Grupo de Moda SOMA SA

BOVESPA:SOMA3

Earnings Call Transcript 2023-Q2

[Unknown Executive]

Hello. Good morning, everyone, and welcome to our earnings call for the second quarter of the Grupo SOMA. This presentation and the earnings release are already available at the earnings call center at the Investor Relations website at the company's website. This event is being recorded and will be available on our website.

We'll start off with a message from our CEO, Roberto Jatahy; then Gabriel, our CFO, will present the operational management results. And finally, we'll open up for the Q&A.

[Operator Instructions] Now I'll pass the word on to Roberto, so we can begin our presentation. Thank you. Roberto, you may proceed.

[Roberto Jatahy Gonçalves, executive]

Thank you, Mary. Good morning, everyone. The second quarter of '23 at the Grupo SOMA had a gross revenue of BRL 1.5 billion with an increase of 9.3% compared to the same period in the previous year. We ended the quarter with a base of 5.5 million customers, over 14,000 wholesalers active and a thousand -- we had 708 franchise stores. The gross profit reached BRL 744.2 million, an increase of 4.1% compared to the previous year.

It's important to highlight that in the second quarter of '22, our brands reached all-time high revenue sales levels, generating a very challenging base for this year. We also had a drop in the gross revenue of 1.8 percentage points, reaching 57% in the second quarter of '22. It's important to mention that second quarter of '23 was a normalized quarter, free of the atypical effects that took place in the second quarter of '22. And the drop in the gross margin is due to the high comparative basis from last year that came due to many extraordinary effects in the market, such as the complete opening of the economy in 2022 after Omicron. We had physical retail coming back very strong, which really surprised us and generated a lot of supplies in our stores. And due to this, we practically do not have special sales for winter in '22, which positively impacted, of course, our gross margin in this period. We also had a quarter with temperatures are very low, and this favorable scenario, of course, led to a bigger demand for our collection items for winter, which increased our full price sales and impacted our margins. When you add this to the month of 2023 with tax effects, with the reintroduction of DIFAL and the adjustments in the ICMS credit rules for the PIS/COFINS calculation basis. And we also had in April -- and in May, this year, an important retraction in the market. And this was a combination of a more challenging scenario in March with higher temperatures, which made us more aggressive in this migration process. And this was going to happen a lot more with the ex-Hering brands than the actual Hering brands. After, we're going to talk about Hering below.

So as soon as cold weather came around in June, we had a quick recovery in our sales in all of the group's brands. We have another important point to highlight also which is related to the behavior of the brands when it comes to the gross margins, brands like FARM, Animale, NV and Cris Barros, especially B2C in markets where you have -- more heated market with higher full price sales, there's more elasticity in their gross margins that took place in the second quarter last year. But Hering doesn't capture the same upside because the commercial relationships are more established, but in compensation with a more difficult quarter since Hering is more B2B, it's more protected and other brands are -- end up being a little more exposed to the impact of the gross margin. The adjusted EBITDA reached BRL 215 million, an increase of 2.4% compared to the same period last year. The EBITDA margin was 16.6%, a drop of 0.9 percentage points compared to the second quarter of '22. The gross margin pressure was partially offset by greater efficiency and expenses, especially Hering that has been advancing a lot in profitability and optimization of operational expenses. The adjusted net income added up to BRL 102 million, reaching a performance very consistent. Despite a scenario that's so challenging, our adjusted net margin was 7.8%, with a drop of 2 percentage points and this retraction was impacted with a greater volume of depreciation due to higher investments performed in the last few years as well as the increment of the SELIC rate, which contributed to an increase in financial expenses in the company.

Now we'll move on to the brands. The portfolio of the SOMA Group, ex-Hering had solid growth of the gross revenue compared to high comparison basis, a peak of 13.4% reaching BRL 928 million in the second quarter of '23. We also had an increase in our active customer base with an increase of 7.4%, with consistent gains in market share even in a period with more challenges in the market as we saw in the second quarter this year. FARM had a revenue of BRL 283 million in the second quarter of '23, with a growth of 7.4% compared to the strong performance in the same period last year where we had the reopening of the economy.

This growth trend was even stronger throughout the second quarter. When we look at the first quarter, we see that there was an increase of 18.5% compared to the first quarter of '22. And our active customer base continues to grow. We went over 855,000 customers, and we have a growth of 11% compared to last year. But we're not stopping here. We really believe in the potential for growth in the operation in the national market and also the reach of these new target audiences. We have 89 stores only in Brazil.

Now we recognize that this number is still very shy compared to the addressable market that the brand has, which is why we should open up another 15 stores this year till the end of the year. In 2024, we should also continue to open up FARM stores. And besides this, the global FARM success in the United States and Europe is really something that values our brand in the Brazilian market. We're recognized as a market that generates desire in important markets. And the spontaneous publicity generated by celebrities that use our clothes has been very well taken advantage of, generating a lot of value for operation in Brazil as well. At global levels, our efforts have been benefiting not only the U.S., but also Europe, where we expanded our presence in markets like Paris, London and Milan. The digital channel is still the main channel, and it continues to perform surprisingly. The e-commerce revenue grew 31.1% versus the second quarter of '22 levered by the double -- double the amount of accesses of customers on our website. We're really inspired with the recovery in our digital channel. And we see -- if we look at the second year of operation in digital in the U.S. and compare with the second year of the digital operation in Europe, we can see that this growth of 70%. So Europe was 70% better than the U.S., which demonstrates the size of the potential that we have in this new market.

