ERJ - Embraer S.A. (ERJ) Q3 2022 Earnings Call Transcript
Embraer S.A. (ERJ)
Q3 2022 Earnings Conference Call
November 14, 2022 08:00 ET
Company Participants
Francisco Gomes Neto - President and Chief Executive Officer
Antonio Carlos Garcia - Chief Financial Officer and Procurement
Leonardo Shinohara - Director, Investor Relations
Erwin Maier - Staff Seargant
Conference Call Participants
Marcelo Motta - JPMorgan
Cai von Rumohr - Cowen
Myles Walton - Wolfe Research
Florence Shalloo - MetLife
Pedro Fontana - Bradesco BBI
Presentation
Operator
Good morning, ladies and gentlemen and welcome to the Audio Conference Call for Embraer’s Third Quarter of 2022 Financial 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 and participates, 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 might not occur. The company’s actual results could differ substantially from those anticipated in the forward-looking statements. It’s important to mention that all numbers are presented in U.S. dollars as it is our functional currency.
Participants on today’s conference call are Mr. Francisco Gomes Neto, President and CEO; Mr. Antonio Carlos Garcia, Chief Financial Officer and Procurement; and Mr. Leonardo Shinohara, Director of Investor Relations.
I would like now to turn the conference over to Mr. Gomes Neto, who will proceed with the first remarks. Please go ahead, sir.
Francisco Gomes Neto
Good morning and thank you all for joining our third quarter 2022 results call today. Mainly due to our continuous focus on efficiency, we were able to deliver better margins even with the supply chain constraints. And our firm order backlog is one of the highest since the beginning of the pandemic. It is important to highlight that we, the whole company, had concentrated our focus on year-end aircraft deliveries. There are comprehensive initiatives in place and they are progressing well to mitigate the production challenges always keeping a strong focus on safety and quality.
Regarding growth, several campaigns are advancing well both in commercial aviation mainly the E2 family and in defense, including the C-390 and A-29 Super Tucano. In this quarter, as we will see on the next slide, we have already reached new regions in operators for E2. Having said that, we maintain our confidence in our guidance for the year and we are pleased to share that our free cash flow will increase to $150 million or better.
On the next slide, we will see more details of business unit highlights in the quarter. In commercial aviation, we announced a firm order of 20 E195-E2 from Porter Airlines, now totaling 50 orders and 50 options. We also announced the expansion of our presence to the Middle East with a new operator, SalamAir, which ordered 6 E195-E2. On the freighters project P2F, we signed a firm order for up to 10 aircraft with NAC. More recently, we received a great and promising news, the China Aviation Authority granted certification for our E190-E2, opening the door of a relevant market for the E2 family. And considering the 9-month period, the gross margin in our commercial aviation improved to 10% from 3.2% in the previous year. Our executive aviation keeps up the good momentum with fantastic performance. We delivered 23 jets in Q3 ‘22, 10% higher than the same quarter last year. And the gross margin was 20.6% in the last 9 months compared to 16.3% in the previous year.
On defense, the conflicting environment continues to influence countries around the world to revise plans and update their capabilities in readiness. During the quarter, we were pleased to announce a partnership with L3Harris to expand the capabilities of the KC-390 Millennium as a jet-powered agile tanker addressing the U.S. Air Force’s operational requirements. More recently, we signed some MOUs with South Korean aerospace industries for future collaboration in the KC-390 program.
Finally, we reached a final agreement with the Brazilian Air Force on the KC-390 contract, preserving the company’s cash flow and ensuring the economic and financial viability of the project. The service and support business continues to positively evolve with a growing backlog and positive gross margin, which reaches 29.90% in the 9-month period versus 26.4% in 2021.
I will now hand it over to Antonio to give further details on the financial results and I will return at the end. Thank you.
Antonio Carlos Garcia
Thanks, Francisco and good morning, everyone. We delivered reasonable results in the third quarter reinforce our confidence in our financial performance for the year end, highly focused on enterprise efficiency. As a remark, our guidance does not include Eve numbers. Moreover, we also define our numbers also includes the account adjustment performed by Eve in the second quarter.
So moving to Slide 5, aircraft deliveries, Embraer delivered 33 jets in the third quarter, of which 10 commercial jet aircrafts and 23 executive jets. Year-to-date, we have delivered 27 commercial and 52 executive jets. We all know the supply chain constraints which is impacting Embraer a movie, big portion of the deliveries to Q4. Deliveries are in a good pace. And we have a noticed concern from the Street about deliveries for the whole year. We hear firm order aspects of our 2022 revenue and delivery guidance.
