Good afternoon, everybody, and welcome to the Embraer Third Quarter 2017 Earnings Call. This conference call is being held during our Embraer Day in New York with the presence of investors and market analysts. So thank you all for coming. At this time, we present the Q3 results and the financial outlook. Afterwards, we will conduct a question and answer session and instructions to participate will be given at that time.
During the call, please press the star key followed by 1. Thank you all that are here attending our event live. It's a pleasure to have you all here. As a reminder, this conference is being recorded and webcasted at ri.mbraere.com.br. This conference 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 others, general economic and political business conditions in Brazil and in other markets where the companies 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 those risks and uncertainties, the forward looking events and circumstances discussed on this conference call may might not occur.
The company actual results could differ substantially from those anticipated in the forward looking statements. Participants on today's conference call are Paolo Cesar, de Souza and Silva, our President and CEO Jose Filippo, Chief Financial Officer and IRO myself, Eduardo Goto, Director of Investor Relations. We also have John Slattery, Commercial Aviation Michael Malfitano, Executive Aviation Jackson Schneider, Defense and Security and Johan Bovadas, Service and Support. Now I would like to turn the conference over to Jose Philippe, our CFO. Please go ahead, Philippe.
Thank you, Eduardo, and welcome again to our Q3 2017 earnings results and financial outlook. Starting with the highlights of the Q3 in Page 4 with Commercial Aviation. We delivered 25 e Jets in the Q3 of 2017 and to September to date, we have 78 delivers in active jets sorry, in commercial aviation e Jets. As far as commercial activity, we had 2 new orders from SkyWest in the quarter for a total of 45 E175, an information that AerCap placed 5E190E2 with Erastanen. Continuing with commercial aviation, an important milestone related to the EGS program that reached 1,000,000,000 passengers transported since the entry into service.
Regarding service activity, we launched the 1st Embraer full training center in Johannesburg, South Africa. And finalizing the highlights of commercial aviation, an update on the E2 development program with information of the successful conclusion of the simulated ice and cabin evacuation test, the confirmation of the first delivery of its 2 aircraft to withdraw set for April 2018 and the achievement of 80% of the campaign for A1982 certification. Moving to next page, highlights of Executive Jets. We delivered 20 Executive Jets in the 3rd quarter, broken by 13 light jets and 7 large jets. And we have until the Q3 of 2017, 59 deliveries.
In those deliveries, we included the first delivery of the Lagos 500 produced in Florida and the delivery of the first new Lagasse 650E to Air Hamburg. In terms of production development, we launched at the recent NBAA, the new Pheno 300E featuring new interior design. Regarding customer satisfaction, Embraer was ranked number 1 in customer support for the 2nd consecutive year by AIN. And concluding the highlights of AdaptiveJets in relation to our organization, we appointed Steve Friedrich as our new CCO. Next page, Page 6, Defense and Security highlights.
In terms of commercial activity, the first in relation to the Super Tucano, we signed orders for 12 aircraft, including 6 Super Tucano Surdu U. S. Air Force that will be operating in the Afghanistan and 6 others to an undisclosed customer. The U. S.
Government also approved the sale of 12 Super Tucano to Nigeria. Regarding the potential OAX opportunity, the Super Tucano fulfilled all mission requirements for the U. S. Air Force initial capability test. In relation to the KC-two ninety campaigns, Portugal continues to advance with contract negotiations for 5 units.
And the update of the K6-two ninety program development, certification is progressing with 2 prototypes with more than 1450 hours operation. The delivery of the first case with United is scheduled for the second half of twenty eighteen. Next page, up the highlights of the business units. Now moving to the financial results and you're going to Page 8, which is the 3rd order backlog. We ended the Q3 of 2017 with backlog of $18,800,000,000 an increase of $300,000,000 when compared to the previous quarter.
Next page, as far as deliveries, starting with commercial aviation. In the left hand side of the presentation, we delivered 25 aircraft in the 3rd quarter. It's now 78 to date as of September. In relation to Executive Jets, delivery of 20 aircraft broken by 13 light and 7 large and accumulated as of September of 59 in the year, broken by 40 light and 19 large claims. We take the opportunity to confirm our expected outlook for 2017 of the range of 97 to 102 aircraft for Commercial Aviation and 105 to 125 aircraft in executive jets.
