Hapvida Participacoes e Investimentos SA

BOVESPA:HAPV3

Earnings Call Transcript 2024-Q1

[Operator]

Hello, everyone. Thank you for waiting. Welcome to Hapvida's First Quarter 2024 Earnings Conference Call. Joining us today are George Pinheiro, CEO; Luccas Augusto Adib, VP; and Guilherme Nahuz, IRO. Should you need simultaneous translation, please be aware that this feature is available on this platform by clicking on the interpretation button and choosing the English channel. This event is being recorded and will be made available on the company's IR website with a complete earnings release material. [Operator Instructions] Now I would like to turn the floor over to Jorge Pinheiro, CEO, who will start the presentation. George, you have the floor.

[Jorge Fontoura Pinheiro de Lima, executive]

Hello, everyone. Thank you very much for joining us in the first quarter 2024 Earnings Conference Call. Joining me today are Luccas [indiscernible]and in New York, we have Luccas, Guilherme and [indiscernible], who will share some details with you.

First, we would like to express our solidarity with our brothers and sisters in the state of Rio Grande do Sul. They are facing an extremely difficult time, we're deeply sorry for all the losses suffered in this beloved state. We have set up a crisis committee with daily meetings where we have been discussing all our actions and initiatives for the region. Despite the difficulties, our hospital service network is fully operational with our teams working over time.

We have developed extraordinary operational rituals involving specialized teams in different areas to ensure care and support to our members in the region when they needed the most. We have set up our own air logistics scheme to make sure our units can operate fully with appropriate inventory of materials and medication.

Additionally, the company has been taking social actions, providing care to the population in general and to mitigate the difficulties they are facing right now. We have also been providing full support to our employees in the region who are either homeless or displaced. So all of those working at Central Clinical Gaucho hospital, Humaniza and our other health care units, the greater [ portal Alegre ] area, we stand with you.

Now let's get started on Slide 2 of the presentation. Here, you can see an overview with some financial highlights that will be further explored later on by Luccas. But first, I would like to comment on some of them. The first quarter of 2024 was a historic quarter for us. We started the year with exceptional results that reflect the commitment and discipline in each one of the strategies implemented throughout 2023, and that are leading to significant improvements quarter after quarter. We have only been able to deliver these results because of our people. I would like to thank our team of over 65,000 employees for their dedication and commitment as well as our teams of doctors, dentists and other service providers, totaling nearly 130,000 people. The evolution of our cash MLR was the highlight of the quarter with an impressive improvement of 4.3 percentage points against Q1 2023. The ratio was 68%, exceeding the numbers of the last quarter of 2023, which had been the best ratio since the business merger comfortably beating our historical seasonality.

The reduction in cash together with dilution of selling and admin expenses resulted in Hapvida, [ Natrium Intermedica ], reaching another significant milestone. The record number of just over BRL 1 billion in adjusted EBITDA, up 60% year-over-year. Our net revenue grew by about 4%, reaching BRL 7 billion.

Results of the consistent and responsible pricing in new sales and the necessary adjustments in existing contracts, where we see a consistent evolution of the average ticket. The member base remained virtually stable throughout the quarter, and the sales of new contracts continues strong. Our new clients have been choosing more verticalized products that help oxygenate the portfolio and future profitability as they come through competitive and sustainable pricing.

We know that healthy tickets and healthy portfolios are the foundations for the long-term sustainability of our business. Our capital structure also showed sequential advances. We reduced leverage in nominal terms with operational cash generation reaching close to 80% of EBITDA.

Net debt over EBITDA continues its gradual downward trajectory ending the quarter at 1.13x, a very comfortable level in our view.

Moving on to Slide 3. Here, I'd like to share a bit more about the progress we have made in the integration process. Over the past 2 years, several activities preceding systems integration have already been completed in Sao Paulo, such as operational standardization, centralization of supply and procurement of materials and medication optimization of our own and accredited networks.

For 2024, we will complete the integration of the company's operations in Sao Paulo and we are in the final phase of systems implementation in our care units. Two waves of implementation, covering approximately 50 care units have already been executed very successfully. Only 2 phases remain which will take place in the coming months with the final systems turnover, that of the health insurer expected to take place in Q4.

