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Good morning, ladies and gentlemen, and welcome to the audio conference call that will review Embraer's first quarter 2018 results. Thank you for standing by. [Operator Instructions] As a reminder, this conference is being recorded and webcasted at ri.embraer.com.br.
This conference call includes forward-looking statements or statements about events or circumstances which have not occurred. Embraer has based these forward-looking statements largely on its current expectations and projections about future events and financial trends affecting the business and its future financial performance. These forward-looking statements are subject to risks, uncertainties and assumptions, including, among other things, general economic, political and business conditions in Brazil and in other markets where the company is present. The words believe, may, will, 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 might 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. Paulo Cesar de Souza e Silva, President and CEO; Mr. Nelson Salgado, Executive Vice President Finance and Investor Relations; José Filippo, Executive Vice President; and Mr. Eduardo Couto, Director Investor Relations. I would now like to turn the conference over to Mr. Paulo Cesar de Souza e Silva.
Thank you. Good morning to all, so thank you for joining us this morning. Before I start, I'd like to just make few comments. So Filippo, as you know, he is leaving the company shortly. Filippo is staying with us until beginning of May and then he will leave. I would like to take this opportunity to thank Filippo very much for this excellent job he did here at Embraer for the last -- almost 7 years. At the same time, since you heard about Nelson Salgado. Nelson has been with Embraer more than 30 years. So Nelson has been already in many functions at Embraer, including, years ago, he was the controller of Embraer and Nelson knows very well the company. So I welcome Nelson and wish him good luck in his new responsibilities. So with that, I would ask Nelson to start the presentation.
Okay, Paulo. Thank you. Good morning, everybody. We start the presentation at Slide 4, with the Commercial Aviation business highlights. Embraer delivered 14 E-Jets in the first quarter. The big highlight of the quarter, however, was the certification of the first E190-E2. The E190-E2 was the first aircraft to receive triple certification from ANAC, Brazil; FAA, U.S. and EASA, Europe, simultaneously. That happened in the end of February in our facility in São José dos Campos. As far as performance is concerned, the E190-E2 exceeded by 1.3% the original specification of 16% better fuel burn, confirming the E190-E2 as the most efficient aircraft in its segment, with more than 17% fuel consumption improvement compared to our current generation E-Jets.
Just some days later, we delivered the first E190-E2 to the Norwegian company Widerøe on April 4. And that aircraft has already started revenue flights, with the first flight being completed on perfection on April 24.
Finally, our second model of the E2 family, the E195-E2 is also on track for entry into service in the first half of 2019.
Next page, Page 5, we will show you the Executive Jets business highlights. We delivered 11 Executive Jets in the quarter, 8 light jets and 3 large jets. On market activity, we started to see signs of improvement in the business jet market conditions during the first quarter of 2018, recording sales of 17 aircraft between the periods. As far as sales activity, we delivered the first Phenom 300E after receiving certification from FAA and ESA and ANAC in the first quarter. The Phenom 300E is a new version of the Phenom 300, with a completely redesigned interior and also some other improvements. Another important milestone that we have mentioned before is the Phenom 300 was again the best selling and most delivered light business jet for the sixth consecutive year globally.
We also launched a new tool called Fleet Logic to support corporate flight departments planning. And finally, on customer support, we developed a Phenom 300 interior layout option to seat up to 11 occupants, which is the highest number in its class.
Moving on to Defense & Security highlights and starting with the KC-390. The KC flight test campaign is moving towards final certification, with the 2 prototypes exceeding 1,600 flight hours. First delivery is expected for the second half of 2018 to the Brazilian Air Force. With the advance of the certification campaign, we've started also the production process with a family of aircraft numbers 003, 004 and 005.
As far as sales activity in other products in Defense, we delivered 2 A-29 Super Tucanos to a Latin American customer in the first quarter of 2018. We also delivered the fifth Phenom 100 to Flight Training Services, a provider in the U.K. that provides training services for the U.K. Ministry of Defense.
And finally, our subsidiary Atech implemented the first fixed command and control and air traffic management center for an African nation.
With that, we conclude our business unit highlights and move to the financial results.
On Slide 8, we present our backlog. Our backlog reached USD 19.5 billion in the end of the first quarter. It is important to note that with the launch of a separate business unit for Services & Support, we started to include services contract in the backlog like pool parts and maintenance programs that we did not include before. Excluding that addition from our backlog, the backlog was almost flat, with increase in Executive Jets, offset by a decline in Commercial Aviation.
