20-F 1 d332497d20f.htm FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011 For the fiscal year ended December 31, 2011
Table of Contents

As filed with the Securities and Exchange Commission on April 13, 2012

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 20-F

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

Commission file number 001-15102

EMBRAER S.A.

 

(Exact name of Registrant as specified in its charter)

EMBRAER Inc.

 

(Translation of Registrant’s name into English)

Federative Republic of Brazil

 

(Jurisdiction of incorporation)

Avenida Brigadeiro Faria Lima, 2170

12227-901 São José dos Campos, São Paulo, Brazil

 

(Address of principal executive offices)

André Gaia

Head of Investor Relations

(55) 12 3927 4404

investor.relations@embraer.com

 

(Name, Telephone, E-mail and/or facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

 

Title of each class:

  Name of each exchange on which registered

Common shares, without par value (represented by, and traded only in the form of, American Depositary Shares (evidenced by American Depositary Receipts), with each American Depositary Share representing four common shares)

 

New York Stock Exchange

US$500,000,000 6.375% Guaranteed Notes due 2020 of Embraer Overseas Ltd. Guaranteed by Embraer S.A.

 

New York Stock Exchange

Securities registered or to be registered pursuant to Section 12(g) of the Act.

None.

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

Title of each class

US$500,000,000 6.375% Guaranteed Notes due 2017 of Embraer Overseas Ltd.

Guaranteed by Embraer S.A.

Number of outstanding shares of each of the issuer’s classes of capital or common stock as of December 31, 2011:

740,465,044 common shares, without par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  x    Accelerated Filer  ¨    Non-accelerated filer  ¨

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP  ¨    International Financial Reporting Standards as issued by the International Accounting Standards Board  x    Other  ¨

Indicate by check mark which financial statement item the registrant has elected to follow. Item 17  ¨    Item 18  x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

 

 


Table of Contents

TABLE OF CONTENTS

 

               Page  
Part I   
ITEM 1.   

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     4   
ITEM 2.   

OFFER STATISTICS AND EXPECTED TIMETABLE

     4   
ITEM 3.   

KEY INFORMATION

     4   
   3A.   

Selected Financial Data

     4   
   3B.   

Capitalization and Indebtedness

     7   
   3C.   

Reasons for the Offer and Use of Proceeds

     7   
   3D.   

Risk Factors

     8   
ITEM 4.   

INFORMATION ON THE COMPANY

     19   
   4A.   

History and Development of the Company

     19   
   4B.   

Business Overview

     23   
   4C.   

Organizational Structure

     45   
   4D.   

Property, Plant and Equipment

     45   
ITEM 4.A   

UNRESOLVED STAFF COMMENTS

     48   
ITEM 5.   

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     48   
   5A.   

Operating Results

     49   
   5B.   

Liquidity and Capital Resources

     68   
   5C.   

Research

     72   
   5D.   

Trend Information

     73   
   5E.   

Off-Balance Sheet Arrangements

     76   
   5F.   

Tabular Disclosure of Contractual Obligations

     79   
ITEM 6.   

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     80   
   6A.   

Directors and Senior Management

     80   
   6B.   

Compensation

     86   
   6C.   

Board Practices

     88   
   6D.   

Employees

     90   
   6E.   

Share Ownership

     90   
ITEM 7.   

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

     90   
   7A.   

Major Shareholders

     90   
   7B.   

Related Party Transactions

     91   
   7C.   

Interests of Experts and Counsel

     93   
ITEM 8.   

FINANCIAL INFORMATION

     93   
   8A.   

Consolidated Statements and Other Financial Information

     93   
   8B.   

Significant Changes

     98   
ITEM 9.   

THE OFFER AND LISTING

     98   
   9A.   

Offer and Listing Details

     98   
   9B.   

Plan of Distribution

     99   
   9C.   

Markets

     99   
   9D.   

Selling Shareholders

     102   
   9E.   

Dilution

     102   
   9F.   

Expenses of the Issue

     102   
ITEM 10.   

ADDITIONAL INFORMATION

     102   
   10A.   

Share Capital

     102   
   10B.   

Memorandum and Articles of Association

     102   
   10C.   

Material Contracts

     115   
   10D.   

Exchange Controls

     115   
   10E.   

Taxation

     116   
   10F.   

Dividends and Paying Agents

     122   
   10G.   

Statements by Experts

     122   
   10H.   

Documents on Display

     122   

 

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   10I.   

Subsidiary Information

     123   
ITEM 11.   

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     123   
ITEM 12.   

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     126   
   12A.   

Debt Securities

     126   
   12B.   

Warrants and Rights

     126   
   12C.   

Other Securities

     126   
   12D.   

American Depositary Shares

     127   
Part II   
ITEM 13.   

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     128   
ITEM 14.   

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

     128   
ITEM 15.   

CONTROLS AND PROCEDURES

     128   
ITEM 16.A   

FINANCIAL EXPERT

     129   
ITEM 16.B   

CODE OF ETHICS

     129   
ITEM 16.C   

PRINCIPAL ACCOUNTANT FEES AND SERVICES

     130   
ITEM 16.D   

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     130   
ITEM 16.E   

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

     130   
ITEM 16.F   

CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

     131   
ITEM 16.G   

CORPORATE GOVERNANCE

     131   
Part III   
ITEM 17.   

FINANCIAL STATEMENTS

     133   
ITEM 18.   

FINANCIAL STATEMENTS

     133   
ITEM 19.   

EXHIBITS

     134   

 

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INTRODUCTION

In this annual report, “Embraer,” “we,” “us” or “our” refer to Embraer S.A. All references herein to the “real,” “reais” or “R$” are to the Brazilian real, the official currency of Brazil. All references to “US$,” “dollars” or “U.S. dollars” are to United States dollars.

Presentation of Financial and Other Data

Financial Data

Our audited consolidated financial statements at December 31, 2011 and 2010 and for each of the years ended December 31, 2011, 2010, and 2009 are included in this annual report.

Our consolidated financial statements have been prepared in accordance with International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board, or IASB. Our financial statements for the year ended December 31, 2010 are our first annual financial statements that comply with IFRS as issued by the IASB. As permitted by the applicable rules, when making the transition from U.S. GAAP to IFRS, we did not include in this annual report our financial statements as of and for the years ended December 31, 2008 and 2007, as they were prepared in accordance with U.S. GAAP and not IFRS.

After analyzing our operations and businesses with regard to the applicability of International Accounting Standards, or IAS, 21 – “The Effects of Changes in Foreign Exchange Rates,” particularly in relation to the factors involved in determining our functional currency, management concluded that our functional currency is the U.S. dollar. This conclusion was based on an analysis of the following factors, as set forth in IAS 21: (1) the currency that mainly influences the sale prices of our goods and services, (2) the currency of the countries whose competitive forces mainly determine the sale prices of our goods and services, (3) the currency that mainly influences prices of raw materials and other costs involved in providing our goods and services, (4) the currency in which the funds for financial operations are principally obtained, and (5) the currency in which revenue from operations is usually received. Items included in the financial statements of each of our subsidiaries are measured using the currency of the primary economic environment in which such subsidiary operates. Our audited consolidated financial statements included elsewhere in this annual report are presented in U.S. dollars, which is our presentation currency. Our financial statements and financial data presented herein and prepared in accordance with IFRS do not reflect the effects of inflation.

In our 2011, 2010 and 2009 financial statements, gains or losses resulting from the remeasurement of the monetary items and from foreign currency transactions have been reported in the consolidated statement of income as single line items.

For certain purposes, such as providing reports to our Brazilian shareholders, filing financial statements with the Comissão de Valores Mobiliários (Brazilian securities commission), or CVM, and determining dividend payments and other distributions and tax liabilities in Brazil, we have prepared, and will continue to be required to prepare, financial statements in accordance with Law No. 6,404 of December 15, 1976, as amended, or Brazilian Corporate Law. Effective 2008, significant changes were introduced to the accounting aspects of the Brazilian Corporate Law by Law 11,638 of December 28, 2007. In addition, in 2008 certain changes to the accounting principles, as well as other changes to the accounting practices adopted in Brazil, or Brazilian GAAP, were introduced by the Comitê de Pronunciamentos Contábeis (Brazilian Accounting Standards Setting Board), and have become effective in 2010. These changes to the accounting aspects of the Brazilian Corporate Law and Brazilian GAAP impacted our parent company financial statements as of and for the years ended December 31, 2011, 2010 and 2009 and the basis of our distribution of minimum mandatory dividends. Other than that, such changes had no effect on our consolidated financial statements prepared in accordance with IFRS that are included elsewhere in this annual report. Our parent company financial statements as of and for the years ended December 31, 2011, 2010 and 2009 which are prepared in accordance with the Brazilian Corporate Law, which are not included in this annual report, differ from those prepared in accordance with IFRS.

