Here with us, Mr. Breno Oliveira, CEO, and Mr. Adalmario Couto, CFO and IRO. Also Ms. Vivian Angiolucci, Strategic Projects and Planning Officer. 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. After the company's remarks, there will be a Q&A session only for investors and analysts, when further instructions will be provided. Should any participant need assistance during the call, please press star 0 to request the assistance of an operator. Questions can only be asked by telephone, so if you are connected to the webcast, you should email your questions directly to the IR team at ir@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 you that statements made during this conference call might be forward-looking statements, which refer to future expectations and, therefore, are subject to known and unknown risks and uncertainties that could lead the company's actual results to not match the forward-looking statements. Now, I will turn the floor over to Mr. Breno Oliveira, who will start the presentation. Please, Mr. Oliveira, you may carry on.
Good morning, everyone, and welcome to our results conference call relative to the first quarter of 2019. Before I start the comments about the company's operational performance, I would like to touch upon the works of the independent committee. No major news on top of what has been already reported in the last call. Works have been continuing as planned. We do not have a deadline for the conclusion of the work conducted by the committee.
There is no impact on our everyday activities and on the company's strategy either. We continue to work and make the necessary investments to speed up the mid to long-run growth of the company. Now, moving on to the operational part. As I mentioned in the last call, the optimization of the company's working capital was one of the priorities for 2019. We would go after that as early as the first quarter of the year. Since the change in the company's top management one year ago, we have been discussing the need of an investment in working capital, especially in receivables.
With the operational improvements that we obtained since the end of 2017, including an increase in production capacity, a reduction in lead time, and also an increase in the coverage by our sellouts team out in the field, we concluded that we were in a position to reduce our inventory at the clients and consequently invest our working capital. As expected, we have been successful in concluding that adjustment process in the first quarter of the year. We have reduced sales, selling at the branded prescription and consumer health units, reducing the inventory level of those products at the clients, and consequently, with an average time of receivables. Starting the second quarter, we started to concentrate all our efforts in the growth of the sellout brand arm, keeping the current inventory at our clients. This new model brings on board a series of benefits to the company.
Among them, allocation of 100% of funds for clients for the sellout of new products, a higher assertiveness in sales planning, and a lower level of orders which are not met at the factory level. An easier way to place products with our clients of new launches, which is key to the success of our growth. On top of a lower level of working capital, which will contribute to a positive operational cash flow, and for the allocation of more efficient capital in expanding the plant and in projects of innovation.
We also were able to book the tax credit relative to the favorable ruling over the exclusion of the ICMS, the state tax, in the amount of BRL 546 million, and we saw a growth of EBITDA by 11%, and of the net revenues of continuing operation of 10%, despite the one-off adjustment, which resulted in a drop in revenue to the tune of 60%. Starting this quarter, we'll now share information about sellouts, the objective is to give more transparency to the market about our performance. In the quarter, our sellouts grew 6% with a tendency to accelerate. In the months of February and March, the growth sat at 8.5%, whereas the pharmaceutical market as a whole grew by 8.8% in the first quarter.
This accelerated growth in sellout of the company starting the second half of the quarter was boosted mainly by investment in marketing, points of sale, and also by the initial results with an increase in coverage by our field sellout team. We continue with our bold investment plans to leverage the sellout growth in the second quarter and throughout the year, including promotions, visibility actions at the point of sales, and also media initiatives, which should benefit demand generation and also our revenues, which in the second quarter will have a performance which will be in line to that of the sellout. On top of those investments, we also launched important products in this quarter. For example, Fluviral Dia , day and night in the market, and the anti-flu drugs, as we run deep in the painkiller market.
Lastly, in the last Friday, the board of directors approved the creation of a new planning and projects office, which will be led by Vivian Angiolucci, which will focus on projects that will generate value with the objective of reaching a new level of effectiveness in terms of commercial and operational arms. The board also approved the appointment of Adalmario Couto, IR and New Businesses Officer, as CFO of the company. Adalmario will continue with his activities related to new businesses and will add to that the CFO task. On top of those changes, Luiz Clavis, Vice President of Marketing and Sales since 2018, is now part of the company's executive office. Sweet. Now I give the floor over to Adalmario, who will comment on the company's quarterly results.
