How To Analyze Lupo

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Business Model

LUPO is a Brazilian company that manufactures and sells textile products, mainly sportswear, beachwear, underwear, pajamas, and socks, under the brands Lupo, Lupo Sport, Scala, and Trifil.

LUPO’s business model is mainly B2B (business-to-business), where the Company develops and manufactures clothing items and sells them to retailers throughout Brazil. Its products and collections are available in more than 35 thousand points of sale, including franchisees and exclusive stores (currently entirely belonging to third parties, since the Company does not have proprietary stores); multi-brand retail stores; and department stores. The Company also sells clothing items through its e-commerce with the logistics support of the franchisee network; sells directly to multi-brand stores abroad; and sells private label products (production for other clothing brands).

The Company currently has three large manufacturing units located in Araraquara/São Paulo, Itabuna/Bahia, and Pacatuba/Ceará, which also feature distribution and inventory centers, and has approximately 9,000 employees. The Company occasionally may use third parties’ production capacity and logistics warehouses to adapt to variations in demand, costs, and inventory level. The logistics of raw materials may increase because of price and purchase conditions, currency variation in certain cases, physical space, and planning and control of production in each manufacturing unit.

As a rule, the Company aims to launch several product collections in the year, following global trends in fashion and sustainability, new demands from end users, and respecting the winter and summer seasons in Brazil. The price policy is mainly related to production costs, the purchasing power of end users, and the price dynamics practiced by competitors.

The Company regularly invests in innovation, not only in the design of clothing pieces but also in the development of new yearns and raw materials. It also invests in improvement processes, new machinery and technology for the production lines, and systems to optimize sales.

The Company is managed in an extremely professional fashion aiming at complying with its vision and delivering the planning defined by shareholders, which includes ethics at work, with no concessions; the Company’s growth and sustainability in the long term; conservative and predictable cash management; and deep respect for the partnership entered into employees, franchisees, and the local community.

Grupo Lupo has more than 100 years of operations and is headquartered in Araraquara/São Paulo. The Group is composed of Lupo S.A., Scalina Ltda., Lupo Nordeste Ltda., and Scala Comércio de Roupas e Acessórios Ltda., all of which are managed as a single business unit within a single operational segment (textile).

COGS (Cost of Goods Sold)

The main COGS items in Lupo’s Income Statement are (i) raw material and use and consumption items; (ii) factory personnel; (iii) electricity; and (iv) depreciation and amortization. Other COGS items include the rental of the factories in Araraquara/São Paulo and Pacatuba/Ceará; outsourced clothing services; and rental of space and services in logistics warehouses.

The raw materials regularly used are yarns and fibers (polyamide, polyester, coated elastane, cotton), knits, anilines, and dying chemicals, as well as trims and accessories. Consumable materials are usually machinery inputs, such as needles, lubricants, and parts.

Around 30% of the raw materials – on average over the last three years – are imported products and inputs. The Company adopts a hedge accounting policy to mitigate the currency variation risk. For information on this policy, see the section ‘Financial Revenue and Expenses’ below, and item 5.2,(b)(iii) of the Company’s Reference Form.

SG&A Expenses - Sales and Administrative expenses

The main SG&A items in Lupo’s Income Statement are (i) personnel, commercial, and administrative; (ii) sales commissions; (iii) freight; (iv) service providers; and (v) advertising and marketing. Other SG&A items include consumption materials; copyrights; and depreciation and amortization.

Cash Flow

The average collection terms and default level at the Company are historically low and controlled – in the first nine months of 2022, the average collection term was 90 days and the allowance for loan losses accounted for a little more than 2% of revenues.

The average collection term for suppliers is around 30 days, which Management considers healthy and appropriate regarding good working capital management practices.

Investments made in the last three years were mainly aimed at the acquisition of physical assets related to the Company’s operational capacity growth. The Company acquired new seamless and socks machinery; renewed technology in the manufacturing park; and acquired machinery and equipment for its new factory located in Pacatuba/Ceará.

Dividend Policy

Lupo’s dividend policy consists of the payment of the minimum mandatory dividends of 25% of the adjusted net income calculated on the non-consolidated financial statements, under Brazilian Corporation Law and the Bylaws. The annual declaration of dividends, including any payment of dividends exceeding the minimum mandatory dividends, requires approval at the Annual Shareholders’ Meeting by a majority vote of shareholders holding shares and will depend on several factors, including operational results, financial standing, cash requirements, and the Company’s prospects, among others deemed relevant by Lupo’s Board of Directors and shareholders.

Business Plan

The Company decided not to disclose projections or estimates, of any nature, related to its activities and the activities of its subsidiaries, as permitted by article 20 of CVM Instruction 480 (guidance).

The Company’s business plan focuses on investments mainly in (i) expansion and increase of the share of sports products in the revenue mix; (ii) research and development of new products; (iii) acquisition of new businesses; (iv) technology and logistics with the store network; and (v) environmental sustainability.

Financial Income and Expenses

The Company has maintained a comfortable financial position over the last few years, reporting net cash rather than net indebtedness.

Cash management is responsible, conservative, and predictable, prioritizing protection and prompt availability of values. In the nine first months of 2022, the Company recorded earnings from financial investments between 100% and 108% of the CDI rate.

The Company’s financial expenses are controlled and, historically, have a low impact on the results. At the end of September 2022, the Company had only two working capital debts denominated in U.S. dollars and with floating interest equivalent to 65% and 70% of the CDI rate.

The Company carries out hedge accounting on its revenues and expenses denominated in U.S. dollars. It seeks to align values and dates receivable per exported goods with payments to suppliers and creditors abroad to generate a currency hedge. The variations in other foreign currencies are mainly related to the acquisition of machinery, equipment, and parts, whose currency variation will compose their acquisition cost.

Operating Income

The Company’s gross revenue mainly arises from the sale of sportswear, underwear, socks, and accessories. Less than 2% of revenue – on average over the last three years – comes from other sources such as the sale of private label products, the sale of surplus raw materials, and property rental. Virtually all sales are in Brazil and in Brazilian reais. A little more than 1% of sales – on average over the last three years – is aimed at multi-brand retailers abroad in foreign currency.

The Company recognizes revenue upon delivery of the product to customers. It does not work under the consignment sales model nor with loyalty programs or equivalent methods. Regarding seasonality, it normally recognizes higher revenue in May because of Mother’s Day, and October and November, because of demand related to Black Friday and the Christmas season.

Discounts on gross revenue come from taxes (together, approximately 16.5% on average in the last three years) and returns, rebates, and discounts (together, approximately 2.5% on average in the last three years). Taxes charged consist of PIS (1.65%), COFINS (7.60%), ICMS (from 2% to 19%), and CPRB (2.5%). The Company benefits from ICMS tax benefits in the States of São Paulo, Bahia, and Ceará.

The Company’s management prefers to analyze net revenue under two criteria (i) sales channels: multi-brand retail, franchises, department stores, and the company’s e-commerce; and (ii) the brands Lupo, TriFil, LupoSport, and Scala. The Company discloses its operating and financial results under this format every quarter. It is worth noting that until December 2021, e-commerce sales were not consolidated within Grupo Lupo since this operation was carried out by related parties.

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