Edited Transcript of PARD3.SA earnings conference call or presentation 25-Mar-20 1:00pm GMT

As you can see on Slide 2, our customer service offers an increasingly better customer experience, working as a communication hub that can be accessed through several channels. Our digital platform called MyPardini has been completely refurbished for a more agile, easier experience, where we offer continuous improvement for a number of services and relevant information for our clients day-to-day. We have reduced the time line for issuing reports through the new NTA in the south region. We also had an increase in capacity and the evolution of the enterprise project focusing on better logistics. All of these measures provide us with greater interaction with customers, differentiated digital solutions and increasing efficiency in service.

In this quarter, we concluded the integration of Laboratório Solução, located in Itajaí, strengthening our presence in the south, bringing us even closer to our local customers, who will benefit from better turnaround time and expansion of the local team and greater competitiveness in the region.

For the PSC segment, we have launched 4 new units: 1 in Belo Horizonte, with the Pardini’s brand; and 3 in Rio de Janeiro, with the CMNG brand. The strategy implemented during the year really focused on expanding the services of clinical analysis, retrofitting, reducing fixed costs, a smart agenda, among others, was essential for operational and financial evolution of the service units.

On Slide #3, I would like to highlight once again our operational excellence. We reached a record production volume for the quarter and also for the year. In addition to the significant increase in production, we achieved excellent results from our customer satisfaction’s indicators, culminating in an increase in the number of revenue generated in customers.

On Slide #4, I would like to highlight other relevant operating points for the fourth quarter of 2019. Firstly, I would like to point out that our research and development area has implemented 7 new tests with the Pardini Group exam list, with 4 process improvements and 3 exams that are now being done internally. Also in February, we developed the COVID-19 detection test, which can reach a TAT of up to 24 hours of turnaround time. We offer this test preferentially to customers in specific hospitals in Brazil whenever they need faster testing. We are progressively increasing our production capacity through the new validations of research and development and the availability of inputs.

As with other medical and epidemiological needs such as arboviruses like dengue, Zika, Chikungunya, yellow fever, among others, the Pardini Group remains committed to contributing to the health of the population, always following the strictest criteria of safety, quality and ethics.

Finally, in relation to the Enterprise Project, the treadmills are already in operation and reached 50% of the volume forecast in March 2020. In early April, we reached 100% of the program following for the treadmill.

Now I would like to hand it over to Mr. Camilo de Lelis, our CFO.

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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, everyone. Over the next slides, we’ll discuss relevant aspects that impacted our financial performance in the fourth quarter of 2019. Please remember that for comparison purposes, the following figure will be presented without the impact generated by the IFRS 16 standards.

On Slide 5, which is in the fourth quarter of 2019, we had a record gross revenue for the quarter, with an increase of 11.2% year-over-year. This increase in gross revenue reflects the positive effects of the projects implemented during the year, as previously mentioned by Mr. Santoro, as well as the acquisitions made during this period.

With regard to disallowances, we continue seeking ever greater efficiency. In 2019, we managed to reduce disallowances by 20% year-over-year, even though in 2018, we had already achieved a 72% reduction year-over-year.

EBITDA and net income increased significantly in the fourth quarter of 2019 year-over-year. We reached BRL 74 million in EBITDA, an increase of 41.1% year-over-year. This quarter, we had a positive impact of BRL 10.1 million and an increase in gross margin.

Net income increased 73.2% from BRL 26.5 million in the fourth quarter of 2018 to BRL 45.9 million in the fourth quarter of 2019.

On Slide 6, we see the initiatives implemented under the Corporate Efficiency Project, which led to a reduction in costs, higher back office productivity and a significant impact on our operating expenses.

Sales, general and administrative expenses decreased from 16.5% of the net revenue in the fourth quarter of 2018 to 13.9% of net revenue in the fourth quarter of 2019.

Our ROIC without goodwill increased by 478 basis points in the fourth quarter of 2019 year-over-year, reaching 33.2%. The increased returns have an impact on revenue growth, gross margin and increase in efficiency in projects such as the Enterprise Project and the Corporate Efficiency Project. Another positive outcome from cost reduction and efficiency projects was a significant improvement in the company’s working capital. Finally, I would like to highlight that in December, we paid BRL 9.4 million of interest on equity, totaling BRL 39.8 million in 2019.

