Embraer S.A. (EMBJ) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon, everybody. And welcome to the Embraer Third Quarter 2017 Earnings Call. This conference call is being held between our Embraer Day New York with the presence of investors and market analysts, so thank you all for coming. At this time we will present the third quarter results and the financial outlook. Afterwards, we will conduct a question-and-answer section, and instructions to participate will be given at that time. [Operator Instructions] Thank you all that are here attending our event live. It’s a pleasure to have you all here. As a reminder, this conference is being recorded and webcasted at ri.embraer.com.br. This conference includes forward-looking statements or statements about events or circumstances which have not occurred. Embraer has based these forward-looking statements largely on its current expectations and projections about future events and financial trends affecting the business and its future financial performance. These forward-looking statements are subject to risks, uncertainties and assumptions, including, among others, general economic and political business conditions in Brazil and in other markets where the 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 obligations to update publicly or revise any forward-looking statements because of new information, future events or other factors. In light of those risks and uncertainties, the forward-looking events and circumstances discussed on this conference call may -- might not occur. The company’s actual results could differ substantially from those anticipated in the forward-looking statements. Participants on today’s conference call are, Paulo Cesar de Souza e Silva, our President and CEO; José Filippo, Chief Financial Officer and IRO; myself, Eduardo Couto, Director of Investor Relations; we also have John Slattery, Commercial Aviation; Michael Amalfitano, Executive Aviation; Jackson Schneider, Defense & Security; and Johann Bordais, Services and Support. Now I would like to turn the conference over to José Filippo, our CFO. Please go ahead, Filippo. José Filippo: Thank you, Eduardo. And welcome again to our third quarter 2017 earnings results and financial outlook. Starting with the highlights of the third quarter in page four with Commercial Aviation, we delivered 25 E-Jets in the third quarter of 2017 and to -- September to-date we have 78 deliveries in executive jets, sorry, in Commercial Aviation E-Jets. As far as commercial activity, we had two new orders from SkyWest in the quarter for the total of 45 E175 and information that Aercap placed five E190-E2 with Air Astana. Continue with Commercial Aviation, important milestone related to the E-Jets program that reached 1 billion passengers transported since entry into service. Regarding service activity, we launched the first Embraer full training center in Johannesburg, South Africa. And finalizing the highlights of Commercial Aviation and update on the E2 development program with information of the successful conclusion of the simulated ice and cabin evacuation tests, the confirmation of the first delivery of E2 aircraft to Widerøe set for April 2018 and the achievement of 80% of the campaign for E190-E2 certification. Moving to next page. Highlights of Executive Jets, we delivered 20 Executive Jets in the third quarter, broken by 13 light jets and seven large jets, and we have until the third quarter of 2017 59 deliveries. In those deliveries we included the first delivery of the Legacy 500 produced in Florida and the delivery of the first new Legacy 650E to Air Hamburg. In terms of production development, we launched at the recent NBAA the new Phenom 300E featuring new interior design. Regarding customer satisfaction, Embraer was ranked number one in customer support for the second consecutive year by AIN. And concluding the highlights of Executive Jets in relation to our organization we appointed Steve Friedrich as our new CCO. Next page, page six, Defense & Security highlights, in terms of commercial activity the first in relation to the Super Tucano, we signed orders for 12 aircraft, including six Super Tucano to the U.S. Air Force that will be operating in the Afghanistan and six other to an undisclosed customer. The U.S. government also approved the sale of 12 Super Tucano to Nigeria. Regarding the potential OA-X opportunity, the Super Tucano fulfilled all mission requirements for the U.S. Air Force initial capability tests. In relation to the KC-390 campaign, Portugal continues to advance with contract negotiations for five units. And the update of the KC-390 program development, certification is progressing with two prototypes with more than 1,450 hours operation. The delivery of the first KC-390 is scheduled for the second half of 2018. Next page, after the highlight of the business units, now move into the financial results and going to page eight, which is the firm order backlog. We ended the third quarter 2017 with backlog of $18.8 billion, an increase of $300 million when compared to the previous quarter. Next page, as far as deliveries, starting with Commercial Aviation, in the left-hand side of the presentation, we delivered 25 aircraft in the third quarter, it’s now 78 to-date as of September. In relation to Executive