Arezzo Industria e Comercio SA

BOVESPA:ARZZ3

Earnings Call Analysis

Solid Growth and Strategic Moves Boost Arezzo&Co's Performance

Arezzo&Co reported strong revenue growth of 7% year-over-year to BRL 2.9 billion with a stable gross margin. E-commerce and owned stores grew by 11% and 22%, respectively. The company achieved a recurring EBITDA of BRL 203 million and a net income of BRL 135 million. A strategic move with Grupo Soma led to a 23% increase in SG&A due to restructuring costs, which are expected to normalize. The acquisition of a plant improved CapEx efficiency by 11%. The firm maintains a healthy leverage ratio and working capital efficiency, signaling robust financial health and readiness for future expansion and synergies with Soma.

Navigating Financial Changes

During the recent earnings call, the management addressed a significant change in the accounting model related to subventions which impacts net revenue and cost of goods sold (COGS). This adjustment contributes to an apparent increase in both figures, leading to what they believe are enhanced metrics for financial health. The implications here are two-fold: while gross profit remains unaffected, the adjustments yield different gross and EBITDA margins, and a lower income tax burden for the quarter.

Strong Revenue Performance

For the quarter, the total revenue reached approximately BRL 1.5 billion, marking a yoy growth of 7%. Specific brands contributing to this include Arezzo, with BRL 396 million in revenue, and a notable 10% growth in B2B sales. E-commerce channels grew by 11%, while own stores reported a robust 22% increase in revenue. This indicates strong market traction, particularly for Arezzo products which witnessed significant growth during promotional events like Mother's Day.

Stable Gross Margins Amid Inventory Adjustments

Despite fluctuations in sales channels, gross margins remained stable at 54.9%. The management reported no major markdowns were necessary, suggesting that inventory levels are healthy and that pricing strategies are effective in maintaining margins without excessive discounting. This also reflects a positive cycle in operations, underpinned by strong demand in both domestic and international markets.

Enhanced Operational Efficiency

The management highlighted improvements in efficiency, evidenced by a reduction in working capital requirements by 301 basis points year-over-year. Corporate CapEx also fell by 11%, reflecting a strategic decision to judiciously allocate financial resources post-acquisition. As a critical measure, net debt was reported at only 0.8 times EBITDA, underscoring the company’s solid financial footing.

Ongoing Focus on Expense Management

Despite the robust revenue figures, operating expenses grew, particularly in SG&A, with an increase of BRL 17 million or 23%, driven by investments in infrastructure to support the integration with Grupo Soma. Management expects these costs to stabilize moving forward, as they have already begun a streamlining process to optimize efficiency and reduce overheads.

B2B Strategy and Retail Outlook

The focus on B2B channels remains a strategic thrust, given that 16% of Arezzo's revenue originates from these channels. The management expressed that the sell-out performance continues to exceed sell-in results, suggesting a healthy demand environment. They reiterated a long-term growth strategy encapsulating both a focus on franchisees and retail growth strategies, which is crucial for sustaining upward momentum.

Future Prospects and Market Dynamics

Looking ahead, management provided guidance on maintaining stable gross margins and aimed for revenue projections that reflect sustained levels. The overarching growth rate anticipated across key brands, especially those under Grupo Soma, aims for between 12% to 25% growth annually, driven by innovative marketing and brand repositioning. This strategic direction aligns well with overarching market trends, indicating a healthy outlook for the coming quarters.

Earnings Call Transcript 2024-Q2

[Alexandre Birman, executive]

Good morning, everyone. Welcome to our Video Conference related to the Earnings Results for the Second Quarter of 2024.

This is a very special day for us. Together here with us, we have our new member of the team, Tobias Stingelin who will be our M&A Strategy and our Investors Relations Director, and together with us also, we have Bianca Faim, and we would like to thank her for her great work. She will take a very important role, organizing the governance for us as also Chief of Staff; our CFO, Rafael Sachete, who has been brilliant with us in the last 20 years, helping us Arezzo&Co, throughout our journey in such a milestone to us. And in a very special iconic way, I'd like to share this call with our current, not future, but my new partner of an amazing journey, Roberto Jatahy, the founder of Grupo Soma, who will be here available to answer also questions related to all the results of the Grupo Soma for the second quarter of 2024.