Next slide, Slide 9, we show aircraft deliveries by business units. As mentioned before, we delivered 14 Commercial Jets. This is a decline versus last year's first quarter, but it is in line with our 2018 guidance of 85 to 95 planes. In Executive Jets, we delivered 18 [sic] (11) aircraft, broken by 8 light jets and 3 large jets. Here it is important to say that 5 planes were delayed to be delivered in the second quarter. We delayed our 2018 guidance of -- we reiterate our 2018 guidance of 105 to 125 airplanes, broken by 70 to 80 light jets and 35 to 45 large jets.
Next slide, Slide 10. As far as revenues, we reported USD 992 million in the quarter, broken by USD 380 million in Commercial Aviation, USD 128 million in Executive Aviation, USD 243 million in Defense & Security and USD 239 million in Services. Compared to last year, our revenues in Commercial or Executive Aviation were affected by lower deliveries, while Defense revenues were positively impacted by the KC-390 program. Our outlook for 2018 is unchanged at USD 5.4 billion to USD 5.9 billion.
Moving to Slide 11. Sales and general and administrative expenses. We reported a flat year-over-year SG&A at USD 115 million, broken by USD 44 million in G&A expenses and USD 71 million in selling expenses. We remain focused on our cost-cutting initiatives that will continue to positively affect SG&A as well as other costs in the near future.
Next slide, we show the operating results. Embraer reported an EBIT of USD 26 million in the first quarter, implying an EBIT margin of 2.7%. This margin and result is in line with normal seasonality in the first quarter with lower dilution of fixed costs. We didn't have any special item in the quarter. Looking at the margins by segment, we reported Commercial Aviation at 4.5%, Executive at minus 16.7%, Defense at 4% and Services at 9.8%. Again here, we reiterate our 2018 EBIT guidance of USD 270 million to USD 355 million, with 5% to 6% margin.
Next slide, Slide 13. Our EBITDA, which at $90 million in the quarter, with a margin of 9%. Again here, we reiterate the guidance of $540 million to $650 million, equivalent to 10% to 11% EBITDA margin.
Moving to Slide 14. We show -- Embraer reported a net loss of $25 million the first quarter of 2018, implying a negative margin of 2.5%. Our earnings were down to the combination of lower operating results and higher financial expenses. These higher financial expenses are, however, in line with our strategy. In the end of last year, we anticipated that interest rates would go up, and we issued a bonus in line with our strategy of maintaining a high level of liquidity. So we issued a $750 million bond. And now we are seeing the interest rates go up, which should benefit our financial revenues in the future.
Moving to investments. We -- our investments reached $46 million during the first quarter, broken by $10 million in research, $13 million in development and $23 million in CapEx. Our first quarter development investment was positively impacted by $65 million received from supplier's contribution for the E2 program. The E2 development program, it is important to note, remains in line with our plan as far as budget and performance is concerned. Again here, we maintained our 2018 investment outlook of USD 550 million.
Next slide. As far as free cash flow, we reported a free cash flow consumption of $431 million, broken by $311 million of operating cash flow, $40 million CapEx and $80 million development. Given the normal seasonality for our first quarter, our free cash flow reflects higher inventories of $330 million as we prepare for higher deliveries in the coming quarters and also with addition of some finished goods aircraft, which deliveries were postponed to the second quarter. We reinforce our expectation of usage of no more than USD 100 million of cash flow in 2018.
Finally, on Slide 17, we show our indebtedness profile. We ended the quarter with a total debt of USD 4.2 billion and total cash of USD 3.4 billion, resulting in a net debt position of $759 million, around $50 million better than first quarter 2017. Our debt level remains comfortable, with an average maturity of 5.7 years. With that, we conclude the presentation of our financial results and move on to the Q&A session. Thank you.
[Operator Instructions] And our first question from the line of Robert Spingarn from Crédit Suisse.
This is Audrey Preston on for Rob. So I was just curious, could give us an update on the potential Boeing tie up and what details are left to be negotiated? And what benefits are you expecting to derive from this deal and then what are you expecting to bring to the table yourself? And then a follow-up after that, with the Airbus and Bombardier deal expected to close next month, would that generate any additional pressure to accelerate that negotiation timeline?
