Good morning, ladies and gentlemen, welcome to the audio conference call that we review Embraer's third quarter of 2018 results. Thank you for standing by. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions to participate will be given at that time. If you should require assistance during the call, please press the star key followed by zero. As a reminder, this conference is being recorded and broadcasted at ri.embraer.com.br. This conference call includes forward-looking statements or statements about events or circumstances which have not occurred. Embraer has based these forward-looking statements largely on its current expectations and projections about future events and financial trends affecting the business and its future financial performance.
These forward-looking statements are subject to risks, uncertainties, and assumptions, including, among other things, general economics, political and business conditions in Brazil and in other markets where the company is present. The words beliefs, may, will, estimates, continues, anticipates, intends, expects, and other similar words are intended to identify forward-looking statements. Embraer undertakes no obligations to update publicly or revise any forward-looking statements because of new information, future events, or other factors. In light of these risks and uncertainties, the forward-looking events and circumstances discussed on this conference call may not occur. The company's actual results could differ substantially from those anticipated in the forward-looking statements. Participants on today's conference call are Mr. Paulo Cesar de Souza e Silva, President and CEO, Mr. Nelson Salgado, Executive Vice President, Finance and Investor Relations, and Mr. Eduardo Couto, Director of Investor Relations.
I would like now to turn the conference over to Mr. Nelson Salgado. Please go ahead, sir.
Good morning, everyone, thanks for joining our call. We start at slide four with the commercial aviation highlights. Embraer delivered 15 E-Jets in the third quarter and 57 year-to-date. We anticipate a strong fourth quarter in terms of deliveries and expect to reach the middle of our guidance range from 85-95 planes. I would like also to mention that a few E-Jets deliveries moved from third quarter to fourth quarter without any impact to the full-year results. Another highlight is the entry-into-service performance of the E190-E2 at Widerøe from Norway. With 98.5% schedule reliability and 99.5% completion rate, these are exceptional results for the entry into service of a new aircraft with a new customer. As far as sales activity, Embraer signed a firm order contract for 12 E190-E2s with Helvetic Airways from Switzerland. Another European customer, Binter Canarias from Spain, acquired two E195-E2s.
We want to highlight that we have seen solid sales activity. We expect to close 2018 with a book-to-bill around 1.5. Finally, in terms of product development, the E195-E2 program is on track for certification in the first half of 2019. Next slide five, we present highlights of the executive aviation business. In terms of deliveries, Embraer delivered 24 executive jets in the third quarter and 55 year-to-date. Similar to previous years, we expect higher deliveries at the fourth quarter, but we believe we should be closer to the low end of our guidance at 105 planes. It's important to mention that we have been focused on price and profitability recovery rather than volumes and market share. In the quarter, our Legacy 450/500 family reached a milestone of 100 deliveries, including the 50 Legacy 450 for the Canadian operator, Airshare.
In terms of new models, Embraer dominated the NBAA Air Show with the launch of the Praetor 500 and 600. The models are the most disruptive and technologically advanced jets in the mid-size and super mid-size segments, with unprecedented range in their segment, 2,250 nautical miles for the Praetor 500 and 2,900 nautical miles for the Praetor 600. They have the best-in-class cabin altitude, superior cabin design, and ultra-quiet interiors, as well as full fly-by-wire with active turbulence reduction and best-in-flight cabin connectivity. The Praetors are part of our value strategy to improve profitability using superior products. Moving to the safety and security highlights of slide six. We start with the KC-390. The KC-390 has achieved an important milestone and received a certification from the Brazilian Civil Aviation Authority, ANAC. The first delivery to the Brazilian Air Force remains scheduled for the first half of 2019.
Also, regarding the KC-390, aircraft number 3 successfully performed its first flight, and aircraft 4 to 8 are already under assembly for delivery to the Brazilian Air Force. As far as other programs, the Brazilian Air Force's Special Flight Inspection group received its third Legacy 500 from the IAS program. Embraer was shortlisted in the Brazilian Navy Corvette Class program to provide the combat management and system integration. Third, Embraer received the initial request for a proposal for the Light Attack Aircraft program, the LAA program of the US Air Force. Moving now to the financial results. We start at slide eight, with the firm order backlog. Our backlog reached $13.6 billion at the end of the third quarter. The backlog was negatively impacted by two facts. First, we removed an order from SkyWest for 100 E175-E2s from the backlog.
