Embraer SA (ERJ) 2016 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the audio conference call that will review Embraer's Second Quarter 2016 Results. Thank you for standing by. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-session and instructions to participate will be given at that time. (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 believes, may, will, estimates, continues, anticipates, intends, expects and similar words are intended to identify forward-looking statements.

Embraer undertakes no obligation to update publically or revise any forward-looking statements because of new information, future events or other factors. In light of these risks and uncertainties, the forward-looking events and circumstances discussed on this conference call may not occur. The Company's actual results could differ substantially from those anticipated in the forward-looking statements.

Participants on today's conference call are Mr. Paulo Cesar de Souza e Silva, President and CEO; Mr. Jose Filippo, Chief Financial Officer and [IRO]; and Mr. Eduardo Couto, Director of Investor Relations.

I would now like to hand the conference over to Mr. Jose Filippo. Please go ahead, sir.

Okay, thank you and good morning everybody and thanks for joining our conference of the second quarter financial results. I'm going to go as usual through the presentation and I'll pass to Paulo Cesar for his remarks and after that we'll be ready for the questions.

So starting the presentation in page 3, with the Corporate highlights, earlier this month we participated in the 2016 Farnborough Airshow where we had a chance to review our E190-E2 and the KC-390 in the international market. Together with that, we were able to have the first-time display of the Legacy 500, Super Tucano and Defense Systems in the same Trade Airshow.

In terms of commercial activity, we were able to announce the commitment for 25 E-Jets, the current generation and the E2 version.

Next page, page 4 is regarding highlights for Commercial Aviation. We delivered 26 E-Jets in the second quarter of 2016. Regarding new operators, TAP from Portugal became a new E-Jets operator.

As far as orders activity, we had several recent announcements. Japan Airlines order for an additional E190, Nordic Aviation Capital order four E190, Kalstar Aviation from Indonesia order for up to 10 E190-E2, and Arkia from Israel, Letter of Intent for up to 10 E195-E2. In relation to the E2 development of the program, we had the second prototype join the flight test campaign and now we have over 50 hours of flight tests.

The next page, page five, moving into the Executive Jets highlights, we had a delivery of 26 jets in the second quarter, broken by 23 light jets and three large jets, which included the delivery of the first Phenom 100 to Etihad Flight College.

In terms of commercial activity, we announced that across from Mexico had an order for 23 jets, being eight Legacy 500, eight Phenom 300 and seven Phenom 100. Also AirSprint, order for up to 12 Legacy 450, and Air Hamburg the purchase agreement for an additional Legacy 650. Regarding production activity, we started in our Melbourne facility the first assembling line of the Legacy 450/500.

Next page, six, highlights of Defense & Security business. Starting with KC- 390 program, three important information. First that the flight campaign reached over 400 hours with now two prototypes. Also that the KC-390 were able to do a demo tour in Europe and Middle East after the Farnborough Show. And very important to the commercial phase of the program, Embraer and Boeing signed an agreement on global marketing and support for that product.

An update on the LAS program for the US Air Force, we delivered the aircraft number 19 out of 20. And finalizing the highlights of defense in relation to the other Embraer defense programs, Visiona advanced with the satellite tests for the Brazilian client.

Next page and finalizing the highlights, but before entering into financial results, two important informations. First, the update on the SEC and DOJ investigations, and in page eight, we have been reporting this matter since 2011 and in May [2015] we informed that we started negotiations with the authorities for a potential settlement. Now we are seeing that the negotiations have significantly progressed, due to that we recognizing a loss contingency charge of $200 million. It is important to say that the final settlement is likely to include a deferred prosecution agreement and imposition of independent monitor. It's also worth to mention that negotiations with the US authorities are ongoing and subject to change.

Next page. The second important update before the financial results is the 2016 outlook revision. Page10, and due to more difficult conditions in the business jet industry this year, we are reducing expected deliveries by 10 aircraft for 2016. We now expect the range of 105 to [125] deliveries in Executive Jets, broken by 70 to 80 light jets and 35 to 45 large jets, resulting in lower revenues to the range of $1.6 billion to $1.75 billion, from $1.75 billion to $1.9 billion. We are also reducing the other revenues by $50 million.

