the end of the year.

Additionally, our raw material inventories is very well sized, and we're buying materials especially jeans -- or denim, rather. And this is related to inventory that we have in the stores. We should mention that when we see inventory levels on the front end with a franchisee that there's a significant balance between supply and sellout, which means that not only level, but also the quality of the inventory is quite healthy. And it has been so for a few quarters, which represents better quality and profitability and, as a consequence, better capacity for reinvestment.

Now as to your question, even though we are witnessing quite robust growth in our e-commerce, I think that we have quite a long way to travel. And we -- our vision is relatively low, so there is not much of a contribution over same-store sales. And I repeat again, even though growth is robust, I think there's a long way to go before we reach the objective that we have defined as a goal for the share of e-commerce over total sales.

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Felipe Cassimiro de Freitas, HSBC, Research Division - Analyst of LatAm Retail [16]

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Now since you're talking about e-commerce on omni-channel, could you share some metrics with us a little bit more?

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Rafael Bossolani, Cia. Hering - CFO, DRI & Member of Executive Board [17]

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So the level of involvement is quite high in the network shortly ago. That might have been a concern. I think that we should close the year with the entire network once in our omni-commerce environment we still see as the main modality showrooming. They are the ones that participate the most actively in some stores. It's 6 to 7 incremental sales -- pointing in incremental things. We have also ship from store. We have been working to increase its share of the total omni sales, and this modality needs to account for the highest share of our omni-channel sales. And that's why we are running some pilots to make sure that the main stores, the main centers can effectively play the role in terms of distribution. Thank you very much.

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Operator [18]

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Now we continue with Thiago Bortoluci from Goldman Sachs. .

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Thiago A. Bortoluci, Goldman Sachs Group Inc., Research Division - Research Analyst [19]

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We have 2 questions. Number one is related to selling. The trend is relatively weak along the year, and part of that is very much related to incentive in the network. We would like to understand, when and -- are you going to sort of sell in? And where is it headed towards?

Number 2 is SG&A. So part of the gross margin was diluted by operational expenses. Should the company have more normalized prices next year? Or could you still implement some marketing and branding adjustments before doing that?

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Rafael Bossolani, Cia. Hering - CFO, DRI & Member of Executive Board [20]

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Thiago, this is Rafael. So first, SG&A, yes, we do understand and that we are going to a healthy and appropriate level considering our ambitions. And so we accelerated new investments of marketing. So there are 2 main moments, 1 in Q2, and then the other 1 in Q4, and this is going to be like that in the future. We have made several efforts in terms of productivity gains and restructuring in the company, and this will be reflected in the run rate that we are going to see from now on. And we even disclosed it. And we are disclosing it. We are disclosing the cost of the restructuring and everything that we've been doing, always in the pursuit of freeing funds for us to direct initiatives that may leverage and guide the business with top line growth.

Now talking about sell-in and sell-out and, basically, in franchise, even though we do not see a sustainable growth this quarter, what we see is a balance of the channel aligned with summer levels that we have been seeing in all channels and franchise channels. And it has not been gaining volume and accelerated because we are sort of cleaning up the franchise base, and we've been doing it for a few quarters. It's important to highlight that this channel is -- now has a positive same-store sales. So what we've seen in sell-in is aligned with sell-out levels. And that, too, means good quality of inventory that we can expect from now on once we resupply as we see sell-out going up. Thank you very much.

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Operator [21]

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(Operator Instructions) If there are no more questions, I give the floor to Thiago Hering for his final remarks.

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Thiago Hering, Cia. Hering - COO [22]

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I just would like to close briefly. Delivering a very straightforward message. This is a channel for investors, but I'm quite sure that some of our collaborators, people from our team, who are listening to this call, so I'd like to emphasize how much aligned and focused we are to our strategic activities. There is a growing engagement by our team. There is an increasing level of confidence, execution little by little also improving. We know that we still have a long journey ahead us. So our ambition ruler has to be really high, so we should be raising the bar every single day. If we devote 120% of our work and efforts, we will get there. Thank you so much for your time and attention, and we are always at your disposal for questions or comments. Thank you.

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Operator [23]

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So this conference call from Cia. Hering is over. We thank you all for your participation, and we wish you a very good day. Thank you so much.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]