This order remains effective. SkyWest is committed with the E175-E2. During the contract's conditionality terms related to scope clause change, Embraer decided to adapt a conservative approach in line with the latest IFRS rules, and removed the order from the backlog. The second fact was that we removed 24 jets for JetBlue, given the recent fleet renewal decision from the company. It is important to say that Embraer is working to finalize the important deals that were announced during the Farnborough Airshow. We are confident, as I said before, to finish 2018 with a book-to-bill around or superior to 1.5, and with that, we expect to recover the backlog. Moving to slide nine, we show aircraft deliveries. In commercial aviation, we delivered, as previously said, 15 jets... 57 in the year
We expect a strong fourth quarter and anticipate to reach the middle of our guidance range from 85-95 jets. In executive jets, we delivered 24 aircraft in the third quarter of 2018, 17 light and seven large, with 65 year-to-date. This year, again, we will follow historical seasonality with higher deliveries at the fourth quarter. However, we expect to end 2018 closer to the lower end of our guidance at 105 deliveries. Next slide, we present net revenues. Consolidated revenues reached $1.152 billion, which were broken by commercial aviation, $382 million; executive jets, $312 million; Defense and Security , $222 million; services and support, $233 million. As far as consolidated revenues, we had a relatively lower level, primarily because of commercial aviation deliveries.
I mentioned before that a few aircraft delivery from third to fourth quarter, and we expect to recover that in the fourth quarter and in the year. We maintain our full guidance for $5.4 billion-$5.9 billion in revenue in the year, broken by commercial from $2.2 billion to $2.45 billion, executive $1.35 billion to $1.5 billion. In the executive, we will be closer to the lower end of the guidance. Defense from $800 million to $900 million, and services and support from $900 million to $1 billion. Moving to slide 11, SG&A expenses. SG&A expenses reached $118 million in the third quarter, with G&A at $44 million, below the same period of 2017, and selling expenses at $74 million, above the same period of last year. That was due to the Farnborough Airshow that this year took place in July, third quarter, and last year took place in June, second quarter.
Embraer remains focused on reducing SG&A expenses through our efficiency programs. Next slide, 12, adjusted EBIT. We reported EBIT of $44 million with 2.9% margin in the third quarter. Our year-to-date EBIT reached $181 million, with 5.2% margins. Looking at third quarter margins per business, commercial aviation was 1.1%. Here, we had the effect of relatively lower deliveries and a bit of mix as well. Executive jets, 4.1%. Defense, 2.4%. Services and support, 10.7%. We reiterate our 2018 EBIT guidance of $270 million-$355 million , with margins from 5%-6%. Next slide is slide 13. We present adjusted EBITDA. Embraer reported EBITDA of $105 million in the quarter and 9.1% margin. Year-to-date, EBITDA was $366 million, with EBITDA margin of 10.8%. Similar to EBIT, we reiterate our EBITDA guidance of $540 million-$650 million, with 10%-11% margin. Moving to slide 14, we highlight adjusted net income.
Embraer reported a net loss of $29 million at the third quarter. The net loss is driven first by lower operating results, which we expect to recover in the fourth quarter, and higher financial expenses. Regarding financial expenses, we had a $20 million increase in the quarter due first, because of $10 million in residual value guarantee recognition, which we expect to be half that in the next quarters. $10 million from market-to-market 2019 hedge operations. We had to market-to-market the 2019 hedge operation. What happened here was that there was a big volatility of the BRL against the U.S. dollar in this last quarter. That led to the recognition of accounting losses that we expect to revert in the future as we have a more stable effect. Moving to investments at slide 15.
