Good morning, ladies and gentlemen, and welcome to the audio conference call that will review Embraer's second quarter 2017 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 webcasted at ri.embraer.com.br. This conference call includes forward-looking statements or statements about events or circumstances that have not occurred. Embraer has based these forward-looking statements largely on its current expectations and projections about the 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 other markets where the company is present. The words believe, 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 statements, 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. José Filippo, Chief Financial Officer and IRO, and Eduardo Couto, Director of Investor Relations. I would now like to turn the conference over to Mr. José Filippo.
Please go ahead, sir.
Okay. Thank you, and welcome, and thanks for joining Embraer's second quarter 2017 earnings results. We're going to go through the presentation. I'll pass to Paulo Cesar to give some comments, then we'll be following the Q&A section. Okay, starting the presentation, on page three, regarding the highlights. We start with the corporate highlights. In June, Embraer attended the Paris Air Show with its largest presence ever. We showed at the air show the units for each of our business, the E195-E2, the KC-390, and the Legacy 450. The E2-195 and the KC-390 not only showed at the static but also did flight demos. Also, in corporate highlights, Embraer was awarded the most innovative company in Brazil for the second consecutive year.
Moving to the next page four, in terms of highlights for commercial aviation, we delivered 35 E-Jets in the second quarter, a growth of 35% when compared to 2016. As far as commercial activity, we announced 51 commitments at the Paris Air Show, being 18 firm orders and 33 purchase rights. In terms of firm orders, we sold 22 planes in the year to date. Finalizing commercial aviation highlights, regarding the E2 development, we advanced with five prototypes, one for E195 and four prototypes of E190, which now reached over 1,000 flight hours test and more than 3,000 ground test hours. Next page five, highlights for Executive Jets. We delivered 24 Executive Jets in the second quarter, being 16 light and eight large aircraft. Those deliveries included the delivery of the Embraer Executive Jet number 1,100 to NetJets customer.
An important milestone of our manufacturing in the West was the first flight of the first Legacy 500 assembled in Melbourne. This plane will be delivered to a corporate flight department in Florida this year. Regarding commercial activity, we secured an order of three Legacy 650E to Air Hamburg. Next page six, highlights for defense and security, starting with the formation of the successfully launch of the Brazilian satellite, which happened in May. In terms of deliveries of Super Tucanos, we had our final delivery to the U.S. Air Force of six Super Tucanos commissioned to the [level]. In relation to the KC-390 program, we continue to advance the schedule with two prototypes with more than 1,200 flight hours. We are confident on the commercial success of the KC-390.
At the Paris Air Show, we had more than 60 delegations visiting the plane, and after that, we performed a demo tour visiting places in Europe, Asia, Middle East, and Africa. In terms of commercial opportunity in defense, we will participate in the U.S. Air Force capability assessment for light attack platforms of the Super Tucano, which can be potentially a new program. Also, our subsidiary, Savis Radar, established a partnership with Thales for air traffic control radar solutions. With that, we conclude the corporate highlights. We now move into the financial results. Starting page eight, our firm backlog. We reached a total of $18.5 billion at the end of June. This amount reflects the strong deliveries of commercial aviation in the second quarter. In terms of sales activity in 2017, we are positive with the campaigns of the KC-390, with the book-to-bill above one in executive jets.
For commercial aviation, we expect to reach a book-to-bill of one this year. Next page nine. As far as deliveries, starting with commercial aviation, we delivered a total of 35 aircraft in the second quarter and 53 year-to-date. We are maintaining our estimate of the range of 97 to 102 aircraft for 2017. In terms of executive jet deliveries, we had a total of 24 deliveries in the second quarter, broken by 16 light and eight large planes. In the year, we already delivered 39 aircraft, being 27 light jets and 12 large jets. Also, for executive jets, we are maintaining our guidance of 105 to 135 aircraft in the year, being 70 to 80 light jets and 35 to 45 larger jets. Next page 10. We show our net revenues.
We reached $1.77 billion in the second quarter, which is a growth of 30% when compared to last year. All three segments of business reported growth from last year, with revenues reaching $1.09 billion for commercial aviation, $340 million for executive jets, and $335 million for defense. For all business units, we are confirming our expectation for the year. Next page. As far as SG&A expenses, we reported a total of $135 million in the second quarter, broken by $40 million in G&A expenses and $85 million in selling expenses. The reduction of total SG&A expenses when compared to last year, reflect our focus on cost control. Next page 12, regarding operating results. Excluding non-recurring items listed in the highlighted box, our adjusted EBIT reached $165 million in the second quarter, with 9.3% margin, reflecting the level of deliveries of commercial aviation.