Now I would like to hand it over to Mr. Matheus Torga, our Executive Investor Relations and M&A Manager, who will discuss our financial results in detail.

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Matheus Torga, Instituto Hermes Pardini S.A. – IR and M&A Executive Officer [4]

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Thank you. Thank you, Camilo. Good morning, everyone. I would like to stress that we have had good financial and operational performance in the fourth quarter of 2019, with an increase in gross revenue, gross profit, EBITDA and net profit. This is due to our ability to generate value organically and through strategic acquisitions.

As you can see on Slide 7, gross revenue reached BRL 1.5 billion in 2019, with a significant increase of 12.1% year-over-year. This increase in gross revenue took place both in the Lab-to-Lab and the PSC segments. In the Lab-to-Lab segment, this increase was mainly due to new customers and revenue from acquired companies, especially Pardini Toxicology.

We also started a new sales project, which led to the highest organic volume growth of the year. This was very important for us since it goes to show that we still have plenty of opportunities to implement initiatives that will have a substantial effect on our results. We strive for better balance between volume, price and profitability.

Regarding the PSC segment, which has significantly contributed to our results, we continue to grow, and most importantly, continue to see an increase in profitability of the sales channel.

On Slide 8, we see an increase in the number of revenue-generating customers in the fourth quarter of 2019, totaling 5,638 customers, an increase of 81 customers year-over-year. We ended the year with 6,204 [revenue-generating] customers, our all-time high. We know that this is a relevant sign to support our growth and increased market share and share of wallet.

In the PSC segment, if we disregard the 4 units opened in the quarter, gross revenue per store grew by 6.4% when compared to the same period last year. As previously mentioned, this increase mainly reflects the introduction of clinical analysis services in Rio de Janeiro and São Paulo and initiatives that we have implemented to improve customer service.

On Slide #9, we see the gross profit in the fourth quarter was BRL 89.5 million, a 15.9% increase year-over-year, increasing gross margin to 27.2%, which is an increase of 112 basis points in comparison to the gross margin in 2018.

On Slide #10, we see gains obtained with the corporate excellence project (sic) [Corporate Efficiency Project,] which contributed to the reduction in sales, general and administrative expenses, reaching BRL 45.7 million in the fourth quarter of 2019 in comparison to the BRL 48.7 million year-over-year. Accordingly, as already mentioned by Camilo, the percentage of SG&A expenses/net revenue decreased from 16.5% to 13.9% year-over-year. It’s important to highlight how the company is able to optimize back-office processes, which contributes to increased profitability and higher quality of service. As a result, as we can see on Slide 11, the adjusted EBITDA totaled BRL 74 million in this quarter, also benefiting from positive impacts during this period, as mentioned by Camilo.

On Slide 12, we see extremely comfortable leveraging at the level of 0.9x our net debt/LTM EBITDA in addition to an extended payment term. As a result, we had a record net profit of BRL 45.9 million in the fourth quarter and a net margin of 14%. In 2019, our net income was BRL 163.5 million, an increase of 32.5% year-over-year.

On the next slide, we can see that the company’s ROIC without goodwill was 33.2% in the fourth quarter, which represents a spread between ROIC and goodwill and the cost of debt of 30.1 percentage points, reflecting the company’s ability to generate value for its shareholders in a consistent and ever-increasing way.

Thank you very much. And now we can move on to the question-and-answer session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Thiago Macruz, 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 two questions. First, I’d like to hear a little bit more about the sales contact you have. Could you please tell us about when this is going to have an impact on the company’s results? What kind of volume increase do you expect? And what kind of tests are you going to offer? Are they going to be specialized tests or regular tests?

My second question is, I want to understand how this competitive scenario will play out in the next months and years. What do you expect? Do you expect increased customers in your units? Also right now, do you feel a better competition environment? What do you think about the small players? What do you think about the competitiveness in this market?