Next page, regarding revenues. We reported a total of $1,300,000,000 in the Q3 of 2017 and accumulated of $4,100,000,000 in 2017. Revenues by business in 3rd quarter were EUR 846,000,000 in Commercial Aviation, dollars 267,000,000 in Executive Jets and $190,000,000 in Defense and Security. For the total individual business revenues outlook, we are maintaining our estimates for 2017. Next page, Page 11, SG and A expenses.
We have in the 3rd quarter the total of $116,000,000 in SG and A expenses lower than the previous quarter and last year. The reduction reflects our focus on cost control and in relation to G and A, it was negatively affected by a one time expense, which will not repeat in the following quarters. As of September 2017, the total SG and A expenses achieved 355,000,000 Next page, in relation to adjusted EBIT, we reported a gain of $69,000,000 in the full quarter with margin of 5.3%. When we break our margin by segment in the quarter, we have Commercial Aviation with 13.8%, Executive Jets of negative 11% and Defense of negative 8.5%. In Executive Jets business, the margin was negatively affected impacted by the lower deliveries and unfavorable mix.
Despite the negative figures, we identified gross margin and price improvements when compared to the previous quarters. In Executive Jets, given the typical seasonality, we expect a strong Q4 returning to a full year margin to breakeven. In defense, margins we have negatively impacted by cost base revision and scope reduction in the modernization programs. For the full year, we expect low single digit positive margin. For full year 2017, we are confirming our outlook expectations of $450,000,000 to $500,000,000 and 8% to 9% margin, more towards the low end of the range.
Okay, next page, adjusted EBITDA. We had $143,000,000 in the 3rd quarter with 10.9% margin. As of September, the accumulated EBITDA reached $492,000,000 with 12% margin. For the full year, we are maintaining our estimate of EBITDA from $770,000,000 to $890,000,000 and 13.5% to 14.5 percent margin. Next page, Page 14.
Adjusted net income was $17,000,000 in the 3rd quarter so $75,000,000 in the 3rd quarter with 5.7 percent net margin. Year to date adjusted net income reached EUR 221,000,000 with 5.4% margin. In Page 15, investments. Total investments as of September 2017 were 398 $1,000,000 broken by $32,000,000 in research, dollars 259,000,000 in development and $107,000,000 in CapEx. Our investment outlook for 2017 remains for $650,000,000 Next page, adjusted free cash flow.
We had the consumption of $23,000,000 in the 3rd quarter, reflecting the operating cash generation. For the full year, we are maintaining our estimates of maximum consumption of $150,000,000 but we believe we can do better. Page 17, regarding our capital structure. As of the end of the quarter, we had a total debt of $4,300,000,000 with total cash of $3,600,000,000 returning to a net debt of $733,000,000 Our debt average term was 6.1 years at the end of the quarter. Okay.
With that, we conclude the financial results of the Q3 and turn to the discussion of the financial outlook. Next page, in Page 19, we would like to reiterate our outlook for 2017. However, we would like to mention that we may finish the year at the lower end of EBIT margin range and in terms of free cash flow, we may be better than the consumption of $150,000,000 maximum indicated. Next page. As we consider that 2018 will be a transition year, we would like to present the preliminary outlook for the year.
In terms of revenues, we are indicating the range of $5,300,000,000 to $6,000,000,000 For deliveries, the range of $85,000,000 to $95,000,000 commercial aircraft and $105,000,000 to 125 effective jets. EBIT is being estimated from $265,000,000 to $360,000,000 with margin range between 5% 6%. Free cash flow should be a consumption of EUR 150,000,000 or better. Next page, we highlight the short term headwinds that we believe will affect 2018 results, which includes the ramp up of the E2 program, the final development of that program as well, the commercial aviation delivers below the level of 100 aircraft, a soft business jet market and also constraints of Brazilian budget that is affecting the business. However, when we see the midterm, we anticipate meaningful gains in our profitability and cash generation related basically to the complete development of the E2, the levels of above 100 aircraft for deliveries in commercial aviation, expectation of an improvement in the business jet market, higher revenues from service, KC-three ninety international opportunities as well as Super Tucano opportunities, the phase of production of the KC-three ninety in and a more normalized CapEx.