With the end of this integration journey, we will have a 100% systemically integrated company with significant gains in customer journey control and full visibility of all our health care quality indicators, which are key for our management. We understand that the integration investments we have made also translate into health care quality and customer satisfaction. For example, looking at the overall complaint rate or IGR, which is an index published only by E&S, NDI Saudi, IGR has been showing successive improvements, reaching its best position in the last 16 months. If we add up all of the group's operators, our position in the ranking would be #22, 3 positions better than the average of the major operators, which is 19. It's important to mention our efforts in fighting dengue fever and other viral diseases. We're going through the largest dengue-fever epidemic in the country's history. And so the company has been investing heavily in opening specialized units and increasing the number of beds in order to fulfill our mission. The volume of urgent ambulatory care and tests related to dengue fever and other viral diseases have been above our historical volume for the period.

Some regions are already showing a reduction in volume. But in other regions, the volume remains pronounced. Before I hand over to Luccas, who will give you further details about our results. I want to conclude by emphasizing that we continue focused and disciplined facing the challenges and making the most of the opportunities that come ahead of us in 2024 and working hard to continue the strategies implemented last year.

We continue to invest in strengthening our operations and seeking a healthy balance in our margins. Once again, thank -we want to thank the contribution of our employees, doctors, dentists, brokers, suppliers and the trust of the Board of Directors, shareholders and most importantly, the trust of our customers. Luccas, you have the floor. Thank you.

[Luccas Adib, executive]

Thank you, Jorge. Hello, everyone, and thank you for joining us. It's a great pleasure to be with you in another Hapvida's earnings conference call. I'll get started on Slide 4 about net revenue with the chart on the top left corner.

Consolidated net revenue grew by 3.9% in Q1 '24 compared to Q1 '23, as Jorge mentioned earlier.

Now let's move on to the chart on the top right corner about our health plan revenue which had an increase of 5.87% year-over-year, driven by 10.6% increase in average ticket. In dental, here at the bottom of the slide, we had a 4% revenue increase, also driven by the average ticket adjustment of 3.8%, in line with revenue from sales of services and other activities, we had a reduction of [ 40.5% ] because of the sales of some assets such as San Francisco Resgate and Maida, as mentioned before.

In the sales of services, we have 2 effects: first, a reflection of reduced demand in the quarter, especially January and February, in line with what we saw in our operations in the market.

Second, we have maintained and will continue to maintain our selectivity in offering services to third parties, reducing our exposure to credit risk and prioritizing our hospital capacity for use by our members.

Now giving you further details about member base and average ticket on Slide 5. We lost 11,000 lives on a net basis. So we are virtually stable quarter-over-quarter, reflecting a gradual downturn compared to the losses we saw in recent quarters. Gross sales continue very robust. We added 480,000 new lives, high-quality contracts, verticalized products and healthy pricing in line with our portfolio sustainability paradigm.

Another piece of good news is that we have returned to grow in areas where we were in the integration process, such as Minas Gerais as for the cancellations of nearly 490,000 lives, they are a result of the necessary adjustments for contracts, economic balance and optimization, verticalization and regulation process of the care network. Turnover also showed balance this quarter.

At the bottom of the slide, you can see the evolution of the average ticket, up 10.6% year-over-year. In the first column, net price, we had an increase of 11.4%, reflecting price adjustment efforts already net of verticalization and copayment effects in existing contracts. In the second column, you can see minus 0.8% in what we call mix which represents the net difference in average tickets between gross sales and cancellations. This exchange results from our commercial focus and a greater demand for more verticalized products with lower tickets. While constellations are concentrated in contracts with higher tickets but with greater exposure to the accredited network with higher, less sustainable MLRs.

We have even started to see again a migration of lives from insurers with higher tickets to our more verticalized product line. All the movements mentioned above are part of the company's strategy and the plan to recover our historical margins, which continues firm and disciplined in 2024, and that is being executed with rigor and discipline, which are keywords for the year.