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Alessandro Ferreira, Instituto Hermes Pardini S.A. – VP of Sales & Marketing [3]

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Thiago, this is Alessandro. Let me answer your question about the competition, and then we’ll talk about impact on results. Right now, we’re going through a scenario where things change every day and every week. Up until this specific point in time, the Lab-to-Lab segment has shown to be very resilient. It’s very resilient when facing the coronavirus crisis. And right now, we see that some labs have increased the amount of services or the volume of services they are — that they are providing. Some diagnosis are also going up, not only when related to coronavirus, but regarding other diseases. For example, since the beginning of the year, we saw an increasing trend for arboviruses. So this is what we see for the Lab-to-Lab segment. We see small and medium-sized labs that work as support labs, and this is a part of our reality. Now if we think about the medium run, we need to see how our economy is going to react to this. But what we do see is that these labs have a very important, very strategic role to play.

Now in the PSC segment, we have mobilized and assigned resources to work with the current scenario. We had this guideline of people not leaving their homes. So it would be only logical to think that we would see a decrease here, but people still need to do their testing, and we need to offer them this service. So we’re trying to allocate more resources into home sampling, because this is how we’ll be able to cater to our customers’ needs. We need to understand how health care providers are going to react to the impact of COVID-19. Yes, we’ll have increased costs for hospitalizations, but we’ll save in other expenses that sometimes are more optional in health care. I think this market will be resilient.

Now when it comes to our results, it’s very hard for us to understand right now what the impacts will be on our company. We’ve run some simulations on how this is going to play out, and we are working with 3 different scenarios. We have a more optimistic, a more pessimistic and a more conservative scenarios.

Now every day, what the company does is to analyze volume, revenue, tests, and we try and adapt the company for these scenarios. We adapt the company not only with internal procedures and guidelines for the ability to cater to coronavirus tests, but also when it comes to our whole operation. It’s very hard to forecast anything right now. But the truth is, the Hermes Pardini Institute has been getting ready to work with any kind of scenario, both on the optimistic and the pessimistic spectrums. We’ll be ready to absorb the demand brought on by this market, both in PSC and Lab-to-Lab.

It’s also important to remember that this crisis will pass, and people will go back to needing tests at a large scale. So at the end of this epidemic, we’ll be ready to cater to this demand. Right now, this is what we’re doing.

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Unidentified Company Representative, [4]

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My name is Emerson. Let me add something to what Alessandro said. Yes, the nature of the business model in the Lab-to-Lab segment ends up helping us diversify risk, the risk that we’re going through in Brazil right now. So with the Lab-to-Lab segment, we have geographical diversity. We see that some regions are being more impacted than others. We also have diversity in the type of customer we have. We have different sizes of customers and different natures of customers. We have hospitals and labs, for example. And we also have more diversity in the types of tests we have. As Alessandro said, we had growth in some tests, for example, the tests to detect arboviruses. Because of that, we have a more resilient outcome. That does not mean that we are not being negatively impacted. Yes, we are being impacted, but it’s not as much as in the PSC segment.

Now when it comes to the business that we have announced in the Northeast, during the Investors Day last year, I said that we were close to closing our first deal for the Pardini start-up operations for the hospital segment, and this finally happened. We signed an agreement in January with a very large customer in the Northeast with a hospital approach. We are going to offer them every test they need, that includes emergency testing and lab testing, that also includes low complexity testing and high complexity testing. So we’re talking about a broad portfolio, a complete portfolio, which is in alignment with our strategy that we were talking about during the Investors Day. We want to become protagonists in the hospital segment.

We cannot mention any numbers right now because of an NDA. But I can tell you that probably for the first month of operation, they have already become the biggest customer for the Lab-to-Lab segment at the Pardini Group.

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Operator [5]

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Our next question is from Gustavo, Bradesco BBI.

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Unidentified Analyst, [6]

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My name is Gustavo, I am from Bradesco BBI. I have two questions. One of them is related to what Emerson asked. And the other one is related to the company’s strategy. We always see a strategy focused on clinical tests, and now we see a lot on toxicology. But how about imaging? We see relevant growth in this PSC segment, so what do you think about imaging? And what about opening new units? Do you think coronavirus is going to have a negative impact for you, not only on the amount of volume, but also on opening new units?