For the six months of 2017, we had a total of $196 million with 7% margin. The 9.3% operating margin in the second quarter can be broken by positive 15.1% in commercial aviation, positive 3.5% in defense, and negative 2.7% in executive jets. We are maintaining our guidance range for 2017 of $450 million-$550 million, with margins from 8%-9%. In page 13, the adjusted EBITDA. We reported total of $245 million in adjusted EBITDA for the second quarter, with 13.9% margin. For the six months of 2017, the total adjusted EBITDA was $349 million, with 12.5% margin. For the full year of 2017, we are maintaining our guidance of the range of $707 million-$890 million and margins between 13.5%-14.5%.
In page 14, adjusted net income, excluding extraordinary items, which includes primarily deferred income tax, we reached the total of $133 million in the second quarter of 2017, with 6.9% net margin. The total of 2017 year-to-date reached $146 million, with 5.2% margin on adjusted net income. The next page 15, in terms of investments. For 2017 year-to-date, we had a total of $244 million, being $18 million for research, $148 million for development, and $78 million for capital spending. For full year, we are estimating the total investments of $650 million. Next page 16, adjusted cash flow. We had a positive cash generation of $220 million in the second quarter due to the positive results, combined with improvement in working capital requirements, mainly related to the reduction of inventories. Our estimate for 2017 is maintained of a consumption of $150 million or better.
Next page, finalizing the presentation before I turn it to Paulo. Our debt at the end of June was $4.2 billion, with cash of $3.5 billion. We turn it to a net debt of $662 million, better than the previous quarter. Regarding our debt profile, the average terms of debt reached 6.2 years with 93% maturity after 12 months. With that, we conclude the presentation, and I turn it to Paulo's comments before we go into the Q&A section.
Thank you, Filippo. Good morning to all. Thank you for joining us this morning for this call. A few comments I'd like to make. I believe, as you can see, we have a very strong quarter. We continue to see improvements on our costs. This is the result of the Mission 200 that we implemented last year, and more and more so we are seeing the benefits of this program. I'd like to make a few comments on the business units. On executive aviation. I believe we are seeing some improvements. Of course, the market is still under big pressure. However, we are seeing some signs of improvements on the used markets. There are some stability in prices. No further deterioration in general in the value of the aircraft.
For us here at Embraer, we had a good improvement in cash operation, generation of cash for the business jet unit, it's more stable as well. The strategy that we adopted for a few quarters already of having more discipline in terms of price and emphasizing more value in our business, is starting to generating improved margins. We can see already that. Probably in the next quarters, this will be even more evident. You will see even more in the next quarters. On the commercial aviation. We had a soft first half in 2017. A few orders were announced. We are seeing very strong sales activity. I'm very confident that we can make big progress in the second half of this year. As you can see, the margin in commercial aviation is quite good.
We continue to see also in commercial aviation, the continuation of the E2 program on time, on budget. We continue to be very bullish that the first delivery will indeed happen in the first half of next year, in 2018. On defense, the KC-390 program also continues to move very well. I'll make some comments on the Paris Air Show, after the Paris Air Show, the KC-390 went for a demo tour. We covered 18 countries in Europe, Africa, Asia, and Oceania. We had 52 landings in 18 different countries, and we covered 50,000 nautical miles in 40 days. You can appreciate that the KC-390 is already a mature product. Not yet certified. It's in the process of the certification, however, showing already signs of a very good maturity for an aircraft like this one. 40 days, 50,000 nautical miles program without any problem.
Completely flawless. We are very happy and satisfied with the performance of the KC-390. We are starting the discussions with the government of Portugal to negotiate the contract. The ministers council approved this transaction. Embraer in Portugal now, we have 90 days to negotiate the contract. Last but not least, a few comments on the Paris Air Show. For those who were there, I think you could see our very strong presence. It was the best ever air show for Embraer. We brought two new programs still under certification, the final stage, the E2 and the KC-390. The Legacy 450, already certified.