Despite the challenges supply scenario, we should stay in the lower end of the delivery guidance for both commercial and executive jets, with some minor risk on the downsides. Firm order backlog ended third quarter ‘22 at $70.8 billion or $1 billion versus the same period last year. This is one of the highest quarter since the beginning of the pandemic driven by solid sales activity in executive aviation and service and support. Revenue reached $929 million in the quarter, down $30 million compared with the same period in the third quarter ‘21 mostly driven by lower revenue in defense and security partially offset by the order business unit. The revenue breakdown evenly spread through the business units have helped to contribute to the consolidated gross margin.
Moving to Slide #6, let’s talk about adjusted EBIT and EBITDA before that. Just to report, in the first 9 months of 2022, Embraer reported consolidated gross margin of 20.9% than 16% reported in the same period of 2021 due to the enterprise efficiency as a whole 1% mix, 1% one-time effect, and 2% margin improvements driven by enterprise efficiency, even with lower volumes that we delivered in the first 9 months.
Adjusted EBIT and EBITDA were $50 million and $93 million respectively, yielding an adjusted EBIT margin of 5.4% and adjusted EBITDA margin of 10%. Adjusted EBIT in the third quarter ‘22 also includes extraordinary items. If we exclude our extraordinary items, adjusted EBIT margin would have been around 6.8% or $63 million in the third quarter ‘22. Adjusted EBITDA margin would be around 11.4% in the third quarter ‘22. In regards to our guidance for EBIT and EBITDA, we should stay in the upper range of the guidance for EBIT and EBITDA with some upside potential if all deliveries happened as planned. Quarterly G&A expenses reached $41 million with no significant changes compared to the second quarter ‘22.
Selling expenses reached $67 million due to higher volumes of campaigns in all segments, promising in Defense and Commercial Aviation. Investments in the third quarter, Embraer invested a total of $41 million in product development and research, mainly due to development, for example, E2 family, Executive Aviation and other products. And we invested $40 million in CapEx mainly for the services and support expansion.
Moving to Slide 8, starting with adjusted free cash flow. Free cash flow in the third quarter was negative $109 million. This easily to expand due to the higher working capital needs for the higher deliveries in the fourth quarter 2022. Free cash flow year-to-date is negative $86 million is slightly better than 9 months consolidated basis. Therefore, regarding to the free cash flow, we continue highly focused on the cash flow discipline and we decided to increase our free cash flow guidance from $50 million to $150 million or better in 2022. On the right side, the adjusted net result was a profit of $24 million adjusted, trending positive from efficiency and less interest expenses year-to-date, we are more or less close to zero.
Slide #9, we are extremely happy with develop our strong liquidity profile. The company reduced the quarter finished with a total debt of $3.1 billion or $808 million less year-to-date, in line with our liability management strategy to reduce gross debt and interest expenses. The current schedule of our debt, give us comfortable situation on our monetization for the next 2 years. If you see, we do have $37 million residual value to pay in 2022, $244 million in ‘23. Moreover, the $310 million we have for 2024 has been already refinanced being postponed to 2027. Means we do have 3 years and a comfortable situation to overcome any kind of recession or volatility in the market. And we continue to work on increasing duration and improving the financial metrics. To ensure the company liquidity, Embraer October 2022, a revolving credit facility in line RCF in the amount of $650 million and the renewable of the current loans with the National Bank in Brazil with additional 2 years maturity from $300 million. We thank all of our banking partners for the support to the revolver credit facility.
To finish my presentation, moving to Slide #10, talk about if accounting restatement for the second quarter ‘22, non-cash adjustment. Eve issued warranties to states and spec investor during the IPO. In September, we reviewed its account for starts warrants that were issued and became accessible at the close in May. Based on such a review, Embraer expects to recognize the falling no cash expenses associated with the issuance of such awards for the second quarter. Warranties, the revised accounting treatment is to measure the warranty at the fair value. Based on these premises, we recognized a non-cash impact of $76 million in net results, of which $142 million in other operating expenses and $67 million of fair value financial income. Second, listing expenses. We recognized a non-cash expense of $136 million in other operating expenses as a leasing expenses. All values were now, but was previously booked and their equity. Now we are recognizing the profit and loss before impact the equity of the company.
Transaction costs. Embraer assessed its direct and incremental costs and concluded that the amount to be reclassified is $15 million in equity to other operating expenses. With that, I conclude my presentation, pass Francisco through the final words. Thank you very much.
