Good morning, ladies and gentlemen, and welcome to the audio conference call that we will review Ingres' Second Quarter 2018 Results. Thank you for standing by. As a reminder, this conference is being recorded and webcasted atri.engbriela.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 believes, may, will, estimates, continues, anticipates, intends, expects and similar words are intended to identify forward looking statements. Embraer undertakes no obligation 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 might not occur. The company's actual results could differ substantially from those anticipated in any forward looking statements.
Participants on today's conference call are Mr. Paulo Cesar de Sozisilva, President and CEO Mr. Nelson Salgado, Executive Vice President, Finance and Investor Relations and Mr. Eduardo Couto, Director of Investor Relations. I would now like to turn the conference over to Mr.
Nelson Salgado. Please go ahead, sir.
Good morning, everyone. We start with our presentation at Slide number 4 with corporate highlights. First, Embraer and Boeing announced on July 5, a potential joint venture in commercial aviation as well as new opportunities to explore defense and security business, especially on our new military cargo plane, the KC-three Magazine. We are excited about this potential partnership with Boeing and what it could bring to our businesses, not only with gains in commercial aviation, but also cost synergies and new sales opportunities for Defense and Executive Business. In our second highlights, in July, we attended the Fargo Air Show in London with static display and demo slides of our most recent models, the E190 E2, the KC 390 and the Legacy 500, with a lot of interest from customers.
During the quarter, Embraer X, our new brand for disruptive technology unveiled its VTOL concept, which is a new vertical take off and landing vehicle that could be used in urban areas to solve mobility problems. Finally, Embraer was selected once again the most innovative company in Brazil and one of the best places to work. Next slide, Slide 5, we show Commercial Aviation highlights. Embraer delivered 28 commercial jets in the Q2 of 2018, including the initial deliveries of our new Embraer 190 E2. We delivered 3 190 E2s to withdraw from Norway.
So far, the aircraft had a great entry into service with 100% completion rate in the 1st 3 months, confirming the highest level of maturity of the E2 program. As far as new orders activity, we announced 15 E175 jets to American Airlines in May. Combined with 3 previous orders already placed by American, we had 89 E07 sold so far to them in the new contract. During the air show, we also announced several orders that will be detailed in the next slide with a total of up to 300 aircraft commitments, including 3 orders, LOIs and auctions. In the next slide, Slide 6, we show the Farnable Air Show announcement in more detail.
During the air show, we announced 37 stream orders, including 25 E175s to United Airlines, 2 E175s to Moline Airlines and 10 E195E2s to ATHENA from Kuwait. That order also includes another 10 options. We also had important LOIs announced during the air show, including up to 200 E175 to Republic Airways, an additional 21 E195 E2s to Azul, 3 E190s to NAC, up to 24 E195 E2s to Helvetix from Sweden and up to 5 E195 E2s to an undisclosed customer. We expect to confirm a great deal of this into same orders until the end of this year. Moving to Slide 7.
We start with the highlights for Executive Jets. We delivered 20 Executive Jets, 15 light and 5 large jets in the Q2 of 2018, including the first Phenom 300E in Asia Pacific to Northern Escape Collection. Air Hamburg also signed an order for 4 more legacy 650. As far as performance, the legacy 450 set a new speed record in a flight between the United States and Europe in March. We continue to invest in new features of our Executive Jets programs.
The Phenom 100EZ, the Legacy 450 and 500 received enhancements including interior design, avionics and entertainment systems. Next slide, Slide 8, we show the defense and security highlights, starting with the KC-three ninety program. First, it's important to note that the flight test campaign of the KC-three ninety continues to evolve with 1700 flight hours, and we expect the Brazilian Civil Aviation Certification from ANAC in the second half of 2018 as initially planned. In May, we had an incident with the KC-three ninety prototype number 1 that experienced a runaway exclusion during ground testing our facility in GPX, which resulted in extensive damage to the plate. Due to that incident, we had to change the planning for the final phase of the product development.
We have now 96% of the product development completed. But we had to negotiate with the Air Force to use aircraft number 3 to replace the first prototype to complete the flight test that we still have ahead of us. With that revision of the development program, we had to perform a cost base revision of USD 127,000,000 that was already recognized in the results of the Q2 of 2018. The first delivery to the Brazilian Air Force will take place in the first half of twenty nineteen with aircraft number 4. The field production of the KC-three ninety program progresses normally with assembly of aircrafts 4 to 8.
