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Edited Transcript of HGTX3.SA earnings conference call or presentation 6-Mar-20 2:00pm GMT

Q4 2019 Cia Hering Earnings Call

Mar 28, 2020 (Thomson StreetEvents) -- Edited Transcript of Cia Hering earnings conference call or presentation Friday, March 6, 2020 at 2:00:00pm 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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* Eugenia Tedde Cavalheiro

JP Morgan Chase & Co, Research Division - Research Analyst

* João Pedro Ribeiro Soares

Citigroup Inc, Research Division - Assistant VP & Associate

* Thiago Capucci Macruz

Itaú Corretora de Valores S.A., 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 holding, and welcome to Companhia Hering Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions) Before we proceed, I clarify that eventual statements which might be made during this conference call related to the company's business perspectives as well as projections, operational and financial goals are forecasts based on the management's expectations. These expectations are highly dependent on the internal market conditions and the overall economic performance of the country and international markets, therefore, are subject to changes.

With us here today in São Paulo are Mr. Fabio Hering, company's Chief Executive Officer; Mr. Rafael Bossolani, Chief Financial and Investor Relations Officer; and Mr. Thiago Hering, Chief Operations Officer. Management will be -- will make a brief introduction and following will answer the questions.

Now I would like to turn the floor over to Mr. Fabio Hering. Please, Mr. Fabio, you may proceed.

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

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Hello, everyone. Good morning. You are all most welcome to our Hering Conference Call for 2019 earnings. Actually, this is our second call, as in January, we had anticipated our preliminary fourth quarter earnings results, which somehow has guided the market to be able to understand fourth quarter results. Having said that, I would like to guide this opening session to an overview, 2019 overview. Considering the year as a whole, we are just concluding and disclosing fourth quarter results for 2019. And we have a disclaimer and a very important message among several others. We see 2019 as a very important year to our company as part of a cycle, which is promoting significant transformations to have a much more promising year for 2020. We will celebrate 140 years of existence next September, which makes all Hering's collaborators very proud to be part of this company as well as everybody else who is part of our system, be it our franchisees or any other operators who are part of our business structure.

2019 was a very important year where we had deeply explored our culture, the existing culture, identify within this culture what are those main values which have to be emphasized, enhance to guarantee a future to the company. Such a task was conducted with a very deep due diligence in the first quarter -- in the first half of the year. During the second half of the year, we associated such a potential that should be developed in such a way that it would encompass and include the organization as a whole.

In 2019, we realized an important advancement in our organizational structure, not only in terms of flow chart, but also considering some opportunities that were raised in terms of people turnaround, people that consumes and had executed new challenges in our company, taking office in some new positions. We also promoted and we allow a much better integration during the decision-making process and some directions to be taken, raising entrepreneurship culture where people, they have to guarantee a 360-degree vision about the business considering all the levels of complexity of the business that we perform. Such a cultural approach was very significant to our company. And we also addressed significant innovation in information technology. We took our company or we turned our company into an omnichannel company where we managed to implement a very joint fully association between the online and off-line universe for our company. And that used to be a huge challenge in the past, considering the complexity of our distribution with different distribution channels, with different franchisees, different companies working with us, several barriers in our tax framework, but luckily, we overcame all barriers and successfully we implemented all these new actions.

Also, 2019 added a number of new achievements for the history of our company, which I see as a transformational period, a transformation towards the future to which we are all looking after in order to build up a cycle that will guarantee growth and profitability to our business. I keep saying that this is a company which gathers resources from a capital investment, economical standpoint as well as business models, resources which are different in the market with their own specificities, shared to a universal sourcing, and above all, with a personnel resource, people that are really engaged and committed to make things happen and are willing to promote such entrepreneurship spirit for this company. This is the base of everything, which makes me personally very optimistic about our future and very -- I'm very happy about our near future, not just the long-term time, but also in our near future. I am pretty sure that we are considering a new future from a long-term perspective to be able to transform our brands into desirable and dear brands by our dear consumers.