As we mentioned, we have an iconic movement, we have rich results that we believe are of satisfying results for the great result compared to 2023 second quarter. And if we focus on a structured way, the CAGR we reached in the last 3 years is very high. Our year-over-year is of 22%. So we were able to have a solid growth. And obviously, it's a moment where we dedicated much energy and attention to constituting Azzas Group and we will briefly give you information about Azzas 2154 that will also have a special day in the city of Blumenau tomorrow. And our sellout, which is also including of our franchising because of the significant 10% growth, we were able to reach a high number of revenue when we compare to the last year. When we talk about our brands as Vans, our men's apparel and also Anacapri, which shows a 10% growth. Tomorrow will be very important. We will give details of how we built our governance and how we define our organizational structure, and we will prioritize on the synergy phases where we already see good results when it comes to the details of the next or the last 6 months of work, excuse me.

A bit more of a snapshot of our results. We have a BRL 1.5 billion for our gross revenue, based on a very strong base compared to 2023, and the accrued for the year, we have a BRL 2.9 billion gross revenue, 7% year-over-year growth, and stable gross margin where we have reached a fine growth. And when we talk about recurring EBITDA, we'll talk about the new mechanics together with Soma Group, BRL 203 million and a net income of BRL 135 million of 10% recurring net margin, a maintenance on our invested capital of 25.1% and a growth both in domestic markets and abroad, which is the foreign market that focus, which was reduction of expenses, we were able to have quite a leverage of operating margin. And to get into our channels, we have here on the pie chart on the bottom right, we have the split consolidating all our brands here, and we always have a pie chart that is nearly at similar share. So we have here our own stores and e-commerce reaching more than 50% of our revenues and the B2B very much split between franchise and multi-brands. I believe that the strength of multichannel is very important.

We will focus a bit more about the penetration of B2B market. We have a new launch of our collection for the summer for apparel and handbag. And what was great was to see Commercial Directors present of Soma Hering and also Arezzo&Co to really show the strength that we have and an important role in multi-market.

And I'd like to get into our main brands and highlighting them Arezzo. When we see this revenue here of BRL 396 million for Arezzo, 16% is B2B. So we have quite a sellout, which is very big. The market share is very strong. It was able to balance its growth, and we should highlight the growth of e-commerce of a reserve member in 2015, when we started the e-commerce of Arezzo, we had a concern with the new franchising new stores, but we see quite a growth at a great piece as well. And talking about the most important moment of our quarter, which is a milestone for Arezzo brand specifically, the sellout for Mother's Day had quite a growth, more than 500,000 pairs and handbags sold in 26 days alone. And we also launched the new architecture keeping the Arezzo brand always updated the campaign for the summer collection 2025, [before '25] that can really show here with Sasha, bringing young view to the brand. And in the last quarter, we retrofitted the Iguatemi store, and it really worked well, a very good sales store at a brand that has already a high sales to get in here. We have a rollout for this. And the Arezzo brand definitely is a cash-cow, one that has been increasing growth and that's the goal.

Schutz as we talked about before, goes through a process of reformulation. We reached great results, especially when it comes to branding, specifically for the campaign of summer that started in August. So we have a very positive sales at store and we see the consolidation on the second quarter. It has a slight growth. But when we think about this channel specifically, which is the major source, not only of revenue, but profitability for Schutz, which is multi-brand is very active. We also introduced in 6 stores, the clothes category, where we're selling really well, footwear, which is already 12% of the revenues of this store, highlighting the JK mall store. And here Anacapri that has gone through a wide expansion in the last few years, we have focused here specifically on year-over-year result at 28.9% growth where we have a brand that gets into a maturation stage strongly with B2B channels, multi-brand and franchise. Today, we just have 2 stores, and that is the focus of Anacapri. And we have Anacapri station, which is a hub and a store that is at the Morumbi mall or franchising. And also, we see quite growth in this quarter.

And our menswear, AR&Co had quite a growth of 12.5%. This third quarter that started in July shows very positive results. You might have seen an iconic campaign, very disruptive, made for Father's Day with [indiscernible] with a very positive results for the month of August.

