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Embraer SA (NYSE:ERJ) Q4 2018 Earnings Conference Call March 14, 2019, 9:30 a.m. ET
Contents: Prepared Remarks Questions and Answers Call Participants Prepared Remarks:
Operator
Good morning, ladies and gentlemen, and welcome to the audio conference call that will review Embraer's Fourth Quarter of 2018 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 call, please press the * followed by 0. As a reminder, this conference is being recorded and webcast 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 a forward-looking statement.
Participants on today's conference call are Mr. Nelson Salgado, Executive Vice President Finance and Investor Relations, and Mr. Eduardo Couto, Director of Investor Relations.
I would like now to turn the conference over to Mr. Nelson Salgado. Please go ahead, sir.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Good morning, everyone. Thanks for joining our call.
Please start at Slide 4 with a summary of the most recent events related to Embraer and Boeing strategic partnership. After a few months of some uncertainty and speculation, we are very glad that the transaction was approved by the vast majority of our international and local shareholders with 96.8% of shareholder a favorable vote at the extraordinary shareholders meeting held on February 26th. Before the general assembly, we had signed the contracts for Boeing on January 24th, and we had the Golden Share go ahead on January 5th. The deal is still subject to approval from antitrust authorities and satisfaction of other customary conditions. The closing is expected at the end of 2019 subject to all approvals being obtained in a timely manner. We believe the transaction will bring a lot of value to our customers, shareholders, and employees. And Embraer will continue to keep the market informed as we advance in the transaction.
Now, moving to the next slide, Slide 5. We start with business units' highlights. First, on Commercial Aviation. In 2018, we delivered 90 e-jets including the E-jets 1,500th which is a very important milestone for the E-jets but are not many commercial aircraft in the industry that features this level of delivering.
As far as sales activity, we had a very strong year in 2018, especially in the last quarter. We have 207 new firm orders including large orders from important customers like American, Azul, Republic, Skywest, United, and others. With that, our book to view relative to 2018 was better than 2 which is very good. And also, the effect that had on our backlogs.
Moving to the E2 performance. We remember that the first 190-E2 was delivered to Wideroe in April after having received the triple certification from ANAC and FAA. And the operation is going very well. The fleet at Wideroe has reached and accommodated 98.5% of schedule reliability and 99.5% completion rate, which are outstanding figures for the start of operation of a new type.
In terms of the E2 development program, the program continues to advance as planned. We expect to have certification for the 195-E2 in the first half of 2019 with first delivery to large customer Azul in the third quarter of 2019. The development of the E175-E2 progresses as well. During 2019, we will be assembling the first prototype of the 175-E2.
Moving on to Slide 6. We will talk about the Executive Jets highlights. We delivered 91 Executive Jets in 2018, 64 light jets and 27 large jets. We are very proud to announce that in 2018 our Phenom 300 was again the most delivered light jets in the industry. That's for the 7th consecutive year in a row, exceptional results for our Phenom 300.
Regarding new products, we launched the new Praetor 500 and Praetor 600 at NBAA 2018. Those two planes are the most disruptive and technologically advanced midsize and super-midsize jets. They have an unprecedented range in their segments, 3,250 nautical miles for the Praetor 500 and 3,900 nautical miles for the Praetor 600. They are also the best in class in cabin altitude, cabin design, and have an ultra-quiet interior. It is important to highlight that the new Praetor 600 already concluded the flight test campaign with results that exceed the requirement and specifications and the program is on course for first deliveries starting in the second half of 2019. Important also to say that the program is sold out for 2019 and there has been a huge demand from customers for this new product. Finally, as far as customer support is concerned Embraer was ranked #1 in Pro Pilot and #2 in AIN customer support surveys, reinforcing the commitment Embraer has with supporting its customers with excellence.
Moving on to Slide 7, Defense and Security highlights. Starting here with the KC-390 joint venture. As we have been mentioning, the KC-390 joint venture is an integral part of the strategic partnership with Boeing and it will in our view unlock global sales potential and promote new markets for the KC-390. Important to highlight that the KC-390 program is in a very special moment of its life where we in 2019 will finish a long period of almost 10 years in product development and move into a new phase where the KC-390 will be in serial production contributing more than $5 million for revenue will result in dissonance.
The program has already received certification from the Brazilian Civil Aviation Agency and the flight test campaign with two prototypes now exceeds 2000 hours of flights. The first delivery to the Brazilian Air Force is expected to happen in 2019 and we have already aircraft #004 to #009 under different stages of assembly for delivery to the Brazilian Air Force in the next years.