So thank you for your question. We don't have too much to add on this topic Boeing Embraer. I think we have released, again, an update together with our financial results. So we continue to work on the transaction with Boeing and with the Brazilian [indiscernible] Technical Group that was established. So there the negotiations are quite complex. It's going well. But we have no expectation for any timeframe to conclude this. So this is what I can add in addition to what was already disclosed in our results.
And our next question comes from the line of Cai Von Rumohr from Cowen and Company.
This is Bill on for Cai. Wanted to check-in on biz jets for a second. First, can you confirm the biz jet margins in Q2? I didn't hear those. Were they negative 16.7% or positive 16.7%? And if they were negative, how much were the impairments? And then just broadly on biz jets, if you could speak to orders. What are you seeing, have they picked up recently? And what are the products people are most interested in?
Okay, thank you. It's confirmed negative 16.7% and that's basically due to a lower level of deliveries. There's no impairment impact here in executive aviation. And as we mentioned in the call, we see signs of recovering this market with actually average price is going up a bit and increased sales activity.
And then just a follow-up on Commercial margins. They were down a lot year-over-year. Can you just discuss what's going on in that business line in Q1?
Basically, Cai [sic] (Bill), the commercialization and also business jets we have -- we are short of about 5 deliveries in line of business jets and I believe 3 or 4 in Commercial Aviation. So aircraft was being manufactured, but it was not delivered given that the client asked to deliver these aircraft in the second quarter. So this is basically the major impact in both businesses.
Yes, and that's because the lower number of aircraft, as I said, it affects the EBIT margin, because of lower dilution of fixed cost. The gross margin, however, is very much in line with what we used to have or what we have generally.
And if I add, Nelson, if we exclude these few deliveries that moved to the upcoming quarters, the EBIT margin wouldn't be too different from what we report on the previous year, okay?
And your next question comes from the line of Ronald Epstein from Bank of America Merrill Lynch.
Can you give us a quick update on how we're doing on sales campaigns for the E2? The sales of the program over the last couple of years have been reasonably anemic. Now that the airplane is certified and in service, right, what's going on? Are we -- is there anything closer to being booked? How would you describe that?
Thank you, Ron, for your question. Yes, definitely, after the certification in February, right? Of the E2 -- E190-E2 and the first delivery and EIS of day 2 of this week. So since the certification we are seeing more and more traction or interest. Our teams are very busy involved with our already clients and potential clients. Of course, I cannot disclose here any names and any stage of these negotiations. But I feel pretty good that we are going to have a very good year. The EIS of the 2 this week has been great. So the aircraft is performing very well, and we are very bullish that's going to be a strong year for us.
Okay, can you just give us a sense, are you thinking of book-to-bill greater than 1? I mean that's sort of 1 metric maybe you could mention?
Yes, so we are targeting at least 1, at least 1. But given the level of activities that we are seeing so it can be greater than 1.
Okay, okay, great. And the back to business jets for a moment. When you -- the sense of recovery that you're seeing is it just in the smaller product, is it in the larger product, is it the U.S., is it Europe? And can you give anymore feel for the kind of the tone and tenor of the recovery you're starting to see?
Sure. I think, first of all, we are seeing overall improvement in the used aircrafts, right? So inventory is being reduced. So prices on the used aircraft is tough to not to fall. We are seeing slightly better prices on the new aircraft. Definitely U.S. and Europe, I think these are the -- both markets -- regions that are leading this recovery, okay? So you ask, given the -- like the tax reform and the economic growth, Europe more, of course, on the economic growth in the whole Europe -- European countries. We are seeing a good perspective for the medium-size aircraft, super mid, legacy 450, Legacy 500. So we are seeing a very good activity there. So we are also on the business jet unit business. So we are more positive this year. So I believe we are coming out of the woods finally. It's not a great improvement, but it's an improvement.
And our next question comes from the line of Noah Poponak from Goldman Sachs.
This is Gavin Parsons on for Noah. Just taking a step back and looking at regional jet demand from a higher level now that the global fleet has been pretty flat for -- over the last decade or so and most of the demand has been replacement-driven. So do you think that changes meaningfully over the next 5 to 10 years? Or do think replacement demand will kind of be the more meaningful driver for you?