And lastly, here, let's talk about our license business that we had in a parking lot in this moment, not having as our main focus when we're going through the merger with the Soma Group, but definitely it shows our capacity to operate international brands in Brazil. It is something, as I have mentioned, that is not a strategic strategy for the short run, but everything that we can build with Vans will make us have a solid basis. So once we are 100% ready to start our pipeline for this growth, we were talking about for December 2023. We're about to sign one that would be very relevant to Brazil, and we're still working on this deal. So Vans is here to show the capacity of Arezzo to operate. And we know that overall, we did not have a good result in the last few quarters with the Vans brand. And here it shows how our multichannel is very strong, resilient, representing a very strong quarter for the Vans brand that will reach a relevant amount in terms of revenue.

So now I'd like to pass the floor or excuse me, pass into the sellout, and we'll talk a bit about our financial KPIs. So as I said before, had a 10% growth in our sellout reached BRL 1.3 billion, and this includes the sales of our franchise that had a growth of 4.5%.

And to close here, I will present to you the agenda for tomorrow where we have been working on and we're very happy with, right, Roberto about what we've built with our team. I'd like to thank in advance all the energy, the willingness of everyone. We really made a great work to make of 2 companies with multi-brands, multichannel with solid growth to have it up and running to have the largest fashion group in Latin America. So we will have here between Navegantes and Blumenau where we will have reaching around 10 AM, we'll have the registration moment, then we'll start a presentation at quarter to 11 at a plenary session, and then we'll have about 1.5 hour presentation. We'll have a quick brunch. We have this just to give us some time because our focus is on our interaction to be able even to get back a bit before 2:45 with our Q&A session. And lastly, but not less important, everybody, please get ready to dive into their brand. Our slogan today has changed because now it's from 18:18. And I know that everybody has a financial focus on synergies, but it's worth understanding the culture of the Hering brand and what has been implemented in less than 6 months of the creation production that was in Sao Paulo, having a hub in Blumenau right next to the plant of fabric so that we can have a very agile process for creation, adapting the models of what we have at Arezzo&Co, showing the great importance of the industry in the city and to show how important it is for multi-brand and franchise. Then we'll have a coffee break, and then we will have the moment of toast.

So thank you, everyone. I'd like to pass the floor now to Rafael Sachete.

[Rafael Sachete, executive]

Thank you, Alexandre. Good morning, everyone. Welcome to our earnings call.

Let me cover our financial results. Before I dive into the figures, I would like to talk about a change regarding subventions in Q2 '24. This change in the accounting model has an impact in Q2 that is connected to Q1. The third column eliminates the impacts that you see from this adjustment. This is a practice to balance Soma and Arezzo's figures. And this difference takes place in the deductions line right after the gross revenue. So we have one line that is positive, which is credit for tax benefit. This credit has always been dealt within a net manner. So over the figure of subvention, we deduct the size of the ICMS, which is not used when we purchase goods, whereas at the Soma Group, this has been acknowledged in the gross manner. So this difference is acknowledged in COGS. Usually, this change does not alter the gross profit and the EBITDA of the companies. But this difference leads to a higher net revenue and higher COGS. And that leads to different margins, gross margin and EBITDA margins that are different because the gross or the net revenue increases. So we are now using a higher subvention and therefore, we acknowledge non-payment of income tax over a larger figure. The advantage is lower income tax for this quarter, year-to-date figures, and we can also look back at the last 5 years. This credit for the next last 5 years is not acknowledged here, and we will do this in Q3.

So let's look at our figures. When it comes to revenue, we have the e-commerce channels and also our own stores growth of 11% and 22%, then we have AR&Co and Vans. When we look at gross margins and when we analyze it recurringly versus last year, it is flat, same figure, 54.9%. We have some positive and negative impacts in the mix of products and the local market, the impact is positive in the U.S. operations, a higher share of the B2B channel and also of the Arezzo brand. We also worked into some previous inventory. We lost on gross margin, but the impact is a positive for U.S. operations versus 2023. Well, as for SG&A, we have some growth versus last year. We have a negative impact from general and administrative expenses, BRL 17 million, representing 23%. The impact is higher investment in structuring the company to support our strategic move in this joint project with Grupo Soma, and we will not have these impacts in the next quarters.

