Welcome to Hypera Pharma teleconference. This is the first quarter of 2020 results. We have Mr. Breno Oliveira, CEO, and Mr. Adalmario Mandelli, CFO, are here with us today. We would like to inform you that this event is being recorded, and all participants will be in a listen-only mode during the company's presentation. We will have a Q&A session for investors and analysts only when further instructions will be given. If you need any assistance during the call, please press star zero to reach the operator. We would like to inform you that questions can only be asked by phone. If you are connected through the webcast, you should email your questions directly to the RI team at ri@hypera.com.br. Today's live webcast may be accessed through the company's investor relations website at www.hypera.com.br/ir.
We would also like to inform that statements made during this conference call may constitute forward-looking statements. Such statements are subject to known and unknown risks and uncertainties that could cause the company's actual results to differ materially from those set forward in the forward-looking statements. We would like to turn the floor over to Mr. Breno Oliveira. You can begin your presentation now, sir.
Good morning, everyone. Welcome to our Q1 results call. In the previous call, we talked about the conclusion of our committee. There will be a delay. We will be informing the market as soon as this work is concluded. Let me talk about our operational performance. In Q1, our sell-out grew by 11%.
It's the fourth quarter in a row that we had two-digit growth, especially because of strong demand on consumer health in the second and third weeks of March, because consumers went to drugstores to stock their medicine cabinets because of COVID-19. Flu, painkillers, and vitamins. In brand prescription, Rinosoro, Colflex, Oscal, especially because of recent news about the importance of Vitamin D. Other important categories, such as dermatology and pediatrics, suffered in sales because the crisis promoted brand prescription sales. That hurt short-term sales. In the last week of March, we had some fall, but there seems to be a gradual boost in demand in recent weeks. In the first quarter, we had net income of BRL 815 million. We recovered our gross margin of 67%, that reached 31% for the quarter, in alignment with what we expect for the rest of the year.
The pandemic brought additional challenges to our day-to-day operations. That was no different to us. I would like to talk about the measures we took on slide four. Our main focus has been to take care of our employees. We've adopted home office to 100% of our admin workers. All our employees are on vacation. When they come back, we'll be adopting special safety measures. We have brought reinforcement to our corporate health team and extended the benefits to all our employees. We donated 20 ventilators to the city of Anápolis. We gave donations of drugs, food, and hand sanitizers. Also, we did the same in São Paulo and Rio. It's important to protect our plant and our innovation center. We've adopted several prevention measurements. We are taking the temperature of our employees, especially in the entrance and the mess hall.
On top of that, we placed orders from China ahead of time, and we do not expect any shortages of inputs in our production facilities. We must make sure that everyone has access to drugs and medical services, and we are taking care of the communities where we operate. We also try to boost our short-term liquidity, given the uncertainties of current times. We have a credit line of about BRL 900 million for this year and next year. We are over BRL 2.5 billion in debentures. We'll be paying out the FARER for the fourth quarter of 2020. We have more than enough cash to conclude this operation. Back in March, we sold our portfolio, or we maintained our sole focus in the pharmaceutical industry in Brazil.
With recent derivatives operations conducted back in March and April, our exposure is below $400 million, less than 50% of the original exposure. Before I turn over to Adalmario, let me talk about innovation. Total investments in R&D reached 7.2% of net income, reinforcing our commitment to innovation and sustainable growth, especially during the pandemic. In the quarter, we acquired the Glenmark dermatology product line. With the other important brands that we already have in our portfolio, reinforce our positioning within the dermatology segment. We've acquired leading brands, Vitamin D, Addera, and the Dutro. I'll turn over to Adalmario now. He'll be talking about this quarter results.
Thank you, Breno. Good morning, everyone. Let me start with the highlights on slide six. Net revenue was BRL 815 million, more than double year-over-year.
It's not a good basis for comparison given the drop in sales in Q1 of 2019, aiming at reducing inventory levels at that time. Gross margin was below the sell-out sale. Just like Breno said, that was very prevalent in the first two weeks of March. We could not replenish our customers' inventory levels. We've had huge demand because of the pandemic associated with the lack of definition on sales, prices, updates, or increases. The sell-in growth will be very close to the sell-out growth since we are now adapting this new business model, reducing inventory levels at our customers. For Q2 of 2020, sell-in should be bigger than sell-out to replenish our customers' inventory after the above-average demand we had back in March. Gross profit amounted BRL 543 million. Gross margin was almost 67%, an almost 7% improvement when compared to Q4 2019.