Regarding the Super Tucano, we delivered 9 aircraft in 2018 and got new orders for another 12 aircraft which is a very good result for the Super Tucano program. As far as new opportunities, the Consortium Aguas Azuis formed by Embraer was shortlisted in the Brazilian Navy Corvette Class program. In this program, Embraer will provide combat management and system integration. And finally, regarding services, it was a record year in terms of sales for Defense Services which is something we believe is very important.
Moving now to financial results. Starting at Slide 9, we show our backlog. Embraer ended 2018 with a backlog of $16.3 billion. Important to highlight that in the fourth quarter of 2018, our backlog grew $3 billion. We believe this is an important milestone and reverses the trend of reduction of backlog that we've been observing in the last few years. That increase in backlog was led by commercial aviation sales that we have announced mostly at the Farnborough airshow and was done in the same contracts in the last quarter of 2018 as we have anticipated. But also, new orders for the Praetor aircraft which as I mentioned to you the aircraft is sold out for some period and it's already helping us to accommodate some backlog.
Moving to slide 10, we show deliveries which we've already mentioned. In Commercial Aviation, we delivered 90 planes closing at the middle of our guidance, which was from 85-95. In Executive Jets, we delivered 91 planes, 64 light aircraft and 27 large, in line with our revised outlooks which was exactly 91 aircraft. In Executive Jets, we had lower deliveries in 2018 mostly driven by the announcement of the new Praetors in 2019. This aircraft we will start to deliver in the second half of 2019. Also, the lower deliveries they are a result of our continued discipline in terms of pricing which on the other hand has already started reflecting very positively in the results of Executive Jets as I will mention later on.
On slide 11, we show net revenues. We reached net revenues of $5.071 billion in Embraer as a whole. This revenue was mostly in line with the revised guidance we presented which was $5.1 billion. It is important to mention that our revenues were affected by lower deliveries in Commercial. We at the beginning of the year could get up to 95 deliveries, and Executive as I mentioned before. But also, by the cost base revision that we had to do in the KC-390 that affected both our EBIT but also our revenues regarding the KC-390 and our defense.
Next slide, slide 12, we show SG&A expenses. We continue to show about our trends in SG&A finishing 2018 at about $485 million, broken by $183 million in G&A and 304 million in selling expenses. This continuous reduction is partially driven by our cost-cutting program called Passion for Excellence launched in 2019, but generally reflects the function of the company regarding reducing its costs.
Moving to operating results at Slide 13. We reported 2018 adjusted EBIT of $224 million with a decline in margin of 4.4%. These numbers are slightly above our revised guidance of approximately $200 million and 4% EBIT margin. Breaking our margins by business, we had in 2018 6.5 EBIT in Commercial Aviation, 1.5 EBIT in Executive Aviation, -9.1 in Defense, and 12.5 in Sales and Services. Looking at the margin by business, Commercial and Defense presented a decline in 2018 versus 2017. In the case of Defense, results were affected by the accident with the KC-390, the incident, and we adjusted for part of that. But there was an additional cost that was recorded in the last quarter for the year which we did not adjust. If it was not by this cost, Defense would have been almost break-even despite the difficulties last year.
It is very important to mention that our margin in Executive has recovered. Gross margin has grown almost 500 comparing 2017 to 2018. In 2017 we had a gross margin of 12% and in 2018 the gross margin was 17%. This is very good evidence of our cost discipline and how we are working to really extract value from our products. We expect these trends to continue for the next year.
Next slide, slide 14, we show adjusted EBITDA. Generally speaking, everything that affected the EBIT affected also the EBITDA. We closed the year with $474 million implying a margin of 9.3%. This is also in line with our revised guidance.
Moving to net income. We reported a net loss of $54 million in 2018 mostly due to the weaker operating results and higher financial expense. That result implies a negative margin of 1.1%.
As far as investments at Slide 16, we spent $305 million broken by $94 million in capex and $211 in R&D. Important to mention that we had the important contribution of more than $100 million from suppliers so that the actual activity of our investments was more in the order of $400 million than $300 million. Which means that we are continuing the development of our product portfolio as planned both in Commercial Aviation but also in Executive Aviation with the announce of the Praetors. But the comparison of those results with previous years it shows clearly that we are getting to end of a very strong product development phase that we had in the past and we should expect that change to go in the future.
Moving to free cash flow at Slide 17, we reported a positive free cash generation of $422 million in the fourth quarter. We ended 2018 with a free cash flow consumption of $128 million, which is better than the revised outlook that we gave which was better than the consumption of $200 million. Important to highlight here the strong cash flow generation in the fourth quarter which was better than the fourth quarter of 2017 which was also already good.