Moving to Super Tucano, we delivered 2 additional A29 Super Tucano to the West Air Force under the Light Air Support, NAS, program. We start at Slide 10 to show our financial results with the firm order backlog. We ended the second half second quarter twenty eighteen with a backlog of USD 17,400,000,000 That backlog still doesn't reflect recent orders announced at the Airshow that we will include in the backlog in the 3rd quarter. Actually, 35 stream orders from the air flow will be included in the 3rd quarter. And as I previously mentioned, we expect a great deal of the LOIs that were announced to be incorporated in the backlog and turned into semi contracts until the end of this year.
Moving to Slide 11, we see aircraft deliveries. We delivered 28 commercial jets in the Q2 of 2018 and 42 year to date, which is in line with our guidance of 85 to 90 5 deliveries in 2018. As far as Executive Jets, we delivered 20 jets in the 2nd quarter, 15 light and 5 large jets. Year to date, we have delivered 31 business jets and we expect again a strong second half in terms of deliveries, especially Q4. We reiterate our guidance of 100 and 5 to 125 Executive Jets this year.
Next slide represents net revenues. We reported US1.257 billion dollars net revenues in 2nd quarter broken by $757,000,000 in commercial, dollars 207,000,000 in Executive Jets, dollars 34,000,000 in Defense and dollars 256,000,000 in Services and Support. It is important to highlight that the defense revenues were negatively affected by the KC-three ninety cost base revision of 127,000,000 dollars due to the incident with the prototype number 1 that led to a retraining of the program. And that happens because the defense accounting is based on percentage of completion. So higher costs in the Q2 generates a revenue reversal of around USD 100,000,000 On the positive side, our services revenue grew 5% year over year in the Q2 of 2018.
We maintain our revenue guidance unchanged to our 4 businesses units, Commercial, Executive, Defense and Services as shown in Slide 12. Moving to SG and A at Slide 13. We reported Q2 2018 SG and A of 100 and $12,000,000 broken by 41 G and A and 71 selling expenses, which was €80,000,000 below the same period of last year. These numbers were positively impacted by the Brazilian real depreciation against the dollar. Next slide, Slide 14, represents the operating results.
Adjusted EBIT that excludes special items reached $110,000,000 in the 2nd quarter, implying an adjusted EBIT margin of 8.7%. The adjusted EBIT in the 2nd quarter excludes the non recurring impact of $127,000,000 related to the KC development cost base revision. Looking at our EBIT margin by business, Commercial Aviation reported 10%, as active jets, minus 2.4 percent defense, excluding KC, was negative 2%. Services and support was 16.8%. Including the service components in Executive Jets and Defense, EBIT margin for those 2 business units were around breakeven during the Q2 of 2018.
This reflects the good operational performance reflects the results of our excellence programs and many activities that we have been developing to make sure that our operational activities are as best as possible. And this with this, we maintain our 2018 outlook of 5% to 6% consolidated EBIT margin or an EBIT between $270,000,000 $355,000,000 In Slide 15, we show our EBITDA. Adjusted EBITDA that excludes special items reached 170 $1,000,000 in the 2nd quarter, implying an adjusted EBITDA margin of 13.6%. Here, we also maintain our EBITDA guidance of around 10% to 11% margin. That is from USD540,000,000 to USD 650,000,000 Next slide, we show net income.
Embraer reported $6,000,000 adjusted net income, excluding deferred income tax. Our net income was negative impacted by lower operating results as highlighted in the previous slides and higher financial expenses, including foreign exchange losses to the recent BRL depreciation. Moving to accumulated investments in Slide 24. We reported $67,000,000 in total investments broken by $20,000,000 research, dollars 10,000,000 development and dollars 37,000,000 CapEx. It is important to mention that total investments are net of suppliers' contribution that in the first half of twenty eighteen amounted to US125 million dollars.
For the rest of the year, we expect total investments to go up as we continue to progress as planned in the H2 program, and we don't anticipate any additional contribution for front suppliers in
the rest of the year.
