Good morning, ladies and gentlemen, welcome to the audio conference call that will review Embraer's second quarter 2013 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 conference call, please press the star key followed by one. As a reminder, this conference call 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 and uncertainties, assumptions, including, among other things, general economic, political, and business conditions in Brazil and in other markets where the company is present. The words believes, may, will, estimates, continues, anticipates, intends, expects, and similar words are intended to identify forward-looking statements. Embraer undertakes no obligation to update publicly or revise any forward-looking statements because of new information. Future events or other factors in light of these risks and uncertainties, the forward-looking events and circumstances discussed on this conference call might not occur. The company's actual result could differ substantially from those anticipated in the forward-looking statements. Participants on today's conference call are Mr. Frederico Curado, President and CEO, Mr. José Filippo, Chief Financial Officer and IRO, Ms. Elaine Funaro, Director, Tax Accounting, Andre Gualda, Controller, and Mr. Luciano Froes, Director of Investor Relations.
I would now like to turn the conference over to Mr. Frederico Curado. Please go ahead, sir.
Thank you. Good morning, all. This quarter came very much in line with our planning as far as the operations of the company. As everybody's aware, we did have a strong devaluation of Brazil's currency during this quarter. That, according to IFRS, that creates the need for a provision on our income tax related to our non-monetary assets, which it's a non-cash event. That turned all of our operating profits into a net loss in the quarter. Filippo here, our CFO, will explain, of course, this effect in more details during our conference. I will ask Filippo to go through our presentation, and later on, I'll be back with the rest of the team for a Q&A. Thank you.
Thank you, Fred. We'll go through the presentation. We'll open for the questions then. Starting page three with the corporate highlights. We had this quarter one important milestone in the company's history. It was the launch of the E2 E-Jet program, following the early this year announcements of contracting major suppliers. We were able to launch it during the Paris Air Show in June. I'll go to some highlights of the commercial activity of this aircraft in the commercial page. Here is this important milestone, then the launch, followed by an important upgrade that we received from Standard & Poor's credit rating, upgrading from BBB- to BBB, with a highlight for the recent commercial orders, the business diversification, and also operational efficiency. This is important recognition with the neutral trend.
Important also for corporate highlights, Embraer's recent recognition from major magazines and institution. We were awarded by the Company of the Year from Brazilian Exame magazine, as well as maintaining our position in one of the best companies to work in Latin America from the Great Place to Work, as well as award from the Brazilian National Confederation of Industry, the CNI, National Innovation Award. Next page, in terms of highlights of the commercial aviation business. We delivered in the quarter 22 aircraft, an increase in quantity compared to the first quarter. We have currently, year to date, 39 aircraft delivered. Important also, orders for the current generation of the E-Jet, the United Airlines order of 30 aircraft with an option for additional 40.
We have the Conviasa Venezuela order for seven, together with SkyWest, which signed a 40 E175 jet plus 60 reconfirmables and also options for additional 100. This expected to be delivered in the following three years. It's good activity for the current generation of the E-Jet. There's finalizing to mention that we had disclosed firm orders for five E-Jets from Air Costa in India and Japan Airlines. Regarding the E2 program, which I mentioned of the launch. We had the launch with the large orders of 365 aircraft, with 100 firm orders from SkyWest, plus option of 100. Also 50 firm orders from ILFC, which at the time of the launch, we couldn't disclose and couldn't confirm, actually. They were LOIs. Now, we are able to confirm those orders with 50-plus options. Together with the total orders for this product, LOIs for another 65 undisclosed customers.
Moving to the next page. In the executive jets activity, the highlights. The delivery of 29 aircraft in the quarter. Good deliveries, an increase from the first quarter. More in the light jets with the market, as Fred mentioned, with still some challenges. Important as well with NetJets, receiving the first Phenom 300, entitled the Signature Series, which is one major customer. A potential contract for 125 aircraft. The confirmation of quality product recognition from Best of the Best by Robb Report for Phenom 100 and 300 for the third consecutive year. Important for this business. We'd finalize these highlights for executive jets with important milestones for this business. From the delivery of the Phenom number 400 jet, also the first delivery of the Phenom 300, actually, the sale of the Phenom 300 to China.
