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Embraer Brazilian Aviation Co (NYSE:ERJ)
Q2 2020 Earnings Call
Aug 05, 2020, 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 second quarter of 2020 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 the other things, general economic, political and business conditions in Brazil and 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 these risks and uncertainties, the forward-looking events and circumstances discussed on this conference call might not occur. The company's actual results could differ substantially from those anticipated in the forward-looking statements. Participants on today's conference call are Mr. Francisco Gomes Neto, president and CEO; Mr.

Antonio Carlos Garcia, 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. Francisco Gomes Neto.

Please go ahead.

Francisco Gomes Neto -- President and Chief Executive Officer

Good morning everyone, and thank you all for joining our call today. I am Francisco Gomes Neto, president and CEO of Embraer. I will make some initial remarks before turning to our CFO, Antonio Garcia, who will detail the results of the company. Our main priority continues to be the health and safety of our people, focusing on preventive measures, raising awareness on the risks and right behaviors to avoid the contamination and reduce the spread of COVID-19.

Regarding business continuity, there are key initiatives in place to emphasize the business intelligence in alignment within the management team to implement the necessary measures to support the company's short- and medium-term performance. In the short term, our focus continues to be on cash preservation. Besides initiatives already implemented, such as a more strict control of accounts payable, accounts receivable, general expenses and investments, we have advanced in additional initiatives such as the implementation of world-class procurement and logistics areas to bring more focus and intelligence on our purchasing and material management processes. The focus here is to reduce further in a very structured way, the cost of what we buy and reduce our inventory levels as well.

More specifically, in the field of expenses control, we have implemented a new process called spending control tower with a new and much more robust approval process for indirect purchases. In operations, we have initiated many projects to reduce the production cycle of our aircraft. Through where we structure value stream mapping processes, combined with a series of Kaizen projects. These initiatives will contribute a lot to reduce costs of our products as well as working capital.

As I said, all these initiatives will help us to improve our financial performance in the short and medium term. Through the COVID-19 pandemic, in the current market scenario, Embraer keeps pursuing measures to become a leaner and more efficient organization. We have started a restructuring process initially with important changes in the top management. We consolidated the vice presidencies of engineering and strategy and adjusted the structure in operations, commercial aviation and EmbraerX.

And here, I'd like to thank the VPs, Mauro Kern, Nelson Salgado and Helio Bambin, who left our organization in this process for a great contribution to the company over the past years. We also revised our second layer of directors and managers, eliminating duplications created during the separation of the commercial aviation business. In short, we have already recovered synergies over the last few months. Such changes in the organization have a focus not only on cost reduction but also to help us to better executing our strategic plan '21, '25, keeping our strength in all key areas, such as market intelligence, sales, engineering, technology, operations, finance, procurement and innovation.

It is important to highlight that all the initiatives and projects we have created and implemented in a very collaborative process involving the leadership team and key persons of different levels of the organization, helping us to achieve high levels of engagement, commitment and motivation, even during this very tough moment. Regarding the business plan update, we are working to finalize our strategic plan for the period of '21 to '25 which we expect to conclude in the coming weeks. We are focusing on improving our cost structure with short-term actions, but at the same time, making sure we will have the intelligence and muscle to exit this crisis stronger, taking advantage of all potential opportunities to grow in all business areas. Our recent investment in cybersecurity is very much aligned with Embraer's strategic plan as it is an area with several business opportunities and great growth potential in the coming years, in which the company intends to expand its operations in Brazil and abroad.

We also continue to pursue potential partnerships to help us to introduce our state-of-the-art products in new markets and develop new projects, such as a next-generation turboprop aircraft. Finally, we are starting to see positive signs pointing to a recovery in some markets in the second half of the year. Regional aviation has been a key element in maintaining essential services and airline networks during the crisis. Some airlines are already gradually resuming commercial flights using e-jets in the United States, Europe and other parts of the world.

It is also important to note that our relationship with our customers remains strong. We have been working very closely with them in order to better understand their present needs and overcome challenges, building a win-win strategy based on confidence and collaboration. The company has developed innovative solutions for a better use of the current fleet and to enhance the safety of the cabin environment in our aircraft, such as solutions to transport cargo in the cabin of commercial aircraft and enhanced cleansing procedures to sterilize passengers' cabin. In addition, the areas of business aviation and defense have shown greater resilience.