The idea is to have consumers as close as possible to us where our team works happily. With that, they will be able also to help our consumers and help those consumers to be very happy and satisfied with the brands they buy. That -- these are my first remarks.

Now please Rafael, could you please talk a little bit more about earnings. And later on, Thiago, Rafael and myself, will be at your total disposal for your questions. Thank you for the time being.

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

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Thank you, Fabio. Good morning, everybody. Thank you for being here attending our earnings release conference call. As we announced in January, the sales in Q4 '19 was marked by challenges in sales, but I would like to highlight that we continue to be focused on our strategic guidelines that are very much related to a better shopping experience, renewing our product metrics, continuous pursuit for operational excellence and to reinforce our brands in addition to engagement and strengthening of our business network as a whole.

So the strategy of diversifying store formats to facilitate the choice of consumers to provide a better shopping experience for the public, we have opened our first large store, the concept one-stop shop with the results that so far are above expected. So we have reversed the trend of reducing the number of stores in the last quarter, and we had a net opening of 14 new stores in the period in Q4, and currently, we have a network of stores that is much healthier than we used to have in the past. We should also mention that we have accelerated the renovations in Hering network, which led to 40 stores that have been renewed along 2019, totaling 101 stores that have been renewed in 2019 alone. This new model, as a reminder, has contributed greatly to improve productivity of stores through better product display, focusing on visual merchandising and, of course, a better shopping experience.

Additionally, we are still engaged in improving our operations by an accurate supply of our store chain, and keeping high levels of compliance with our recommendations. We're still confident in our strategy to recover sale in multi-brand channels with a new management model in a different -- differentiated value proposition with actions, including rationalizing our customer base, having closer relationships with the most relevant customers. And there are some other initiatives that we will need to add to more growth in this channel that is so important for our company.

Now talking a little bit about omnichannel. We closed with 91% of the entire network or chains integrated, including franchises and our owned store. And we have new modalities of omnichannel with a highlight of pickup and ship from store when we deliver a product from the stores with a single journey for our customers. So we should highlight that we have increased our revenues in comparison to last year and our growth is of more than 23% comparing to Q3 2019 in omnichannel. We have also gained knowledge of our consumers, and we are still expanding the volume of data that we have available to us. So now we can have customized offers to our customers with the help of some CRM initiatives, and we have almost 9 million customers registered. As to our brands, we are still focusing on strengthening levers with commercial and differentiated commercial actions, and focusing our target audience as to continue our investments in marketing as a whole.

So with all of that, we're confident of our strategic choices, and we are sure of our capacity of execution, and we are confident that we will be able to deliver a very good near future for Hering as a company.

So now moving to Slide #3 in our presentation, you can see the gross revenues of the company that has reached BRL 502 million, 5.2% below Q4 '18, and this was influenced especially by the performance of selling in multi-brand and franchise channels in spite of growth in e-commerce. So e-commerce had a growth of more than 48% and today accounts for 4.4% of the company's revenues, and it's been gaining share year after year, 1.6 percentage points in the company's mix of channels. The main driver for that was an increase in the flow to the platforms that we have noted and also our marketing investments that have contributed, especially to improve the performance especially around the Black Friday period. We should also mention that in Q4, we launched a new website for the brands Hering and Hering Kids. We're now an integrated journey for the consumers with a better shopping experience in our digital platform.

So our owned store sales dropped 1.9% as compared to the last quarter in the previous year. In spite of a higher flow to our stores, we noted a drop in conversion rates, which led to a smaller number of service provided. As to franchise stores, there was a drop of 5.2%, with the impact of net closing of 13 stores over the past 12 months and a consequent reduction in sales, we saw a reduction of more than 3%. I would like to highlight the preservation, which is very important. The preservation of sustainability of the chain as a whole and our inventory levels versus sales to final consumers. So franchisees have had a well-balanced supply of their inventories, which made it possible for them to place orders for replacement as they were selling.