Thank you, Breno. Good morning, everyone. First, sorry about my raspy voice. I just bought Benegrip, Coristina, Menozono, our anti-flu bundle to take care of that. Let's move on to the numbers of the quarter and talk about our future perspectives in more detail. In this quarter, we have an impact of two non-recurring effects in our revenues. We had a reduction to BRL 386 million, as mentioned by Breno. This was impacted by the optimization of the working capital, which led to a drop in sales of branded prescription and consumer health products. We also had a positive impact of other revenues of almost BRL 520 million due to that tax credit related to that favorable decision or ruling over the exclusion of ICMS from the calculation of the base of PIS federal tax. The gross margin reached BRL 148 million.
That reduction is tied to a reduction in sales of branded prescription products, which raised the relevance of similar and generics in sales. Our expectation is that gross margin will be normalized around 30%, starting in the second quarter. Even with a drop in revenue, we maintained relevant investments of about BRL 160 million in marketing to boost mainly growth and sell-outs of our leader brand in several categories, and also recent launches, with a higher focus on initiatives to generate market share. For this year, our ad packages will be more relevant to the appearing in the second quarter because of the higher concentration of launches for this year, which will happen in the second quarter. Expenses in SG&A had an increase of 5.5%, which reflected mainly the growth of 20% in our R&D expenses, and also an increase in our sales force.
This growth shows our commitment and continue to invest in innovation and in accelerating the launches of new products. The total investments in R&D included an amount accounted for as intangible assets and totaling BRL 51 million in the first quarter, 31% above the first quarter of last year. With that, continuing operations EBITDA reached BRL 401 million, a growth of 10.10% quarter-on-quarter. The net income from continuing operations reached BRL 331 million, up 9.5% when compared to the previous quarter. I'd like to emphasize that the company paid out interest on capital at the tune of BRL 161 million or BRL 0.25 per share, an increase of 20% when compared to the first quarter of 2018. Moving on to our cash flow and indebtedness in slide number six.
Our cash flow from operations sat at BRL 192 million, 25% below the other quarter. The main driver was an increase in income tax retention on capital when compared to the previous year, which we exclude that effect. The cash flow stayed at the same level of last year. We will have a drop in cash generation in this quarter because of lower investments in this first quarter. Free cash flow was lower than first quarter of 2018, also impacted by a drop in investment or impacted by the investments in the plant expansions in Anápolis and other R&D investments. Our net cash sat at BRL 613 million, or BRL 163 million was the number reached in the first quarter of last year. An increase in net cash or free cash flow when compared to last year was mainly due to a growth in free cash flow in the period.
Now I give the floor back to Breno for his final comment.
Thank you, Adalmario. To wrap up, in this quarter, we concluded the optimization of our working capital, which we had scheduled, which will bring about several benefits for the company and for our shareholders. On top of that, we started to concentrate our efforts in the sell-out growth, besides having already defined and implemented new initiatives to boost growth as early as the second quarter. Those initiatives include important launches for the consumer health unit already scheduled for the second quarter in the market for vitamins and anti-flu drugs. On top of innovations, which will contribute to a pickup in growth for vitamin D markets in the coming quarters.
We are confident that all these initiatives will boost our growth in sell-outs as early as this year, will contribute to our sustainable growth in the mid to the long run. We continue. We remain confident in the potential of growth of this market in Brazil. Hypera Pharma is the best-positioned company to capture those opportunities. We have the most attractive margins in the industry, we are the company which invests the most in innovation, in expansion, and productive capacity. We are the only company which operates relevantly in all segments across the Brazilian pharmaceutical market: OTC, OTX, branded prescription, dermo-cosmetics, similar and generic products. We have invested heavily in the past to create this single, unique platform, which is very difficult to be replicated. We continue to invest to make sure we maintain our growth in a sustainable manner for the next five to 10 years.
We'll now move on to the Q&A session.
Thank you. We'll now start the Q&A session from investors and analysts. If you have a question, please press star one. The first question comes from Mr. Tobias from Citibank. Mr. Tobias, you may carry on.
Thank you. Good morning, Adalmario, Breno. If you could give us some more color in terms of sell-out for the remaining of the year, what kind of speed do you see that growing? You mentioned that in January it was better, you're also investing in sales force, you're also investing in marketing. Can we have a better idea of what to expect moving forward for the end of the year, for the other quarters? Also, specifically about the sell-outs, you're comparing those 6% with the market as a whole on comparable basis, or are you talking about an absolute number?
