Good morning, ladies and gentlemen. Welcome to the audio conference call that will review Embraer's first quarter 2018 results. Thank you for standing by. At this time, all participants are in 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 one. As a reminder, this conference is being recorded and webcasted 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 economic, political, and business conditions in Brazil and in other markets where the company is present. The words believe, may, will, estimate, continues, anticipates, intends, expects, and 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 might 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, José Filippo, Executive Vice President, and Mr. Eduardo Couto, Director, Investor Relations.
I would now like to turn the conference over to Mr. Paulo Cesar de Souza e Silva. Please go ahead, sir.
Thank you. Good morning to all. Thank you for joining us this morning. Before I start, I would like to just make few comments of Filippo. As you know, he is leaving the company shortly. Filippo is staying with us until beginning of May. Then he will leave. I would like to take this opportunity to thank Filippo very much for this excellent job he did here at Embraer for the last almost seven years. At the same time, say a few words about Nelson Salgado. Nelson has been with Embraer more than 30 years. Nelson has been already in many functions at Embraer, including years ago, he was the controller of Embraer. Nelson knows very well the company. I welcome Nelson and wish him good luck in his new responsibilities. With that, I would ask Nelson to start the presentation.
Okay, Paulo. Thank you. Good morning, everybody. We start the presentation at slide four with the commercial aviation business highlights. Embraer delivered 14 E-Jets in the first quarter. The big highlight of the quarter, however, was the certification of the first E190-E2. The E190-E2 was the first aircraft to receive triple certification from ANAC Brazil, FAA U.S., and EASA Europe simultaneously. That happened in the end of February in our facility in São José dos Campos. As far as performance is concerned, the E190-E2 exceeded by 1.3% the original specification of 16% better fuel burn, confirming the E190-E2 as the most efficient aircraft in its segment, with more than 17% fuel consumption improvement compared to our current generation E-Jets. Just some days later, we delivered the first E190-E2 to the Norwegian company, Widerøe, on April fourth.
That aircraft has already started revenue flights, with the first flight being completed with perfection on April 24th. Finally, our second model of the E2 family, the E195-E2, is also on track for entry into service in the first half of 2019. Next page five, will show the executive jet business highlights. We delivered 11 executive jets in the quarter, eight light jets and three large jets. On market activity, we started to see signs of improvement in the business jet market conditions during the first quarter of 2018, recording sales of 17 aircraft during the period. As far as sales activity, we delivered the first Phenom 300E after receiving certification from FAA, EASA, and ANAC in the first quarter. The Phenom 300E is a new version of the Phenom 300, with a completely redesigned interior and also some other improvements.
Another important milestone that we have mentioned before is the Phenom 300 was again the best-selling and most delivered light business jet for the sixth consecutive year globally. We also launched a new tool called Fleet Logic to support corporate flight departments' planning. Finally, on customer support. We developed a Phenom 300 interior layout option to seat up to 11 occupants, which is the highest number in its class. Moving on to defense and security highlights, starting with the KC-390. The KC flight test campaign is moving towards final certification, with the two prototypes exceeding 1,600 flight hours. First delivery is expected for the second half of 2018 to the Brazilian Air Force. With the advance of the certification campaign, we've started also the production process with assembly of aircraft number 3, 4, and 5.
As far as sales activity in other products in defense, we delivered two Super Tucanos to a Latin American customer in the first quarter of 2018. We also delivered the fifth Phenom 100 to Flight Training Services, a provider in the U.K. that provides training services for the U.K. Ministry of Defence. Finally, our subsidiary, Atech, implemented the first fixed command and control and air traffic management center for an African nation. With that, we conclude our business unit highlights and move to the financial results. In slide eight, we present our backlog. Our backlog reached $19.5 billion in the end of the first quarter. It is important to note that with the launch of a separate business unit for services and support, we started to include services contracts in the backlog, like pool parts and maintenance programs that we did not include before.
Excluding that addition from our backlog, the backlog was almost flat, with increase in executive jets offset by a decline in commercial aviation. Next slide 9, we show aircraft deliveries by business units. As I mentioned before, we delivered 14 commercial jets. This is a decline versus last year's first quarter, but it is in line with our 2018 guidance of 85-95 planes. In executive jets, we delivered 18 aircraft, broken by 8 light jets and 2 large jets. Here, it is important to say that 5 planes were delayed to be delivered in the second quarter. We reiterate our 2018 guidance of 105-125 aircraft, broken by 70-80 light jets and 35-45 large jets. Next slide 10.
