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Edited Transcript of PARD3.SA earnings conference call or presentation 13-Aug-19 1:01pm GMT

Q2 2019 Instituto Hermes Pardini SA Earnings Call

BELO HORIZONTE Aug 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Instituto Hermes Pardini SA earnings conference call or presentation Tuesday, August 13, 2019 at 1:01:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alessandro Ferreira

Instituto Hermes Pardini S.A. - VP of Sales & Marketing

* Camilo de Lelis Maciel Silva

Instituto Hermes Pardini S.A. - Chief Administrative & Financial Officer and Chief IR Officer

* Fernando Ramos

Instituto Hermes Pardini S.A. - Lab-to-Lab Director

* Mauricio Leite

Instituto Hermes Pardini S.A. - Corporate Manager of IR

* Roberto Santoro Meirelles

Instituto Hermes Pardini S.A. - CEO & Member of Executive Board

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Conference Call Participants

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* Joseph Giordano

JP Morgan Chase & Co, Research Division - Senior LatAm Healthcare Analyst

* Marco Calvi

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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Good morning, ladies and gentlemen. Thank you for waiting. Welcome to the Hermes Pardini Institute earnings release presentation to discuss the second quarter of 2019.

Today, with us, we have Mr. Roberto Santoro, our CEO; Mr. Camilo de Lelis, our CFO; and Mr. Mauricio Leite, our Investor Relations Manager. (Operator Instructions) Both the audio and the slides you'll see during this call are being broadcast in real time at www.hermespardini.com.br/ri. There you'll find this presentation for download at the Results Center.

Before proceeding, we'd like to highlight that any forward-looking statements made during this earnings release presentation concerning our business prospects or any operating and financial forecasts are based on beliefs and assumptions by the Board of the Hermes Pardini Institute as well as on all of the information available to us as of now.

These forward-looking statements are not a guarantee of performance, as they concern future events and therefore, depend on things that may or may not happen, they entail risk and uncertainty.

The overall economic scenario, changes to our industry and other operating factors may impact the company's future, leading to outcomes that may be significantly different from the forecasts contained in such forward-looking statements.

Now I would like to hand it over to Mr. Roberto Santoro, our CEO. You may speak, Mr. Santoro.

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Roberto Santoro Meirelles, Instituto Hermes Pardini S.A. - CEO & Member of Executive Board [2]

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Good morning, ladies and gentlemen. Welcome to the Pardini Group earnings conference call for the second quarter of 2019. Camilo, our CFO; Mauricio; and I will make the presentation based on material available on our Investor Relations website. Soon after, we'll start the question-and-answer session, in which the other Directors who are here will also provide you with more details on specific topics and questions.

Today, with us, we have Ms. Adriana Linhares, our Business Director; Mr. Alessandro Ferreira, our Sales and Marketing VP; Mr. Fernando Ramos, our Lab-to-Lab Business Director; Mr. Guilherme Collares, our COO; and Mr. João Alvarenga, our IT Director.

I would like to start our presentation by talking about operating highlights in the second quarter of 2019.

On Page 2, we highlight that the Enterprise Project continues to evolve in line with our operations schedule and that we have over 80% completion. In August, we completed the transition for immunological and hormonal testing at our Technical Operations Center, which was the biggest step for Enterprise in terms of volume and production. We've completed the first flow tests with the production belts and we begin volume tests at the end of July. The second belt has also been assembled and is currently in the final phase of flow testing.

The control room, another innovation by the Enterprise production model is already being tested. It will allow us to control all production units when it comes to quality, machinery availability, productivity and production flow in order to maintain the same level of service at every one of our centers.

At our Advanced Technical Centers or NTAs, located in the cities of Belo Horizonte, Goiânia, São Paulo and Rio de Janeiro, the main lines are already operating as per the Enterprise production model.

As a result of transitioning various exam groups to the Enterprise production model, we can already see positive impacts on our gross margin as Camilo and Mauricio will show you.

Also on Slide 2, I would like to shed light on some of our activities in personalized medicine, which is highly relevant for our growth strategy.