As for EBITDA, BRL 203 million, 100 bps, and this pressure comes from an increase in expenses and also from an increase in commercial expenses in our own stores and e-commerce, which is a result in the growth of revenue. Net revenue, BRL 135 million. And when we eliminate subventions, we have BRL 93 million; BRL 42 million of those are recurring from now on, because they are now part of the new way we will treat the situation. Last year, we had JCP in Q2 or in the second half, which helped us reduce the base of calculation for interest rate. So there is a difference of impact here.

Let's look at our ROIC. It's stable. Even when we see recurring, it's quite stable versus last year. It's important to highlight the efficiency of working capital. We reduced this by 301 bps versus last year and also focus on CapEx, which is 11% lower versus last year. We reduced corporate CapEx. We've increased the number of stores, and there is a growth in general CapEx because we acquired a plant in the State of [Sera]. Over 1,000 employees and the cost of acquisition was quite low compared to the cost we would have if we would start a plant from 0 from scratch. We acquired this from a company that was in a difficult financial situation.

And now we can move to cash. We finished this period with a net debt that represents 0.8 times and 0.1 times and 1 times the EBITDA when we look before and after IFRS, leveraging levels are healthy for the company. And the positive highlight is our working capital. In this period, we've had some payments of installments of acquisitions we made, and that had a negative impact on cash. But these were contracts that we signed beforehand.

So this is the end of the financial results, and we can open for the Q&A session. Thank you very much.

[Operator]

I will read some questions, and I would like to remind you that you can use the chat box or the Q&A function.

We have Luiz from BTG. He asks, can you comment on the price transfer for different brands of the group for the next quarters? Do you see new strategies for the launch of products, both in the entry segment and also in higher average tickets.

[Alexandre Birman, executive]

This is Alexandre speaking. Yes, we have launched most of our summer collection, which is going to be a revenue for the second half. Arezzo and Schutz we are below inflation rates. So we managed to negotiate good prices for raw materials. You know that our pricing system is cost plus, so it's directly connected to the cost of raw material plus labor costs. There was a collective agreement that was low for August due to the impact of the floodings in the state of Rio Grande do Sul. It's a very difficult moment the state is going through. So the industry is not back on its feet yet. That's why unions were low in their negotiation. For Anacapri, we had a strong work connected to our new plant in the Northeast of Brazil, and we managed to reduce prices. This brand had to keep a growth level above 2 digits, and we will see that late this year. So we managed to improve the situation versus the situation we had in 2023. So these are the highlights regarding price transfer.

[Operator]

Second questions come from Danny. First one is about Schutz and she says regarding the Schutz brand, in the release, you said that the new positioning will come this month. Can you share what are the main changes or pillars addressed? And how should we think about this positioning compared to Arezzo. This is a question from Danny.

[Alexandre Birman, executive]

Yes, this is a very exciting topic. I have to say I created Schutz brand when I was 18, and we are very happy with the results of this work. Through the acquisition of [indiscernible], we had an access to several creators from the fashion industry that sets trends in Italy. We hired an agency in December 2023, and in February, we had an immersion in Milan, and we went back to the essence of the Schutz brand. Our model is so simple. It says Schutz is Schutz. We have this DNA of a bold, authentic woman, a woman that makes things happen. She has a strong identity. It's a sexy feminine product. And this summer campaign that we launched last week on August 8, we had a major event with Bruna Marquezine and several digital influencers that are very much connected to this brand. We have a new communication position in social media, and we see positive results in our flagship stores. We are looking at younger consumers, who are looking for trendy products. So now this brand is moving away from Arezzo. We are going into a specific niche. The apparel category helps bring a vision to this brand, a lifestyle vision to this brand. As for our targets, we want to create a model of stores that really is different, just like we did in 2011 when we began expanding shoots, going into brick-and-mortar stores. We still have not reached the model we want, the CapEx is still very high. So we are still doing work to create the environment in these stores. And I invite you to visit our JK Shopping Mall store. But this is still not the format we want. It's a process. And this year, we want to inaugurate in November a concept store. Handbags for this brand, they will become a more important product from now on. So we are excited with the path forward, but we don't expect double-digit growth for this brand in the short-term. It has huge awareness, over 4.2 million interactions in Instagram, but we believe health levels will be great and we will overcome the threshold of BRL 1 billion.