I believe Embraer has shown its force and its important presence in the three units, showing that Embraer is prepared for the future with the state-of-the-art, very up-to-date aircraft that we will compete going forward as we start to deliver the E2 and the KC-390. With that, I believe we can move to the questions, please.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star and then the one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Myles Walton of Deutsche Bank. Your line is now open.
Thanks. Good morning.
Morning, Myles.
I was hoping you could talk a bit about the order activity. You're sounding incrementally positive as it relates to the commercial aviation business. Obviously, you had about 20 orders in the first half, but 80 implied orders to get to your 1 times book-to-bill seems like a pretty high hurdle. Again, Paulo, you sound pretty darn bullish. Can you talk either specifically or about relative geographic areas of strength that you're seeing that could come and close deals that quickly?
It's a little bit spread out. We have North America, we have Europe, we have Asia. I wouldn't like to go into the details at this stage. I feel very good on the campaigns that we are involved. It's not a guarantee that we will close them. With our experience in these markets, I feel very good that we have a very good opportunity here to do a 1 to 1 in terms of book-to-bill.
Is that E1 or E2? The E1 is where you'd need to cover a lot of ground for next year in terms of production. Are you seeing the E2 traction now that you're getting closer to first enter into service?
That's the beauty of what we are seeing. It's a combination of E1, E2s. It's a combination of the smaller aircraft and also the bigger one. It's really a mix. This is quite positive.
Okay. Just one other one, Filippo, on cash flow. You're in a pretty good position relative to your full-year guidance. You're usually not in quite this good a position halfway through the year. Is there actually upside pressure to your full-year targeted guidance or how are you feeling relative to the greater than $150 million burn?
Yes, Myles, I think that you're right. I think we had a very good second quarter. The accumulated year is also something that probably in the past, we never saw that situation. There's a combination that I think that mostly you have to remember that we had some contributions from suppliers in the beginning of the year. The good working capital improvement, I think, helped. I believe that we, at this point, we don't have a position to review that in terms of how we see.
There's still a lot of investments to be made, especially in the E2 program at the second half of the year. The $150 or better, I think we have some space to get an improvement there. Again, it's too early to commit with that. I understand we are well positioned to really put in place a strategy to benefit in terms of cash generation this year.
Okay. All right. Thanks.
Thank you. Our next question comes the line of Peter Skibitskiy of Drexel Hamilton. Your line is now open.
Good morning, guys. Just to go further on both those themes. I thought last quarter you talked about your 2018 expectations for commercial deliveries being around 85-90 aircraft. Is that no longer the case? Whatever your expectation is, how many of those slots are filled, and how many will be E2s would you expect?
Yes, Pete. We're still working on 2018 and the following years. As you know, 2018, we start the very transition of the current model to the new one and the 190, and that will be entering to services. I feel that this is important for us to not to review it at this point. We still think some challenges. I think sales campaigns are on way. Like Paulo mentioned, we are positive the way we see. It's a little bit different dynamics. We see more spread in geographic, those activities. We feel confident that we can, this year, have you, remember about the book-to-bill of one. That's what we're working these days. We still have, of course, challenges because of the transition that we have next year.
Okay. I don't know how sensitive this is, can I ask about Iran? I see Airbus and Boeing have locked in commercial deals with Iran. Embraer has not. It was kind of in the press, there's also some reports out there that maybe Brazil is not willing to finance any deals with Iran. I was wondering if you could validate any of that and give us a sense of, is Iran completely off the table or not?
Well, of course, Iran is a very important country in aviation, so there are very good opportunities there for the manufacturers. We see this market as an excellent opportunity also for our segment. We continue to work with the OFAC office. Of course, as we know, Airbus and Boeing have gotten their approval. In general, it takes nine to 11 months, as I understand, to go through the process. We are still within this period. We are expecting that OFAC will approve our request after they have approved, more recently, the Boeing order. Let's see. There is no news as of yet. We continue to be engaged with the opportunities, but of course, we have to wait for the clearance of the OFAC office to move forward.
Pete, just adding, we don't think it's an issue of financing. I think the Brazilian government is ready to support all the exporters that can sell products to Iran. It's more a question, like Paulo said, about the clearance from OFAC.
