Welcome to the conference call of Vega about the results of the Q4 of 2016 and for the year 2. This conference call is being recorded. And right now, all participants are connected in listen only mode. Later, we are going to start a Q and A session, once further instructions will be provided for you. We are simultaneously registering this conference call along with a slide deck, and they are available at Zeg's Investor Relations page at www.zeg.net/ir.
As a reminder, we are recording this conference call. And right after the end, the audio will be available in the Investor Relations website. Journalists should send their questions through telephone, 4732-764-295. Any forward looking statements and any statements made during this conference call about future events, business prospects, operational and financial projections and goals and the growth potential for ZEG, they are near beliefs and assumptions of ZEG's management, and they are based on information currently available. These forward looking statements involve risks and uncertainties, and therefore, they depend on circumstances that may or may not happen.
Investors should understand that general economic conditions, industry conditions and other operational factors may affect the future performance of AEG and leads to results that will be materially different from those expressed in such forward looking statements. Now we would like to remind you that this conference call is being held in Portuguese with simultaneous translation into English. Today, with us in Jarraguadu Sur, we have Mr. Andres Luis Rodriguez, Managing Director and Finance Super Independent and Paulo Cohesi, CFO and IRO of VEG. Please, Ms.
Andre, you may start. Good morning, everyone. It's a pleasure to be with you once again for the conference call to announce the earnings of 2016, more specifically about the Q4. I would like to start by highlighting the main points. First of all, revenues.
We have been dealing with a difficult environment with low global growth and important segments with a recession in CapEx. Everything indicates that Brazil is going through a regularization after a long and deep recession. The outlook is positive, but the process has only just started. In this environment, net operating revenue has dropped 13.1 percent this quarter compared to the same quarter last year. The performance in domestic markets was relatively better, but the negative impact of the FX rate and the conversion of revenues in the foreign market is very large.
We'll speak more about that shortly. The second highlight are the results of operational results that we conducted along the past quarters. As we said in the beginning, that our focus would be to preserve margins and returns, keeping our reaction capacity while we were dealing with a challenging environment. At first, we managed to curb the drug process that had started in Q3 'sixteen. And in this manner, we can see the regularization of the market that is producing as well as margins and returns.
In this manner, in the Q4 2016, EBITDA margin has reached 16.9% with an EBITDA with a growth both as compared to the previous quarter and to the previous year. We have attained a quite good net margin of 13.6%. It's important to compare to remember that in the previous period at the end of 2016, we saw a strong variation in foreign exchange rate, which did not happen last year. Lastly, the third highlight was our discipline in using capital, very much focused on increasing productivity and efficiency. Two aspects demonstrate that: number 1, our management of the operating working capital and number 2, our just missed investment capacity optimizing the use of our capacity.
Now I would like to turn the floor to Mr. Polesi. Thank you, Andre. Good morning, everyone. Going to Slide 4, I would like to detail the behavior of our revenues in the different markets this quarter.
In domestic markets, the process of regularization of business environment continued slowly and gradually. What we saw is that this process is going to follow its natural path, which started with serial projects, more commonly applied in maintenance investments. Demand for engineered products, more related to capacity expansion, is still weak. In this manner, in a domestic market, we saw a high of 0.8% over the Q4 of 2015, the first growth of 4 quarters of negative comparisons. The global market of Industrial Electrical Projects practically is not growing with a slowdown in investments such as in the industries of mining and oil.
We have been able to grow by going to new markets foreign market have demonstrated a drop as compared to Q4 'fifteen of 21.8% in Brazilian reals and 24.6 percent growth in Brazilian reals and 8.8% growth in U. S. Dollars and a growth of 1.5% in local currencies. The performance on different business areas shows a similar situation. Industrial, Electro, Electronic equipment, which is the area with the highest exposure to the foreign market, the low growth is and slowdown in the Global Industrial Investment limit our performance.
As we said, we need to explore new markets and to gain share. The gradual regularization of the Brazilian market is clear in serial projects of short life cycle. And in terms of equipment for energy generation, transmission and distribution, GTD, we have 2 different things. In generation, there is a surplus in offer in Brazil, which reduces the need for new investments and replacement of orders. We have been seeking alternatives to make this transition until this sector starts growing again.
In transmission and distribution, it's better because there is no surplus of offer much to the country. And the regulation environment is already encouraging new investments and new orders. In the area of engines for domestic use, we did not see any relevant changes. The Brazilian market remains stable at a relatively low level overseas, where we are new entrant, we have suffered with a variation in volumes. Finally, in the area of coating, we are capable of finding alternative markets and applications with relative success.