I'd like to understand that number a little better. Are you going to adjust those to different categories so that we could have a better idea of what's performing better and what's performing not so well?
Okay. Hello, Tobias. Thank you for your question. As for the first question, we expect a gradual growth throughout the year. A good portion of our growth will come from launches. Some more mature markets, as I have mentioned, have been decreasing somewhat, we expect to offset that with new launches, this will happen gradually throughout the year. The expectation is that at every quarter, we'll have a small acceleration in growth in sell-out. As for your question about the breakdown of the sell-outs, that's the total number. With no adjustments whatsoever. That's a market absolute number.
As the market, we also grew more under similar and generic products. As I mentioned, the vitamin D market and anti-flu market in the first quarter, that market as a whole performed negatively, a drop of around 6%, but we have our own initiatives, as I mentioned, to leverage our growth in this specific market. Anti-flu medications, we are going to be spinning up more. It's becoming more relevant in the second and third quarter because of the flu season, of course. The market for vitamin D, we have a few launches and a few initiatives to leverage growth even in a market which is not so positive.
Okay. Just a follow-up question. Sell-out is part of your compensation targets. Is that target based on market share, or are you talking about growth? You have lost some market share. That's why I'd just like to understand, is sell-out an absolute number for that target or is it not?
We also included some growth in that equation, which is at the end of the day, is what matters to define inventory levels at clients and also the delivery of our results to shareholders. We could also do that based on market share. It's implicit in our budget that there is an expectation of a gain in market share as well.
For this year, too?
Yes, for this year as well.
Okay. Thank you.
The next question comes from Mr. Giordano from J.P. Morgan. Joseph Giordano, carry on.
Good morning, everyone. Breno, Adalmario, thank you for taking my question.
Going back to the innovation issue, I'd like to understand a little more how has the innovation index behaved throughout the first quarter, given the high volume and launches in the second half of the year? Also a follow-up, you mentioned that gross margin will probably resume 70% level. When we look at vitamin D, that's a segment with a very high margin, right? I'd like to understand if vitamin D may be somewhat of a hinder in that project. As for the tax credits, I'd like to hear from you how will those credits be consumed throughout time. Lastly, if the receivables level today at about BRL 1 billion, if that level should be the standard going forward. Thank you.
All right, Joseph. I'll start with the first question. Then I will continue.
Innovation index in the first quarter stayed at 28%, a slight drop when compared to the fourth quarter of last year, it was expected. We expect that this year the innovation index will remain at that level, around 30. It will pick up in 2020 because we have products which are now leaving the index. We only consider the past five years, we have some relevant, Addera, for example, which will leave the innovation index. We'll maintain the index for the new launches. Starting 2020, we do believe that that index will pick up. I'll also answer the credits question, then Adalmario will address the margin and receivables issue. As for the tax credits, we believe that we won't be using that in the short run. We already had something close to BRL 300 million in federal credits.
This year, we will amortize the bonus. We'll start now consuming those tax credits now, and also the accumulated fiscal damage, or loss, which is above BRL 1 billion. There are several assets on the table right now, but those credits will start being used, I think, I believe, in about 2 years. An interesting thing to mention is that as this was a tax which was unduly paid, it is corrected as we move forward. It's not a problem to use them in the mid-run because we accumulate a financial revenue, which will be corrected until the date when it's actually used. I give back the floor to Adalmario for the other questions.
Hi, Joseph. We believe that starting the second quarter, that margin will resume the 70% level, as I mentioned, especially because we'll be more relevant in terms of brands.
Because of the sellout initiatives and also because of new launches. The mix effect will improve when we compare that year-on-year. The first quarter was a one-off quarter, right? The second quarter will be business as usual. We'd expect a mix similar with what we have in the previous years, even with a drop in market for vitamin D. As Breno mentioned, we have several initiatives which are already being implemented to gain market share in that market. Even with a slowdown in that market, we expect to gain market share there. We'll be working with the level of inventory we closed the first quarter should be maintained throughout the year. That's the strategy going forward. As for the receivables question, that should increase in the second quarter as we have a more normalized revenue level.