In this page, we show the changes in our estimates, but it's also important to highlight that the reduction on the margins, EBIT and EBITDA and the lower free cash flow generation, driven by higher inventory levels and lower profitability. We had the revision on the free cash flow generation for the year from negative $100 million to negative $400 million.

In next page, we will detail our new guidance. So, now in page 11, we now expect total revenues with the range of $5.8 billion to $6.2 billion. When we break this by business unit, in Commercial Aviation, there was no change, deliveries in the range of 105 to 110 E-Jets and revenues from $3.45 billion to $3.65 billion. This would represent 59% of the revenues consolidated of Embraer 2016.

In terms of Executive Jets, as already adjusted, deliveries from 70 to 80 light jets, 35 to 45 large jets and the net revenues in the range of $1.6 billion to $1.75 billion, which would represent 28% of the revenues of the Company.

In terms of Defense and Security, net revenues unchanged in the range of $0.70 billion to $0.75 billion. To sum up the total revenues, other revenues of $50 million, representing 1% of the total revenues.

Continuing, next page, page12, in terms of EBIT and EBITDA. The EBIT range from $405 million to $500 million, the margin from 7% to 8% and EBITDA from the range of $735 million to $840 million with margin from 12.7% to 13.5%.

In terms of free cash flow, as already anticipated, the expected use of less than $400 million. And finalizing the outlook for 2016, we are maintaining our total expected investments of $650 million, broken by $50 million in research, $325 million in development and $275 million in CapEx.

Now we move to the financial results for the second quarter 2016 and the year. And starting with page 14, our firm backlog, it was unchanged compared to the end of March in the total of $21.9 billion.

Page 15, as far as aircraft deliveries, from the left, we delivered 26 aircraft in Commercial Aviation to the total of 47 to date, actually in the end of the second quarter, June 2016. In the right side of the sheet, we have the delivery of 26 Executive Jets in the second quarter, broken by 23 light jets and 3 large jets, and accumulated of 35 light jets and 14 large jets in the year. In the bottom of the page, our outlook for 2016, already adjusted, Executive Jets from 35 to 45 large and 70 to 80 light jets and maintaining the E-Jets commercial from 105 to 110 deliveries.

Moving to next page, page 16, we reported net revenues of $1.36 billion in the second quarter with accumulated of $2.67 billion in 2016.

Next slide, slide 17, breaking revenues by segment. The top right, Commercial Aviation reported $857 million in the second quarter, accumulated of $1.57 billion in the year. Going down -- right down, in terms of Defense, the total of $210 million in the second quarter, accumulated of $0.4 billion in the year. And moving down left -- bottom left, the Executive Jets reported revenues of $293 million in the second quarter, with accumulated in the semester of $0.69 billion.

Next page, in page 18 regarding SG&A expenses. We had a total of $147 million in the second quarter, similar to the same period figures in the second quarter of 2015. Accumulated, $287 million in the year.

Next page, page 19. As far as operating results, we reported negative operating result of $127 million in the second quarter, but excluding the $200 million provision, the operating result would be positive in $73 million. The recurring EBIT margin was 5.3% in the second quarter, broken by -- EBIT margin by business of 10.7% in Commercial Aviation, 2.4% in Defense and negative 8.5% in Business Jets. Accumulated total EBIT margin was 5.9% in 2016.

In page 20, regarding EBITDA, we had the a recurring EBITDA of $152 million in the second quarter with a EBIT margin of 11% in the quarter. In 2016, EBIT reached $320 million with a 12% margin, without extraordinary charges of $200 million.

Page 21, we reported net loss of $99 million in the second quarter, which would be a positive $101 million, excluding the $200 million provision. Accumulated in the year, we have the recurring $205 million and with the charges, the reported [$104 million] as of June 2016.

In page 22, in terms of investments, we had a total of $245 million in the year, broken by $17 million research, a $139 million in development and $89 million in CapEx. We are maintaining our estimate of $650 million for the full year investments.

