EMBJ

Business Context and Reporting Period

Embraer S.A., a leading manufacturer of commercial, executive, and defense aircraft, reported its unaudited financial results for the second quarter ended June 30, 2015. The company operates globally with headquarters in Brazil and significant operations in the U.S., China, and Europe. The reporting period covers the three and six months ended June 30, 2015, with comparisons to the same periods in 2014 and the prior quarter (1Q15).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Q2 2015 revenue decreased 14.1% year-over-year to $1.51 billion, driven by lower deliveries across all segments and a 39% year-over-year revenue drop in the Defense & Security segment.
• Margin Compression: Gross margin fell from 21.9% in 2Q14 to 18.9% in 2Q15 due to lower revenue volume affecting fixed cost dilution and cost base revisions in Defense & Security. EBIT margin declined to 6.8% from 10.6%.
• Net Income Resilience: Despite lower operating income, Net Income remained relatively stable ($129.3M vs $143.4M) due to a significant $49.6 million foreign exchange gain in 2Q15 compared to $3.7 million in 2Q14, and reduced income tax expenses.
• Debt Position: Total debt increased to $3.53 billion from $2.39 billion in 1Q15 following the issuance of $1.0 billion in 5.05% bonds maturing in 2025. However, Net Debt improved to $510.7 million from $581.3 million due to strong cash generation.
• Backlog Growth: The firm order backlog reached a record high of $22.9 billion, up from $20.4 billion in 1Q15, driven by 102 new firm orders for E-Jets.

Guidance, Outlook, and Risks

Revised 2015 Guidance

Embraer revised its full-year 2015 outlook to reflect the devaluation of the Brazilian Real and slower Defense & Security development work:

• Revenue: Lowered to $5.8 – $6.3 billion (previously $6.1 – $6.6 billion).
• EBIT: Unchanged at $490 – $560 million.
• EBIT Margin: Raised to 8.5% – 9.0% (previously 8.0% – 8.5%) due to favorable currency impacts on margins.
• EBITDA: Unchanged at $730 – $850 million.
• EBITDA Margin: Raised to 12.6% – 13.6% (previously 12.0% – 13.0%).

Operational Outlook

The company expects Free Cash Flow to improve in the second half of 2015, with a full-year guidance of a use of $100 million or better. Commercial Aviation remains the largest revenue contributor (58.3% in 2Q15), while Defense & Security revenue is expected to range between $800 – $950 million for the year.

Risks and Contingencies

• SEC/DOJ Investigation: The company is under investigation by the SEC and DOJ regarding potential FCPA violations related to aircraft sales outside Brazil. Discussions for a resolution are ongoing. The company states there is no adequate basis to estimate potential fines or sanctions at this time.
• Currency Risk: Approximately 15% of net revenues and 25% of costs are denominated in Brazilian Reals. The company utilizes hedging strategies to mitigate cash flow exposure.
• Defense Program Delays: Slower pace of development work on certain Defense & Security contracts contributed to the revenue guidance reduction.

Investor Verification Checklist

• FCPA Resolution Status: Monitor updates on the SEC/DOJ investigation to assess potential financial impact from fines or sanctions.
• Defense Segment Recovery: Verify the timeline for the KC-390 certification (expected H2 2017) and the impact of the revised $800M–$950M revenue guidance on future profitability.
• Currency Hedging Effectiveness: Review the impact of the Brazilian Real's volatility on future margins, given the company's reliance on favorable exchange rates to offset lower revenue volumes.
• E-Jets E2 Progress: Track the conversion of options to firm orders for the E2 program and the ramp-up of deliveries starting in 2018.
• Debt Maturity Profile: Confirm the sustainability of the debt load given the recent $1 billion issuance and the company's ability to service interest obligations with projected EBITDA.