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Embraer SA (NYSE:ERJ)

Q1 2012 Earnings Call

April 27, 2012 09:30 a.m. ET

Executives

André Gaia – Head, Investor Relations

Frederico Curado – President, Chief Executive Officer

Analysts

Noah Poponak – Goldman Sachs

Cai von Rumohr – Cowen & Company

Ray Neidl – Maxim Group

Myles Walton – Deutsche Bank

Joseph Nadol – JP Morgan

Nicolai Sebrell – Morgan Stanley

Milan Posarac – Scotiabank

Stephen Trent – Citigroup

Alexander Amson – Santander

Operator

Good morning, ladies and gentlemen and welcome to the Audio Conference that will review Embraer’s First Quarter 2012 results. Thank you for standing by. At this time all participants are in a listen only mode. Later we will conduct a question and answer session and instructions to participate will be given at that time. (Operator Instructions). As a reminder this conference is being recorded and wecasted 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 and 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 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.

Participating on today’s conference call are Mr. Frederico Curado, President and CEO; Mr. André Gaia, Head of IR; and Mr. Rodrigo Rosa, Controller. I would like to now turn the conference over to Mr. Frederico Curado. Please go ahead, sir.

Frederico Curado

Good morning, everyone from a very rainy and dark snowfall. So few words about the quarter, we delivered 21 E-jets and we also sold 12 new aircraft, 10 for Azul, one for BA, and for 1 for Japan Airlines.

With those orders, we have a total of 1,063 aircrafts sold in the E-jets family, this comprises 60 campaigns in 42 counties. So because of they keeps expanding, last two editions as operators of Bulgaria Air and Estonian Air, which are – falls into the capillarity and the liquidity of our assets, of our aircraft.

And as far as the executive jets we have 13 delivers this quarter of those 12 are Phenom’s and 1 Legacy. Importantly we keep in developing the Legacy 500 in every pass within the four flights for this initial flight that’s, which was happened in the third quarter. So even time for that. So low speed taxi and high speed taxi and also (inaudible) signal vibration plus all going well so far.

As far as deliveries, we got 13 deliveries, we’ve reached 300 Phenom’s delivered to the market, to the worldwide market and we have also brought to the market 100 business jets and Embraer business jets in Brazil. It’s a very important march for us.

Doing business, that’s our dealer customer Minsheng, in China which has an important legacy order also ordered the Lineage 1000, so we announced three aircrafts recently for the same customer which elevates the strength of the Chinese market in particular and their going presence in that market. We obviously continue to invest in our global support network as that it grows, we continue to invest and step out in our new service centers and according to the plan.

Shifting gears to defense and security, we – this business is growing as predicted, it’s showing the robustness in its growth. So in this quarter, it went 20% of the revenues of the company and our outlook for the year is 16%. So it’s probably going to stay between 15% and 20% throughout the year, this is our expectation. We have the first flights of the second AEW 145 for Indian aircraft of the three so the performances keep moving.

We also announced during the Dubai Air Show, three new customers for the Super Tucano all of them in Africa. And also I think important to emphasize, we acquired participation of EADS has in OGMA. So by taking OGMA in Portugal now with 65% remaining 35 in the hands of the Portuguese Government.

So a bigger bounce here about financials, we have slight deflection in our backlog and our revenues, we reached $1.16 million two-thirds of that coming from the area of commercial aircraft business, 20% to France and 13% business to US. Our gross margin is more or less where we thought, it should be, now at 23% showing a consistent behavior as for as last two quarters.

With that, we also really achieve in operating margin of 7.4% which is $86 million result is 1.15 revenues. Our SG&A is going back to life, our SG&A, we broke that the trends which are throughout last year in our growth, in our increasing of cost in SG&A. So we are able to reduce both in riyals and US dollars and this is clearly a focus for us not to allow you to keep growing but rather stable or in more and more efficient as we go.

With $86 million of EBIT, our EBITDA was $148 million and 12.8% on sales and we remained solid about the outlooks of both EBIT and EBITDA where revenues EBIT and EBITDA for the year. Net income of 5.4%, $650 million is coming from a large impairment of less borrowed but again relatively in line with our expectations.

On the cash side, a little bit of frustration of revenues which of course, as we have lost some, if you believe us, which we shall believe in the next quarter did finalize our cash flow little bit. You can see that’s reflected in the increasing inventories but again volatilities among quarters, so nothing that should not be result within the course of the year.