As far as revenues, we reported $992 million in the quarter, broken by $380 million in commercial aviation, $128 million in executive aviation, $243 million in defense and security, and $239 million in services. Compared to last year, our revenues in commercial and executive aviation were affected by lower deliveries, while defense revenues were positively impacted by the KC-390 programs. Our outlook for 2018 is unchanged at $5.4 billion-$5.9 billion. Moving to slide 11, Sales and General and Administrative expenses. We reported a flat year-over-year SG&A at $116 million, broken by $44 million in G&A expenses and $71 million in selling expenses. We remain focused on our cost-cutting initiatives that will continue to positively affect SG&A, as well as other costs in the near future. Next slide, we show the operating results. Embraer reported an EBIT of $26 million in the first quarter, implying an EBIT margin of 2.7%.
This margin and result is in line with normal seasonality in the first quarter, with lower dilution of fixed costs. We didn't have any special item in the quarter. Looking at the margins by segment, we reported commercial aviation at 4.5%, executive at -16.7%, defense at 4%, and services at 9.8%. Again, here we reiterate our 2018 EBIT guidance of $270 million-$355 million, with 5%-6% margin. Next slide 13. Our EBITDA reached $90 million in the quarter, with a margin of 9%. Again, here we reiterate the guidance of $540 million-$650 million, equivalent to 10%-11% EBITDA margin. Moving to slide 14, we show earnings. Embraer reported a net loss of $25 million in the first quarter of 2018, implying a negative margin of 2.5%. Our earnings were down due to the combination of lower operating results and higher financial expenses.
These higher financial expenses are, however, in line with our strategy. In the end of last year, we anticipated that interest rates would go up. We issued a bond in line with our strategy of maintaining a high level of liquidity. We issued a $750 million bond. Now we are seeing the interest rates go up. This should benefit our financial revenues in the future. Moving to investments. Our investments reached $46 million during the first quarter, broken by $10 million in research, $13 million in development, and $23 million in CapEx. Our first quarter development investment was positively impacted by a $65 million received from suppliers' contribution for the E2 program. The E2 development program, it's important to note, remains in line with our plan as far as budget and performance is concerned. Again, here we maintain our 2018 investment outlook of $550 million. Next slide.
As far as free cash flow, we reported a free cash flow consumption of BRL 431 million, broken by BRL 311 of operating cash flow, BRL 40 million CapEx, and BRL 18 million development. Given the normal seasonality for our first quarter, our free cash flow reflects higher inventories of BRL 330 million as we prepare for higher deliveries in the coming quarters, and also with addition of some finished goods aircraft, which deliveries were postponed to the second quarter. We reinforce our expectation of usage of no more than BRL 100 million of cash flow in 2018. Finally, in slide 17, we show our indebtedness profile. We ended the quarter with a total debt of BRL 4.2 billion and total cash of BRL 3.4 billion, resulting in a net debt position of BRL 759 million, around BRL 60 million better than first quarter 2017. Our debt level remains comfortable, with an average maturity of 5.7 years.
With that, we conclude the presentation of our financial results and move on to the Q&A session. Thank you.
Ladies and gentlemen, at this time, if you have a question, please press the star then the number 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, you may press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Robert Spingarn from Credit Suisse. Your line is now open.
Hi, this is Audrey Preston on for Rob. I was just curious, could you give us an update on the potential Boeing tie-up? What details are left to be negotiated, and what benefits are you expecting to derive from this deal? What are you expecting to bring to the table yourself? Then a follow-up after that. With the Airbus and Bombardier deal expected to close next month, would that generate any additional pressure to accelerate that negotiation timeline? Thank you.
Thanks for your question. We don't have too much to add on this topic, Boeing-Embraer. I think we have released, again, an update together with our financial results. We continue to work in the transaction with Boeing and with the Brazilian technical group that was established. The negotiations are quite complex. It's going well, but we have no
expectation for any timeframe to conclude this. This is what I can add in addition to what was already disclosed in our earnings results.
All right. Thank you.
Sure.
Thank you. Our next question comes from the line of Cai von Rumohr from Cowen and Company. Your line is now open.
