Good morning. Thank you very much for waiting. We'd like to welcome you to the conference call for Tupy for Q1 2018. All the participants are in the listen- mode only. Later on, we will have a Q&A session when we will give you further instructions. If you need any help from the operator, please dial star zero. This conference call is being recorded. The company would like to remind you that this event is also being transmitted via webcast, and it can be accessed at www.tupy.com.br/ri, where you will find the presentation. The selection of the slides will be controlled by you. We remind you that the participants in the webcast may send through the website questions for Tupy.
The company clarifies that any declarations made during this conference call on perspectives, projections or operational and financial goals concerning Tupy's business are based on the expectations of management and concerning the future of the company. These expectations are highly dependent on international and domestic market conditions, the economic performance of the country and the sector. Therefore, subject to change. We have with us Mr. Fernando Cestari de Rizzo, CEO, and Thiago Struminski, Vice President of Finance, Administration, and Control. Mr. Fernando, you may proceed.
Thank you. Good morning. We'd like to welcome you to the conference call for the results of Tupy. We would like to begin with the main indicators in the first quarter, and then we will go on to the Q&A session. This is my first conference call as Chairman. On behalf of all the employees, I would like to thank the management that during these 15 years, they did a restructuring of the debt, a new growth strategy that is successful, internationalization of our manufacturing operations. They reopened also the company to the equity and debt markets, placed the company in Novo Mercado in our stock market, and brought initiatives in order to diversify the company's products. Looking at results. First of all, I'd like to thank the trust of our clients. Our team in all the areas of the company does every sale with the best possible quality.
I'd like to thank each product that is sold. This hard work with collaboration is our business model, which is superior to that of the competition. Our team had an excellent Q1, good performance in all the areas of the business. Q1 2018 reached a record revenue, reaching BRL 1,059,000,000, a growth of 23.9% in relation to Q1 2017, and the results are impressive. We increased the EBITDA getting to 148.3 million adjusted EBITDA. Although we had an increase in the price of raw materials of 22.3% in comparison to the first Q1 last year and 7% more than Q4 2017, we were able to improve the results with gains in efficiency, cost control, expense control, and a better product mix.
We reached better sales than expected in all the segments, showing the trust of our clients in Tupy and sustained by a vigorous global growth, which increased the volume of commodities. This is very favorable for the capital gains that we were able to reach with investments in all the regions. In transportation vehicles, agricultural machines, electricity generators, and a great diversity of equipment and capital goods. The growth has positive signs in most of our markets. Cargo transportation vehicles, we see an increase in the production in the U.S., 5% for mid-size trucks with a great volume and an expressive also growth in heavy-duty vehicles, the ones we export less. A very strong market for pickups with diesel engines in the U.S. and with gains in relation to passenger cars with record numbers in the last quarter.
Also, the production of machinery and trucks in Brazil, the recovery was strong, brought a lot of growth to the company, and also the export market also increased our volume in Latin America, China, and India. The industrial off-road for infrastructure, the construction sector in the U.S. and China and neighboring countries brought a great demand for backhoes, tractors, loaders, wheel loaders, and we can see this in the housing start indicators in the U.S., using light equipment for construction, also diesel pickups, also oil and gas with shale gas in the U.S. also brought a lot of demand for our Tupy's products for stationary engines, electricity generators, trucks, and auxiliary equipment for the exploration of shale oil. Also, the global economy is also growing. Excavators in China also, an increase of 48%, and many of them with parts from the U.S.
In hydraulics, we have profiles and connections strengthened by a favorable exchange rate that should continue during the year. Our operational costs were well managed. We increased our efficiency with an expressive increase in volume and one factory less in operation in relation to Q1 2017. Our investments were 2.8% of net revenue, continuing with our standard and efficiency similar to other periods. We have focused our investments in increasing the efficiency of production and also those products that are more value added. With all of this, we also expanded our investments in work safety in the company's plants. Our cash flow improved well in relation to Q1 2017 with a decrease of 10 days in our CPV. Our dividends, the company really is foreseeable.
O n May 25, we will pay interest on own capital, BRL 37.5 million , corresponding to the first installment of dividends announced this year, BRL 150 million. On slide number two of the presentation, I'd like to comment on our markets, where we are present, and the diversification of our revenue. Only 14% of our business comes from passenger cars. Essentially, the company's performance is related to cargo transportation sector, infrastructure in general, and agriculture. We changed the names of the segments in our communication material to show better this reality. In terms of investments, lights, trucks, heavy mining equipment, construction equipment, wheel tractors, harvesters. Now, products that are less obvious are electricity generators, naval engines, also engines for forklifts, defense equipment, locomotives, and airport and port equipment, and many other equipment for reforestation, et cetera, that use diesel engines.