On Slide 6, you can see how this connects with our main operational performance indicator, MLR. Our cash MLR this quarter was 68%, a decrease of 4.3 percentage points compared to Q1 '23 and 1.3 percentage points compared to Q4 '23, far surpass the seasonality, which indicated an increase for the period.

Our goal is this gradual and responsible margin recovery journey to overcome seasonality. This is not rocket science. It's all about a series of initiatives that we implement, monitor and refine every day to deliver this evolution. And all of this is coupled with our perennial goal of delivering quality health care, as you can notice in our better position in the IGR rate since the beginning of last year.

We continue to work hard on price adjustments, increase the verticalization standardizing protocols, optimizing provider network and various cost control measures. As a result, per capita costs have been decelerating and verticalization and tickets have been increasing, as Jorge mentioned earlier. It's important to highlight that we're going through possibly what it is the largest dengue fever epidemic in Brazil's history, and we're closely monitoring the high volumes of urgent ambulatory care and tests. Volumes have been quite pronounced and above our historical levels in March and April.

On Slide 7, you can see cash admin expenses, excluding the effects of [ soft ] depreciation, amortization and nonrecurring items. We are 0.5 point better than Q1 '23 and 20 bps above Q4 '23. This quarter, we included one more chart at the bottom of the page about personnel to help in our explanations as a more visual aid.

We had positive impact in Q4 '23 that were not repeated in Q1 '24. We explained this last quarter, but let me highlight this again. We had reversals of BRL 47.2 million between variable compensation from 2023 and reclassification of retroactive expenses from the dental sales team. This quarter, we have made specific reclassification between lines of BRL 16.8 million in system maintenance moving from location and operation to third-party services. Just a line swap here. We also had nearly BRL 14 million in IT expenses related to system changes that impacted the third-party services item, in line with what we have been saying about specific one-off expenses with these integrations.

Now personnel, an additional reversal of BRL 16 million from variable compensation in 2023 after final assessment of our goal achievement and an allocation of variable compensation to cost of BRL 10.5 million in sales expenses, BRL 5.3 million that was provisioned entirely in admin expenses in 2023. And finally, we have a column that says others with 5 million, which is basically provisions for increases, salary increases.

As mentioned in the last call, we can see a rapid behavior in the coming quarters. This is normal and expected. Since there are expenses related to systems integration with changes in implementation involving support staff, travel, temporary existence of [ legal ] systems with new systems, which may cause this line to behave up or down. We are confident that there is room for improvement through initiatives that we will undertake as these integrations stabilize.

Now moving on to sales expenses on Slide 8. We can see here a stable level compared to the previous quarter without major news. As we said earlier about the reallocations between admin expenses and selling expenses, the positive highlight here is on commissions for 2 reasons. First, due to a reduction of deferred acquisition costs, write-offs the brokerage due to a lower level of contract cancellations within these deferral products; second, after the systems implementation in Clinipam and NDI Minas, we updated the deferral periods, making them longer within our standardization of policies and processes.

The reduction of BRL 12 million in advertising and marketing is normal as expenses are temporarily lower at the beginning of the year, while we structured the campaigns for the rest of the year. Now PDD has increased by BRL 32 million because we're being more conservative and slightly more rigorous in credit assessments imposing an incremental safety view in light of IFRS 9. The remaining value in this line comes from a specific client-related provision.

On Slide 9, you can see our adjusted EBITDA, which was a bit over BRL 1 billion in the quarter, a milestone in our history, as Jorge mentioned. Just to recap briefly, this is the company's highest EBITDA since the merger resulting from an increase in net revenue, continuous efforts in different areas for cost control and optimization as well as rationalization of admin expenses.

Now moving on to Slide 10. Cash flow. This chapter was a novelty that we introduced last quarter to facilitate understanding of our cash management. Free cash flow for Q1 '24 of BRL 614 million also came at a very significant volume with a conversion of 80% of EBITDA into operating cash, an extremely healthy level. Looking at the table in the bottom left corner we can see cash consumption of BRL 132 million in Q1 '24, which comes basically from the following math. BRL 614 million from free cash flow generation, BRL 35 million from M&A activities and a consumption of BRL 781 million in financial activities, which I will detail later.