And to finalize we took some low cost short-term indebtedness, also to cope with this little bit of the frustration in some revenues in the quarter. We remain very solid in cash position. We remain very comfortable, as far as the maturity and the cost of our indebtedness. So our net cash in the quarter and at the end of the quarter was $300 million, which is roughly $2.3 billion in cash and about $2 billion in debt, with that difference, gives us $300 million in net cash.

So with that, I’ll open for Q&A and thank you for your attention.

Question-and-Answer Session

Operator

(Operator Instructions). The Our first question comes from (inaudible) of Royal bank of Canada. Your line is open. Our next question comes from Noah Poponak of Goldman Sachs. Your line is open.

Noah Poponak – Goldman Sachs

Hi, good morning everybody.

Frederico Curado

Good morning, Noah.

Noah Poponak – Goldman Sachs

Fred, I wondered if you could talk about what happened with your CFO. It seemed a little odd to see him come on and leave in that short of period of time and what the plan is for the next person in the position?

Frederico Curado

Noah, he got from (inaudible) unrefuseable proposal. As the message (inaudible) he got a – as he when remind, he came from units, has his own career, I mean, long time career there – and have his old career, and a as little with CFO, then he left the company. He went to another steel deal company, he came to Embraer and he – just speaking, he is taking office I believe today, or to be yesterday. Yesterday to be posted as a Chairman of and I understand in a very, very attracting and aggressive package. So –, there’s absolutely nothing, none in part market as soon as in Brazil, a better place to be as CFO in Brazil, by the way now, Noah.

Noah Poponak – Goldman Sachs

Okay. And plans for –

Frederico Curado

Yeah. Weeks, we are weeks away announcing our new CFO who will be certainly somebody really very seasoned and will experience in both Brazil and US markets. We’re in a final stage of our search.

Noah Poponak – Goldman Sachs

On commercial orders, they’ve been relatively light year-to-date. Can you just elaborate a little bit more on why that’s been the case and I guess more importantly why your expectation is for the remainder of 2012 for commercial orders?

Frederico Curado

There is some softness in the market clearly, not to the point that it gives us let say major concern, we do see china with strong prospect, Asia is kind of resilience either obviously is very soft but option activity is small one’s and two’s here and there, we by the way just had just one airplane from BA, but no large growth coming from there. Some slowdown in Latin America, although we still have some growth. I think Azul story art in Brazil relatively speaking is a good story.

So we just had another 10 airplanes for Azul. I think we can be a little bit more optimistic about the US and so overall, we are at this stage, we’re sticking to our view that it is feasible that we maintain a one to one book-to-bill ratio and let’s see how the U. S. market unfolds. Of course, you know, US – there is activity tends to be large, but full year we are cautiously optimistic. We are parallel, we have a stable – I think a reasonably view of what’s going to happen through the year.

Noah Poponak – Goldman Sachs

Do you now need one of the larger binary US scope cause driven orders to have book-to-bill of one in 2012 or can you get to that one times level without any of those larger one-time U.S. orders?

Frederico Curado

So it is just to answer – let me put it this way. At this stage, I would not say that and if there is such – if there is a large order like this, we’re going to – let me answer you in a different way. If we have one of those large orders, it certainly is going to pass. We are going to take this beyond the one-to-one. So we have not given up yet ex-U. S. as far as our ability to keep up the position line growing, I mean, 1,000 jobs is no concern and we are sustaining obviously the revenues in our guidance. But, if you expand your quest for the next three years, maybe.

Noah Poponak – Goldman Sachs

Okay, great. Then last one for me, the tax cut benefit from this Brazil stimulus package, clearly positively impacts you. Can you talk about the degree to which that does or does not help you in the year 2012, and then can you quantify what the annualized impact is, whenever it’s going to be the case that it impacts you for a full year?

Frederico Curado

We do have some positive impact this year. I don’t think it is going to be let’s say, huge things from announcement to implementation, takes a while in this country. There is a lot of regulation in the way the things happen. So between expectation and announcement, when the real accounting of those results, there is not only delay, but some time there is some heat lost in the system.

On a stable, I can actually – would like to say for next year, if everything remains the same as announced, probably it’s like $100 million of earnings. This year it will be something between zero and less than that, certainly much less than that, because some of the measure will not impact our costs and to the second half in some, not even until in the last quarter. So it’s – in the next few months, we will have a more clear picture. But, let’s keep in mind that those things are there, to try to offset some of the headwinds that we have.