The world is getting richer, demanding more energy, more food, and raw materials. Globalization has increased international trade. Tupy is in a privileged position to capture these trends. The long-term projections should consider the solid pillars of our main businesses and clients. I would like to pass the floor to Thiago, our CFO.
Good morning. I would like to give you some numbers concerning the highlights. Slide number three, the increase of 11.6% in sales despite the closing of the Mauá plant and its business. For the first time, net revenue overcame BRL 1 billion. Apart from the increase in volume, we had a positive operation with a better mix. The company's EBIT also had a growth of 23.9% with a 14% margin that is stable in relation to Q1 2017, in spite of the strong increase in the price of raw materials. This effect was compensated by many actions to control costs done in 2017, which today are giving us results in 2018. I would like to say that our contracts are there for increases in commodities. We have this under control. In terms of capital allocation, investments in the quarter represent 2.8% of revenue.
We reduced 10 days in the cash conversion cycle in comparison with Q1 2017. On slide number four, we have more details about sales, 150,800 tons, an increase in 11.6% in the domestic market. This is the physical volume of sales. In the domestic market, once again, commercial vehicles increased and outside Brazil, off-road vehicles, also 20.5% were relating to machining. Also, we see here our exports in the domestic market, there was a growth, 30.4%. Export market, 26.7%. 75% of the revenue had an origin in NAFTA. I would like to say that many of our clients use this region as an export platform, so they do not necessarily keep these products. 18% South America, Central America, especially Brazil, 12% Europe, 6% Africa, Asia. In terms of investments, 81% of commercial and off-road vehicles, 14% passenger vehicles, 5% hydraulics.
Slide number six, we see the evolution of revenue in transportation, infrastructure, and agriculture in the domestic market. They had a benefit with exports. So this way, we can see here the numbers, commercial vehicles, 74%, and also off-road equipment, 15%. Slide number seven, revenue of the export market had an impact due to the U.S. market and also devaluation of our local currency, real, 0.4% in passenger cars, a growth of 26% in light commercial vehicles with strong demand for this type of vehicles, especially in small businesses. Expansion of 3% in average commercial trucks and also heavy. They had an impact due to the sales in Q1 2017 at the time, certain clients increased inventory, an increase of 42% in off-road applications due to the good performance of the market in oil and gas, mining, agriculture, and infrastructure.
Slide number eight shows the performance in hydraulics, 4.9% of revenue. Domestic market, a drop of 3% due to the discontinuity of our business in Mauá and also closing the plant in Mauá, and also the sale of connections. Exports grew 62%, especially due to the demand in the U.S. market and the improvement also in the European market and also the favorable exchange rates. Now going on to slide number nine, we see the products sold and expenses. You can see BRL 885 million, 23.1% higher than Q1 2017, which resulting in a gross margin of 16.2% with an improvement therefore in relation to the previous year, which was 15.7%. An increase in the volume produced naturally had an effect on cost. We highlight 37% in the cost of raw materials and processed materials due to price variations.
Most of this variation is passed on to the prices paid by clients. The growth of 21% were the expenses relating to labor, increase of headcount in Mexico and using overtime due to the strong volume. Also, we see here a decrease in materials and maintenance from third parties due to the closing of the Mauá plant. Here we see also the implementation of a new budget control system. Operational expenses went up 9%, especially with more expenses with labor, freight, and commissions on sales due to the increase in volume and also development of some new projects for R&D. Slide number 10. Here we see the adjusted EBITDA, an increase of 24%. The margin is stable in relation to Q1 2017, although we had a strong increase in the price of raw materials.
At the bottom, we see here net profit, BRL 57 million, and in comparison with BRL 47 million last year. Slide number 11, we show the variation of the main working capital accounts in the previous quarter, Q4 2018. Here we see accounts receivable, eight days. Here we see growth of revenue and also a different product mix, higher inventory, BRL 8 million, a reduction of one day, and an increase of BRL 42 million in accounts payable, both due to the increase in volume. Here we would like to highlight the significant improvement of these improvements in relation to Q4 2017 and also in relation to Q1 2017. Therefore, we have now better payment terms for vendors. We would like to highlight the gains of 10 days in the cash conversion cycle in relation to 2017.