We also had a balanced working capital management between clients and providers. We highlight the main cash consumption coming from rents and payment of annual bonuses in March, which usually happened in April. But even with a bonus we had substantial growth here. We recorded payment of BRL 94 million in income tax and social contribution. Remember that there is a mismatch between competence and cash that was recorded in December and is paid in January and so on. The amount is significantly -- significant and reflects the profitability of our operational entities. It's important to remember that there is ongoing corporate restructuring program that will be accentuated once we are 100% integrated from a systemic point of view.

CapEx remains under control at BRL 105 million with significant investments in IT. We are projecting CapEx between BRL 600 million and BRL 1 billion, which should be slightly higher in the coming quarters, especially if we advance in the projects of hospitals in Sao Paulo and Rio.

On Slide 11, we can see M&A activities with a generation of BRL 35 million with a receipt of BRL 22 million from the remaining portion of the sale of San Francisco Resgate and BRL 21 million from the sale of Maida Health in February. Financial activities consumed BRL 781 million, driven by the payment of BRL 840 million from the fourth issuance of debentures with funds raised at the end of last year.

We also had financial income of BRL 186 million, close to the CDI respecting our conservative cash investment policy. As you saw last week, our Board of Directors approved the raising of BRL 1 billion at the cost of CDI plus 1.60 per year and maturity in 2031 to meet our upcoming maturities concentrated in the second half of 2024, restructuring our debt. Settlement already occurred in May and the cash is already in our balance sheet. With this, the company has maintained its disciplined gradual and responsible pace of deleveraging quarter after quarter reducing net debt by BRL 404 million and dropping leverage from 1.38x to 1.13x EBITDA in the methodology of the covenant of our issuances.

Going to the last slide before we open for questions, we have our regulatory requirements. These are applied only to individual operators. So when trying to compare with the consolidated company, there will be differences. Technical provisions had a slight retraction, partly due to the increase in medical bills payable in March following the increase in utilization, as we mentioned in the cost and another part from cash consumption as we saw earlier, regulatory capital, on the right-hand side, we expanded our PLA surplus in relation to CBR with the net profits generated by the operators. Thank you all for your patience. I hope this has been useful and now we open for questions. The questions will be answered by Jorge, by myself and Guilherme Nahuz, who is here with us. Thank you very much, and have a great afternoon.

[Operator]

[Operator Instructions] First question is by Vinicius Figueiredo sell-side analyst at Itau BBA.

[Vinicius Figueiredo, analyst]

I think we can start with a question about the competitive landscape. I think you talked a bit about this already. But a few weeks ago, we saw a strong readjustment by the competitors. When we look at the readjustment in full, which was made public, but what can you tell us about the new product table. What can your commercial teams see here in the behavior of a mill and other competitors here in the Southeast region of Brazil, can we see Hapvida standing out as the one with the lowest price among these products, which is a bit different from what we saw at the end of last year.

Now you commented it in other opportunities about how exchanges in the accredited network brings about attrition with customers. But since PPO is an important point in your commercial perspective, it's not only about losing this portfolio, but actually improving profitability. So if there is no space to make changes in the accredited network, what are possible levers to improve MLR?

[Unknown Executive]

Okay. I will start by talking about the competitive landscape. What we can see throughout the industry and among competitors, we have made the necessary adjustments, the most radical ones last year and most operators made 2 to 3 adjustments throughout the year as well. But this year started and we have made a first readjustment in Q1. And we might make another readjustment throughout the year. Going back to our old practice of 2 annual reviews in those sales. So this year, we expect readjustments to new sales at a lower level than what we had last year because of all the readjustments in our portfolio and the advances in our verticalization and integration process, so put us in the position to make lower readjustments this year than last year.

About the competition, what we see is a similar dynamic, the competitors have made strong adjustments last year.

