Good afternoon, ladies and gentlemen, welcome to the audio conference call that will review Embraer's third quarter 2015 results. Thank you for standing by. This conference call is being held during the Embraer day in New York with the presence of investors and market analysts. At this time, the company will present its third quarter 2015 results. Afterwards, 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 www.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, estimates, 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 may not occur. The company's actual results could differ substantially from those anticipated in the forward-looking statement. Participants on today's conference call are Mr. Frederico Curado, President and CEO, Mr. José Filippo, Chief Financial Officer and IRO, and Mr. 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, good afternoon, thanks for joining the Embraer third quarter 2015 earnings results. As we normally do, we'll go with the presentation, then we'll be open for questions. Starting on page three with the corporate highlights. We were listed for the sixth consecutive year on the Dow Jones Sustainability Index. Important for us very much in terms of sustainability initiatives. Also, regarding management excellence, we received a Magna Cum Laude recognition from the Brazilian National Quality Foundation, which is equivalent to the Malcolm Baldrige National Quality Award. Also in relation to people management, we received important recognitions in Brazil and Latin America. Next page four. In terms of highlights for commercial aviation. We had the delivery of 21 E-Jets in the third quarter of 2015. We have now accumulated 68 aircraft delivered this year.
Also, we were able to record 20 new firm orders, accounting now for 146 to date. In these 20 orders, we would like to break this, highlighting the SkyWest order of 18 E175s that will fly for United Airlines, and also two undisclosed orders for E190s. Also, in terms of orders, the highlight of the firm orders for 19 E175s, also from SkyWest, that will fly for Delta Air Lines. This was announced after the closing of the quarter in October 2015. Confirming the good commercial performance, we achieved the ratio of book-to-bill above two over the first nine months of 2015. Finalizing these highlights, in relation to the development of the E2 program. It was initiated, the final assembling of the first E190-E2 prototype. This was shown to the market last week, actually. Okay. Next page, sorry.
Going to page five, the highlights of commercial and executive jet business. We had a delivery of 30 executive jets in the third quarter, broken by 21 lights and 9 large aircraft. We account now for 57 light and 18 large year to date. In relation to the Phenom program, we had in the third quarter, the delivery of the Phenom 300, number 300. It's an important milestone in this program. Also, as far as the Legacy 500 and 450 program, important information related to the certifications of the Legacy 500 in Mexico and China, also the Legacy 450 in Brazil, U.S.A., and Europe. In relation to the quality and customer perception, we also ranked by important magazines. At this time, we show here the first place in the global executive jet industry ranking by the Professional Pilot Magazine. Next page six.
Now the highlights of Defense & Security business. We start with the information that a contract with the Gripen program became effective. We actually have currently a group of engineers already in Sweden preparing for this program that is starting now. Also regarding the KC-390 program, we had a resumption of the flight test campaign with a second flight that actually happened yesterday. In relation to the LAS program, we had the delivery of two aircraft in the third quarter of 2015 to the U.S. Air Force. Now, actually to date, we have 12 already delivered, which includes two additional ones that happened after the end of the quarter. Next page, regarding the financial results of the third quarter. On page eight, we start with the backlog.
We reported the firm backlog of BRL 22.8 billion at the end of September, basically in line with the figures of the previous quarter. Next page nine. In relation to deliveries, already mentioned, but just reemphasizing here, starting with the commercial aviation on the left, 21 aircraft delivered in the third quarter, 68 to date, actually to the end of the third quarter. In relation to executive jet aviation, we had the 30 delivered, broken by 21 lights and 9 large in the quarter, and accumulated figures of 75 deliveries, broken by 57 lights and 18 large. With that, we take the opportunity to confirm our outlook for the year, which is in the range of 95 to 100 E-Jets in the commercial aviation, and 35 to 40 executive large jets, and 80 to 90 executive light jets. Next page.