Francisco Gomes Neto
Thanks, Antonio. To close, I would like to make some comments on the year-end and near future. The end of the year will still be challenging with a concentration of deliveries in the fourth quarter. But we have known this since the beginning of the year and the company’s focus has been on mitigating such issue, and we are prepared to deliver solid full year results. Regarding the coming years, we foresee a better perspective in terms of revenues and profitability growth. The aircraft slots the production line for deliveries in 2023 and 2024 are almost completely filled for both Commercial Aviation and Executive Jets. And as I said before, we are working in many activity campaigns with good chances of new orders for the years ahead in all business units. On top of that, considering the new campaigns under negotiation, the continuous focus and discipline to increase enterprise efficiency and innovation projects, we are very confident about the midterm future of Embraer.
In closing, I’m very pleased to announce that Embraer has been awarded with a Great Place to Work certification in several countries we operate. We celebrate this recognition and continue to believe that engaged and passionate people achieve the greatest results in nature, a happy and healthy work environment. Our people are what make us fly as stated in our values, and we will continue to work to deliver the best value to them, to our clients, shareholders and society.
Thank you for your interest and confidence in our company.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first questions come from Marcelo Motta from JPMorgan. Please Marcelo, you may proceed.
Marcelo Motta
Hi, everyone. Good morning. Thank you for taking the question. I mean it’s more of a strategic question regarding Eve. I mean when we look at the company, the market cap has been growing since its listing today is worth more than the state that Embraer holds on the company. So even though there are several look-up agreements, just wondering how Embraer think about Eve in the long-term, if maybe it could be a company that you could monetize part of it and also strength even more your cash position. So how do you guys see the current moment for Eve and how you see your sales holding a position in need in the long-term? Thank you.
Francisco Gomes Neto
Marcelo, Francisco speaking, Antonio will answer together this question to you. I’ll start saying that we continue to be very excited with this project. We have more – we have now more than 200 engineers working dedicated to the Eve development. So that is moving well. And we do believe that if we will be – it was a great movement of Embraer in terms of innovation to help our growth in the long-term. So again, about the future of Eve, we are confident that it was a very positive movement. So about the finance, I’ll leave this with Antonio to answer to you.
Antonio Carlos Garcia
Marcelo, we, for sure, we have today, 90%. And if the shareholder who wants the warrants if they aside the warranties, we are going to get $0.5 billion in the cash flow and probably are going to dilute a little bit, which is our way to monetize. but at least, we all are locked up for the next 2 years. There is no short-term anything that we could think a part of the warrants that could provide us more cash flow than we have today. But the next 3 years, nothing is going to happen.
Marcelo Motta
Perfect. Thank you very much, Francisco and Antonio. Have a nice day.
Francisco Gomes Neto
And Marcelo, just to complement this, we are also finalizing the studies for the industrialization of Eve with the global network of production and logistics. So we are moving according to our plan to have the Eve entering in servicing by 2026.
Operator
Our next question comes from a number that begins with 1 656 from New York, you were allowed to talk. [Operator Instructions]
Cai von Rumohr
Yes. I think that’s me, Cai von Rumohr from Cowen. So you said that you’ve pretty much filled for ‘23 and ‘24. Can you give us any helpful color in terms of where those deliveries might be for commercial and business jets?
Francisco Gomes Neto
Well, I mean, we are – thanks for the question, Cai. So Francisco speaking. We are still in the middle of our planning process for the next 5 years, including 2023. But what I can tell you that we see two-digit growth of Embraer. And basically, our business units should grow two digits in 2023 according to our view at this point of time. So we are very positive about the years ahead.
Cai von Rumohr
Thank you.
Operator
Our next question comes from Myles Walton from Wolfe Research. Please Myles, your microphone is open.
Myles Walton
Thank you. Good morning, Francisco and Antonio. I was wondering, Antonio, could we talk about the cash flow for a moment. The fourth quarter implied cash flow, I think, is just under $250 million. And if you look back at the last 5 years or so, you generate in the fourth quarter, anywhere between $400 million and $700 million of free cash flow. And obviously, you’re looking for a very large delivery number. So, why only $250 million of implied fourth quarter revenue?
Antonio Carlos Garcia
Good morning, Myles, thanks for your question. We put 150 or better because in regards to we are in the, I would say, the final split for the year. Just 5 yards to the touched on with one. If it’s something happened in the deliveries, then we are going to miss a big portion of the cash flow, you are right. If you complete the guidance what you are seeing today, it’s being much higher than the $150 million, but in the order to not, I would say, give a false information, perfecting to say $150 million, it’s just a matter to get the aircraft out of burden probably is going to be much better, and you are totally right in comparison to the previous year. But at least today, assuming the risk we have in front of us, we are a little bit cautious to give you higher numbers. But a lot of upside potential, you are right.