We expect that investment in working capital will resume levels close to what we had in 2015, 2016. That's what we are working on.
Okay. Thank you. Just one follow-up about credit. You feel that there are some outstanding legal issues to recover past credits. Can you give us a magnitude of those credits still to be received? In your expectations, you mentioned that there are legal cases still requesting for credits. How much is that still outstanding?
This is Vivian. Hello. Those credits are not really relevant. It's immaterial, I'd say.
Okay. Thank you.
Thank you.
Have a nice day.
We have a question from Mr. Mauricio Cepeda from Itaú BBA. Mr. Cepeda, you may carry on.
Hello. Good morning. We saw a nominal drop in marketing expenses, as you mentioned in the release. My question is, what should be a normalized marketing expenses?
Would it be something close to last year for the next 3 quarters of the year? The second question is if you have an idea of how much that drop in marketing expenses affected the sellout, or where would your sellout be if you had had a more normalized marketing expenses level? That's the question. Thank you.
Hello, Mauricio. As I mentioned in the release, that drop had to do with the seasonality of the year. In the second quarter, with several new launches that we are promoting, also using media outlets, and also the anti-flu medications coming on board, that will increase. For the year, as a percentage of the revenue, we do not expect to see a drop. Excluding the first quarter, of course, where we had a lower revenue.
For the remaining of the year, we expect similar levels to what we had in 2018, maybe with a migration towards marketing at the points of sale. With all the action initiatives that I have mentioned, we should see some migration towards marketing at the point of sale. Medical visits as well will increase. As I mentioned, we have increased our sales force in terms of visiting doctors, so that's also a place where we should be migrating marketing expenses.
Okay. As for sell-out, do you have any idea what kind of effect did the sell-out suffer with the drop in marketing expenses?
No. There is no direct relation in the short run. We're talking about an investment in the mid-run, an investment in the brand. No relationship with the short-run sell-out.
Okay, Breno. Thank you.
Next question comes from Mr. Ruben Couto from Santander. Mr. Couto, you have the floor.
Good morning, everyone. Could you talk about the inventory level after the first quarter, in the direct channel, small chains, and how was that received by the market? Is there still something to be done, or can we assume that all adjustments, irrespective of the size of the clients, has been done? Thank you.
Hi, Ruben. No, it's all been done. As I mentioned, the adjustment has been done in the first quarter. We are talking about clients who work with branded prescription, both distributors and chains. As you mentioned, we have been talking with those clients throughout the past months. The process was quite agreed upon from both sides, a very transparent negotiation if you will. There are no other adjustments planned going forward.
Okay. If I can you share with us the expansion status at Anápolis? Just the schedule, if you may, in terms of expansion for Anápolis.
We hope to have the expansion finalized by the end of next year. In the second half of the year, we'll start some civil works, construction, and then we have assembly equipment, so that we'll have a plant operating at 100% capacity by the end of 2020.
Okay. Thanks.
Regardless, we have other initiatives to increase our capacity. We're buying machinery or higher capacity machinery at the same time. So we hope to see a growth in capacity irrespective of the completion of our expansion in Anápolis by the end of next year.
Okay. Thank you.
Next question comes from Miss Irma Sgarz from Goldman Sachs. You may carry on, ma'am.
Thank you for taking my questions. Breno, 2 questions.
As for the adjustments you made, I thought it was interesting that you now have a metric which is linked to the sell-out, which is related to the variable part of the bonus. What has changed inside in terms of processes? What have you learned with those adjustments? Those were somewhat large adjustments that you made in the past 6 months, and especially in the first quarter. What's different now? You have checks and balances, more monitoring to avoid problems in the future. The second question is as with the guidance. I understand you are maintaining the guidance for this year. It would be useful to know, if you have different impacts on the profit line, it would be nice or useful for the market to know what you expect in terms of market growth, in terms of the top-line growth.
In other words, around the company's fundamentals. Thank you.
Hi, Irma. I'll start with the guidance question. As for the guidance, we are maintaining the guidance, as you mentioned. We see no reason now to change that. We are not providing a top-line guidance as we did in the past, but the growth in net income is quite in line with our growth in top line and also with market growth. Excluding the first quarter, we're talking about a growth of around high single digits, both for our top line and for the market. High single-digit growth. Consequently, maintaining margins to meet that net earnings guidance. As for the other question about the changes and adjustments that were made, I'd say that in terms of visibility, we already had a good level of monitoring of stocks or inventory at the clients. It was our internal policy.