The net investment reached $158 million year-to-date, broken by $29 in research, $75 in development, and $54 in Capex. It is important to note that we have received $120 million in contribution from suppliers. If we consider that, the gross amount of development investment would account to $200 million and the total to $282. We expect to end 2018 below our current guidance of $450 million. All programs are on track despite the lower investments. Next, slide 16, free cash flow. Embraer reported negative free cash flow of $166 million at the third quarter and minus $549 year-to-date. The negative free cash flow year-to-date is mostly driven by higher inventory as we prepare for higher deliveries in the fourth quarter. With those higher deliveries, we expect to revert a very good portion of the negative free cash flow.
We expect to be at the lower end of our guidance regarding cash flow, which is around minus consumption of $100 million this year. Finally, at slide 17, we show Embraer's indebtedness. We ended the third quarter with a cash position of $3.14 billion and a debt position of $4.22 billion, implying a net debt of $881 million, which again, as we completed third quarter deliveries, we expect this position to go back to what it was in the beginning of the year. In terms of average debt maturity, we remain at a comfortable level of 5.5 years. With that, we conclude our presentation and are available now for questions. Thank you.
Ladies and gentlemen, we will now begin the question-and-answer session. If you have a question, please press star one. To remove your question from the queue, press star two. Our first question comes from Robert Spingarn with Credit Suisse.
Hi, this is Audrey Preston on for Rob Spingarn. I just had a couple questions. Going back to slide 15 with your investments. Even incorporating the supplier contributions, it still looks like you're tracking below where you were expecting for the full year. Could you elaborate on some of your planned investment opportunities in Q4? Is there any reason why the investments are tracking below expectations? Thank you.
Changing scope. Oh, sorry. Coming back to investments. As I said, we will be below the guidance in investment this year, without any difference in the product development targets. That is happening mainly because we are being more efficient in our investments, which result from our efficiency program. We will be below the level of investment that with the current development programs, without any change.
Great. Thank you. If we can just take a closer look at the SkyWest orders as well. Now that you've taken them out of backlog, but there's still no change to the terms and conditions, what is the timeline on these orders, and when could we expect to maybe see them go back in backlog, and when could we expect a little bit more certainty around those orders as well? Thank you.
Well, as I mentioned, we are working very hard to convert the announcement we made in the primary escrow into firm orders, but we cannot really commit to a date when this is going to happen. We expect it to be as soon as possible. Regarding the SkyWest order, as we mentioned, it is connected to the changing scope clauses in the U.S. regarding the E175-E2. We are not seeing, at this moment, any priority in the airlines in changing scope clauses. However, Embraer has an 85% market share in that segment with our current E175-E1. The fact that the scope clauses may change later does not imply any harm to us. On the contrary, we will remain with a very good market share in this segment because the E175-E1 is by far the best product for the segment.
Great. Thank you.
Our next question comes from Josh Neuberger with Morgan Stanley.
Good morning, everybody. Thank you for the call. My first question is if you could give us some additional perspective on the improvement of your executive and defense profitability in the quarter and also the sustainability of the better numbers. You mentioned your focus on price. On the executive side, we were wondering if price was the main driver of the better margin and what, if any, other factors helped. Obviously, better revenues and better fixed cost dilution helped you. That's my first question.
Okay. Thank you. I think in executive aviation, we've announced it many months ago that we were implementing a program to turn around the business with a big focus on value rather than competing exhaustively for market share. I think what we are seeing now is a result of that effort. We have been able to maintain prices that are good for our products, which we think deliver more value to the customers. We invested also in cost reduction, either material and internal costs for our production processes as well. I would say that what the results we are seeing, we have seen so far, are the result of these efforts that we've been consistently implementing. As for the sustainability, everything that we are doing is for those results to be sustainable over the long term. We, as I said before, will go on investing in new product development.
We just launched two new products, which we think will again deliver superior performance and will deserve a premium price. Regarding defense business, we had during the year been impacted by losses in the KC-390 program development. As I explained here earlier in other results presentations, the way the revenues and margins of the program are accounted for mean that whenever we have something that does not go as planned, we have to recognize an accounting loss. Right? This year, in the second quarter, we had to recognize a $127 million loss because of the loss of the first prototypes. With that, we had to re-plan the program, and we do not expect to have further problems moving ahead. If we manage to stick to the new schedule, we think that those margins that we see now are sustainable.