Jets, delivery of 20 aircraft broken by 13 light and seven large, and accumulated as of September 59 in the year broken by 40 light and 19 large planes. We take the opportunity to confirm our expected outlook for 2017 of the range of 97 to 102 aircraft for Commercial Aviation and 105 to 125 aircraft in Executive Jets. Next page, regarding revenues, we reported a total of $1.3 billion in the third quarter of 2017 and accumulated $4.1 billion in 2017. Revenues by business in third quarter were $846 million in Commercial Aviation, $267 million in Executive Jets and $190 million in Defense & Security. For the total individual business revenues outlook we are maintaining our estimates for 2017. Next page, page 11, SG&A expenses, we have in the third quarter the total of $116 million in SG&A expenses, lower than the previous quarter and last year. The reduction reflects our focus on cost control and in relation to G&A it was negatively affected by a one-time expense, which will not repeat in the following quarters. As of September 2017, the total SG&A expenses achieved $355 million. Next page, in relation to adjusted EBIT. We reported a gain of $69 million in the third quarter, with margin of 5.3%. When you break our margin by segment in the quarter, we have Commercial Aviation with 13.8%, Executive Jets of negative 11% and Defense with negative 8.5%. In Executive Jets business, margin was negatively affected and impacted by the lower deliveries and the favorable mix. Despite these negative figures, we identified gross margin and price improvements when compared to the previous quarters. In Executive Jets, given the typical seasonality, we expect a strong fourth quarter, return to full year margin to breakeven. In Defense margins, we have negatively impacted by cost-based revision and scope reduction in the modernization programs. For the full year, we expect low single-digit positive margin. For full year 2017, we are confirming our outlook expectations of $450 million to $500 million, and 8% to 9% margin more towards the low end of the range. Next page, adjusted EBITDA, we had $143 million in the third quarter, with 10.9% margin. As of September, the accumulated EBITDA reached $492 million with 12% margin. For the full year we are maintaining our estimate of EBITDA from $770 million to $890 million, and 13.5% to 14.5% margin. Next page, page 14, adjusted net income was $70 million in the third quarter -- sorry, $75 million in the third quarter, with 5.7% net margin. Year-to-date, adjusted net income reached $221 million with 5.4% margin. Page 15, investments, total investment as of September 2017 was $398 million, broken by $32 million in research, $259 million in development and $107 in CapEx. Our investment outlook for 2017 remains for $650 million. Next page, adjusted free cash flow, we had the consumption of $23 million in the third quarter, reflecting the operating cash generation. For the full year, we are maintaining our estimate of maximum consumption of $150 million, but we believe we can do better. Page 17, regarding our capital structure, as of the end of the quarter, we had a total debt of $4.3 billion, with total cash of $3.6 million. We turned into a net debt of $723 million. Our debt average term was 6.1 years at the end of the quarter. Okay. With that, we conclude the financial results of the third quarter and turn to the discussion of the financial outlook. Next page, page 19, we would like to reiterate our outlook for 2017. However, we would like to mention that we may finish the year at the lower end of EBIT margin range and in terms of free cash flow we maybe better than the consumption of $150 maximum indicated. Next page, as we consider that 2018 will be a transition year, we would like to present the preliminary outlook for the year. In terms of revenues, we are indicating the range of $5.3 billion to $6 billion, for deliveries the range of 85 to 95 Commercial aircraft and 105 to 129 -- 125 Executive Jets. EBIT is being estimated from $265 million to $360 million, with margin range between 5% and 6%. Free cash flow should be a consumption of $150 million or better. Next page, we highlight the short-term headwinds that we believe will affect 2018 results, which includes the ramp up of the E2 program, the final development of that program as well, the Commercial Aviation deliveries below the level of 100 aircraft, a soft biz jet market and also constraints of Brazilian budget that is affecting the business. However, when we see the midterm, we anticipate meaningful gains in our profitability and cash generation related basically to the complete development of E2, the levels of above 100 aircraft for deliveries in Commercial Aviation, expectation of an improvement in the business jet market, a higher revenues from service, KC-390 international opportunities, as well as Super Tucano opportunities, the phase of production of the KC-390 and the more normalized CapEx. Also we have in place a cost control and cut program, which includes basically tools like zero based budget, digitalization, cost management, organizational design. We -- those initiatives will contribute to the performance improvement. So, with that, we conclude the presentation of the third quarter results and the financial outlook and we turn into the Q&A section. Thank you.