As to the multi-brand channels, there was a decline of 13% quarter-on-quarter because of fewer customers and the drop in productivity, especially for warm collections, so we are selling fewer products with higher value-added for the year. So the total revenue was BRL 1.8 billion, a high of 0.5% as compared to the same period in the year before. And the highlight is the growth in all channels, except for the multibrand part.

Now moving to Slide #4 for Hering network. We had a drop of 5.8% in sell-out, and same-store sales have dropped 4% as compared to last year and to the same quarter in the year before because of fewer services provided. In terms -- as compared to 2019, so we had a positive growth of 2%, driven by growth in productivity in stores, and sell-out sales totaled more than BRL 1.5 billion, a high -- 0.2% below the year before. So it's worth mentioning that this suffered the impact of 1.5% reduction in our sales footage.

Now moving to Slide #5. You can see that the gross profit is more than BRL 185 million in Q4, a decline of 6.6% as compared to Q4 '18 as a result of smaller sales volume in the period. Gross margin has reached 43.4%, which represents a drop of 90 basis points as compared to the year before. And this was essentially explained by the lower dilution of fixed costs and our overhead because of declining sales and also higher provision for obsolete products in our inventories. So these effects, it's important to mention, were partially offset by the manufacturing productivity increase related to the resizing of our production cycles that we could implement. In the year, gross profit has reached more than BRL 678 million, a high of 3.5% as compared to 2018. And a gross margin of 43.8%, an expansion of 120 basis points, and this is related to an improvement in manufacturing productivity and better sales mix with a greater share of sell-out sales of our owned stores and also in the webstores, so with better margins.

On Slide #6, we can see the EBITDA reached BRL 82.7 million, a drop of 6.9% as compared to the fourth quarter of 2018, and EBITDA margin was 19.4%, a drop of 0.4 basis points and this is essentially because of lower revenues. In the year, EBITDA has reached more than BRL 264 million, so a high of 2% as compared to 2018, with the effects of IFRS 16, and a margin of 17.1%, representing an expansion of 0.2 percentage points. This high is related to an increase in sales, combined with the expansion in the gross margin that I have mentioned before. So when excluding the impact of IFRS 16, the EBITDA for the year would total BRL 236.5 million, a drop of 8.9% which represents 15.3% EBITDA margin.

Next Slide #7. Net income in the quarter totaled BRL 63.2 million when compared to the fourth quarter 2018 due to operating result worsening and higher income tax and social contribution. Such an effect is explained by the difference phase in the interest to own capital payment in addition to the impact of retroactive expenses that were excluded from the calculation base in 2018, impacting the comparison basis, increasing our effective profit. Net profit amounted BRL 214.7 million, a 10.4% decline versus 2018 and 13.9% of margin, explaining that -- explained by the operating result worsening. Without the impact of IFRS 16, the year profit would decrease around 9.6%, reaching 14% of net income -- net margin.

Slide 8, investments in the quarter totaled BRL 34.1 million and were mainly allocated to technology and innovation with the development of CRM integrations platform and the launch of the new Hering and Hering Kids brands website, among other IT systems, opening and remodeling of owned stores and anticipation of machinery acquisitions for the development of our industrial park.

Investments in 2019, we totaled BRL 64.7 million, an increase of 30.4%, especially related to the increase in investments in the industry and stores, which is related to the anticipation of machinery acquisition, which I have just mentioned.

Next page. The company generated BRL 61 million of cash, a higher investment in working capital where we allocated higher resources, especially from a vendor's perspective. Despite some retraction on the sales, we had concluded the year aligned to 2018. Additional to that, I would like to highlight over BRL 7.4 million increase in CapEx due to that anticipation in machinery investments for the production process development.

In 2019, cash generation was over BRL 175 million with a drop of BRL 123 million in relation to the previous year due to the greater investment in working capital, considering that new strategy that we had deployed in the year 2018 with our vendors.