On the next slide, number 12, we see investments in intangible assets, BRL 30 million, 62% higher than observed in Q1 2017, but still 2.8% of net revenue, half of the depreciation. This is a strategy of the company to allocate its assets and increase the return on invested capital. The main highlights: development of new projects for IO and other operational improvements, cost reduction, and the revamping of some equipment, and also work safety and environment. On the next slide, we see the net debt of the company concerning 1.47 x adjusted EBITDA. Our debt is in foreign currency, 90%, which is in line with our business profile. We would like to highlight that most of the debt in foreign currency is represented by our debt, which will mature in 2024.
Concerning our cash, 63% in local currency reais, in order to take advantage of a good exchange rate, and also reduction of cash, especially due to prepayment of debts, BRL 191 million done in January. Well, finally, I would like to talk about the payment of dividends. The company has a business model with strong cash generation, and we have one of the largest disbursements. In March, we made the payment of BRL 50 million for 2017, the last part of BRL 200 million announced and paid. Yesterday, we approved the distribution of interest on our own capital, worth BRL 37.5 million. These will be paid on May 25. This is the first installment of minimum dividends of BRL 150 million already announced for 2018. This will happen every three months. We are different from the market due to the foreseeability of our payments.
We announced the minimum dividend that we will pay. With these highlights, I would like to pass the floor to Fernando for some of his final comments.
Thank you, Thiago. In December 2017, on Tupy Day, we showed the growth in volume of 5%. We had more than 10% during Q1, and no signs of deacceleration of these levels. The Brazilian market has a consistent recovery, and our clients abroad continue strong due to a strong global economy. The revenue, we expect the volume higher, costs of raw material, and launching of products in the second semester. The investments have been done, and we are expanding our plant in Mexico during Q3 and Q4. The impact on EBITDA, we have a forecast of 50% margin for the year with absolute EBITDA and cash generation higher than our plan. Concerning capital allocation, we will continue adopting rigid controls for investments and our capital control.
The company maintains its strategy, and our focus and the fundamental word I would like to leave with you closing my comments is execution of our plan. Our focus is execution. We did our homework, we decreased the costs, and now we have to improve efficiency and carry out the sales that we made in the last few years. Our markets have a favorable cycle, and the word is plan execution in order to have the best possible results. The market, we have a positive perspective for 2018. I would like to thank you all for your interest in our company, and now we would like to begin the Q&A session.
Ladies and gentlemen, we will begin now the Q&A session. To ask a question, please dial asterisk one. To remove your question, please dial asterisk two. Our first question comes from Rogerio Araujo, UBS.
Hello. Good morning. Thank you for the opportunity. First of all, Fernando, congratulations. The first question has to do with the price of scrap. Could you clarify how much of the increase was passed on to the price for clients, the increase in price for scrap? What is the adjusted EBITDA margin if all these increase had already passed on to prices for clients? Also, what would be an adjusted EBITDA margin in the current reality after the price adjustments? We are also looking at recent depreciation, exchange rate depreciation with the strong volume you have, closing the plant of Mauá. How much do you believe would be a normalized margin? Thank you.
Rogerio, Thiago speaking. First of all, I would like to stress that as materials got more expensive when comparing with Q1 2017, and they increased more than 20%, even in relation to the previous quarter, this should have brought a violent margin corrosion. We were able to maintain the margin stable. We are talking about 7% on a unitary basis. Some cost increases were already passed on to prices. Some have still to be done, but the message is, we are still guiding the market to a margin of 15% based on what happened to Q1. Of course, we have potential for more. We have good projects that the investments have been made and will continue in the second semester. We can do more than 15%. We already made 17%, even more than 17%.
So right now we are thinking of 15%, but once we reach this number, we may continue. 15%, so the margin is 15% with a higher absolute EBITDA.
My second question was already answered concerning the new projects. What are the projects you have worked on, the new projects? How many projects do you have, and what is the timing for delivery? What is the margin contribution you expect from these new products?
These are projects that we will do the work that is outsourced right now. So in three segments, essentially, large engines for mining equipment, oil and gas for an important client in the U.S., and another project, the conversion of an engine block to pickup trucks in the U.S. market. This will be part of the launching of a new product. Apart from the foundry, we will include also services. We estimate that our total volume, which today is 20% of what we cast, we have sold. We should take this to around 23%, 24% machining. We're talking about machining services. We estimate the margin of machining services, 17 points higher.
