Welcome to WEG's 2017 second quarter's interim results from the conference call. As a reminder, this conference call is being recorded, and at this time, all participants are on listen-only mode. Soon after, we will hold a Q&A session where new instructions will be provided. Should you need any assistance during the conference call, please request the help of an operator by typing asterisk zero. We are simultaneously webcasting this conference call and the accompanying slides, which can be accessed via our IR website at www.weg.net/ri. We would like to remind you that we are recording this conference call, and after its conclusion, the audio will be available on our IR website. Journalists should direct their questions to the press release office at 4732-764295.
Any forward-looking statements contained in these documents or any statements made during this conference call regarding future events, business perspectives, projections, targets, operational and financial results, and WEG's future growth potential are assumptions and expectations of WEG's administration and are based on information currently available. These statements involve risks and uncertainties and therefore depend on circumstances that may or may not take place. Investors should understand that general economic conditions, industry conditions, and other factors may affect the future performance of WEG, and results may differ materially from those expressed in such forward-looking statements. We would like to remind you that this conference call is being conducted in Portuguese with simultaneous translation into English. With us today in Jaraguá do Sul, we have Mr. André Luís Rodrigues, Managing Director, Financial Superintendent, Mr. Paulo Polezi, Finance and Investor Relations Officer, Vilson Vasco, Controller Officer, and Mr. André Salgueiro, Investor Relations Manager.
Mr. André Rodrigues, you have the floor.
Good morning to everyone. It's a pleasure to be with you in the conference call of the results of the second quarter of 2017. As usual, we will highlight the three main points of this quarter. Number 1, the performance of the net operating revenue or growth of 6.9% vis-a-vis the first quarter this year, although there is a drop of 2.3% in this quarter vis-a-vis the second quarter of 2016. In the domestic market, we saw the opportunity of the stabilization process after a long recession period. The different segments are reacting in different speeds, and this is possible to see due to the repetition of the positive environment of the industrial product growth in the short term that are series. We see a stabilization of maintenance investments and the emergence of projects in gains of productivity and improvement of profits.
We do not see a short-term scenario change that will be in the engineered program like the high voltage motors. This is valid for the business of Generation, Transmission and Distribution because we have not recovered expansion in investments in capacity in industry or in infrastructure in foreign market. The recovery signals are more clear in our main markets, below historic average. We face a competitive scenario, we continue finding opportunities of growth in revenues in the increase of additional market share participation where we are present or the development of new markets. With this, we are growing, the negative impact of the exchange rate in the conversion of revenues in the foreign market is still important.
The second point is the recovery of our margin or EBITDA margin, result of operating adjustments that we carried out in the past quarters in the recovery of our sales in the short cycle products. We want to preserve competitiveness in the long term with operating adjustments to broaden margins and returns. Our EBITDA margin totaled 16.2% with a positive evolution of 220 basis points vis-à-vis the second quarter of 2016. Net revenue followed the same trend with a growth of 6.7% when we compare it to the second quarter of 2016 with a margin of 11.9%. At last, I would like to highlight as the last point the continuity of our efforts to increase efficiency and productivity. Our discipline in capital use allow us to maximize investment capital and continuity in the operational cash generation.
Paulo Polezi has the floor. Thank you, André.
Good morning to everyone.
When we go to slide 4, we see the behavior of the revenues in the different markets during this quarter. In Brazil, as André mentioned, we continue observing the continuity of the stabilization process of the industrial sector. The industrial products in short cycles and series are in a recovery process. In dynamic markets, this process will follow a natural path with each market reacting their way and the diversification present in our business model will be relevant. The demand by engineered products that depend on CapEx of expansion and infrastructure investment is shy from its targets and depends on investments outside of Brazil. The global market of industrial electrical products presents growth in local currencies. We have been able to grow with entering new markets with gains in market share.
During the second quarter of 2017, the revenues of the foreign market showed a drop vis-à-vis the second quarter of 2016 of 5.8% in BRL. Nevertheless, a growth of 2.8% in USD and 5.9% in local currency. In industrial electro electronic equipment in Brazil, we saw a movement of recovery in the market with the stabilization of new orders of series products or short-term cycle products. Abroad, we saw recovery in important markets like the U.S., China, Germany, and Australia. The stabilization of the market, both in Brazil and abroad, is still highlighted by series products of short cycles. For customized products of long cycles, the recovery depends on the rebound of investment and the increase of industrial capacity or infrastructure. The demand in Brazil is weak due to a lack of investment in oil, gas, mining, cement, and petrochemicals.