Myles Walton
Okay. And one other one on cash flow. You make adjustments for the income statement and the balance sheet for Eve, but I haven’t seen an adjustment for cash flow for Eve. So, can you provide them?
Antonio Carlos Garcia
Yes, absolutely. Myles, it was just accounting adjustments with no cash adjustments. It was just pure accounting issues, for example. Warranties we needed to…
Myles Walton
Antonio, I am not speaking to the restatement. I am just sorry about the ongoing operations. I haven’t seen an adjustment for how much Eve is burning.
Antonio Carlos Garcia
It’s just $1 million for each quarter. More than that was in Q3. 16, sorry, 16.
Myles Walton
I am sorry, six, zero or one, six.
Antonio Carlos Garcia
One, six, 16.
Myles Walton
Thank you. And one for Francisco, with the certification of the E2 in China, Francisco, should we expect a significant change in the order dynamics out of China that haven’t really been active in the last couple of years?
Francisco Gomes Neto
Myles, I have here a special guest with me Erwin Maier. So, I brought him because I knew this question will question will come. So, Erwin please?
Erwin Maier
Yes. Thank you, Francisco. Good morning Myles. Thanks for the question. Well, first of all, we are very pleased we got the certification over the line very recently. We are actively working in the Chinese market. So, that is progressing. What I will say is that the reason why I was so pleased with the E2 is we believe the 190, which is certified now the 195 E2, which you will certify next. Those fall very nicely between the ARJ21, which is the smaller Chinese jet product and the 919, which is the narrow-body. So, we feel that E2 complements the Chinese production line very well. So, we have very good hopes for the Chinese market.
Myles Walton
Okay. Very good. Thank you.
Francisco Gomes Neto
You’re welcome.
Operator
Our next question comes from telephone from the number that starts with 19175. Please sir. [Operator Instructions]
Unidentified Analyst
Hi. This is Elizabeth Grenfell on for Ron. Can you hear me?
Francisco Gomes Neto
Yes, we can hear you.
Unidentified Analyst
I think you spoke to, there is weaknesses in the supply chain and there is downside risk to your delivery forecast for the year. Could you speak to what you are seeing in the supply chain? Where are there specific weaknesses and how much downside risk you do see to the full year delivery guide?
Francisco Gomes Neto
Hi Elizabeth. So, thanks for the question. Well, we are really still suffering with the supply chain this year, a lot, especially with engines, avionics and interiors. And we are getting parts, but with a lot of delays. And then we have to try to change a lot our production schedule during the past month to accommodate the production with the delays. We see this still – the situation is still growing, especially into the first half of next year. I mean improving, but still with a lot of delays, and we see that delays being reduced during the second half of next year, but still not at a normal situation. I think this situation will normalize completely only 2024. But again, we are prepared to with our production plan to live with this situation in 2024.
Unidentified Analyst
So, the downside risk to deliveries versus where you originally expected for this year is what…?
Antonio Carlos Garcia
Yes. Elizabeth, when we placed the guidance, if you see commercial aviation $60 million to $70 million, $100 million to $110 million. We foresee beginning of the year this constraint in charter is in supply chain. That’s why, as I mentioned in my speech, we are seeing ourselves today in the lower end of the guidance, $60 million to $100 million. If I would cover risk three to four aircraft each business unit, no more than that. For this year and for next year, we should have, I would say a growth of two digits for commercial and executive even with such restriction. But I would say, if you ask me today, we are at the lower end of our guidance, means we lost 10 aircrafts in commercial. We lost 10 aircrafts in executive and we may have additional risk between four and five aircraft each business unit. If – but we continue to fight to the last day of the year. All aircrafts on the assembly line to be finished to get their missing parts and the leverage of those customers.
Unidentified Analyst
Okay. Great. And then one more question, if I could, please, on the defense side. Could you speak to the percentage of completion recognition – revenue recognition on the A-29 program? What was the impact there attributable to?
Antonio Carlos Garcia
Compared to previous year, we have a gap of something around $60 million. We were not able to sell away any A-29s yet this year, that’s why last Q was a strong one. We have a lot of revenue out of the A-29. This year, we were not able to perform any sales. We do have aircraft in inventory, but we were not able to recognize as a revenue for the missing contracts. However, we do see a nice potential in front of us for the A-29s for the coming months, we are going to announce for sure campaigns. But it’s not going to inflect this year, unfortunately.