Initially, of course, we are focused a lot on brand awareness in Europe. In this quarter, we should once again open up the Le Bon Marche 200 square meter area, and the investments in marketing has also been very relevant, making them operation not reach breakeven yet, but this should happen by '24. In the wholesale channel, our summer collection that was launched had excellent performance, and we had a sellout all-time high in department stores in the U.S. We placed FARM once again among the most desirable brands in these POSs. However, due to the historical -- the recent history of overstocking, the buyers had a global purchase budget restricted with -- which, of course, impacted the recurring revenue that normally is part of our results in the quarter. The revenue from our own stores grew 54.5% versus the second quarter of '22. We know we have a gap of our own stores at FARM in the U.S. And during the pandemic, we believe that we would be a lot more digital and physical. Now we believe the importance of having all 3 channels. And we've been able to recover the time lost. So we should be opening up a lot of stores in the next quarters in the United States and in Europe and will be -- it will be very important to monitor not only the revenue from these stores, but also the margins of these stores. We should be opening till the end of the year, a flagship store in London, still in 2024 and in Melrose in Los Angeles.

Another brand that was surprising was Animale, the gross revenue reached BRL 194 million in the second quarter, and there was a growth of 17.8% upon the second quarter of '22. And we had already delivered very good growth, but we reached a gross revenue of BRL 190 million with an increase of 14%. And now that all these problems solved, we should continue at a pace of growth that's more accelerated. Finally, I want to mention that we had Cris Barros having an important highlight with BRL 43 million in gross revenue, 44% higher than last year. It's a brand that has full price sales at all swing and strong profitability growth.

Moving on to Hering. Hering had a growth of 3.4% compared to the same period in the last year, which is a result that does not reflect our expectations for the brand. We understand we're in the right direction with this strategy. It's being well executed when we look at the long-term. How Hering operates in a market that is highly pressured by economic situation? So we've been really been disciplined at good margin levels and really help structure the brand, so they can grow in the mid- to long-term in the second quarter of '22 was also hindered by climate issues. We know that brand -- it's a brand that's really sensitive to higher temperatures since it's more of a functional period of purchases. Just to give you an idea, the same-store sales for April and May were less -- or minus 4% with the higher temperatures. When cold weather came in, in June, same-store sales went to 21%. And in July, continued to grow at double-digit levels. But finally, since we're in this reconstruction of the brand and being very careful when it comes to gross margins, we decided to not monitor -- to keep up with the monitoring movement in the market with anticipation of special sales. Although the strategy seems to be good, it did pressure our sales since there is a price symmetry, especially in the month of May and June, but we continue to keep firm with our strategy and are trusting it.

And now I'm going to pass the floor to Gabriel, so he can about our financial results. Thank you.

[Gabriel Silva Leite, executive]

Thank you, Robert. Good morning, everyone. It's an important highlight and we get into Slide 9. We once again had a quarter for growth in the gross revenue in the company. The revenue in the portfolio without Hering reached BRL 928.1 million with a growth of 13.4% versus the second quarter of '22. As Roberto already mentioned in details, even when we consider a base that's very strong last year, the brands in our portfolio, ex-Hering grew well, with important highlights to FARM Global that grew 20.1%, Animale, grew 17.8%, FARM Brazil grew 7.4%, NV's been growing above 14% and Cris Barros, which has really been the main highlight in our portfolio with growth of 44% in the quarter. When it comes to the channels, retail overall, which considers physical and digital added up to BRL 652.9 million with a peak of 14.3% versus the second quarter of '22, which also represented a share of 70.3% in the total gross revenue in the company.

It's important to highlight that in this quarter, digital went back to having performance that was outstanding, reaching a gross revenue of BRL 287.9 million, a growth of 26.8% versus the same period last year. This growth in digital brought in an important gain in share in the channel with 3.3 percentage points in the total gross revenue. On the other hand, physical retail had growth that was a little more timid, reaching a gross revenue of BRL 365 million and a peak of 6% versus the second quarter of '22. And naturally, losing a bit of a share in the total gross revenue in the quarter. Then wholesale was pretty stable when it comes to share and we reached a revenue of BRL 272.7 million with a growth of 11.5% versus the same period in '22, which had a share of approximately 29.7% in the gross revenue overall. It's important to highlight that this variation in wholesale and especially between the physical and digital mix had an important relevant impact that we're going to mention in greater detail in this presentation up ahead.

And Slide 10. In this quarter, as you can see, differently than other quarters, we had a negative impact in our line for taxes on sales, which, of course, impacted not only our gross revenue, but also the gross margin. But even the EBITDA and the net income in the quarter, and we're going to provide more details about this as well. Now when we get into these effects, the main effects, we had an impact in the increase of 3.4 percentage points in the tax rate for the Brazilian operation without Hering, especially due to some factors. The main one was -- and the first one was related to lower level of subventions related to the tax benefits for the [ Lei the Model ], the fashion law in Rio, which is due to an anticipation of the products and the distribution center and the high winter collection.

As Roberto mentioned, and I think it's important to remind you all to make sure this is clear, the scenario of supply in '22 and '23 is substantially different because in the past, we had a supply chain that was more restricted. And actually, because of this, the receipts that were closer to the launch of the collections for high winter which took place in April.