So – which I mean, we’re working very hard as you know, to keep our efficiency and productivity and competitiveness. So this is, I think this is – I think is old to us, it’s not something which is really like a gift. So it helps a lot. Last year, as you know, a 10% increase in pay rate, it’s difficult to keep going like that. So it’s refreshing that there is some concern and awareness in Brazilian government, that the Brazilian industry needs some more level playing field in whatever form, which is possible.

Noah Poponak – Goldman Sachs

Thank you, very helpful. Thanks a lot.

Frederico Curado

Thank’s Noah.

Operator

Our next question comes from Cai von Rumohr of Cowen & Company.

Cai von Rumohr – Cowen & Company

Yes, thank you very much Fred. If you could update us on the tone of biz jet demand and kind of your thoughts about any thing you might do if Hawker or parts of Hawker become available?

Frederico Curado

Well, biz jets, we’ve seen some of the – we’re taking more calls in the United States now. So we’ll have to hope at this stage, I think we’re hoping in belief. But we’re hoping that there is some ramp in activity. We’re busier in that respect. So I think again, I think we are at this stage just steep into our guidances.

As far as Hawker, we’re following up the situation. We are evaluating how this thing is going to unfold. Obviously, their financial situation is pretty good. We – maybe some assets could be of interest to Embraer. We just have to see how that develops. But if there is a possibility that some assets becomes available pre or post bankruptcy, we would certainly take a serious look in how that could leverage our ramp up, of our own executive jet business.

For example, the infrastructure support, that’s something we keep investing. So that – value showed synergy there. And at the product line, we have to see whether there is some synergies that could be complemented. But this would be, let’s say, our view. It’s not a target in itself. It’s something which may or may not become an interesting opportunity.

Cai von Rumohr – Cowen & Company

Okay. And going back to Noah’s question on the stimulus. Could you give us a little more specific kind of, it’s obviously very small this year, but maybe some help in terms of the rollout as we go through the year in terms of selling and G&A expense, you’ve kind of still told us we’re doing R&D about $100 million, but should we just continue the rate of selling and G&A in absolute – do they trend up as they did last year?

Frederico Curado

No, definitely no. We have to continue and here this is – this is bringing us – calling our attention. I mean, last year we had a step function – SG&A. Some of it, it’s good, some of it would – reflects increasing commercial activity as we’re investing for example, more in those flight demonstrators and we’ve tried to steer up more sales. On the other hand site, it is – it has to be – as it has been a wholly war against overhead costs. So I think, this slight reduction of the last quarter and in this quarter shows a trend. I mean it is – in worst case scenario has to be a flat number, in worst case scenario and that’s something we’re going to keep combating very seriously inside the company.

Cai von Rumohr – Cowen & Company

Okay. If you just say, you mentioned as we get to 2013 that we should see about $100 million from stimulus and yet if you kind of take the formula of that 14% of parts is real based and most of research and 18% of G&A and so on and you apply the 16%, 17%, you come up with a number on paper of $200 million. Is that the better number or is it a smaller number because you reinvest some of it, how should we think about that?

Frederico Curado

Can I ask the support of Andre here.

André Gaia

Cai, I think the numbers you are referring is first to the total labor cost and the benefit of 20% goes over just to the payroll itself. So you have to take this number, divide it by the 1.8 approximately and then apply to 20% benefit. So then you get closer to this $100 million that Fred mentioned.

Frederico Curado

Oh, yeah.

Cai von Rumohr – Cowen & Company

Okay. Very good and on your question on SG&A, just so unclear, does that mean we should be looking at about a rate of close to $180 million in the next couple of quarters in that ballpark?

Frederico Curado

I think that’s a fair assumption.

Cai von Rumohr – Cowen & Company

Okay. Terrific. Thank you, very much.

Frederico Curado

Thank you.

André Gaia

Thank you, Cai.

Operator

Thank you. Our next question comes from Ray Neidl of Maxim Group.

Ray Neidl – Maxim Group

Yes, good morning.

Frederico Curado

Good morning.