Some factors contributed to that effect, reducing idle times in our plant and the increase of average price, reducing the number of POS, and that offset the negative impact of exchange rate. Average return was about BRL 4 when compared to the exchange rate of BRL 3.68 we had in Q1 2019, an almost a 10% increase. Let me remind you our policy to hedge 100% of purchase orders from imported inputs. We had additional hedging earlier this year to protect us from purchases throughout the year. The impact of lower exchange rates will be minimized in gross margin for 2020. Factors that negatively impacted include high number of returns above our expectation, but things should get back on track in the remainder of the year. The better gross margin helped our EBITDA margin to go above 30%. We had more discipline in managing expenses in Q1, given the pandemic.
Let me give you some color on that. We reduced our promotion activities in our POSs, given social distancing in several states. That brought about a 25% reduction of those promotions in POSs in this last quarter. In terms of commercial expenses, they remained at the same level that we had last year. Our R&D expenses was offset with marketing and sales force adjustments, and more expenses were allocated to R&D projects. Marketing expenses were BRL 23 million more given the increase of the sales teams and free samples given in this past quarter. Part of that growth was offset given a better negotiation of on and offline media packages. Admin expenses were somewhat smaller, and we had a reduction of BRL 35 million given tax credits granted. Financial results were positive because of the cash flow and given the P&L hedging to reduce or to offset exchange rate variations.
We had a positive contribution from income tax, given the return on capital that maximizes tax benefits. The total amount was BRL 185 million at BRL 0.29 per share, 15% above that in Q1 2019. We had capital gain for shareholders for the fourth quarter in a row. We maintain that return on capital, adjusting their own capital. That shows how confident we are in the cash generation of our business now and also in the future. Let me now talk about cash flow on slide seven. Our operational cash flow was BRL 170 million in Q1. In May, that was more than necessary to support CapEx and intangible investments. Investments in the pipeline projects, they are all leveraged. Just like Breno said, our R&D investments grew by 11% in the quarter, reaching BRL 58 million. All those that were deactivated and those that are activated.
We had a free cash flow of BRL 45 million. Just like Breno said, our goal is to improve our liquidity. We had over BRL 600 million of additional investments by late March. This greater investment, with the additional BRL 300 million, with almost a BRL 2.5 billion, that show our capacity to have access to the capital market, and if necessary, we'll be able to reach the best deals. Maintaining our solidity and our balance is key given the current scenario, so that we can ensure sustainable growth in the long run. Our free cash flow position in the quarter was BRL 240 million after we paid interest on our own capital as to 2019. I'll turn over back to Breno for his final remarks.
Thank you, Adalmario. Just like in all previous crises, this will be no different. There will be opportunities. We're working to come out even stronger.
Recent investments include trade marketing structure focused on the e-commerce platform. Sales more than doubled in recent weeks. In early 2019, we created a virtual medical system. We offered that platform to over 1,000 medical events. They can online and offline operate their clinics. We are getting closer and closer to startups in the medical industry to address opportunities in important industries. Despite short-term adversities, our long-term growth projections in our industry remain intact, especially with the growing population. Concluding, the transformational acquisitions we've had will make Hypera Pharma the leading pharmaceutical company. A robust platform, leading brands, and our strong investment capacities put Hypera as the company that is better prepared to benefit from the opportunities in the pharmaceutical industry in Brazil. Thank you very much. We'll move on to the Q&A session.
Thank you. We'll now have our Q&A for investors and analysts. Press star one to ask a question. Mr. Robert Ford from Bank of America.
Good morning. I hope you all are safe and sound. Let me ask you the first question. Could you elaborate on the current operational trends? Number two, what are the plans for your sales force? How are you trying to implement new technology when things get back to normal? How can you talk about the gross margin? What are your expectations for this year's growth margin?
Hi, Bob. Good morning. Thank you for your questions. I hope you are all safe, your family as well. Let me address the first question. Adalmario will be fielding the third one. As to current trends, in mid-March, we've seen some uptake in demand. We've seen variations of demand, depending on the product. Flu medications, vitamins, especially Vitamin D, they're doing very well.