In terms of net revenues by segment, starting from the top right, commercial aviation reported revenues of BRL 688 million in the third quarter, with a total of BRL 2.23 billion as of September. Going down to the bottom right, Defense & Security, with a total of BRL 182 million in the third quarter, with accumulated in the three quarters of BRL 0.61 billion this year. Continuing with the executive jet business, the total, BRL 402 million in the third quarter, accumulated BRL 0.97 billion in the year. The consolidated figures. Maybe moving to the next page. I think we have in BRL and in U.S. dollars, a total reported of almost $1.3 billion in the third quarter, accumulated of $3.8 billion in the year. With that, we also take the opportunity to reiterate our guidance range of net revenues from $5.8 billion to $6.3 billion in 2015. Next page.
As far as SG&A, we had a total of $121 million in the third quarter, broken by $43 million in G&A expenses and $78 million for selling expenses. Those figures are the lowest when we compare to the previous quarters, 2015, and they represent 9.4% of revenues in the third quarter, compared to 12.2% in the third quarter of last year. We would like to confirm our commitment with cost control and reduction. Next page. Now, page 13. As far as EBIT, we reported operating profit of $84 million in the third quarter, accumulated of $266 in 2015. Operating margins were 6.6% in the quarter and 6.9 accumulated in the year. Next page. In terms of EBITDA. In terms of EBITDA, we had a total of $158 million in the third quarter, accumulated $485. Margin in the third quarter achieved 12.3%, with accumulated of 12.6 in the year until September.
Next page. In terms of net result, we had a net loss of $110 million in the third quarter, accumulated loss of $43 million in 2015. The main reason for this figure was the negative impact of the deferred income tax in the third quarter of $181 million. Without this effect, we would be reporting a net profit of $71 million in the quarter. This negative impact reflects a non-cash effect, which results from the income tax on the Brazilian local currency gains on the non-cash asset items. Basically, as you can see, we had 28% devaluation of the Brazilian real against the dollar in the quarter. That return to the Brazilian real's gain on those non-cash items, which we had to record on deferred income taxes, a non-cash income tax, and that's the way you have to record in terms of the Brazilian tax law.
The non-currency items, they refer to typically fixed assets, intangible assets, and inventories. Next page. In terms of cash flow, we had a cash consumption of $150 million in the third quarter, with positive operating cash generation of $70 million, offset by $76 million of CapEx and $110 million of development, both primarily related to the E2 program development. As of September 15, the free cash flow accumulated was negative $482 million. Considering our expectations for the fourth quarter, we reiterate our estimate of the negative $100 or better in terms of cash generation in the full year 2015. Next page 17. In terms of investments, we had a total investment of $334 million as of the end of the third quarter, broken by $27 million in research, $164 for development, and $143 for CapEx.
The figures for the year are tracking below guidance, mainly due to the weaker Brazilian real currency. Next page 18, and finalizing the presentation. Regarding our cash and debt position, we achieved a total net debt of $644 million at the end of the third quarter, which we expect to be reduced by the end of the fourth quarter. Our cash position in the end of the quarter was $2.75 billion, and a total debt of $3.39 billion. In terms of our debt profile, it has an average term of 6.5 years and 91% maturing in the long term after 12 months. Okay. With that, we finalize the presentation, and we now open for the Q&A session. Thank you.
Certainly. Thank you. Our first question comes from the line of Darryl Genovesi from UBS. Please go ahead.
Hi, guys. Thanks for the time. Filippo, on the adjusted net income number that you've provided, where you're just backing out the deferred tax impact, it's actually above the pre-tax income. I guess that would imply a tax gain in the quarter. Is that a cash gain, and is that something that's sustainable for some reason?
Basically, like I mentioned, we have to take all the assets, the non-monetary assets, and they are referred to in dollar terms. When we take the Brazilian real, we have a non-cash gain, and we have to record the income tax of that gain. This is a non-cash, like we said, this is deferred. The assumption is that those inventory will turn into final good, and sometime this will be sold, and then the profit will come. That's why actually it's an anticipation of that. This is not a cash item. It's just like a non-current income tax.
Right. I guess what I'm saying is the adjusted number that you provide, the $71.5 million, compares to $59 million pre-tax on the income statement in your release. I guess I'm just trying to reconcile why the adjusted net income number is higher than the unadjusted profit before tax number.