Well, we are stick to our market forecast about 6,000 jets for the next 20 years. From this segment, 76, up to 130. So don't forget that we have the U.S. markets for our 76-seater, right? So it's still a lot of opportunities in the West for these aircraft as we move forward. And for the 190, 195-E2, as I mentioned before, starting to deliver so we are seeing and we will continue to see a great opportunity. So we are stick to our market forecast. So we continue to see that size of the market. We have China with opportunities, not for replacement, but for growth, right? And we have other markets in Asia as well for growth and replacement in Europe, so definitely, right? And as well as Middle East, but I think it's a mix of growth, replacements, right? And a scope, change or scope of relaxation a little bit in the United States as we replace the 70-seater with Embraer 175.
Okay. And then you called out impairments, I guess, residual value, guarantee impairments on Commercial jets. Can you talk about what you're seeing in the marketplace today as far as values, the trends and remind us what your total exposure is and what you have in guidance for the year?
I don't have the specifics here. So I'm sorry, you are talking about the $1.5 billion?
Yes, and other expense you highlighted, expected impairments on Commercial?
In terms of Commercial, so it's basically with reference to the ERJ 145 that we still have some in our books, right. And from time to time so we have these impairments, but I don't have the specifics now here. They market is improving a little bit for the 145. We are seeing a relatively good demand in countries in Africa, for instance, in the Eastern Europe. So we have been able to place these aircraft in the secondary market, but always there is a need for some impairment, right? In the past, these impairments were so much bigger, now it's being much reduced but I don't have the specifics here. Salgado do you have any...
Yes, in the first quarter we had around $10 million to $11 million on these impairments of used aircraft. These aren't really [average]. For the upcoming quarters we are expecting less than that, so we shouldn't see the same amount for the rest of the year. But it's always difficult to know.
Great. And then just one last for me. You're highlighting improvement in the business jet market and orders, but 1Q deliveries looked a little bit seasonally light. Did you say there was some slippage to the second quarter there?
Yes, exactly. So 5 aircraft that slipped to the next quarter.
And our next question comes from the line of Pete Skibitski from Drexel Hamilton.
And best of luck to José Filippo. Also congratulations on the E2 entering service. My question is, on the strong revenue growth in defense, I'm not sure I understand what drove that? It was up really sharp year-over-year. It looks like you think it will kind of flatten the balance of the year. Can you give some more color on the strength in Q1?
Yes. The -- that growth was mainly driven by the KC-390 because we actually started the work on the contract for the serial delivery of aircrafts to the Brazilian Air Force. So as I mentioned, we have aircrafts, some 003, 004 and 005 in preproduction and that contract is -- has revenues recognized as we move on with the assembly of aircraft. So that is responsible for most of the increase in the defense revenue in the first quarter.
Okay. And it's percentage of completion, so you're not going to get a bump in revenue in the second half when you actually deliver, is that correct?
Well, it's -- you recognize revenue as you assemble the aircraft, but there is always a portion, a significant portion left for the final delivery of the aircraft.
Okay. Okay, that's very helpful. Okay. And then, last question is just, as the Brazilian economy kind of stabilizes and returns to growth, what kind of defense budget growth are you guys expecting going forward as a result of that?
Well, we are expecting the growth in our program so that we can have the commitments the government has for the delivery of the KC-390s ahead. There is no new program for the moment, but we have the contracts for the final, the big contracts for the final certification of the KC and also for the -- for deliveries of the KC. Looking at our other product lines, we have expectation of continuing work on the border protection program. And also, we've been working with the government to -- for the second geo-stationary satellite that is actually needed already for Brazil. So I'll say these are the major activities that we foresee with the government of Brazil.
Okay. Do you guys think the election later this year is going to have any kind of meaningful impact to the defense outlook?
No, we don't expect impact because these are long-term contracts that don't -- they go from one government to the other. So we don't really expect any impact because of the change in government.
And our next question comes from the line of Turan Quettawala from Scotiabank.
Also wanted to wish Filippo all the best for his future. Just I guess, my first question, just wondering if you could talk a little bit about your executive aviation business. Obviously, the sales were -- the deliveries were a little bit soft here in Q1. I understand that there was a bit of movement from Q1 to Q2. But could you give us a sense of how much sales you need to do in that business to kind of get to the guidance here on deliveries for 2018?
Well, we -- despite the soft deliveries in the first quarter, we are maintaining our guidance for the year, right? So if you look at our guidance, that's where we expect to get, and with that, we will improve our margins as well.
It's important to mention also the transformation we are going through in the company, right, with the program, Passion of Excellence. So we are now in the -- this year '18 is a very important year. So we have launched the program in August last year and we're implementing now. So it's going well. So it's moving well. So our plan fully, right, takes into account the -- this program that is being managed by us with the support of McKinsey. So it's going very well, as I said. And we are on target so far.