Yeah. [Operator Instructions]

Thank you. Good afternoon. Filippo, the EBIT margin guidance for next year the 5% to 6%, I imagine the bulk of that pressure is transition in Commercial with the E2, but what is that consolidated 5% to 6% contemplate as far as Executive Jets and Defense? José Filippo: Okay. In terms of Executive Jets, we still see a soft market, so we are keeping a flat level of the market and deliveries as well. We still having program improvement in terms of the manufacturing system, we are moving into the Florida facility and that furthers to process of positioning our product into the levels of price and margin, which I already mentioned that this quarter we are going to saw an improvement of that. If you see, we don’t -- this information of course is sometimes you cannot see internally, but we can tell you that even prices and gross margins were improved, if you compare by module from quarter-to-quarter that last quarter to this quarter. So we think that’s the positive indication. But we still see the market soft, so that’s not enough for us to really have a difference in terms of the contribution. In terms of the Defense, we are still in phase of developing, just starting to manufacturing of the aircraft KC-390. We -- as we indicated we plan to have the first delivery next year, but that brings all the inefficiency of the learning curve of the manufacturing. So that’s basically the combination of the other businesses that will not be able to offset the level of deliveries in Commercial Aviation.

Okay. Thank you. And if can just ask a quick related follow-up, I think, the cash flow guidance for next year, which is similar to where you see that you’re shaking out is, probably, pretty in line with where expectations were, but I think, on a lower EBIT margin range then what people were expecting. So what -- where is the offset. Is it on the working capital, is it on the investments? José Filippo: Basically the investment in the E2 that we get to a phase where we have lower investments, the pick of the investment was basically this year and last year, so we start to see reduction in the level of investment that compensate that. That’s basically why we are setting the same level this year.

Okay. Thank you.

Good morning. Could you give us some more color on the $50 million roughly loss in the other column this quarter, in terms of how much of that is just ongoing corporate expense, if we exclude all one timers going forward into ‘18, what’s the normalized level for corporate expense? José Filippo: Normalized corporate expense, I think, we should consider about $30 million to $40 million.

For quarter. José Filippo: For that quarter we had an impairment impact, which sometime happen, it’s not a recurring thing, but because of the way we have to account, sometime we have this impact, also some IT expenses, because we had an upgrade in the system that we had to incur with that and basically other corporate projects. But we don’t see that is being like a trend for that. So typically like I said we could use like $30 million to $40 million will be a different level for that.

Okay. And then just, biz jets have been weak year-to-date, you have kept your guidance, how many are in backlog already, how many slots are sold for the fourth quarter, just want to get a sense of the risk there and is that the major governing factor to your -- the width of your EBIT margin guidance of 8% to 9% or are there other factors? José Filippo: We don’t see difference that we saw before. They are same level, the challenging market, the short decision from the customer, so the backlog is not a large backlog that we are going to -- as we saw recently, when we at the end of the year that -- when we release the backlog by business. This is smaller piece of Executive Jets, that’s basically because the decision on the customer is more short-term, so it’s not a -- I don’t think this is the best way you have seen this. But it’s more likely the typical dynamic of the market today.

Is that the major factor to the width of your EBIT margin guidance, 8% to 9%... José Filippo: Yeah.

…whether it come upper end of your biz jet range or lower end of your range? José Filippo: Yes. Correct. That’s an average to what we see for 2018.

Thank you.