Sectors of foreign market, we see signals of recovery of these industry but below the historic average. In equipment for generation, transmission, and power distribution, the scenario is still challenging. In generation, there is a surplus of offer in Brazil, which drops the needs of new investment and the entry of orders. In transmission and distribution, there is no surplus capacity. The auctions in October 2016 and April 2017 gave us a positive perspective with new players in the process. The reflection on the portfolio of orders will only be seen in the next quarter up to 2021. Domestic motors, we have seen a stabilization when we follow the consumer goods market. Abroad, we have been positioned as the main suppliers of manufacturers of consumer goods in the world. We have focus on development of new products, clients, and markets.
Now, paints and varnishes, although a downturn in the revenue, there is an improvement in some segments like machines and equipment for agriculture. Now the recovery of preventive maintenance in important segments like oil, gas, mining, and the navy industry. We are focused on market diversification, developing added value product for sectors where we still do not perform and looking for new clients, especially in Latin America with Brazilian consolidated products. As André said, our focus on preserving margins guaranteeing the maintenance of our competitiveness will continue in 2017. On slide five, we see the EBITDA evolution in 2017. We can see that despite the drop of revenues, we maintained our focus in the maintenance of costs and operating expenses. Our EBITDA presented a growth of 13.7% vis-a-vis the second quarter of 2016. There was a significant increase in the EBITDA margin that was of 16.2%.
We continue believing that the stabilization of business conditions in Brazil will provide the stabilization of our margins. On slide number six, you can see the net financial result. It continues positive, although below recent periods totaling BRL 9.9 million. This result was mainly impacted by lower interest rate verified throughout the second quarter of 2016. Additionally, we had a negative impact of the mark to market of derivative operation used to protect the indebtedness in foreign currencies. These operations have an accounting effect once the disbursement of cash only carries out when we settle the operation. The net financial result that is positive is a result between the difference of financial goals and attractive condition and the compensation in investment due to the solid capital structure of WEG. 7, we have a cash flow analysis.
The cash generation and operating activities totaled BRL 623 million during the first semester. Despite the better operating performance, the cash flow was below 2016. This is a result of working capital in 2017. We would like to highlight that despite the consumption of working capital, we can see that we have maintained our operating indicators. Investment activity consumed BRL 183.8 million in the quarter, focusing on productivity capacity and maximization of invested capital return. With this, we adapted the disbursements in investments and capacity and expansion. Financing activities consumed BRL 208 million in the period, with net BRL 274.9 million in loans and financing. On slide eight, we see the investments in the past quarters. During this quarter, the investment totaled BRL 61.7 million, 60% growth abroad and 40% in Brazil. We are 25% shy from the results of the second quarter of 2016.
Part of this difference is explained by the exchange variation in the investments abroad. With this, I finalize my part. I give the floor to André, Paulo. Thank you very much.
Before we start our Q&A session, I would like to strengthen some points. 1, as we have mentioned, our focus continues being the preservation and competitiveness in the long term, carrying out operating adjustments for better margins and returns. The adjustments in the last months have long-lasting effects. We are ready to make the best of the opportunities of sustainable growth that start emerging. Another point is the diversification. That is the base of the business model that will continue positively contributing throughout the stabilization process. Point number 2, in Brazil, the recovery of economy is gradual and slow.
Although there is a continuity of recovery of short-cycle products, we depend on investments and expansion of capacity and infrastructure for the recovery of long-cycle products. We're facing the worst recession of the country's history and uncertainties with political crisis. There are reasons to continue believing in something that we call, during the first quarter, cautious optimism. In the foreign market, we see recovery signals, although we're below historic average. We see the recovery of new orders of short-cycle products and for oil and gas and mining projects that have emerged. We announced on June 21st the acquisition of CG Power USA, a company specialized in manufacturing transformers of distribution and power, with very relevant in the market of transformers in the U.S. market.
Together with our productive platforms in Brazil, Colombia, Mexico, and South Africa, will allow us to make progress quickly in our internationalization and business transmission and distribution project. We will now start our Q&A session. Our operator may proceed receiving questions. Ladies and gentlemen, we will now start our Q&A session. We would like to remind you once again that this conference call is being conducted in Portuguese with simultaneous translation into English. To pose a question, please press star one. To withdraw your question from the list, please press star two. Our first question from Minister Daniel Gewehr, Santander. Good morning to everyone. I can see that you have significantly improved your cost control, expense control, and gross margin. How much of this control is there space for improvement to increase your marginalization? Your second question is your EBITDA grew more than your EPS.