[Operator]

Danny has another question regarding Farm, and she says, the acceleration of Farm is a reflection of adjusts in the brand besides the normalization of wholesale. Can we expect this acceleration to be preserved?

[Alexandre Birman, executive]

Well, I don't think this is connected to the creative revolution we mentioned recently. Every 5 years, we revisit the brand. We revisit because we want this brand to have its punch. And Farm's results are a result of Farm's power of their creativity power. This brand has a huge capacity to create, to look into new areas. The country is not growing very much, but Farm keeps on growing in its creativity and looking for new paths. We have some projects that are very interesting, and we will probably launch next year, these projects, they will support Farm Brazil's growth. We are looking at something around 12%, 15%. It's challenging, but we have great projects to support this growth for 2025 and 2026.

[Rafael Sachete, executive]

And if I may add, we mentioned in the last quarter, there are some revenue changes that would happen in the second half. And we see this clearly as we mentioned, in Q1. Sometimes it happens in wholesale, and it's difficult to compare. It can generate some uncertainty. But everything is under control. Farm is strong, and we're looking at interesting growth looking forward in different areas we're working on.

[Operator]

We have now a question from Clara Lustosa from Itau BBA. She has 2 questions. Let's start with the first one. which is regarding Soma brands. The growth of feminine fashion Soma ex-Hering was a highlight for this quarter at Azzas. Since Roberto is here, can you share a little bit with us the main factors that pushed this growth? Is there a driver that was stronger, especially in Farm, both in Brazil and global?

[Roberto Jatahy Gonçalves, executive]

Well, there was nothing specific for this quarter. We will see better and worse quarters regarding comparables and revenue. When we look quarter-on-quarter, that might lead to some distortion, but the brands for Soma, if we look at Farm and Farm Global, as I said before, we are quite comfortable in supporting this growth for the next 2 years. We're looking at 12%, 15% for Global Farm. There is a challenge, of course, but we have paths that we have designed to reach these results. It is our goal. This is not a guidance. We are a growth BU, and we want to keep on being a growth BU. Other brands at Soma Group, I am very comfortable to say that we will keep on growing as well. Regardless of Farm, Grupo Soma ex-Farm Brazil, yes, we will have high growth rates because we have several vectors for growth. We will now be able to really focus and support the other brands. Looking globally, we're very consistent. We want to keep on growing at the same pace, 25% on average a year. And sometimes, we even deny on some opportunities because we want to work with quality. We don't want to get lost along the way. Global Farm had a less aggressive stance when it comes to activations, looking at margins and everything we saw last year, we had some tax scarce. And therefore, we decided to be very diligent when it comes to expenses. So we locked, we froze our ad cost. Today, we are very comfortable again with the paths to lead the situation. But Farm, of course, we decided to step on the brakes. And next year, we will be all in Farm reached a size that requires a structure abroad. Commercial directors, merchandising so that we can support this growth, and we are very proud of it. So we are comfortable. We feel safe with our portfolio of Soma ex-Hering.

[Operator]

And the second question is about the expenses of Arezzo&Co, says, the growth was also solid at Arezzo. So what is the current attention, what is some of the pressure on profitability in terms of expenses. And that was fully justified by investments to strengthen the structure. If you could share a little about how this line should move forward, that would be great.

[Alexandre Birman, executive]

And I think one point that we should bring here is that second quarter of last year of an EBITA margin of 19% in the operation in Brazil. So there was a level of concentration that was a bit less compared to the rest of the year, and this comparison could have made it harder the perception. So we had also a bit of the margin, but we need to take into consideration the second quarter last year. In terms of expense as a whole and also focusing on structuring as you mentioned yourself, the company has had a long-term focus. So some quarters will have a level of expense that it's a bit greater, always with long-term structuring focus. And for this quarter, it was important to have this level of expense to structure the new company and to have new executives and new structures and some backup structure, so we could support what we had to go through. So the whole process of closing started from February to July 31, and we had to carry-on with the day-to-day of the company and check the new operation and build new pillars to give the support to the new company with a new management model with unification of reports of accounts. So we needed support and with our own structure, we wouldn't be able to deliver it. So definitely, there is a focus on efficiency, and we will be talking a bit more to more about the levels of efficiency that we expect and what will be the main pathways and the main triggers to drive us to better margins through best as [indiscernible] and also, we want to focus on the long-term special care with our brands to protect their strength, and we need to have a very well structured healthy company. So that's a discussion that we always have. It's present to us and efficiency will come, and we are sure of that. And we have many triggers and leverages to go after the efficiency, and now with Grupo Soma and unifying the team and the infrastructure we have.