What we did is only the adjustment for the deferred tax. It's just like a calculation to help to see without that effect, which we have the current income tax, which was as we recorded that, but just the piece related to the deferred piece, actually.
Okay. Also, can you quantify the adjustment at the defense business?
Can you repeat, Darryl?
Sure. In your press release, you talked about a cost-based revision for certain contracts in the Defense & Security segment due to the negative impact of foreign exchange variation. Can you quantify that?
Yes. It was $30 million in the third quarter, accumulated $90 million in the year. That is the effect, again, is the same effect of the currency, which we have to reset the contract, and then we make this adjustment every quarter when we have the variation. Normally, we used to do this every quarter. When we have a devaluation like we had recently, in recent quarters, this effect is higher.
For the third quarter was at $30 million. We have to accumulate in the three quarters of $90 million.
Great. Thanks very much.
Thank you. The following question comes from the line of Myles Walton from Morgan Stanley. Please go ahead, sir.
Good afternoon, everyone, and thanks very much for the call. I had a couple questions on the commercial division. The first one is just if you could update us on how you're seeing the 2016 outlook for deliveries and for mix. How's your visibility on next year, and with the firm backlog as it stands, is it reasonable to expect that we could have a similar level of deliveries next year? I don't know what you can say. Maybe that's not something you're ready to comment on.
Oh, sure. Glad to answer. We are totally sold out, of course, for 2015. Always some, of course, customer finance things to be finished. We do not see any risk at this stage for the guidance that we have provided. It looks really, really solid. Same thing probably for next year. I think, as we mentioned, in the last quarter, we feel increasingly comfortable with at least maintaining the current level of production revenues in that market. Of course, we can give you more color, early next year. With this recent sales, last year, 2014, was a very strong year in sales and 2015 again. That really gives us a very comfortable position in the years ahead.
Okay, that's great. The other thing is just with respect to your residual value guarantees, and whether the level of provisioning we saw in the third quarter is what we could expect going forward. If there's anything else relevant to highlight on that particular issue.
Yeah, that's an important question. Thank you. Recently, there has been a revision by all the appraisers in the whole industry. In general, there is a reduction of expected values over time of commercial airplanes in general. It is possible that we have an impairment in the fourth quarter. We estimate at this stage something in the range of BRL 30 million. That's something which is possible. If that is confirmed, will be a downside risk to our guidance. That's still to be confirmed.
Okay, great. Appreciate that.
Okay, I would like to put on hold the questions remote, please, to give a chance for people inside here to ask questions. Myles, then.
Could you touch on the margins by segment, Eduardo? Also, in terms of the non-recurring FX charges in Defense of about BRL 90 million year to date, obviously presuming those don't recur into next year, what's the outlook for Defense from here? Are we kind of bouncing around the bottom, kind of in a break-even situation, and are you able to contain the cost to keep it there?
Yeah, just to give the EBIT margin breakdown by business. We had third quarter commercial aviation at 12%, business jets around 5%, and Defense and Security negative 11%. The consolidated margin was 6.6%.
Yeah. The Defense, Myles, as you said, this impact of the exchange rate on negative there, we have to do this every quarter. This is not the first time we're doing this year, because we saw that the currency in Brazil has been losing, especially with the higher rates. If that stays stable in the fourth quarter, we shouldn't see this in the next quarter. This is too much exposed to this effect. This is basically the reason why the Defense business had negative margin.
But if I may add, Myles, if I got your question completely, that business was hit by two major, let's say, trucks. We ran over by two major trucks this year. We were impacted by the currency, 50%. That's specific to Brazilian-denominated revenues, a 50% devaluation in the year. 28% alone in the last quarter. That goes from the top line and of course, everything downwards. Also, financial problems with our main customer in Defense, which is the Brazilian government. Which, they have cash issues, so that has impacted our cash flow and also our revenues. 2015, I think a good way to look at what happened is an adjustment. I think we are now at a different level. There's a step function downwards as far as the size of the programs. The KC-390, as we have already divulged, is being delayed by a year.