Acute medication, they depend on a medical consultation. Pediatrics, children are not going to school, are not getting sick. We've seen major changes in performance depending on the category. April started out slowly, but week after week, performance is improving. We should have a net zero growth for April, but a gradual positive trend. In terms of competition, there are some smaller players. They are not as aggressive as they used to be. You know the effect of the exchange rate on our brands and also on the competition. The credit crunch will be even more complicated to smaller players. As to your second question, when we go back to business as usual, our field teams are operating from home. Some weeks later, we gave them a collective vacation, and these teams are slowly going back to the field, merchandising, people that replenish shelves.
They came back just last week, taking all the necessary precautions, wearing gloves, masks. They have a more flexible work hours, and the medical visitation teams are going back to work today. They're beginning to use a new tool so they can visit clinics remotely. We do believe that these new technologies are here to stay. This, of course, will require major changes in the behavior. Doctors, patients are becoming more and more accustomed to telemedicine. This is only working as a catalyst to boost this trend. This adoption rate is picking up. They're changing the way representatives relate to doctors and doctors to patients. I think I answered your first two questions, and then I'll turn over to Adalmario to field the third question.
Hi, Bob. How are you doing? Good morning. We do not have a formal guidance for growth or gross margin. Given the more challenging scenario, given the weaker BRL, we believe the gross margin should be close to what we had in this first quarter. We expect a more positive result from our product mix, new launches, and prescriptions as well, and also because of the positive effect from some categories in our portfolio, such as Vitamin D, such as Addera. Greater margins than the average margin for our products. There has been a substantial growth in demand for this Vitamin D product. A product that was struggling in the past, but as of March, sales picked up, and Addera is a leading brand, so that's why it had a chance to expand its market share.
We believe that the gross margin would be similar to what we had this first quarter. In our budget, we calculate a BRL 5 exchange rate, how it would impact our margins. Let's see how things play out in the weeks and months to come. We'll find out whether any additional adjustments are necessary if the exchange rate goes even higher.
Thank you.
Joseph Giordano from JP Morgan is next.
Good morning, everyone. Actually, I have three questions. The first question is about hedging. You're operating at a BRL 5 exchange rate. My question about the operational hedging, are you using the same exchange rate? My second question is about the pandemic. What was the sell-out up until mid-March? You ended with at BRL 11. I would like to break that down if possible. Maybe trying to extrapolate numbers for Q2. What is the take of those products in the total sell-out? My final question is about price increase of some 4% odd. Is there any chance of a gradual price increase given the pressure from exchange rates that are higher?
Let me answer your first question about hedging. Ever since we announced the acquisition of Takeda, we've been hedging, reducing our foreign exchange exposure. It was about BRL 450 then. On the first day, we did some hedging. The average cost today, the average rate, it's about BRL 516 on average. About BRL 240 million that we hedged. We are, of course, closely monitoring it. When it's close to BRL 5, we can increase our hedging level. Our intention is to reduce our exposure even further. As to the purchasing hedge, we've always done it once we place orders all the way to the payment. When we place the order all the way to the payment date, we've been hedging.
The only thing we did differently was to have that additional hedging operation to cover the entire year. For the first two weeks of January, we locked that exchange rate all the way to June, between BRL 4-BRL 4.10. That was the expectation earlier this year. When we have that purchase hedging, plus that additional hedging operation, we hope that this higher exchange rate will begin to impact our numbers in late September, more towards the end of the year. We'll be monitoring it to increase that hedging even more. As to the other questions, what was your second question?
The sell-out pre-COVID-19, what would be the trend without the pandemic effects? My second question was, how much prescription, or what's the participation of prescription within your selling?
Well, things picked up. It was in the high single digits in the first two months of the year. What happened was the demand variation back in March. Cosmetics slowed dramatically, the market didn't grow in Q1. It's more important to us than the market average. Prescription overall accounts for about 40% of our portfolio. You have different effects within prescription. Acute medication suffered the most. People are not working out as often. They don't get hurt as often. They don't go to the doctor, and there are fewer prescription drugs being prescribed to patients. There's a growing trend. We could not react as positively in selling, given the fact of the delivery of goods were also hurt. This has been recorded yet in Q2, we hope there will be some effects by the end of the quarter.