 

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As a result of the listing of our common shares on the Novo Mercado segment of the BM&FBOVESPA S.A.—Bolsa de Valores, Mercadorias e Futuros de São Paulo, or São Paulo Stock Exchange, since January 2009 we are required to translate into English our quarterly and annual financial statements.

Other Data and Backlog

In this annual report:

 

   

some of the financial data reflects the effect of rounding;

 

   

aircraft ranges are indicated in nautical miles;

 

   

one nautical mile is equal to approximately 1.15 ordinary or “statute” miles, or approximately 1.85 kilometers;

 

   

aircraft speeds are indicated in nautical miles per hour, or knots, or in Mach, which is a measure of the speed of sound;

 

   

the term “regional jet” refers to narrow body jet aircraft with 30-60 passenger seats;

 

   

the term “mid-capacity jet” refers to jet aircraft with 70-120 passenger seats. All of our regional and mid-capacity jet aircraft are sold in the commercial aviation segment;

 

   

the term “commercial aircraft,” as it applies to Embraer, refers to our regional jets and mid-capacity jets;

 

   

the terms “entry-level jet” and “light jet” refer to executive jets that carry from six to eight passengers and up to nine passengers, respectively, that are designed for short take-off distances;

 

   

the term “ultra-large jet” refers to executive jets that have longer range and over-sized cabin space and carry, on average, 19 passengers; and

 

   

the term “executive jets,” as it applies to Embraer, refers to our aircraft sold to companies, including fractional ownership companies, charter companies and air-taxi companies and high net-worth individuals.

We calculate the value of our backlog by considering all firm orders that have not yet been delivered. A firm order is a firm commitment from a customer, represented by a signed contract and customarily accompanied by a down payment, for which we have reserved a place on one of our production lines. Every time we refer to our backlog in this annual report, we make reference only to firm orders and not to options. We also include the number of aircraft sold by our defense and security segment to state-owned airlines in our commercial aircraft backlog.

Special Note Regarding Forward-Looking Statements

This annual report includes forward-looking statements, within the meaning of Section 27A of the U.S. Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the U.S. Securities Exchange Act of 1934, as amended, or the Exchange Act, principally in Items 3 through 5 and Item 11 of this annual report. We have based these forward-looking statements largely on our current expectations and projections about future events, industry and financial trends affecting our business. These forward-looking statements are subject to risks, uncertainties and assumptions, including, among other things:

 

   

general economic, political and business conditions, both in Brazil and in our markets;

 

   

changes in competitive conditions and in the general level of demand for our products;

 

   

management’s expectations and estimates concerning our future financial performance, financing plans and programs, and the effects of competition;

 

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the effects of customers canceling, modifying and/or rescheduling contractual orders;

 

   

the effect of changing priorities or reductions in the Brazilian federal government or international government defense budgets on our revenues;

 

   

continued successful development and marketing of the EMBRAER 170/190 jet family, our line of executive jets (including the Phenom 100, Phenom 300, Lineage 1000, Legacy 450 and Legacy 500) and our defense aircraft;

 

   

our level of indebtedness;

 

   

anticipated trends in our industry, including but not limited to the continuation of long-term trends in passenger traffic and revenue yields in the airline industry;

 

   

our short- and long-term outlook for the 30-120 seat commercial airline market;

 

   

our expenditure plans;

 

   

inflation and fluctuations in exchange rates;

 

   

the impact of volatile fuel prices and the airline industry’s response;

 

   

our ability to develop and deliver our products on a timely basis;

 

   

availability of sales financing for our existing and potential customers;

 

   

existing and future governmental regulation;

 

   

our relationship with our workforce; and

 

   

other risk factors as set forth under “Item 3D. Key Information—Risk Factors.”

The words “believe,” “may,” “will,” “forecast,” “estimate,” “plan,” “continue,” “anticipate,” “intend,” “expect” and similar words are intended to identify forward-looking statements. We undertake no obligation 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 in this annual report might not occur. Our actual results and performance could differ substantially from those anticipated in our forward-looking statements. As a result of various factors such as those risks described in “Item 3D. Key Information—Risk Factors,” undue reliance should not be placed on these forward-looking statements.

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

ITEM 3. KEY INFORMATION

 

3A. Selected Financial Data

The following table presents our selected financial and other data at and for each of the periods indicated. Selected financial data as of December 31, 2011 and 2010 and for each of the years ended December 31, 2011, 2010 and 2009 have been derived from our audited consolidated IFRS financial statements which are included elsewhere in this annual report. You should read this selected financial data in conjunction with our audited consolidated financial statements and related notes thereto included elsewhere in this annual report.

 

     Year ended December 31,  
     2011     2010     2009  
     (in US$ millions)  

Consolidated Statements of Income Data

      

Revenue

     5,803.0        5,364.1        5,497.8   

Cost of sales and services

     (4,495.9     (4,338.1     (4,428.4
  

 

 

   

 

 

   

 

 

 

Gross profit

     1,307.1        1,026.0        1,069.4   

Operating income (expense)

      

Administrative

     (262.5     (197.5     (191.3

Selling

     (419.3     (374.1     (304.6

Research

     (85.3     (72.1     (55.6

Other operating (expense) income, net

     (221.5     9.4        (138.5

Equity

     (0.3     —          —     
  

 

 

   

 

 

   

 

 

 

Operating profit before financial income (expense)

     318.2        391.7        379.4   

Financial income (expenses), net

     (90.7     17.5        10.2   

Foreign exchange gain (loss), net

     20.0        (1.1     (68.8
  

 

 

   

 

 

   

 

 

 

Profit before taxes on income

     247.5        408.1        320.8   

Income tax (expense) benefit

     (127.1     (62.7     158.1   
  

 

 

   

 

 

   

 

 

 

Net income

     120.4        345.4        478.9   
  

 

 

   

 

 

   

 

 

 

Attributable to:

      

Owners of Embraer

     111.6        330.2        465.2   

Noncontrolling interest

     8.8        15.2        13.7   
     Year ended December 31,  
     2011     2010     2009  
     (in US$)  

Earnings per Share – Basic

      

Net income attributable to owners of Embraer

     111.6        330.2        465.2   

Weighted average number of shares (in thousands)

     723,667        723,665        723,665   

Basic earnings per share – U.S. dollars

     0.1542        0.4563        0.6428   

 

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     Year ended December 31,  
     2011      2010      2009  
     (in US$)  

Earnings per Share – Diluted

  

Net income attributable to owners of Embraer

     111.6         330.2         465.2   

Weighted average number of shares (in thousands) – diluted

     723,667         723,665         723,665   

Dilution – issuance of stock options (in thousands)

     1,180         354         —     

Weighted average number of shares (in thousands)

     724,847         724,019         723,665   

Diluted earnings per share

     0.1540         0.4562         0.6428   

 

     At December 31,      At January 1,  
     2011      2010      2009      2009  
     (in US$ millions)  

Consolidated Balance Sheet Data

  

Cash and cash equivalents

     1,350.2         1,393.1         1,592.4         1,820.7   

Financial assets

     753.6         733.5         953.8         380.8   

Other current assets

     3,065.6         2,856.2         3,096.5         3,669.0   

Property, plant and equipment

     1,450.4         1,201.0         1,101.3         1,059.6   

Intangible assets

     808.3         716.3         725.5         689.9   

Other long-term assets

     1,430.2         1,490.9         1,420.0         1,331.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

     8,858.3         8,391.0         8,889.5         8,951.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Short-term loans and financing

     251.8         72.6         592.4         539.0   

Other current payables

     2,589.9         2,316.1         2,158.2         2,986.9   

Long-term loans and financing

     1,406.3         1,362.2         1,465.9         1,300.8   

Other long-term liabilities

     1,492.5         1,508.6         1,790.0         1,598.9   

Company shareholders’ equity

     3,007.3         3,028.4         2,792.7         2,455.6   

Noncontrolling interest

     110.5         103.1         90.3         70.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total shareholders’ equity

     3,1117.8         3,131.5         2,883.0         2,525.6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities and shareholders’ equity

     8,858.3         8,391.0         8,889.5         8,951.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Year ended December 31,  
     2011     2010     2009  
     (in US$ millions)  

Other Consolidated Financial Data

  