First, I would like to highlight investments made in innovative equipment, including NovaSeq from Illumina, considered one of the most robust DNA sequencing equipment featuring NGS technology. Along with our other sequencing platforms, this piece of equipment will further improve our competitiveness regarding the delivery time. It also improves productive capacity and quality in all genomics and personalized medicine tests.

Another very important achievement for personalized medicine was the launching of the ICU test consisting of a very unique test that uses combined methodologies to analyze over 850 genes and diagnose up to 1,000 severe diseases. It is widely used for newborns admitted to Intensive Care Unit at a critical condition. In addition to saving the lives of newborns, this test can also generate great savings in the health care value chain.

During the first half of the year, we further refined our structure for personalized medicine. In order to do that, we have expanded our highly qualified clinical staff and improved our service to doctors, patients, health care providers and Lab-to-Lab customers. One of these improvements was the creation of a customer service team dedicated to personalized medicine consisting of highly qualified professionals ready to provide information about these tests. We hope all of these improvements in technology, clinical staff and level of service will enable our group to become one of the world's leading players in personalized medicine.

On Page 3, I would like to point out that we continue increasing the volume of tests. In the second quarter of 2019, we processed 24.8 million tests, an increase of 8.7% year-over-year, growing at a faster pace than in the first quarter of 2019. In May, we hit a record of over 8.8 million tests being processed. This increase in volume is also a result of Lab-to-Lab customer growth, which reached to almost 5,500 new customers in 2Q 2019, representing over 253 new customers year-over-year.

Also in the Lab-to-Lab segment, it is important to highlight that we were pioneers in using the ACSI index for health care in Brazil. Since the beginning, we've been performing above 80 points, which shows a high level of satisfaction of our Lab-to-Lab customers. ACSI stands for American Customer Satisfaction Index, one of the most well-respected B2B satisfaction measurement methodologies in the world.

Speaking of customer satisfaction, I would also like to point out that our Net Promoter Score or NPS, which measures our customer satisfaction in the PSC segment, is still close to 80 points and the improvement in Rio de Janeiro is worth mentioning since they are almost at 75 points.

On Page #4, I would like to highlight other operating points for the second quarter. Firstly, our research and development has added 10 tests and 2 bioinformatics analysis systems to our portfolio. One of their highlights is the ICU test mentioned previously. Offered only by our group, this test is run on newborns, allowing us to save lives and generate savings in the health care value chain through better diagnostics.

As a result of our dedication and our investments in R&D, the Pardini Group has been recognized by Valor Inovação Brasil 2019 as one of the 3 most innovative companies in the medical services category, ranking first for medical diagnosis. The award held by Valor Econômico newspaper recognizes the 150 most innovative companies in the country in 23 industries. We have been awarded since our first participation in 2017, which shows how innovation is in our essence and how we're able to create content, tests, research and development for this industry.

Another relevant award we won in the second quarter of 2019 was the Top of Mind for clinical analysis in Belo Horizonte, where we once again are the leaders for this region.

Finally, I highlight that research and development had 25 scientific papers accepted at the congress of the AACC, the American Association of Clinical Chemistry. Out of 25 papers submitted, 25 of them were accepted and one of them was awarded third place in tumor markers and cancer diagnostics.

Still on Page 4, I would like to highlight that between June '16 and '19, we hosted one of the most relevant events in diagnostic medicine in Brazil. The Brazilian Conference on clinical analysis by the Brazilian Society of Clinical Analysis. More than 2,000 health care professionals attended this event and they came to the Pardini Group booth. The event was held at Expominas, our mining capital. We shared a lot of knowledge technology and experience through lectures and courses given by our group. Over 30 professionals shared their knowledge on personalized medicine, toxicology and management over 40 hours for the workload. Throughout this conference, the Pardini Group was honored for its 60 years of -- in its legacy in the field of diagnostic medicine in Brazil.

During this conference, we presented and disseminated for the first time, a lot of technical information about our production model, our technology called Enterprise for customers and potential customers on our website, which is near Belo Horizonte.

During this period, we received more than 190 visitors in our technical operations center. We received wonderful feedback, proving how innovative the Enterprise production model is and all the connections and benefits that this will bring to our current and future customers.