Again, product development of a very innovative and high technology program is something that we know in this industry that you cannot say 100% for sure you're not going to have problems. If those problems do not happen, we will sustain this kind of results. Important also to note that as you change phase in this program from product development to serial production, our Defense Business Unit will enter a totally new phase, because during the last few years of heavy product development on the KC, those uncertainties bring some volatility to the results. As we enter into serial production and deliveries, once we go over the initial ramp-up phase, we should see a Defense Business which makes better and sustainable results.
Okay. That's very helpful. A related question, it's a question that ties into your point about cost reductions and their sustainability. I think you guys have talked in recent months about being able to rightsize Executive and Defense with the Boeing transaction. I was just wondering, with the work that you've done advancing the deal these last several months, if you have a better idea now of maybe what the magnitude of the opportunity could be, to sort of rightsize the businesses as a byproduct of the transaction.
Yeah. Although the negotiations for the deal are going on, the management of the company is not taking those into account. Actually, everything that we are doing in Executive Aviation and Defense is just regular course of business. We are just managing the company, looking at the way it is today, and all the results that we are seeing comes from this. There is nothing here that accounts for any benefit that could come from the deal.
Okay. That's great. Thank you very much.
Our next question comes from Ronald Epstein with Bank of America.
Good morning, guys. This is Kristine Liwag calling in for Ron. My first question is the timeline about your deal with Boeing. If you already have government approval from the current administration, why not complete the deal now? Even if the new administration seems supportive of the deal, it seems like postponing the timeline adds unnecessary risks.
Good morning. This is Paulo. Thanks for your question. We are still in the final stage with Boeing to finalize the last details. As soon as we materialize this final agreement, we'll bring the deal to be approved or appreciated by the government, the current administration. It is already public information that the current administration will share our request with the new government, with the team that will be a transition to the new government. After that, when we have the go-ahead from both, the current government and the transition team, we will call for a general assembly, which still is our expectation that this will occur any time in December. It's difficult to say now each day of December, but our expectation is that this will happen still in December.
After that, upon approval of our shareholders, we have the antitrust step, which will bring us into 2019, more likely the second half of 2019 for the closing of the transaction.
If I recall, when you guys first communicated the timeline, the expectation was that you only needed approval of the current administration. Did something change, that you now need new administration? Can you talk about other factors that may have come in in the past few months?
Well, I think basically, regarding the administration, it's being said now by the current government that they would like to share our request, this transaction, with the new administration. That was not 100% clear a month ago, but now it's being made clear, so that Mr. Temer would like to share
Our request for this deal, approval of this deal with the new administration.
That's very helpful. Switching to executive aviation, how many firm orders and letters of intent did you receive for the Praetor family at NBAA?
We do not disclose that information.
There have been a lot of-
There has been a lot of interest in the new product at the airshow. There's a lot of activities, but we will not disclose the amount of orders we received.
Thank you very much. Our next question comes from Cai von Rumohr with Cowen.
Thank you very much. Could you give us some color in terms of where the commercial deliveries may be next year? What part is sold out today? In terms of how many deliveries you have for 2019, then maybe comment on the impact of the Boeing JV. The fact that you are negotiating for one has had on people completing orders. Has it been a plus, or are people waiting until it is completed to really finalize and place their orders? Thank you.
Okay. Regarding the last part of your question, no, we are not seeing any difference because of the deal with Boeing. We continue to operate business as usual. We are closing deals. We have made very good announcements in Farnborough. We are now working to have these contracts confirmed until end of this year, and it is going well in this regard. We will have a very good year this year, book-to-bill probably above one, more likely above one. This regardless the negotiations that are going on with Boeing. Your other question was, sorry, the first part?
Was, how many orders do you have-
I see, yes
for 2019 right now? Obviously you expect more.
It's early to say, right? Early to say because we still have a few months to go until we can have a clear view. I could anticipate more or less the same level that we will see in 2018.
Thank you. The last question would be, I believe your biz jet book to bill was a little bit below one. Could you give us some color on biz jet demand? Is that a function of stronger pricing? What do you see for book to bill in the fourth quarter? Thank you.