Regarding manufacturing, the Melbourne facility received the FAA certification for the Phenom 300. The ongoing certification campaign for the Legacy 500, we completed 45% of the test campaign. Now with the 450 hours flight of the three prototypes of this equipment. Finalizing important information of maturity of a program, the Lineage 1000, reaching the 10,000 hours flown. With that, we finalize the highlights of the executive jets and we turn to next page on defense and security. Another important contract announcement with the Brazilian Air Force, the contract for logistics support and service for the Super Tucano aircrafts. Following recent MOU announcement during the Paris Air Show with Boeing, we now were able to disclose the signed design of the partnership with Boeing to sell the KC-390 in specific markets. Regarding the strategic communication satellite program, we continue advances in selection of major suppliers.
For the SISVAN project, we are also advancing well in supplier selection, and we were able to complete part of this process during the second quarter. Moving to next page. Starting to the quarter activity. In terms of aircraft deliveries, we had, in page seven, the commercial jets deliveries and executive jet deliveries split by category. We had 51 deliveries in the second quarter. It is now accumulated 80 aircrafts within commercial and executive business in the year. There is expectation that we increase this amount of deliveries during the second half, and we are maintaining the guidance towards the low end of the range. For here, the executive jets, 25-30 large jets, 80-90 light jets, and commercial jets, 90-95 deliveries in the year. Next page eight. Regarding backlog.
We recently announced the amount for the second half, second quarter, in the end of June. Total of $17.1 billion of backlog. A strong increase of 29% compared to the first quarter. This reflects orders, primarily in the commercial business units. We got back to levels of the third quarter of 2009. It is good to recall that this does not include, so far, the 50 E2 orders that we recently confirmed from ILFC. Next page nine. Regarding revenues by segment. Total of $1.6 billion in the second quarter, with accumulated of $2.6 year-to-date. Increasing revenues from the first quarter in all of the business segments, and we expect to continue the growth for the second half of the year.
It is good to recall here that the defense and security, although it had increased, it has half of its revenues denominated in reais, which had the impact of the dollar devaluation. Despite this fact, it is still growing, getting to $309 million in the second half, Second quarter accumulated of $551 in the first half. Next page 10, the consolidation of the net revenues in dollar terms and BRL terms. Total in reais, here the new information of BRL 5.4 billion. We are, at this point, maintaining our guidance range for the year between $5.9 billion and $6.4 billion range. Next page. SG&A expenses in dollar and BRL. In terms of G&A, we show stable expenses compared to the first quarter. This reflect our focus on cost control and maintaining the monitoring of these expenses. We are confident we can keep this level throughout the year.
We show an increase in selling expenses, primarily as a consequence of the level of commercial activity in the first half and the second quarter, both in commercial and executive activities. Going forward to page 12, income from operations. We had operating profit of $135 million in the quarter, with a margin of 8.7%. Accumulated margin for the year in 6.6% and $175 million in operating profit. We had this quarter, the second quarter, an increase from the first quarter, in the direction of the guidance range, which we are maintaining at this time. In addition to the SG&A expenses, we had an increase in the research expenses, mainly related to the final stages of the E2 program launch. When we compare to the second quarter of 2012, it's important to recall that it has here the impact in 2012 of cancellation fees, which didn't occur this year.
That explains part of the reduction that we had in terms of the second quarter of last year. Again, we are maintaining the guidance for the year, which is for operating result from a range from $530 million-$610 million, and operating margin from 9%-95%. Page 13, EBITDA. We had in the total of $204 million in the second quarter, $204 accumulated in the year with a margin of 13.1% in the second quarter, accumulated of 11.5% year-to-date. The target, the guidance for the year, the range of $770 million-$900 million, and EBITDA margin between 13%-14%. Page 14, regarding net income, we had a net loss of $5 million in the second quarter, accumulated profit of $25 million in the year.
As we did experience before in previous situations where the dollar gets stronger against the BRL, because of the recognition this in the economics, the balance sheet, we had the non-cash impact, which generated a deferred tax effect, which led to this number. If we do in a pro forma basis, just an exercise without this effect, we should have reported $92 million of profit in the second half. Sorry, second quarter of the year. Page 15, the inventories. We had $2.5 billion in the end of the second quarter of the year. Inventories level stable compared to the first quarter and compatible with the planned deliveries that we have in the second half. We are in line then with the first quarter of this year. Page 16, free cash flow. Total free cash flow of $2 million in the second quarter.
