Business Context and Reporting Period
Company: EMBRAER S.A. (Embraer)
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2009
Business Overview: Embraer is a leading global manufacturer of commercial aircraft (regional and mid-capacity jets), executive jets, and defense aircraft. The company operates in four primary segments: Commercial Aviation, Executive Aviation, Defense, and Aviation Services. The company's functional currency is the U.S. dollar, and financial statements are prepared in accordance with U.S. GAAP.
Key Financial Metrics (Year Ended Dec 31, 2009)
| Metric | 2009 (US$ Millions) | 2008 (US$ Millions) |
|---|---|---|
| Net Sales | 5,466.3 | 6,335.2 |
| Gross Profit | 1,114.1 | 1,343.5 |
| Gross Margin | 20.4% | 21.2% |
| Operating Income | 335.6 | 537.0 |
| Operating Margin | 6.1% | 8.5% |
| Net Income (Attributable to Embraer) | 248.5 | 388.7 |
| Net Income Margin | 4.5% | 6.1% |
| Cash & Cash Equivalents | 1,592.4 | 1,820.7 |
| Total Debt | 2,042.9 | 1,825.4 |
| Working Capital Surplus | 2,872.1 | 2,371.2 |
| Backlog (Firm Orders) | 16,634.8 | 20,935.0 |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 13.7% to $5.47 billion, primarily driven by a 20.5% drop in Commercial Aviation sales due to reduced deliveries (122 aircraft in 2009 vs. 162 in 2008) caused by the global economic crisis.
- Executive Jet Growth: Despite the downturn, Executive Aviation sales increased 2.6% due to a 219% surge in deliveries, largely driven by the Phenom 100 (93 units delivered).
- Profitability Compression: Operating income fell 37.5% to $335.6 million. Gross margin declined to 20.4% due to a less favorable product mix and the learning curve costs associated with new executive jet production.
- Significant Provision: The company recorded a $103.0 million charge against income related to financial guarantees for aircraft sold to Mesa Air Group following its Chapter 11 bankruptcy filing.
- Cost Reductions: Operating expenses decreased 3.6% due to a 20% workforce reduction in February 2009 (costing ~$60.4 million) and process optimization programs.
- Debt Increase: Total debt increased to $2.04 billion, largely due to the issuance of $500 million in 6.375% Guaranteed Notes due 2020 in October 2009.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- 2010 Production: Embraer maintains an estimate to deliver 227 aircraft in 2010 within its commercial and executive aviation businesses, maintaining a production rate of 23 jets per month.
- Backlog Trend: As of March 31, 2010, the firm order backlog decreased to $16.0 billion from $16.6 billion at year-end 2009.
- Capital Expenditures: The company expects to invest approximately $300 million in capital expenditures in 2010, with $160 million allocated to R&D.
- Market Recovery: Management anticipates a gradual recovery in the commercial airline industry but expects the executive jet market downturn to persist through 2010, with a recovery beginning in 2011/2012.
Risks and Contingencies
- Customer Credit Risk: Significant exposure to customer defaults, highlighted by the Mesa Air Group bankruptcy provision. The company faces risks from order cancellations and rescheduling due to the global credit crunch.
- Guarantees and Trade-Ins: Maximum off-balance sheet exposure for financial and residual value guarantees was $1.6 billion as of December 31, 2009. The company may be required to make significant cash disbursements if aircraft values decline or customers default.
- Government Financing: Approximately 32% of commercial aviation deliveries in 2009 were supported by Brazilian government financing (BNDES). Budgetary constraints or changes in government policy could impact sales competitiveness.
- Legal Proceedings: A $414.7 million provision exists for tax and payroll charge litigation, including a major challenge to the constitutionality of social contribution taxes on export sales.
- Exchange Rate Volatility: While the functional currency is the U.S. dollar, approximately 13% of production inputs are in Brazilian Reais. Appreciation of the Real increases costs in dollar terms.
Key Facts for Investor Verification
- Mesa Air Provision: Verify the status of the $103 million charge related to Mesa Air Group and the potential for further losses from other customers facing financial distress.
- Backlog Quality: Assess the stability of the $16.0 billion backlog, noting that a significant portion of ERJ 145 orders is concentrated with the HNA Group in China, which previously reduced its orders.
- Off-Balance Sheet Exposure: Review the $1.6 billion exposure related to financial and residual value guarantees and the adequacy of the $308.9 million held in escrow.
- Tax Litigation: Monitor the outcome of the Supreme Court case regarding the social contribution tax on export sales, which involves a $294.7 million accrued liability.
- Executive Jet Mix: Evaluate the sustainability of the Phenom 100 sales surge and the ramp-up costs for the Legacy 450/500 programs, which are expected to enter service between 2012 and 2013.