Book to bill will be around one. Little bit changes here. As I mentioned before, we have been seeing steady growth in prices, which are starting to show up in our P&L. We expect that trend to continue in the next months.
If I can add a little bit, another information on this topic. The launch of the Praetor 600 and the Praetor 500 at the NBAA was very successful. We are seeing great interest in these aircraft. I believe the positioning of these aircraft vis-à-vis what the competitors are offering. The clients are telling us that this will be a very demanded aircraft. We are very bullish. I think it's fair here to anticipate that we may have a good year for new sales, because of these two new products. The price point is excellent. The attributes of the aircraft are great, so the range and the performance. We believe that it will be a very successful aircraft. Having said that, 2019 may be a better year than 2018 in terms of sales.
Thank you very much.
Our next question comes from Myles Walton with UBS.
Good morning. This is actually Louis Riptac on for Myles. How are you?
Fine. You?
I just want to make sure, the commercial aviation margins again, what were those in the quarter?
1% EBIT margin in the quarter.
Okay. Do we think that this is the bottom, or is there more pressure going into 2019, I guess, as the next aircraft begins to ramp up?
Well, I think as I mentioned, the margin in the quarter will be affected by relatively lower deliveries than we expect. We expect as the deliveries are going to up to normal level, the margins will recover.
Okay. How do you guys see going into the fourth quarter? The gross margins were positive and they were good in the quarter. Any way you guys can break those out as well?
Yeah. We have around 15% gross margin in Commercial. Executive Jets, 17.5%. Defense, around 14%. Service and Support, around 29%.
Okay, great. Thank you, guys.
The next question comes from Cenk Orcan with HSBC.
Hey, good morning, guys. Thank you for taking the question. Regarding the E2, I know you guys have been producing it for most of this year. Has there been any challenges or difficulties in the ramp-up of the E2 production? When we think about that going into next year, what kind of mix can we expect for E1 versus E2 delivery? Thank you.
Yeah, we have had no problems with the ramp-up of the 190s or the E2s. Everything is moving smoothly. We have not disclosed so far the mix for next year. We will do that later on when we have the guidance.
If I can just add and go back to the first information Nelson gave on the highlights. The schedule reliability of the 190-E2s are really great. We are seeing 98.5% schedule reliability for a new program, this is fantastic numbers. We delivered the first 190-E2 in April. Widerøe is flying quite a lot with these aircraft, many cycles. It's not flying many hours, but also many cycles. The aircraft is really going and delivering very well. I think this is a point to be noted.
Okay, thank you very much.
Our next question comes from Noah Poponak with Goldman Sachs.
Hey, good morning, everyone.
Good morning, Noah.
Hey. I guess, are you still expecting eventual scope clause change that allows you to sell and fly the E2-175 in the U.S., or should we really be looking more at the legacy aircraft type backlog there?
Well, Noah, as we said before, we do not see any movements right now on priorities from the airlines to change scope clause. For us, that is a comfortable situation. The E175-E1 remains with a market share around 85% in that market. If the scope does not change, we will remain selling the 175 E1s. If it does change in the near future, we will have the 175 E2 for this. There's nothing we can say at the moment beyond that.
Okay. Is 2019 sold out at the current production level, the 85-95 you're expecting for 2018? Are there still some spots open?
Noah, the commercial aviation, as I mentioned, we are seeing very good orders this year, a part of this order will be for the next year. I think we are very comfortable with more or less the same level that we will deliver this year for next year.
Okay.
Maybe even a small upside.
Okay. When does Republic start to take deliveries of their recent order?
Republic, if I'm not mistaking, I will have to confirm this to you, but I believe it's 2020.
Okay. Got it. Final question. At the total company adjusted segment operating margin, are you expecting that to expand, stay the same, contract 2019 versus 2018?
Well, it is still a bit too early to talk about margins in 2019. We will give that guidance when time comes.
Okay. Thanks so much.
Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star one. This concludes today's question and answer session. That does conclude Embraer's audio conference for today. Thank you very much for your participation, and have a good day.