Welcome to the conference call of WEG about the results of the fourth quarter of 2016 and for the year too. 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&A session, once further instructions will be provided for you. Should you need the assistance during this conference call, please request the help of an operator by pressing star zero. We are simultaneously webcasting this conference call along with a slide deck, and they are available at WEG's Investor Relations page at www.weg.net/ir. As a reminder, we are recording this conference call, and right after it end, the audio will be available in the investor relations website. Journalists should send their questions to the telephone 4732-764295.
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 WEG, they are mere beliefs and assumptions of WEG'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 the general economic conditions, industry conditions, and other operational factors may affect the future performance of WEG and lead 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 Jaraguá do Sul, we have Mr. André Luís Rodrigues, Managing Director and Finance Superintendent, and Paulo Polezi, CFO and IRO of WEG.
Please, Mr. André, 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 fourth quarter. 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 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% 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 in 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 drop process that had started in Q3 2016, 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 fourth quarter 2016, EBITDA margin has reached 16.9% within 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 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 adjustments investment capacity, optimizing the use of our capacity. I would like to turn the floor to Mr. Polezi.
Thank you, André. Good morning, everyone. Going to slide number four, 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 products more commonly applied in maintenance investments. Demand for engineered products more related to capacity expansion is still weak.
In this manner, in the domestic market, we saw a high of 0.8% over the fourth quarter of 2015. The first growth of four quarters of negative comparisons. The global market of industrial electrical products practically is not growing with a slowdown in investment, such as in the industries of mining and oil. We have been able to grow by going to new markets and gaining share rather than due to the growth in the market. In Q4 2016, the revenues in the foreign market have demonstrated a drop as compared to Q4 2015 of 21.8% in BRL, of 24.6% growth in Brazilian real, and 8.8% growth in US dollars, and a growth of 1.5% in local currencies. The performance on different business areas, shows a similar situation.
Industrial electrical and electronic equipment, which is the area with the highest exposure to the foreign market, the low growth 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 clearing serial projects of short life cycle. In terms of equipment for energy generation, transmission, and distribution, GTD, we have two different things. In generation, there is a surplus in offer in Brazil, which reduces the need for new investments and the placement 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 contrary, 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 a new entrant, we have suffered with a variation in volume. Finally, in the area of coatings, we were capable of finding alternative markets and applications with relative success. As André said, in 2016, our objective was to preserve margins and returns, guaranteeing our competitiveness. Slide five shows the evolution of EBITDA between Q4 last year and now. We can see that the drop in revenues was offset by the favorable evolution of operating costs and expenses. In this manner, there was an absolute growth of 4.9% in EBITDA as compared to Q4 2015, and a strong increase in EBITDA margin of 16.9%.
This permitted us to close the year 2016 with EBITDA margin very close to that we had in 2015. 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. This is not a linear process, but we hope that it is very consistent. In terms of net income, detailed in slide six, it was smaller than in recent periods, but without any significant changes and is still positive with BRL 47.6 million in terms of our net financial result. The hedging operations to protect us from foreign exchanges working very well. This positive net financial result is the result of WEG's sound capital structure.
We continue to benefit from very attractive debt conditions, both in terms of cost and times. Slide seven shows our cash flow. The cash generation in operational activities has reached BRL 2.13 billion in the year, with consistent efficiency gains in the management of our working capital, which offsets the slowdown demand in the Brazilian market and the smaller cash generation in operations. Investments took BRL 852.7 million in 2016. We reduced the pace of disbursement investments for expansion of the capacity. We optimized our production capacity and maximized the return on that capital invested. Our funding activities took BRL 1 billion in the period, and we amortized with a net amortization of BRL 136.9 million in loans and financings in the period. Lastly, on slide number eight, you can see investments in capacity expansion in the past few quarters.
We closed 2015 with BRL 325.2 million investments in the expansion and modernization of production capacity, with a highlight for the projects of the new plants for electrical engines in Mexico and 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 bases for our business model. In this manner, we can make the most in terms of return over the capital investment. Now I close and turn the floor back over to Mr. Rodrigues. Before starting the Q&A, I would like to reinforce a few points. After years of drop investment affecting all industries, the outlook for 2016 is for regularization in the Brazilian economy. That is, the diversification, one of the bases 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. The political crisis increases uncertainty. The market give signs that the worst is past. Secondly, the world is growing slowly, though consistently, but the global market of industrial electrical equipment is not growing. WEG's growth overseas is a result of consolidation. That is, going to new markets and gaining market share. There is an outlook of some recovery of demand in specific industries, but the economic and political scenario have 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 answers session. Please, operator, you may continue.
Ladies and gentlemen, we are now going to start our questions and answer session.