As Andres said, in 20.60, our objective was to preserve margins and returns, guaranteeing our competitiveness. Slide 5 shows the evolution of EBITDA between Q4 last year and now. And we can see that the drop in revenues was offset by the favorable evolution of operating costs and expenses. In Esmejena, there was an absolute growth of 4.9% in EBITDA compared to Q4 'fifteen and a strong increase in EBITDA margin of 16.9%. This permitted we have to close the year of 2016 with EBITDA margin very close to that, that we had in 2015.
And this is very important for us because EBITDA margin is one of the ways to see our competitiveness in the market. The regularization of business environment in Brazil will make it possible for us to see the continuation of the regularization of our margins. And this is not a linear process, but we hope that it is very consistent in terms of net income. Detailed in Slide 6, was smaller than in previous in recent periods, but without any significant changes and is still positive with BRL 47,600,000 in terms of our net financial result, the hedging operation to protect us from foreign exchange is working very well. And this positive net financial result is the result of VEG's sound capital structure.
We continue to benefit from very attractive debt conditions, both in terms of cost and times. Slide 7 shows our cash flow. The cash generation in operational activities has reached BRL 2,130,000,000 in the year with consistent efficiency gains in the management of our working capital, which offset the slowdown demand in the Brazilian market and the smaller cash generation in operations. Investments took BRL 852,700,000 in 2016. We reduced the pace of the investment investments for expansion of the capacity, we optimized our production capacity and maximize the return on net capital invested.
Our funding activities took BRL 1,000,000,000 in a period, and we amortized with a net amortization of BRL 136,900,000 in loans and financings in the period. Lastly, on Slide number 8, you can see investments in capacity expansion in the past few quarters. We closed 2016 with $325,200,000 investments in the expansion and modernization of production capacity, with a highlight for the projects of the new plant for electrical engines in Mexico in China. This amount was below what we had originally planned for the year. This difference in terms of adjusting the speed in capacity increase is one of the basis for our business model in this manner.
We can make the most in terms of return over the capital player back over to Mr. Rodrigues. And before starting the Q and A, I would like to reinforce a few points. After years of job investment affecting all industries, the outlook for 2016 is for a regularization in the Brazilian economy. That is, diversification, one of the basis of its business model, will work again.
The environment will continue challenging, especially in the beginning of the year because the country is slowly coming out from the recession of political crisis, increases uncertainty. But the market gives signs that the worst is past. Secondly, the world is growing slowly, though consistently, but the global market of industrial and electrical equipment is not growing. Outlook of some recovery of demand in specific industries, but the economic and political scenario cut many risks. In any way, we are confident in our competitiveness to make the most of growth opportunities.
We can now move on to our questions and answer session. Please, operator, you may continue. Ladies and gentlemen, we are now going to start our question and answer session. As a reminder, this conference call is being held in Portuguese with simultaneous translation into English. Our first question comes from Mr.
Joao Norreno Nordona from Santander. Good morning, everyone. About improvement in the gross margin, could you give us more details in what changed from the 3rd to the 4th quarter in terms of cost? And also, any changes in the domestic environment where we saw that there was an increase in the provision for bad debt. What was the driver for that?
Good morning, Joao. One very important thing is that the net margin in the 4th quarter is not the basis for 2017. As the market regularizes, this margin is going to become more regular, too. This is our expectation. Also, the process of regularization is not linear.
It doesn't improve every quarter on quarter. So what we had in the Q4 was had many drivers. The main was the concentration in long life cycle products with smaller margins, our focus on GTV. And so we have made some efforts of reengineering products and processes. Another point is the impact of our initiatives of cost reduction that we implemented along 2016, for example, the reduction in the work hours.
When we go to the foreign market, it's similar to previous quarters. The world is growing slowly and especially in industries where they operate. So these were the main drivers that had an impact on the margin in the Q4. Okay. Thank you very much.
Our next question comes from Mr. Rogerio Araullo from UBS. Our next question comes from Mr. Marcio Prado from Goldman Sachs. Good morning, everyone.
Thank you for the conference call. I have a follow-up question about margins. How do you work in terms of revenue for the possible orders that you're going to have in transmission and distribution of energy? There were auctions in April, October. There will be there's an upcoming auction now in April or May.
Have you received any orders? Do you have any orders in your backlog? And how do you define the revenues along the project? Can you see this in a short term? Or as these lines take 4 or 5 years to be built, this will have an impact in VEG's revenues more towards the future.