Now I'd like to address some future perspectives for the company. Our focus is to regrow our same-store sales growth and also to improve the sales expansion in the channels, combined with the maintenance of healthy margin levels; engagement, once again, in the execution of our strategic consumer-related priorities; emphasize and strengthening our brands through the prudent intensification of marketing investments, product development and focus on the relationship with the consumer; optimization of the manufacturing plants and strengthening the distribution network; continuous focus on productivity gains and capital discipline that enable the necessary investments in the business; and consequent generation of shareholder value.

Next, then I'd like to give the floor to the operator so we can open our Q&A session. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Let me remind you that this call -- earnings release conference call is exclusive to investors and market analysts. Any questions addressed by journalists should be addressed to Ana Camara by our press release conference. The phone number is (11) 3846-7658 or the e-mail: anaclaudia.camara@approach.com.br. So please hold while we are compiling the questions.

Our first question is from Thiago Macruz from Itaú BBA.

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Thiago Capucci Macruz, Itaú Corretora de Valores S.A., Research Division - Research Analyst [2]

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I have 2 questions, actually. First one, about inventory and gross margin. I would like to understand how you understand and evaluate the quality and the level of inventory after you close the year? There might be some sort of additional work to regulate the quality levels in the coming future. And still along those lines, what was the impact in the gross margin due to that obsolete inventory? And what are you expecting in terms of debt impact? When do you believe that debt impact will take place? Maybe in the first half or the second half that we might see still some impact in the gross margin considering the inventory.

My second part of the question, as to e-commerce, we see that, that increases share in the revenue once we have omnichannel fully integrated. Can you share what is the current penetration ship from store and pickup collect at your stores? I also like to better understand if you are considering consumers' profile from a different standpoint in the omnichannel, if they have a different shopping profile, if they buy more and if they also spend more with the company. These are my questions.

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

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Emerson (sic) [Thiago], this is Rafael. Well, gross margin is fully related to top line growth considering operational leverage. We can see that with our overhead admission, which represent something around 20% of total cost. In the quarter, we lost 90 basis points, and 120 of those, they are due to the non-leverage of the previous year. Another 100 basis points, they are related to that obsolete products provision that you had just mentioned, obsolete products and also fabric that is left that are useless. So these are the base points. All these impacts, they were somehow offset by a better plant use, and we had rebalanced our production, guaranteeing more efficiency during the quarter. That has restrained somehow the impact we realized in the gross margin. And looking forward, we have a storage where we hope to keep a gross margin around 44% to 45% as we had anticipated before. We might have some challenges throughout the second half considering cost pressures and some other field issues. But considering our top line growth, we believe that there will be no margin pressure throughout this year.

Inventory quality, how about that, and levels of inventories. We had a joint effort in the last quarter to balance our inventory levels. We wanted to have them above the level that we had initially. Initially, we thought that it would decrease our inventory, and our focus is really towards that indicator for quite a while. But the quality is quite good, especially when we consider that we have in our inventories today, the summer inventories, I mean, our last summer collection, which is still in inventory. They are -- they amount to less than 3%. I mean the old collection, the old summer collection. And at the end, I mean, at the stores, that is very well balanced. The network as a whole, December inventory has finished with a decrease of 8% in relation to the previous year when we compare the same stores 1 year after another. Therefore, we might not see any gross margin decrease in the next quarters due to any sort of reduction.

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Thiago Hering, Cia. Hering - COO [4]

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Good morning, everyone. This is Thiago speaking. I'm going to answer Emerson's (sic) [Thiago's] second question. In fact, our omnicommerce channel has been growing at accelerated pace, and this is much more related to sales generated by our e-commerce operations. But in 2020, we're seeing it very optimistically, the acceleration of all omnichannel modalities. In 2019, in the beginning when we started -- we opened some stores and we ended with more than 60 stores in omnichannel stores. So in the beginning, the showroom seems to be the one -- the best one with the infinite hanger and then more sales were generated from stores, but 2020 will be a year when we are going to fast -- rapidly adjust systemic issues, also to adjust pick up from store, and all these modalities are going to account for the biggest share of our omnichannel strategy.