As far as free cash flow, we had $48,000,000 cash flow generation in the Q2 of 'eighteen with $134,000,000 in cash flow from operating activities and a cash consumption of $31,000,000 in additions to PP and E and $55,000,000 in intangible assets. Year to date, we reported a free cash flow consumption of $383,000,000 We expect to generate positive free cash flow in the second half of twenty 18, which is in line with our normal cash flow consumption of BRL 100,000,000 or better. On the Slide 19, we highlight our indebtedness profile. We ended up the Q2 of 'eighteen with BRL 3,200,000,000 in cash and BRL 4,100,000,000 in debt, implying a net debt provision of $721,000,000 Our debt profile remains healthy with average debt maturity of 5.6 years in line with our cycle of long term figures. Finally, in Slide 21, we maintain our outlook unchanged and reiterate all aspects of our guidance.
With that, we conclude the presentation section and open to Q and Q
and Our first question comes from Ronald Epstein with Bank of America Merrill Lynch.
Yes. Hey, good morning, guys. Good morning. I just have 1 or 2 questions for you. There are a lot of LOIs announced at the Farm Bureau Aerohs.
Can you discuss a little bit about the conversion of those LOIs to firm orders and kind of what timeframe that we would expect that?
Yes. This is Ron. Good morning, everyone. We are we expect to finalize these LOIs, Ron. If not in the next quarter or until end of September.
So more likely, otherwise, definitely until end of this year.
Okay, great. And then when we look at the sales campaigns going on right now, now that the potential deal with Boeing has been announced, are we starting to see some more things firm up? Because I would imagine some airlines might have been waiting on the sideline to see what was going to happen. I mean, I guess it's another way to ask when we look at the ongoing campaigns, is there more
factors. We were engaged already in many campaigns. So what we announced in Fibril are the ones that were more advanced. The firm, of course, are the firm ones, but the LOI is pretty advanced. I mean, it's an LOI because it's not a contract yet.
However, the negotiation in these LOIs are already very advanced. So for the other campaigns, we expect that we can do a well on that as well. Going forward, with Boeing, of course, can be a very good it's going to be very positive, right, going forward. Of course, we have concluded that it was going and so on and so forth. I'm not saying that we will achieve this, but we do expect that we can definitely reach good terms with these lines throughout the remainder of the year and beginning next year.
And then maybe just one last question and then I'll hand it on. When we look at the deal with Boeing and the timeline that you guys have articulated, Is there a way to potentially accelerate that in terms of maybe making some of the activities in parallel? Like is it possible to start going down the antitrust path and get their government approvals at the same time? Other things are going on. That way maybe the deal could close in the first half of twenty nineteen as opposed to the second half.
Is something like that possible?
Yes. We are analyzing this now. We believe that we couldn't have a possibility, but we are still analyzing this. And it is our intent, of course, to do this in as short as possible, right, in terms of timing going forward. For the approval of the deal itself with the Brazilian government and then with our shareholders, we are targeting beginning of December.
Okay? But for the antitrust, our priorities in different countries. So we are seeing how much we can speed up this process in order to anticipate.
Our next question comes from Ricardo Alves with Morgan Stanley.
Hi, good morning, gentlemen. Two questions on my end. First on the service and support, I think I missed the number you mentioned in the highlights, but we calculated close to mid teens margin, EBIT margin. So it has been a little bit more volatile than what we expected, the profitability of services and support. So I was wondering if you could explain a little bit what drove, the strong performance this quarter on that division and maybe what we could be looking at in the second for the second half?
And maybe if you could give a little bit of color on how much commercial services contributed to that overall services and support performance? And then I'll ask my second question afterwards. Thank you.
Okay. The EBIT margin for services and support that we mentioned was 16.8 percent to 17%, right? It was a bit higher than we generally expect. So for the year, project something around 14%. That's not very big variation.
Okay. That's
helpful. And your next question, it's around 60% commercial and 40% executive And
then my second question is going back to the cost base revision. Just if you could clarify if we should expect any further revisions or if you feel relatively comfortable with what's done this quarter? And also, you mentioned the incident in May, but it would be helpful if you could remind us if there was any other issues related to the KC-three ninety project that led you guys to do the cost base revision just to make sure we're not missing anything here just because the $127,000,000 sounded a little bit higher than what we expected initially. So just a little bit more color on that. Thank you very much.
Okay. Actually, the revision that we made in the KC-two 9 program was due to the incident that we had with prototype number 1. And losing the prototype in terms of use of it for the flight test signify that we had to change the program so that we could use aircraft under 3 to make the flight test, right? And with that, we had to keep in the new engagement for a bit longer than we expected, not only in ourselves, but in suppliers as well, right? So the $127,000,000 that you see is the combined result of everything that we see that had to be re planned so that we can achieve the program targets as we just spoke.