Thank you.
Thank you. Our next question comes from Rubens Oliveira, Banco Plural.
Good morning, Fernando, Thiago. Thank you for the opportunity. I have two questions. The first question, I'd like to know, what are your thoughts and overview of the price of scrap in 2018? Also with this discussion, President Trump, in relation to the price of steel. Will this have an effect on Tupy? My second question, mergers and acquisitions. Do you have any updates concerning this? Have you mapped anything? Once again, congratulations.
Thank you. Concerning scrap, the market is fluctuating in Brazil. Mexico, it is on a high level. Scrap, we have to think of scrap in relation to what is happening in the steel industry. This determines the price of scrap in the different markets, the level of activity, and steel works. I believe the quotas that Brazil will have will limit Brazilian production. This should decrease the price of scrap in Brazil with the quotas, but it's not happening. The producers of board still use a lot of scrap. They will continue exporting a lot to the U.S. Steel sheets, they continue exporting. I believe that the market will find a new balance. We've seen more balance with a light trend to grow with steel plates also. With the economic activity we see in the U.S. and Europe, we don't see any drop in the price of materials.
Brazil exports scrap. So one way or another, through steel industry or direct exports of scrap, you have in the main markets, the trend is for the Brazilian market to continue strong. Brazil has a structure with the consolidation of steel scrap in Brazil. They created structures ready to export. So they need an export channel open, and they always try to align the price with international price. I believe that we should not have a growth as strong in Q1, but we believe that it will continue on a higher level. Concerning M&A, we continue analyzing M&A opportunities while we don't reach a level that is ideal to give an adequate return to shareholders. Capital allocation, we continue with dividends. So as we close a good deal, we can go to the market. For the time being, we continue distributing the right amount of dividends paid to shareholders.
We announced that BRL 150 million is the minimum. If we have a cash generation that is higher, we may, even without M&A, increase the disbursement to shareholders. The important message is that this industry does not show the need for organic investments. Our growth should come from acquisitions, so we are always alert about this. Our agenda is internal execution. We have a good portfolio of sales for the year. We are developing products like machining services. We have made investments already for this, and we continue focused on the execution of internal plans and always alert to opportunities.
Thank you.
Our next question in English comes from Juan Tavares.
Hi. Thank you. Good morning, everyone. My first question is just to touch a little on the metal price lag or the pass-through of your raw material cost. Could you give us a sense of how long does it usually take to pass through? Let us say if prices for scrap went up 10% today, how long on average does it take to pass through to your clients? Is it three months? four months? Just to get a sense of, as we see volatility during the quarter, how we should think about that metal price lag. Second, maybe if you have any insights on how your backlog is looking today, and maybe the end markets specifically, which ones are showing better than expected momentum or a little softer activity than what you were looking at December of last year. All right, thank you.
Well, thank you, Juan. Our contracts say that we will increase the prices when there is an increase of raw materials from one to three months. We have this agreement in the contracts, one to three months to increase the prices. In retail, we have a policy of increasing prices immediately when we have higher scrap prices, but normally one to three months. So in Q2, we should recover all the impact that we had in Q1. Now, we are seeing the market as being very strong in construction, very strong market in agricultural machines. Our clients that produce pickups with diesel engines have very good sales and are buying a lot. They are having growth. The prices of oil are sustaining the expansion of growth in oil and gas in the U.S., in cracking operations, and also engines, motors for shale gas. They continue very strong, these operations.
In the Brazilian market, the Brazilian market is strong independent of the uncertainties in the domestic market. But we see the Brazilian capacity to make cars and engines continues very strong because Brazil is a large supplier of engines to the U.S., Europe, and markets like China and India for the construction market. They are very strong, these markets. We do not see signs of a decrease. I would like you to observe the guidance of our main clients. We have talked to the markets, and we see higher growth on the part of our clients, higher growth in the beginning of the year. So we continue with the positive signs of demand for 2018.
Great. Thank you.
Reminding you to ask a question, please dial star one. Our next question comes from Lucas Marquiori, Banco Safra.
Good morning, Fernando, Thiago. Thank you for the call. A quick question. Fernando, you have been mentioning competition with foundries that are reducing prices, working with 3%-4% margin. Now, with a higher price of raw material, these competitors, they are not working with a loss, are they? How do you see what are these competitors doing after the increase of prices of raw materials?