Thanks. Filippo, on the cash flow for this year, have you ever had a fourth quarter where it’s a negative cash flow? José Filippo: Yeah. That’s right.

Implied as, I think, a negative $150 million much of your Embraer has ever had a negative fourth quarter cash flow. So, I am just wondering is there, what’s the level of conservatism there, it’s seem like, it would be well north of positive? José Filippo: Yeah. Exactly. Because it’s better than $150 million, we indicated that we believe that it’s not going to be in the lower end of this guidance. Fourth quarter is typically stronger than the others. What we have here is of course some investments that we had the contribution of suppliers mostly in the beginning of the year, so we don’t have this in the end of the year. And also that we may have to -- in the ramp up of E2 as we start to produce E2 next year, it’s going to be some working capital that will be required for the E2 program. That’s why we didn’t revise that. But we indicated, I think, we can believe that and expect that we can be better than that limits.

Okay. Okay. And then, the margins as you look beyond your midterm, the pretty steep ramp, is the chart graphically accurate, can I take a ruler, but can you give some color what is midterm, is it 19… José Filippo: Two years to three years.

Two years to three years. José Filippo: And margins would be like high single-digit.

Okay. José Filippo: Low double-digit, in that range.

Okay. Thank you.

I was wondering if you can give a little bit more color in terms of 2019, because the E2 production ramp will probably be going up, you will have more deliveries of E2 in 2019, but you probably get a bit of a learning curve impact as you kind of -- as you work through it. So -- and maybe just you had a little bit of a better biz jet market. Does that sort of triangular to flattish margins into 2019 or do you think there is more pressure in ‘19 as well. José Filippo: We don’t want to give some specifics for ‘19, I think, at this point. We are trying to elaborate a little bit more in 2018, because we really think this is not a typical year. And going forward it’s more like the view of the midterm rather than to the specific in ‘19. Of course, all those will -- call the tailwinds that we highlighted there would be contributed to this and we believe that in two years to three years we have a normal situation if you will that we can compare to the years that we have before without those typical effect that we would be facing these days. But basically we don’t want to be specific on the next year, I mean, following the 2018.

Thank you. José Filippo: Maybe you take a question from the phone. We have a question from Cai Von Rumohr from Cowen. Cai, you…

Yes. Thank you very much. So, Filippo, maybe you could give us some color on next year in terms of what are the milestones we should look for to tell us that the E2 is improving or the KC-390 is improving? And secondly, you’re assuming the margins go down fairly substantially, is that likely to be a bigger dip in the first half, an improvement in the second half relative to your normal pattern or does it get worse relative to the normal pattern as we go through the year? Thank you. José Filippo: Hey, Cai. Thanks for the question. Cai, I believe that we going to have of course the same seasonality of the business that we had before. So no -- of the margin normally in the beginning of the year tends to be lower than the end of the year especially the fourth quarter. We don’t believe that’s going to change for next year. We plan and we expect to be about 10% deliveries next year related to the E2 and that brings this inefficiency that we just mentioned about the learning curve for that. And we will know if the programs are doing well, if you follow the certification process, if you follow the capacity for us to start to manufacture and I think that’s basically how we see next year. And again, we are calling this level of 100 aircraft, which is the level that we will be seen in recent years that next year because of the estimate that we just send out are going to be lower in that amount, so that’s also the dilution of fixed costs is going to be impacted with that. And we need to have an increase in production going forward due to the increasing revenues, sorry, increasing deliveries up in the midterm that we mentioned. So that’s basically, if I am understanding to exactly what you asked is basically how I see this trend in the short-term.

Thank you.