Lower investments and accounts receivable were both highlights in the free cash flow. While we ended up the year with a higher than desired inventory of Executive Jets and we did not deliver as many jets as we would have liked. Which means if we had done so our cash flow in the fourth quarter would be even stronger.
Moving to indebtedness at Slide 18. We ended 2018 with around $3.2 billion in cash and $2.6 billion in debt implying net deposition of $440 million. Our fourth quarter 2018 net debt of $440 million was significantly better than the third quarter 2018 net debt of $881 million due to the strong cash generation in the fourth quarter.
Finally, on Slide 19 we show our 2019 outlook that we already presented on the Investor Day in January. Important to note that 2019 will be a different year for Embraer because of the completion of the deal which is expected to happen at the end of the fourth quarter. We expect net revenues to increase to $5.3 billion to $5.7 billion with the delivery of 85 to 95 e-jets and 90-110 business jets. Important to note that in 2019 we only delivered the first two KC-390 to the Brazilian Air Force and we plan to deliver 10 Super Tucanos.
Despite this growth that we expect in revenues, as far as operating results we expect the results to be break even. And that is mainly due to the separation costs that we anticipate that we will incur during 2019 to prepare the carve out of the Commercial Aviation units by the end of the year.
And finally, and very important, as we approved the deal in our general assembly, we committed to paying $1.6 billion in extra dividends to our investors and to start 2020 with Embraer with no leverage and a $1 billion net cash position at the close. These cash targets are very important and will be pursued will all energy during 2019.
With that, we conclude our presentation and would like to open for Q&A.
Questions and Answers:
Operator
Ladies and gentlemen, we will now begin the question and answer session. If you have a question, please press the * followed by the 1 key on your touchtone phone. If at any time you would like to remove yourself from the questioning queue, press *2.
Our first question comes from Cai von Rumohr with Cowen and Company.
Jeff Molinari -- Cowen and Company -- Analyst
Hi, yes. Good morning. This is Jeff Molinari on for Cai. Thank you for taking my question. The first question is what were the adjusted EBIT margins by segment for Q4 and also for the year?
Eduardo Couto -- Chief Financial Officer
We had two main adjustments in the EBIT margin. The first one was in the second quarter of 2018 that we had a negative impact from the incident we had with our KC-390 was around $130 million in the second quarter. That was the first impact. And the second one was around $60 million now in the fourth quarter which was an impairment of our Lineage platform on business jets. So, those are the three facts we adjusted in 2018.
Hello? Jeff? Operator? Are we connected?
Operator
Jeff seems to be disconnected so the next question comes from Myles Walton. Mr. Myles Walton, your line is opened.
So, the next question comes from Victor Mizusaki, Bradesco BBI.
Victor Mizusaki -- Bradesco BBI -- Analyst
Hi. I have two questions here. The first one is just a double check in terms of operating margins. So, can I assume that 2018 Q4 the adjusted operating margin in Executive Aviation was I think close to 6%? The other part with regards to the margin in Q4, you mentioned that you had a number of cost complications which came out to $40 million. Is this correct?
Eduardo Couto -- Chief Financial Officer
Sorry, Victor, the first question was regarding the margins on Executive jets in the fourth quarter?
Victor Mizusaki -- Bradesco BBI -- Analyst
Yes.
Eduardo Couto -- Chief Financial Officer
Yeah. We had in the fourth quarter an adjusted margin of 6.5% and for the full year, as Nelson mentioned, 1.5%. Also, important to highlight that the gross margin on executive jets, as Nelson mentioned, had a very strong performance going from around 12% in 2017 to 17% in 2018. The decrease of more than 500 basis points was not fully translated on the operating margins given the lower delivered, but I think it's in line with our focus to recover the cost.
Victor Mizusaki -- Bradesco BBI -- Analyst
Okay. In the case of the Defense business, in Q4 you had a couple of cost revision base can you confirm the amounts of adjustment in Q4?
Eduardo Couto -- Chief Financial Officer
Yeah. We had in fact around $40 million in the fourth quarter in Defense that was not adjusted. So, in the end, we had these negative margins around 9% in Defense for the full year but excluding this $40 million, margins would be slightly negative around 1% or close to break even for Defense. I'm talking about operating margins in Defense for the full year 2018.
Victor Mizusaki -- Bradesco BBI -- Analyst
Okay. My last question here, I wanted to look at your guidance for 2019. You say break-even margin, but this number includes the percentage of cost. So, I don't understand disclosed exactly the amount or the expected cost. What the deal?