And almost all of them had similar readjustments or a bit lower than last year in their product portfolio. So the whole industry is going to take 2 years in the cycle that is starting in this year and will end in April next year with higher readjustments so that they can go back to historical levels of profitability. Our model, given the verticalization, integration and all the improvements that we have been making allows us to be, on average, 30% to 35% of less readjustments than our competitors, and this has been helping us greatly in corporate channels where we've been selling a lot. About the PPO product, Vinicius, we have no network adjustments to be made. We have made changes throughout last year. We discontinued the sales of some of the products that we considered to be unsustainable. But on the other hand, we ended up encouraging the sales or creating products in PPO because we have a good relationship with some providers that we now consider to be more sustainable. And this has led to improved margins in PPO as well. So the recovery that we shared with you is stronger in HMO plans, but we also see improvement in margins in PPO.

And PPO products are very important for larger cities like the Greater Sao Paulo, the greater Rio de Janeiro and the greater [ Beller Edison tea ] area, especially in Sao Paulo, which will compose our product grade. This is key so that we can have all types of offers to make to a large company in those regions.

[Vinicius Figueiredo, analyst]

Congratulations on your results.

[Operator]

Let's move on to our next question by Leandro Bastos sell-side analyst at Citi.

[Leandro Bastos, analyst]

I have 2 questions here. First, can you tell us about the effect of dengue fever in the months of March and April, is the frequency much higher in Q2 as well? And what can the effect be on MLR which is seasonally higher in Q2.

Now my second question is about the commercial dynamics. Can you tell us about your readjustment strategy for the large corporate channel? I remember what you saw -- what you said during Hapvida's day last year, what are you planning now for the large corporate channel?

[Unknown Executive]

Leandro, thank you for your questions. First, let's talk about frequency and volumes that we've been seeing with the dengue fever. You know that our business is seasonal. The seasonality respects variations in rainfall and temperatures starting in the north of the country and then moving south. It's been following a typical seasonality of recent years this year as well. But this year, we have a higher intensity with dengue fever effect in several regions of the country. Therefore, we have a higher volume this year than the average of previous years with higher volume.

And we see that some cities are already in a downward trajectory. This is a typical curve. You have 45 to 60 days in an upward trajectory, and then you have a drop in a shorter period than that. So the curves are respecting their historical patterns, but with a higher intensity of volume in ER and lower complexity admissions.

About Q2, well, we cannot tell you much, but yes, we have a greater volume. But on the other hand, when we look at the longer run, we can see that this is part of our historical seasonality curves and this should not affect us in the longer run.

About commercial readjustments. Well, when we look at the mix between individual small businesses and large corporate companies. The results of all of that will bring us for the year according to our strategy, something that can vary from 1 percentage point to a bit more than that, lower than what we had last year. The readjustments vary according to each region. We see greater need for readjustments in small and medium businesses in Region 2 and a lower need for that in more mature regions, such as Northeast in the countryside of the state of Sao Paulo. But in total, we should have 1 or 1 something percentage point lower rates than what we applied last year.

[Operator]

Moving on to our next question by Samuel Alves sell-side analyst at BTG Pactual.

[Samuel Alves, analyst]

I have 2 questions here on my side. First, about the aspiration for MLR. What is your target? You talked earlier about how the company wanted to have a cash MLR of 68%. So now after this first quarter, which brought you a victory in this recovery trajectory. Can you have a bolder target?

And my second question is about NERD. Luccas mentioned in the presentation that you've been seeing a migration of higher ticket insurance companies to Hapvida. So do you foresee a growing base in Q2, inorganic growth there in Q2? I don't know whether you're still foreseen such a growth in the second half of the year rather than in the second quarter.

[Jorge Fontoura Pinheiro de Lima, executive]

Okay. I will start, and then Luccas and Guilherme can add to my answer. About cash MLR, 68% is a number that accounts for the combination of MLR premerger of Hapvida and NGI and pre-pandemic levels excluding the new or most recent acquisitions that have higher MLRs. So the number that we achieved is indeed spectacular. Delivering before this number before the integration is completed is something we should be celebrating for 2 reasons. First, because it shows the consistency of implementation of all of the measures that we've been taking and that are not finalized yet. We still have integration to go verticalization to go portfolios to be launched. So we see room for improvement here in the long run, respecting, of course, the seasonality of Q1 and Q4 which are lower than Q2 and Q3. And of course, Q1 was benefited with lower volumes. So many factors have led us to this very significant result.