Now this year, we have a scenario that's more normalized and supplies have more capacity, and we were able to have excellent results when it comes to sourcing and PCP. And we had an important volume of the collection in the month of March already, which was anticipated compared to last year, which brought in a positive effect because we were able to have a level of service that was really high to launch the brands in the second quarter. However, on the other hand, there was a displacement in the receipts within the collections between months of May -- March and April, which made us at a volume level, and subvention level considering that this is 100% connected to the volume of products that go to our factory in Rio, which has these incentives. This, of course, reduced the amount of incentives in the month of April, which impacted by 2.2 percentage points. If we look at the semester, naturally, we have a switch of pockets from March to April and the effect is basically offset. But when you look at the second impact, it's related to the fact that was discussed by many people already, which is the reintroduction of the DIFAL, which impacted 1.5 percentage points in our rate this quarter. This impact was even greater at Grupo SOMA in this quarter specifically than in the first quarter because of the high growth I mentioned in digital in this quarter.

On the next slide, we provide some details on this quarter related to the profitability of our operation at Grupo SOMA, ex-Hering. Gross profit reached BRL 527.8 million, an increase of 3.4% versus the second quarter of '22. And the gross margin reached 66.1%, which represented a setback of 4.2 percentage points versus the second quarter of '22. It's fundamental, considering the size of the setback that we really explained in detail each of these impacts that affected our gross margin lines and we would like to start explaining especially and mentioning a bit of what we've presented in the previous slide, we had a negative impact in the taxes upon sale coming from -- coming due to lower levels of subvention and tax benefits. And of course, the reintroduction of the DIFAL. These 2 combined effects when you look at the gross margins, consolidated, they pressured our margin by 1.2 percentage points. The second impact is related to a shift in the tax scenario with a change in the ICMS in the PIS/COFINS basis, which affects our CMV line, and this is impacted naturally in this quarter, considering that from now on, we have the impact in the operation of implemented effectively. And this had an impact in 0.7 percentage points in our gross margin in the quarter.

So when you look at the comparable basis, and if we disconsider the tax impact, we would have a margin of 68% in the second quarter. If we were to be operating in the same base of what we would call the fiscal or tax structure at a Brazilian level. The delta additionally at the 68 point -- was a gross margin last year in the Grupo SOMA Ex-Hering, which is pretty much a delta that's operational. And it's important to mention, Roberto had already of course, explains part of this, but we should go deeper and say that when you look at the month of April and May, with sales at full price they're a little slower due to the impact from the macro scenario and also the higher temperatures, as you mentioned, with a long-time for cold weather to come in from June onwards, we had to accelerate the markdowns to really have a good alignment in the stock levels. Besides this, as we already mentioned last year, we had a scenario that was not sustainable for gross margins or a level of a full price stock turn in the long run.

So with the Omicron ending after the second quarter of '22 and due to the high levels of coverage that we were operating with a more restricted supply chain, we had a period of special sales and markdowns. It was very short compared to this year where the scenario was different with higher stocks due to higher level of service and sales slower, especially in the physical channel, which is where we carry our biggest markup. In this semester, the gross margin at Grupo SOMA Ex-Hering reached 66.8% and our practical terms are very close or in line with our levels expected for the year of 66% -- 67%, sorry.

Moving on to Slide 12. We show Hering's numbers that gross revenue reached BRL 576.6 million, an increase of 3.4% versus the second quarter of '22. When we get into details about the numbers, the focus that we had in this quarter, Hering was to grow even if we were growing in a more limited way but without giving up on our profitability. Our comparison basis in the second quarter of '22 was really high at Hering, and we had already been growing 37.5% versus the second quarter of '21. And besides this, we still had the impact of the higher temperatures in this challenging macro scenario. And when we look at the macro scenario, we see all of the peers providing markdowns and special sales on their products ever since April. And of course, we waited on this to protect their profitability. And we held on to this markdown levels until the month of June, where we were actually able to get into a period that was more promotional. We had already performed good showroom sales in the B2B channels for the franchisees and wholesales. And it's important to remember that the showroom sales that take place in the winter collection happened in the first quarter. But since it's part of our business, especially for Hering, where you have a higher volume of the share in the B2B channel, there is a relevant part of the sales that take place in season with the replacement of the stocks in the collection.

So with months of sales that are a little slower, the franchisees were naturally having stocks that were higher than as originally planned, and they did not have the replenishment levels that we expected. When winter arrived in June, the channels were super well supplied, and they were able to have good performance in sales and the sellout -- and the franchisees grew 18% in the month of June compared to the previous year, and it's important for our recovery when it comes to sales, but also when it comes to the stocks for the purchase of future collections, which is the case that we had seen between summer and high summer.

The wholesale channels were the channels at most grew with a peak of 5.2% versus the second quarter of last year and a good retention in the customer base due to progressive improvements in the level of services and the increase of quality in women's products, which are the main factors for our growth in the channel. In digital, Hering is really focused on the recovery of profitability as this was growing at high rates, with the gross margins very pressured and we adjusted this from 2022 onwards with our strategy in our channel. Without giving up on growth, we increased our full price sales to about 70% of the collection, and we had gains in profitability in this quarter. When it comes to revenue, we went back to growing with a peak of 4.8% versus the second quarter of '22.

Then on Slide 13, we bring in another indicator that's an important fundamental for the Hering operations in second quarter. The gross profits grew 6% versus the second quarter of '22 with a gross margin that continues to be on a growth pace, in line with our expectations, and we've been always talking about how Hering is recovering its profitability over time, mainly levered by an improved profitability in its gross margin. The gross margin in the quarter reached 43.6% with a gain of 1 percentage point versus second quarter of last year. And this was due to some factors -- some of them have already been mentioned in other quarters and others have been shared by Roberto himself. The first is the search for better negotiations with inputs. Maybe the main -- the best example would be about our good negotiations for buying cotton threads, and we've been taking advantage of the drop in prices in the global market. And we've been having really good negotiations from a utility level in our factory, such as negotiations in gas and electric power.