Net cash generated by operating activities

     480.2        873.8        3.6   

Net cash used in investing activities

     (602.0     (288.3     (378.0

Net cash generated by (used in) financing activities

     96.4        (802.2     (23.9

Depreciation and amortization

     238.8        219.2        229.3   

 

     At and for the year ended December 31,  
     2011      2010     2009  

Other Data:

       

Aircraft delivered during period:

       

To the Commercial Aviation Market

       

ERJ 145

     2         6        7   

EMBRAER 170

     1         9 / 2 (1)      22   

EMBRAER 175

     10         8        11   

EMBRAER 190

     68         58        62   

EMBRAER 195

     24         17        20   

To the Defense and Security Market

       

EMB 120 Brasília

     —           —          —     

Legacy 600

     —           1        —     

Phenom 100

     —           —          4   

EMB 145

     —           —          —     

EMB 135

     —           1        1   

EMBRAER 170

     —           —          —     

EMBRAER 190

     —           —          2   

 

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     At and for the year ended December 31,  
     2011      2010      2009  

Other Data:

        

EMB 145 AEW&C/RS/MP

                       

EMB 312 Tucano/AL-X/ Super Tucano

     —           —           26   

To the Executive Aviation Market

        

Legacy 600/650

     13         10         18   

EMBRAER 175 Shuttle

     —           —           3   

Phenom 100

     41         100         93   

Phenom 300

     42         26         1   

Lineage 1000

     3         8         3   

To the General Aviation Market

        

Light Propeller Aircraft

     54         —           34   
  

 

 

    

 

 

    

 

 

 

Total delivered

     258         246         304   
  

 

 

    

 

 

    

 

 

 

Aircraft in backlog at the end of period:

        

In the Commercial Aviation Market

        

EMB 120 Brasília

     —           —           —     

ERJ 145

     —           2         8   

ERJ 135

     —           —           —     

ERJ 140

     —           —           —     

EMBRAER 170

     6         10         17   

EMBRAER 175

     46         40         15   

EMBRAER 190

     162         157         185   

EMBRAER 195

     35         41         40   

In the Defense and Security Market

        

EMB 145 AEW&C/RS/MP

     3         3         3   

EMB 312 Tucano/EMB 314/EP Super Tucano

     24         16         57   

EMB 145

     —           —           —     

EMB 135

     —           —           1   

Legacy 600/Phenom 100

     —           —           —     

EMBRAER 170/ EMBRAER 190

     —           —           —     

In the Executive Aviation Market

        

Legacy 450/500/600/650/Phenom 100/300/Lineage 1000/EMBRAER 170/190 Shuttle

     421         551         737   

In the General Aviation Market

        

Light Propeller Aircraft

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total backlog (in aircraft)

     697         820         1,063   
  

 

 

    

 

 

    

 

 

 

Total backlog (in millions)

   US$ 15,441.2       US$ 15,543.2       US$ 16,634.8   

 

(1) Figures appearing after a forward slash (/) refer to aircraft delivered under operating leases.

Exchange Rates

Prior to March 4, 2005, there were two principal legal foreign exchange markets in Brazil:

 

   

the commercial rate exchange market, and

 

   

the floating rate exchange market.

Most trade and financial foreign exchange transactions were carried out on the commercial rate exchange market. These included the purchase or sale of shares or payment of dividends or interest with respect to shares. Foreign currencies could be purchased only in the commercial exchange market through a Brazilian bank authorized to buy and sell currency in these markets. In both markets, rates were freely negotiated.

Resolution No. 3,265 by the Conselho Monetário Nacional (National Monetary Council), or CMN, dated March 4, 2005, consolidated the foreign exchange markets into one single foreign exchange market, effective as of March 14, 2005. All foreign exchange transactions are now carried out through institutions authorized to operate in

 

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the consolidated market and are subject to registration with the electronic registration system of the Central Bank of Brazil, or Central Bank. Foreign exchange rates continue to be freely negotiated, but may be influenced by Central Bank intervention.

Since 1999, the Central Bank has allowed the real/U.S. dollar exchange rate to float freely, and during that period, the real/U.S. dollar exchange rate has fluctuated considerably. In the past, the Central Bank has intervened occasionally to control unstable movements in foreign exchange rates. We cannot predict whether the Central Bank or the Brazilian federal government will continue to let the real float freely or will intervene in the exchange rate market through a currency band system or otherwise. The real may depreciate or appreciate against the U.S. dollar substantially in the future. See “Item 3D. Key Information—Risk Factors—Risks Relating to Brazil.”

The following table sets forth the selling exchange rate, expressed in reais per U.S. dollar, for the periods indicated:

 

     Exchange Rate of Reais to US$1.00  
     Low      High      Average(1)      Period-end  

Year ended December 31,

           

2007

     1.7325         2.1556         1.9500         1.7713   

2008

     1.5593         2.5004         1.8346         2.3370   

2009

     1.7024         2.4218         1.9957         1.7412   

2010

     1.6554         1.8811         1.7601         1.6662   

2011

     1.5345         1.9016         1.6709         1.8758   

 

     Exchange Rate of Reais to US$1.00  
     Low      High      Average(2)      Period-end  

Month/period ended

           

November 30, 2011

     1.7270         1.8937         1.7905         1.8109   

December 31, 2011

     1.7830         1.8758         1.8369         1.8758   

January 31, 2012

     1.7389         1.8683         1.7897         1.7391   

February 29, 2012

     1.7024         1.7376         1.7179         1.7012   

March 31, 2012

     1.7152         1.8334         1.8221         1.8221   

April 2012 (through April 10, 2012)

     1.8314         1.8317         1.7755         1.8317   

 

Source: Central Bank.

(1) Represents the average of the exchange rates on the last day of each month during the relevant periods.
(2) Represents the average of the exchange rates during the relevant periods.

We will pay any cash dividends and make any other cash distributions with respect to the common shares in reais. Accordingly, exchange rate fluctuations may affect the U.S. dollar amounts received by the holders of American Depositary Shares, or ADSs, upon the conversion into U.S. dollars by the depositary of our ADS program of such distributions for payment to holders of ADSs. Fluctuations in the exchange rate between the real and the U.S. dollar may also affect the U.S. dollar equivalent of the real price of our common shares on the São Paulo Stock Exchange.

 

3B. Capitalization and Indebtedness

Not applicable.

 

3C. Reasons for the Offer and Use of Proceeds

Not applicable.

 

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3D. Risk Factors

Risks Relating to Embraer

A downturn in commercial aviation may reduce our sales and revenue, and, consequently, our profitability, in any given year.

We expect that a substantial portion of our sales in the near future will be derived from sales of commercial aircraft, particularly the EMBRAER 170/190 jet family. Historically, the market for commercial aircraft has been cyclical due to a variety of factors that are both external and internal to the air travel industry, including general economic conditions.

The commercial airline industry has been negatively impacted by a number of factors. For example, in 2004, we reduced scheduled deliveries from 160 to 145 aircraft following US Airways’ second Chapter 11 filing in September 2004. Moreover, in 2004 we re-evaluated our risk exposure related to aircraft valuations and customer credit risk, which resulted in charges to income of US$16.0 million. In 2011, AMR Corporation, or AMR, the parent company of American Airlines, which currently operates a fleet of 216 ERJ 145 family aircraft through its wholly-owned subsidiary, American Eagle, filed for a Chapter 11 bankruptcy. As a result of the expected fleet adjustments that will take place at AMR, we have provisioned a total of US$317.5 million to account for expected expenses related to obligations from financial guarantees and residual value guarantees for these 216 aircraft. See “Item 5E. Operating and Financial Review and Prospects—Off-Balance Sheet Arrangements.”

Although the U.S. and world economies showed some signs of recovery starting in 2004, many airlines continued to face increased competition, escalating insurance costs, increased security costs, credit downgrades, liquidity concerns and bankruptcy, and later sharply higher fuel costs.

In the second half of 2007, the economies of the U.S. and many other countries began to experience downturns which were characterized by, among other factors, instability in securities’ value and capital markets, instability of currencies, a widespread reduction in demand, sharp reductions in the availability of credit and inflationary pressure.

By the second half of 2008, the additional effects of the severe economic downturns in our markets included significant reductions in air travel and contractions in corporate and personal spending which, as a result, have negatively impacted our product lines. Additional impacts of such downturns on the air transport industry have included a decrease in orders of executive jets and a decrease in the volume of financing available to our customers for aircraft purchases, particularly in the commercial and executive aviation segments (see “Item 4B. Information on The Company—Business Overview—Aircraft Financing Arrangements”). A continued downturn in general economic conditions could result in further reductions in air travel and decreased orders from our customers for our aircraft. Our customers could also defer or cancel their purchases of our aircraft. We cannot, at this time, predict the magnitude or duration of the impact that the above events will have on the air transport industry as a whole and on our business in particular.