Now trying to answer your question in an objective manner. Yes, we do expect this year to have better MLR than we had last year just like the second half of '23 already had a change of behavior, achieving much better results in the first half of '23. So we expect the first half of '24 to be better than the second half of '23. We had a 2-year plan, as you can recall. And at the end of that plan, we would be very close to -- our historical MLR levels, excluding recent acquisitions, of course. And that's what we're aiming for.

Maybe in Q2 or Q3 next year, we'll be able to see what level of we're going to have because it's only by then that we're going to have all of those measures implemented. About NERD, we have great news. This has been going on since Q4 last year and Q1 this year, we have been negotiating with medium-sized and large-sized companies with significant contracts already implemented and other contracts already signed in process of implementation with insurance, insurers and cooperatives. So the corporate channel continues heated, and we have hope that in the coming months, this will continue quite heated considering our business pipeline.

About the retail channels, the year started slow in January and February, but it's now heading up February was better than January, March was better than February. April was better than March, and May is now better than April with this upward trend in retail. That's a very encouraging news -- is of news. We haven't yet reached our targets in retail channels, but we are already exceeding our targets in corporate channels. But the pace of growth in retail channels encourage us to believe that if we keep the same pace, we'll soon be reaching our targets in the retail channels as well. So with a strong corporate channel, reduction in cancellation levels.

We have just finished reviewing our portfolio in April, and that's an annual journey. And now with the retail channels in this upward trend, we believe that we're going to have a very good period from the commercial perspective. The second half of the year is quite encouraging. We expect many fruits coming from the commercial area.

[Samuel Alves, analyst]

Congratulations on the improvements that you have made.

[Operator]

Our next question is by Gustavo Miele, sell-side analyst at Goldman Sachs.

[Gustavo Miele, analyst]

I have 2 questions. The first is about MLR being more specific as well about cost per life. You had very good MLR rates in a scenario of stability in ticket prices quarter-on-quarter. So can you share a bit with us how much this cost performance is due to the rationalization of portfolio that you've been making with a churn in contracts with a higher cost level and how much comes from a more organic performance or more legacy portfolio, so if you could give us some color into this, I would appreciate. That's my first question.

Another topic I'd like to explore with you is about capital allocation. For some quarters now, you have had strong deleveraging, same applies to this quarter. So can we expect the company to accelerate your own network expansion plans or return on shareholders is something that you're going to prioritize now? Or would this offend regulatory standards of solvency and other issues or not? I believe not. But can you give us some color into this as well? These are my 2 questions.

[Jorge Fontoura Pinheiro de Lima, executive]

I will start and then Luccas can complement my answer, especially about capital allocation also about the first question, cost per life. This is affected by many variables as we grow more in corporate channels and as we sell more verticalized products, more products with co-participation, this mix of products will have a decisive impact on the average cost per life. But of course, many other factors should be added to this such as verticalization or network adjustments? Or review of special material suppliers or medication suppliers, systems implementation, prevention programs, kits and procedures that is -- there is this whole set of tools that have been helping us to control the current portfolio better. And this is added to our strategy of selling products that are more vertical.

As I said earlier, we're going to keep our comprehensive portfolio with all products, but we do favor more verticalized products. That's our calling, we know this segment very well, and we believe that we can make the most of it. And it's a more affordable segment which is a need of the Brazilian population.

About capital allocation, I will start, and then Luccas can help me out here. Last year, with a lot of discipline and a focus on reducing leverage levels, we made a CapEx of around BRL 400 million. This year, this is going to vary from BRL 600 million to BRL 1 billion. And our cash generation is going to be enough for us to pay for all of these investments that will help us verticalize and enhance our operations with new projects. We're going to build 3 hospitals, Sao Paulo, Rio and Recife, we're going to reopen a hospital in Sao Paulo, so the CapEx of the year can get up to BRL 1 billion to cover all of that. But Luccas, can you add something to my answer.