[Operator]

Now the next question comes from Joao Soares from Citi. He asks about handbags, 1 point that stood out was the drop in handbags. Is there any specific seasonal effect? Could you detail that a bit more?

[Alexandre Birman, executive]

This is Alexandre. First, talking about revenues in terms of volume, it has a lot to do with our track record. So the revenue of handbags had a 10% drop. And we had 20% a bit more because of the average increase of average price. So when we talk about sellout, this handbag revenues flat compared to 2023. So what we talk about in terms of revenues, the 10%, there's a lot about the B2B in sell-in, which was an increase that we had to have the first quarter. And I think it's important to say that we had that in July. So it will be back to normal. We won't see this drop for the next quarter of 2024. When we talk about the reallocation of revenue and also the price-point that we will not have an increase compared to 2023.

[Operator]

The second question is related to expense specifically related to the deal. So the question is, what should we expect in terms of annualized growth when we talk about the recurring structure demand.

[Alexandre Birman, executive]

Well, we must say that in the next 24 hours, we already have this detail from the fiscal bank, lawyers' fees, integration costs with personnel costs, this will be detailed by quarter. We want to show transparency. Obviously, these are estimates, and they can be built accordingly. But we have a good map-out for that, and we want to give a clarity from day 1 on to all our investors so that we can build a trust relationship and to have that related to the disciplines and the cost of the company. In the long run, definitely, we'll bring a focus for 2024-2025, we'll have other projects, but the biggest ones related to it are for the 2024 year, and we'll bring them in detail here.

And I want just to add that all the expenses that are smaller, but when added up, there is quite a significant volume. So the trip of all the teams back and forth all the time and talking about what Sachete has said, it's on a recurring, it's not here as the specific point. So we're talking about the cases of deals, so we're talking about consulting personnel, the trips and the new demand for the brand. So in the short run, we have a full investment that is being launched as expenses for the mid-long term from 2025 on, we'll show initiatives and fronts of work to reduce expenses, that was our goal.

[Operator]

And the next questions come from Eric from Santander. He has 2 questions. The first one related to Vans. So he says, could you comment on Vans sales performance? Can we attribute this acceleration and growth to any specific factor?

[Alexandre Birman, executive]

Well, within the quarter in a year focus, we have a great performance, and we have been growing with high revenue and specifically for franchise and owned stores. So these are 2 channels that have been working really well and have a positive impact. On our second quarter, there is some mismatch when it comes to the first quarter. I don't know if you can recall from the growth that we have and as we have it on the second quarter. And the outlook into the year is a good growth. We expect to have something a bit over the average of the company, especially driven by the franchise and e-commerce channels, which has shown really relevant performance. And within a long-term building plan with a partnership with [indiscernible] where we want to have a consistent growth, and we see room for the brand to deliver great growth above the average of what we have with Azzas Group.

[Operator]

And the second question is related to Hering. Regarding Hering, could you talk about how you have seen the recent evolution of franchise and wholesale? How is the outlook?

[Alexandre Birman, executive]