So we added a second point, which is important with a better efficiency in our processes, which indicate management that is completely focused on improving general processes and increasing the efficiency of the factory. So one example in this quarter was the recent close down of the Parauna unit, which took place from the second quarter onwards. And here, we want to highlight that the closing of this unit already took place within the context of the project for the revision of the diagnosis of opportunities I've been working on in our Industrial Park, which is mainly to improve operational efficiency and also simplify the network for Hering operations. So Parauna's operation is related to part of this. And we also have to redistribute this for the Goianesia operations with significant reduction in fixed costs, about BRL 6 million per year. And so we still capture value of about BRL 3 million in the second semester of 2023. So the third point that's very important is that we had a better improvement of what we call in-sourcing, going onto outsourcing. And so this balance of what we produce internally and externally, we've been mentioning that we have a cap of production of transfers that are being done for in-sourcing and outsourcing, and this has been taking place in a very structured way, and of course, more lower level of stability and capturing value in this differential that we had mentioned in our own production and also the production -- we've been capturing new suppliers out of Brazil with more competitive prices as well and also the increase in sales at full price, which contribute to our total gross margin.

So we move on to the next slide, Slide 14, our adjusted EBITDA consolidated, excluding the LP impact on the expenses of the Parauna's operation added up to a growth of 2.4% versus the second quarter of '22. The EBITDA margin was 16.6%, a drop of 0.9 percentage points versus the second quarter of '22. And this was partially offset by the pressure in the gross margin with good contributions from Hering when it comes to controlling operational expenses and better profitability.

Moving on to Slide 15, we present the adjusted net income, which reached BRL 102.1 million, a drop of 21.9% versus the second quarter of '22. And the adjusted net income reached 7.9%, a reduction of 2.9 percentage points versus the second quarter last year. And I think that naturally, it's important to mention that the macroeconomic scenario is still a very challenging with high interest rates. Naturally, we had impacts in our financial expenses due to the increase in this interest curve, which mainly happened -- what happened in previous quarters actually than the second quarter of '22, which led to -- ever since we've had more normalized interest rate. And we think that this curve forward can actually absorb maybe an important financial result line. And of course, additionally, we also had a bigger volume of depreciation this quarter, which is due to more investments that we've been working on in the last 24 months when it comes to CapEx in the company.

And finally, when it comes to debt and cash management, in the second quarter, we -- of '22, we had a fundraising initiative for debt -- paying debts. The balance sheet for FARM Global abroad with very attractive costs. And the main focus was to balance this relation between the cash in Brazil and the cash abroad, which naturally has some benefits with a natural hedge since it's dollarized in its revenue and cost. Additionally, that's pretty much it. We completed an agreement with the Banco Santos to solve 2 lawsuits. Historically, that added up to BRL 43 million. That was the agreement, BRL 43 million. And we already performed the previous court deposit to have the approval of this agreement that is still being officialized by the court. So this is very important when you consider the size of this contingency that was something that we discussed broadly. So we want to reverse the provision that we have established, leading to a positive impact in results in the future, cleaning our balance sheet by 2023.

So these are the financial highlights in the quarter. Now we'll get into Q&A. Thank you.

[Unknown Executive]

So now we're going to begin our Q&A. And our first question comes from Daniela [phonetic]from XP. Daniela asks about the following.

It caught my attention that you had the outperformance of Hering versus other players in the quarter. Now we've already seen some signs and improvement in the trend in the second quarter due to what Roberto just presented. Could you share with us a bit of the perspective that you guys have in regards to the second quarter and the first half -- and the second half of the year for Hering and for SOMA, especially when it comes to FARM, please Roberto?

[Roberto Jatahy Gonçalves, executive]

Thank you for the question, Dani. I think I'm going to take advantage of this question and give you some context on the recent history of what happened in the company strategy during 2021, we had a -- we were hoping that a crisis would arrive and we were always buying less than what we had the potential capacity to sell. From '22 onwards, and we kind of less money on the table, and we noticed that this play was wrong. From '22 onwards, we started to use our indicators in-house to determine kind of forgetting a bit of the macro scenario and determine the budget issues and the impact on purchases. But we knew, of course, that at such a moment, the growth rates we had would at some moment slow down. And this happened obviously in this quarter. We hadn't seen such a slowdown, but this happened. And -- but of course, we bought for more revenue, and we didn't reach this revenue along with what we've already presented in this call. And it's natural that there's going to be some residual leftovers, but the difference between what we bought and what we sold is different. And the leftovers made us have some kind of an extension in this special sales and markdowns, which impacted -- and it was one of the impacts we had in our margin, of course, if compared to the second quarter of '22, which is a margin that was completely different, and the scenario of those was completely different.