In the United States, business aviation activity is already approaching 2019 levels. And in the defense area, we have several activity sales campaigns with opportunities for the C-390 Millennium and the Super Tucano worldwide. With that, I conclude my remarks and would like to pass to our CFO, Antonio Garcia. Thanks for your attention.

Antonio Garcia -- Chief Financial Officer

Thank you, Francisco. Now moving to the financial highlights at Slide 5. Embraer is operating during an unprecedented aviation market slowdown caused by the COVID-19 pandemic. The impact of COVID were meaningful during the second quarter and were mostly concentrated on commercial aviation.

The commercial aviation business has experienced low volumes with only four deliveries that generated excess capacity and a cost that were recognized in our financial results instead of going to the inventories, adding to the one-off impairment of $90 million and onetime depreciation of $100 million related to 2019 when commercial aviation business was booked as available for sales. Putting all together, we have a nonrecurrent event of almost $200 million in the commercial aviation results during the second quarter of 2020, explaining the majority of our soft numbers which we don't expect to see again in the following quarters. The COVID impact on the executive defense business were much lower and our guidance for 2020 remains suspended, even though we already start to see initial improvement signs and expect much better performance, in particular, for the fourth quarter of 2019. Despite of all challenge faced during the first half, our performance in executive jets and defense and security had a meaningful improvement when compared to 2019.

As we promised last year, several initiatives such as cost-control price discipline, rightsized production and to enter into serve new products such as Praetor and C-390 Millennium are already helping and will continue to help our financials in executive jets and defense. Some other financial highlights that we will detail during this presentation include a stronger backlog with a 0 cancellation in commercial aviation. In regards to Embraer cash management team, who have been meeting daily to discuss our financials and identify potential cash opportunities for Embraer. And so far, we already mapped approximately $800 million in cash savings for this year, implemented or to be implemented in the coming months with a meaningful reduction in investments, selling generics, administrative expenses and overall costs, a detailed plan to optimizing by our working capital in the following quarters.

Additional funds recently secured of $700 million to further improve our cash liquidity in the second half of 2020 and '21. And in the end, we are quite proud to inform that we'll end up with the monitorship and its financial cost impact at Embraer. Turning to Slide 6 with some highlights for our commercial aviation business. We have been working to integrate the commercial aviation business and prepare the future steps of this very important business unit.

As part of the integration process of -- into Embraer, we recently announced that Arjan Meijer, previously, the chief commercial officer of Embraer commercial aviation, has become the new president and CEO of the commercial aviation business, reporting directly to our group CEO, Francisco Gomes. We believe the future of the business is in good hands with Arjan, we are excited about this, who brings extensive commercial and operating experience from both the OEM and the airline side. I would like also to take this opportunity to thank John Slattery for his time and hard work here at Embraer, and wish him good luck in his new role at General Electric. During the quarter, we delivered four e-jets and nine in the first half of the year, with our deliveries being impacted by COVID-19 and each effect in the airline industry.

It's important to note that we didn't suffer any cancellation on the commercial aviation since beginning of this year. One of our recent deliveries was the aircraft number 1,600 of the e-jets program and in 192 for Helvetic Airways, underscoring the great success of this family of jets. During the second quarter, Helvetic also upgraded an order of four E190-E2 to the bigger 195-E2s to better serve their future growth needs. Congo Airways also upgraded an order of two 175-E1 aircraft to the 190-E2, take advantage of the best-in-class performance of the E2 family.

Although we are not in point where we can give a guidance on expected delivery of financial performance due to the uncertainties caused by the COVID, I'd like to point out that we are cautiously optimistic for the future as we have seen the rebound in domestic flights activity in several markets around the world. As an example, you could see in the chart on the top of the right side, 175-E2 service in the U.S. is already 90% in July, mid of July in services. And if you see the graph below on the right-hand side, you see that the information of IATA, showing that we do have I would say flat U-shaped recovery that we are going to suffer 2020, 2021.

But in fact, we do see a fast recovery path for the domestic traffic which we do believe is going to impact also our regional and e-jets aviation products. Now, moving to executive business jet at Slide 7. We delivered a total of 13 jets during the second quarter, with nine of them being a light jet and four of the large jets. The jet delivered in the first half of 2020 were 22 aircrafts during the quarter.