That's very helpful. Thank you very much. My last question, I feel like I've hit on this theme every quarter in terms of the slope of the potential improvement in free cash flow over the next few years as E2 development winds down. Are you confident? Is that development spending going to come down pretty linearly over the next few years as the E2 enters service? Does the visibility seem pretty good that free cash flow can then become pretty nicely positive over the next few years?
We still work with the same projection. However, just to make sure that we have the entrance service in phasing. We started with 190, we have the 195 in 2019, to 175 in 2021. We still have investments to be made in these programs. I would say that by 2020, definitely it's going to go down because we end up most of the development of the major pieces of this project. That's exactly the way we used to be. I think we're on track on that and on schedule.
Great. Thanks so much, guys.
Thank you. Our next question comes from the line of Cai von Rumohr of Cowen and Company. Your line is now open.
Yes, thank you very much. What is your lead time on E1s for delivery in 2018? I assume you still have slots to sell. When do you have to sell them? If you don't, because I assume you do 15 to 20 E2s, you're really locked into doing under 100 planes.
Well, as Filippo mentioned, we are still working for 2018, we don't have yet the final numbers. We have a lead time of about nine months that we can work, give or take. It's not a fixed number of months, but depending on the type of aircraft, we can go a little bit more aggressive. We feel good that we still have the right time this year to close more deals and take the commitment to deliver this aircraft next year.
Got it. You mentioned, that the pickup in demand, and really, if we go back to earlier in the year, there was not a lot of interest. What's changed?
It's the dynamics of the market in general, right? You have airlines that have needed to upgrade the fleet, replace old aircraft. We have others that are startups, like in Asia, big Asia. You have airlines that want to replace smaller jets. It's a combination. There's not only one reason. I think it depends on the region, depends on the type of the airline and the needs of the airline.
Thank you. Can you refresh our memory in terms of your rough margin targets for the three businesses for the full year?
Yeah. In some color on this, I think the commercial aviation, like low double digits. In terms of the commercial aviation and defense, maybe mid-single digit is what could be an information for you.
For biz jet, also mid-single digit?
Yes.
You'd mentioned, Felippo, that next year, you have the transition to the E2. I assume, if deliveries are flattish to down, there's more pressure on commercial. Can you just talk directionally about what should we look? I would assume, for example, that the Executive Jets would be considerably stronger because you would be building closer to the delivery rate, and the market might be stronger. Any color you could offer would be great.
Yes. Again, I think it's too early for us to give the guidance for next year. As we've been saying, related to next year, maybe we should think about, of course.
If the lower level of delivery is expected for commercial aviation with the historical average, I think we can be more like in the high single digits. I think it's not the moment now to anticipate how Executive Jets will work. We believe that with some sentiment about positive of the market, that we can have some improvements, and that can partially, if not in full, offset that. We believe that Executive Jets definitely is going to be a better year next year compared to the previous ones, and that could help to be in that level. That's basically what we can say at this point. Sometime, closer to the end of the year, we'll be releasing more specific information about next year's expectations.
Thank you very much.
Thank you. Our next question comes to the line of Alberto Valerio of Citibank. Your line is now open.
Hi. Thank you for taking my questions. Today, I listened from one of your competitors that the CSeries can be used to longer and thinner routes. Routes that are not dense enough for Boeing and Airbus, and too long for service by regional jets. I've seen the same potential for E2?
Yes. I think the E2, the E195-E2, we have announced in Paris an extended range. We are going up to 2,600 nautical miles. This is enough to cover maybe 98% of the narrow body mission worldwide. I think we are in very good shape in this regard, and with excellent economics, very appealing operational costs. We are definitely very bullish.
Okay. Thank you very much. Has Embraer and Boeing been consulting each other regarding what seems to be a common complaint about CSeries pricing?
As we announced already back in December of last year. We asked the Brazilian government to go to the WTO and challenge the Canadian programs, and help us to support our case against Bombardier. We are always looking to have a level playing field in both, in development and financing of aircraft. Financing of aircraft, we already dealt with that many years ago, among all the manufacturers, and we have a program that has been working very well. Regarding development, we are not happy at all with the situation, and we have to be sure that everybody will be operating in a level playing field. The Brazilian government is supporting Embraer, and we are supporting the Brazilian government, of course, in this action, and hopefully, this will pay right benefits going forward.
Okay. Thank you very much for the answers.
Sure.
Thank you. Our next question comes to the line of Pedro Bruno of Santander. Your line is now open.