In February 2009, we had to lay off approximately 20% of our labor force as part of our efforts to reposition Embraer in view of the global economic downturn. The cost of these layoffs was US$61.3 million. In addition, we also experienced cancellations of 60 aircraft orders by several of our customers (for more information on aircraft cancellations, see “Item 3D. —Our aircraft sales are subject to cancellation provisions that may reduce our cash flows”).

We cannot guarantee that material cancellations will not occur in the future or that our other businesses will not be affected. Material cancellations, delays or decreases in the number of aircraft delivered in any year in the future would likely reduce our revenue and backlog.

We depend on key customers and key suppliers, the loss of any of which could harm our business.

Commercial aircraft. As of December 31, 2011, 41% of our firm orders in backlog for the EMBRAER 170/190 jet family were from Flybe, in the U.K., JetBlue Airways and Air Lease, in the U.S., and Azul, a Brazilian airline founded in 2008. We believe that we will continue to depend on a number of key customers, the loss of any one of which could reduce our sales and reduce our market share. Fewer sales could reduce our profitability.

 

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Increasingly, due to the global economic slowdown, the commercial airline industry is seeking to reduce costs and increase efficiency, and is experiencing a consolidation process through mergers and acquisitions and alliances through code-sharing arrangements. Although it is expected that such consolidations and alliances may result in the creation of more stable and competitive airlines, they may also have the effect of reducing the number of existing and potential customers and, possibly, the number of purchases of our aircraft.

Defense aircraft. The Força Aérea Brasileira, or Brazilian Air Force, is our largest customer of defense aircraft products. Revenue arising from sales to the Brazilian federal government accounted for 25.0% of our defense and security revenue for the year ended December 31, 2011. A decrease in defense spending by the Brazilian federal government due to defense spending cuts, general budgetary constraints or other factors that are out of our control could decrease our defense and security revenue. We cannot assure you that the Brazilian federal government will continue to purchase aircraft or services from us in the future at the same rate or at all.

Key suppliers. Our risk-sharing partners develop and manufacture significant portions of our aircraft, including the engines, hydraulic components, avionics, interior and parts of the fuselage and tail. Once risk-sharing partners have been selected and program development and aircraft production have begun, it is difficult to substitute these partners. In some cases, the aircraft are designed specifically to accommodate a particular component, such as the engine, which cannot be substituted by another manufacturer without significant delays and expense. This dependence makes us susceptible to the risks of performance, product quality and financial condition of these risk-sharing partners.

We cannot assure you that we will not experience significant delays in obtaining key equipment in our manufacturing process in the future. A large number of the equipment employed by the aircraft industry is subject to export control regulations and, as such, deliveries are dependent on suppliers having secured the applicable export licenses. In 2007, deliveries of equipment for one of our defense products were temporarily suspended due to export control requirements. Although we work closely with, and monitor the production process of, our risk-sharing partners and major suppliers, the failure of our risk-sharing partners and other major suppliers to meet our performance specifications, quality standards or delivery schedules or to comply with regulatory requirements (including export control requirements) could affect our ability to deliver new aircraft to customers in a timely manner.

Our aircraft sales are subject to cancellation provisions that may reduce our cash flow.

A portion of our aircraft firm orders is subject to significant contingencies, both before and after delivery. Prior to delivery, some of our purchase contracts may be terminated, or all or a portion of a particular firm order may be canceled, for different reasons, including:

 

   

extended delays in delivering aircraft or failure to obtain certification of the aircraft or otherwise meet performance milestones and other requirements;

 

   

failure of a customer to honor its aircraft purchases; or

 

   

production rate shortfalls.

Our customers may also reschedule deliveries or cancel orders, particularly during an economic downturn. In 2011 we had an unusually high liquidated damages revenue, of approximately US$67.1 million, compared to US$30.4 million in 2010, which were recognized in other operating (expenses) income, net, due to the termination of certain aircraft sales contracts. Although these cancellations occurred primarily in our executive aviation business, we cannot guarantee that in the future we will not experience material cancellations in our other aircraft segments. Material cancellations, delays or decreases in the number of aircraft delivered in any year in the future would likely reduce our sales and revenue, and, consequently, our profitability, for that year. A substantial number of cancellations or extensions of delivery schedules could reduce our sales and revenue for a given year, which in turn would reduce our cash flow and backlog.

 

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Some of our aircraft sales may be subject to financial and residual value guarantees and trade-in options that may require us to make significant cash disbursements in the future.

We have in the past guaranteed, and may in the future guarantee, the financial performance of a portion of the financing for, and the residual value of, some of our aircraft that have already been delivered. Financial guarantees are provided to financing parties to support a portion of the payment obligations of purchasers of our aircraft under their financing arrangements to mitigate default-related losses. These guarantees are collateralized by the financed aircraft.

Residual value guarantees typically ensure that, at the 15th year as of the aircraft delivery date, the relevant aircraft will have a residual market value equal to a percentage of the original sale price. More recently, residual value guarantees have been issued to ensure a residual market value for the 10th year following delivery of the aircraft. Most of our residual value guarantees are subject to a limitation (a “cap”) and, therefore, on average, our residual value guarantee exposure is limited to 17% of the original sale price. In the event of an exercise by a purchaser of its residual value guarantee, we will bear the difference, if any, between the guaranteed residual value and the market value of the aircraft at the time of exercise.

Assuming all customers who are supported by off-balance sheet financial guarantees defaulted on their aircraft financing arrangements, and also assuming we were required to pay the full aggregate amount of outstanding financial and residual value guarantees and were unable to remarket any of the aircraft to offset our obligations, our maximum exposure under these guarantees (less provisions and liabilities) would have been US$682.8 million as of December 31, 2011. As a result, we would be obligated to make substantial payments that may not be recoverable through proceeds from aircraft sales or leases, particularly if in the future we are not able to remarket any of the aircraft to offset our obligations or financing defaults occur with respect to a significant portion of our aircraft. The value of the underlying aircraft is more likely to decrease and third parties are more likely to default during economic downturns. For further discussion of these off-balance sheet arrangements, see Note 40 to our audited consolidated financial statements.

In addition, in connection with the execution of purchase agreements for new aircraft, we may provide trade-in options to our customers. These options provide customers with the right to trade in existing Embraer aircraft upon the purchase and acceptance of a new aircraft. From the 18 trade-in options we had in 2010, in 2011 we accepted five aircraft for trade-in and another 12 trade-in options were cancelled. Also, in 2011, we accepted two aircraft for trade-in pursuant to trade-in aircraft options signed in 2011. As a result, we are currently subject to trade-in options relating to one aircraft, as a result of trade-ins tied to contractual obligations with customers and to their taking delivery of certain new aircraft. In addition, other aircraft may become subject to trade-in due to new sales agreements. The trade-in price is determined in the manner discussed under “Item 5A. Operating and Financial Review and Prospects—Operating Results—Critical Accounting Estimates—Guarantees and Trade-In Rights” for commercial and executive aircraft. We may be required to accept trade-ins at prices that are above the market price of the aircraft, which would result in financial loss for us when we remarket the aircraft.

We continuously re-evaluate our risk related to financial guarantees and trade-in obligations based on a number of factors, including the estimated future market value of our aircraft based on third-party appraisals, based on information on similar aircraft remarketing in the secondary market, and the credit rating of the customers. In this regard, based on our risk assessment of Mesa’s Chapter 11 filing, in 2009 we reserved US$74.4 million of collateral in the form of cash deposited in escrow, in recognition of estimated losses that at the time we had classified as probable with respect to financial guarantees extended by us in connection with sales of our aircraft to Mesa. As a result of the AMR Chapter 11 filing in 2011, and related exposure from financial guarantees and residual value guarantee obligations, we made a total net provision of US$360.7 million related to these obligations. Of this amount, US$107.4 million is accounted for under financial (expenses) income, net, and, therefore, does not impact our operating margin. The remaining US$253.3 million is accounted for under other operating income (expenses), net, and, therefore, impacted our operating margin for the year.