Ray Neidl – Maxim Group

Basically, I was just trying to clarify this. The negative impact on the earnings this year, it looks like there was more financial related to the tax deductibility of the dividends, and the exchange rate. But also on top of that, you kind of alluded to, that the administrative expenses are up that the salary costs was up due to the – partly, maybe due to the real. Is that pretty much a summary of what’s happening there, the basic operational results still look solid, but looks like it’s more financial matters and the dividends that have really impacted the income for this quarter?

Frederico Curado

There is always some volatility in the mix of progress and price mix. So this element is always there in the first quarter of last year was exceptionally positive. We have emphasized that many times last year. But as we have this – the non-distribution of interest on capital, reduced our ability to get more favorable income tax, and as far as the RVG adjustment, it is normal process normal as we do every quarter, we have a new appraiser, so a new appraiser I’m not sure one or two in all – the appraiser base that we use with our auditors to keep track of the values of our feeds there were some changes as it would reflect in this, I think it was $11 million of change; and FX a little bit, I think about 2% of variation.

Ray Neidl – Maxim Group

Compare to fourth quarter.

Frederico Curado

So it’s not anything – but a combination of two or three factors that – but again, I think it was relatively as expected quarter, except for the little miss, about may be $100 million or $102 million in revenue, therefore impacting the cash generation in the inventories.

Ray Neidl – Maxim Group

Okay.

Frederico Curado

So that, there were no large surprises here.

Ray Neidl – Maxim Group

Okay, but you don’t feel that the administrative costs are getting out of hand, something of that sort?

Frederico Curado

Not at all. I will just add this to $180 million, we think this could be used as a trend going forward.

Ray Neidl – Maxim Group

Okay great and you said going forward, there was some softness in the market worldwide. Are we just talking about the executive jet or are we talking about the commercial as well?

Frederico Curado

When I speak about softness – well the business jet has been soft for some time. So we are seeing some positive signs in the United States. When I say softness, I was referring more to the airline side.

Ray Neidl – Maxim Group

Okay great and finally, the AMR write-off we know there is a major restructuring going on at American Eagle right now, and you are taking that penalty upfront. But to me when they get the new scope clause agreements in the bankruptcy, there might be a huge opportunity for Embraer to sell them up the 170s or 190s. Is that something that you’re looking at? Is that a potential advantage that could happen maybe three or four quarters down the road?

Frederico Curado

Yeah, we actually involves in the discussion with the American, between American and yes we expect that discussion as to our understanding, its going well. We believe this should be over. I mean, this let’s say the 145 fleets, the discussion should be over sometime around the end of May. Then you’ve to see when is American going to emerge from bankruptcy. There are discussions about this future of American Eagle going after larger aircraft, depending basically on scope clauses.

We believe AMR reemerged stronger from the bankruptcy. So the timing on the new fleet, it’s hard to predict. It will have a direct result of when they actually emerge from bankruptcy. It is being discussed. The airplane is – the E-Jets are perfect. The growth they need, that are obviously several other considerations to be made, so we are very close to the issue and hopefully will be able to maintain our strong presence there.

Ray Neidl – Maxim Group

Great. Thank you.

Frederico Curado

Thank you.

Operator

Thank you. Our next question comes from Myles Walton of Deutsche Bank.

Myles Walton – Deutsche Bank

Thanks. Good morning.

Frederico Curado

Hi, Myles.

Myles Walton – Deutsche Bank

I was – can we go back to the SG&A map for a second if I could Fred? So if you can keep this run rate it would imply SG&A for the last three months of the year as a percent of sales is only 11% and I know there is some headwind on R&D. But it’s actually not that much, it would point to your operating margin guidance of 8% to 8.5% having in the 100 basis points of upside potential. Can you give us what’s the put on the other side of that that would kind of force it downward?

Frederico Curado

Maybe some uncertainty on the – of course, it depend on the higher revenues. We have a band for the revenues, obviously they are higher, yet the better is to dilute fixed costs. We always have some unpredictable elements, so just being 3.5 months in the year, I think is too premature to raise our estimate. But that’s not necessarily, I would say more uncertainty, this base model, is our position as far as, how things unfolds, other than knowing that you’re going to have something negative to offset potentially some upside that we may have coming from our compensation costs and also whatever we get from the stimulus package.

André Gaia

Okay. We’ll, maybe if it was a mid-year, we’ll have a – I will have a more clear answer to your question and we’d say where we are, what we can. This is still a little bit too early to change.