As a reminder, this conference call is being held in Portuguese with simultaneous translation into English. If you want to ask a question, please press star one. If you want to take your question from the list, please press star two. Our first question comes from Mr. João Noronha from Santander. Good morning, everyone. About improvement in the growth margin, could you give us more details in what changed from the third to the fourth quarter in terms of costs? Also any changes in the domestic environment where we saw that there was an increase in the provision for bad debts. What was the drivers for that?
Good morning, João. One very important thing is that the net margin in the fourth quarter is not the basis for 2017. As the market regularizes, this margin is going to become more regular too, which is our expectation.
The process of regularization is not linear. It doesn't improve every quarter-over-quarter. What we have in the fourth quarter had many drivers. The main was the concentration in long life cycle products with smaller margins, our focus on GTD. We have made some efforts of re-engineering products and processes. Another point is the impact of our initiative 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 WEG operates. These were the main drivers that had an impact on the margin in the fourth quarter. Okay. Thank you very much. Our next question comes from Mr. Rogerio Araujo from UBS. Our next question comes from Mr. Márcio 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's an upcoming auction now in April or May. Have you received any orders? Do you have any orders in your backlog? How do you define the revenues along the project? Can you see this in a short term or as these lines take four or five years to be built, this will have an impact in WEG's revenues more towards the future. Hello, Márcio. Thank you for your question. This is Paulo answering. In terms of T&D.
If talking about the past in the second half of 2016, our portfolio demonstrated good quality as an evidence that our competitiveness is similar to what André just said. We implemented significant product changes in 2015, which helped our competitiveness. More specifically on T&D, there is no surplus capacity in this industry, much to the opposite. There were no investments in these areas in the past few years. This is one thing. The other point is that we also see improvement in the regulation environment. The last auction last year already demonstrated this very clearly. We saw major participation of private companies. This regulation environment is very positive. This will continue in the future auctions. This is in terms of our portfolio. We are expecting new auctions in 2017. Building a good quality portfolio is very important for us.
This will happen because of our participation in this market. There is one issue with regards to prices. Prices are still low, as a reflex of the beginning of the process. The outlook is good, and we are going to work to build this portfolio as auctions happen. Our next question comes from Mr. Lucas Mattioli from Safra Bank. Good morning. First, you mentioned gaining market share, new market, 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? This is the first question. Number 2, what is the tax rate that you recommend that we should use for 2017? Thank you very much. Hi, 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, the market is growing slowly and consistently. Though consistently, it's slow. Also the market of electrical equipment is not growing. We expect some recovery in the demand in some specific industries. Mining is one case, where once the price situation of some commodities improve, will 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.
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 say this, we're not talking about tax planning. Our process has economic reasons. 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, WEG's production was meant for the foreign market, almost for export, and as a result, we brought funds at a rate of 25%. As we increased our production outside Brazil, it made it possible to use the external base that we created. We created a trading company, and exports started to go through it. As our group grew internationally, we have the need of using the funds overseas and with investment in China and Mexico. In a nutshell, any type of operation, we go from the level of 20% to a new level of 20% on average.
Thank you very much. Our next question comes from Mr. Leandro Fontanesi from Bradesco. Thank you for taking my question. I have two questions. First is about the guidance for 2017 in terms of investment. It would be at a much higher level than in previous years. Why? Investments are going to China and Mexico, you said, in terms of plants. Could you comment on your investments in Mexico, considering all the uncertainties that country is faced with? Thank you. Leandro. 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.
We also took into consideration that we have the expectation that long cycle products, these 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. This justifies this increase in working capital. It is important to tell you that this indication of a growth in operating working capital does not consider the worsening of performance indicators that the company has been having. We started a work of optimizing inventories, which started in late 2015. A lot has been done. 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.
We also found opportunities in payment times. 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 investment in Mexico, our CapEx projection, 60% of what we are forecasting is based on the foreign market. Of the 60%, 51% is based on continuing our expansion plans in Mexico. We are developing a project for a new foundry. This project is continuing. We have a strategic decision of investing in Mexico and China. 60% in the foreign market. China accounts for more or less 23%. The rest is concentrated in other units that WEG has around the world. 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 Moldo from JP Morgan. 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 projects that you already implemented in 2016? This is Paulo answering your question talking about cost. First, we should talk about last year, the cost reduction actions that we implemented last year. For example, the reduction in the labor hours. This was very positive. The expectation of regularization in Brazil or recovery in Brazil, that we've been focused in Brazil, we're going to have a better dilution of fixed costs. We take off for adjusted revenues and gain in productivity.
In a nutshell, we hope that 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 size machines, high voltage engines and generators. In this case, our employees need to approve. They approve. Every three months, we define the shifts that we'll use to remain effective in cost. For the other units, we are not expecting the need to reduce work shifts. It's more focused on large sized machines. Our next question comes from Mr. Lucas Barbosa from UBS. Hello. Good morning to everyone. This is Rogério Araujo actually. 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 WEG's cost? 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? According to the expectations for upcoming quarters, can you tell us of what you're expecting in terms of next quarter? You said the fourth quarter in 2016 is not the parameter, but in terms of how recurring are 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? Rogério, thank you for your question. 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've seen. The problem is not so much the price and volatility. That's what we don't like. Copper and steel, they are not as volatile as the FX rate. Price transfers are manageable. We do not see that with much concern. 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 lifecycle projects for us to have an analysis in one quarter. There are quarter variations. That's why I said in the beginning. This improvement is not linear. It comes a long time. It takes longer. I don't see many changes in what we've been saying.