Unidentified Analyst
Okay. Great. Thank you very much.
Francisco Gomes Neto
Thank you.
Operator
Our next question comes also via phone and the number starts with 0056. [Operator Instructions]
Florence Shalloo
Hi guys. This is Florence Shalloo from MetLife. Can you hear me well?
Francisco Gomes Neto
Yes.
Florence Shalloo
Thanks for taking my questions. And I have a couple of questions. One is regarding services and support, which has been a business that performed very well during the year with very high margins, with your expectation regarding margins by next year for this business? And the other one is, I think a follow-up regarding deliveries. You mentioned that you continued to see plant issues for next year and perhaps for the next of this year, so why is the main reason that you are still reaffirming the guidance regarding deliveries, or when do you expect some more downside on commercial loan executive checks? Can you provide more color on that point? Thank you.
Antonio Carlos Garcia
This is Antonio speaking here. Good morning. So, services and support were the two digits EBIT margin this year. And I would say, we continued to perform very well on the services and support. We should keep the same level for the years to come, especially in 2023, and we are also growing in the services and support because our fleet is growing, and we need to fulfill those services. That’s why continues to drive the enterprise efficiency and make sure that we continue to write this, reported this nice margin. Second, in regards to deliveries, our forecast today for scheduled delivery schedule is – continues to be on the guidance we placed since the beginning of the year. And for next year, we already adopt the shortness. But however, there is already two-digit growth for next year. And our positions there are buckets [ph]. And I would say, even with the supply chain constraints, we have some – the situation is improving, but not at the speed we would like to see, and now it’s concentrated jet fuel suppliers before it was almost all of them. Today is just the fuel suppliers. This year will continue to be in the lower end of the guidance. We are going to fight towards the end of the year, every day counts. And next year, we adopt. And Francisco, you may want to comment.
Francisco Gomes Neto
Yes. Just a quick comment that you mentioned this year, we – even with the tough situation with the supply chain, we are continuing – we continue affirming that we will be within the guidance. The reason for this is because we were more conservative in the beginning of the year announcing the guidance. So, we announced a range that we knew that we would face difficulties this year with the supply chain. So, we knew since the beginning of the year. So, that’s why we – with all the difficulties, we still believe we will be in this lower end of the range of the guidance that we gave to the market in the beginning of the year.
Florence Shalloo
Okay. Thank you so much. And just a quick follow-up regarding the free cash flow. In terms, are you expecting some improvement on the working capital side? And regarding this excess free cash flow, are you expecting any liability management in the near-term?
Antonio Carlos Garcia
No, not really. In fact, if you take into account that we are going to have in Q4, almost 40% of the whole year revenue is going to be done in Q4. We are going to release a lot of. That’s the main reason of the free cash flow. And there is no special measures in Q4 in order to improve our free cash flow guidance, just to get rid of those aircraft out of the door. It’s is the only reason.
Florence Shalloo
Okay. Prefect. Thank you.
Operator
Our next question comes from Pedro Fontana from Bradesco BBI. [Operator Instructions]
Pedro Fontana
Hi. Good morning. Thank you for taking my questions. Congrats on the results. If you could provide us some color on the ongoing pilot strategy in the U.S.? And how is this impacting your commercial campaigns? And when do you expect this situation to improve? Thank you.
Francisco Gomes Neto
Okay. Now here, I will hand over to Erwin Maier to talk about this issue in the U.S.
Erwin Maier
Thank you, Pedro, for that question. Yes. The pilot shortage in the U.S. is affecting the E1 deliveries. So, we think it’s going to be less than we have seen in the previous years in ‘23 and ‘24. We do believe that, that will correct itself towards the end of ‘23, somewhere in ‘24. So, we will have to see how that develops. Fortunately, what I will add is that we see a lot of traction at the moment on the E2 side. So, we have seen some deals close over the last couple of months. And we see a very good appetite from airlines on that side. So, we believe that the mix of the E1 and E2s together is going to stay healthy going forward. And we believe the E1s over time will start to pick up again towards ‘24, ‘25.
Pedro Fontana
Very clear. Thank you.
Operator
[Operator Instructions] This concludes today’s question-and-answer section. That does conclude Embraer audio conference for today. Thank you very much for your participation and have a wonderful day.
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Embraer S.A. (ERJ) Q3 2022 Earnings Call Transcript