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Alessandro Ferreira, Instituto Hermes Pardini S.A. – VP of Sales & Marketing [7]

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This is Alessandro. When it comes to opening new units, right now with the pandemic of the coronavirus, we had to stop the process of opening up new units because red tape and administrative processes become more complicated. Right now in Brazil, every authority is focused on fighting coronavirus, but we have only paused those plans. It’s only temporary. Some units were almost finished being refurbished, and they were about to open up. In those cases, we were able to open them up. But for those that we were still planning and modeling, we temporarily interrupted this process.

However, once again, it is important that — to stress that we are reinforcing our home sampling. Right now, home sampling is considered a unit. And in Belo Horizonte, for example, it is the second biggest unit. So we are increasing our activity in home sampling to cater to this demand. We even have mobile ultrasound units or MAPA units or router units to have home testing, even for imaging. Right now, that’s very important. And we also have the flu shots that are crucial at this point in time.

Yes, we’ve had a decrease in the interest for some tests because people are now self-isolating, but we have teleradiology services, and we are trying to work with smaller radiology studios or doctors who are in self-isolation or hospitals that need this kind of service.

It’s important to remember that teleradiology is not only an internal service for the Pardini Group, but we also provide this service to hospitals. So we’re trying to have different initiatives to offset the decrease in volume. As Fernando said, yes, this will have an impact on the company, but we’re doing everything we can to minimize this impact. And right now, because of the broad range of services we have, it’s easier to go with the motions.

The Lab-to-Lab services are very good. We have PSC. We were able to quickly increase home sampling with customized service, everything according to the guidelines that we should follow. And with imaging, including CT scan or MRI, yes, we felt a reduction in interest, but this is only temporary. And we’re trying to boost teleradiology with hospitals and different clinical studios so that we can offset that. This is what we have been doing.

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Operator [8]

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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 [9]

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I have two questions. Number one, I want to know if we still have gains to capture from the Enterprise Project in the next quarters. My second question has to do with different efficiencies. What kind of initiatives do you have right now? And what could we expect for the next quarters?

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Guilherme Collares, Instituto Hermes Pardini S.A. – COO [10]

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Eugenia, this is Guilherme Collares. When it comes to the Enterprise Project, a part of it is going to be done with 100% of operations, which we expect to start in April. This is when everything will be done in our pipeline, and we’ll be able to reduce manual processes. We’ll use the treadmill or the belt. Also, the time that it takes to deliver tests or the improvement of processes that affect customers are going to show. We’ll have test consolidation after 100% of the project have been implemented. We’ll be able to have the automatic inclusion of tests, and this will have an impact on customer experience. We also have an impact on the expenses for our inputs and everything we spent to collect samples. So we’ll see a lot of changes after we implement 100% of the project, especially when it comes to operating gains, especially when it comes to the gains in level of service that are going to be felt by customers.

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Camilo de Lelis Maciel Silva, Instituto Hermes Pardini S.A. – Chief Administrative & Financial Officer and Chief IR Officer [11]

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Eugenia, this is Camilo. When it comes to efficiency projects, we still have a number of initiatives, and we’re always looking for gains in efficiency for this field. We have a number of projects, one of them is called DPN, when it comes to SG&A. This will still generate a number of gains in the next few months. Of course, because of this pandemic, this company will take those projects into account.

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Eugenia Tedde Cavalheiro, JP Morgan Chase & Co, Research Division – Research Analyst [12]

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Great. I have one last question. What do you think about the competition in the Lab-to-Lab segment?

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Alessandro Ferreira, Instituto Hermes Pardini S.A. – VP of Sales & Marketing [13]

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This is Alessandro. Well, up until — before COVID-19 had an impact on Brazil, the competition was stable. Yes, we had a competitive scenario, but some competitors were changing their approaches on prices, we’re making a few adjustments, and everyone understood that we had achieved a certain ticket, and that now we needed to reposition our companies to gain margin in these markets. Our first quarter was good. Fernando can talk a little bit more about that. We had interesting levels of growth in the Lab-to-Lab segment in the first quarter. But with the coronavirus crisis, it’s very hard to analyze the competition right now.