The smaller programs also have been all adapted to the new reality of the ability of the government to pay us on time. We're not planning to fund those programs on our own, we prefer to adjust it to the capacity, of the real capacity, because to pay it. It's a year of transition. I think, Jackson, you will go into more detail in his presentation, but I think it did a great job in rapidly adjusting the business to the new reality. What I expect for next year in Defense is something of a similar level as far as activity. Maybe some upsides, because there is increasing activity in exports. Certainly, a return to profitability, hopefully to the levels where we were before. That's a kind of a macro vision.
Oh, by the way, if I may add, just anticipating maybe a question about the KC-390. I heard some questions about, "Well, why did it take so long between the first and the second flight?" The answer is that, well, that coincided, of course, with this whole commercial discussion about the new pace of the program. Strategically, what we decided was to do two things. One, to go and do all the ground vibration tests on the airplane, the GVTs. Another was to have a full layout of the airplane to the state-of-the-art of our engineering design. That will significantly increase the efficiency of our flight test campaign. From now on, we're going to see the airplane flying much, much more than the last several months.
It looks like the fourth quarter is going to be a really strong cash flow quarter for you to hit your guidance. Can you talk about the puts and takes there? Is it lower development expense because of the real, or are you expecting cash advances, or are there just other puts and takes that are going to lead to a really strong quarter year-over-year?
The strong quarter, of course, typical seasonality of the business brings this as fourth quarter as a strong quarter. Regarding investments, that's correct, your point. We had early this year, some contributions from partners that reduced some of this. We don't expect to see that mostly now in the end of the year. Also, engineering was the major piece of investment until then. Now we enter in the phase of more certification and other tests that brings more dollar-denominated costs. We expect to see this increasing, but enough probably to meet the levels that we expected before. I think we end up the year with a better position in terms of cash consumption without affecting any of the schedule of the program. Program is on schedule completely as expected and going forward. That's how we expect.
Peter, I think to your point, we will see a reduction in inventories. That's going to help the cash and the activity, of course, all the income from the deliveries. There's going to be twofold. More deliveries, cash inflow, and reduction in inventories. I think that's a major contribution for the cash flow in the fourth quarter.
Great. This is Derek Spronck at RBC. Have you changed your hedging policy at all?
No, we do hedge. All the balance sheet is hedged all the time. Our cash flow hedging position, the policy established that we do this every year. We're now in the process of contracting the 2016 hedging for the cash flow position. We didn't change our hedging position.
If the Real stays at current levels, would the defense division, going forward on a quarterly basis, then be producing positive gross margins?
Yes, it tends to be positive because most of the effect was the adjustment on the currency. As we have the program stabilized in terms of currency impact, it tends to be profitable and returning margins, definitely.
Okay, just one more quickly. Your reduction in SG&A, could you break that out between how much of it was FX-related versus cost controls that you've implemented?
I don't think we have this number available at this point. We can make some calculation and inform you later.
Yeah. One thing I think we can say now is that, we control that by currency, the piece in reais, we are below budget in both currencies. We are also being leaner in reais. It is not 100% currency. That much we can say.
Do you have specific cost reduction programs that you're implementing?
You bet.
Yeah. Okay, great.
All right.
Excuse me, please.
Yes. Thank you, José. This year, you got caught short because of the big decline in the real in terms of your cost collar. I think it's around 340. Can you tell us kind of preliminarily what kind of a range or cost on the cost collar of the FX you would anticipate for next year, or at least your approach to that issue?
If we stay in this level of the currency, maybe I should say in a different way. We keep on the 25% of the cost associated to the BRL denominated. This is the benefit that we have. With part of this benefit, of course, goes into the deferred assets, which is development of the programs, and part to go into the cost. You have to take into account that to benefit from that, this cost has to go through the inventory, and then when we deliver, then we capture. There's a delay about two or three months to have a full capture of this effect. Going forward, maybe we should think that the currency shouldn't be increasing that much. We expect to see this more stable. What we saw this year was more a volatile approach from the currency.
We still continue to benefit because we're not increasing the costs, so we're retaining this, in U.S. dollar terms, the piece of the BRL cost that we have.
If I may add, Filippo. You're asking about the hedge?
Yes, exactly. About the cost.