We saw an increase in operating cash generation when compared to 2012 and to the first quarter as well, which supported the company's investment strategy, which was in terms of CapEx. We had mainly the increase was related to the Évora plant . It was planned that there's an increase in the expenses this quarter. This is the seasonal effect that we have for the year. We had a little bit more of CapEx this quarter. It's not going to happen throughout the remaining of the year. Regarding the development programs, we continue to invest mainly here, in fact, the Legacy 500, 450 program. We expect to see, going forward in the second half of the year, a positive cash generation, reflecting the nature of the business. Page 17, investments. We had a total amount of $297 million in the first half.
We're still projecting the guidance of $580 for the full year. As I mentioned before, we had a concentration in CapEx in the first half, which is reflected in this year-to-date figure. We don't expect to see the same amount for the second half in terms of CapEx, we're still keeping the guidance, given the $180 for the full year. The outlook for the year, total investment of $550 million is what we are expecting. $580. Page 18, regarding our capital structure. We had an improvement in the net debt profile in this quarter. As you can see, the increase in the long-term portion of the debt, now 94% compared to 85 in the previous quarter, and also an increase of the average maturity of the debt from 5.1 years to 5.4 years.
In the net cash position, we had a $51 million of net cash in the end of June, already considering the $30 million paid as interest in shareholders' equity made in the second quarter. The total debt in the end of the second quarter was $2.2 billion, and the total cash, $2.3 billion in these numbers. Okay. With that, we finalize the presentation, we open now for questions. Thank you.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star, then one on your touchtone telephone. If your question has been answered and you wish to remove yourself from the queue, simply press the pound key. Again, ladies and gentlemen, if you have a question, please press star one on your touchtone keypad. Our first question comes from Joe Nadol with JPMorgan. Please go ahead with your question.
Thanks. Good morning.
Morning, Joe.
My first question is just on the income statement. The other operating expense line, I understand that you had liquidated damages last year that offset expense. You have an $18 million or $19 million expense each quarter so far this year. What is the run rate there without items?
Joe, what we had here, of course, you got the comparison to the previous year that we had a positive effect last year. What we have mainly here was the discontinuing of some engineering project, and also some adjustments in the impairment of used aircraft. We understand that this year, what we have is an expected normal level of other expenses here. These two items on this line.
In the first quarter, you had a provision, I think, of $9 million or $10 million in that line item. My expectation was that the expense would come down quite a bit because of that provision going away. Is that not going to be the case going forward?
That provision that we had was related to labor disputes. We're not expected to see any of this going forward.
Right. I understand that. I'm just trying to understand the normal level of that line, because you had the provision in the first quarter, it went away, but the expense did not go down. Is the normal level $10 million or $20 million per quarter?
Joe, this is Luciano. If I may add here. Also in the first quarter, you had still, back to Filippo's point as well, a higher level of cancellation fees. Roughly around $6 million or so of more cancellation fees. Again, some of that delta of the provision is taken away by that lower cancellation in the second quarter. Number one. Number two, going forward, this is an expense line, typically you will see in that low double digit range, mid-teens range, let's say, for expenses going forward. For modeling purposes, that's what I would say you should be.
Okay. That's helpful. Second question. Any update on the corporate jet business, on demand in general, and also on the certification process for the Legacy 500. How's that going?
Sure, Joe. This is Fred. On certification, we are about half of the campaign through. We feel very comfortable about our target of entering into service by mid-next year of the Legacy 500, and one year after that, the 450, which we are already assembling the first prototype. We are on track. No showstopper. Of course, we learned a lot with all these fly-by-wire problems, which made us, of course, delay this program a year. Now, we feel much more comfortable about where we are. So far, the campaign's going well. The airplane is flying well. The aerodynamic configuration is pretty much confirmed. We are optimistic about the final result of not only certification, but the success of this product in the market. It will be, in our point of view, another champion, if you will.
As far as the market, we see, on the low end, let's say in the Phenom category, it's been the same story over. It's a very fiercely disputed market. We are doing relatively well there. We feel comfortable about meeting our guidance numbers there. We see some softening on the upper range, on the Legacy 650 market, in this higher-end business jet market. We also have challenges there. At this stage, I would say that we are probably going more towards the lower end of our guidance than the higher end. Still confident that we can meet our numbers. It's important to say that, if you compare where we are vis-à-vis last year, we are actually a little bit better than we were last year. Although we do have challenges to meet our numbers, and we're working hard to do that.
Fred, just on the softening you're seeing in the 650 category. Do you think that's competitive because there's new aircraft coming into the market, or do you think that is just the market overall that's getting weaker?