As to price increases, I think the associations or the trade associations and the government have been negotiating the price increases. We believe we are going to have the price increases that have been announced. This will affect 16%-18% of our portfolio. As of March, price increases had been authorized for similar and generic products. We have a very high level of discounts. Even if prices do not go any higher than what had been announced, there won't be any changes. The impact will be in prescription drugs. They're similar to the list prices already, and that will impact about 17% of our portfolio, as I said.
Thank you. Thank you, Breno. Thank you, Adalmario. Have a good day.
Mr. Gustavo Oliveira from UBS.
Good morning. Sales were below expectations in Q1. What are you thinking about the guidance you had announced? Do you believe you can maintain that guidance? You also said that in Q1, the market didn't grow as much. What are the market expectations? What were the growth expectations for the market as you're considering?
Sales were smaller in sell-in than we expected. It was not that different from what we expected. If you take sales from Q1 when compared to the guidance for the year, it's about 19%, right? Sell-out accounts for about 20%. That's about 20% for the rest of the year. We have a very strong portfolio for the winter, especially Q2, Q3, flu medication, and antihistaminic, Rinosoro, Princini. They usually sell more in the winter.
Sell-out for Q1 is a little more?
Yes, that's right. It's less than a quarter for the year. In other words, we are comfortable with those numbers. There was more demand towards the end of the quarter. We could not replenish stocks because deliveries were hurt. That can be offset in the first weeks of April.
I understand. What is your expectation for the market growth? The market was flat, and you had 11% growth in sell-out. You gained market share. What is your take for the rest of the year?
It's too soon. We expected high single-digit growth, but we've been talking to customers. We've seen that happen in several of our customers. We will have weaker growth in April that will offset the stronger growth we had back in March. We do not see any reason to change our guidance, but we do not expect major variations in demand. When you consider market averages, some categories will suffer more, will benefit more, as I said. I believe the trend should be maintained, high single-digit growth.
Let me ask you a final question, if I may. I missed the initial presentation. Could you please elaborate on why it happened?
What I said, we were expecting to conclude that work in April to present that proposal to regulatory agencies. Given the pandemic, we had to postpone some meetings. We believe the process should be concluded in late March. It's a one-month delay.
I believe you've been talking to some regulatory agencies, haven't you? Do you keep on talking to them?
I do not have any detailed information. The impact is internal.
Thank you very much. That was very clear.
Gustavo Miele from Itaú BBA.
Good morning, Breno and Adalmario. I hope you are all well. Two questions. The first one is about the dermatology portfolio. Can you share some information about that portfolio, about its weight, and your total sell-out? I think there are nine brands. Do you expect growth that will be very different? Could you give more detailed information about these brands? Thank you. My second question, can you elaborate on that partnership you had with Rappi? Do you expect or do you consider extending that kind of partnership with other products? These are my two questions. Thanks.
Let me answer your first question, Breno. We'll view the second. Strategically speaking, that discussion, that partnership brings in a lot of synergy. Cosmetics, skincare, it's a leading brand in Brazil. You have, of course, L'Oréal that owns several brands. As a single brand, we are leaders in that segment. We have that need for medication in that cosmetics industry. They supplement that portfolio very nicely. Initial sales are low, but we believe that under our portfolio, once we can expand promotions with our representatives, we can increase sales, especially in the first and second years after the start of the promotion. They had less or fewer than 30 representatives.
We have over 150 reps. The boost in sales will be captured further down the road. As to the partnership with Rappi, we're taking into account the social aspect. Any purchases of medications through Rappi, we are offering that free delivery. Thinking about the social aspect, and also to promote Benegrip and Addera. It's a long-term marketing activity with that social component, as I mentioned. We don't expect major sales in the short term. Of course, we're considering other initiatives, sponsorships of these live streaming. Engov Benegrip, and donations. As I said, we made that donation to an NGO in the state of Goiás. We donated 20 ventilators to the city of Anápolis. We're conducting several activities along the same lines.
Thank you. I'd like to ask a third question, if I may. I had to leave the call for about 10 minutes, and I would like to apologize if you already mentioned it. Did you detect any replenishment activities back in April to offset that mismatch in sell-in, sell-out in March? Have you noticed some activities in that regard?
Yes. We've seen an uptake in customer orders once delivered. Orders were placed by March 31st, but replenishment orders had already been placed. This mismatch must be adjusted or should be adjusted in the next quarter.