When we talk about revenue, I think that it's important also when we consider the beginning of the year in the first semester, it's really important to give you some context about a fact, which is we ended spending the year of '21 and '22 really pressured with the difficulty to receive products at the right dates and on time and full was really bad. We had structural issues in Brazil with a lot of demand and not much supply and not reestablishing the commercial relationships with Asia. And so having said that, when we reached the first quarter, we had a decompression of this chain. And this is actually one of the indicators that made us think about how the crisis could be coming. And that's when we received a lot of products in the first quarter, considering the service levels in the first quarter, which is a lot higher than the history. And we have a policy in the company that we really believe in, which is billing as quick as possible for the wholesalers, even if we have to give a bit more timing. We have an understanding that the quicker this product arrives, the more time it will have for sale within the wholesales and this retrofeeds future purchase. So clearly, we understand that there's an anticipation in the billing of the wholesale operations in the first quarter and a reduction in the revenue in the second quarter.

So when we look at revenue at Grupo SOMA, I would suggest that we look at the semester, so that we can clean out these effects. And when we look at the semester, we see growth of 18.6%. This is growth I think is quite robust. We always spoke about a growth of about 15% that's sustainable. And I don't see much of a problem with revenue, if we look at the year overall. When we look at the group as a whole, going through Hering, we have growth of 13.8%. So we can't forget that Hering at this moment in the market it operates in is very compromised and sacrificed. And even so, it performs better than the market average. So we understand these results to be natural results as they are part of the natural course of the company. And I suggest that you look at the sales in a combined manner due to the anticipation of the billing for the wholesale operation.

And so when we look up ahead and also connecting with Dani's question, we can also have like a futurology or guessing exercise. I see that July was a month that was very similar to June, which is a little better. But I wouldn't risk saying that the next quarter is going to be supergood because July is not -- doesn't have the necessary weight to determine the results in the quarter. When we look at -- in Hering's case, for example, when we look at the amount of orders and how the showroom performed for summer, what we noticed is that it doesn't really determine clearly like ex-Hering does because there's a replenishment that's recommended in an automatic replenishment. So when you see these replenishments were a little more difficult due to higher levels of stock. And this, of course, replenishes an important revenue source of the brand. And so we look up ahead, the Hering showroom was just as good. But if we don't have the effect that we had in this quarter, we could be more optimistic, which is the effect of the nonautomatic replenishment. If this replenishment is having a little more traction, then we'll have a level that was a lot better than the second quarter.

[Unknown Executive]

Let's move on to our second question, which was set also by Dani, and it's for Gabriel.

The second question is if you could talk about growth. I think it's very clear to see the main drivers in the gross margin pressure at Grupo SOMA in the second quarter. But we want to hear where your expectations are in the future. Does it make sense to think about this normalized margin, considering that the pressure for the base is the markdowns and the lower level of subvention should be eliminated? And how can we imagine the evolution of the gross margins at Hering?

[Gabriel Silva Leite, executive]

I'm going to keep my camera off. But just to answer about the gross margin. I think it's important to segregate the gross margin from the portfolio ex-Hering and Hering's portfolio as we bring Hering into the space. So when we talk about the portfolio ex-Hering, I think we brought this in our presentation in the call, we had months like May and April with slower sales, which naturally we ended up being a little more active commercially and more promotional. But this is a natural, the normalized level of stock. And obviously, it's not possible to correct 100% of the stocks in just a single month, but we additionally also have the carryover -- partial carryover that's a little longer in the month of July if we compare with the year of '22. In '22, we had supplier that was more restricted coverages that were a little lower at the end of the collection since we had a full -- turnover at full prices. And this year, on the other hand, we had a second quarter that started at little slower and actually brought us due to cash discipline issues and stock control issues that made us perform at a level of activation that was a little more aggressive than last year, which was extended in the beginning of July, we were a lot more aggressive in this collection. And that's when we come into the summer collection with stocks a little healthier. And I think it's important to mention that by the end of the year, we are very controlled and well organized and planned, and we're going to be ending the end of 2023 with stocks from the collection and our off stocks are very well balanced. We have no risks towards this.

And so we're always, of course, weighing out and valuing control between profitability and cash management. It's important to also mention that this does not mean, well, this greater markdown in June and then special sales period was longer. We can see that there's special savings that are a little more extended because it pressures the margins a bit. And so if you compare this with our initial plan and in the second half of the second semester, I think we have margins that are 100% normalized with high winter stocks and with what we've planned originally. So this first phase is really on track. And so we're going to be inside this level without any problems when it comes to the level of stock.

And so the second part of the question was that it's important to mention the gross margin at Hering. We noticed that we're really happy with the work they've been doing. Even with this more challenging market when it comes to sales, we can't control this, but we're not giving up on guarantees for a very healthy margin in our Hering operation. We will reach this no doubt with a combined margin of 44%. This is our expectation. We did not change this original expectation, and we are following this in line with our original plan, gaining margins quarter-over-quarter. And so to answer your question, Dani, and segregating this portfolio, we're very well planned. We have no big concerns towards this in the portfolio without Hering and even with Hering.

[Unknown Executive]

And now we're going to move on to our question from Luiz Guanais with BTG.

How promotional do you think the market can be in a more high-end segment when you look at the next quarter?

[Roberto Jatahy Gonçalves, executive]

So I think that -- well, thanks for the question. I think that in the third quarter, the market is going to be less promotional due to the Black Friday that takes place in the fourth quarter. And of course, if the market continues at the same situation with this impact and being pretty much the same, we should have a third quarter that's having promotional gains. But if at the end of the year, we're going to have a market that's a little more promotional, I also don't believe in this because last year, we had a comparison basis that was easier. And I don't think that we'll have World Cup issues or political problems. So I think we're going to reach a point where we're going to be normalized. And in the third quarter, we think that it's a question mark, but for the fourth quarter, we're a lot more comfortable.