A good question. It may be preliminary. We see a market softening, not competitive. It's a bit early to tell. I'm not talking about, of course, let's say, the Gulfstream 650, all the way up. That's very resilient. This super mid-size segment, large cabin. In our point of view, it's kind of an early symptoms of maybe some softening altogether.
Geographically, is that outside of the U.S. mostly?
I would not know, Joe. We can dig in with our business jet guys later.
Okay.
I just have the-
All right. Thank you.
Our next question comes from Peter Skibitski with Drexel Hamilton. Please go ahead with your question.
Good morning, guys.
Good morning.
I'm just wondering on the spike in research this quarter, you mentioned, that was sort of due to the E2 introduction, or launch. I know you kept research, the guidance intact for the year at $100 million, but shouldn't we expect the research line to decline meaningfully now that, I'm assuming, E2 expenses will now be capitalized per IFRS?
Peter. You are correct. The expenses of the E2 tend to be capitalized, but they were not that high. It was just like starting some of the expenses. As they increase now, it is going to be capitalized. It is not going to be something that we are already expensing too much. It is going to be changing the line in terms of being capitalized. It does not impact the projection, because of this effect.
I see. I understand. Okay. Just in terms of the margin ramp the rest of the year, should we assume margin expands sequentially in the third quarter, and then we get another large spike in the fourth quarter? Is that kind of the profile that you are anticipating?
Go ahead, Ricardo.
Hi, Pete. I would say, roughly speaking, of course, probably going to be more back-end loaded. Q4, particularly. We don't see margin suppression in Q3 necessarily, but again, the spike trending more towards the back end of the year, really in Q4.
Understood. Okay, thanks. Given the commercial order flow in the quarter, I know you kept the guidance for this year in terms of commercial deliveries intact. Frederico, have you set your delivery rates for commercial yet for 2014? Do you have a view of the profile there? Maybe 2015 as well. Is 2015 sold out at this point? Can you give us some color on that?
The best vision we have at this stage is a stable production rate for the next few years. 2015, of course, is a little bit out. There may be some upside there. We still have 18 months to sell aircraft which can be deliverable in 2015. Talking about more 2014, I think most likely scenario is a stable production rate. A bit different mix, of course, because there'll be more contents of E175s rather than E190s, due to these campaigns in the United States. That's the best we can see now.
Okay, thanks very much.
Thank you.
Our next question comes from Turhan Beriker with Scotiabank. Please go ahead with your question. Turhan, your line is open. Could you try pressing your mute button?
Good morning. Can you hear me now?
Yes.
We can hear you.
Great. Thank you. I guess my first question was on the U.S. Super Tucano order here, within the U.S. Is that helping you with sales campaigns in other countries, and when can we see maybe some more traction there on that product?
We expect so. Of course, the cycles in the defense business are pretty long. Of course, we are still also at very early stage, the LAS, so we will not see aircraft actually being physically built in Jacksonville until another 6-8 months. I think as we deliver aircraft to the U.S. Air Force, of course, the aircraft go into service, then our expectation is, yes, this seal of credibility on the product will help us out. It's somewhat subjective, and we don't see a short-term immediate reaction, but I think it's a very strong endorsement for the program in the mid and long run.
Great. If I could just ask one more, Fred, on the numbers here. You talked about the stable production rate next year in 2014, you also said, obviously, that there are going to be more 170s, and obviously, a lot of those are from the U.S. campaigns here. Does that mean that margins are going to have a bit of a tough time next year, just based on all those different things?
Well, on the pricing side, obviously, we have pressure coming from, of course, a smaller aircraft. The top line will be smaller on each unit. As we all know, large campaigns, they put pressure on pricing. On the cost side, we are working very hard, of course, to maintain our margins. Obviously, some tailwinds are important, such as the currency devaluation in Brazil. A bit early to talk about margins, but on the pricing side, for sure, it's going to be a challenge because of the nature of the mix of the aircraft.
Great. Thank you very much.
Our next question comes from Noah Poponak with Goldman Sachs. Please go ahead with your question.
Hi. Good morning, everybody.
Morning, Noah.
Fred, I wanted to go back to the business jet market. I know you already asked about it, but hoping to get a little bit more color. In the small, or the light end of things, your main competitor has taken production down 20%, 25% from where they basically started this year, and you're essentially not changing. It's a pretty big variance. Do you feel like you're taking share back, or is the market just so volatile that it's almost random, or is it something else?