In page 23, as far as free cash flow, we reported a negative free cash flow of $439 million in the second quarter and accumulated consumption of $655 million in 2016. The use of $200 million in operating activities was due mainly to higher inventories. As we already indicated, we are now estimating this consumption of no more than $400 million in 2016.

The next page and finalizing the presentation, our capital structure. The total debt of $3.7 billion with an average maturity of 5.7 years and as a consequence of the accumulated negative cash generation in the first half of the year, we reported a net debt of $613 million in June 30.

With that we finalize the presentation and before we start the Q&A section, I would like to turn to Paulo Cesar for his remarks. Thank you.

Thanks, Filippo. Good morning. So thank you for joining us in this call. So this is my first call as a CEO of Embraer and for me it's an honor to take the leadership of this Company. And I'm very glad to assume this leadership in a moment that the Company has a huge legacy coming from Frederico Curado, the former CEO, who took over in 2007 and started to make important investments in new products, setting the tone for the future. So for those that who attended Farnborough this year, so you could see the materialization of what I'm saying. So for the first time, Embraer brought all the three business units with updated products. So we had there the KC-390, the 190-E2 and the Legacy 500. So all brand new aircraft, brand new programs, representing total investment of about $5.5 billion in the last years. So we believe that -- I believe that we are in a good position, an excellent position to move forward and to maintain our position in the market.

When we look at the performance of this -- especially the KC-390 and the E2, I will start by the KC-390, only around 100 hours after the flight test, Flight Campaign I started. So this aircraft flew to Farnborough in the Airshow, a very high level of maturity in this flight. After Farnborough, the KC-390 went to visit a few countries and it was also a spectacular performance. So the same for the E2. So, 50 hours after the first flight, we brought the E2 to Farnborough and also with the excellent flight, so showing that both aircraft have a very good level of maturity. So we are set to go to the markets and be successful with these new programs.

So the Legacy 500, also is being -- showing a lot of interest and is being considered already the best aircraft right in the category. And the E2 family, the most efficient aircraft in the segment from [70 to 136]. So the E2 [also] family, so we have launched this program a little bit over three years and we have accumulated so far almost 300 firm orders and more than 670 orders, when we add also options in LOIs. So this is already a huge success in the market.

So I'm sure that Embraer is set for a bright future. There are good opportunities here for us to improve our margins. I believe that now since we have now invested a lot in these programs, as I said, we have to concentrate now in our cost side, in becoming more efficient and adjust the Company in a way that we can deliver a better margin. So I am quite positive that there is good room for that and this is where one of the -- my focus will be exactly on this.

Talk about the markets a little bit, starting by Business Jets market. It is a soft market, it is a soft market. The new guidance, or the revision of the guidance that we are making today is in line with what the market is doing. So we are seeing the market in general reducing guidance by around 8%. So we are doing the same. We do not want to fight against the market, so we have to recognize that there is a soft market, so we will no longer fight for market share. I believe that we have to sustain our business and make it a sustainable right business. So it's not [by selling], but it's selling in order to also make money and give return to our shareholders. So this is what we are looking for.

Business Jets may not recover for a while, nobody knows, but no one expects that in the next two years or three years this market will recover. We still have a lot of used aircraft in the market, around 11% of used aircraft inventory when compared to the size of the fleet, total fleet. So we have around 400 used aircraft in the market. And the forecast this year is for deliveries of around 650 aircraft only, coming down from the peak in 2008 of 1,200 aircraft. So it is a different market and we have to adjust to this new market.

On the Commercial Aviation, so we are very bullish, as I said. So the E2 is going very well. So we are involved in many campaigns, a lot of interest in these aircraft. And on Defense, definitely. So, we have the KC-390, has a huge potential to boost the Defense business. So the show-up of the KC-390 in Farnborough, the level of interest that this aircraft has attracted. The agreement that we made with Boeing for marketing and after-sale support for the KC-390 on a global basis. The efficiency of this aircraft, the flexibility of this aircraft. So I'm sure that the KC-390 will be a huge success. So we are very bullish on the Defense -- on the KC-390 going forward.