Also, we have in place a cost control and cost program, which includes basically tools like 0 based budget, digitalization, cost management, organizational design. Those initiatives we contribute to the performance improvement. Well, with that, we conclude the presentation of the 3rd quarter results and the financial outlook and we turn it to the Q and A section. Thank you.
Yes. Just for the Q and A instructions, if you're in the audience, just raise your hand. We have mics on the room. If you're on the phone, just press star 1 in your phone. We'll start with the audience.
So just raise your hand and you can start.
Thank you. Good afternoon. Philip, the EBIT margin guidance for next year, the 5% to 6%, I imagine the bulk of that pressure is the transition in commercial with the E2. But what does that consolidated 5% to 6% contemplate as far as executive jets and defense?
Yes. In terms of executive jets, we still see a soft market, but we're keeping a flat level of the market and it delivers as well. We still have improvement in terms of the manufacturing system. We are moving into the Flanta facility. And that for us is still a process of positioning our product into the levels of price and margin, which already mentioned that this quarter we already saw an improvement of that.
If you see, we don't give this information, of course, sometimes you cannot see internally, but we can tell you that even prices and gross margins were improved if you compare by module from quarter to quarter, not last quarter to this quarter. So we think that's a positive indication. But we still see the market soft. So that's not enough for us to really have a difference in terms of the contribution. In terms of the defense, we're still in the phase of developing.
We're just starting the manufacturing of the aircraft KC-three ninety. We as we indicated, we plan to have the first delivery next year, but that brings all the inefficiency of the learning curve of the manufacturing sector. That's basically the combination of the other businesses that will not be able to offset the level of deliveries in commercialization.
Okay. Thank you. And if I could just ask a quick related follow-up. I think the cash flow guidance for next year, which is similar to where you see this year shaking out is probably pretty in line with where expectations were, but I think on a lower EBIT margin range than what people were expecting. So where is the offset?
Is it on the working capital? Is it on the investments?
It's basically the investment in the E2 that will get to a phase where we have lower investments. The peak of the investments were basically this year and last year. So we still we start to see reduction in the level of investment that can compensate. That's basically why we're setting the same level this year.
Okay. Thank you. Good morning. Could you give us some more color on the $50,000,000 roughly loss in the other column this quarter in terms of how much of that is just ongoing corporate expense? If we exclude all one timers going forward into 2018, what's the normalized level for corporate expense?
Normalized corporate expense, I think we should consider about $30,000,000 to $40,000,000 Per quarter. For that quarter, we had an impairment impact, which sometimes happens. This is not a recurring thing, but because of the way you have to account, sometimes we have this impact. Also some IT expenses, because we had an integrated system that we had to incur with that. And basically other corporate projects, But we don't see that as being a cut trend for that.
So typically, like I said, we could use like $30,000,000 to $40,000,000 of year at this level for that.
Okay. And then just on business jets have been weak year to date, you've kept your guidance. How many are in backlog already? How many slots are sold for the Q4? Just want to get a sense of the risk there.
And is that the major covering factor to your the width of your EBIT margin guidance of 8% to 9%? Or are there other factors?
We don't see different that we saw before. The same levels, the challenging market, the short term decision from the customer. So the backlog is not a large backlog that we're going to as you saw recently, when we in the end of the year that when we release the backlog by business is a smaller piece of effective jet. That's basically because the decision on the customer is more short term. So it's not I don't think this is the best way of seeing this, but it's more like the typical dynamic of the market today.
Is that the major factor to the width of your EBIT margin guidance, 8% to 9% whether you come upper end of your business range or lower end of your range?
Yes, correct. That scenario is still what we see for 2018.