Hello, Mario. Thank you for your question. This is Paolo answering. In terms of T and D. So talking about the past, in the second half of twenty sixteen, our portfolio demonstrated good quality as an evidence that our competitiveness is similar to what Andre just said.
So we implemented significant product changes in 2015, which helped our competitiveness. More specifically on T and D, D, there is no surplus capacity in this industry, much to the opposite. There were no investments also see improvement in the regulation environment. The last auction last year already demonstrated this very clearly. We saw major participation of private companies.
And this regulation environment is very positive, and this will continue in future auctions. So this is in terms of our portfolio. We are expecting new auctions in 2017, and building a good quality portfolio is very important for us. This will happen because of our participation in this market. But there is one issue, which regards prices.
Prices are still low as a reflex of the beginning of the process. But the outlook is good, and we are going to work to build this portfolio as auctions happen. Our next question comes from Mr. Lucas Massioli from Safran Bank. First, you mentioned gaining market share in new markets and new market opportunities, especially overseas.
Could you tell us what's coming up and where the new opportunities are, the geographies or which specific products? What good opportunities are emerging for you in the foreign market? And this is the first question. And number 2, what is the tax rate that you recommend that we should use for 2017? Lucas, thank you for your question.
I'll answer the first one, and Paulo will complement the second. As to the foreign market, as I said in the beginning, when the market is growing slowly and consistently. And though consistently, it's slow. And also, the market of electrical equipment is not growing. But we expect some recovery in the demand in some specific industries.
Mining is one case, where once the price situation of some commodities improve, we'll make it possible for us to get on maintenance CapEx. Same thing for oil and gas. We expect this to bring some opportunities in that segment, which has been at a slowdown. So in terms of taxes, we don't see any reasons to change what we have been seeing over the past few quarters. On the whole and in the future, our rate is going to remain at 15%.
There's one thing that's important to explain. When we save this, we're not talking about tax planning. Our process has economic reasons. So going back, we have a trading in Austria that has been operating since late 2016 with many objective reasons to be operating. In the past, bag's production was meant for the foreign market almost for export.
And as a result, Brazil, Then as we increased our production outside Brazil, it made it possible to use the external base that we created. Then we created a trading company, and exports started to go through it. And then as our group grew internationally, we have the need of using the funds overseas and with investments in China and Mexico. So in a nutshell, any type of operation, and we go from the level of 20% to a new level of 20% on average. And this is a trend that will remain for the next few periods.
Our next question comes from Mr. Leonardo Fontanelli from Bradesco. I have two questions. First is about the guidance for 2017 in terms of investment. So it would be at a much higher level than in previous years.
Why? And investments are going to China Mexico, you said, in terms of plants. So could you comment on your investments in Mexico considering all the uncertainties that country is faced with? Leandro, so first, the working capital, About the growth, first of all, our need for operating working capital is related to the sales volume. We are expecting the regularization.
We are also expecting revenues to grow. And we also took into consideration that we have the expectation that long cycle projects in so called engineered products will experience a more significant recovery as of the second half of the year. The manufacturing of long life cycle products calls for more inventory products, and this justifies this increase in working capital. It's important to tell you that this indication of growth in operating working capital do not considering the worsening of performance indicators that the company has been having. So we started the work of optimizing inventories, which started in late 2015.
A lot has been done. And we think there are more opportunities for us to develop overseas. We have standardized processes. Now we are going to implement what has been done in Brazil. We have controlled and increased our strictness in managing credits to avoid any problems with accounts receivable.
And we also found opportunities in payment times. So we think that this increase is following the trend that we are projecting for the development of our businesses and increasing the engineered products in our mix. The second question about our investments in Mexico. Our CapEx projection, 60% of what we are forecasting is based on the foreign market. And of the 60%, 51% is based on continuing our expansion plans in Mexico.
We are developing a project for a new foundry, and this project is continuing. And we have a strategic decision of investing in Mexico and China. So 60% in the foreign market. China accounts for more or less 23%, and the rest is concentrated in other units that ZAG has around the world. So basically, Trump's election hasn't changed your plans in any way.
Yes, I think it's too early for us to make any changes. Our next question comes from Mr. Carlos Mauro from JPMorgan. Thank you for the question. Are you planning to implement any cost reduction plans in terms of closing a line or something like that?
Or are you going to keep the cost reduction project that you already implemented in 2016? This is Paulo answering your question, talking about cost. So first, we should talk about last year the cost reduction actions that we implemented last year. So for example, the reduction in the labor hours, and this was very positive. So the expectation of regularization in Brazil or recovery in Brazil that we've been focusing in Brazil, we're going to have a better dilution of fixed costs.