Finally, I would like to point out that this month, we celebrate 60 years of the founding of the Pardini Group. This is an important milestone for our company, which courageously built a beautiful story. I'm especially pleased to realize that we continue to exercise the pioneering spirit behind this business. Right now, we are a testament to the energy that brings us forward. We will have the delivery of the Enterprise, the biggest project in our history. We're also modernizing our management processes, integrating companies and systems and investing heavily in the initiatives that bring benefits to our customers.

All of this makes us proud of the entrepreneurial trajectory that has always inspired our group and we want to drive innovation, content, technology experience and good service for every customer all over Brazil.

Now I hand it over to Mr. Camilo de Lelis, our CFO, who will talk about the second quarter.

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Camilo de Lelis Maciel Silva, Instituto Hermes Pardini S.A. - Chief Administrative & Financial Officer and Chief IR Officer [3]

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Thank you, Roberto. Good morning. In the next slides, I will highlight relevant points that had an impact on our excellent financial performance in the second quarter of 2019.

On Slide #5, we see a historical record of volume and revenue in May 2019. As a result, we reached a volume of 24.8 million tests in the second quarter of 2019, an increase of 8.7% year-over-year. This increase in volume and revenue reflects the growth of clinical analysis in the PSC segment, primarily in Rio de Janeiro and São Paulo as well as our Lab-to-Lab strategy to protect our market share after price drops in 2018.

The average Lab-to-Lab ticket remains stable showing a lower decrease than when compared to the previous period. When we look at the evolution of the average ticket, for example, between the first and second quarters and we exclude the impact of acquisitions, we actually see an increase in the average ticket. I would also like to highlight the reduction in our production costs. A significant part of this reduction results from more efficient production lines that have already adopted the Enterprise production model. For the products already running on the new production model, this production was about 27% in the Lab-to-Lab segment. But the PSC segment, this decrease represents around 16%. As mentioned by Mr. Roberto, we have completed over 80% of the Enterprise Project so far.

Mainly as a result of higher internal efficiency, the company's gross margin surpassed 30% and returned to historical levels in the second quarter of 2019. This reinforces our strategy of not losing customers to the competition and compensating for price declines with greater internal efficiency.

In addition to the adoption of the Enterprise production model, I would also like to highlight the positive effect of the PSC segment on the company's gross margin.

On Slide #6, we see that PSC segment performed better in every region, especially in Rio de Janeiro. This was mainly due to structural adjustments such as improving imaging equipment saturation and operational control at the centers through daily performance monitoring and operational performance. We continue working towards increasing efficiency for disallowances. In the second quarter of 2019, we kept disallowances below 0.3% of our gross revenue. In the first half of 2019, we were able to reduce disallowances by 49% year-over-year, even though we had already achieved a 42% reduction compared to the first half of 2017.

I would also like to point out that the initiatives carried out within the scope of the Corporate Efficiency Project already had significant impact on our operating expenses. Sales, general and administrative expenses minus the impact of acquisitions decreased from 14.2% of net revenue to 11.7% of net revenue in the second quarter. Mauricio will go into more details later.

Our EBITDA and net income were record breaking in the second quarter. We reached BRL 70 million in EBITDA, an increase of 18.4% year-over-year. Net income increased from BRL 33.2 million to BRL 43.1 million year-over-year. The effective corporate tax rate was 23% in the second quarter, in line with the rate recorded year-over-year.

Finally, I would like to highlight that in June, we announced the payment of BRL 9.9 million of interest on equity. We are reaping the fruits of all projects started in late 2018 and early 2019.

Now I would like to hand it over to Mr. Mauricio Leite, our Investor Relations Manager, who will talk about our financial results in detail.

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Mauricio Leite, Instituto Hermes Pardini S.A. - Corporate Manager of IR [4]

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Thank you, Camilo. Good morning. On Slide 7, I would like to highlight some points about gross revenue, which totaled BRL 368.8 million in the second quarter, an increase of 14.3% compared to the same period of 2018. In the first half, gross revenue reached BRL 730.2 million, an increase of 14.2% year-over-year. This gross revenue growth occurred both for the Lab-to-Lab segment and for the PSC segment.

At the Lab-to-Lab segment, we had a 20% growth in gross revenue in the second quarter of 2019 year-over-year. This increase was mainly due to the acquisition of new clients, to the expansion of personalized medicine products and to revenue from the companies that we bought.