Players are now focusing on the implementation of coronavirus tests, not only because that’s what the market needs, but because support labs are extremely important to make sure we promote and foster health care in Brazil, both in public and private sectors. A number of hospitals we work with can perform coronavirus tests for their patients because of us, so that is why the Lab-to-Lab segment is so important. So right now, it’s very hard to talk about the competition. Some players have kept their operation, and some players have reduced their activities. Of course, they want to remain active in the market. We also have sales initiatives that are running parallel to coronavirus initiatives. We have new products for hospital labs and for small-, medium- and large-sized labs. So every other operation is running in parallel with coronavirus efforts.

So in summary, during the first quarter, we saw continued stabilization of the competition. However, now because of this pandemic, it’s very hard for us to talk about the competition. We keep on offering a number of products and a number of sales initiatives. And remember, people keep on getting sick of a number — for a number of reasons. They still get sick because of other bacterial, viral diseases, cancer, diabetes. Children still need different tests because they are children. So because of our broad range of tests, from neonatal testing to cancer testing, we have also a broad range of options for this time in our history.

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Fernando Ramos, Instituto Hermes Pardini S.A. – Lab-to-Lab Director [14]

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Alessandro, I think your answer was very complete. You mentioned our competition really well. And as Alessandro said, we see a stable competitive environment. At least that’s what we saw until mid-March, before we had the coronavirus crisis. It’s also important to mention that the initiatives that we mentioned during the Investors Day last year. And in this case, we have 3 big strategic pillars for the Lab-to-Lab segment this year, including offering best customer experience. We want to increase the amount of tests in the next 5 years as well, and we want to find higher profitability. And all of those initiatives, all of those 3 pillars were on track. And the increase in volume that we’ve seen and that we saw until March 15 was very impressive and very accelerated in comparison to the previous quarter. It is a pity that we have suffered the impact from the coronavirus crisis because we were doing really well.

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Unidentified Analyst, [15]

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I have a question. My name is [Gonçalves] from Bradesco. What’s the impact you’ve seen on your deadline of payments to suppliers because of the COVID-19 pandemic?

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Unidentified Company Representative, [16]

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As Alessandro said, the impact we’ve seen on revenue is still going to be assessed. We’re still undergoing changes, for example, with the home sampling option. We’re also analyzing the impacts from Lab-to-Lab customers. Now when it comes to paying suppliers, we have analyzed volume internally. And yes, right now, with a decrease in volume, we see immediate impact on inputs and suppliers, or especially inputs. Now we have been talking to our biggest suppliers so that we can take the appropriate measures within the following days.

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Operator [17]

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(Operator Instructions) Our questions-and-answer session is now over. I now hand it over to Mr. Roberto Santoro for his final remarks. Mr. Santoro, you may speak.

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Roberto Santoro Meirelles, Instituto Hermes Pardini S.A. – CEO & Member of Executive Board [18]

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Ladies and gentlemen, before we wrap up, I think it is very important for us to say that we need to understand coronavirus tests a little bit better. We’ve seen a number of methodologies and a number of accuracy options.

Right now, to talk about the role of this kind of lab, I’d like to stress how important tests are for this kind of pandemic. So Mr. Guilherme Collares will talk about some of the methodologies that have been used. He’s also going to talk about how accessible these tests are, so that you have a scenario, and you understand the ecosystem of a lab for certain tests. They are going to be relevant to keep this pandemic under control.

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Guilherme Collares, Instituto Hermes Pardini S.A. – COO [19]

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Yes, thank you. Let me tell you a little bit about how we get ready for this kind of crisis. Labs are extremely important right now because it is in labs that we diagnose cases, and that we understand the epidemiology for this disease in different regions in the country. Our tests are already in operation since the beginning of cases in Brazil.