We delivered the first Phenom 300E, showcasing our ability to maintain the competitiveness of our products, make the best-selling aircraft in the light segment even better. The enhanced Phenom 300E is faster, quieter and receive several other upgrades including of avionics and in-flight connectivity. We also announced several breakthrough cabin enhancement for our Praetor families of jets, consolidated operators position as the best cabin environment among all medium jets. With the lowest cabin altitude in the class and 100% fair share capability with standard futures in operators' aircraft.

Further, we announced this week the launch of the Phenom 300 Med, a unique Medevac solution which is also available for retrofitting the existing Phenom 300S and is designed an ideal medical solution for both civil and defense application. We would like to reinforce that now with the COVID pandemic, we are even more committed to maintain prices discipline and rightsize the production plans to meet the current business jet market demand. Although we cannot give guidance at this time, we are confident that we will have a much stronger second half in deliveries of executive jets. And you have seen very few deferrals, even less cancellations so far with highly committed customer to their orders.

Finally, as far as the business jet flying activities, we have been seeing significant improvement since year April. As shown in the graph with the number of bizjets, flights worldwide returning faster 2019 pre-COVID level. In April, business aviation activity was 65% lower than 2019 which improved to 44% lower in May and 23% lower in June. The preliminary figures in July had been trained to only around 10% to 15%, lower than last year which gives us confidence of a V-shape recovery in this segment of the market.

On Slide No. 8, we show the highlights for our defense and security segment. During the second quarter, we delivered the third KC-390 to the Brazil Air Force. And these aircraft had been very important in the country's humanitarian missions to combat the COVID-19 pandemic, presenting a very high dispatchability in the transport of supplies, cargo and troops.

There are currently five KC-390 Millennium in various stage of production for deliveries to both Brazil and Portugal Air Force, with one additional delivery expected to the Brazil Air Force still in 2020. The development of the Portuguese version of the C-390 Millennium annual aircraft also reached an important milestone, recently entering in the preliminary design review phase. Other highlights in terms of deliveries during the period were the delivery of the first Super Tucano for the Nigerian Air Force as well the last six M60 Radar units for the Brazilian army related to Brazil surveillance of the broader program. Finally, we also signed two contracts for acquisition in their cybersecurity space in Brazil, make our continued diversification of defense and security business into a highly strategic and fast-growing segment.

Now turning to the services and support business at Slide No. 9. In the mid of the COVID pandemic, our people have been worked hard to create innovative solutions in service and support, allowing remote training with full qualification and certification capability, development of a cargo transportation solutions for the ERJs and e-jets and enhanced cleansing procedures for disinfecting aircraft. Our service, support business also successfully completed the first conversion of a Legacy 450 to a Praetor 500 aircraft, adding more than 400 nautical miles of range to the plane among other improvements.

The conversion are taking now place at two service centers in U.S., one in France and one in Brazil. We are also proud to announce that the Phenom maintenance schedule was extended to 800 flight hours which is twice the industry average, helping our customers to avoid the unnecessary spend on aircraft maintenance. And in Portugal, our Ogma subsidiary signed 12 new contracts for maintenance and repair across commercial defense and executive customer during this period. Finally, we show an update on the right-hand side about the Embraer global fleeting service.

As you can see, since April, our service has already increased a lot and reached approximately 70% utilization in July which is significantly above other aircraft model. Moving on to our financial results for the period on Slide 11. Our backlog finished at $15.4 billion, remaining strong and represented several years of revenue for Embraer. It's important to highlight again that despite some deferrals, we didn't have any cancellation in commercial aviation.

And we have several activities in campaign right now that may support a backlog expansion in the upcoming quarters. Moving to Slide 12, we show our aircraft deliveries. As mentioned previously, we delivered four commercial jets in the second quarter, roughly in line with four deliveries for the first quarter with the COVID-19 pandemic, significantly impacting our deliveries in this segment. Our guidance remain suspended, but we expect a better delivery performance during the rest of the year.

Our executive jets business has seen less of an impact from COVID, and we deliver a total of 13 aircrafts in the second quarter, with our high-quality backlog following a strong year of sales in 2019. We are confident that the executive jets delivery will continue to increase in the second half of 2020 as our customer continue to reconfirm their upcoming deliveries. At Slide 13, we show our net revenue on a consolidated basis. With second quarter coming in at $537 million, the net revenue declined during the second quarter, affected all of our business segment due to the cost.