Considering the potential impacts to the regional aircraft secondary market and aircraft values that may come as a result of an increase in aircraft availability due to the AMR restructuring process, we also revised existing provisions, which also relate to our financial guarantee and residual value guarantee obligations, and the net effect of such revisions was negative US$43.2 million. It should be noted that, among other things (such as residual value guarantee related provisions), these revisions include an additional provision related to the Mesa Air Group

 

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bankruptcy process that occurred in 2010. This additional provision was as a result of the latest market developments in the 50-seat segment and the expectation that the Mesa aircraft will be remarketed in the coming months. It is important to note that with this additional provision for the Mesa Air Group obligations, we have now provisioned for the maximum potential expenses related to such obligations and, therefore, no additional provisions are expected for these guarantees. For further information, see Note 40 to our audited consolidated financial statements.

Any future decrease in the market value of the aircraft covered by trade-in rights or financial guarantees would decrease our ability to recover the amounts payable to satisfy our obligations and cause us to incur additional charges to income. If we are required to pay amounts related to such guarantees, we may not have sufficient cash or other financial resources available to do so and may need to seek financing to fund these payments. We cannot assure you that the then-prevailing market conditions would allow us to resell or lease the underlying aircraft at its anticipated fair value or in a timely manner. Consequently, honoring our financial guarantee or trade-in obligations could require us to make significant cash disbursements in a given year, which, in turn, would reduce our cash flow in that year.

Any decrease in Brazilian federal government-sponsored customer financing, or increase in government-sponsored financing that benefits our competitors, may decrease the cost-competitiveness of our aircraft.

Historically, when purchasing our aircraft, our customers have benefited from export financing incentives provided by Brazilian government-sponsored export programs. The most important of these government programs was a system of interest rate adjustments called the Programa de Financiamento às Exportações (the Export Financing Program), or ProEx.

As a result of past disputes between the Canadian and Brazilian governments at the World Trade Organization, or WTO, regarding the granting of export subsidies relating to sales of aircraft, the Brazilian federal government ultimately amended ProEx, so that any ProEx payments would not decrease the effective interest rate below the interest rate permitted by the WTO, and the Canadian government has also made changes to its financing arrangements for sales of aircraft by Bombardier, Inc., or Bombardier, a Canadian aircraft manufacturer.

Although ProEx is currently in compliance with WTO rules, other export financing programs available to our customers may be subject to challenge in the future. If, in the future, ProEx or another similar Brazilian export financing program is not available, or if the terms of the ProEx are substantially changed such that our customers’ export financing costs become higher than those offered by other export credit agencies, or ECAs, that support our competitors exports, our competitiveness in the commercial jet market could decrease.

In July 2007, Brazil and the Organization for Economic Co-operation and Development, or OECD, countries entered into an agreement known as the Aircraft Sector Understanding to establish a “level-playing field” for official financing support for aircraft exports. Export Credit Agencies, or ECAs, from signatory countries are required to offer the same basic financial terms and conditions when financing sales of aircraft that compete with those produced by the jet manufacturers of their respective countries. The effect of the agreement is to encourage aircraft purchasers to focus on the price and quality of aircraft products offered by aircraft manufacturers rather than on the financial packages offered by their respective governments. As a result of the above agreement, financing support by the Brazilian federal government to the potential purchasers of our aircraft will contain similar terms and conditions offered to such purchasers by The Boeing Company, or Boeing, Airbus S.A.S., or Airbus, Bombardier or any other competitor from a signatory country to the Aircraft Sector Understanding of the OECD. By the end of 2007, the Banco Nacional de Desenvolvimento Econômico e Social (Brazilian Social and Economic Development Bank), or BNDES, started to offer financing to our customers under terms and conditions required by the OECD’s Aircraft Sector Understanding. To the extent we do not continue to maintain the pricing advantage and quality of our aircraft, our future sales may be negatively affected. In addition, aircraft manufacturers from countries which are not signatories to the agreement may be able to offer financing packages which will negatively affect the cost competitiveness of our products.

Any future government subsidies supporting any of our major competitors may cause the cost-competitiveness of our aircraft to suffer and our sales to decline.

 

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The Brazilian federal government may reduce funds available to our customers under government-sponsored financing programs.

From 2004 through 2011, approximately 18.0% of the total value of our export deliveries was subject to financing support by the BNDES and the Export Guarantee Fund (Fundo de Garantia à Exportação), or FGE, a special fund linked to the Ministry of Finance and managed by the BNDES to foster exports. We cannot ensure that the Brazilian federal government will continue to provide sufficient funding for the financing of our aircraft or that other sources of funding will be available to our customers. The loss or significant reduction of funds available to customers, without an adequate substitute, could lead to fewer deliveries and result in lower profitability for us.

We may face a number of challenges resulting from the development of new products and the possible pursuit of strategic growth opportunities.

As we continue to develop new products, we may need to reallocate existing resources and coordinate with new suppliers and risk-sharing partners. From time to time, there is significant competition within the aviation industry for skilled personnel in general and engineers in particular. To the extent such competition reoccurs, we may be unable to recruit and retain the necessary number of highly skilled engineers and other personnel we require. Failure to coordinate our resources in a timely manner or to attract and retain skilled personnel could slow down our development efforts and cause delays in production and deliveries of our aircraft, which would delay recognition of revenue.

We may pursue strategic growth opportunities, including joint ventures, acquisitions or other transactions, to expand our business or enhance our products and technology. We may face a number of challenges, including difficulties in identifying appropriate candidates, assimilating their operations and personnel and maintaining internal standards and controls, as well as the diversion of our management’s focus from our ongoing business. We cannot assure you that we will be able to meet these challenges or that our business will not face disruptions.

We may have to refund cash contributions in connection with the production or development of the EMBRAER 170/190 jet family and the Legacy 450/500 jet family if certain milestones for each of these aircraft are not reached.

We have arrangements with our risk-sharing partners, pursuant to which they have contributed to us, in cash, a total of US$652.4 million through December 31, 2011. Cash contributions do not have to be refunded by us to the risk-sharing partners if we fulfill certain milestones agreed with our risk-sharing partners. An amount of US$650.5 million of these cash contributions had become nonrefundable through 2011. If we cancel the production of the Phenoms 100/300 family or any aircraft in the EMBRAER 170/190 family, or if we cancel the development of the Legacy 450/500 family, because we are unable to obtain certification or for other nonmarket related reasons, we may be obligated to refund US$1.9 million of the total cash contributions already received. The Legacy 500 executive jet is expected to enter into service in late 2013, and the Legacy 450 is expected to enter service one year after the Legacy 500.

If we are unable to meet certain milestones agreed with our risk-sharing partners, we may be required to refund cash contributions for which we have not established provisions.

We face significant international competition, which may adversely affect our market share.

The worldwide commercial aircraft manufacturing industry is highly competitive. We are one of the leading manufacturers of commercial aircraft (i.e., regional and mid-capacity aircraft) in the world, along with Boeing, Airbus and Bombardier, all of which are large international companies. Certain of these competitors may have greater financial, marketing and other resources than we have. Although we have attained a significant share of the market for our commercial aircraft products, we cannot assure you that we will be able to maintain this market share. Our ability to maintain this market share and remain competitive in the commercial aircraft manufacturing market over the long-term requires continued technological and performance enhancement to our products. Our primary competitor in the regional and mid-capacity jet markets is Bombardier Inc., a Canadian company, which has significant technological capabilities and financial and marketing resources and, in some instances, benefits from government-sponsored product development subsidies. These companies also may have significant technological capabilities and greater financial and marketing resources than us. Additionally, Chinese, Russian and Japanese companies are developing mid-capacity jets and already have firm orders in backlog.

 

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We also face significant competition from companies with longer operating histories and established reputations in this industry. Also, some of our competitors in the business jet market may reach the market with their product before we do, allowing them to establish a customer base and making our efforts to gain greater market share more difficult. Recently, some of the most traditional manufacturers have been engaging in aggressive sales and marketing strategies, such as lowering sales prices, offering additional service packages and targeting advertisement to specific consumers. In addition, we have also been facing significant competition from sales of slightly used or almost new pre-owned aircraft. We cannot assure you that we will continue to increase our market share in the business jet market segment as we have been able to do in the past, or that we will not experience a reduction in our current market share in this segment.

We may have to make significant payments as a result of unfavorable outcomes of pending challenges to various taxes and payroll charges.

We have challenged the constitutionality of certain Brazilian taxes and payroll charges, as well as modifications and increases in the rates and basis of calculation of such taxes and charges. Interest on the total amount of these unpaid taxes and payroll charges accrues monthly based on the Selic rate, the principal lending rate of the Central Bank, and we make an accrual as part of the financial expenses, net item in our statements of income.

