EMBJ

Business Context and Reporting Period

Company: Embraer S.A. (Embraer-Empresa Brasileira de Aeronáutica S.A.)
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2008
Accounting Basis: U.S. GAAP (Functional Currency: U.S. Dollar)
Business Overview: A leading global manufacturer of commercial, executive, and defense aircraft. The company operates through four primary segments: Commercial Aviation (66.9% of 2008 sales), Executive Aviation (13.8%), Defense and Government (8.0%), and Aviation Services (9.5%).

Key Financial Metrics (2008)

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 20.8% to $6.34 billion, driven primarily by a 25.5% increase in Commercial Aviation sales due to higher delivery volumes (162 aircraft in 2008 vs. 130 in 2007) and a favorable product mix.
• Profitability Decline: Despite higher operating income, Net Income decreased 20.6% to $388.7 million. This was primarily caused by a shift from net financial income in 2007 to net financial expense of $171.4 million in 2008, driven by $148.3 million in derivative losses and a significant drop in interest income from temporary cash investments.
• Foreign Exchange: The company recorded a net foreign exchange gain of $71.7 million in 2008, compared to a loss of $37.7 million in 2007, reflecting the depreciation of the Brazilian Real against the U.S. Dollar.
• Cost Structure: Cost of sales increased 21.9%, largely due to higher delivery volumes and a 10.1% salary increase approved for the workforce in September 2008. Gross margin compressed slightly from 22.0% to 21.2%.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• 2009 Production: Management maintains an estimate to deliver 242 aircraft in 2009 across commercial and executive aviation segments, despite the global economic downturn.
• Capital Expenditures: Expected 2009 capital expenditures are approximately $350 million, with $200 million allocated to R&D. This represents a reduction from previous estimates due to the economic crisis.
• Executive Jet Market: Management anticipates a reversal of the growth cycle in the executive jet market for 2009, with a recovery expected in 2011-2012. Order cancellations and financing difficulties are expected to persist in the short term.
• Workforce Reduction: In Q1 2009, the company reduced its personnel by approximately 20% (costing ~$53.5 million) to align with reduced demand.

Key Risks and Contingencies

• Order Cancellations: In Q1 2009, the HNA Group (a major Chinese customer) reduced its firm orders for 50 ERJ 145 aircraft to 25. The company warns of potential further cancellations in commercial and executive segments.
• Financing Constraints: The global credit crunch has severely impacted customer access to financing. Traditional bank financing for commercial aircraft is expected to decrease by 50% in 2009. The company relies on Brazilian government financing (BNDES) to offset this gap.
• Off-Balance Sheet Guarantees: As of December 31, 2008, the maximum exposure under financial and residual value guarantees was $1,870.1 million. While the company holds escrow deposits and expects proceeds from asset sales to cover these, a severe downturn could trigger significant cash disbursements.
• Tax Litigation: The company has recorded a $332.1 million liability for taxes and payroll charges it is challenging in Brazilian courts. An unfavorable outcome could result in significant payments.

Investor Verification Checklist

• Backlog Stability: Verify the current status of the firm order backlog (reported at $19.7 billion as of March 31, 2009) and monitor for further cancellations from key customers like HNA Group.
• Financing Availability: Assess the extent to which the company can rely on BNDES financing to support customer purchases as commercial bank credit dries up.
• Derivative Exposure: Review the impact of interest rate and currency swaps on future earnings, given the $148.3 million loss recorded in 2008.
• Executive Jet Demand: Monitor order intake for the Phenom 100/300 and Legacy 450/500 programs, as this segment is highly sensitive to the economic downturn.
• Tax Litigation Outcome: Track the status of the $332.1 million tax contingency and the likelihood of the company prevailing in Brazilian courts.