But commercial aviation and its related service were particularly impacted, representing almost 75% of this total revenue decline during the quarter. Next is Slide 14, selling and administrative expenses continues to decline. And the second quarter helped by several actions taken to gain efficiency and in the spend as well, as the furloughs and salary reduction measures took and concentrate in the second quarter. It's important to mention that selling expenses include $60 million in additional bad debt provision compared to last year second quarter, mostly on commercial aviation customers.

Excluding this provision, selling expense would have been even lower comparing to the level recognized in the second quarter of 2019. At Slide 15, we show operating results. Embraer reported adjusted EBIT of a loss of $141 million in the second quarter of 2020 with a margin of minus 26%. It's important to highlight that executive jets, defense and security and related service and support reported EBIT numbers close to breakeven during the first half of 2020.

And commercial aviation was really the segment responsible for the negative operating results during the first half which is a reflection of the very few deliveries due to the COVID-19 and the January shutdown for the segregation of the commercial business into a separate entity. As already anticipated, despite the COVID challenge, executive aviation defense has been showing a meaningful improvement versus the first half of 2019 due to a price discipline, improved mix and lower cost base revenues. Finally, the adjusted EBIT in the second quarter excluded a total of $200 million in non-cash special items, mostly related to the commercial aviation including impairments of the E-Jet family and the recognition of the depreciation and amortization expenses related to the quarters when commercial aviation was recorded as a discontinued operation available for sale. Slide 16 shows our adjusted EBITDA which was a loss of $120 million and also excluded the special items.

I already mentioned in the previous slides, adjusted EBITDA margin was minus 22.4% for the second quarter, also reflecting the pressure on profitability coming from few deliveries in commercial aviation during the period with executive jets, defense and security Services, reporting much better numbers. Moving to the next Slide 17 with earnings. Embraer adjusted net income reached a loss of $199 million in the second quarter, implying a negative margin of 37% for the quarter. Our earnings have been negatively impacted by the combination of lower deliveries and revenues and the higher separation costs, similar to the impact already shown in the EBIT and EBITDA and higher financial expenses.

Our reported net income was much bigger loss of $315 million, but mostly driven by the previously mentioned noncash special items partially offset by the lower deferred income taxes items. We expect to show much better bottom-line performance in the second half as delivery margins start to improve during the rest of the year. Moving to Slide 18 which shows Embraer investment over the last several quarters. The company has launched initiatives to reduce investment including capex as well research and development.

This reflects our actions to minimize nonessential investment to preserve cash flow in the context of the pandemic. It also reflects updated portfolio with state-of-the-art products in commercial aviation, executive jets and defense and security. Embraer has invested a lot in the last five years, bringing new programs and products to the market. And now we expect the coming years to show lower investment.

We have also announced a new time line of entry into the service of the 175-E2 now in 2023. With that, our capex development spending related to this program can be also better spread into the next two or three years. So assuming that it's not so easy to talk about profit and loss during this quarter, let's talk about cash flow moving to Slide 19. Our free cash flow was a usage of $476 million in the second quarter.

The free cash usage was primarily impacted by lower commercial aircraft deliveries in the quarter, leading to lower profitability and higher working capital needs, especially due to higher inventories. This impact were partially offset by lower investment spend and other actions taken to reduce cash outflows to its higher focus on accounts receivables and payables. Several working capital and expenses control throughout the second quarter, we're able to reduce our cash consumption compared with the first quarter, and we are confident that our free cash flow will continue to be much better in the second half of the year, particularly in the fourth quarter with the high deliveries and the working capital reduction leading to these improvements. Finally, at Slide No.

20, we are happy to show our liquidity position. We would like to highlight that despite two quarters of a cash burn, our liquidity position remains solid as well, finished the second quarter with $2 billion in cash. We also recently signed an additional financial contract with development bank in Brazil private and public banks for an additional $600 million as well another $100 million supported by the U.S. EXIM Bank.

Of a total of $700 million of additional liquidity coming mostly now in the third quarter, this incremental liquidity combined with higher expected delivery give us extra comfort to maintain our solid liquidity throughout the end of this year and into 2021. Our debt maturity are also mostly concentrated in 2022 and beyond that, in average maturity of almost four years. And again, we are quite happy how we are treating, how we are preserving cash and our liquidity and gives the comfort that Embraer remains strong, and we are prepared for any kind of change in the market's faster recovery, any kind of second phase of COVID and make sure that you have a good, solid liquidity position toward the future. With that, I conclude my presentation, and I'd like to pass to Francisco for his closing remarks before we open to the Q&A session.