I think definitely, Noah, we are taking some share. Let's keep in mind that this year, it's probably the first year where we do not have Beechcraft delivering aircraft in that segment. I think it's fair to say that we are probably taking most of that, let's say, empty space. We have delivered 31 Phenoms in the first half, and our guidance is between 80 and 90. Yeah, it's a little bit below 40%. We will have a very busy fourth quarter. Again, last year, the outlook for the year was even more challenging than it is this year. I'm not underestimating the challenges, we still believe, and strongly believe it is doable. Again, more maybe probably towards the lower end of the guidance. The fact is, the Phenom 300 is really the best in class, and it's been a great success.
It is the aircraft which is leading the sales in this segment, it's taking most of the market share in this segment. I think it's very much due to the quality of the Phenom 300. The 100 as well, but it's a smaller market demand. 300 is really the driver here.
On your larger aircraft or the Super Mid, I know you were just asked which geographies you're seeing a little bit more softness in, and you said it's sort of hard to tell. What makes you say you are seeing that? Is it just a quarter or two of softness on your aircraft specifically, or are you looking at market-wide pricing activity or inventory levels, or what drives you to say you're seeing some softness there?
At least on our side, we saw a stronger demand last year, for example, on China, than we are seeing this year. The U.S. is still, the level of activity. In the particular case of the U.S., is more us than maybe the market. We have to capture a little more market share in the United States. We are probably underperforming compared to competitors, even compared to ourselves in other regions. There are some reports that, of course, we follow, specialized people who are tracking the markets. Again, I do not have the specifics here with me, those reports, they suggest that there is some softening there. Talking more broadly, if you look at the control panel, everything looks good. There are some clouds ahead in the worldwide economical horizon, we think, and we see that.
The question is how this turbulence, how far it is from where we are, is it going to happen or not? The softening of China. Brazil is going down for sure. Europe, stabilizing. I think there's an overall macroeconomic, I'll say, concern, or at least awareness, that there may be some bumps ahead. The executive jet segment is very sensitive to that. Perception there creates an immediate reaction. Having said all that, we have a challenge there. We have to deliver 10 airplanes out of a guidance of 25 to 30. That's where it lies, our major challenge, is to find another 15 aircraft to be delivered. It's going to be, again, a fourth quarter with high activity. At this stage, we still believe it's doable.
Okay. I appreciate the market color. Thanks.
Okay.
Our next question comes from Myles Walton of Deutsche Bank. Please go ahead with your question.
Thanks. Good morning. Fred, at a high level, can you talk more about the defense environment, particularly in Latin America, and particularly on some of the larger contracts that are relevant to you? Is there a slowdown in contracting activity? Is there any type of pullback from some of the larger initiatives that they've started with respect to SISFRON and SISGAAZ? Also on SISGAAZ and the FX-2 program, could you give us a timeline of what you see today?
Sure, Myles. We have accumulated a strong backlog. We have a strong execution challenge in our programs. Your question is more towards the new programs. I think it's undeniable that Brazil has now some budget challenges as a country. You may or may not have read about some recent cuts on 2013's budget. It would be naive to imagine that those cuts and whatever comes for 2014 will not affect the defense budget. We feel, on one side, comfortable that the existing programs will be capped and will be maintained at their present course. Of course, we have the strong execution challenge. I think it's less evident what's going to happen to new large defense contracts in Brazil. SISFRON, of course, it's a necessity, but it's also a large dollar amount, another pressure on the budget.
At this stage, as I said, it's hard to predict whether or not that's going to happen. I think it's less likely than it was a few months ago, when there was still some positive outlook for the Brazilian economy. The FX-2, it falls in the same basket, but maybe can be different, because there is an operational need for the Brazilian Air Force. They just have to, sometime in the future, renew their fighter fleet-
which is aging. I'm not sure, the effects can be only analyzed through the spectrum of budget, but also strategically for Brazil's defense. Maybe that's the best vision I can give at this stage, Myles.
Okay. Then one quick one. I think NetJets was a big contributor this year to differentiating your business jet deliveries, maybe versus the competition. As you look to next year, is that buyer's profile deliveries a headwind, a tailwind, or neutral?
No, I don't think NetJets, as far as quantities, has been that much relevant this year. Next year, I think we'll have probably Luciano can confirm that later, but as far as I remember, I think we have more deliveries next year than this year for NetJets.