Hi, good morning. This is Bill on for Kai. Wanted to check in on biz jets for a second. First, can you confirm the biz jet margins in Q2? I didn't hear those. Were they negative 16.7% or positive 16.7%? If they were negative, how much were the impairments? Just broadly on biz jets, if you could speak to orders, what are you seeing? Have they picked up recently? What are the products people are most interested in?
Okay. Thank you. I confirm it's negative 16.7%, and that's basically due to a lower level of deliveries. There's no impairment impact here in executive aviation. As we mentioned in the call, we see signs of recovery in this market, with actually average prices going up a bit and increased sales activity.
All right. Thanks. Just to follow up on commercial margins. They were down a lot year-over-year. Can you just discuss what's going on in that business line in Q1?
Basically, Kai, the commercial aviation and also business jets, we are short of about five deliveries in business jets, and I believe three or four in commercial aviation. Aircraft is being manufactured, but it was not delivered, given that the client asked to deliver these aircraft in the second quarter. This is basically the major impact in both business.
Yeah, that's because the lower number of aircraft, as I said, it affects the EBIT margin because of lower dilution of fixed cost. The gross margin, however, is very much in line with what we used to have or what we have generally.
If I add, Nelson, if we exclude these few deliveries that moved to the upcoming quarters, the EBIT margin wouldn't be too different from what we reported on the previous year. Okay?
All right. Thank you, gentlemen. Appreciate it. I'll pass along.
Thank you. Our next question comes from the line of Ronald Epstein from Bank of America Merrill Lynch. Your line is now open.
Hey, good morning, guys.
Good morning.
Can you give us a quick update on how we're doing on sales campaigns for the E2? The sales for the program over the last couple of years have been reasonably anemic. Now that the airplane is certified and in service, what's going on? Is there anything closer to being booked? How would you describe that?
Thank you, Ron, for your question. Yes, definitely after the certification in February of the E2, E190-E2, and the first delivery and EIS of the E2 this week. Since the certification, we are seeing more attraction, more interest. Our teams are very busily involved with our existing clients and potential clients. Of course, I cannot disclose here any names and any stage of these negotiations. I feel pretty good that we are going to have a very good year. The EIS of the E2 this week has been great. The aircraft is performing very well, and we are very bullish that it's going to be a strong year for us.
Hey, can you give us a sense, are you thinking of book-to-bill greater than one? That's one metric maybe you could mention.
Yes. We are targeting at least one.
Okay.
Given the level of activities that we are seeing, so it can be greater than one.
Okay. Great. Then back to business jets for a moment. The sense of recovery that you're seeing, is it just in the smaller product? Is it in the larger product? Is it the U.S.? Is it Europe? Can you give any more feel for the tone and tenor of the recovery you're starting to see?
Sure. I think, first of all, we are seeing overall improvement in the used aircraft. Inventory is being reduced. Prices on the used aircraft have stopped to fall. We are seeing slightly better prices on the new aircraft. Definitely U.S. and Europe. I think these are both markets, regions that are needing this recovery. U.S., given the tax reform and the economic growth. Europe, more, of course, on the economic growth in the whole of Europe, European countries. We are seeing a good perspective for the medium-size aircraft, in Super Mid-size, Legacy 450, Legacy 500. We are seeing a very good activity there. We are also on the business jet unit business. We are more positive this year. I believe we are coming out of the woods, finally. It's not a great improvement, but it's an improvement.
Okay, great. Thank you very much.
Sure.
Thank you. Our next question comes from the line of Noah Poponak from Goldman Sachs. Your line is now open.
Hey, this is Gavin Parsons on for Noah. Good morning, everyone.
Morning.
Just taking a step back and looking at regional jet demand from a higher level. Now that the global fleet has been pretty flat for the last decade or so, and most of the demand has been replacement driven. Do you think that changes meaningfully over the next 5 to 10 years, or do you think replacement demand will be the more meaningful driver for you?
Well, we are stick to our market forecast. About 6,000 jets for the next 20 years from the segment 70 seats up to 130. Don't forget that we have the U.S. market for our 76-seater. It's still a lot of opportunities in the U.S. for these aircraft as we move forward. For the 190, 195 E2, as I mentioned before, starting to deliver, we are seeing, and we'll continue to see a great opportunity. We are stick to our market forecast. We continue to see that size of the market. We have China with opportunities, not for replacement, but for growth. We have other markets in Asia as well for growth. Replacement in Europe, definitely, as well as Middle East. I think it's a mix of growth, replacement.