Thank you.

Francisco Gomes Neto -- President and Chief Executive Officer

As you saw in the presentation, we had a very difficult first half, heavily impacted by the COVID-19 crisis and the redundancies in the commercial aviation business. At the same time, as I mentioned earlier, we are already taking the necessary actions to regain synergies and adjust the company to the COVID-19 scenario and to guarantee the execution of our '21, '25 strategic plan. We may still face some challenging months ahead but I am very confident that we will get at the end of this year much stronger and well prepared for a sustainable future. I'm really proud of all the efforts made so far as the Embraer leadership team is united and focused to do what needs to be done to allow this great company to succeed.

That, together with the continued support of our customers, suppliers and investors, will make Embraer to emerge even stronger from these turbulent times. Thank you.

Questions & Answers:


Operator

[Operator instructions] Our first question comes from Mr. Myles from UBS.

Myles Walton -- UBS -- Analyst

Thanks. Good morning Francisco, Antonio Garcia. Could you maybe go over a little bit about the cash in the second half. You previously talked about wanting to maintain $2 billion of liquidity at all times.

And you're always taking out some debt here. As you look to the second half, is it still a burn in the second half on the order of a low number or is it a positive in the second half from here?

Antonio Garcia -- Chief Financial Officer

Hello Myles. Thanks and it's a good question. And we -- I do believe we are going to stay in the same level at the end of this fiscal year, because historically, the seasonality of our business is always very hot in the third and especially the fourth quarter, where we have our revenues and the cash inflows. I would say, more or less stable to the end of this fiscal year.

Myles Walton -- UBS -- Analyst

OK. So breakeven free cash flow for the second half?

Antonio Garcia -- Chief Financial Officer

Yeah.

Myles Walton -- UBS -- Analyst

OK. And then in terms of the operating margins in the segments, I imagine commercial was the largest drop here. But can you give us some more color on operating margins of executive and defense? And within defense, I think you took a charge on the KC-390 to reset the cost base. Can you just elaborate if that's -- or what size of that?

Antonio Garcia -- Chief Financial Officer

I'm going to pass this to Edu. Edu, please.

Edu Couto -- Head of Investor Relations

Yes. I can give some color, Antonio. Yes. On executive jets, Myles, we did very well in the first half.

We had breakeven margins despite lower deliveries and as we show in the charts, the deliveries are picking up. So I would say second half should be quite interesting for business jet, so around breakeven margins in the second quarter and first quarters. So good numbers in executive, especially if compared to the previous years when we are suffering much more with the product mix. I think we're able to improve that a lot with the Praetors and also with price discipline, rightsizing the production, a lot of measures that Michael is implementing on business jets.

In defense of course there is some seasonality, but we prefer to look at the first half as well. And defense margins in the first half were also breakeven which we believe are good news. As we have highlighted in the past, there was a lot of focus to improve margins in executive and defense and we are really showing that. So the drag on the margins were -- they really came from commercial and now we had very few delivers and that affected the margins.

So once commercial deliveries start to recover, the expectation is margins ready to pick up in the upcoming quarters.

Myles Walton -- UBS -- Analyst

OK. All right. Thanks. I'll leave it too.

Thanks.

Antonio Garcia -- Chief Financial Officer

Thanks Myles.

Operator

Our next question comes from Mr. Ron from Bank of America.

Ron Epstein -- Bank of America Merrill Lynch -- Analyst

Yeah. Good morning.

Antonio Garcia -- Chief Financial Officer

Hi Ron.

Ron Epstein -- Bank of America Merrill Lynch -- Analyst

I wondered if you could maybe characterize how the conversations are going with airlines. Like you mentioned, you said you haven't seen any cancellations. But how does deferrals look? And when do you expect some airlines to begin to take more commercial airplanes?

Antonio Garcia -- Chief Financial Officer

Ron, thanks for the question. I would say, we -- I guess, we have the conversation about deferral, it was highly concentrated between March and April. And still I would say the same situation right now. For sure, we are having a lot of conversation with the airlines.

And for a lot of negotiations and a lot of discussions ongoing. I cannot assure that the market recovery is going only in favor of the regional jets. But again, we do have a lot of campaigns in the field right now. And also in regards to change models, changed setup of more regional domestic than I would say big airplanes, in summary, deferrals stop and we are just talk about new campaigns that again we are having a lot of requests.