Regarding the average ticket, we saw stability. In fact, as already pointed out by Camilo, in the second quarter of 2019, the average ticket for Lab-to-Lab, excluding acquisitions, even showed a slight increase when compared to the first quarter of 2019. When it comes to the PSC segment, the gross revenue increase happened for every region. I would like to highlight the performance we had in Rio de Janeiro, where we continue to grow, mainly in clinical analysis. As already noted, our NPS is above 75 points. We also refurbished some centers and we had higher saturation for imaging equipment, which also contributed to the increase in PSC gross revenue.

On Slide #8, I would like to highlight additional points about the Lab-to-Lab gross revenue. Firstly, I would like to point out that the gross revenue in the second quarter of 2019 showed an increase of 3.2% compared to the second quarter of 2018, minus the effect of the acquisitions of DLE, Labfar and Psychemedics Brasil as well as the effect from 2 relevant clients that left our base in the second half of 2018. This growth represented an acceleration in comparison to the first quarter of 2019. When considering the same basis of comparison, there was only 1.7% growth in comparison to the first quarter of 2018.

Also on Slide #8, we see the increase in the number of revenue-generating customers in the second quarter of 2019, which totaled 5,497, an increase of 253 customers when compared to the second quarter of 2018. This increase reflects the company's sales approach. It also shows our differentials in the market.

As said before, we had 8% increase in PSC gross revenue in the second quarter reflecting positive performance in every region. In this half of the year, PSC gross revenue reached BRL 331.5 million, a 7.6% increase year-over-year. Gross revenue per store also increased and reached BRL 1.4 million, which is 10.7% higher year-over-year. This increase in gross revenue at PSC mainly reflects the introduction of the clinical analysis services in Rio de Janeiro and São Paulo, including the initiatives that we undertook to improve customer experience within our stores and the increased saturation of imaging equipment.

On Slide #10, we highlight that the net revenue increase 14.1% in the second quarter of 2019 year-over-year. There were no significant differences in taxes, disallowances and other deductions as a percentage of the gross revenues. As already said by Camilo, in the first half of 2019, we saw a reduction of disallowances by 48.9% year-over-year.

On Slide #11, we highlight that the gross profit in the second quarter totaled BRL 105.2 million, an increase of 26.5% year-over-year. In the first half of 2019, gross profit reached BRL 199.2 million, a 16.2% increase over year-over-year. Our gross margin in the second quarter of 2019 was 30.6%, an increase of almost 300 basis points compared to the gross margin in the second quarter of 2018. We were able to resume gross margin to historical levels, offsetting the price drop we had in 2018 through greater internal efficiency. I would like to highlight that in the second quarter of 2019, the costs of services provided included nonrecurring and nonoperating effects to a positive total of around BRL 1.7 million. That includes mainly the recovery of Enterprise Project equipment, including set-up costs incurred in the first quarter of 2019.

Now on Slide #12, I would like to firstly explain the variations in selling or sales, general and administrative expenses without the effects of other operating revenues/expenses and the effect of acquisitions because we want to convey more clearly the impact that we were already able to achieve because of the excellent -- the Corporate Excellence Project. As we can see here, sales, general and administrative expenses minus the company's DLE, Labfar and Psychemedics Brasil decreased from BRL 42.3 million in the second quarter of 2018 to BRL 36 million in the second quarter of 2019, which means a reduction of 14.2% of net revenue, excluding acquisitions to 11.7% of net revenue, excluding acquisitions as well in the second quarter of 2019. This significant improvement resulted from the company's efforts to increase internal efficiency, mainly through the Corporate Excellence Project and Process Automation.

Regarding other operating expenses and also excluding acquisitions, it is important to highlight that in the second quarter of 2018, we had to work with provisions, which contributed to a positive impact of approximately BRL 4.9 million in this period.

On Slide #13, we see that the adjusted EBITDA totaled BRL 70 million in this quarter, an 18.4% increase year-over-year and a record for the company. The adjusted EBITDA margin in this period was 20.4%, which represents a 74 basis points increase year-over-year. I would also like to stress that we were able to improve the adjusted EBITDA margin even though we had a scenario with a lower Lab-to-Lab average ticket, excluding acquisitions in comparison to the second quarter of 2018.