This recovery process is going to start with short-life cycle products. Low voltage, small engines, some automation equipment, and other small items. In a long time, this will go to the market that we call long lifecycle products. The long lifecycle products, which are more related to generation and transmission. That will come along the second half of this year. Okay. It's very clear. Thank you. The second question relates to your strategy. You have been focusing on a strategy of growing in international market. Could you talk about differences in margins between the Brazilian operation and what you are seeing internationally? When you see your competitors internationally, they are reporting consistently lower margins than you are reporting. Should we expect a reduction in your margin because of the mix?
Also regarding your strategy in terms of Mexico and China, 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 Jaraguá do Sul? If anything is missing in my question, in my answering, you may complement. 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 Brazil and China and Europe. What changes are the market conditions? If you have one market that is shrinking, the margins have less room. 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 do in 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 WEG 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. Electric engine manufacturers in China, there are more than 2,000 of those in China. It's basically this that I can tell you. Our plant in Brazil also complements some volume surplus or can absorb market movements.
The drop in the Brazilian market, we started using and supplying other units of the group overseas. We have what we call a 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. 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.
This is already happening in Mexico, that are lines that are fully dedicated to the U.S. We can meet the needs of Mexico. Yes, we can. For the U.S. market, when we are more productive here, and we manufacture them here. The main manufacturer for the United States is Mexico. Thank you very much, and have a good day. Thank you. Our next question comes from Mr. Juan Tavarez 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 sub-sector, 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. 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 your utilization rates to maybe remain subpar or some pricing issues? How are you assessing that risk there? Will there be possibility of shifting capacity to the U.S.? Just to understand how you're thinking about that. Thank you.
Thank you for your question. I'm going to answer in Portuguese, then you're going to get the simultaneous translation. First, why we consider long life cycle projects 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 bases, and this is likely to be positive.
Secondly, there's a transmission auction that is likely to take place in April, and according to information we have, this auction will have the largest number of lots. 30 to 35 lots will be auctioned in this occasion. We are expecting the backlog in long life cycle projects will recover as of the second half of the year. As to Mexico, Paulo is going to complement. Well, talking a little bit about Mexico. First of all, as André just said, it's still too early for us to know what is the negotiation stands 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. The termination of NAFTA, which would be very negative, but it's highly unlikely.
It's very important to emphasize when we talk about Mexico and WEG, the product of electrical engine in the United States is greater than their production capacity. If they increase import fees will mean high in prices in the United States, and an effect devaluation in Mexico, which we have already been seeing since last year. To WEG. Mexico is important, first of all, as a production basis. We have approximately 40% of what is manufactured in Mexico is exported, and of those, 80% go to the U.S. with a total direct exposure of 36%. The Mexican domestic market is also important, as André 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.
In contrast, we have had the recent devaluation of peso, which have already made our operations more competitive in the short term. This is a summary of what we think about Mexico. Juan?
Okay. Thank you very much.
As a reminder, if you want to ask a question, please press star one. 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. Let's first speak about Brazil. I think that internationally, it's following our investment plan in Mexico, Latin America as a whole. More clearly, Brazil needs to invest. Brazil cannot grow without energy. This process of growth in Brazil in terms of energy, the investment in renewable energies is a solution for the country. There are many opportunities, we can see what happened in terms of wind power generation. We have a full portfolio until the beginning of 2018.
If there is a new generation auction this year with better conditions than we have been having so far. The issue of solar power which 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. André for his closing remarks. Please, Mr. Rodrigues. There are two things I would like to say. Once again, I closed the call in the fourth quarter 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, 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 WEG once the recovery takes place. In this manner, what we expect once the recovery is on, is that WEG, along 2017, will deliver or present growth in revenue, performance, margin, and on return on capital or return on capital investment. This is the focus of WEG's management right now. The second point, I think that most of you may know, and saying that our investor relations head decided to leave the company, we didn't announce that in the call, but he has been with us here.
WEG really values the respect to our employees, and our relationships, and we 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 as the head of our investor relations. I would like to praise him for the work, to thank him for everything, and to wish him great success in the new phase in his career that he's going to pursue from now on, and he's still our friend even though he will no longer be with us. Luiz, congratulations. Thank you very much for everything you did on behalf of WEG's management. Thank you. Folks, I'll see you next time. Thank you very much for your participation. The conference call of WEG has now ended. We would like to thank you all for your attendance.
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