And I cannot make sure that's a trend, but I would say we do have a good feeling. I don't know if you got to answer your question as you want to but.

Ron Epstein -- Bank of America Merrill Lynch -- Analyst

Yeah, I think that's helpful. How is demand for the E1-175 been now that the E2-175 has been delayed? I mean have you seen demand for that pickup?

Antonio Garcia -- Chief Financial Officer

The main deferral was highly concentrated in 195 instead in the 175. 175, I would say most of the customers, they are still committed to take the aircraft, especially the U.S. customers.

Ron Epstein -- Bank of America Merrill Lynch -- Analyst

Got it. Got it. And then maybe one last question, if I may. The business environment seems to be doing better, and you guys have alluded to that in the second half, we could see a pickup in deliveries.

How are those conversations going? And what -- when you look at the customers, there's no reticence to get airplanes around the economy or are they looking at business aviation as a secure -- more secure way to travel given the pandemic, if you could maybe offer some more color around what those customers are thinking.

Antonio Garcia -- Chief Financial Officer

Yeah, it's a good question. How you see today, the fleet owners, even the fractal flights, they are quite busy with their frac traffic today. And what we are seeing right now, I cannot say is a trend that we are having a lot of I would say private-owned jets being bought right now. And again, the fleet and the fractal owners, they are really reevaluating how to go forward.

And I do see I would say stable with a slight positive trend, especially in the private-owned jets. But we cannot make sure 100% that because of the COVID, the pandemic that regional aviation is going to be bigger than last year, but I would say, if you see the graph we displayed, we are very close to the levels of 2019. But the replacement of the aircraft is still I would say under evaluation. What I can make sure, historically, our second half for the executive Jet is very strong compared with -- on the first half.

Francisco Gomes Neto -- President and Chief Executive Officer

Francisco speaking. Yes, maybe perhaps the COVID brings us more opportunity for the executive aviation in 2021 as well.

Ron Epstein -- Bank of America Merrill Lynch -- Analyst

Got it. All right. Thanks very much.

Antonio Garcia -- Chief Financial Officer

Thank you Ron.

Operator

Our next question comes from Mr. Robert from Crédit Suisse.

Unknown speaker

Hi. Good morning. Just on the last question that Ron asked on executive aviation. As you see opportunity perhaps in the second half, where do you see it? Is it at the Praetor level, at the Phenom? Any color on the interest levels?

Francisco Gomes Neto -- President and Chief Executive Officer

Well, Robert, thanks for the question. The Phenom 300 continues to be our best seller and where we have I would say highest potential of sales. But also we are quite optimistic with the Praetors as well.

Unknown speaker

OK. And you talked about stronger second half because of higher deliveries across the commercial portfolio, executive Jet portfolio, how good is the visibility here? How reliable are these deliveries and the customers?

Antonio Garcia -- Chief Financial Officer

I would say, for the -- Robert, for the commercial aviation, again, we -- for sure, we have talks every day for customer. But what you see for the second half of the year is confirmed, OK? And there should be no change or no big surprise, maybe with even upside rotation and the executive aviation let's say a big portion of the second half is already sold. It's just to deliver and we still have just a few white tails to be sold in the second semester. That's why we are confident about the -- what we are communicating to the market right now.

Unknown speaker

OK. And then longer-term question on defense. Given the new areas that you're beginning to pursue and with the product portfolio that you currently have, if we look out a few years, how big do you see the business annually in terms of revenues?

Francisco Gomes Neto -- President and Chief Executive Officer

We are now -- as I mentioned earlier, we are now finalizing our '21, '25 strategic plan. And we foresee a growth in all business units including defense, especially in defense, we have now campaigns, open campaigns going with the KC-390 with different potential customers. So -- and we are now be working in all different segments in defense. So we are optimistic that all the business, especially defense will show important growth in the following years.

Unknown speaker

OK. Thank you very much.

Francisco Gomes Neto -- President and Chief Executive Officer

You are welcome.

Operator

Our next question comes from Mr. Cai von from Cowen.

Cai von Rumohr -- Cowen and Company -- Analyst

Thank you very much. So if I could follow up with Myles' question. If we're looking for breakeven cash flow in the second half, does that assume a big deficit in the third quarter because your fourth quarter historically always has been huge. And maybe give us some color on some of the moving parts, for example, the inventories, the contract liabilities were down in Q2.