[Luccas Adib, executive]

Sure, Jorge. You talked about one of the main issues of our capital allocation, which is the necessary for the successful [ detainvestments ]. We have a of up to BRL 1 billion in our budget for us to continue with investments in strategic locations such as Sao Paulo and Rio de Janeiro. But the industry has been facing many difficulties and we have space in our balance sheet. We are very well positioned to make the most of the opportunities that may arise in the industry. We are focused on completing the integration process successfully and comfortably without any friction in users. And our focus is also on verticalization. We have a lot of space in capital allocation into verticalization. Of course, we have to check for the appropriateness of CapEx to see if this is pertinent and necessary for the company at a certain point in time. So of course, we have metrics of capital allocation in verticalization as well.

And we have space to consider M&A opportunities that may arise. This is not our focus right now. but the company will get to the end of the year at a leverage level that is quite comfortable and space in our balance sheet, 100% integrated with part of our CapEx allocated for that. So yes, we can look into the opportunities. But this capital allocation will not be made. I'm not talking about any specific M&A. But this allocation, of course, will have to be tested with our strict rules of capital allocation. We're not going to acquire just for the sake of it. We want to grow in a smart way but we're going to be very well positioned in our balance sheet to consider these opportunities at the end of the integration cycle.

The company is becoming more profitable. This has impacts on distribution to controllers payments of bonus and Hapvida Participações. When we paid net profit to the shareholders, I mean, this is going to be distributed at the proportion defined by law. But the focus of our company remains on integration verticalization, and we do have space in our balance sheet to consider opportunities after these processes are over.

[Operator]

Moving on to our next question by Mauricio Cepeda sell-side analyst at Morgan Stanley.

[Mauricio Cepeda, analyst]

Still talking about CapEx. As far as I understand, verticalization has been helping you to control MLR and it's good that you have migrated to a higher level of CapEx to increase verticalization in 2024. But what are your verticalization targets, do you have internal targets? How does that translate into CapEx throughout the years?

And our second question, which is also related to this is, will that take you to choose any specific region? Are you going to verticalize in certain regions or micro regions or you believe some locations are not attractive and are not going to be a priority for you.

[Unknown Executive]

Of course, the best of our business model, the best of our experience is in regions where we have a minimum concentration of lives to pay for our own network that is comprehensive with outpatient, ER and hospitals. And we have a minimum level for that. But we have mapped the whole country, and we have identified all of the regions for which this model would be a good fit and they are our priorities for expansion. But we have to make choices. Right now, we're investing more in regions where we see a quicker return potential. So these are regions with a lower level of verticalization. We see opportunities in Sao Paulo. We've been in this journey to increase verticalization in Sao Paulo, in Rio de Janeiro and other cities as well. So our strategy has been to expand in regions where we can get returns quicker and where we have more volume or a greater potential to expand our own network. But of course, we're also assessing other cities where we are not present or that we are present, but with a small footprint that can get further investments. And the good news is that there are many opportunities in Brazil.

Brazil is huge. We really like many cities that are not yet a good fit for our model. So we are prioritizing investments with a good rate of return. Luccas, would you like to add anything?

[Luccas Adib, executive]

Yes, I think that you are very clear, Jorge. I fully agree with you, Cepeda, the adherence test of our CapEx are very strict. We're being very disciplined in this. So we look at the locations that are good for our strategy the profile of products that we have to offer in the HMO and our virtualization capacity. This is what we intend to do throughout 2024 and beyond. That's our plan.

[Mauricio Cepeda, analyst]

Great Luccas. Do you see more years of investments?

[Luccas Adib, executive]

Well, we have many verticalization projects and they're not going to end now, they're not going to end with these hospitals in Sao Paulo and Rio. George is our strategic mind and he can add something to my answer, but my view and the view of the company internally is that this is a long journey to optimize our portfolios with verticalization. So I don't think we're going to stop in Sao Paulo and Rio. We have room to optimize our portfolio and verticalize MLR in the coming years as well.

[Operator]

Our next question is by Joseph Giordano sell-side analyst at JPMorgan.