A scope change or a scope relaxation a little bit in the United States as we replace the 70-seater with the Embraer 175.
Okay. Then you called out impairments, or I guess residual value guarantee impairments on commercial jets. Can you talk about what you're seeing in the marketplace today as far as values, the trends, and remind us what your total exposure is and what you have in guidance for the year?
I don't have the specifics here, I'm sorry. You are talking about the 145?
Yeah. In other expense, you highlighted expected impairments on commercial.
Impairments on commercial. It's basically, with reference to the ERJ-145, that we still have some in our books. From time to time, we have this impairment. I don't have the specifics now here. The market is improving a little bit for the 145. We are seeing a relatively good demand in countries in Africa, for instance, in the Eastern Europe. We have been able to place these aircraft in the secondary market. Always there is a need for some impairment. In the past, this impairment was bigger. Now it's being much reduced. I don't have the specific here. Do you have any?
Yeah, in the first quarter, we had around $10 million-$11 million on this impairment of used aircraft. It's not really RVG. For the upcoming quarters, we are expecting less than that, we shouldn't see the same amount for the rest of the year. It's always difficult to know.
Great. Then just last one for me. You are highlighting improvement in the business jet market and orders. 1Q deliveries looked a little bit seasonally light. Did you say there was some slippage to the second quarter there?
Yes, exactly. Five aircraft that slipped to the next quarter.
Got it. Thank you.
Sure.
Thank you. Our next question comes from the line of Peter Skibitski from Drexel Hamilton. Your line is now open.
Good morning, guys, and best of luck to José Filippo.
Thank you.
Congratulations on the E2 entering service. My question is, excuse me. On the strong revenue growth in defense, I am not sure I understand what drove that. It was up really sharply year-over-year. It looks like you think it will kind of flatten the balance of the year. Can you give some more color on the strength in Q1?
That growth was mainly driven by the KC-390, because we actually started the work on the contract for the serial delivery of aircraft to the Brazilian Air Force. As I mentioned, we have aircraft from three, four, and five in production. That contract has revenues recognized as we move on with the assembly of aircraft. That is responsible for most of the increase in the defense revenue in the first quarter.
Okay. It's percentage of completion, so you're not going to get a bump in revenue in the second half when you actually deliver. Is that correct?
Well, you recognize revenue as you assemble the aircraft, but there is always a significant portion left for the final delivery of the aircraft.
Okay. That's very helpful. Okay, then last question is just, as the Brazilian economy kind of stabilizes and returns to growth, what kind of defense budget growth are you guys expecting going forward as a result of that?
Well, we are expecting the growth in our program so that we can have the commitment the government has for delivery of the KC-390s ahead. There is no new program for the moment, but we have the big contract for the final certification of the KC, and also for deliveries of the KC. Looking at our other product lines, we have expectation of continuing work on the border protection program. Also, we've been working with the government for the second geostationary satellite that is actually needed already for Brazil. I'll say these are the major activities that we foresee with the government of Brazil.
Okay. Do you guys think the election later this year is going to have any kind of meaningful impact to the defense outlook?
No, we don't expect impact because these are long-term contracts that they go from one government to the other. We don't really expect any impact because of the change in government.
Okay. Thanks, guys. Appreciate it.
Thank you. Our next question comes from the line of Turan Khediwala from Scotiabank. Your line is now open.
Yes. Good morning. Thank you for taking my question. Also wanted to wish Filippo all the best for his future. I guess, my first question, wondering if you could talk a little bit about your executive aviation business. Obviously, the deliveries were a little bit soft here in Q1. I understand that there was a bit of movement from Q1 to Q2. Could you give us a sense of how much sales you need to do on that business to kind of get to the guidance here on deliveries for 2018?
Well, despite the soft deliveries in the first quarter, we are maintaining our guidance for the year, right? If you look at our guidance, that's where we expect to get. With that, we will improve our margins as well.
It's important to mention also the transformation we are going through in the company, right? With the Passion for Excellence program. We are now in this year, 2018, is a very important year. We have launched the program August last year, and we are implementing now. It's going well. It's moving well. Our plan fully takes into account this program that is being managed by us with the support of McKinsey. It's going very well, as I said, and we are on target so far.