Myles Walton – Deutsche Bank

Okay, now that’s fair. It’s just as good to hear that SG&A could continue at this level. The other question is on the service related revenue, total for the company aviation services, I think the guidance had been looking for kind of a mid-teens growth in this quarter. I think if you compile all the service businesses together it’s about flat year-on-year. Is that where the revenue shortfall came or is that as expected and there is easier comps in acceleration to the back half of the year?

Frederico Curado

All right, we missed a few deliveries in the quarter. So there is some carryover for the next quarters. I think it came from the – on the airplane side. I don’t know Andre, if there is any – on the service side any –

André Gaia

Myles, in terms of services, services there is some level for unpredictiveness in this process because some of the sales are spot sales. So it’s hard to be precise on a quarterly basis. We do see some expansion in services this year as the fleet continues to grow, as it continues to age and as we continue to market to this product. And as you can see by the inventory’s position in the spare pools, you see certainly some growth on potential heaviness from services. So all that together will make us believe that throughout the year, this will materialize. On a quarterly basis as I said, because of the natural way that the sales happens, hard to say.

Myles Walton – Deutsche Bank

Okay. And then the last one for me is, if you look to year-end, obviously a weak cash performance here in the quarter, you had to build the inventories as you alluded to. Where does the net cash position come out by year end? Do you claim that all back plus a little or just kind of what’s the outlook for net cash by year-end?

Frederico Curado

Well, we are certainly shooting for a net cash position, not to lose that position. We have this year, significant commitment as far as their investments. So we should be relatively stable, as far as our cash position. Realizing our – one is to be – we make a degree or other our revenues and cash generation. We will be able to perform our own investment and still remain a relatively stable cash position.

Myles Walton – Deutsche Bank

Okay, great. Thanks.

Frederico Curado

Thank you.

Operator

Thank you. Our next question comes from Joe Nadol of JP Morgan. Your line is open.

Joseph Nadol – JP Morgan

Hi. Let’s go back to the business jet area. Fred, you had some cancellations in the quarter. Could you discuss the magnitude of those, and what you’re really seeing in that area?

Frederico Curado

We did it Joe. We – and this is probably the largest single contributor throughout (inaudible) in our backlog. We had a customer in the Middle East, which has a large order. I don’t have it by heart, but it has Lineages and Legacies, and maybe even Legacy 500. And that alone is a significant piece of the cancellations in the quarter. So I think is a little bit nonrecurring event, but really caused some step function effect there.

Joseph Nadol – JP Morgan

Okay.

Frederico Curado

Just to add, I mean, we were not alone. So, this same customer also had consultation with other players, it’s no. Of course, I cannot mention their identity. It was a (inaudible) Embraer was affected by that.

Joseph Nadol – JP Morgan

Was their customer that passed away?

Frederico Curado

No.

Joseph Nadol – JP Morgan

Okay.

Frederico Curado

As a business you mean, right?

Joseph Nadol – JP Morgan

Yes. So if we look at your other income, were there liquidated damages in there, that were significant?

Frederico Curado

Some was recognized this quarter and some we recognized next quarter. I think there was a settlement there. I don’t know, Andre, exactly there, right? Yeah.

Joseph Nadol – JP Morgan

Okay. You delivered one large cabin aircraft and I guess it was to Jackie Chan. How many – your guidance is 15 to 20, do you still feel good about that number?

Frederico Curado

Yeah we do.

Joseph Nadol – JP Morgan

Okay, can you update us on how many of those are sold?

Frederico Curado

I sincerely don’t know. I think Joe, I think it’s fair to say that we either have orders or LOIs, it’s not all most of it. So the last time I spoke specifically about the Skyline, I mean I felt comfortable about the prospect of sharing our numbers.

Joseph Nadol – JP Morgan

Okay.

Frederico Curado

Maybe within the week, you can call us and get more information. But I just don’t have the number here with me.

Joseph Nadol – JP Morgan

No, it’s okay. Fred, going over to the re-engineering of the E-Jets, is there any update on your schedule there, or which way you are kind of go on some of the various outstanding issues, you previously said on the timeframe that year-end was your – by year-end when you’re going to announce is that possible it might flip into next year at this point or you’re still targeting by year-end.

Frederico Curado

We’re not reading worst there. I’d say the more likely that we – as an announcement for announcement, I think it’s going to be next year, we may announce some important milestones this year eventually, engine selection depends on the master phase plan of the program. But I think as a full disclosure of what if the aircraft expect all the conditions. I think more towards next year?