[Unknown Executive]

Guanais sent us another question also about how stock-up franchisees are Hering for the second quarter?

[Roberto Jatahy Gonçalves, executive]

The stock levels in the franchisees are in line with what we planned. There's no overstocking or low stocking. All of this balance with the supply and the franchisees is that it's normalized for quite a while already, and we don't see any kind of deviation or risk in the future for this aspect.

[Unknown Executive]

Now let's move on to our third question. This is from Thiago Macruz from Itau.

On our side, we want to understand how you guys understand the quality dynamic of the stock at SOMA, ex-Hering at the moment?

[Gabriel Silva Leite, executive]

Thank you, Thiago. I think it's important to mention, and I just answered this indirectly in my first question from Dani, but getting back here to talk about details a bit more. I think that we had at end of the quarter with stocks that were naturally a little higher than what we had originally planned for, and this leads to a component of non-sales as planned. That doesn't mean we had bad sales, it just means that we planned for sales that were a little more aggressive, a little higher than what we delivered. And naturally, we have our corrective measures considering our cash discipline and so that we can normalize the stocks as soon as possible. This was done partially within the month of June with sales -- special sales a little stronger than last year, which was extended a bit in the month of July. When we look at our stocks up ahead, we are really well planned to finish the year with a stock in line with the original plan and our OTG and our control for receipt and purchases. And additionally, for the collection stocks, we have coverages that are very healthy, and we have no big concern towards quality of the stock. So I think that's a key point.

And once again, we're prioritizing and guaranteeing that at the end of the year, we can have a healthy margin in operation ex-Hering that should be kept as we always mentioned, at about 67%. And at moments where the market is a little better, we can have a full price sale a little higher, which is the case last year, which we consider to be kind of an outstanding scenario about it with the boom market, we kind of sort through this, and we have margins that are even higher, about 68% or 69%, but this is not normal. The normalized scenario is close to 67%. And in a period where you have to be a little more promotional due to a correction in stock as what is what would happened throughout the second quarter. We can see this occasional effect, which is not structural where you have margins a little more pressured. But this doesn't concerns us. In the long run, we're very well planned. And of course, we should see this all connected.

[Unknown Executive]

Macruz sent us another question also.

When you look at FARM Global, the division has had a growth path that's very accelerated in Europe. And how should we consider the dynamic for investments in the brand in this region? Could you also talk about the growth dynamics up ahead? That would be very good.

[Roberto Jatahy Gonçalves, executive]

Thank you, Macruz. At this moment, we are reaching a new region. And just as with the American market, we have free operational expenses with marketing that are very important. So the level of investments we've been working on has been pretty high. And in the digital channel, this has already demonstrating some very quick responses. But we don't have the same capillarities we have in Europe as we have in the U.S. So we're already building the brand awareness and all of this so that we can capture this through digital. And in a year, we're going to have a stronger play because there, we don't have that much ease in the department stores as in the U.S., it's more like a concession play. So we have more investments in CapEx ahead, which doesn't concern us that much considering the cash generation at FARM, we even consider that the American market has a lot more stores open.

We had the cash to do this, and this was generated by FARM Global. So we had a big difficulty also to accelerate this process, considering the nonavailability of commercial real estate on the streets, which is where we want to focus the distribution of the physical stores at FARM. So moving on, we have an expectation, as I've been mentioning in Europe, and it really surprised us a lot. So if we look at the second year, as you mentioned in our calls, the second year of operation in the U.S., we can see a growth of 70%. So this operation was a lot better than in the U.S., and we're really excited.

[Unknown Executive]

We're going to take advantage of this FARM Global issue, and I'm going to mention a question that Pedro Pinto sent from Bradesco BBI.

FARM Global continues to perform well despite this market scenario in wholesale. But how do you consider this reacceleration of the sell-in wholesale now that we're getting closer to the fourth quarter?

[Roberto Jatahy Gonçalves, executive]

So Pedro also asked about how we're going through a moment with a market scenario in the wholesale, how do we look at the appetite and reacceleration of wholesale from the fourth quarter onwards at FARM Global? So it's difficult to understand this because we've seen a behavior in the U.S. is quite strange. Although we see our physical stores performing very well, we see a bit of a big concern with budgets that are very controlled, although we have a really good full press sales in the American department stores, we see a concern when we buy. And so -- this dynamic that is something that's a little more difficult for me, and I'm going to attribute this to something due to the limited knowledge I have about the history in the market and how it behaves overall, with digital, physical stores and wholesale.

So I don't have a strong opinion about this and this topic.

[Unknown Executive]

Now we're going to get into FARM Brazil. The question is from Joao Pedro Soares at Citi.

Sales performance. You guys highlighted a recovery in sales in all of the brands in June. I wanted to hear about how the performance was at FARM Brazil, how the brand evolved and how the performance is in the sell-out and wholesale channels?

[Roberto Jatahy Gonçalves, executive]

So we can notice a vision for the deacceleration in the market perception at FARM Brazil. Also this is -- I'm going to react to this, there's a CAGR of 21.1%. FARM Brazil, at this semester has been growing 18.5%. So it's a brand that already has a pretty big size and has a lot of stores to open. So there's 80 POSs, and I think that we have a lot of growth up ahead with FARM. And as I already explained previously, we had the anticipation of the sales in the wholesale channel, and we're really comfortable with FARM. There's a lot to grow and it's a very desirable brand, it's going to make us very happy at Grupo SOMA.