If I may add, Paulo. It's a [indiscernible]. We had the -- I would say a positive trend in terms of pricing on executive jets. If you look our average prices, they were 4% to 5% better in the first quarter of this year compared to last year, and this improvement was across most of the models. So we are feeling better demand and some price recover, so that's the reason we are, I would say, cautiously optimistic on executive jets.
No, I understand that. I just want to understand how much of the 105 or so in deliveries is in backlog?
It's -- we are very comfortable -- confident in our guidance of 105 to 125. So I think the risk is very reduced. We don't disclose how much sold out we are, but we are very, very comfortable with.
That's helpful. I guess, maybe just one more for me. Paulo, I was wondering if you can talk a little bit about -- obviously, I understand the Boeing deal is pretty complicated here to, kind of, get done. Just wondering if the uncertainty around that affecting the business at all with regard to maybe campaigns on the E2 and, I guess, even just something maybe you could provide some insight on how the employees are faring as well?
No, it's not affecting at all. So we are in touch and contact, of course, with our clients, so the campaigns that we are involved is not predicated at all in the transaction. So we feel very good about that. So internally, of course, there is anxiety to see the outcome of this. But there is, I mean, no issue whatsoever. So I'm sure that people is very much focused on their job. And however, having said that, we want to, of course, to have an outcome for this transaction as soon as possible. So it's important that we reach a final resolution on that soon.
And our next question comes from the line of Stephen Trent from Citi.
And I echo other folks' comments, very best wishes to Filippo. I had 2 follow-up questions on the defense segment. When we look at the activity here in the United States, there seems to be at least some indication that there might be additional opportunities for the A-29 and maybe Air Force having a close look and, just curious, if you have any comments on that?
Yes, there is a growing interest in the Super Tucano. And the United States Air Force is actually performing right now an evaluation process for light attack aircrafts. The Super Tucano has been selected as one of the 2 finalists of this campaign, which is moving ahead. And we are cautiously optimistic about our prospects in these, as the Super Tucano is really the only aircraft around with combat-proven experience.
Okay. That's very helpful. Appreciate the color. And just one more, while I'm at it, it's encouraging to hear the KC-390 rolling along in terms of -- in the contractual work you're doing for Brazil's military. Any indication at this point -- anything you can say with respect to how the efforts are going vis-à-vis potential international traction for the aircraft, especially as Boeing has some skin in the game on this process?
Well, in the defense market, we know that things really started -- start to heat up when your own air force receives and starts to operate the aircraft, right? So we continue to seek a lot of interest in the KC. We've been approached by many, many air forces throughout the world. There are some campaigns going on, but we really expect to see that turning into real sales as the air force -- the Brazilian Air Force receives and starts operating the aircraft.
And our next question comes from the line of Ricardo Alves from Morgan Stanley.
Just one for me. Most of my questions have been answered. On the defense profitability, I mean, this big improvement from minus 8% to positive 4%. Now that you're getting ready to deliver the first aircraft, is this the kind of profitability we should expect for the next few quarters? I remember you guys guiding a low -- if I'm not mistaken low to mid-single-digit margin for the defense segment in 2018. So just wondering if that should continue? And also if you could give a quick update on what you're expecting in terms of margin per segment? I guess, it shouldn't have changed because you're reiterating your margin guidance, but just to make sure because we saw this big bounce back on defense and a significantly lower profitability on the executive side.
Okay, thanks, Ricardo. The -- I would say that the first quarter margins on defense were more normal or back to a normal level, that last year was really unusual. We had negative margins mostly driven by some cost base revisions that we have in some of our programs. This year, at least in the first quarter, we didn't have any cost base revision. At this point, we're not anticipating that for the remaining of the year. So we expect to see better defense margins. Looking the margins per business, we don't give a guidance on that. But as we already mentioned, executive jets should be a low to mid-single, similar to defense. On commercial, we expect to see a mid to high single digit; and service and support, mid-teens or a low double digit. That's more or less how we see the margins for our business.
And I'm showing no further questions over the phone lines at this time. I'd like to turn the call back over to Nelson Salgado for closing marks.
Well, thank you very much all for attending our results conference. Thank you.
And that does conclude Embraer's audio conference for today. Thank you very much for your participation. Have a good day.