As of December 31, 2011, there was a US$386.5 million provision recorded as a liability (taxes and payroll charges) on our balance sheet in connection with litigation contingencies that we classify as representing probable losses to us. We are awaiting a final decision in these proceedings. We cannot assure you that we will prevail in these proceedings or that we will not have to pay significant amounts, including interest, to the Brazilian federal government in the future as payment for these liabilities.

Risks Relating to the Commercial Airline Industry

Scope clause restrictions in airline pilot contracts may limit demand for regional and mid-capacity jets in the U.S. market.

A key limiting factor in demand for regional and mid-capacity jets is the existence of scope clauses contained in airline pilot contracts. These scope clauses are union-negotiated restrictions on the number and/or size of regional and mid-capacity jets that a particular carrier may operate. Current scope clause restrictions, which are more prevalent in the United States, include restrictions on the number of seats, weight of aircraft and number of 60-90 seat commercial aircraft in an airline’s fleet operated by regional carriers. As a result, our opportunities for near-term growth in the U.S. regional jet market in the 60-90 seat categories may be limited. The continuation or further tightening of scope clauses could also lead some of our customers who have purchased options to acquire our regional and mid-capacity jets not to exercise those options. We cannot assure you that current restrictions will be lessened, or will not be expanded, including by amending these scope clauses to cover larger-sized commercial aircraft. Furthermore, although scope clauses are less prevalent outside the United States, we cannot assure you that scope clauses will not become more prevalent or restrictive, or that some other form of restriction will not take effect, in Europe or in other markets.

We are subject to stringent certification requirements and regulation, which may prevent or delay our obtaining certification in a timely manner.

Our civil aviation products are subject to regulation in Brazil and in each jurisdiction where our customers are located. The aviation authority in Brazil known as the Agência Nacional de Aviação Civil - ANAC (National Civil Aviation Agency), or Brazilian Aviation Authority, as well as in other countries in which our customers are located, most notably the U.S. Federal Aviation Administration, or the FAA, and the European Aviation Safety Agency, or the EASA, must certify our civil aviation products before we can deliver them to our customers in those regions. We cannot assure you that we will be able to obtain certification of our aircraft on a timely basis or at all. We also believe that environmental requirements, such as reduction of greenhouse gas emissions, are becoming one of the main drivers of airline fleet decisions and will influence future aircraft developments. If we fail to obtain a required certification from an aviation authority for any of our aircraft, that aviation authority can prohibit the use of that aircraft within its jurisdiction until certification has been obtained. In addition, complying with the requirements of the certification and other regulatory authorities can be both expensive and time-consuming.

 

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Changes in government regulations and certification procedures could also delay our start of production as well as entry of a new product into a new market. Despite our continuous efforts to strictly observe and comply with all certifications and other regulatory requirements, we cannot predict how future laws or changes in the interpretation, administration or enforcement of laws will affect us. We may be required to spend significantly more money to comply with these laws or to respond to these changes.

Any catastrophic events involving our aircraft could adversely affect our reputation and future sales of our aircraft, as well as the market price of the common shares and the ADSs.

We believe that our reputation and the safety record of our aircraft are important selling points for our products. We design our aircraft with backup systems for major functions and appropriate safety margins for structural components. However, the safe operation of our aircraft depends to a significant degree on a number of factors largely outside our control, including our customers’ proper maintenance and repair of our aircraft and pilot skill. The occurrence of one or more catastrophic events involving one of our aircraft could adversely affect our reputation and future sales, as well as the market price of our common shares and the ADSs.

Risks Relating to Brazil

Brazilian political and economic conditions have a direct impact on our business and the trading price of our common shares and ADSs.

The Brazilian federal government has frequently intervened in the Brazilian economy and occasionally has made drastic changes in policy and regulations. The Brazilian federal government’s actions to control inflation and affect other policies and regulations have often involved, among other measures, increases in interest rates, changes in tax policies, price controls, currency devaluations, capital controls and limits on imports. Our business, financial condition, results of operations and the trading price of the common shares and the ADSs may be adversely affected by changes in policy or regulations at the federal, state or municipal level involving or affecting factors such as:

 

   

interest rates;

 

   

monetary policies;

 

   

exchange controls and restrictions on remittances abroad (such as those that were imposed in 1989 and early 1990);

 

   

currency fluctuations;

 

   

inflation;

 

   

liquidity of domestic capital and lending markets;

 

   

tax policies; and

 

   

other political, diplomatic, social and economic developments in or affecting Brazil.

Uncertainty over whether the Brazilian federal government will implement changes in policy or regulation affecting these or other factors in the future may contribute to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets and securities issued abroad by Brazilian companies.

Historically, the political scenario in Brazil has influenced the performance of the Brazilian economy. In particular, political crises have affected the confidence of investors and the public in general, which adversely affected the economic development in Brazil. In addition, 2010 was an election year in Brazil and a new president, along with state governors and members of congress, were elected. Although the transition of power in the last decade has been less disruptive to the overall Brazilian economic scenario than in prior periods, we cannot ensure that a new administration would not implement new government policies that would not be disruptive to Brazil’s relative economic stability that has prevailed in recent years.

 

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These and other future developments in the Brazilian economy and governmental policies may adversely affect us and our business and results of operations and may adversely affect the trading price of our common shares and ADSs.

Inflation and government efforts to combat inflation may contribute significantly to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets and, consequently, may adversely affect the market value of our common shares and ADSs.

Brazil experienced extremely high rates of inflation during the decade of the 1980s and in the early part of the 1990s. Since 1994, Brazil’s inflation has been under control. More recently, Brazil’s annual rate of inflation was 4.5%, 5.9%, 4.3%, 5.9%, and 6.5%, from 2007 through 2011, respectively, as measured by the Índice Nacional de Preços ao Consumidor Amplo (National Consumer Price Index), or IPCA. Although inflation rates in Brazil are under control to a certain extent, there continues to be some inflationary pressure as a result of the strong expansion of the Brazilian economy in recent years. Among the effects of such inflationary pressure, labor costs have risen in the past couple of years. More recently, the Brazilian government has taken certain fiscal actions in order to keep inflation under control.

Future Brazilian federal government actions, including interest rate decreases, intervention in the foreign exchange market and actions to adjust or fix value of the real may trigger increases in inflation. If Brazil experiences high inflation again in the future, our operating expenses and borrowing costs may increase, our operating and net margins may decrease and, if investor confidence decreases, the price of our common shares and ADSs may fall.

Exchange rate instability may adversely affect our financial condition and results of operations and the market price of our common shares and ADSs.

Although most of our revenue and debt is U.S. dollar-denominated, the relationship of the real to the value of the U.S. dollar, and the rate of depreciation of the real relative to the prevailing rate of inflation, may adversely affect us.

As a result of inflationary pressures, among other factors, the Brazilian currency has devalued periodically during the last four decades. Throughout this period, the Brazilian federal government has implemented various economic plans and utilized a number of exchange rate policies, including sudden devaluations, periodic mini-devaluations during which the frequency of adjustments has ranged from daily to monthly, floating exchange rate systems, exchange controls and dual exchange rate markets. Although over long periods depreciation of the Brazilian currency generally has correlated with the rate of inflation in Brazil, devaluation over shorter periods has resulted in significant fluctuations in the exchange rate between the Brazilian currency and the U.S. dollar and other currencies.

For example, in 2002, the real to U.S. dollar exchange rate increased by 52.3% due in part to political uncertainty surrounding the Brazilian presidential elections and the global economic slowdown. Although the R$ to US$ exchange rate decreased by 18.2%, 8.1%, 11.8%, 8.7%, and 17.2% in 2003, 2004, 2005, 2006, and 2007, respectively, in 2008 it appreciated by 31.9%, mainly as a result of the global economic crisis. In 2009 and 2010, the real to U.S. dollar exchange rate decreased 25.5% and 4.3%, respectively, mainly as the effects of the global economic crisis on the Brazilian economy appeared to be less severe than in other parts of the world. In 2011, such rate increased another 12.6%, a trend that persisted in the first months of 2012. No assurance can be given that the real will not appreciate or depreciate significantly against the U.S. dollar in the future.

Historically, depreciations in the real relative to the U.S. dollar have also created additional inflationary pressures in Brazil by generally increasing the price of imported products and requiring recessionary government policies to curb aggregate demand. On the other hand, appreciation of the real against the U.S. dollar may lead to a deterioration of the current account and the balance of payments, as well as dampen export-driven growth. Depreciations generally curtail access to foreign financial markets and may prompt government intervention, including recessionary governmental policies. Depreciations of the real relative to the U.S. dollar would also reduce the U.S. dollar value of distributions and dividends on our ADSs and may also reduce the market value of our common shares and ADSs.