Nelson Salgado -- Executive Vice President Finance and Investor Relations
We are not disclosing that value because we are learning about this process as we go deep in the planning. But I think we are confident to say that our margins after these costs will be break even as we mentioned in the guidance.
Victor Mizusaki -- Bradesco BBI -- Analyst
Okay. Thank you.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Thank you.
Operator
Our next question comes from Myles Walton, UBS.
Myles Walton -- UBS Bank -- Analyst
Hey, good morning. I apologize if this question was asked because there was a little bit of a block in the call for a little bit there.
Jeff Molinari -- Cowen and Company -- Analyst
Yeah. Sorry. I think we had --
Myles Walton -- UBS Bank -- Analyst
I want to understand the executive impairment charge and what the source of that was? And also, on the KC-390 the extra costs, can you just clarify where the costs are coming from? Was it the design change or something that is now behind you?
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Okay, Myles. Regarding the Executive Jets, the extra costs come from the impairments of some R&D expenses that we had to amortize regarding the Lineage program. The sales have been slow in line with good accounting practices. We made impairments regarding those values. The Lineage program, the value is $61 million.
Eduardo Couto -- Chief Financial Officer
If I may add, Nelson, it's important to make clear that it's related to the Lineage platform which is the Legacy platform, our old platform that we had. So, it had nothing to do with our new platform. It was 100% related to the Lineage platform.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Yes, which is also in line with our strategy for closing the new platform that we mentioned lately. And the charge on Defense, first we had the $127 million that we recognized with the new operating year, which we have been set apart here. But we had another charge of around $40 million related to insurance that we recognized in the fourth quarter which we did not set apart. Leading the results to this minus 9 EBIT that we showed but that, as we mentioned, we would have something close to minus 1 or 2 if that had not happened as well.
Eduardo Couto -- Chief Financial Officer
If I may add, Nelson, it is still related somehow to the incident that we lost the prototype number 1. That was an insurance charge that brought this additional $40 million charge in the fourth quarter.
Myles Walton -- UBS Bank -- Analyst
Okay. And then you're in production phase up to units #009 for the KC-390? I just wanted to make sure that the costs, the write-offs you're taking now, were not related to the recurring costs of those aircraft? They're related to the development costs, is that right?
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Yes. It is just charges related to product development and most specifically the consequences of the incident that we had last year.
Eduardo Couto -- Chief Financial Officer
It's important to add that we are now going to a transition phase on the KC as we move from the development to the fuel production in which that will have positive effects on the Defense margin going forward. Because the development especially in the last two years we had some additional costs and cost base revisions that we don't see on the serial production. So, it's very important that the KC goes through this transition and starts serial production.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Serial production is a much more stable phase generally speaking. Although, there two comments that we are very proud to think that interfere with production. We have a learning curve to fill those margins and the initial products. We will not be able to present the tip of the margins that we will get once we move ahead in deliveries.
Myles Walton -- UBS Bank -- Analyst
Okay. Thank you.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Thank you.
Operator
The next question comes from Peter Vishenko, Barclays.
Peter Vishenko -- Barclays -- Analyst
Hi, good morning. This is Peter Vishenko with Barclays. Thanks for taking my question. First, can you please discuss where you are on the regulatory approval front? What was the initial feedback from various Antitrust regulators?
Nelson Salgado -- Executive Vice President Finance and Investor Relations
I think we can say that the process is moving well. It's not a simple process but there is nothing that we could highlight here as negative. The process is moving well, and we've already started that in all jurisdictions, which are quite a few.
Peter Vishenko -- Barclays -- Analyst
Okay. And maybe an additional question. When do you plan to file with HRS in the US?
Nelson Salgado -- Executive Vice President Finance and Investor Relations
I'm almost certain that we had done that already. We can confirm that and get back to you, but I am very positive that we have done that already.
Peter Vishenko -- Barclays -- Analyst
Okay. And my second question on the backlog. It seems that looking at the 175-E2, can you maybe provide any color on when you expect the backlog to go there? Also, it seems like your 190-E2 backlog declined by roughly 30 aircraft this year. I am wondering can you both provide the color on that aircraft as well?
Eduardo Couto -- Chief Financial Officer
What is the decline that you're talking about of 30 planes? Sorry, I am not with you.
Peter Vishenko -- Barclays -- Analyst
I mean the old backlog on the 190-E2 were at 74 jets the front order backlog and now it's 43.