[Joseph Giordano, analyst]

Let's go back to MLR. There is a calendar effect here. So what are the estimates I want to establish the right expectations because if you look at Q1 and annualize this, considering the seasons, we would be at a better level than other normalized MLR levels. So my first question is about April. Maybe this is not the most relevant month. But when we look at the calendar effect, this can be relevant. We had dentists holiday, an Easter last year, which were in different months this year. So if you look at MLR in the first 4 months of the year, it's much better, but can you tell us about the magnitude of all of this and you used to have Regions 1 and 2. Is there a gap between them as compared to the legacy times of Hapvida. Now about capital allocation and the health of many service providers. When you think about creating a high-end PPO product, do you think it would make sense for you to acquire assets that serve this more intermediate to high segment of the chain ?

[Jorge Fontoura Pinheiro de Lima, executive]

Okay. Joseph, I'll start and then Luccas will answer the question about capital allocation. About MLR, Joseph, structurally speaking, the company has been able to reduce cost from a structural perspective. Q1 did really well because of that and also because of lower volumes. And these 2 factors led to a historical MLR level. The good news is that the improvements are structural and in the medium and longer run, they will bring consistent MLR reductions until the end of the cycle in May next year.

Seasonal variations because of holidays or a more intense viral disease period, I mean, this will always happen. More intense periods, less intense periods. This will always happen. But what matters the most here is that we see that the sentence period of viral diseases that has already happened in certain cities that is still happening in certain cities. They are self-limited and they have beginning and end. So our greatest concern is been able to see the structure of the company to make sure we have the best prevention programs in place that we are delivering on our verticalization programs were consistent integration processes, the best deals with providers. So we will consistently reduce MLR by doing all of that. And I can tell you that yes, we are at better levels today than we were last year. There's no doubt about that and we expect to have margin increments this year.

About PPO, yes, we do have PPO products, 470,000 lives in PPO throughout the whole country. And we've been training and qualifying our own network more and more. Of course, this product will always have a broader network of providers, but it's natural that part of the users will use our own network because of better addresses, better locations, better infrastructure, to medical and nursing staff that we have. So we noticed that a larger part of the PPO customer base has been using our own network because we do have a good footprint in those regions.

And we have announced that we're going to build another beautiful hospital in Sao Paulo, another beautiful one in Rio de Janeiro and another wonderful hospital, which is in the final stages of building in Recife. So yes, we offered this to all of our users, including PPO users, we're offering better and better services. And we expect that a larger part of the PPO customers choose to use our own network. Luccas, would you like to answer the question about capital allocation.

[Luccas Adib, executive]

Sure. All about capital allocation, just like I said earlier, it's not the calling of our company to work on capital allocation to setup. I'm sorry. Can you hear me?

[Jorge Fontoura Pinheiro de Lima, executive]

Yes, we can hear you, Luccas. Go ahead.

[Luccas Adib, executive]

I apologize. I had a connection problem here. But Giordano, as I was telling you, it's not our calling to focus on this 100%, but this is still an important factor and generating lives and revenue. The HMO plans that we sell part is with PPO, the other part goes to HMOs. So we have to do the math to know whether we're going to have significant allocations for more sophisticated PPO products from the level of 600 to Infinity. But we're very much focused on the integration process right now and in executing our CapEx to verticalize and this is very much related to what Jorge just said, and we're going to be very well positioned at the end of this integration cycle. And at the end of this readjustment cycle to look into inorganic growth opportunities as well.

[Unknown Executive]

Let me just add something, Luccas, either inorganic or organic growth through greenfield movements and acquisitions, it doesn't matter. We have qualified hospitals that are reference centers in many regions in the country. And this is what we want to do to qualify our own network to be at the best locations with the best technology and the best professionals will always raise the bar constantly to offer to our members, either HMO or PPO, the best products with the best exclusive network.

[Operator]

This completes the question-and-answer session. This is the end of Hepfida's First Quarter 2024 Earnings Conference Call. The IR team remains at your disposal should you have any further questions. Thank you for joining, and have a great afternoon.