I assume you paid off your suppliers. Is that an opportunity that maybe you could move back to more normal levels?

Edu Couto -- Head of Investor Relations

Hi Cai. It's Edu here. I will take that question. Yes, fourth quarter will be, for sure, stronger than third quarter.

We are not anticipating a big cash burn in third quarter. I think third quarter will already be good. But fourth quarter, for sure, positive. So maybe there is some room for -- to be positive in the second half, but to be more conservative, we're assuming breakeven, but definitely fourth quarter stronger and third quarter still more soft.

Antonio Garcia -- Chief Financial Officer

Just to complete it though...

Cai von Rumohr -- Cowen and Company -- Analyst

Thank you very much.

Antonio Garcia -- Chief Financial Officer

Cai, just to be a just to complete it, in regards to the liability with supplier base, we still just really, really few discussions with one or other suppliers about renegotiation. But I would say the big guys we already discussed and agree how to move forward and with the new volumes, we are quite confident to not see any big liability in the second quarter or the second half of the year.

Cai von Rumohr -- Cowen and Company -- Analyst

And then a second question, I know that you haven't completed your 2021 to '25 strategic plan. But if one looks at the history of Embraer, you've done an incredible job of developing high-performing products, both in regional and bizjet, now KC-390 and yet you pretty consistently have not generated substantial profits or cash flow for shareholders. As you think about that strategic plan, what kind of priority is there in terms of return to the shareholders? And what are you doing to assure that?

Francisco Gomes Neto -- President and Chief Executive Officer

Good question, Cai. I mean again, it's a combination of actions we are taking, right? I mean in the short term, we are -- as we mentioned before, we are focusing on the cash preservation with all measures mentioned before. We are also taking care to adjust the organization in the light of the COVID-19 impact and also to eliminating the duplications we had to do because of the deal with Boeing. We are recapturing all the synergies.

And then we are also putting in place a lot of other projects like to reduce the production cycles of our aircrafts to put more focus on procurement activities to put more focus on material management to work with less inventory and reducing the working capital. And all of this, combined with this future growth that are included in the growth drivers of our '21, '25 strategic plan, we believe this will improve a lot our financial performance in the following years.

Cai von Rumohr -- Cowen and Company -- Analyst

Thank you very much.

Operator

Our next question comes from Mr. Gabriel from Bradesco BBI.

Unknown speaker

Hi. Thank you. I have two questions here on my side. I wonder if you could comment a little bit on the higher operational expenses in the services and support division? And also my second question there's been a lot of news in the media regarding layoffs.

Could you comment a little bit on that? I mean how are negotiations with labor unions evolving?

Edu Couto -- Head of Investor Relations

Yeah. Maybe I can take the first one regarding services. Yes, the service business, especially in commercial, were also affected in the second quarter, right, given lower activity as we show in the charts, especially April was a very soft month in terms of flight operations, April and May. And that affected the fixed cost dilution of service and that was reflected in the second-quarter numbers.

But as the activity is returning, we believe service will have better, better numbers in the second half. We also had some bad debt provisions, right, in services that affected the costs in the second Q.

Francisco Gomes Neto -- President and Chief Executive Officer

Gabriel, could you please repeat your second question?

Unknown speaker

Yeah, sure. Yeah, it was regarding layoffs and negotiations with labor union?

Francisco Gomes Neto -- President and Chief Executive Officer

Well, we are working this restructuring program. We have -- we decided to start in the upper level with the vice presidents. So we made some important changes there as I mentioned before. And we also did -- we went out to the second level of directors and managers and make some change in the adjustments in that -- those levels.

And now we are studying the following levels. In parallel, we opened this PDVs, the voluntary dismissal program to help us in this process. So now we are going step by step, I mean, in this restructuring program, that's our plan.

Unknown speaker

OK. That was helpful. Thank you.

Operator

Our next question comes from Mr. Noah from Goldman Sachs.

Unknown speaker

Hi everyone.

Francisco Gomes Neto -- President and Chief Executive Officer

Hi Noah.

Unknown speaker

Is it possible to attempt to quantify or give a little bit more detail on your production and delivery mismatch? I assume you're producing ahead of deliveries as you field near-term deferrals. And so I'm just wondering how many aircraft built but not delivered that you end the quarter with? And how much of that will you flush through the inventory by the end of the year or how many will you end the year with in commercial?