Well, Lucas, all the foundries work with long-term contracts, and for car companies to switch vendors is very expensive. Most of our competitors are also increasing their prices, passing the prices on to their products, because demand has been strong for our competitors, too. As always, we are very careful in fighting for market share because it is a difficult industry. The business model is differentiated, guaranteeing a differentiated margin in relation to the competition, but we are very careful with these things.
Thank you.
I would like to add something. We always focus on the following: We export high-technology products. We do not export cheap products. We have a portfolio. We had components that did not have a good added value. We removed those. We are increasing with more complex products, and the market share in the sophisticated products is more than 70%. So sophisticated products have come to us, and we formed a strong team in machining services to supply machining to these clients. We have grown year- after- year and developing these projects. We understand our capacity as being valuable. We always go after advanced products, and this has guaranteed better margins, better conditions for us in relation to our competitors.
Thank you.
Our next question is in English from Juan Tavares, Citibank.
Hi, thanks for the follow-up. Just had a follow-up question regarding your current initiatives. I know you mentioned that the main focus right now is execution of those initiatives. I am curious how you look at the timeline of that execution. Do you see it kind of all of 2018 as the execution phase where you can reset where the margins are? Or will we see this kind of execution phase being a multi-year process? Afterwards, after you are able to complete this execution of your current initiatives in efficiency and machining, I am curious how you see the opportunity strategically in terms of either expanding your product offering. Is that something you want, or your regional exposure? I know when you answered the question on M&A, you kind of said that there aren't real opportunities organically, so it has to be acquisitions.
Could we see anything in terms of a new product or a more aggressive regional presence as you start to look for those opportunities? Thanks.
Thank you, Juan. Excellent question. When we talk about execution, we understand that the company has opportunities to be captured in sales. In the operation of the company, gains in efficiency to be reached still in our plants, in our internal costs, and in our operations involving acquisitions. There are many opportunities to be captured. We are focusing on this. We are improving processes. In other words, what we did last year to stop the foundry and the plant that had a higher cost shows this. So we improved the efficiency of the other plants belonging to Tupy with a greater efficiency. I was able to accumulate more products in these plants and stop the operation of my most expensive plant. We believe there are more opportunities within the company, and we continue going after them. We have a strong sales portfolio, very diversified by segments and markets.
We have to explore the best potential of this existing portfolio. At the same time, for example, the machining in Mexico has brought new opportunities. The proximity with clients decreased barriers, and now clients are buying more complex products. When there is machining, these are long-term agreements in relation to foundry products. The fact that we are close, one to three days from the operations of these clients, this has reduced the concern of our clients, and this has brought great business opportunities for the company. We believe there is a lot of value to be captured, and we believe that acquisitions make sense because it's an industry that has surplus capacity, and we believe we can adopt the same business model for a larger company after acquisitions. With this we will be able to get more advantages and efficiency and bring more value to our shareholders.
That's the first point. Now, concerning expanding to other markets. We sell to Asia. We understand that there are opportunities in Asia, but they are not interesting in terms of opening a plant in Asia. There are few independent players in the Asian market. We have exports to China, especially Thailand, India, but products that are more sophisticated than products that are normally used in these markets. With some specific applications, they have sophisticated rules for emissions. For example, special buses in the cities. There's opportunity for us to sell products. The machines, the engines are sold. They export these engines to markets that have restrictions on emissions. That's where we have an opportunity too. We have sold in these markets. We believe it's not worth the while to internationalize manufacturing in that region.
That's why we believe there's a great opportunity in gaining efficiency for this industry, and we believe there's a lot of value to be captured, and we're doing this.
Thank you. Very helpful.
Once again, to ask questions, please dial star one. We'd like to conclude the Q&A session for Tupy. I'd like to pass the floor to Mr. Fernando for his final comments.
Thank you. I'd like to make a comment to conclude concerning execution. I'd like to say that here the company is very vibrant. All the companies are really working hard, and execution for us means delivering results in 2018. We're not talking about long-term. The market is favorable and brings us opportunities for sales, engineering, purchasing. The company is very focused, very mobilized to get more results in 2018. A lot of determination. We prepared the company for this. We brought the company to this point. We improved our plants. We have a trained team that is highly motivated, and the market is favorable. It's time to harvest. We're very focused. We believe this year will be a turning point in the market. I would like to thank you all for your participation and that we will go back to work.
We have a lot to do, and we are very motivated. Thank you very much.
Tupy's conference is concluded. We thank you all for participating and wish you a good day.