Thanks. Filippo, on the cash flow for this year, have you ever had a 4th quarter where it's a negative cash flow? That's right. It's implied as I think a negative 150. I'm not sure if Embraer has ever had a negative 4th quarter cash flow.
So I'm just wondering, is there a what's the level of conservatism there? So it seems like it would be well north of positive.
Yes. Like I said, the guidance is better than $150,000,000 We indicated that we believe that not going to be in the lower end of this guidance. 4th quarter is typically stronger than the others. What we have here is of course some investments that we have the contribution of suppliers mostly in the beginning of the year. So we don't have this in the end of the year.
And also that we may have to in the ramp up of the E2 as we start to produce the E2 next year, going to be some working capital that will be required for the E2 program. That's why we didn't revise that. But we indicated and I think we can believe that and expect that we can be better than that limit.
Okay. Okay. And then the margins as you look beyond your midterm, they're pretty steep ramp. Is the chart graphically accurate? Can I take a ruler?
But can you give some color? What is mid term?
Is it 2019? For 2 to 3 years.
2 to 3 years.
Okay. So margins could be like high single digit, low double digit in that range.
Okay. Thank you. I was wondering if
you can give a little bit more color in terms of 2019 because the E2 production ramp will probably be going up, you'll have more deliveries of E2s in 2019, but you probably get a bit of a learning curve impact as you kind of as you work through it. So and then maybe just you get a bit of a bit better business at market. Does that sort of triangulate to flattish margins into 2019? Or do you think there's more pressure in 2019 as well?
No, Toda, we don't want to give some specifics for 2019. I think at this point, we're trying to elaborate a little bit more on 2018 because we really think this is not a typical year. And going forward, it's more like the view of the midterm rather than the specific 2019. Of course, all those, what we call the tailwinds that we highlighted there will be contributing to this. And we believe that in 2 to 3 years, we have a normal situation, if you will, that we can compare to the years that we have before without those typical effects that we'll be facing these days.
But basically, we don't want to be specific on the next year, I mean, following the 2018.
Thank you. Maybe you take a question from the phone. We have a question from Kai Van Roon from Cowen. Kai,
you Yes.
Thank you very much. So Filippo, maybe you could give us some color on next year in terms of what are the milestones we should look for to tell us that the E2 is improving or the KC-three ninety is improving? And secondly, you're assuming the margins go down fairly substantially. Is that likely to be a bigger dip in the first half, and improvement in the second half relative to your normal pattern? Or does it get worse relative to the normal pattern as we go through the year?
Thank you.
Hey, Kai. Thanks for the question. Kai, I believe that we're going to have, of course, the same seasonality of the business that we had before. So the margins normally in the beginning of the year tends to be lower than the end of the year, especially in the Q4. But we don't believe that's going to change for next year.
We plan and we expect to be about 10% deliveries next year related to the E2 and that brings this inefficiency that we just mentioned about the learning curve for that. And we will know if the program is doing well, If you follow the certification process, if you follow the capacity for us to start to manufacture. And I think that's basically how we see next year. And again, we're calling this level of 100 aircraft, which is a level that we've been seeing recent years that next year because of the estimate that we just send out, we're going to be lower in that amount. So that's also the dilution of fixed costs is going to be impacted with that.
And we'll need to have an increase in production going forward due to the increasing revenues sorry, increasing deliveries up in the midterm that we mentioned. So that's basically if I don't understand exactly what you asked, that's basically how I see this trend in the short term.
Thank you.
Good afternoon, gentlemen, and thanks for the time. Two questions for you. When we think about the margin on the E2, is there any plan to include gains from risk sharing partners as you did back in 2004 with the E Jets rollout? And then the second question pertains to the Brazilian budget. I mean, maybe it's obvious, but excuse me, if you could give us maybe a little more detail as to where the process is now on the KC-three ninety versus where you thought it was?
Thanks, Steve. In terms of the contribution to this risk sharing, we're already having this during the development phase. So it will follow typically how we do in terms of development. I don't think there's something that we should change now. This is what you reflected in the situation today and the program itself.