The labor cost, if we already have a zero-cost collar in place for next year.
We do. No, we're starting to do. What we've been doing so far is, we have a cap of above six BRL and a floor of about BRL 3.5, BRL 3.4, BRL 3.5. That's how we're working on it.
Terrific. Thank you.
Thank you. Good afternoon, gentlemen. Stephen Trent from Citi. Just two questions from me, if I may. I noticed in the quarter, if you look at current and non-current receivables, in Q3, there was a small sequential decline, versus Q2, which I thought was intriguing. When you dig into that number, is there any sense you can give us as to whether the flow from the Brazilian government was in line with your expectations, or below or above, or if receivables turnover was much stronger in a particular area than you'd anticipated?
Oh, yes. As Fred mentioned, we already reviewed that contract, especially the main customer, which was something that led us to increase these accounts receivable. We currently are experiencing a balanced situation, where the expenses are the same, where the revenues are related to the payments, so we keep seeing that. The variation is primarily due to some exchange variation effect on some part that is local currency. Basically, we are continuing to receive what we've been expensing.
Okay. Got it. Thank you. Just one other general question. When you look at your campaigns for commercial aircraft, other companies are showing up in these RFPs. What are you seeing in the competitive environment? More of Mitsubishi, less of other competitors? If you could give us a sense as to what that looks like.
Sure, Steve. Be glad to. If we separate in two different markets artificially, in the regional pure, like 75-seaters market, typically regional feeder market, and the mainline market. Currently, in every campaign that we have, we have ourselves, we see Mitsubishi, and we see, of course, Bombardier there. We have been successful, especially after the enhancements to our E175, which we introduced last year. Have been successful in seizing all the opportunities, or almost all the opportunities which are there. I think on that front, we feel very comfortable. On the mainline side of 190, 195, we have less of a concentrated demand. There are several campaigns out there. We just mentioned two undisclosed orders, which are not the U.S.
If I may add, let's say one possible positive prospect, of course, this is something which is a ways from being a reality, but can happen, is major airlines in the U.S., discussing with their pilots, and possibly flying 100-seaters at mainline level. If that happens, of course, that's a plus to everything that we are doing. Between the E2, E1 and the E2, which is on time, by the way, absolutely on time. You saw the picture. Paulo will go into details. We feel that we're covering from the 70-130-seat markets pretty well, and comfortable that we keep being the dominating player there.
Okay. Very helpful. Thank you.
Thank you.
Let's take the two last question here, and so we'll be ready to cut this part of the event and continue the presentation.
Thank you. I guess my question is on next year, on the Commercial Aviation segment. Obviously, you have the skyline pretty much filled up for the year, so you know what the pricing's going to be, and the Real is going to be a tailwind here as well. Is it fair to assume we can see a decent increase in margins next year for the Commercial Aviation segment?
It's possible. We'll see where the currency will stay. Of course, let's say it stays at level 4. That's a tailwind for us. Everything we're doing is to keep. Maybe if we go back probably two years ago, when we said that we were seeing at that time that the mix of aircraft, the 190s, 195s versus 175, which historically tends to have a lower margin. We saw the mix changing significantly over the next several years. We thought we could have resilience in holding, maybe not exact same margin, but kind of a low double-digit margins. And I think we have demonstrated that in the last 18, 24 months. This is pretty much the story. Yeah, the exchange rate helps in that. As the standardization of larger contracts, same configuration, that helps. More scale, you dilute more fixed costs.
It's a good momentum in that sense.
There's nothing in the pricing that should be extremely worrisome for there?
No. There is pricing pressure. We are seeing pricing pressure. There is one competitor in particular, who's been very aggressive in both commercial and executive jet segments. Of course, to say that this is really irrelevant is not true. I mean, it is relevant. We have to react to that. We have maybe felt that a little bit. We're feeling that a little bit more, in the executive jet segment. On the commercial, we have been able to really sustain, certainly the value of the aircraft products really differentiates itself and help us to sustain a healthier price, and therefore, margin. On the cost side, the relentless efforts.
Thank you.
That does conclude Embraer's audio conference for today. Thank you very much for your participation. Have a good day.