Well, Roberto, if you allow me, in the last few months, we went through the process of transition as the official data, Thursday, and we have been celebrating here Hering where we have a double management, I would say, but I will really be able to answer this. Main focus of our presentation tomorrow will be that. That's why we chose the headquarters of Hering in Blumenau and we'd like to thank everyone for all the work done and also for all the ones I have confirmed their presence. We have 86 to come. And we would like to talk about the channels that we have greater control there, which are the DTC, especially e-commerce. The big investment for Hering this quarter was a reformulation where it was a process that had been started in January, where Roberto went through a marketing transition with also a role that was open in marketing. So we were able to bring in executive that had already been with Arezzo&Co. And we were able to bring the change and a reaction of the Hering brand having the highest growth not only in its track record, but in terms of the e-commerce. And that's what we see in this year, we will see as the largest brand for all the work and what has been done in the last few years. So we can say that Hering did not have a digital before. And I think we should also talk about B2B. So the time of reaction to B2B is a bit slower, but we will present the sales for the summer and high summer collections for the second semester of 2024, it already shows a growth much less than what we would expect from direct-to-consumer market, but already showing a growth. So if we see the last 3 years, the vector changes because usually, we had them as the channels that were going down. So we go from flat to positive now. Well, for this June, we made some work, and we had a great effect here, showing that in our market. So it was quite assertive in terms of new market and the level of what is stocked up is quite healthy. We have no complaints there. And the most important KPI to measure the health of a franchise network is delinquency level. And at Hering, we see that we have nearly 100% healthy franchisees, which are there very healthy with great appetite to invest and transform Hering store in mega store, and we'll show a guidance for that for the next few years, and this is some work that has been done. So those are the main points that I would share with you now and to remind you the focus that we'll have on Hering tomorrow.

[Operator]

The next question comes from Irma from Goldman Sachs. And he asks about the franchisee channel, and about the demand of the major one of our Azzas co-brands were a bit modest for the second quarter. So I'd like to know the franchisees appetite embedding the new spring/summer collections for the last or the latest [indiscernible].

[Alexandre Birman, executive]

I would like to talk a bit more about franchise. We started this in the '90s in an organic way with multi-brands and franchising. So we have a 30-year experience, and we've learned that franchising is a living organism. So we have cycles of affirmation. So in 2020, Arezzo&Co took a leading role in terms of bringing the omnichannel sales influenced to take that to many franchising, showing resilience. And we definitely were on the bandwagon in terms of the solid growth in the last 3 years. Starting last year, we realized that we needed to come back with the pillars of foundation of franchise, and we have a consulting company that have been supporting us for many years, and that was very relevant where we worked with research and we created for the first time a franchise committee for the Arezzo brand that brought a very healthy opinion. And specifically for this quarter, we deliberated and focused on half an improvement in sell-out compared to sell-in, reducing some of the purchase of sell-out. You might have seen that for the franchise is much higher than sell-in. So we still have this to take place. So the appetite from what we see is a better balance from what we have in terms of sell-out to sell in, and we'll have a growth in sell-in, still less than sell-out for the next quarters to come. But definitely, this metric needs to take one step at a time, always looking into the last 12 months and the sell-out needs to be together there with sell-in. So that's very important for us to have worked with our commercial team in a structured manner, and this makes us really well-positioned in terms of long-term trust of our franchisees.

[Operator]

Thank you, Alexandre. Next question comes from Guilherme, JPMorgan. It's about the gross margin. It's a question about gross margin, he writes, how is the markdown level versus last year in Arezzo and Soma brands? Can we think of an impact in that in the gross margin of this quarter?

[Rafael Sachete, executive]

And I'd like to speak a little bit about the gross margin. Yes, we had quite a stable gross margin in Q2. Our mix of channels is a little bit more positive in Brazil, and we had a small decrease in the U.S. operation, which is less than 10% of our revenues. We had a flat figure versus last year, but there was a gain of efficiency versus 2022. So the level of efficiency of the gross margin is quite healthy. Levels of inventory in which we finished our switch from one collection to another was very healthy. And now we have our summer collection with new products, new launches. So our inventory levels are quite close to last year's. Healthy levels, we don't need to give major discounts, and we believe that our perspective of gross margin for Q3 is as healthy as 2023. With no major changes, we're not going to change our channel mix and our U.S. operation is quite stable. Summer for Q2, we had some leveraging of gross margin, but Roberto is going to cover that. Yeah. From our sales, I would like to say from the B2B sales, have a fixed gross margin. There are no changes in our gross margin in the B2B channel. And this is really important. The variations we see are mainly connected to the channel mix. And of course, there's a markdown of the DTC channel, levels are healthy.