It's important to note that we already had 96% of the development completed. So at the same time that we cannot say that there will not arise any new issue. We don't expect anything new to happen, both because there is not that much left to be done, right? But also because we did this revision with the best information, the best knowledge that we have.
The next question comes from Petr Grishchenko with Barclays.
Good morning, gentlemen. Thanks a lot for taking my questions. I just wanted to clarify a little bit on your backlog. What portion of that relates to services and support? Just want to understand how backlog kind of moves
generically. Okay. Thank you for the question. It's around US1.5 billion dollars that is related to services and support.
Okay. So since Q4, backlog declined from, call it, dollars 18,300,000,000 to around $16,000,000,000
Okay. This quarter already had the
same amount of services.
Yes. The 2018 already had the same amount of services.
Okay. And I wanted to ask a question on Boeing, kind of follow-up with previous caller asked. Has you talked about the bonds and how you intend to treat the bondholders. But specifically, has the party agreed that potential JV would assume the bonds given the gross leverage of the new entity would be in pro form a?
Yes. Well, what we envisage is that all bonds that we have, which are actually tied to commercial aviation exports, they will migrate to the new JV with a similar amount of cash. So that the new JV started with around 0 net debt, right? So that's the structure that we are looking at.
If I may add Nelson, we are still checking the details, right, how we're
going to do that.
So we still have a lot of previous steps in terms of approvals and the whole transaction to go first. But that's Nelson mentioned that's the initial idea, okay?
That's great. I think it's a great addition. But my question is, has Boeing agreed to this structure? Has Boeing agreed that the bonds will migrate to the entity given pro form a leverage?
Yes. It's been discussed in this phase and that is the structure that has been agreed, the migration of the bonds because they are actually tight commercial aviation exports, as I mentioned. So they are part of commercial aviation.
Great. Thanks a lot and best of luck guys.
The next question comes from Victor Mizusaki with Bradesco BBI.
I have two questions. The first one, can you comment what's the current status of the integrity? Because of the truck driving strike, we have heard that the government could cancel these kind of incentives. So I'd like to know if you can comment about this. And the second one, I mean, in the local press, we have seen a lot of pushback from local investors about this deal with Boeing.
So I don't know if you can comment what the company is doing to address these complaints.
Can you please repeat the first question?
So if the Hincagra will be maintained or not? Because I mean, we heard that the tax I mean, the tax rebate would be reduced in maybe September. So I don't know if you can comment about this.
Yes. No, we are not counting on any losses programs. We've already assumed that at some point, it will be gone. So there is no provision included in our results about those programs, right? And regarding the second question, I think it's natural that there are questions about the deal.
It's a very complex deal, right? But we do not see that any of the shareholders are being treated differently, right? So the proposed partnership, it doesn't change our current shareholder structure and it does not change any shareholders' rights, right, including the Brazilian government rights that has the special share class with the Golden share, right? We think that this deal will bring operation and marketing gain that will benefit all shareholders equally without any distinction. So it's important to make clear that we don't have any change in the equity structure of Embraer or any acquisition of Embraer shares by Boeing, right?
So the transaction of the partnership is aiming actually to explore our commercial aviation assets and liabilities in a more efficient way given the current aviation assets. We think it's natural that there are some questions regarding the deal, and we hope that as soon as we are able to make more information available, shareholders, we see that this deal is a very good one. And obviously, it's important to highlight that all the governance of the process is being totally respected and will continue to be, right? So the deal has to be approved by the Board of Directors, by the Brazilian government, regulators and shareholders in the end, right? So the proposal partnership is that does not imply change of control
of Embraer.
So we are very positive that we will be able to show shareholders that this
is a very good deal.
Okay. And I mean, do you have any sense in terms of I mean, I remember on the company also conference call to discuss this transaction that it would be possible to pay a special dividend and also to draw buyback. So I don't know if you have any update on this front.
So we imagine that we will be able to pay special dividends when the dividend or when the transaction is concluded, right? We just cannot affirm right now the exact amount because it depends on many factors that we are detailing and with the carve out process that is going on right now. But it is our plan to play a healthy dividend to shareholders.
Our next question comes from Augusto Encik with HSBC.