Moreover, we have also intensified marketplace sales, always being very careful to assure in terms of brand and channels, to be very cautious. And we could also -- as this is still very much in the beginning of e-commerce and other growth lever, the growth in the main marketplace is here in Brazil.

Now talking a little bit about omnichannel customers and a little bit about their features. Yes, we do see a quite higher frequency, twice as much as our typical customers or the average of our customers with average expenditure that is 3x greater. So they usually shop 3, 4 times a year. And the average ticket in those transactions is 3x as much, more than BRL 450 for the omni customers. So there is an important opportunity for productivity as we increase our omni population in our customer base.

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Operator [5]

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Our next question is from Eugenia Cavalheiro from JPMorgan.

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Eugenia Tedde Cavalheiro, JP Morgan Chase & Co, Research Division - Research Analyst [6]

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I have 2 questions to ask. Number one is the sales trend for Q1. Do you see an improvement as compared to Q4? Could you tell us more about that? And along the same lines, what is your strategy, your multi-brand strategy from now into the future considering what happened in the last quarter? How do you intend to operate in that front?

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Thiago Hering, Cia. Hering - COO [7]

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As to the sales trend, we can divide what happened here in Q1 in 2 very different and opposing scenarios. In the beginning of the quarter was still very challenging as was the end of Q4 was as it reflects of the same product cycle in December, still in a sale environment and dealing with the same-store sale basis that was very solid when we grew in the quarter, 11.5% and more than 15% in the first half of the quarter. On the other hand, we've been seeing on the second half, a slight recovery as we renew our products and we launched our fall collection. We see sales picking up and especially if we compare collection with collection, we have a positive contribution, but the beginning was still very challenging. And now we are focused on this recovery and the collection has been very satisfactory in terms of its acceptance. And these renewed products will create the levers for us to grow towards the end of the quarter and also especially after Q2.

As to the multi-brand channel, yes, we acknowledge there was a drop in level, a more -- or a sharper level in Q4. And in our conference -- last conference call in January, we showed the elements that no longer justify, but they are evidence of that drop. We have been working intensely in rationalizing our customer base, augmenting and trying to reinforce our main customers, especially in the pursuit for a less transactional journey and more effective know-how transfer, reinforcing our point of sales, more sell-out vision, contributing to merchandising strategy, brands on a point of sale, trade marketing. So we are trying to reestablish a sell-out virtuous cycle so that recurrence and strengthening of share of wallet comes from a good turnover, and this is how we are going to reestablish our good relationship with these customers. We have some information, some data that although very tentative -- and we've been monitoring sell-out especially in points of sale, which accounts for slightly more than 10% of our sales in the channel, and we had a 7% fall in -- or drop in our inventory and our sell-out, after a while, was positive for these customers in the last quarter, which creates a positive outlook, and we have started to see some good response in the showroom for Q1 that started late last year, beginning of this year because of the supply for Q1 and Q2 for these customers.

Additionally, we have opened an important agenda of key accounts, both digital players and physical players. And we've been witnessing a significant growth in our customer base for customers with a level of planning and sales that is much more effective with a very mathematical and open exchange with -- and we now understand this is an important lever. It's a channel that was never too relevant for us because of strategic issues, but now it's, again, an important channel, and you will be seeing this number growing and increasing our multi-brand channel again.

And lastly, we would like to reinforce, as we've been saying in every conference call and whenever we interact with you, we want to strengthen the channel to transfer more know-how, to include commercial intelligence, trading, merchandising to assure a good sell-out cycle that will turn into a sell-in cycle in terms of replenishment. In the showrooms in Q1, there was a good response already, which might generate to a change in level and a recovery of levels above the BRL 153 million that we had in Q4 and still within our objective and goals for the channel for the year. It's picking up speed again, and this is related to sell-out initiatives and the know-how transfer with our main customers in the same way.