Okay, great. Thanks again.
Thank you.
Our next question comes from Ronald Epstein with Merrill Lynch. Please go ahead with your question.
Just to follow up on maybe Myles' question, in a broader sense, given all the recent, I don't know, call it social unrest in Brazil, have you seen any impact at all in terms of your labor force or impact on the business? Maybe just broadly speaking.
No. In general, no, not at all. The protests in Brazil, they were against, let's say, the status quo of overall social issues such as healthcare, such as transportation, security in the large cities, urban transportation. It's more towards criticizing politicians and political parties and, let's say, the major institutions. Companies in general, they were not affected by that. In particular, Embraer, we felt absolutely no effect in that regard.
Okay. Maybe moving back to aerospace stuff now. When we think about now and the rest of the year, how are the campaigns going? I think everybody knows that there's an active one with Eagle right now. What else is going on around the world when we think about campaigns for either the updated current generation of E170s and E190s and then the E2 family?
Ron, as you know, there was a strong concentration of orders announced, in Paris, something around 1,000 or 1,100 aircraft, something of that order of magnitude. Most of those airplanes were narrow body and regional aircraft. There is a natural hangover of the post-Paris. I don't think we should expect major orders announced by anybody in the very short term. The U.S. is probably the brightest prospect for the industry at this stage. The profits of the airlines there for this year is projected around $4.5 billion. The clear consolidation, a positive consolidation outcome, in the industries. The relaxation of the scope clause, of course, bringing opportunities for us. We just are in the first wave of orders for the renewal of the regional fleet. When you talk about Europe, the LCC is giving the network carriers a very hard time, as you know.
That's a tough environment for the network carriers, for the, let's say, the flag carriers or the classic ones. We are, on our side, seeing some opportunities on the eastern part of Europe. The recent certification in Russia for the E190/E195, opens up possibilities there for the region. In that region, I think we have something like eight customers, or maybe seven or nine, but around eight customers. We have some expansion there. Middle East, some activity brewing up. It's been quiet for a while. Some nice resumption of discussions. Africa, kind of stable, but maybe just to mention one example, we are initiating, let's say, a business model trial with a couple of E190s in Royal Air Maroc, which is a short-term lease from one of our lessors, Jetscape.
It's almost like, as I said, a trial of a business model, that hopefully opens up a regional feeding system conclusion. A regional feeding system, something which can bring value to African airlines. Of course, if that proves to be correct, does not mean that Embraer will seize everything. We are just, let's say, the guinea pig in supporting that initiative. Hopefully, that will play in our favor in the future. India, Air Costa, as we mentioned. China, some discussions about existing, but also about the E2 opportunities. I would say nothing short-term. Brazil, losing momentum. We have a backlog in Brazil, and this backlog, we feel very comfortable about executing that backlog with Azul and Trip. There is a clear slowdown in the domestic market here. I tried to walk you through the whole world. This is where we are.
In the end, we are seeing a strong market. I think $12 billion or $13 billion or something like that is the IATA profit forecast for the year, which is a stronger industry than it was certainly a few years ago. We are cautiously feeling good about, let's say, the general state of the airline industry.
Maybe just one last question, jumping back to defense. Can you give us an update on how the KC-390 program is doing, where we are, and where we have to go?
Sure. We are in the middle of the, let's say, the massive delivery of drawings, release of drawings from engineering to production. I do not have specific numbers, but we are pretty much on schedule as far as the production of drawings. It's important to say that the way we have set up the program, we are releasing the, let's say, the most complicated parts. I'm talking about, for example, spars and ribs, and ribs also for both wings and fuselages. It's going pretty much as planned. We probably will start building a prototype, I would say, around early next year. Maybe it'll start even later this year or early next year. Everything tells us that the first flight is doable before the year-end of 2014, before 18 months from now, approximately.
As far as the cash flow, the government, the program is also on schedule, so we have no delays in payments. As I told Myles, we expect the existing programs to be protected by any budget restrictions that might affect the defense business in Brazil. I think, if there are some constraints, they'll be more towards new programs rather than cutting existing programs.
Great. Super. Thank you.
Thank you.
Our next question comes from Stephen Trent of Citi. Please go ahead with your question.
Good morning. This is Kevin Krasnow on behalf of Steve Trent.
Morning.
Morning.