Hey, good morning, gentlemen. Just a question on the executive segment. You guys are about 30 or so aircraft in so far this year and to hit the bottom end of the guidance you have another like 70 or so 7 years aircraft to get there. And we've seen EBIT margin for the X segment improve significantly. Can we then assume that by year end you're going to be touching in the positive EBIT margin and hopefully there's a big improvement in the gross margin this quarter.
Is this sustainable for year end? So can we get to mid single digit positives for EBIT?
Yes, positively. We are very confident in the turnaround of our effective business so that we can sustainably generate positive margins and cash flow. The results from the first quarter was a bit low because of the lower deliveries, but that is a normal seasonality that we have and we will be within our guidance for the year, right? And we are really very positive and it's important to point out that we continue to be very disciplined with our prices, right, so that we if we have to lose any sale to keep our prices, that's the priority nowadays. And we are very confident that we will deliver consistently mid single digit margins from this year onwards.
Thank you. And as far as so you guys have been stressing a participant. Have you seen that to be the case with your competitors? Have you noticed any of them offering maybe outsized incentives or otherwise?
Sorry, I do not understand. You're talking about the executives.
Just how the competitive landscape is currently in the index of segment?
Well, the business jet market is quite competitive, right? So as we all know, I don't know exactly what sort of incentives we are you are talking about. In our side here, in our case here, so what we are seeing is a good recognition for the services that we provide, the after sales support. As you probably know, we have got for the 2 years in a row the best light service in the segment. And with that, we are seeing our clients giving value for this.
So we have been able through the recognition to get better prices in our for our products. We have recently delivered the first Phenom 300 EV with a new interior. We have the Phenom 100 also with more range being delivered and, of course, the legacy for 5,500. So all in all, there is a lot of incentives that we are offering to our customer, which are making us with the ability to get a better recognition from the market and therefore, better prices and more sales.
Thank you very much. Appreciate it.
The next question comes from Augusto Winzig with HSBC.
Hi, sorry. Thank you for taking the follow-up. Actually, on the defense side, is there any update in terms of sales campaigns for the KC-three ninety? Is there any detail you can give us on any that you might be, I guess, getting close to firming up? Thank
you. Well, the campaign for the sale in Portugal is progressing very well. And we hope that we will conclude that within a short period, right? And I think it's important also to mention that the formation of this new JV is blank in defense, which will focus in the short term in the case of 2019 sales potential, right? We believe that this new JV will open up very important markets, which we had not counted on previously because of the geopolitical influence that our competitors did have there.
But with the partnership with Boeing and the engagement in selling and marketing the product, we believe that we will gather much more sales in the KFC in the midterm.
Perfect. Thank you again.
The next question comes from Noah Poponak with Goldman Sachs.
Hi, everyone.
Hi, Noah.
Hi. This is Matthew on for Noah. In your conference call on the JV with Boeing, you alluded to additional investment in the KC-three ninety and business jets. Could you help us understand what that entails and provide some sense of the sizing and timing of those investments?
No. We have not a strong definition on that, right? We just anticipated that with the KC-three ninety JV, there may be need for some investments, right? And this is important because this is and that's different from the type of partnership that we had with Duane in the past in the KC-three ninety. So we're thinking about doing other different things now that may require some investment, right?
But there is no definition on the amount of that and no definition of investment in executive aviation either, which we in Executive Aviation, we keep focused on our turnaround plan. So we want to get this business with positive returns and positive cash generation, and we will do that thinking about any other new product development. It's important to note that we go on, however, updating our products to keep them competitive. So that we will continue to do.
Got you. So following up on that, you talk about sort of the potential next generation K-three ninety and the investments going into that. Could you give us a sense of sort of maybe the extent of those potential changes, sort of what markets you're targeting and potential timing for that?
No, that's something that JV, we are working with the line in the business case development. Not necessarily anticipate that there will be a new version of the KC, right? There may be differences in part of the industrial strategy. We don't know. But we will do whatever is necessary to unlock markets that today we cannot accept.
But it's not right to assume that we will result in a new version of the KC.
Got it. Thank you. And just thinking about the commercial JV, if there were to be a new aircraft developed there that sort of would involve additional capital infusions, Would you look to be contributing additional cash in order to avoid dilution or seek to maintain that cash position at Embraer?
Yes. In principle, yes, so we want to keep our share right of 20% and going forward. So that's the idea.
This concludes today's question and answer session and Embraer audio conference for today. Thank you very much for your participation and have a good day.