Our policy was to have a higher inventory, but with the improvements we've seen inside the company, we felt safe enough to bring that inventory level slightly down and maintain the same level of service provided to clients. As I mentioned earlier in this presentation, we saw changes in efficiency, in logistics, and delivering the products, improvements at the factory level in terms of capacity, fewer problems with lack of product, by significant reduction in orders not filled. We also improved several processes. Sales and operational planning is one of them, which is now more in line with the business units and the plant and with the logistics arm and other areas of the company which are involved in the process. There were some changes throughout the past year and a half, which allowed us to make that adjustment at this moment. I'm not sure I addressed your questions.
Yeah, no, kind of. Okay. Thank you.
Next question from Mr. Vinicius Figueiredo from Bradesco BBI. You may carry on, sir.
Good morning, everyone. Thank you for taking my questions. Two questions. Number one, the changes with Adalmario and Vivian. I can't understand the scope of Vivian's new role. What does that impact in the company's day-to-day operations? Number two, looking at your SG&A, it increased by 12%, which is partially explained by a drop in the payroll. Can you give us a breakdown of the impact? Is there anything else to explain that increase? That's all. Thank you.
Vinicius, I'll address the first one, and then Adalmario will address the second one. This is Breno. As for Vivian's role, she will maintain some of the tasks she was already in charge of.
For example, planning was something she already did, and we'll add other activities, which is related to projects. The idea, as I answered to Irma, we are trying to achieve improvements in other processes in the company. Of course, at the end of the day, trying to generate more value for the company so that we can invest in those areas that generate revenues and benefits for the company in terms of marketing or the company. In other words, reallocating investments. That's the main objective, the main target of Vivian in this new role that she will be playing. As for the impact of the compensation, we're talking about BRL 8.6 million in EBITDA, but that was offset by an impact of CPC 16.
Compensation alone, we would reduce our EBITDA by BRL 8.6 million. CPC 16, which has to do with the reclassification of leasing revenues, would have an impact of BRL 8.2 million positive. In other words, one practically offsets the other.
Okay. Thank you. Next question from Mr. Gustavo Oliveira from UBS.
You may carry on. Good morning. Thank you for taking my questions. Breno, going back to the inventory question. You mentioned that in the past 18 months, you implemented processes that allowed you to make those adjustments now. What were the premises? What did you base your decision on? Is logistics better, more efficient, or would you say that clients are more comfortable working with lower inventory levels? Are you going to be working with an inventory level which will be much lower than that of the industry, or not? Will that lead industry to decrease average inventory levels or not?
Maybe you do not have such a sophisticated client that is able to work with low inventory levels, and what kind of increase in logistics expenses that entails. What led you to make that decision, in other words? You did not adjust similar engineering products. Is that in the radar, or we're talking about a different dynamic for that specific industry, where you have different inventory levels? When you complete your expansion process, you think you will need to make our adjustments going forward? I'd like to have a better idea of the sustainability of that decision. How will that impact your consumers or clients, in other words?
Hi, Gustavo. We believe that, as I said, the adjustment was finalized in the first quarter. We believe that we are closing with the new inventory level is upwards in the range of the industry average. We still benefit from the fact that our inventories are slightly higher than the average. The idea is to avoid stock-out. As you know, at some clients, that's not a simple issue. Some clients have 6, 7, 10 distribution centers throughout Brazil. Per SKU, we have about 1,000 SKUs. For each DC, to analyze that's quite complex. We are still sticking to that policy of staying in the upper range of the industry average in terms of stock or inventory. Now, as for changing the policy, as you asked, we are keeping a close eye on that, and I mentioned that sellout is part of the target.
Just as working capital inventory levels, those are also part of our targets for the business units. As for the logistics cost, it's the opposite. We believe that cost will drop because of that. We hope that with these new commercial policies, we will have a more efficient process that will lead logistics prices to go down. We do not believe we will see an impact in the short run. No. In the mid run, we expect that number to go down, not up. As for similar and generic products, we have not made any adjustment. We did not see an opportunity there to improve. In this case, the level of inventory that we have is beneficial, is good, it's even helpful to clients that will encourage sellouts on their part.