[Unknown Executive]

Our next question is also from Joao, Citi, and it's going to be directed to Gabriel.

Gabriel already talked about the gross margin. And since we received some questions here, it's important to mention this topic. The gross margin, we can see the clear base effect in SOMA ex-Hering. But with the recovery in sales in June, have you guys already seen a recovery in the gross margin at SOMA or is this still a mix effect that could affect the margins?

[Gabriel Silva Leite, executive]

Well, I think that as I've already mentioned a bit, the mix issue was relevant in the second quarter, and it is embedded in this effect in the quarter. I think we had a physical channel that was more challenging in the quarter. The physical channel lost 3.3 percentage points in share with gains in digital. And in digital, we know that there's a margin that's a lot smaller than the physical channel. We're talking about at least 5 to 6 percentage points. So when we look at the structural aspect, I think there is not a concern. I think we're planned for the future sales. And if by any chance, we see the revenue in the wholesale being a lot greater than what took place before it could be that we'll see this in wholesale and digital taking on a bit of share, there could be a mix effect. But from the planning perspective, there's not much to be concerned about, and we consider that we'll be balancing this out to reach a 67% in the gross margin in Grupo SOMA without Hering. And I think your question is about this. And then Hering, I already mentioned that we are working on this. We're being very careful with structurally looking at this margin and bringing it to the levels that are healthier. So this year, we're going to reach the 44%, and the trend is that this number will be growing as we have more of the operation in our hands.

[Unknown Executive]

I'm going to continue with this topic. We have a question now from Eric about the gross margin, and he talks about the effects of the gross margin, especially the DIFAL impacts in the semester about PIS/COFINS. So how could this impact the other quarters throughout the year?

[Gabriel Silva Leite, executive]

While I think that here, we brought in details about these impacts and some of them are actually quite recent. I think he already knew about since last year. But part of this, we try to, in some way, balance out when it comes to price. But of course, due to the Brazil scenario, we also don't think that it's necessary to transfer this full from 1 year to another when it comes to fiscal aspects. So we had 2 effects that were combined. And if we have the transfer at a single moment in a macro moment, where you have about wins that are not so favorable, we think that this could be dangerous. So we're doing this in a very balanced way and gradual way. We've been seeing -- thinking that transfer these effects of the default in the ICMS, when you look at the credits in the CMV and these are being transferred to price and they're reestablishing the profitability of the company over time. But of course, from one quarter to another, it's very difficult to see this kind of effect, and we see this as something more like in the midterm. So it's probably not something that's going to happen in the single quarter.

[Unknown Executive]

We'll continue with you, and now we're going to talk about the working capital. So we had a big increase in the working capital quarter-over-quarter, which contributed to cash burning in the quarter. And we want to understand this dynamic picking at the stock line and suppliers. Did anything change towards suppliers? This question is from Joao Soares at Citi.

[Gabriel Silva Leite, executive]

Well, I think this question is super relevant, Joao. And I think it's important to kind of break down the working capital and cash generation of the company into some factors and lines. So I'm going to try to be as objective as possible. And when you look at the working capital, we have seen some issues that are important to be discussed when we talked about the stocks, as I mentioned in the previous question from Thiago Macruz and Dani, our stocks were higher in the quarter. And over time, they've been normalized when it comes to our planning, we don't have a concern with normalizing this over time. We hope to see this in the third or fourth quarter. But part of this was already done in the month of July with special sales and another part, of course, we're taking to Black Friday. And of course, we also have our own internal planning for special sales or we look at this and we see the sales. And so when we consider this very restricted, considering the coverage and supply chain, historically, we see this full price turnover, which tends to reach a better regime now as we have a more normalized supply scenario as occurred from the first quarter of '23.

When you look at the stocks, there is an issue that's also about focus, but doesn't concern us when we look at the future result? And the second point that I think we need to mention also when it comes to working capital is if we go to look back in the second and third quarters, we brought this in a very objective way for the entire market. And we were doing some intense work as a company to readjust the working capital to the period that we're going to call pre-pandemic. In the pandemic, what happened was that we had to shorten our payment terms to suppliers due to the competition. Now we had to extend the receipt terms from customers. So what we did last year, when this happened, it was exactly in the second quarter, and we went back to the pre-pandemic period. So we shortened our receipt terms. We messed with the installments in credit cards and even wholesale terms that were a little longer due to the pandemic and for the accounts payable. We also extended this supplier term process. And this, of course, had positive effects. But obviously, now we're going to be getting to regime from this year onwards. So if we compare year-over-year, it's natural to see that there's a higher working capital effect due to this variation, but it's not something that concerns us that much because what happened was that we reached the cash position last year with the gain of the renegotiation in the future. So that's the first point. Working capital is really on track, and we're very well planned.

Our cash today is above our original budget, and we don't have like a big concern about this. And so even with sales that were planned to be a bit higher than what had been delivered. But we've been taking care of this when it comes to purchases and we've been very careful and disciplined with this, so that when there's non-sales, we can adjust the stocks quickly and purchases in the future.

So I think it's also important to mention that about our cash position when you consider seasonality in the second quarter. And of course, you guys have to look at the history pre-pandemic to understand in the second quarter of the company was always a quarter with more pressure. And of course, you have consumption that always happens. It's structural consumption issue because that's where we have the receipt of the first quarter. So it's a quarter that's a little weaker when it comes to sales and you have the receive of these sales taking place in the second quarter. And we're also preforming the purchase of our biggest collection, which is the collection for the second semester. So what happens, the seasonality effect. This doesn't concern us. It doesn't concern us because you can be very comfortable that we're really well controlled and planned.