I don't think there's something that we should expect differently now. In terms of the Brazilian budget, of course, this is a common common information about the restriction they're having. However, the key problem for us, which is the KC-three ninety, we're following well. So our accounts receivable didn't increase. So having the same level of last quarter, we keep on track on that.
We already mentioned that one thing that we saw here was the reduction in scope of modernization program, which is not like the same level of the KC-two ninety, but something that also we could see that could be an impact that we saw. We simply were dealing with the reduction on scope to be able to accommodate the requirement of the customer the client. That's basically how we're doing. But in terms of payables we're doing, normally there's no change on that.
Okay. Thanks, Jose Antonio. Thanks. Good afternoon. Just back to the E2 margin topic, any willingness or ability to actually quantify for us how much lower those margins are coming in compared to the legacy regional jet?
And what the ramp to your historical commercial margin looks like on the program? Just that's by far the biggest lever and where the margins go from here?
I think in terms of the margin of the H2O, let's think about 2018 that we indicated most of the reduction on the margin comes from, of course, the commercial aviation programs. It too is one of the drivers for this reduction. But again, we have to think about 2018 as a very unique year for that because we ramping up this first deliveries, like I said, 10% we expect to be delivered at Rieto. That brings all this learning progress. Historically, I think Embraer has been able to improve all this capacity to manufacture.
Remember that when we had the larger orders from the American market on the $175,000,000 that we are delivering now, We mentioned about the price pressure because of the size of the orders. And at that time, we were able to improve the cost through efficiencies and learning on how to do more standard orders. And so I believe that we have capacity to really in the short term be able to transform that into inefficiency and the learning curve should be shorter. So for 2018, we're not counting on that because this is really the learning piece of this process. After that, that we expect to ramp up in terms of increasing margins.
So mostly what we indicated for 2018 reduction is due to the commercial aviation inefficiency, if you will.
Can you tell us if V2 margins in 2018 are slightly positive, breakeven slightly negative, largely negative?
No, they were positive. So low, but positive.
Okay.
That's helpful. Can you speak to pricing in recent commercial orders? And then on top of that, your sort of, I guess, near to medium term outlook for campaigning on the commercial side?
Given the quantum of orders that we the size of the orders that we're experiencing, as Filippo referenced, there has been a certain amount of pressure over the course of a number of quarters. What I can tell you is, as we cadence into the final quarter, and I'll reference it in my presentation later, we are starting to see some more price discipline in the marketplace, our ability to improve margins somewhat. So and we continue I'll give you more granularity in a while. We continue to see a lot of momentum on the E175, in particular, at very significant levels. I'll give you more granularity on that.
So in summary, for sure, there was some softness in those margins, but it does feel now as if we are improving our position when it comes to margins. But we are certainly, in addition to that, maintaining a what I would describe as a significant amount of momentum in terms of orders around the 175E1 platform.
Great. Thank you. Thank you. Can you give us a sense of the E175 sorry, E175, E2 and what your plan would be there if scope clause doesn't get lifted in 2021? And if it is to continue to build it, what that would do to margins?
Sure. Well, firstly, we're committed to the revised guidance of the entry into service of the 175E2 in 2021. That aircraft, we believe will have commercial penetration, significant commercial penetration outside of the U. S. It's a very different machine to the 175E1.
I see opportunities in China, in India, in Western Continental Europe and in the Scandinavian countries. And so we are now proactively marketing that aircraft outside of the U. S, because as you know, it's not scope compliant. And I expect to get some traction on those activities next year. Of course, it's a 2021 entry into service guidance now.
So whether we'll close transactions next year or not, I don't know yet. But I can tell you we're proactively marketing that aircraft outside of the U. S. In relation just to address the U. S.
Environment, whilst we have no visibility as to when scope will change in the North American climate, we continue to address that market very successfully with the 175 E1 platform. On a relative basis, since January 2013, I believe we have won over 85% of the seats in that market in North America. And since January of this year, we've won 100%. So we have the platform that the customers want in North America. When scope is released, we'll have the platform for them with an even more efficient aircraft in the 175E2.