Good afternoon, gentlemen, and thanks for the time. Two questions for you. When we think about the margin on the E2, is there any plan to include gains from risk sharing partners, as you did back in 2004 with the E-Jets rollout? And then the second question pertains to the Brazilian budget, I mean, maybe it’s obvious, but, excuse me, if you could give us maybe a little more detail as to where the process is now on the KC-390 and versus where you thought it was? José Filippo: Yeah. Thanks, Steve. In terms of the contribution of risk sharing, we already having this during the development phase. So it will follow typically how we are doing in terms of development. I think there is something that we should change now. This is rightly reflects in the situation today and the program itself. I don’t think there is something that we should expect differently now. In terms of the Brazilian budget, of course, is -- this is a common information about the restriction they are having. However, the key problem for us which is the KC-390 is following well. So our accounts receivable didn’t increase, so having the same level of last quarter. So we keep on track on that. We already mentioned that one thing that we saw here was the reduction in scope of modernization program, which is not like the same level of the KC-390 but something that also we could see that could be an impact that we saw, recently we are dealing with the reduction of scope to be able to accommodate the requirement of the customer -- the client. That’s basically how we will be doing. But in terms of payables we are doing normally there is no change on that.

Okay. Thanks for the answer. José Filippo: Noah.

Thanks. Good afternoon. Just back to the E2 margin topic, any willingness or ability to actually quantify for us how much lower those margins are coming in compared to the Legacy regional jets and what the ramp to your historical Commercial margin looks like on the program just because that’s far the biggest lever and where the margins go from here? José Filippo: I think, in terms of the margin of E2, let’s think about 2018, we indicate that most of the reduction on the margin comes from, of course, the Commercial Aviation programs. It is one of the drivers for this reduction. But, again, we have to think about 2018 is a very unique year for that, because we are ramping that. This is first deliveries. Like I said 10% we expect to be deliveries of E2. That brings all this learning process. Historically, I think, Embraer has been able to improve all this capacity to manufacture. Remember that when we had larger orders from the American market on the E175 that we are delivering now. We mention about the price pressure because of the size of the order. And at that time we were able to improve the costs through efficiencies and learning on how to do large standard orders. And so I believe that we have capacity to really in the short-term be able to transform that into an efficiency in the learning curve this quarter. So for 2018 we are not counting on that, because this will the learning piece of this process, after that, that we expect to ramp up in terms of increasing margins. So those mostly what we indicated for 2018 reduction is due to the Commercial Aviation inefficiency if you will.

Can you tell us E2 margins in 2018 are slightly positive breakeven, slightly negative, largely negative? José Filippo: They will be positive. Low, but positive.

Okay. That’s helpful. Can you speak to pricing in recent Commercial orders and then on top of that you are sort of, I guess, near to medium-term outlook for campaigning on the Commercial side?

Given the quantum of orders that we -- the size of the orders that we are experiencing, as Filippo reference, there has been a certain amount of pressure over the course of a number of quarter. What I can tell you is, as we cadence into the final quarter and I reference it in my presentation later. We are starting to see some more price discipline in the marketplace, our ability to improve margins somewhat. So we continue -- I will give you more granularity and why we continue to see a loss of momentum on the E175 in particular at very significant level, so I will give you more granularity on that. So, in summary, for sure, there was some softness in those margins but it does feel now as if we are improving our position when it comes to margin, but we are certainly in addition to that maintaining a -- what I would describe is a significant amount of momentum in terms of orders around the E175 platform.

Great. Thank you.

Yeah. Thank you. Can you give us a sense of the E75 -- E175-E2 and what your plan would be there if scope clause doesn’t get lifted in 2021? And if it is continued to build it what that would do to margins?

Sure. Well, firstly, we are committed to the revised guidance of the entry into service of the E175-E2 in 2021. That aircraft we believe will have Commercial penetration -- significant Commercial penetration outside of the U.S. It’s a very different machine to the E175-E1. I see opportunities in China, in India, in Western Continental Europe, and in the Scandinavian countries. And so we are now proactively marketing that aircraft outside of the U.S., because as you know it’s not scope compliant and I expect to get some traction on those activities next year. Of course, if 2021 entry into service guidance now, so whether we will close transactions next year or not, I don’t know yet, but I can tell you we are proactively marketing that aircraft outside of the U.S. In relation just to address the U.S. environment, whilst we have no visibility as to when scope will change in the North American climate, we continue to address that market very successfully with the E175-E1 platform. On a relative basis since January 2013 I believe we have won over 85% of the seats in that market in North America and since January this year we have won 100%. So we have the platform that the customers want in North America. When scope is released we will have the platform for them with an even more efficient aircraft than E175-E2.