Last but not least, words about our provision. I think it's very important that we are getting to the end of this case; that's important for us. So we will turn this page. And with that we will be looking again to develop our business and [prefer] to develop Embraer.

So with that I turn to you for your question, please.

(Operator Instructions) Myles Walton, Deutsche Bank.

I was wondering if you could talk a bit about the cash flow guidance. So $50 million of that looks like lower profitability, with the other $250 million of the negative revision to free cash flow, is that all inventory? And similarly, Filippo, what should we think about planning-wise for 2017 in terms of reversing that inventory?

Actually, it's exactly what you mentioned. The increase of the consumption of cash this year is pretty much related to the [internal production]. Production is already set in terms of supply chain for this year. We tried to make some possible adjustments, but we expect to end up with some higher level of inventories, which will be the higher -- the most impacting in the consumption this year. Of course, we expect to -- in this strategy to really be disciplined in terms the way we approach the executive market in terms of sales. We expect to be -- maybe what's possible next year without [lessening] the price and that definitely we can have an adjustment in terms of production for next year that we -- using the inventory that we end up this year potentially. They'll be reverting part of that next year if possible. That's how we asses this.

But how much of a delivery cut next year -- and that's a pretty big implied delivery cut next year that would take place on business jets, if that's the case. So, I guess as a placeholder, you're looking for business jets to be down 10% next year or more?

I think it's too early to say that the projects for next year is going to be done sometime soon in the future. However, I think that we work -- we don't work in that reduction. This reduction probably we plan to have -- to be flat for next year. That's the first -- not a continuous reduction. That's not we work on.

And then can you comment, Paulo, maybe on the Legacy 450? I don't think it's been delivered here in the first half. When does that start to pick back up in terms of deliveries and what's the obstacle?

So we will start delivering the second half now. So it's all good, so we are in good shape to start to deliver the 450. So we are very bullish, as you know, on the 450/500. So, two great products and I'm sure that -- so the market will recognize the 450 as much as it's been recognizing the 500, as being the two best aircraft in the category.

And last one, could you give the -- Eduardo, could you give the segments margin -- or margin by segments for EBIT basis?

Yes, Myles, I can give to you. For the second quarter, Commercial was 10.7%, Defense 2.4% and Executive minus 8.5%.

Cai Von Rumohr.

Could you maybe give us a little bit of color by model? We're hearing from one of your competitors that you're bringing the price of the 500 down to compete with the Latitude and that the 450 is really not selling well. Thanks.

So, Cai, I believe the pressures on the business jet units are huge, as I mentioned. So we are seeing a soft market and our competitors have adopted a strategy, that is to discount the price of their products. So we are following this. Of course, that we have to be responsible and also give our answer right to the market. However, we hope that going forward now with more discipline in our side and not looking at market share only and also adjusting our cost, our internal cost, especially in the unit, so we believe that we will be able to get back to the margins that we need to make this business sustainable.

Just a quick follow-up. If you're going to carry some inventory over to next year, I assume it's business jets. What is the impact going to be of presumably having to discount, to move some of that inventory and the adverse overhead of kind of cutting production rate down even more? And what can you do to kind of offset that to sustain the profitability, or at least to minimize the profit downsize in biz jets? Thanks so much.

So, the carryover on the inventory on the business jet units is already reflected in the guidance that we gave on cash flow -- on free cash flow this year, coming from $100 million to $400 million negative, so it's already there. And next year we will adjust the production of the biz jet unit for the new levels that we are going to, I would say, forecast for next year. But there will be a carryover for next year.

Alexandre Falcao.

So, my question is really on Defense. We are expecting because of the FX a bigger reversion on the cent. So I just wanted to know, if you guys could walk us through what happened there and is this a part of the reversion of all the provisions that you did last year, or that we shouldn't expect any bigger improvements in the margin on that front? Thank you.