Joseph Nadol – JP Morgan

Okay. And then finally, I hate to beat the drum again on the G&A issue, but just want to make sure we and everyone else – very good sense of where you are. If you look at the last several years, your profile, administrative cost has always been up sequentially and quite significantly throughout the year. And so can you tell us specifically were there any unusual items in the administrative cost in Q1 and if not what’s really driving this and what you’re going to do keep the total SG&A flat to the rest of the year because it’s now what happened historically, what measures are you taking?

Frederico Curado

Joe, we – if you take second quarter of last year, we have now 109, – that’s 64, last four quarters used in – they were 109, 103, 114 to 109 now. If you take G&A, they were 64, 69, 72, 71, so I mean we’re not seeing this real trend of growth. Keep in mind that everything which is in Brazil, we’ve got a 10% raise last year and this will be some partially offset by whatever you get from this stimulus package and obviously all of our efforts, but it is not out of country at all. We manage the company.

Also if we have some growth in commercial activity, is natural that we have on the variable side at least we have some increase. So this is (inaudible) I see as something, which was showing a slight increase strength and we are working through those. We have a little bit lower SG&A this quarter than last quarter.

Joseph Nadol – JP Morgan

Yeah, I’m not saying it’s out of control and let’s exclude the selling expense because you’re right that a lot of selling expense is good. Just looking at the administrative year-on-year, you went from 57 to 71, I understand the 10% increase, but labor is a relatively smaller part of the administrative cost, so there must be something else driving and but you’ve answered a lot of questions on this. So I guess at this point we’ll just wait and see how it plays out for the rest of the year? Thanks.

Frederico Curado

Thank you, Joe. Its – just if you allow me, labor actually is a very reasonable portion of G&A, not small and the real step-up happened last year, it happened from the first quarter to the second and third quarter. I don’t remember, Joe if we had any extraordinary event in the first quarter of last year.

So year-over-year it looks ugly but if you compare the last four quarters, you will see that if there was a shift, if there was a shift, there was a step up. It happened actually about a year ago, and here I don’t remember a year ago, what caused this from 57 to 64 in the first quarter or second quarter. But I take your point Joe, and this is I, as I said this is part of our holy war against all the head costs.

Joseph Nadol – JP Morgan

Okay. Thank you.

Frederico Curado

Thank you.

Operator

Thank you. Our next question comes from Nicolai Sebrell of Morgan Stanley.

Nicolai Sebrell – Morgan Stanley

Good morning, Frederico and André team. Following up on the labor topic, I was wondering if you could talk a little bit more about that. You have realized efficiencies and margin gains over the past five years, despite the weaker effects, and obviously a lot of that was lower labor intensity, greater automation etcetera. So I was assuming, I mean I was looking forward to next year, 2014, as commercial and executive aircraft production recover, or at least, so we hope, to pre-crisis levels. How do you expect your head count to change? Do you feel that you might needing to add a lot of people, or such that your continuous gains in efficiency, etcetera, might mean that head count doesn’t change by a lot? That’s the first question.

Then the second question is, if you don’t mind, following up on the cash position. When you re-engine the E-195, and I know you would have made official guidance, and you don’t talk about CapEx per se. But how might you finance the program, do you foresee leveraging up somewhat, or do you think cash flow will be sufficient to pay for the program, or is there some other option? Thanks.

Frederico Curado

Okay. So on the first half, on the first question, the strategy is clear, that the best way to gain productivity, the best strategy is to contain cross when you are in a growing mode. So we had to make adjustment of the size of the company a few years ago, when there was the crash in the market. So we adjusted that and that I think it was very sad, but necessary measure to preserve the health of the company.

And then I can tell you this, the head count is going to grow, as we grow certainly at the lower base than our growth. So our labor cost will be growing hopefully, they will grow because that’s we mean, that we going to grow with top line, but different slots. I mean, they’re going to grow – they’re going to use any perspective of growth as a strategy to improve our productivity. This is absolutely clear in our company. As far as

we (inaudible) there

Nicolai Sebrell – Morgan Stanley

How are you going to find ancillary?

André Gaia

Well, I think we don’t have the answer, one thing that we are going to do, it’s going to be a combination of the cash flows and competition rates. Eventually some debt financing, and of course, the partnerships we are going to be establishing with the suppliers. That are the three main components, and of course, there are other options that are more interesting or more attractive, we may consider too.