And we take off our adjusted revenues and gain in productivity. So in a nutshell, we hope that the improvement in efficiency and productivity will continue along the lines of what we did last year. As an additional measure, as you asked, if this recovery is slower than we are expecting, we might reduce the work hours as we did last year in our large sized machines, high voltage engines and generators. In this case, Our employees need to approve, and they approve. So every 3 months, we define the shift that we'll use to remain effective in costs.
For the other units, we are not expecting the need to reduce worksheet. It's more focused on large sized machines. Our next question comes from Mr. Lucas Barbosa from UBS. I have two questions.
The first one regards the margins for the next quarters. How do we expect the recent increase in the cost of copper and steel? We've been seeing steel companies talking about prices. How would this affect VEG's cost? And do you think this will be transferred to your customers already or right after these price increases?
Or do you think this will take a little while? And according to the expectations for upcoming quarters, Can you tell us of what you're expecting in terms of next quarter? You said the Q4 in 2016 is not the parameter. But in terms of how recurring the contracts with a wider margin that you had in 2016, are you expecting to have that in future quarters or not? Was that more of a one off situation?
Rogerio, thank you for your question. So first, talking about margins and the cost of copper and steel. If there is a high in commodity prices, this is a good sign that takes place before the recovery cycle that we see. The problem is not so much the price, it's volatility. That's what we don't like.
But copper and steel, they are not as volatile as the FX rate. And so price transfers are manageable. So we do not see that with much concern. Then for the outlook for upcoming quarters will depend on the recovery, as we've been saying. If the recovery process is more intense and faster, we will be able to have better margins.
It's very difficult for long life cycle projects for us to have an analysis in 1 quarter. There are quarter variations. That's what I said in the beginning that this improvement is not linear. It comes a long time. It takes longer.
So I don't see many changes in what we've been saying. So this recovery process is going to start with short life cycle targets. So low voltage, small engines, some automation equipment and other small items. And a long time, this will go to the market that we call long life cycle products, long life cycle projects which are more related to generation and transmission that will come along the second half of this year. Okay.
It's very clear. The second question relates to your strategy. You have been focusing on a strategy of growing international markets. Could you talk about differences in margins between the Brazilian operation and what you were seeing internationally? So when you see your competitors internationally, they are reporting consistently lower margins than you are reporting.
So should we expect a reduction in your margin because of the mix? And also regarding your strategy in terms of Mexico and China, do you expect them to create are you expecting to create a new market internationally? Or are you going to compete with your plant in Brazil, which could mean a transformation in volume that could take up some of what you're doing in Jaragua do Sul. So if anything is missing in my question, in my answer, you may compliment. We are not seeing a situation in margin that different margins in Brazil and internationally.
We have global customers. They know how much they are paying in Brazil and China and Europe. What changes are the market conditions? If you have one market that is shrinking, the margins have less room. And it's also natural, the situation that we are in now in terms of market share.
When we are new entrants in a given market, It's normal for us to start with slightly smaller margins until WEG's number is consolidated, just as we're doing more mature markets, such as Brazil and Mexico or even China. If I remember your question well about China and Mexico, in terms of Mexico, those are markets where VEG is already consolidated, especially in Mexico. In Mexico, we are leaders in the Mexican market. We have a significant share, both in industrial electronic equipment and also in transmission and distribution in China. The market is slightly bigger, and the competition is also more intense.
So electric engine manufacturers in China, there are more than 2,000 of those in China. So it's basically that I can tell you. Our plant in Brazil also complements some volume surplus or can absorb market movements. So the drop in the Brazilian market, we started using and supplying other units of the group overseas. So we have what we call modular expansion that makes it possible for us to be prepared for the oscillations that may happen, meaning Mexico and China, one very important thing about them are not competing with Brazil.
Those are units that are autonomous. They have their own markets, And they are already suited to meet the needs of those markets. It's a prospect of us growing in China, considering the size of the market. If I could follow-up on that. So as you verticalize more and more and gain more scale in Mexico, there is one possibility of you sending electrical engines from Mexico to the U.
S. Rather than from sending them from Brazil. While this is already happening in Mexico that our lines that are fully dedicated to the U. S, So we can meet the needs of Mexico, we can. But for the U.
S. Market, when we are more productive here and we manufacture them here. But the main manufacturer for the United States is Mexico. Our next question comes from Mr. Juan Tavares
from Citi. Hi, thank you. Good morning, everyone. Just my first question to follow-up on your comments on your expectation of long cycle products potentially coming back in terms of demand in the second half of the year. Could you give us some context there?