How do you see in 12-24, the growth rate in EBITDA or your rate of growth? I would like to understand this effect. Thank you, Daniel, for your question. I start answering the margins. You said if there's room for improvement in our margins. Let's analyze the following. There are factors that allow us to understand that there is room for improvement, and there are some factors that may go against us here, and I believe that in the future, we will have to observe which one of them will prevail. The factors that are favorable. From here on, mainly during the second semester, favorable seasonality. We tend to observe the recovery of short-cycle products, something that we have already observed. These cost adjustments that you mentioned in your question, they were implemented properly until today, and they have a long-lasting effect.
I believe that they will help us because of the operating leverage and all the indexes that I have just mentioned. These are the factors that may help us to improve a bit more our margin. Nevertheless, we have to remember two factors that are very important that can go against us. One would be, we are carrying a very significant gap of backlog in our GTD. The xWind is stable until next year, but the other business units have a relevant backlog. A process that strongly helped us last year, this year didn't help us that much, and it was present. That was jornada de redução. It is being valid until July, but during the second semester, we will not see this. In a nutshell, we have to assess two factors here, the positives and the negatives, and we have to observe the trends.
There are more positive than negative factors. Nevertheless, we have to pay attention to them from here on. Regarding the second part of your question, if we will have a detachment of the net income and EBITDA margin. Yes. As your EBITDA margin grows, your net income will follow it, something that we saw this quarter. I believe that the question is the financial result. Although we have a highly competitive structure with very attractive financing lines and good cash position. The financial results changes quarter after quarter, and this can detach a little bit if you see four more years. This is a slow and gradual effect. I believe that this effect will be clearer as of the year 2018. Thank you very much.
Next question, Alexandre Falcao, HSBC.
Good morning to everyone. Two questions. One would be regarding the labor reform.
I don't know if this will affect your results. What can happen in your enterprise if, for example, these new changes in labor unions, how can they affect you? Do you see this reflecting on your results? The second question, the GTD. You said that there is a gap of windmill technologies. What should we expect for you to gain more? What sectors could emerge again and could help you to regain more productivity? Let's start with the labor reform. We are still understanding the aspects of legislation that were changed. This is going to be positive not only for WEG but for all industries in Brazil, because changes will allow us to flexibilize. We will be able to offer more jobs, and we will be able to recover the economy. It's too early. We're still analyzing, but I believe that the result is positive, the provision authorization.
The negotiations with labor unions are following their normal flow. We believe that we will not change our position. Everything is very normal. Your questions about the new opportunities on windmill technology. With the portfolio that we have of generators, our portfolio goes until the middle of 2018, and very recently, a deconstruction was announced, a bid that we won in Furnas that would allow us do this transition until the market would recover, and there was a decontracting. What can we say right now about this point? Number one, that WEG is properly positioned. We're good products, competitive products. We continue exploring export opportunities, and we're mapping available opportunities in the free market in Brazil that is a bit lower. It is very important to remember that in the recent past, we witnessed in Brazil rigorous cycles where we were very important.
We can talk about mining, we can talk about sugar and alcohol sector, and we found paths of growth. An example of a pathway of growth that we're exploring that can help us while the windmill sector is undefined, is solar energy, for example, through WEG. More and More is a supplier of solar energy project with photovoltaic energy products. There is a solar complex of Coremas in Paraíba that will add 93 MW peak with a revenue of BRL 426 million between 2017 and 2018. It still doesn't compensate, but I believe this is positive. An important message to convey here that in situations like this, our model of business diversification with the vertical integration allows us to make these adjustments of idle capacity to see segments that are rising, connected to series and short cycles until the market goes back to normality in the future.
Okay, does this answer your question?
Thank you very much. About the provision. The law has changed. Do you believe that things are going to change?
I would like to elaborate on the provisions. The information that we have does not justify changing our criteria. Let's see the details that will come from this reform. As this is something from the past, the trend is not to change, but we are going to follow this up in detail. We are going to raise this information, then we will send this information to you because we don't have this on the top of our mind right now.
Next question, Lucas Marquiori from Safra Bank.