I don't think there's going to be a major impact in Defense. There is, of course, as we already indicated last year, the exchange rate impacts that -- the contract of Defense. But as we have less to go in terms of the contract, this effect tends to be lower. However, of course, we are seeing that those negative impacts that we had last year they are no longer happening and this is important to confirm this impact there. So you saw a positive. I think the Defense tends to be in a way that we already indicated to you recently, in the mid-single digits, something that we could work for this year. So I don't think it's going to be necessarily major impacts there, but it's going to be something positive, of course, but not a big impact, because of the stage of the development of the contracts that are affected by the exchange rates.

Just one more follow-up question on Commercial. Just wanted to know where you are in terms of the gap between the E1 and E2, where do you see -- after this new orders, what do you see in terms of gap, specifically for 2018, where we are right now and how much more you need to feel comfortable for the transition? Thank you.

Well so we are, in this regard, I think we are doing very well. So we have 2017 in very good shape and 2018, so step by step, so we are closing this gap. So we still have, I would say, about 35% maybe for 2018. But we are very much comfortable that we will also fulfill 2018. So we still have like two years until there and given the level of activity that we are seeing in the Commercial side, so we have the comfort that it's going to be okay. So beyond that it's too early to say. But these orders that we have recently announced, of course, it calls also for deliveries in 2019, you know.

And just to follow up on that. In terms of modeling, how much of the options you guys usually model that are converted, specifically for the E1?

Well, this is a tough question, because, of course, the market is very dynamic. So it depends on the movements of the market. But historically, the ballpark number of rate conversion is about 60%. This is more or less the number. So it's not an exact number, but as I said, a ballpark number.

Derek Spronck.

As you round out the development of the E2, it would seem like a natural progression for you to develop a large cabin business aircraft. Is that still under consideration given the current environment in Business Aircraft, and if not, what are other areas or products that you find potentially interesting as a future development program?

We don't know yet whether or not we will be looking to a new business jet. I think we have to look at what we have done in the last years and monetize these investments before we can move forward and go into new investments -- heavy investments. So as I said at the beginning, so I think that we have excellent products now in the three business units and we have to make sure that we can consolidate these investments before we can plan for new investments in the future. Of course, there will be new products in the future, but at this moment now I think our focus must be in consolidating these investments.

Would you have a couple opportunities in Defense, perhaps, in maybe smaller programs or smaller investments that you're looking at?

No, big investments in Defense now. Of course (inaudible) I would say, a product, but no big investments. So our focus also on Defense is to go more international, trying to diversify more the business in terms of geography. And as mentioned before, the KC-390 is a terrific aircraft and I am sure that we'll go more and more international in Defense as well.

And then just quickly on the Commercial side, can you comment on the pricing and order environment in Commercial and any update on potential scope clause changes in the US to 100 seats. And then finally, are you seeing any competition from the MRJ or the Superjet picking up?

MRJ, Superjet, not really, especially MRJ. So I think they are still late in their program. Superjet, a little bit in Russia and in the countries surrounding Russia. Of course, we have Mexico, but other than that we are not seeing too much Superjet in the market. And scope clause in the US, I think this will not happen any time soon. I think there is still a long way to go until the scope clause may change from 76 seats to 100 seats. Of course, if this changes, we would be very well positioned, since we have the most efficient aircraft right in the segment. We continue to sell very well the 76 seat in the US and we continue to follow the opportunities in that market for the100-seat plus in the major airlines. So there might be opportunities there that we have to be very close to it, and that may happen maybe next year.

And are you seeing any signs of a little bit more rational pricing from your major competitor in the regional jet space?

Well, I think this is well known, right, so what our competitor strategy is right now in the market. So, we are following this very closely. I think we have already been very vocal regarding this point. So we want to make sure that our competitor will not use government money from the tax payers in order to provide aircraft at below cost right in the market. So I think this is very important to make this point and every time that this -- we believe that this is happening, we will be vocal about that.

Pete Skibitski.

Paulo congratulations.

Thank you.

Paulo, can you talk about the Commercial order environment? Farnborough was really quiet. I apologize if this was asked, I got on the call late, but how is the campaign environment in the second half of the year? I've seen some measure of some potential large ones in India. And do you think you can get to a one-times book to bill in Commercial orders this year?

