EMBJ

Business Context and Reporting Period

Company: Embraer S.A.
Filing Type: Form 6-K (Report of Foreign Private Issuer)
Reporting Period: Second Quarter 2012 (ended June 30, 2012) and Year-to-Date 2012.
Business Overview: Embraer is a global manufacturer of commercial jets (up to 120 seats), executive aircraft, and defense/security systems. The company operates in Commercial Aviation, Executive Aviation, and Defense and Security segments.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: 2Q12 revenues increased 26.4% year-over-year to $1,717.3 million, driven by higher deliveries (35 commercial jets and 20 executive jets) and a favorable product mix.
• Margin Expansion: Gross margin improved to 23.6% from 22.4% in 2Q11. EBIT margin rose significantly to 11.5% from 7.8%, aided by operational efficiency and the appreciation of the US Dollar against the Brazilian Real.
• Net Income Volatility: Reported Net Income attributable to shareholders dropped to $54.3 million from $96.4 million in 2Q11. This decline was primarily due to a non-cash deferred income tax expense of $132.2 million resulting from the 11% appreciation of the USD against the Real impacting non-monetary assets.
• Debt Profile: Total debt increased by $167.6 million to $2,155.8 million. This was driven by a $500 million issuance of Senior Unsecured Notes (10-year maturity, 5.15% coupon) to support working capital and cash management, partially offset by a reduction in short-term loans.
• Segment Performance: Defense and Security revenues grew 33% year-over-year. Commercial Aviation remained the largest segment at 68.5% of total revenue.

Guidance, Outlook, and Risks

• Guidance Revision: Embraer revised its 2012 full-year guidance upward due to strong operating performance and currency effects:
  • EBIT Margin: Revised from 8.0% - 8.5% to 9.0% - 9.5%.
  • EBITDA Margin: Revised from 11.5% - 12.5% to 12.5% - 13.5%.
• Outlook: Management believes the company is on track to meet 2012 delivery and revenue guidance. Free cash flow is expected to turn positive by year-end as inventory levels decrease with increased executive jet deliveries.
• Key Risks and Contingencies:
  • Currency Fluctuation: Significant exposure to the USD/BRL exchange rate, which impacts deferred taxes and operating costs (labor in Brazil is Real-denominated).
  • Working Capital: Negative free cash flow year-to-date is attributed to inventory build-up and receivables, though management expects a reversal.
  • Regulatory and Program Risks: Dependence on government contracts (e.g., SISFRON, USAF Light Air Support) and certification timelines for new programs (e.g., KC-390, Phenom 300).

Investor Verification Checklist

• Deferred Tax Impact: Verify the sustainability of Adjusted Net Income ($186.5M) versus Reported Net Income ($54.3M) given the $132.2M non-cash tax charge driven by currency appreciation.
• Free Cash Flow Reversal: Monitor inventory levels and executive jet delivery schedules to confirm the projected reversal of negative free cash flow by year-end.
• Debt Servicing: Review the impact of the new $500M note issuance on interest expenses and the Adjusted EBITDA to financial expenses ratio (currently 5.85x).
• Backlog Execution: Confirm the execution of the $12.9 billion firm order backlog, particularly in the Commercial Aviation segment (1,058 firm orders).
• Defense Contracts: Track the status of the Integrated System for Border Monitoring (SISFRON) bid and the USAF Light Air Support program contract award expected in 2013.