As mentioned earlier, this margin improvement was mainly due to the transition of some tasks into the Enterprise production model. We also benefited from the Corporate Excellence Project and adjustments in the PSC segment, for example, through saturation of imaging equipment.

In the first half of 2019, our adjusted EBITDA was BRL 135.8 million, a 14.3% increase year-over-year.

On Slide #14, I would like to highlight that we finished the second quarter with a net debt of BRL 281 million corresponding to a leverage ratio of 1.2 fold.

On Slide #15, we highlight that the net income in the second quarter of 2019 reached a record of BRL 43.1 million, a 30.1% increase year-over-year. As a result, we've reached a net margin of 12.6% during this period. In the first half of 2019, net income was BRL 73.3 million, a 16.8% increase when compared to the first quarter of 2018.

On Slide #16, we can see that the company's ROIC without Goodwill was 29.4% in the second quarter of 2019, representing a 25.2 percentage points spread between a non-goodwill ROIC and the cost of debt. This shows the company's ability to consistently generate value for its shareholders.

Finally, on Slide #17, we see a table with additional information about the effect of IFRS 16 on the company's financial statements.

Now we can start with the Q&A session. Thank you very much.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our question is from Marco Calvi from Itaú BBA.

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Marco Calvi, Itaú Corretora de Valores S.A., Research Division - Research Analyst [2]

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I have 2 questions for you. Firstly, we would like to understand the relationship between tickets and volumes in the Lab-to-Lab segment. You had a very good growth for this quarter, especially when you exclude the 2 biggest clients you lost in 2018. So what do you think about this organic growth? Because it is around 3%. Now if we think about the first half of the year and if we think about organic growth regarding ticket and volume, do you think this is a weaker base? Also, my question is, should we expect an organic revenue growth for the Lab-to-Lab segment at a faster pace in the future, maybe for a mid-single or a high single?

My second question has to do with the gross margin. We saw significant improvement year-over-year for the gross margin. Can we have some qualitative perspective on that? How did you evolve the gross margins through the semester? Because we had a weaker base for the PSC segment last year, so I want to understand where such a significant improvement came from?

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Fernando Ramos, Instituto Hermes Pardini S.A. - Lab-to-Lab Director [3]

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Marco, my name is Fernando. Let me answer the first question about tickets and volume, especially regarding the Lab-to-Lab segment. What we have seen in this segment is aligned with our figures. We see a market that is growing a little bit lower than it was growing in previous years because of a number of reasons. We have seen that being reported to you and to other analysts. But in this scenario, what we see now is more stable prices. In 2018, especially as of March, we saw steep drops in prices because of the competition. Now since the beginning of this year and especially now, we see more stable pricing for this segment. And of course, this is highly beneficial for our ticket figures. As Camilo said really well during his presentation, our ticket -- our average ticket for the second half or for the second quarter actually was above the average ticket for the first quarter. This also has to do with other initiatives that we started implementing in the Lab-to-Lab segment in May and June.

Now I'm going to hand it over to Alessandro.

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Alessandro Ferreira, Instituto Hermes Pardini S.A. - VP of Sales & Marketing [4]

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Marco, this is Alessandro. Let me add something to what Fernando said. In the Lab-to-Lab market, we're always talking about the competition. However, we know that this market reflects the condition of labs all over Brazil. According to the last figures for this segment in health care providers, we saw a 0.2% growth according to official data, so we see a stable market. That means that for most of the market, except for a few exceptions, we are not going to see growth or for some of our clients, we're going to see very small growth, very little growth. Of course, that is related to a number of macroeconomic factors and everybody is aware of that.

As per the results we got in the second quarter, we have a very good outlook for the future. Of course, we don't have a specific forecast of a high single or a mid-single, but we do see good perspective for growth in the future. At the Hermes Pardini Group, we always have a very interesting, very strong third quarter. Also our level of service is very good right now and it is getting better and better. So that's very good news. That is why all of these elements, including macroeconomic factors and other factors that are going to help us. We see very good times for the market overall, and we saw 0.2% of growth in this market, which is already positive because we had drops in the past. Our average ticket showed a slight increase in the second quarter. For some lines of products, which are highly specialized, we also saw very interesting growth. So our indicators showed that our third quarter is going to be promising, but we don't have specifics forecasts. Right now, according to the indicators, we see that this market is resuming its growth and resuming its strength.