[Roberto Jatahy Gonçalves, executive]

Yes, looking at the Soma Group, for this quarter, we have -- we still have different practices, accounting practices. So yes, there is an impact for PIS and COFINS taxes. So our margins cannot be compared. What we have is a gain in margins, maybe 1 point, 1.5 percentage points. We grew our margins, if we discount on PIS and COFINS impacts. Alexandre really wants us to optimize inventory for working capital purposes, ROI, cash generation purposes. And this is something we've been pushing forward since last year because that leads to healthier sales, gross margins go up, and that leaves -- maybe we leave some money on the table because this is not enough to reach our full potential. Looking at our ROIC targets, we are aligned, and we should continue that way. So our gross margin is the fruit of the desire that we have based on our brand.

[Operator]

I have a question from Isabella from UBS. It's about e-commerce. I would like to know the evolution of e-commerce and of the omnichannel initiatives that keep on showing expressive growth. How do you see this evolution looking forward? Does it make sense to think of e-commerce with a significantly higher participation in the medium and long terms? How would that contribute to the profitability?

[Alexandre Birman, executive]

Yes. Both companies, Arezzo&Co and Grupo Soma, we are highlights in e-commerce. And we've heard many positive comments. We see a positive outlook. Our practices add to each other. Some initiatives are more advanced. At the Soma, their multichannel, their multi-brand channel is a very advanced inventory for a multi-brand can be offered for e-commerce for the sales channel. And this is something we don't have at Arezzo&Co. We also have an interesting point, which is the new way to conduct or to capture new clients to invest in performance. There are best practices and our joint volume now will make this very sound and allow us to improve our cost per click. So this is a very interesting aspect. We have 2 amazing executives, [indiscernible] with an amazing team working with them both in [indiscernible] and AR&Co. It's an amazing team for e-commerce. And yes, certainly, this is a priority channel. Most of all, because now this is an active base of over 11 million individual tax IDs. So yeah, we will create a sound plan for that to internalize cash back programs, loyalty programs, so that we can preserve their credit cards, the client's credit cards in our basis. So a more democratic apparel line, up to shoes of an international brand that can reach BRL 3,000. So it's an all-encompassing e-commerce. Yeah, we will work very hard on this channel and on omnichannel as well. You can buy a product from one brand. And if you want to return it, you might get credit for another brand. So the sky is the limit. And we're going to really invest on that. We have a sound foundation, and we believe we will get very positive results from it.

[Operator]

We have a question from Bank of America. Alexandre, how are you working to retain talent, both for creative talent and also for administrative talent.

[Alexandre Birman, executive]

Yeah, we have a very sound plan, and we will introduce this. We have a great pipeline of talent when we combine the 2 companies. There is a concern from our side. We know that our company is made of talent, over 22,000 people. So yeah, we are very much engaged. On the other hand, I can tell you that we have a huge ability to work with these teams. We've had 3 meetings for high leaderships on May, July and August over 110 directors. We see the synergy among them. And we see an amazing pipeline of people that are very much capable and skilled. We have the best executives of the fashion industry and in Brazil and Latin America. So our people pipeline is something that is very sound. And of course, we always want to retain talent.

[Operator]

And he continues with another question regarding the deal. How do you think of managing complexity and the allocation of resources and capital.

[Alexandre Birman, executive]

Yeah, this is also a very important topic. Tomorrow, we will be presenting a well-structured vision, 4 layers of brands, mature brands, growth brands, brands that are still under definition and new brands. We ran an in-depth analysis of the impact of each channel per brand in each channel consolidated. So our capital allocation will be based on a rational metric, a technical metric, considering CAGR, historic CAGR, future CAGR. It's not just about growth because we have mature brands. Their goal is to have stable growth and high cash generation. We need this to support investment in new initiatives. So this is a key process for us, and we will be telling you more about this tomorrow, how we intend to work with that for 2025. In 2024, we still have budgets that have been pre-established, of course. And this is a fascinating topic. The combination between the 2 groups is very positive in that sense as well.

[Operator]

Thank you. And that's the end of our Q&A session.

[Alexandre Birman, executive]

Well, thank you all for participating on this call. What a pleasure to be here with you in this moment. Congratulations on your results, Roberto and tomorrow, we will be together with our teams in Blumenau, I invite you all once again to join this event. It's going to be very interesting. We're going to have a great exchange. And as I say, interacting with you is very interesting for us because your questions allow us to think and to evolve in our trajectory. We are very happy and excited. So let's get on with our work. Thank you very much.