Frederico Curado

I think it’s fair to say at this stage we are not looking at capital rates.

Nicolai Sebrell – Morgan Stanley

Okay and I’d some part of the question exactly. Then last follow-up if you don’t mind. We got the Farnborough Airshow coming up, I guess in July we hear before you know it. You mentioned that you might make announcement or discuss efficiency gains in the E-Jet. Can you say anything about that or any other potential catalyst that might come along?

Frederico Curado

I don’t know, as we finalize campaigns, we have to announce them, so will we have some campaigns to announce so far, I really don’t know. We had the engine enhancements on the E-Jets, something that we are doing and though you keep improving the airplane before the new generation which will not come before 2018 of which we start talking little bit more completely probably next year, but in the interim, we will keep improving business jets and maybe we may have some – if we get something of more sizable matter, we may announce something in (inaudible), but I think it’s not something which is defined completely as we speak now.

Nicolai Sebrell – Morgan Stanley

Thank you, very much.

Frederico Curado

Thank you.

André Gaia

Thank you.

Operator

(Operator Instructions). Our next question comes from Milan Posarac of Scotiabank.

Milan Posarac – Scotiabank

Hi, good morning. Just filling in for Turan Quettawala today, I have couple of questions, first, I was wondering if you guys can comment a little bit on how a regional jet pricing as these days presumably your major competitors pricing very aggressively to build their backlog, I don’t know if you could have some color to what pricing environment you seen out there?

Frederico Curado

Well, I think the increasing rate of production of narrow-body aircraft, absolutely puts pricing pressure on the whole industry not only for the two major players for everybody else. And I haven’t seen anything really material to that up to now as far as impacting our discussed sales, certainly not what is already contracted.

But I would agree with you that the volume of production being put in the markets have been depressing relatively new used narrow-body aircrafts and you see lease rates on second-hand relatively new narrow-body aircraft, which I think may indirectly cause a pricing pressure in the whole industry. So now a very broad analysis, this is what I see mid-term, no direct impact yet, I think long-term the whole industry may have a negative impact.

Milan Posarac – Scotiabank

Okay. Okay, great. Thank you. I have another question about some of the – from the defense and security side, with the contracts and the works for the Brazilian border monitoring projects. I’m wondering if you have any sort of update on the sense the timing on that from the Brazilian Government, what are you seeing on that?

Frederico Curado

Yeah, I do – the RFP for this system, which is surveillance system of the borders, it shall be released soon and with that you have a more concrete understanding of the timing and the steps and so forth. But the start of the procurement of this system is imminent and probably going to see that very soon the RFP from there, you’ll be able to – we have a better understanding of timing and volume of that. So it is moving.

Milan Posarac – Scotiabank

Okay. Okay. Thank you. Just one more question, if you could discuss a little bit about the recent, I guess agreement or relationship you establish with Boeing, and just provide a little bit of context on that, a little bit of color and some more details? I know, if you have anything to share with what is that in relation to?

Frederico Curado

Yeah, sure. It’s – it is an MOU of really principles and rough, I mean broad areas for cooperation relating to, along side, technology in the aircraft. I think that the initial driver was safe in the cockpit, but also, efficient in the cockpit, efficient of flight altogether. Let me just go one step back to say that Brazil and U. S. have signed a cooperation agreement in civil aviation. We just got rid of a lot of those from air traffic control, to open skies, to collaboration at the industrial level.

So that’s the umbrella. So we – both companies saw that there are some potential for us in the collaboration in research. Also in Lean manufacturing, both companies are investing in Lean manufacturing for several years now. And what can come out of that? There is no real specific objectives or something we want to achieve. It’s more like a path moving forward, more like a framework of collaboration than anything else. Focus, again on this stage in R&D and manufacturing, process automation et cetera.

And let’s see, I think this thing will unfold and it will tell us whether or not some tangible results may emerge. It’s the beginning of a journey. So that’s how we see it. And we see, I’ll just add to that it’s positive for us, hopefully it’s positive for Boeing also. It is certainly positive for us in the sense that they either are – those are two companies which do not start doing things for the sake of just doing things. And there’s an interest in pursuing some opportunities together, which is, I think is important.

Milan Posarac – Scotiabank

Okay. Well, thanks so much for taking my question today.

Frederico Curado

Thank you.