If I may add, Paulo, it's Eduardo here. We had, I would say, a positive trend in terms of pricing on executive jets. If you look our average prices, they were 4%-5% better in the first quarter of this year compared to last year. This improvement was across most of the models. We are feeling better demand and some price recovery. That's the reason we are, I would say, cautiously optimistic on executive jets.
No, I understand that. I'm just trying to understand how much of the 105 or so in deliveries is in backlog.
We are very confident in our guidance of 105 to 125. I think the risk is very reduced. We don't disclose how much sold out we are, but we are very confident with.
That's helpful. Thank you, Eduardo. I guess maybe just one more from me. Paulo, I was wondering if you can talk a little bit. Obviously, I understand the Boeing deal is pretty complicated here to kind of get done. Just wondering, is the uncertainty around that affecting the business at all with regard to maybe campaigns on the E2? I guess even just something, maybe if you could provide some insight on how the employees are faring as well. Thank you.
No, it's not affecting at all. We are in touch, in contact, of course, with our clients. The campaigns that we are involved is not predicated at all in the transaction. We feel very good about that. Internally, of course, there is anxiety, right? To see the outcome of this. There is no issue whatsoever. I'm sure that people is very much focused on their job. However, having said that, we want to, of course, to have an outcome for this transaction as soon as possible. It's important that we reach a final resolution on that soon.
Okay, great. Thank you so much for your help.
Thank you.
Thank you. Our next question comes from the line of Stephen Trent from Citi. Your line is now open.
Good morning, gentlemen, thanks very much for the time. I echo other folks' comments, very best wishes to Filippo. I had two follow-up questions on the defense segment. When we look at the activity here in the U.S., there seems to be at least some indication that there might be additional opportunities for the A-29, and maybe the Air Force having a close look. Just curious if you have any comments on that?
Yeah, there is a growing interest in the Super Tucano, and the United States Air Force is actually performing right now, an evaluation process for light attack aircraft. The Super Tucano has been selected as one of the two finalists of this campaign, which is moving ahead, and we are cautiously optimistic about our prospects in this, as the Super Tucano is really the only aircraft around with a combat-proven experience.
Okay. That's very helpful. Appreciate the color. Just one more, while I'm at it. It's encouraging to hear the KC-390 rolling along in terms of the contractual work you're doing for Brazil's military. Any indication at this point, anything you can say with respect to how the efforts are going vis-a-vis potential international attraction to the aircraft, especially as Boeing has some skin in the game on this process?
Well, in the defense market, we know that it seems really start to heat up when your own Air Force receives and starts to operate the aircraft, right? We continue to see a lot of interest in the KC. We've been approached by many Air Force throughout the world. There are some campaigns going on. We really expect to see that turning into real sales as the Brazilian Air Force receives and starts operating the aircraft.
Okay. Very helpful. Let me leave it there. I'll let someone else ask a question. Thank you.
Thank you. Our next question comes from the line of Ricardo Alves from Morgan Stanley. Your line is now open.
No.
Good morning. Thank you, gentlemen. Just one for me. Most of my questions have been answered. On the Defense profitability, this big improvement from minus 8% to positive 4%. Now that you're getting ready to deliver the first aircraft, is this the kind of profitability we should expect for the next few quarters? I remember you guys guiding a low, if I may take a low to mid-single-digit margin for the Defense segment in 2018. Just wonder if that should continue. Also, if you could give a quick update on what you expect in terms of margin per segment. I guess it shouldn't have changed because you're reiterating your margin guidance. Just to make sure, because we saw this big bounce back on Defense and a significantly lower profitability on the Executive side. Thank you.
Okay. Thanks, Ricardo. I would say the first quarter margins on Defense were more normal or back to a normal level that last year was really unusual. We had negative margins, mostly driven by some cost-based revisions that we had in some of our programs. This year, at least in the first quarter, we didn't have any cost-based revision. At this point, we are not anticipating that for the remaining of the year. We expect to see better Defense margins. Looking the margins per business, we don't give a guidance on that. As we already mentioned, Executive Jets should be a low to mid-single, similar to Defense. On Commercial, we expect to see a mid to high single digit. Service and Support, mid-teens or a low double digit. That's more like how we see the margins per business.
Thank you so much, Edu. Helpful.
Thank you. I'm showing no further questions over the phone lines at this time. I'd like to turn the call back over to Nelson Salgado for closing remarks.
Well, thank you very much all for attending our results conference. Thank you.
That does conclude Embraer's audio conference for today. Thank you very much for your participation. Have a good day.