 

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Appreciation of the real against the U.S. dollar may also have an adverse impact on the competitiveness of our products, as approximately 25% of our total costs are incurred and denominated in reais. Therefore, appreciations of the real against the U.S. dollar or other currencies increases the costs of our products when measured in U.S dollars, and may result in a decrease in our margins.

In addition, because taxes on income are largely determined and paid in reais based on our Brazilian tax books, the income tax expense (benefit) line item of our income statement, which has the U.S. dollar as our functional currency, is significantly impacted by appreciations of the real relative to the U.S. dollar to the extent we must record deferred taxes resulting from exchange rate fluctuations on the reported basis of our nonmonetary assets (principally property, plant and equipment and intangible assets).

Economic developments and investor perceptions of risk in other countries, including both in developed or emerging market economies, may adversely affect the trading price of Brazilian securities, including our common shares and ADSs.

The market value of securities of Brazilian issuers is affected in varying degrees by economic and market conditions in other countries, including in developed countries, such as the United States, and in emerging market countries. Although economic conditions in such countries may differ significantly from economic conditions in Brazil, the reaction of investors to developments in these other countries may have an adverse effect on the market value of securities of Brazilian issuers. For example, the 2008 global economic crisis has had an impact on many economies and capital markets around the world. This crisis was evidenced by instability in the value of securities and capital markets, stock and credit market volatility, instability of most currencies, unavailability of credit, higher interest rates, a widespread reduction in demand, a general economic slowdown and other factors that could adversely affect our financial condition and diminish investors’ interest in securities of Brazilian issuers, including ours. Future crises in other countries could adversely affect the trading price of our common shares and ADSs, diminish investor interest in securities of Brazilian issuers, including our common shares and ADSs, and make it more difficult for us to access the capital markets and finance our operations on acceptable terms or at all.

Risks Relating to Our Common Shares and ADSs

If holders of our ADSs exchange the ADSs for common shares, they risk losing the ability to remit foreign currency abroad and Brazilian tax advantages.

The Brazilian custodian for the common shares has obtained an electronic certificate of registration from the Central Bank permitting it to remit foreign currency abroad for payments of dividends and other distributions relating to the common shares or upon the disposition of the common shares. If holders of ADSs decide to exchange their ADSs for the underlying common shares, they will be entitled to continue to rely on the custodian’s electronic certificate of registration for five business days from the date of exchange. Thereafter, such holders of ADSs may not be able to obtain and remit foreign currency abroad upon the disposition of, or distributions relating to, the common shares unless they obtain their own electronic certificate of registration or register their investment in the common shares pursuant to Resolution No. 2,689, which entitles certain foreign investors to buy and sell securities on the São Paulo Stock Exchange. Holders who do not qualify under Resolution No. 2,689 will generally be subject to less favorable tax treatment on gains with respect to the common shares. If holders of ADSs attempt to obtain their own electronic certificate of registration, they may incur expenses or suffer delays in the application process, which could delay their ability to receive dividends or distributions relating to the common shares or delay the return of their capital in a timely manner. In addition, we cannot assure you that the custodian’s electronic certificate of registration or any certificate of foreign capital registration obtained by a holder of ADSs will not be affected by future legislative or other regulatory changes, or that additional restrictions applicable to such holder, to the disposition of the underlying common shares or to the repatriation of the proceeds from such disposition, will not be imposed in the future.

 

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The Brazilian federal government has veto power over change of control, change of name, trademark or corporate purpose and over the creation or alteration of our defense and security programs, and its interests could conflict with the interests of the holders of our common shares or ADSs.

The Brazilian federal government holds one share of a special class of our common stock called a “golden share,” which carries veto power over change of control, change of our name, trademark or corporate purpose and over the creation or alteration of our defense and security programs (whether or not the Brazilian federal government participates in such programs). Moreover, the Brazilian federal government may have an interest in vetoing transactions that may be in the interest of the holders of our common shares or ADSs. For example, in 2010, we changed our corporate name to Embraer S.A. and altered our bylaws to allow us to enter the defense and security market segments, which actions required the approval of the Brazilian federal government. We cannot assure you that we will be able to obtain approvals from the Brazilian federal government in the future to effect important corporate changes, such as those carried out in 2010, or other important corporate changes that may be required in the future.

Our bylaws contain provisions that could discourage our acquisition or prevent or delay transactions that you may favor.

Our bylaws contain provisions that have the effect of avoiding the concentration of our common shares in the hands of a small group of investors so as to promote the dispersed ownership of such shares. These provisions require any shareholder or group of shareholders that acquires or becomes the holder of (1) 35% or more of the total shares issued by us or (2) other rights over shares issued by us that represent more than 35% of our capital, to submit to the Brazilian federal government a request for making a public tender offer to purchase all of our shares on the terms specified in our bylaws. If the request is approved, such shareholder or group of shareholders must commence the public tender offer to purchase all of our shares within 60 days of the date of approval. If the request is refused, such shareholder or group of shareholders must sell all of such shareholder’s shares that exceed the 35% limit within 30 days, so that the holding of such shareholder or group of shareholders falls below 35% of our capital stock. These provisions may have anti-takeover effects and may discourage, delay or prevent a merger or acquisition, including transactions in which our shareholders might otherwise receive a premium for their common shares and ADSs. These provisions can only be altered or overridden with the approval of our Board of Directors and our shareholders in a shareholders’ meeting convened for this purpose and, with the consent of the Brazilian federal government, as holder of the golden share.

The absence of a single, controlling shareholder or group of controlling shareholders may render us susceptible to shareholder disputes or other unanticipated developments.

The absence of a single, controlling shareholder or group of controlling shareholders may create difficulties for our shareholders to approve certain transactions, because, among other things, the minimum quorum required by law for the approval of certain matters may not be reached. We and our shareholders may not be afforded the same protections provided by the Brazilian Corporate Law against abusive measures taken by other shareholders and, as a result, may not be compensated for any losses incurred. Any sudden and unexpected changes in our management team, changes in our corporate policies or strategic direction, takeover attempts or any disputes among shareholders regarding their respective rights may adversely affect our business and results of operations.

Our bylaws contain provisions that limit the voting rights of certain shareholders including non-Brazilian shareholders.

Our bylaws contain provisions that limit the rights of a shareholder or group of shareholders, including brokers acting on behalf of one or more holders of ADSs, to exercise voting rights in respect of more than 5% of the outstanding shares of our capital stock at any general meeting of shareholders. See “Item 10B. Additional Information—Memorandum and Articles of Association—Description of Capital Stock—Voting Rights of Shares—Limitations on the Voting Rights of Certain Holders of Common Shares.”

Our bylaws also contain provisions that limit the right of non-Brazilian shareholders to exercise voting rights in respect of more than two-thirds of the voting rights that may be exercised by Brazilian shareholders present at any general meeting of shareholders. This limitation will effectively prevent our takeover by non-Brazilian shareholders and limit the ability of non-Brazilian shareholders to effect control over us. See “Item 10B. Additional Information—Memorandum and Articles of Association—Description of Capital Stock—Voting Rights of Shares—Limitations on the Voting Rights of Non-Brazilian Shareholders.”

 

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Holders of ADSs may not be able to exercise their voting rights.

Holder of ADSs may only exercise their voting rights with respect to the underlying common shares in accordance with the provisions of the deposit agreement governing our ADSs. Under the deposit agreement, ADS holders must vote the common shares underlying their ADSs by giving voting instructions to the depositary. Upon receipt of the voting instructions from the ADS holder, the depositary will vote the underlying common shares in accordance with these instructions. Otherwise, ADS holders will not be able to exercise their right to vote unless they surrender the ADS for cancellation in exchange for the common shares. Pursuant to our bylaws, the first call for a shareholders’ meeting must be published at least 30 days in advance of the meeting, the second call must be published at least 15 days in advance of the meeting, and the third call, if necessary, must be published at least eight days in advance of the meeting. When a shareholders’ meeting is convened, holders of ADSs may not receive sufficient advance notice to surrender the ADS in exchange for the underlying common shares to allow them to vote with respect to any specific matter. In addition, the depositary has no obligation to notify ADS holders of an upcoming vote or distribute voting cards and related materials to ADS holders, unless we specifically instruct the depositary to do so. If we ask the depositary to seek voting instructions from ADS holders, the depositary will notify ADS holders of the upcoming vote and will arrange to deliver proxy cards to such holders. We cannot ensure that ADS holders will receive proxy cards in time to allow them to instruct the depositary to vote the shares underlying their ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for an untimely solicitation of voting instructions. As a result, holders of ADSs may not be able to fully exercise their voting rights.