Edu Couto -- Head of Investor Relations

Yeah. It's -- for sure, we have higher inventories that we would expect, given the low volume of deliveries that we had in the second quarter. It's tough to give a number, right, but our total inventories are around $3.2 billion, and they could be above $100 million lower if we were delivering the planes as initially planned. So there is room.

And the second half will show as we pick up the deliveries, we expect a good reduction, right, in terms of inventory that will translate in cash, but it's tough for us to quantify a number because sometimes the planes are really close to conclusion in the production line, but we still show them as work in progress. So we -- it's tough to give a number of how many planes are ready, but we have a good size of inventory in commercial for second half.

Antonio Garcia -- Chief Financial Officer

Just to complete, Noah, good question. We were I would say prepared before the crisis to produce around 100 aircraft. And with the slowdown and deferrals, we should not see more than half of this number, and that's impact our inventory in many cases. That's why we do have this $3.2 billion inventory that is our opportunity to continuously reduce to the second half of the year.

And with the addition of deliveries that we do see historically for the second half of the year.

Unknown speaker

OK. So would you expect to end the year with that production and delivery mismatch gone and everything lined up and then you just reset production for next year or will you move into 2021 with some lingering inventory from this year?

Antonio Garcia -- Chief Financial Officer

I would say we are moving a little bit inventory for next year. We are revising the supply chain and the material have on a daily basis, OK? But we should have some, especially in commercial side, some carryover for 2021, not huge because we did a great job to reprogramming all material, but some material have already in our inventory that is still continue to be to 2021. And with the new schedule for 2021, we are going to get rid of this excess material.

Unknown speaker

Got it. And then when do you expect to be able to pretty confidently set that 2021 production plan, both on the commercial side and the executive side. I mean are you kind of already there now because you've had enough of an evolution in your customer conversation or is it still so uncertain out there that you're not yet really that close to knowing where you want to put production for next year?

Antonio Garcia -- Chief Financial Officer

No, we do have already a number for next year that we set our production or material program. We have the I would say the latest revision change in late August to be done. But we set already I would say with some conservatism here, with some to be more to fit on the ground. We set our number for next year.

And if there is a change, it can be only an upside potential. We are quite conservative for the numbers for 2021. Maybe Francisco want to comment in addition.

Francisco Gomes Neto -- President and Chief Executive Officer

No. That's what we are doing, Noah. We are trying to be conservative for the plans for next year, but adjusting the organization to that -- to those deliveries we are playing for next year. This is what we are doing.

Unknown speaker

Is your -- that's helpful. What I'm trying to get at is your level of confidence in that right now, as you speak to us, substantially higher than it was when you last reported results to us because there's been enough firming up with the customers or is it still -- is it not really that different than the last time you spoke to us because there's so much uncertainty still out there?

Antonio Garcia -- Chief Financial Officer

No, we are much more confident when you have the latest call however we are still having this credit facility which is not available for our airlines. I would say if I would see constraint is related to the credit, but in regards to the schedule for next year, the programs we have, we are much more confident than three months ago.

Unknown speaker

OK. OK, thank you so much.

Antonio Garcia -- Chief Financial Officer

You're welcome.

Operator

Our next question comes from Mr. Ron from Bank of America. Mr. Ron, you may proceed.

Ron Epstein -- Bank of America Merrill Lynch -- Analyst

I'm sorry about that. How has interest from China been? Have you seen a pickup in interest in commercial airplanes or even business aircraft from the Chinese market?

Francisco Gomes Neto -- President and Chief Executive Officer

Ron, actually, we are working in several fronts, looking for potential partnerships to help us to introduce our state-of-the-art products in new markets and also to help us to develop specific projects is the turboprop. But to be very honest with you, we don't have yet any concrete result to be and to open to the market. But we are working very hard on those fronts. I'm personally involved in following those fronts up in a biweekly basis.

But we don't have any concrete to share with you -- any concrete news to share with you so far.

Ron Epstein -- Bank of America Merrill Lynch -- Analyst

OK. Thank you.

Operator

[Operator signoff]

Duration: 60 minutes

Call participants:

Francisco Gomes Neto -- President and Chief Executive Officer

Antonio Garcia -- Chief Financial Officer

Myles Walton -- UBS -- Analyst

Edu Couto -- Head of Investor Relations

Ron Epstein -- Bank of America Merrill Lynch -- Analyst

Unknown speaker

Cai von Rumohr -- Cowen and Company -- Analyst

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