Eduardo Couto -- Chief Financial Officer
It's mostly the JetBlue ones, right, I think that we removed.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Those were the old ones.
Eduardo Couto -- Chief Financial Officer
The 190s, if it's the old E 190s, it's the 24 planes for JetBlue that we removed from backlog after the campaign that we had in the middle of last year.
Peter Vishenko -- Barclays -- Analyst
Well, I was referring to the second generation.
Eduardo Couto -- Chief Financial Officer
The second generation?
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Give us a second.
Peter Vishenko -- Barclays -- Analyst
Can you hear me? I'm not sure if you can hear me.
Eduardo Couto -- Chief Financial Officer
Yeah. We had a couple of planes that were removed from the backlog. The most important or relevant ones, as I mentioned, for JetBlue for the new ones, for the E2. We have Air Costa from India that we removed and also the 175-E2s from SkyWest that during the accounting change we had to remove the order, but the orders are still in place. So, there was no change in the order, it was only an adjustment in the backlogs. So, those were the main changes.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
The contract is still in place but as the one conditionality, we made a contract with the change in scope following the US. We removed those from the backlog.
Peter Vishenko -- Barclays -- Analyst
Okay. Fair enough. Thank you, guys. And that's all I have.
Operator
The next question comes from Victor Mizusaki, Bradesco BBI.
Victor Mizusaki -- Bradesco BBI -- Analyst
Just a last question here. With regards to revenues with service and support, can you give the breakdown of how much will stay with Embraer and how much would be transferred to the JV?
Eduardo Couto -- Chief Financial Officer
Yes. We had revenues around $1 billion, so around $400 million will stay at Embraer and around $600 million goes with the Commercial Aviation.
Victor Mizusaki -- Bradesco BBI -- Analyst
Okay. And thinking about margins with personal descent.
Eduardo Couto -- Chief Financial Officer
We have margins around 12% for the consolidated service and support business. The Executive and Defense are likely lower than that and Commercial are likely higher. But it's not a huge difference. It's like Executive and Defense is a mid to high single and Commercial is more like a mid to high teens. So, it's not a big difference.
Victor Mizusaki -- Bradesco BBI -- Analyst
Okay. Thank you.
Operator
Again, if you want to pose a question, please press *1.
The next question comes from Cai von Rumohr, Cowen.
Jeff Molinari -- Cowen and Company -- Analyst
Hi. Thanks again. This is Jeff Molinari on for Cai. Sorry. Apologies for the interruption before. I think I lost connection. I wanted to follow up with another question here on free cash flow. What are your expectations for free cash flow in 2019 excluding separation and tax costs? Will it be positive?
Nelson Salgado -- Executive Vice President Finance and Investor Relations
So, Jeff, we are not opening up that information. So, we are treating the result as the consolidated cash result which will allow us to pay $1.6 billion extra in dividends and start life in Embraer in 2020 with $1 billion in net cash. However, I think we can mention that we expect a strong cash generation in 2019, which if you just consider the amount of aircraft that we ended up in inventory in 2018, we expect those aircraft to go in 2019. And that will help a lot with the cash flow because the outflow associated with the production of those aircraft has already been incurred.
Eduardo Couto -- Chief Financial Officer
If I may add, Nelson, it's important to say that we have already sold more than $100 million of this carryover inventory. So, we are confident that the additional inventory on business jets will be reduced throughout this year.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Yeah. The addition is around $300 million.
Jeff Molinari -- Cowen and Company -- Analyst
Thanks. That's helpful. And if I may with one quick follow up. You offered some initial expectations for 2020 at your investor day in January. Do those still stand or is there anything you can add to that?
Nelson Salgado -- Executive Vice President Finance and Investor Relations
As I mentioned when we reported that, we see that as a conservative estimate, but for now I think it still holds. We don't want to change that.
Jeff Molinari -- Cowen and Company -- Analyst
Thank you.
Operator
This concludes today's question and answers session. I would like to turn the floor back to Mr. Nelson to his closing remarks.
Nelson Salgado -- Executive Vice President Finance and Investor Relations
We want to thank you for attending our call. Thank you very much, guys.
Operator
That concludes Embraer's audio conference for today. Thank you very much for your participation. Have a good day.
Duration: 45 minutes
Call participants:
Nelson Salgado -- Executive Vice President Finance and Investor Relations
Eduardo Couto -- Chief Financial Officer
Jeff Molinari -- Cowen and Company -- Analyst
Victor Mizusaki -- Bradesco BBI -- Analyst
Myles Walton -- UBS Bank -- Analyst
Peter Vishenko -- Barclays -- Analyst
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