Good morning to everyone. Two questions here. The first one regarding the purchase of CG Power.
I would like to know the major opportunities that you see in the U.S. market, that is your biggest market. In addition to Brazil, I want to know where you can grow more, market/products that you are targeting in the U.S. market. This is my first question. My 2nd question, if you could update the information, how much from your local production is being exported, what is the % of your revenue is being exported, and what figure would be the natural figure for this?
Lucas, thank you for your question. Let's start with the CG Power we announced on June 21st. I would like to explain this acquisition. It's a company that produces power transformers. There are three industrial units in the U.S., two productive and one of service. During the last year, the revenue was $128 million, and it is totally aligned with our GTD strategies.
We wanted to find a good asset, and this asset emerged. Together with strategic alignment, you asked about products and areas. This product is a leader in segments where we still did not have a leadership. That is power transformers. They're leaders in windmill, solar, and it's very relevant. Another positive point, this will allow us to have good synergy with our Mexican plant in a number of areas. It has complementary lines with the Mexican units. Mexico, for example, have a strong presence in dry-type transformers. Today will allow us to increase our market share in power transformers in the U.S. Our market share is a 1-digit, and we want to have a 1-digit high market share, and allows us to mitigate an eventual Trump risk, and this can allow us to mitigate the situation, this risk. I believe this was a very important acquisition.
We are very reassured because we believe we will grow in the U.S. market. We already have a good presence in low voltage motors. Now, exporting hasn't changed a lot. We've continued with the same trend that we announced during the last year.
Next question, Paulo Falaci, Citibank.
Good morning. You mentioned that your backlog is of windmills. How much of the revenue does this represent, and when this backlog will change according to profitability in the future quarters? Well, CG Power, last year, you invested a lot that compromised your cash flow. Could you talk about your asset turnaround strategy? Will we have a positive cash generation in CG Power this year or next year? Paulo, good morning. Well, backlog, André can answer CG Power. From our backlogs, there is a misunderstanding. This backlog of windmill technology is in the future.
Today, our backlog is very low in high voltage motor generation and transformers. This is where we have our backlog. This in Brazil and abroad, these sectors are suffering a lot. This is something that comes from the past, since last year. This effect was stronger this year. The auctions that generate a great deal of demand for these sectors, they did not take place during the last year. They took place in 2015. This is the main reason why we have a weak backlog. Strategically, it is not convenient to give you the figures in terms of backlog. What I can say that they are around 20% below history. It is going to depend on the performance of the second semester.
We are working below the historic average, reminding you that we are reducing labor hours to Fridays less a month within our units of GTD ex-wind. This is the current situation. I believe that this situation will remain during the second semester, and if we do not have new auctions, this may continue next year. A factor that may mitigate this is the industrial recovery. A number of orders in the industrial sector start emerging, and this may help us to mitigate this effect. What is important, our auctions, this is low, and we believe that it will continue low during the quarters. CG, the expectation is improvement, especially during 2018, especially because we will redistribute our product portfolio from one unit and another, and the synergy that we will have with our plant in Mexico, and we expect these results to be reflected on 2018.
Lucas Barbosa, UBS. Good morning, André Paulo. Thank you for answering my first question, because labor hour reduction, how did this help you in your margin? What about the agreement with your labor union? This is my first question, I will pose a second question.
Rodrigues, good morning. The impact of labor hour reduction is very little in margin. I believe that the effect is more on plant occupation. It affects more the assets. Last year, during the second semester, the entire company in Brazil, all the units, Santa Catarina, São Paulo, Espírito Santo, Manaus, all our units reduced labor hours, working hours. Everybody, corporate, administrative. This year it is different. This year, our units are connected to GTD, xWind. These are the transforming units and the power units. These units are less representative in WEG. Nevertheless, the effect on the EBITDA margin is very low.
We do not have this figure on the top of our minds. It is not very relevant. It is very low, and we believe that it will not have a major effect during the second semester if this is your concern of margin. The agreement with your labor union is that you can do this 6 months a year. Yes. We have already taken up this measure. It ends at the end of July.
My second question, just a follow-up regarding the backlog, we would like to confirm. You mentioned that your backlog is 20% below in GTD, or would this be your backlog by and large? If it is in GTD, how would the backlog be in the entire company with historic comparisons? What about PCH sales in India and your sales of transformers in the U.S.?