Yes, I have to be very careful of what I say here, because I don't know if our competitors are on the line, right, so I have to be careful. But anyway, so I think in Farnborough we have announced an important orders, so not very larger in number, however important orders in the sense of new airlines to join the E2 program -- E1, E2 program, new jets program, and also repeating orders. And going forward, in the second half, so we are involved in many campaigns, again, so not individual large orders, but diversified airlines, in the diversified regions of the world, and this is very important to us. So we are not seeing any very big campaign now, but many campaigns and which brings important diversification to us.

And then just one follow-up, on the $200 million contingency, again, I might have missed this, but can you give us a sense of the timing on the cash impact of that? Is the cash payment going to be a similar order of magnitude, or is it likely to be less and is that going to be kind of a 2017 event, can you give us any more color on that?

Not yet. So this is a provision that we made now. We are still negotiating with the DOJ and the SEC and this is what we can inform now.

Victor Mizusaki.

I have two questions. The first one, I've taken a look on your guidance for business jet sales and cash flow generation for this year. If we assume that the production rate is unchanged, can you add basically 10 new business jets to your inventory with an average price of [$30 million]? Is this number correct? And the second question, can you give us an update on the negotiation with Republic Airways?

I think that Victor, in terms of the calculation you made for the inventories of executive jets, I think the number of aircraft is reasonable, however the price seems to be little bit higher than what we should expect. So maybe it's about there, but with a lower amount. So regarding Republic, so I can give you an update. I believe Republic Chapter 11 is moving well, in terms of Republic being able to have agreements with the major airlines and major suppliers. So Republic already -- written agreement with Delta, United, and now is negotiating the final stage, as far as I understand, with American Airlines. Regarding Embraer, so we are in deep dialog now for the 24 aircraft that we have to deliver next year. We are postponing nine aircraft from this year to next year as already announced, and therefore, next year we'll have more deliveries. So we basically will deliver next year approximately 20 aircraft and four in 2018. So it's not yet 100% finalized, but this is the ballpark number. So in this regards, it's going well. So we are in the final stages of negotiations with Republic.

But there are these nine aircraft that should be delivered this year. Is this number incorporated in your guidance, or this is something that maybe can change in the future?

No, the guidance is kept the same, so we are not changing at all the guidance. So we will meet our guidance in the Commercial Aviation.

Victor, it's Eduardo here. Just to be clear, as we shift some slots, we continue to see 105 to 110 deliveries this year, even if we don't deliver planes to Republic this year. So that's the point.

Josh Milberg.

You commented on the margin performance by division in the second quarter. I was just hoping you could give us a rough idea of what margin expectations are for the individual divisions, or what's embedded into your full year guidance in that respect, and maybe also what you see as the biggest risk to that guidance now?

I think that the revision on the guidance was basically driven by the Executive Jets. I think we are comfortable about the other business, the way we started and initially guidance that was provided. So as we said, Commercial like low-double digit, versus the Defense in the mid-single like I already mentioned. Executive is what we are already reviewing. So, it's going to be again probably a little bit less than originally, it will be like targeting the mid-single digits, but probably lower than that, towards that.

And what FX assumption are you working with now?

We worked with the current situation, which is BRL3.3 per dollar.

And then just moving a little bit away from the result, I was just hoping you could revisit the whole issue of any discussions by the Brazilian government on either removing or amending some of the tax breaks you get, either thinking about maybe the payroll tax benefits and the (inaudible).

Of course there's been a lot of discussions on the tax -- the fiscal situation. The Brazilian government is always going to talk about tax benefits that we've given or some type of thing. I don't think that we have any specific benefit of that. I think (inaudible) is something that covers investments in technology for the whole industry, which tends to be capped. We don't think there is a big risk of that to be changed. So basically the adjustments that we already saw are the ones that we are expecting. We don't see major changes going forward for that situation.

Thank you. We have no further questions. This concludes today's question and answer session. That does conclude Embraer's audio conference for today. Thank you very much for your participation and have a good day.