EMBJ

Business Context and Reporting Period

Company: Embraer S.A.
Filing Type: Form 6-K (Report of Foreign Private Issuer)
Reporting Period: Third Quarter (3Q) ended September 30, 2014, and Year-to-Date (YTD) nine months ended September 30, 2014.
Business Overview: Embraer is a global manufacturer of commercial jets (up to 120 seats), executive jets, and defense/security systems. The company operates in three primary segments: Commercial Aviation, Executive Jets, and Defense & Security.

Key Financial Metrics

Note: Negative values in parentheses indicate a loss or net debt position.

Material Changes vs. Prior Period

• Revenue Decline (3Q): Revenue decreased 3.8% year-over-year to $1,239.7 million, driven by lower Executive Jet deliveries (15 units vs. 25 in 3Q13) and a shift in commercial aircraft mix. This was partially offset by a 29.8% revenue increase in the Defense & Security segment.
• Profitability Pressure: EBIT declined to $68.1 million (5.5% margin) due to lower operating leverage from reduced revenues and an 8% increase in wages. However, YTD EBIT grew 38.5% to $347.0 million, aided by favorable exchange rates and cost efficiency.
• Net Loss in 3Q: The company reported a net loss of $10.7 million for the quarter, primarily due to a non-cash deferred income tax expense of $77.1 million resulting from foreign exchange variations on non-monetary assets. Adjusted Net Income (excluding this tax item) was $92.6 million.
• Balance Sheet Shift: Net debt increased significantly from $114.3 million (2Q14) to $326.6 million (3Q14). This was driven by a $327.6 million increase in inventories to prepare for seasonally strong fourth-quarter deliveries.
• Cash Flow: Free cash flow was negative $137.6 million in 3Q14 and negative $691.0 million YTD, reflecting heavy investment in inventory and product development.

Guidance, Outlook, and Risks

• Guidance: The Company's 2014 financial performance and delivery guidance published in February remains unchanged. Management expects cash generation to improve in the fourth quarter due to increased aircraft deliveries.
• Backlog: The firm order backlog reached a record high of $22.1 billion at the end of 3Q14.
• Key Orders: Significant announcements included a potential order for 100 E175-E2 jets from Trans States Holdings, a Letter of Intent for 50 E195-E2 jets from Azul, and firm orders from China (Tianjin Airlines, ICBC Leasing) and Japan (JAL, Fuji Dream Airlines).
• Development: Net development investments for YTD 2014 were $111.6 million, tracking below the $320 million annual guidance. The E-Jets E2 program remains on schedule.
• Risks and Contingencies:
  • SEC/DOJ Investigation: The company is under investigation regarding potential violations of the U.S. Foreign Corrupt Practices Act (FCPA). While the company has expanded its compliance program, it cannot currently estimate the financial impact or accruals related to potential fines or sanctions.
  • Exchange Rate Exposure: Approximately 25% of costs are denominated in Brazilian Reals while only 10% of revenues are. The company utilizes hedging strategies to mitigate this exposure.

Investor Verification Checklist

• Deferred Tax Impact: Verify the sustainability of the $77.1 million non-cash tax expense in 3Q14 and its impact on future liquidity and net income volatility.
• Inventory Build-up: Monitor the $327.6 million increase in inventory to ensure it converts to revenue in Q4 as anticipated to avoid working capital strain.
• FCPA Investigation Status: Track updates on the SEC/DOJ investigation to assess potential future liabilities or reputational damage.
• Order Conversion: Confirm the conversion of Letters of Intent (e.g., Azul, Trans States) into firm orders to validate the record backlog of $22.1 billion.
• Executive Jet Recovery: Assess the recovery of the Executive Jets segment, which saw a 32.2% revenue decline in 3Q14, to ensure it meets YTD delivery targets.