And if I could complement, something that we mentioned in our call in January about multibrand as the basis process, so there are some customers with lower potential and high service cost doesn't mean that we are going to stop opening new customers. So we want to generate more productivity to increase share of wallet with customers with more or higher potential. We're still prospecting and generating leads and new customers. And even with a lower-potential customers, we want to focus our look or to focus on those with a smaller potential, they can be part of our multi-brand ecosystem. We have challenged ourselves to have new agendas, to have a go-to-market agenda. There is more digital with lower tickets, more similar to B2C agenda, that will meet the needs of these lower-potential customers with a good return for the entire chain. So the compliance of these customers to our B2B platform also gradually increases or has gradually increased in the beginning of this year. Thank you.

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Eugenia Tedde Cavalheiro, JP Morgan Chase & Co, Research Division - Research Analyst [8]

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Very clear. If I could add still to my question. As to marketing expenses, we should have a 2020 similar to 2019. Is that so?

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Thiago Hering, Cia. Hering - COO [9]

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Yes. As to our planning, we see a -- we see expenses and overheads very aligned. There will be a reallocation between medias, different channels. I mean that continuous flow of assessments, measurement and productivity. But we had, generally speaking, expenses very much aligned to 2019.

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Operator [10]

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Next, João Soares from Citibank.

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João Pedro Ribeiro Soares, Citigroup Inc, Research Division - Assistant VP & Associate [11]

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Actually, I have some follow-ups, actually. First, as to multibrands. Thiago has emphasized the key accounts, but a little bit more about conversion strategies. I imagine that most of the key accounts, they have a large Hering mix of products, so it makes sense to be part of that franchise format. I even remember that there was a target by 2021 of conversions. Could you then elaborate a little bit more about that process? Because as to marketing overhead, we talk about marketing -- you have been talking about marketing investments and to emphasize the marketing expenses, what you do have in mind in terms of overheads and how to control those expenses, just to make that clear?

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Thiago Hering, Cia. Hering - COO [12]

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Well as to Franchise Light -- this Franchise Light, this is a project of a new format, a format which will comply better to those areas where we have no stores, and it also, but not only, it represents an opportunity of evolution in our systems for the VQs. What sort of game does a VQ get? Well, we have seen in a pilot project being conducted with 100 VQs in São Paulo, we see a very significant power of gain because the brand improves or maybe because the team is more concise or maybe because of replenishment is within time. I mean a base of a franchise system is a know-how transfer mainly. That is still a pilot, as I said, but we see a very important gain and a growth above the control group average, which is very exciting.

The third -- the Q3 -- and that conversion started in the Q3 for VQ and the light franchise. We are very enthusiastic about that as the compliance rate has been very positive. But let me emphasize that light franchise is not just related to VQ, that is also associated to opening new point of sales. I understand that in the past 5 years, we are quite limited. It's closely with 1 single model of shops that -- and after 1 year of test, it is proved that opening for new models such as the megastore, one-stop shop, and on the other hand, you have those more compact formats such as basic shop and light franchise. These are very important activities to address a geographic market in a country with such a great regional and demographic difference as well as purchase power.

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Rafael Bossolani, Cia. Hering - CFO, DRI & Member of Executive Board [13]

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Talking about overheads now. When we say that we are going to keep the marketing investments, those investments, they are related to a sales performance and that has to be aligned to our growth levels. Therefore, investments, they should be capped in relation to the same levels that we followed last year, 2019. There might be some sort of fluctuation throughout the quarters depending on some type of special marketing campaign that we might release. And with that, we are after a constant productivity as to help investments towards what is customer center throughout online media, off-line media or trade marketing.

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Operator [14]

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(Operator Instructions) As there are no more questions, this conference call for Companhia Hering is over. We would like to thank you all for your participation, and wish you a wonderful day. Thank you.

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