In this case, we do not intend to make any adjustment, again, for similar and generic products. Have I covered your concerns, Gustavo?
I think you've covered, yes.
Just one more thing. For similar and generic products, it's like you said, it's the opposite of what I thought. Maybe because the margins are lower for some distributors. I don't know if I'm right in my rationale here. I would expect an adjustment, to be frank. Maybe it's a little early to talk about that. It's like you said, it's the opposite. For us, margins are lower when compared to branded prescriptions. For clients, margins are higher. Usually, clients, especially the smaller ones, do not pass on the same level of discounts that they receive. They have significant margins, much better in generic and similar products than with branded prescriptions.
On our end, we do not see our inventory levels as too high that would justify an adjustment in this policy right now.
Okay. I have two more questions. Your inventory level has increased 30% year-over-year. Accounts payable also dropped. I saw that. The speed was not comparable. How do you see inventory levels going forward? What would be the ideal level? Also looking at your numbers, when you compare net to gross sales, the return levels increased significantly, up to BRL 30 million. Is that linked to the adjustment you mentioned? I'd like to understand that dynamic a little more. Lastly, what the percentage of vitamin D and anti-flu medications represent in your total sales? That might affect your margins down the road, so if you could give us a breakdown for that. Thank you.
Well, Gustavo, inventory levels grew significantly, especially because of finished product inventory. Factories working at normal levels. As I said, we're talking about finished products mainly. As demand resumes normal levels in the second quarter, the idea is that will reduce the inventory levels throughout the year, especially for branded prescription products. For returns, what would be the level which would be comfortable? Last year, we had a safety inventory for raw materials. Today, raw materials, we consider to be at an adequate level. Now we have a higher inventory for finished products. The idea is to close the year with the same levels we had for last year. Okay.
You're going to have few less inventory for sellout, would it make sense for you to have a higher inventory, or would you say that the process is so much improved that you can work now with a lower inventory when compared to your DC? Maybe you have a higher delivery frequency, I don't know. Exactly. We have reduced our lead times. Last year when compared to 2017, we shaved that by more than half the number of days for the lead time for clients. That's clearly a major benefit that allows us to work with lower inventory levels. This quarter, we saw that in fact, because the factory, the plant never stopped. We are resuming normal levels in the coming quarters. Just to complement, Gustavo, even with this level that Adalmario mentioned, the average of last year, it's still higher than what we had in the past.
We do not foresee problems in terms of lack of products because of the current level of inventory. Okay. As for returns, yes, you are correct. There is an impact coming from our policy to optimize working capital. We had an additional volume in terms of returns of products. That's another benefit, another encouragement for us to optimize working capital going forward. The idea is that as that volume drops, is that will reduce that number of returns to the lowest possible level. That cost associated to returns was taken into account in our strategy to improve working capital. Okay. For vitamin D and anti-flu medications, well, they represent about 20% of our revenues. 20%. As a complement also, but that number is going down. If you look back, that number was higher.
With the launches we've made in other categories, the trend is that dependence, if you will drop throughout time. Thank you. The questions you need to address for vitamin D and anti-flu medications, are they issues of competitiveness or of other nature? For vitamin D, we see a very fierce competition. There is price pressure. Does the same go for anti-flu medications? In both cases-- Well, the competition for vitamin D has been in place for some time, since 2016, as other players joined the market. We've seen strong competition, but the main problem was the slowdown in the market. A market which grew in the past 40% in the second half of last year, grew only by 14% in the year as a whole. In this year, a drop of 6%, so very different dynamics. The same goes for anti-flu medications.
2017, the market grew by 20%. Last year it was flat, this year we see a drop also of 6%. More than the competition itself, the major impacts came from other factors. For anti-flu medications, we didn't have such a strong flu season in 2017. For vitamin D, the numbers dropped because we saw a lower number of prescriptions from doctors because of a change in guidelines, especially in the early months of last year.
Okay. Thank you for your answers. Have a nice day.
The Q&A session is now over. I'd like to turn the floor now back to Mr. Oliveira for his final remarks.
Thank you all for participating in our call today, and as usual, our IR team remains available for comments or questions you may still have. Thank you. Have a nice day.