When this epidemic started abroad, we already started developing tests. These tests are done in real time, and it’s very important to tell people that different tests have different uses. People need to understand that. We have blood testing, and we have direct virus detection testing. When we talk about PPR, the ones that we do, we detect generic — genetic material of this virus in different air samples. This test is recommended by the World Health Organization, and it’s very much used in the U.S., because we detect people who are currently infected, because you detect genetic material from this virus in a person.

This test is also a lot of work to do, that is why we don’t have as much capacity for it. We are in the thousands, but we end up increasing this capacity over time. Right now, we’re able to have 1,000 tests per day. We aim to achieve 3,000 tests per day, and we want to go even further than that because we have even higher demand for that. We also see other tests in the market, for example, blood testing for coronavirus. People talk about quick testing and 15-minute testing, but those tests end up detecting if your body is responding to this infection. You see if the person is producing antibodies against this virus.

Now the problem with this test is that at the beginning of symptoms, oftentimes, people do not have antibodies yet, so we could have false negatives at the beginning of an infection. This is a problem because people feel safe, but that is a fake feeling because of false negatives. Usually after 5 days with symptoms, we get true positives. And we end up starting to get symptoms at 5 days of infection. So this test is very risky in a way. And people need to understand that when they do those blood tests, if you are at the beginning of an infection, your test may be a false negative.

Now when it comes to the epidemiology of this disease, this may be an interesting option because you may be able to test a large amount of the population, and you may be able to do it at any lab. You don’t need a specialized lab for that, as you do with PPR. So if you want to analyze volume, especially further down in this epidemic, when we have a lot of infected people, this may be an interesting option, especially if people want to go back to work after 2 to 4 weeks without symptoms.

I think that’s what Roberto wanted me to share with you, because people really mix up the kind of testing that we have in this market. And people have been talking a lot about quick testing. Now the best recommendation for initial diagnosis is the molecular biology test. Sometimes we talk about a reverse test when we talk about those. Because in this case, we detect genetic material from this virus. So remember that the blood testing sometimes presents false negatives at the beginning of an infection. However, for epidemiology purposes, it could be extremely important for our country.

Roberto, if you have any more comments, please feel free to comment on that.

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Roberto Santoro Meirelles, Instituto Hermes Pardini S.A. – CEO & Member of Executive Board [20]

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Yes, making a difference between those methodologies is very important. Also within this context, an accurate quick diagnosis is often able to avoid other kinds of costs. For example, if we have early diagnosis, we are able to isolate people, and we’re able to avoid more contamination. We could also decrease costs with ICU hospitalizations. And right now, this could be a very interesting alternative for Brazil if we compare the cost of testing and the cost of hospitalization. We truly want to help hospitals and labs involved.

Lab medicine in Brazil has evolved a lot in the past few years, and we’re getting more ready to more complex tests. As Guilherme said, this test is more complex, and validating new tests is something tricky. Diagnostic medicine has to play this role in such a complex scenario.

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Guilherme Collares, Instituto Hermes Pardini S.A. – COO [21]

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Let me please add something to that. This is Guilherme speaking. We are keeping up with every new methodology that pops up in the market, and we’re validating many of those, so we have a lot of work with research and development. We do hope we’ll be able to keep up with the evolution of this testing for COVID-19. And it is our hope to offer better improvements and better processes to increase production capacity with testing to diagnose people with COVID-19. We also want to keep on offering tests for other uses as long as they are correctly used. Blood tests are a good example of that. It could be a good option under the right circumstances. Thank you.

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Roberto Santoro Meirelles, Instituto Hermes Pardini S.A. – CEO & Member of Executive Board [22]

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Thank you, Mr. Guilherme. We have now reached the end of our earnings release presentation. Our Investor Relations Department will always be available to you if you have any questions or comments. So please feel free to keep in touch.

Good luck to everyone when it comes to this pandemic. It is very important for us to work on prevention, and our sanitary surveillance authorities will hopefully be able to help us get out of this crisis. It is very important to trust labs and to trust lab medicine all over Brazil. Thank you very much for your attention, and good luck.

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Operator [23]

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We have now reached the end of the Hermes Pardini earnings release presentation. Thank you very much for your attention, and thank you for using Chorus Call.

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