And this is a follow-up, can you tell us should we expect the SkyWest 100 order for the E2 to roll into an E1.

No. SkyWest is very pleased with their E2 order and I expect SkyWest will be one of, if not the largest operators of the E2 in the world in sequence.

Many thanks. So, just staying on the topic of the E175 and your point about that being more of your good deal momentum and also the point about the E2 is representing, I think, 10% of deliveries next year. Can you just comment a little bit on how you see this sort of mix -- the Commercial next year, obviously, your mix has been skewed very heavily toward the E175 in recent and just maybe how you see that in ‘18 and beyond?

I think we are going to continue to see the E175 play a meaningful center stage role for many years to come. I am going to give you some idea of the quantum we are talking about. But it is a very significant demand, it just sort of a series of waves. It’s like surfing off the west coast of Ireland. The waves are coming in very quickly which is great for us, because we seem to have the platform that the airlines are looking for. So I will tell you that our marketing teams are also spending a lot of effort continuing to market and deliver E195 and E190-E1. There is a lot of focus from Paulo and Filippo to ensure that from a revenue and a margin perspective that of course we’ve sell and deliver the larger platforms. But, pragmatically, I think, over the course of the next few years, you are going to see the E175 play a meaningful role in the sales and deliveries.

Okay. That’s great. And then just following up about the question -- prior question on potential conversion, I think, from E2 to E1, are you seeing any prospects for things going in the other direction, some conversions of E1s to E2s?

No. That’s not something that on the Paulo’s guidance, that was just not something that we interchange as a broad matter. There are -- I would say, one, two, maybe one customer in world that say, we are open to having that conversation with, customer possibly not based too far from where we are sitting right now. But as a general matter no, we are not interested in cannibalizing the E1 to sell E2s. And by the way there is no pressure from customers either. Customers that want E1, they want the E1s now. So as customers cadence into the E2, they are going to make larger commitments to the E2s, but as we cadence to the some set of the E1, particularly the 90 and the 95 platform as airlines are ordering their 2s and their 3s and their 5s, if they have a large incumbent fleet of E1, they are not going to make that jump yet to the E2, they are going to add to their fleet with incrementally E1, so we are not seeing that pressure and we are not encouraging it.

So, cash flow related question, if I could, it looks like you’re implied investments for the fourth quarter would be about $250 million to achieve your $650 for the year. I don’t believe I saw investment guidance for 2018. So can you characterize that $250 million in the fourth quarter the peak quarter, how does that look going forward into 2018. José Filippo: We are not breaking it down for next year. They should be less than the level that we having. For two years we have the level $650 million. We may have less in the next year. But we are going to give any more details certainly in the future not now on the -- in the beginning of the year as we release the results of 2017, we want to do a full revision on the guidance and we will provide those detail information, but it could be less than what we had this year.

Thank you. Just discussion about the midterm free cash outlook, one of the big variable, I think, it’s not listed there is, will there be a project to follow on to the E2 and there has been chatter about the turboprops and other biz jet, that sort of thing, to what degree does next generation platform factor into that outlook? José Filippo: The outlook does not consider any new project. We are talking about the midterm to two years to three years, so it not, we have to finalize E2 and we have been investing a lot in terms of plan the new program. We have today E2 under development in the phase 80% are developed. We have the Legacy 450 and Legacy 500. We have the KC-390 plants in Evora, Portugal, the Florida facility, Gaviao Peixoto in [inaudible] (40:05) Sao Paulo. So the huge level of investment that we entered in recent year. I think it’s now and we make those investments to generate some cash flows. So it’s not a -- something that we could expect and not consider in the projections that we are showing there.

You don’t feel a compelling need to launch a platform in the near future? José Filippo: No. There is, of course, the maintenance of the platforms that we currently do like we just exited Phenom 300E, the Legacy 650 also. So we do permanently, we do with investments in terms of maintaining the competitiveness of the product on other new platform.

Thank you.