And it's important to mention this. I talked about this a little bit, and we had this quarter also with the completion of a very important negotiation process of Banco Santos and both of the lawsuits we had. These are in the hands of the judge to be defined and we've already performed the judicial court deposits. This amount has already left our cash. And of course, now it needs to be adjusted. So comparing everything I mentioned, we have an occasional stock effect, but it doesn't concern us in the future. The working capital, it's a lot more related to the structural aspects where we did have an adjustment in the financial cycle. And when you look at the Banco Santos, it's important to mention that this provision was not reversed yet. So it should take place as we have an actual formalization definition of this lawsuit. And so we expect this to happen in the next quarters, but it's not a big concern when we look at cash generation annually in the company.

[Unknown Executive]

Just to complete this issue with the working capital, Irma from Goldman Sachs had a question about stocks, which is Gabriel has already mentioned, but she also talked about how part of the stocks being a little higher is mainly due to the big stock of basics and how this will be looking with this buffer of basics and what you're seeing -- you're thinking about the future?

[Gabriel Silva Leite, executive]

I think it's important to clarify this. I think because at the moment, this buffer was an [ increment ] stock in 2022 compared to if we look at this, we can see that it's very controlled. And we have the coverage of products that are in our buffer that are 100% aligned. And we don't have any concern towards this. But once again, we are very disciplined in the sense when it comes to cash. Our stock is controlled, just like nails, even like expenses, maybe even a little tougher with our stock than with expenses. With expenses, we have more of a mid- to long-term perspective of the stock. We're very careful whatever we sold in the last few months, so they plan to sell. And based on this, we're going to perform various serious purchase. So we're not concerned about this. And it's not a point that we need to be cautious about at the moment. It's very well controlled. That's when we place the chain in a more normalized scenario, and we had to perform this adjustment so that the supply chain can be more normalized for the actual level of services.

[Unknown Executive]

We just received a question from Guilherme. He also asks about if this supply chain is still unbalanced. And if we could expect more impact with large subvention levels in the second quarter of 2023 -- sorry, the second semester?

[Gabriel Silva Leite, executive]

Well, I think it's important to mention that there's subvention effect with these incentives, tax incentives is very occasional. So as you can see, you understand this clearly in our explanatory notes in our balance sheet. But in our statements, we can do the subvention effect at an annual level until now in the semester was basically 0. We had the subvention really in line with revenue, which is kind of what we already planned for. So what happened in the quarter was the effect that I already mentioned of 2.2 percentage points in the operation in Brazil without Hering or ex-Hering was something very occasional. What we look at in the future is that the correction we performed quickly with the displacement -- and we even had an adjustment in our model. We believe this will be very normalized in the third or fourth quarter. So this line is really in line with our annual planning and with what we considered in our original budget.

[Unknown Executive]

Our next question is from Irma at Goldman Sachs and it's geared towards Roberto. How are we looking at pricing strategies for the second semester of '23 at Hering?

[Roberto Jatahy Gonçalves, executive]

Well, we have no notification and -- just as we've done in the second quarter, when we looked at the entire market creating promotions and special sales and adjusting stocks in the market where Hering operates, we probably will have the same kind of behavior. We don't expect that the market will determine our prices. We don't see a need for this. We are focused on repositioning our brand and having an increase in the gross margin. So we're not going to change our price policy due to market conditions in any way.

[Unknown Executive]

I think our next question comes from [ Leonardo Cavocan ]. He's talking about, congratulations on the results. I think I would like to know about how you look at the tax reform in Parliament at the moment in your business and how this will impact?

[Roberto Jatahy Gonçalves, executive]

Well, Leonardo, we have been talking about this a lot, and we've been talked about this in the previous call and discussed this internally a lot. We actually even hired a company to help us understand what our company results will be, but there are so many speculation still and uncertainties. We still are waiting for definitions from the Senate and the higher house. And we don't even have the tax rates defined. So it's very difficult to give an opinion or guidance or sentiment about this at the moment.

[Unknown Executive]

Leonardo is also asking us any -- congratulate us on the result at Cris Barros, which were surprising and he asks if we could talk about the supply chain with China?

[Roberto Jatahy Gonçalves, executive]

Well, I think that when we look at the supply chain, especially in these brands, these are brands that -- well, the more upscale the brand is, the more complex it becomes to have supply in Brazil. And so we currently have these 2 operations, one-in-one situation and the other in a whole other scenario, we were talking about this in the past and the difficulties we had with Cris Barros with adjusting and delivering the stock, the demand was a lot greater than the capacity that we had to offer due to the compliance and productive chain issues in Brazil. We adjusted this though. And when we adjust this, we have a quick response. So when we look at NV, we are really at this moment and then it's not a structural issue in the supply chain, but also something with the calendar and the construction of this collection that impacts the level of services. And so structurally, we are not going to have much of a problem in the second semester in 2024, the commercial relations with China and India are being recovered and these are things that were interrupted in the pandemic. So we've finally reached the conclusion of we had to get back to our discipline in a range and also considering the currency scenario. And we are going to kind of move on along with this. So we don't see any big risks in supply chain up ahead.

[Unknown Executive]

We completed all of our questions and now at the Investor Relations area, we're available. And good afternoon, everyone. Thank you very much.

[Roberto Jatahy Gonçalves, executive]

Thank you. Bye-bye.