Thank you very much. That was very clear.
Fred Lins from Bradesco asks the next question.
Good morning. I have two questions. Let me go back to what Gustavo said. I would like to understand whether that drought in Anápolis had some impacts. That's my first question. When you renegotiate with customers, I know you deal with major players, but these smaller players are being more aggressive trying to renegotiate prices. What's that situation like?
Let me answer the second question first. We haven't had any major conflicts, because that segment is operating somewhat under normal conditions. There haven't been any major impacts in our customers' results. Therefore, there's no need for renegotiation. Of course, we have been preparing ourselves if the scenario becomes any worse. However, delinquency rates, we haven't detected any major issues right now, because there is demand. What was your first question again?
I want to understand the dynamics of revenues. I know Gustavo talked about it, but was there any impact because of that drought? My question is, was there any impact in this quarter as well?
I believe it ended up affecting it too. We talked about it in Q4. Because of the water problem, we had low inventory levels. It happened part of it in Q1, part of it in Q2. We are getting back on track slowly in Q2. Because of the demand concentrated in later in the quarter, the inventory levels in our customers was somewhat smaller than what we expected.
Thank you. That was very clear, Breno.
Irma Sgarz from Goldman Sachs asks the following question.
Most of my questions have already been made or have been asked. My question's about new products. My question's about the marketing mix and what we can do to reduce expenses. My question's about the balance between reductions or in marketing efforts and slower sales.
Let me answer the first question. As to our pipeline, it's a robust one. Almost 100 new launches for the year, most of them in the second half of the year.
We don't see any impacts. We are in the pre-launch phases. We are still getting some raw materials. We're conducting training programs. The schedule hasn't been changed. Of course, we're closely monitoring the situation. Our medical visitation teams, merchandising teams, they should go back to work this week using a new tool that had been tested as of last year. Q2 launches will be conducted using this platform. Of course, this schedule will be dependent upon the pandemic. Drug stores have been open, but some categories, specialists, doctors that are specialists, we should be close to them. We'll be monitoring the situation as time goes by. As to your other question about reductions in expenses, we're not reducing our investments. We're not changing our investment plan. We ran some simulations. If necessary, we'll cut costs, but we haven't detected the need for those cuts.
Some areas, when you visit doctors, reps were on vacation, doctors' offices are closed, clinics are closed, free sampling is not happening. Travel expenses were not incurred. We'll be reducing those expenses because we have just found out that we can do many things online. Sports events. We are renegotiating our campaigns on television. We're not reducing. In April, people are home, TV rates are high. We'll keep on investing in media for the second half of the year. We're not reducing those expenses. We're just reallocating them given the scenario changes. For example, we had an investment plan for the trade marketing in our e-commerce platform. We reallocated those investments to April and May. People are purchasing way more. We are reallocating those investments, but we're not reducing marketing investments. We're keeping our focus on the sell-out and market share.
Tobias Stingelin from Citibank.
Good afternoon, Breno, Adalmario . I have a very quick question. You talked about Addera. I think it reached 10% of sales, right? You changed the protocol. Now, with the pandemic, what do you expect from the growth of that category?
It's about 6%. That's what it accounts in our total portfolio for the year. It was going down about 15%-20%. Now it's back on the rise. It's too soon, Tobias, to detect or to determine whether it's a trend or not. We'll be conducting some clinical studies to try to determine its uptake in sales and the COVID-19 pandemic. Yes, it was a very positive impact on the short term.
Are you talking about Addera specifically? Users.
It was positive. Low single digits, a marginal growth. The brand was growing slightly.
Vitamins are not that important to us. What's the ballpark figure for vitamins.
As you know, Tobias, we have strong brands in that segment. We have relaunched the Vitasay brand and Centrotabs. That's called a smart choice. Our share is still small. March and April proved to be strong months. We have very strong media campaigns on TV. Centrotabs has very good distribution. Addera, Vitasay, and Centrotabs. That accounts for 78% of our portfolio.
Thank you.
This concludes the Q&A session. Mr. Breno Oliveira will be making his final remarks.
Thank you for taking part in our call. As usual, our IR team is available to answer any questions you may have. Thank you. Have a good day.
Hypera conference call ends now. Thank you. Good afternoon.