And just as a follow-up, can you tell us should we expect the SkyWest to roll into an E-one?
No. SkyWest is very pleased with their E2 order. And I expect SkyWest will be one of, if not the largest operators of the E2 in the world in sequence.
Thanks. Just staying on the topic of the E175 and your point about that being where you're seeing a good deal of momentum and also the point about the E2s representing I think 10% of your deliveries next year. Can you just comment a little bit on how you see the sort of mix, the commercial mix next year? Obviously, your mix has been skewed very heavily toward the $175,000,000 in recent years and just maybe how you see that in 2018 and beyond?
I think we're going to continue to see the 175 play a meaningful center stage role for many years to come. I'm going to give you some idea of the quantums we're talking about, but it is very significant demand. There's just sort of a series of waves It's like surfing off the West Coast of Ireland. The waves are coming in very quickly, which is great for us because we seem to have the platform that the airlines are looking for. So I will tell you that our marketing teams are also spending a lot of effort continuing to market and deliver 195s 190e1s.
There's a lot of focus from Paolo and Filippo to ensure that from a revenue and a margin perspective that, of course, we sell and deliver the larger platforms. But pragmatically, I think over the course of the next few years, you're going to see the 175 play a meaningful role in the sales and deliveries.
That's great. And then just following up about the question, the prior question on potential conversion, I think, from E2 to E1. Are you seeing any prospects for things going in the other direction, some conversions of E1s to E2s?
No, that's not something that's under Paolo's guidance. That was just not something that we entertained as a broad matter. There are, I would say, 1, 2, maybe 1 customer in the world that we're open to having that conversation with. Customer possibly not based too far from where we're sitting right now. But as a general matter, no, we're not interested in cannibalizing the E1 to sell E2s.
And by the way, there's no pressure from the customers either. Customers that want E1s, they want the E1s now. So as customers cadence into the E2, they're going to make larger commitments to the E2s. But as we cadence to the sunset of the E1, particularly the 90 and the 95 platform, as airlines are ordering their 2s and their 3s and their 5s. If they have a large incumbent fleet of E1s, they're not going to make that jump yet to the E2.
They're going to add to their fleets with incrementally 1. So we're not seeing that pressure, and we're not encouraging it.
So cash flow related question, if I could. It looks like your implied investments for the Q4 would be about 250,000,000 dollars to achieve your 650,000,000 for the year. I don't believe I saw investment guidance for 2018. So can you characterize that 250,000,000 in the 4th quarter? Is that a peak quarter?
How does that look going forward into 2018?
We're not breaking this down for next year. There should be less than the levels that we're having. For 2 years, we have the level of 650. We may have less than the next year, but we're going to be sending more details soon in the future, not now. On the in the beginning of the year, as we released the results of 2017, we're going to do a full revision on the guidance and we provide those detailed information, but it could be less than what we had this year.
Thank you.
Just a discussion about the midterm free cash flow outlook. One of the big variables I think is not listed there is, would there be a project to follow on to the E2? And then there's been chatter about terminal props and maybe another biz chat, that sort of a thing. To what degree does the next generation platform factor into that outlook?
The outlook does not consider any new project. We're talking about the midterm 2 to 3 years. So it's not we have to finalize the E2 and we have been investing a lot in terms of plants and new program. We have today the 2 under development in the phase, 80% already developed. We have the Lagos 41500.
We have the KC-29 plants in Evora, Portugal, the Florida facility, have you on Quechoto in Cutricera Sao Paulo. So it's a huge level of investment that we enter in recent years, I think it's now time that we make those investments to generate some cash for us. So it's not something that we could expect and not considered in the projections that was shown there.
You don't feel compelling need to launch a new platform in the near future?
No. There is, of course, the maintenance of platforms Legacy also. So we do permanently, we do with the investments in terms of maintaining the competitiveness of the products on other than new platform.
Any other question? Dave, I think that concludes today's Q and A section. Thank you all that are on the phone for connecting. Now we're going to have a short break, and we come back for the detailed presentation.