Backlog is for long cycle products that are in the GTD. Motors and automation of short cycles, we do not have a backlog problem. This is regarding GTD specifically. This is outside Brazil. It is stronger in Brazil and lower below. The average between two would be around 20%. Could you please repeat the question about India?
What about the development of the products that you want to sell in the market in India, the PCH generator, what the market is in India like?
The Indian market is a market that is a good market. It is growing and demands a lot of investments in this market. The power and infrastructure and the main driver would be water pumping. Water is very relevant in the country. The main driver is along these lines.
PCH also exists, but it is not very representative in our portfolio. The great volume in business in India is connected to water pumping. There are actions that we are carrying out, and we want to work with wind farms in India. We still have nothing contracted. This is a movement that will bring benefits in 2018, more specifically 2019. These are the two very important sectors, but water pumping is very important in India. Thank you very much.
Good morning. To pose questions, please press star one. Next question, Leandro Fontanesi, Bradesco BBI.
Good morning. Could you elaborate on the domestic market? You mentioned products with low demand. Could you mention products with a higher demand vis-a-vis last year, because here we can see there was an improvement. The second point, Mexico investment, could you give us an update of the investments in these countries?
Leandro, good morning. Yes, we will recap and we try to be specific in our speech. We will give you details of the domestic market, and then we will talk about China and Mexico. We repeat this constantly. We observe a continuity in the recovery process. This is very obvious in the series and short cycle products. This is clear. We have also observed a number of markets that are more dynamic right now. Which markets are these? One, agriculture, two, food processing, and also the part of beverages. These markets are gaining momentum right now, especially during this quarter. Although there is a lack of greenfield projects, expansion problems, the stability of orders in small and series products have been consistent in the past quarters. This shows us that the maintenance CapEx is reemerging again. This is something that we have to register.
On our side, we also continue trying to expand and to gain markets. The dynamic of Brazil is more or less along these lines. GTD is difficult, as we mentioned when we answered the other questions, and I believe will continue difficult. We are expecting new auctions, one of power decontraction and one of power generation. I believe that now André can answer. Let us start with China. China, positive results. We announced a new capacity at the end of 2015, beginning of 2016. We doubled our motor capacity of low voltage, and we are investing to increase our capacity. The expectation is that in 2020, we will double our existing capacity. Our plant is running, and our expectations of increase of capacity have materialized. Mexico, let us see the internationalization process of Mexico and horizontalization were positive in both companies of low voltage motors, very good.
Mexico presents good quality in labor and a cost that is very competitive. Mexico now we are working with low-voltage motor, and we are in the last stage where we can see verticalization. This is an investment to have a smelting plant that will end by 2018. Both countries have promising results and with promising future. It is following our strategy of expanding our actions in these countries. We are focusing our investments on China and Mexico when it comes to investing in foreign markets. Thank you very much. We have a number of questions that came in written. I would just like to strengthen a point. This was a question that came from Santander regarding net revenue and financial results. I would like to highlight something.
Although we observe a stabilization in interest rates and a drop in the long term, the main message is that at the end, this is very positive. An environment where you have a lower interest rate, it goes hand in hand by a growth environment. At the end, the net income of the company is better because this means that the economy is growing. The scenario then of drop of interest rates is positive for WEG than negative. I just wanted to strengthen this message.
There is another question here from Sérgio Saraiva. He asks, "What is the percentage market share in windmill technology?"
This is strategic information, very important for the development of our business. Unfortunately, we cannot disclose this. The class entities have statistical data, and I believe that they can show you the representativity of Brazilian players and what their market share is.
I do apologize. This is a piece of strategic information, and we cannot disclose this.
There's another question from Sérgio. If WEG is prepared to supply, and what kind of equipment and auto parts are they willing to supply for the automobile industry, especially now with electric cars?
We have technology, and we have prototypes of electric vehicles in WEG, and we have around 250 buses running with a solution of electric engines and frequency inverters. We have technology, we have the capacity. Now I'm talking about the buses when we talk about buses. Light vehicles, well, this is a trend. This is going to become a reality, and we are maturing this technology in the company, and the company is investing time and resources on this type of technology.
We would like to remind you to pose a question, please press star one.
We bring our Q&A session to an end right now. Mr. André Rodrigues will make his final remarks. Mr. André?
Thank you very much for your participation. We expect you during our next conference call with the earnings results of the next quarter. This conference call has come to an end. We thank everyone for your participation, and have a very good day.