Good morning, everybody. My question is on the defense margin for the rest of the year. Because we saw a very low margin, or a highly negative margin in the first quarter because of the satellite delay, which happened in the second quarter now. We saw a quite big improvement in revenues, but not so much in margins. The mid-single digit that was mentioned for the year implies close to 15% margin for the second half of the year in the defense. Is that what we should be expecting? What would trigger that since the satellite program has been launched on the second quarter? Thank you.
Yes, Pedro. Of course, the launch of the satellite that was captured in the second quarter helped the result of defense in this quarter. We still have to deal with some costs associated to the KC-390 development program, although it's in the end of the development phase. That sometimes can impact. I believe that we should look in an annual basis, the defense result. That will be more easy for us to identify. There's still some deliveries of Super Tucano expected for this year that can impact that. We still think that the target for the mid-single that I just mentioned, I think it's the best guess for the year. I think we're still confident that that should be the results for 2017 in defense.
Okay. Thank you.
Thank you. Again, ladies and gentlemen, if you have a question at this time, please press star and then the one key on your touchtone telephone. Our next question comes to the line of Carlos De Lelis of JPMorgan. Your line is now open.
Good morning. Thank you. I have one question regarding the studies for the potential cost reductions going forward. I'd just like to know if you could provide a little bit more detail on this, and whether such cost reductions could help smooth out results for 2018.
Carlos, last year we announced the plan of a cost reduction, specifically a program what we call the Mission 200, which is primarily focused on the overhead and headcount reduction through a voluntary dismissal plan, and also some expenses reduction in travel and other general expenses. We get there. The program of the reduction of headcount was already concluded in the first quarter of this year, and the other expenses already adjusted. All the leaders of the company have their budget adjusted for this new standard. I think that opportunities of cost reduction, we still have. I don't think we're going to have a step like we announced before of our Mission 200 plan, but opportunities may have. The focus on continuing to improve, maybe more slowly, but that's still on.
You have to take into account as well that the company has its activity for the year, that we have to deliver aircraft, we have to manufacture and produce aircraft. It's important that we have the certain level of support for that to happen. Cost reduction is still associated to that. We understand we got a level which has efficiency now, and that we have a lower level of expenses. Again, I don't believe there's going to be a dramatic drop in the future. We still will be able now, I think, to build a structure to benefit from the dilution of those costs as we have opportunities for revenue growth. That's basically how we see this. We continue to see opportunities of efficiency.
This is a permanent program that we have, and that will be capturing whatever opportunity we may have in terms of cost reduction and efficiency.
Perfect. Thank you.
Thank you. Our next question comes from the line of Pete Skibitskiy of Drexel Hamilton. Your line is now open.
Yeah, just to follow up. I want to ask another question kind of qualitatively about 2018. It sounds like commercial deliveries will be down in 2018. Is it fair to think that defense revenue will be down in 2018 as well, just on less satellite revenue, and maybe you haven't ramped fully on the KC-390 yet. That in 2019 and beyond, you kind of start to ramp on the KC-390 and that's maybe kind of a multi-year growth story for you at that point?
No, I don't think so, Pete. I think we don't have the numbers yet for the commercial aviation, as José Filippo already indicated. For the defense, we are expecting good activity for the KC-390 and maybe for the Super Tucano as well. The two main products of the unit. We are seeing very strong activities on the KC-390, a lot of interest. In the Paris Air Show, we received the visit of 65 delegations, this worldwide tour now, almost worldwide tour also, is being showing that the KC-390 has a tremendous acceptance in the market. We are very bullish on the discussions that are going on now. On the business jet, as I said, we might have a better year next year than this year.
I believe we have reached the bottom now in the business jets, and we are counting on improvement step by step, and not a big improvement, but we may see a better year in 2019 than in 2017 for business aviation as well.
Okay, fair enough. I appreciate it. Thank you.
Sure.
Thank you. I'm showing no further questions at this time. I'd like to hand the call back over to Mr. José Filippo for any closing remarks.
Okay. Thank you. In my name and Paulo and all the team here, I'd like to thank you again for participating in this. As usual, our IR team is open and ready for you to access whatever you need for additional information. Thank you very much, and have a nice day.
This concludes today's question and answer session. That does conclude Embraer's audio conference for today. Thank you very much for your participation. Have a good day.