Morning. Just a couple of questions. When should we think of a firm order as a firm order? When the contract is signed and the customer proves they have the financing and they put down a deposit? We were just a little bit confused about some news that came out recently, stating that Republic Airways only recently received financing for that order that they got that announced in January. Was there something different about that announcement? Is the underlying host company still operating under bankruptcy protection?
I'm not sure I understand. Are you talking about Republic or somebody else?
Republic Airways.
Yeah.
Embraer.
Huh?
Procedure.
We are absolutely following up our procedure since ever, for the last, I don't know, at least 15 years. A contract is firm when it's firm, and we have non-refundable deposits on our account. This is true for Republic. It was true for Republic. What was recently announced, I'm not sure I answered your question, but what was recently announced was that Republic assured financing for the 47 aircraft, but the contract was firm. Commercially, it was absolutely firm between Embraer and Republic since January or February, and we announced it then.
Okay, they had put down a deposit at that point then.
Oh, yeah, absolutely.
Okay.
How else would we not consider that firm?
Thank you. Just one more follow-up. Over the long term, what extent do you think Embraer plans to continue acting as an aircraft lessor? Do you believe that the driver behind KLM Cityhopper's decision to lease E190s instead of purchasing them, what do you think? Is that something that you plan on integrating into your model further?
That's an important question. We have been focusing, clearly, in expanding our customer base, also through leasing companies. As you know, leasing companies are fundamentally working with Boeing and Airbus airplanes only. Except for, of course, some specific examples. Fundamentally, the leasing industry works with Boeing and Airbus products. We see that as a very important distribution channel. For the last two or three years, we've been focusing a lot
Expanding our customer base and opening up new lessors. Not, of course, to have an enormous number of lessors, but having some important ones as we have succeeded. Having a large customer base as we have now with 67 customers, that attracts a lessor. Down the road, we see a combination of direct sales and the participation of lessors. If you look at Boeing and Airbus, they probably have something between 25%, 30%, 35% of their backlog to lessors. We are not at that level. We are probably around 15% or 20%. We kind of see it as a healthy strategy down the road.
Okay, thank you. That was very helpful.
Thank you.
Our next question comes from Eduardo Couto with Morgan Stanley. Please go ahead with your question.
Hi. Good morning, guys. Just one question from my side. On the currency side, we had this 10% appreciation on the BRL since the beginning of the year. Can you give us some color on when can we start to see the weaker currency really impacting the results of the company? Just some color on that.
Yeah, Eduardo, good morning. Actually, as you know, the devaluation when it affects the cost, which is positive, it has to follow the flow through the production and then to the delivery. We expect to see that effect going forward. Sometimes still this year, definitely, but not in the very short term. The very short term, as you know, there's a negative impact because of the accounting method of the deferred income tax, but the benefit on the cost and the margin will come forward, probably more towards the end of the year.
We can say that your costs on the second quarter, they're pretty much based on the like a two reais per dollar BRL?
Yeah, definitely.
That's correct.
2.1 maybe. It was a little bit more, no? By the end of the first quarter, we had almost a little bit more than BRL 2. This level that we're having today was not affecting the second quarter.
Okay. Thank you.
Our next question comes from Caio Dias with Banco Santander. Please go ahead with your question.
Yes. Hi, good morning. Just a follow-up on the previous question. The Brazilian real has depreciated significantly since the beginning of the year when you provided the market with an EBIT margin guidance of a margin between 9% and 9.5%. Don't you see upside risk to this guidance given the move we saw in FX-2? Thank you.
No, Caio. Actually, we're still maintaining the range. As we indicated, there's some challenges, of course, in the business activity, it's part of the whole impact in the year. The margin between 9%-9.5% as we indicated, that probably now we foresee more than the low end of the range. The exchange rate will be part of this projection that we have. We don't see that as an upside risk at this moment, at least at this moment.
Okay. Could you please try to clarify what is the part that is pressuring margins?
No, it's more in the delivery trend. No?
Okay.
More on the revenue.
On the revenue side.
Okay. It's more about number of deliveries or prices?
It's more volume delivery.
Okay. Thank you very much.
I'm not showing any other questions in the queue. I'd like to turn it back over for closing comments at this time.
Well, just to thank you all for your attention and consideration and be in touch with you. See you in the next earnings call. Thank you, and have a nice day. Have a nice weekend.
Thank you. This concludes today's question and answer session. This concludes Embraer's conference call for today. Thank you very much for your participation.