I'm now going to hand it over to Camilo de Lelis who is going to answer the second question.

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Camilo de Lelis Maciel Silva, Instituto Hermes Pardini S.A. - Chief Administrative & Financial Officer and Chief IR Officer [5]

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When it comes to the improved gross margin, our expectation is to still see increases and improvements in the gross margin when we finish the Enterprise Project. That is also going to happen when we see more of our Corporate Excellence Project, started in 2018. We're no longer segmenting our margin by type of business, but qualitatively, we are improving daily control of our PSC operation through a business line that we have created internally. We also have the same business line in the Lab-to-Lab segment. With the help of Fernando Ramos and our internal team, we expect that when we finished the improvement of the Lab-to-Lab segment, we are going to have a very interesting increase in the gross margin in the second -- in the third quarter.

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Operator [6]

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Now we have Mr. Joseph.

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Joseph Giordano, JP Morgan Chase & Co, Research Division - Senior LatAm Healthcare Analyst [7]

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I would like to understand the PSC segment a little bit better. We see growing improvement in the revenue per center. I would like to understand the accreditation processes in these centers, especially in Rio de Janeiro. Please tell me a little bit about your performance in the Midwest as well. Do you think there's risk of a consolidated sector? And do you see growth in volume for these centers?

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Alessandro Ferreira, Instituto Hermes Pardini S.A. - VP of Sales & Marketing [8]

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Joseph, this is Alessandro speaking. Regarding the positive results in the PSC segment, they stand from work between sales and customer service. So let me talk about accreditation first. We were able to get a number of accreditations. More specifically in Rio de Janeiro, we were able to make up for portfolio losses in the past. We got new insurance plans, we got new operators, we got new accreditation processes for specialized fields and that basically happened everywhere. That happened for imaging, genetics, clinical analysis, and so on. So we were able to apply accreditation processes not only to centers, but to specific products and to a number of business lines. So that is very relevant. What is also relevant is that we have this strategy to grow in clinical analysis in some specific regions because they used to focus on imaging just like in real. This strategy came about with our expansion. Of course, we were now accrediting these centers and we were working on a level of service, which is way higher than what this kind of patient is used to. So in Rio de Janeiro, we have our NPS and other sensors catering to the same people do not reach the same NPS. So we are able to associate a high level of service and more accreditation for health care providers. We had an interesting performance in the Midwest. Our brand is a market leader in the Midwest. It is also the preferred brand for the middle class, which is very good for us. Now in addition to our history [affair], we have been investing heavily on customer service. Our NPS has been improving in Goiânia as well. Recently, we had a survey and we saw that the Goiânia Center is one of the most acknowledged centers for the Pardini Group. And of course, that has an impact on our growth there.

Now regarding your preoccupation with consolidation, according to what we see in the market and as far as know it, Pardini is able to work on specific centers, especially in both Belo Horizonte and Goiânia with the same levels it's always had. São Paulo and Rio de Janeiro have also been improving through accreditation and better customer service, which shows a very good result for the PSC segment. We expect to see more and more of that throughout the second half of 2019 and for next year, both for accreditation and for customer service. The PSC segment is also impacted by the increase in coverage for highly specialized tests, especially for genomics. So with DLE in our group, we're able to offer our PSC segment centers highly complex tasks and this has an impact on better indicators for this segment.

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Operator [9]

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(Operator Instructions) Our Q&A session is over, now I hand it over to Mr. Santoro for his final remarks.

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Roberto Santoro Meirelles, Instituto Hermes Pardini S.A. - CEO & Member of Executive Board [10]

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Once again, we would like to thank you all for attending our conference call. Please remember that our Investor Relations department is always at your disposal if you have any questions or comments. Thank you very much.

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Operator [11]

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We've now reached the end of the Hermes Pardini Institute earnings release presentation. Thank you very much for your time, and have a great day.

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