EMBJ

Business Context and Reporting Period

Company: Embraer S.A.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2010
Accounting Standards: International Financial Reporting Standards (IFRS) as issued by the IASB. This was the company's first annual report prepared under IFRS.
Functional Currency: U.S. Dollar (USD)
Business Overview: Embraer is a leading global manufacturer of commercial, executive, and defense aircraft. Its primary segments are Commercial Aviation (53.9% of revenue), Executive Aviation (21.3%), Defense and Security (12.5%), and Aviation Services (10.5%).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 2.4% to $5.36 billion. Commercial aviation revenue dropped 14.6% due to a reduction in deliveries (100 aircraft in 2010 vs. 122 in 2009), reflecting the lingering effects of the global financial crisis on airline demand.
• Executive Aviation Growth: Revenue in the executive aviation segment increased 27.8% to $1.15 billion, driven by a 25.2% increase in deliveries (144 aircraft), particularly the Phenom 100 and Phenom 300.
• Defense Revenue Surge: Defense and security revenue rose 34.3% to $670 million, primarily due to an atypical delivery schedule for Super Tucano aircraft.
• Profitability: Net income decreased 27.9% to $345.4 million. While operating profit increased slightly (3.2%), the effective tax rate shifted from a credit in 2009 to an expense in 2010, largely due to foreign exchange impacts on nonmonetary assets.
• Debt Reduction: Total debt decreased significantly from $2.06 billion to $1.43 billion, with short-term debt falling by 66.9% due to effective debt management and prepayments.
• Cash Flow Improvement: Net cash provided by operating activities surged to $873.8 million from $3.6 million in 2009, driven by reduced inventory and increased trade accounts payable.

Guidance, Outlook, and Risks

Outlook and Guidance

• 2011 Delivery Estimates: Management estimates delivering 102 commercial aircraft, 100 light executive jets, and 18 large executive jets in 2011.
• Capital Expenditures: Expected to invest approximately $410 million in 2011 for development and property, plant, and equipment. This includes $210 million for development (excluding risk-sharing contributions) and $200 million for facilities, including new plants in Melbourne, Florida, and Evora, Portugal.
• Market Trends: Management anticipates a recovery in the executive jet segment beginning in the second quarter of 2011. Long-term air travel demand is projected to grow 4-5% annually.

Key Risks and Contingencies

• Customer Concentration: Significant reliance on key customers, including the HNA Group (China), JetBlue, and Azul for commercial jets, and the Brazilian Air Force for defense products.
• Guarantees and Trade-Ins: Maximum exposure under financial and residual value guarantees was $1.34 billion as of December 31, 2010. The company accepted 29 aircraft for trade-in in 2010, including 25 Citation Ultras from NetJets.
• Tax Litigation: A provision of $433.0 million is recorded for probable losses related to challenges against Brazilian taxes and payroll charges, including a $300.2 million accrual regarding social contribution tax on export sales pending Supreme Court review.
• Exchange Rate Volatility: Approximately 15% of costs are denominated in Brazilian Reais. Appreciation of the Real against the USD increases costs and reduces margins, while depreciation affects the USD value of dividends.
• Golden Share: The Brazilian federal government holds a "golden share" with veto power over changes to the company's name, corporate purpose, defense programs, and transfer of control.

Investor Verification Checklist

• Backlog Quality: Verify the stability of the $15.5 billion backlog, noting that 38% of EMBRAER 170/190 orders are concentrated among three customers (HNA Group, JetBlue, Azul).
• Tax Provision Status: Monitor the outcome of the $300.2 million tax litigation regarding social contribution on export sales, as an adverse ruling could materially impact future cash flows.
• Guarantee Exposure: Assess the risk of financial and residual value guarantees ($1.34 billion exposure) in the context of potential airline bankruptcies or market downturns.
• Development Milestones: Track the certification and entry-into-service dates for the Legacy 450/500 executive jets (expected 2012-2013) and the KC-390 military transport (first flight expected 2014).
• Exchange Rate Sensitivity: Evaluate the impact of Real/USD fluctuations on the company's cost structure and the USD value of future dividend distributions.