Operator

(Operator Instructions). Our next question comes from Stephen Trent of Citi.

Stephen Trent – Citigroup

Good morning, everybody and thanks for the time as always. Two questions from me, if I may on the defense side. The first pertains to the KC-390 and forgive me if I missed your comment here. But is everything then on track for let’s say, pricing that product sometime next year?

And my second question also pertains to defense. It seems that the momentum has received some tailwinds so to speak on the back of President Rousseff’s visit to Washington. Can you generally say that over the past few months, the number of potential KC-390 customers you’re speaking to has either stayed the same or at least modestly increased and if it has increased, can you say for instance that people are now far less focused on this foreign corrupt practices investigation that emerged in the fourth quarter? And sorry that was a bit long one, but if I could just get some color that would be great.

Frederico Curado

Thank you. Good morning. The KC-390 is on time. First flight is schedule for 2014 and that’s a certification and there is a end of the contract 2016 if I’m not wrong and Andre is saying that I’m right. Probably yeah, probably it sometime around 2013 and it can’t be much long later than that 2014, we should have discussions with the Brazilian Air Force about the serialization of this aircraft and the airplane will be ready to start, become a product in line by 2016, probably should have some price definition around ‘13, ‘14. So, it’s fundamentally on track.

All major suppliers are defined, engaged and more recurring development from Boeing. So, this vary – as far as customers – no, no, I mean no serious activity as far as having new customers. I believe that the initial cluster of partners is there and probably as the airplane comes to be more visible closer to the flight as the airplane is actually physically visible and to your first point, we also have some more clarity on pricing, then I think the campaigns will start to happen. Till then, I think it’s more likely consultations or understandings of what the airplane is and what can be etcetera.

And I don’t see any relation whatsoever between – let’s say the closer side, between the United States and Brazil (inaudible) and distribution by the SEC which is independent. It has its own course and I don’t see any political play in that at all, it’s just – that’s the technical investigation is being conducted by independent law firm and we have just keeping patience to see what’s the outcome of that.

Stephen Trent – Citigroup

Okay, Fredy. Very helpful and thanks for the time.

Frederico Curado

Thank you, Stewart.

Operator

Thank you. Our next question comes from Alexander Amson, Santander.

Alexander Amson – Santander

Hi, good morning everyone. Just a very quick question regarding your FX rate. I would like to check whether you could disclose, what is your assumption for FX rate that you have included in your guidance for 2012?

André Gaia

We announced the guidance, the FX rate it was around 175, 172 and the baseline we took for the guidance was around 170.

Alexander Amson – Santander

Great. Thanks a lot.

André Gaia

Okay.

Operator

(Operator Instructions). We have a follow-up question from Milan Posarac of Scotiabank.

Milan Posarac – Scotiabank

Thanks for taking, I just wondered, speak a little bit about Legacy orders and how order flow in general is going on that, there’s a sense that they may be a little bit weaker and then I don’t if you can share perhaps some of the reasons behind that; because it seems some of your competitors are seeing some improved order flow on this segment of the market. So if there is any insight you could share, that will be great?

Frederico Curado

For the Legacy-50?

Milan Posarac – Scotiabank

Yes.

Frederico Curado

We are – I mentioned earlier, that we are seeing, we are taking some more phone calls. The Phenom 300 is faring well. The Legacy 50 not so much. We have believed – in our big years – I think we needed something to change in 36 and 40 aircrafts, if I am not wrong, I think it was basically 37, and the last year was maybe a third of that, a little bit more than a third. So yeah, I think there is a room and the calls that we’ve taken and their activated that we see improving, are in the Legacy as expected. So hopefully, we would be able to have a little bit better performance on this aircrafts. The 300 is selling well and the lower entry, the 100 is really, I think the segment of the market that everybody is expecting the most. Not only us, but all the OEM’s.

Milan Posarac – Scotiabank

Okay, thank you so much.

Frederico Curado

Yeah.

Operator

(Operator Instructions) This concludes today’s question-and-answer session. I would like to invite Mr. Frederico Curado to proceed with his closing statement. Please go ahead, sir.

Frederico Curado

Just to thank everyone for their presence. So wish you a nice weekend and a good labor day, in Brazil. Labor Day is next Tuesday. So good bye to all. Thank you.

Operator

That does conclude Embraer’s audio conference for today. Thank you very much for your participation. Have a good day.

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