Is it because you're seeing visibility in your backlog in a specific subsector? Or what's driving your confidence of looking for long cycle products to come back in the market in the second half of the year? And then second, maybe if I can also follow-up on your comments on the implications of the U. S. Border adjustment tax on the context of you making these investments in Mexico.
How have you assessed the risks here if there are less investments in manufacturing in Mexico and if there are taxes put in place for your products, do you expect utilization rates to remain subparo? Or some pricing issues? How are you assessing that risk there? Would there be possibility of shifting capacity to the U. S?
Just to understand how you're thinking about that. Thank you.
I'm going to answer in Portuguese, then you're going to get the simultaneous translation. So first, why we consider long life cycle approaches to be focused or concentrated in second half of the year. This is a consequence of what we've been seeing in auctions that did not happen as they should and what we are expecting for the beginning of this year. It's been a while since we last saw any changes in the area of generation, and we are expecting an auction of cancellation of power contracts. That being the case, we don't know how the market will be because projects that were contracted in the past and the winning companies could not meet those contracts.
This is going to go back to the basis, and this is likely to be positive. Secondly, there's a transmission auction that is likely to take place in April. And according to the information we have, this auction will have the largest number of lots. 30 to 35 lots will be auctioned in this occasion. So we are expecting the backlog in long life cycle products will recover in as of the second half of the year.
As to Mexico, Paolo is going to complement. Well, talking a little bit about Mexico. First of all, as Andre just said, it's still too early for us to know what is the negotiation stance and what are the real intentions of the new government. We can think of some scenarios. For example, the scenario of investment in infrastructure, which would be very positive.
Another scenario with import dues going up, which would be negative and the termination of NAFTA, which would be very negative, but it's highly unlikely. Now it's very important to emphasize when we talk about Mexico and Zeg, our the product of electrical engine in the United States is greater than the production their production capacity. So if the increased import fees will mean high in prices in the United States and an FX devaluation in Mexico, which we have already been seeing since last year. Now to beg, Mexico is important, 1st of all, as a production basis. We have approximately 40% of what is manufactured in Mexico is exported.
And now of those, 80% go to the U. S. With a total direct exposure of 36%. Now the Mexican domestic market is also important, as Andres said, and it's also directly dependent on the U. S.
This is the main feature. Well, lastly, the impact in long term competitiveness in Mexican operations is uncertain. But then in contrast, we have had the recent devaluation of peso, which have already made our operations more competitive in the short term. So this is a summary of what we think about Mexico, Juan.
Okay. Thank you very much.
We have one question that was posted on the Internet. How we see the breakdown of GTD in terms of the future growth of our company. The answer to this question is that we need to invest. So let's take let's first speak about Brazil. I think that internationally, it's following our investment plan in Mexico and Latin America as a whole.
But more clearly, Brazil needs to invest. Brazil cannot grow without energy. And this concept of growth in Brazil in terms of energy is the investment in renewable energies is a solution for the country. There are many opportunities, so we can see what happened in terms of wind power generation. And so we have a full portfolio until the beginning of 2018.
And if there is a new generation auction this year with better conditions than we have been having so far. And also, the issue of solar power, which is, in the long term, will be a very significant alternative for Brazil to grow in terms of power generation. We are now closing our question and answer session. I would like to turn the floor to Mr. Andres for his closing remarks.
Please, Mr. Rodriguez? There are 2 things I would like to say. So once again, I closed the call in the Q4 of 2015 saying that 2016, our focus would be on protecting margin and return. We may have just finished the most difficult year of this recession process in Brazil, and we were able to deliver what we had promised.
As we've been saying, 2017, we are expecting the Brazilian economy to recover, and diversification will work again for VEG once the recovery takes place. And so what in this manner, what we expect once the recovery is on is that drag along 2017 will deliver or present growth in revenue, performance, margin and on return on capital or return on the capital investment. This is the focus of FX management right now. The second point, I think that most of you may know and saying that our Investor Relations had decided to leave the company. Luis Benoit didn't announce that in the call, but he has been with us here.
So he really values the respect to our employees and our relationships. I could not fail to close this conference call since it is his last conference call with us, recognizing the work that he's done with us in as the Head of our Investor Relations. I would like to praise him for the work, to thank him for empathy and to wish him great success in his new in a new phase in his career that he's going to on behalf of Bank's management. Thank you. So Luis, congratulations.
Thank you very much for everything you did on behalf of BEMIS Management. Thank you. So folks, I'll see you next time. Thank you very much for your participation.