The relative illiquidity and volatility of the Brazilian securities markets may substantially limit the ability of holders of our common shares or the ADSs to sell the common shares underlying ADSs at the price and time they desire.

Investing in securities, such as the common shares or the ADSs, of issuers from emerging market countries, including Brazil, involves a higher degree of risk than investing in securities of issuers from more developed countries.

The Brazilian securities markets are substantially smaller, less liquid, more concentrated and more volatile than major securities markets in the United States and other jurisdictions, and are not as highly regulated or supervised as some of these other markets. The relatively small market capitalization and illiquidity of the Brazilian equity markets may substantially limit the ability of holders of our common shares or ADSs to sell the common shares or the ADSs at the price and time desired.

There is also significantly greater concentration in the Brazilian securities markets than in major securities markets in the United States. See “Item 9C. The Offer and Listing—Markets—Trading on the São Paulo Stock Exchange.”

The sale of a substantial number of common shares, or the belief that this may occur, could decrease the trading price of the common shares and the ADSs; holders of our common shares and/or ADSs may not be able to sell their securities at or above the price they paid for them.

Sales of a substantial number of common shares, or the belief that this may occur, could decrease the trading price of our common shares and ADSs. As a consequence of sales by existing shareholders, the market price of the common shares and, by extension, the ADSs may decrease significantly. As a result, the holders of the ADSs and/or common shares may not be able to sell their securities at or above the price they paid for them.

Holders of our ADSs might be unable to exercise preemptive rights with respect to the common shares.

Holders of our ADSs may not be able to exercise the preemptive rights relating to the common shares underlying their ADSs unless a registration statement under the Securities Act is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement with respect to the shares or other securities relating to these preemptive rights, and we

 

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cannot assure holders of our ADSs that we will file any such registration statement. Unless we file a registration statement or an exemption from registration applies, holders of our ADSs may receive only the net proceeds from the sale of their preemptive rights by the depositary or, if the preemptive rights cannot be sold, the rights will be allowed to lapse.

Judgments of Brazilian courts with respect to our common shares will be payable only in reais.

If proceedings are brought in the courts of Brazil seeking to enforce our obligations in respect of the common shares, we will not be required to discharge our obligations in a currency other than reais. Under Brazilian exchange control limitations, an obligation in Brazil to pay amounts denominated in a currency other than reais may only be satisfied in Brazilian currency at the exchange rate, as determined by the Central Bank, in effect on the date the judgment is obtained, and such amounts are then adjusted to reflect exchange rate variations through the effective payment date. The then prevailing exchange rate may not afford non-Brazilian investors with full compensation for any claim arising out of or related to our obligations under the common shares or the ADSs.

 

ITEM 4. INFORMATION ON THE COMPANY

 

4A. History and Development of the Company

Overview

Embraer S.A. is a joint stock company duly incorporated under the laws of Brazil with an indefinite term of duration. Originally formed in 1969 by the Brazilian federal government, we were privatized in 1994. In connection with our privatization, we were transformed into a publicly-held corporation and we are subject to the provisions of the Brazilian Corporate Law. Our principal executive offices are located at Avenida Brigadeiro Faria Lima, 2170, 12227-901 São José dos Campos, São Paulo State, Brazil. Our telephone number is 55-12-3927-4404. Our agent for service of process in the United States is National Registered Agents, Inc., with offices at 875 Avenue of the Americas, Suite 501, New York, New York 10001.

We have grown from a government-controlled company established to develop and produce aircraft for the Brazilian Air Force into a publicly-held company that produces aircraft for commercial and executive aviation and for defense and security purposes.

As part of our evolution, we have obtained, developed and enhanced our engineering and technological capabilities through our own development of products for the Brazilian Air Force and through joint product development with foreign companies on specific projects. We have applied these capabilities that we gained from our defense business to develop our commercial aviation business.

Our first regional aircraft was the Bandeirante, a 19-passenger twin-engine non-pressurized turboprop aircraft initially designed to service the transport needs of the Brazilian Air Force. This aircraft was certified in 1973. The Bandeirante was followed by the EMB 120 Brasília, which was certified in 1985 and is a high performance, pressurized turboprop commercial aircraft seating up to 30 passengers that was designed to serve the longer routes and higher passenger traffic of the growing regional aircraft market. Drawing upon the design of the EMB 120 Brasília and the jet technology acquired in our development of the AM-X, a jet strike bomber for the Brazilian Air Force, we developed the ERJ 145 regional jet family, our first jet product for commercial use. This family comprises three aircraft, which seat up to 37, 44 and 50 passengers. The first member of the ERJ 145 family, the ERJ 145, was certified in 1996. We have expanded our jet product line with the development of the EMBRAER 170/190 jet family, which has the capacity to seat between 70 and 118 passengers and was designed to serve the aircraft market’s trend towards larger, higher volume and longer range jets. The first member of this family, the EMBRAER 170, was certified in February 2004 and its derivatives, the EMBRAER 175, and the EMBRAER 190, were certified in December 2004 and August 2005, respectively. The certification of the EMBRAER 195 was granted in June 2006. We are also marketing and selling the Legacy 450, Legacy 500 and Legacy 600, a line of executive jets in the mid-light, mid-size and super midsize categories, and the Phenom 100, Phenom 300 and Lineage 1000, which are products in the entry-level, light and ultra-large categories, respectively. In addition, in 2009 we presented the new Legacy 650, a large executive jet that will be positioned in our executive jet portfolio between the Legacy 600 and the Lineage 1000. In the defense and security market, we offer a line of intelligence, surveillance and reconnaissance aircraft based on the ERJ 145 regional jet platform.

 

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On November 19, 2010, our shareholders approved a change to our corporate name from Embraer – Empresa Brasileira de Aeronáutica S.A. to Embraer S.A., as well as the addition of capabilities and the broadening of the scope of our defense business unit to allow such business unit to manufacture and trade equipment, materials, systems, software, accessories and components for the defense, security and energy industries, as well as to perform technical activities and services related to these areas. As a result, our bylaws were amended to reflect the addition of these activities to our corporate purposes.

Strategic Alliances and Growth Opportunities

We intend to review strategic growth opportunities, which may include joint ventures and acquisitions, and other strategic transactions, as well as enhance our existing relationships with significant world players in the aerospace and defense and security industries, including any members of the groups or companies below.

Strategic Alliances

European Aerospace and Defense Group

On November 5, 1999, a group consisting of (1) Aerospatiale Matra, currently known as European Aeronautic, Defense and Space Company N.V., or EADS, (2) Dassault Aviation, (3) Thomson-CSF, currently referred to by its trade name ThalesTM, and (4) Société Nationale d’Étude et de Construction de Moteurs d’Aviation, or Safran, all of which we refer to collectively as the European Aerospace and Defense Group, purchased 20% of our outstanding common stock from our existing common shareholders at that time. Most of the common stock purchased by the European Aerospace and Defense Group was owned by our former controlling shareholders.

Because the members of the European Aerospace and Defense Group were, at the time, considered by our former controlling shareholders to be strategic partners of Embraer, they were granted the right, as a group, to appoint two members to our Board of Directors. However, as a result of the termination of the shareholders’ agreement among our former controlling shareholders as part of our 2006 corporate reorganization, the European Aerospace and Defense Group no longer has the right to appoint members to our Board of Directors, other than pursuant to the general right provided for in the Brazilian Corporate Law. In addition, under Brazilian law the European Aerospace and Defense Group is no longer recognized as a group for voting purposes nor considered to be a strategic shareholder of Embraer. ThalesTM sold all of its shares in October 2006, and EADS sold all of its shares in a secondary offering in February 2007.

Our alliance with the European Aerospace and Defense Group allowed us to develop several business opportunities. For example, our alliance with the European Aerospace and Defense Group led us, together with EADS, to acquire a 65% interest in OGMA-Indústria Aeronáutica de Portugal S.A., or OGMA, and also resulted in the integration by us of the ThalesTM mission systems and electronic equipment in some of our EMB 145 AEW&C aircraft, as well as in commercial transactions for the purchase by us of certain equipment and services from the members of the European Aerospace and Defense Group in the ordinary course of our business.

AEL Sistemas

In April 2011, we and AEL Sistemas, a subsidiary of the Israeli company Elbit Systems Ltd., announced the execution of a strategic agreement with the purpose of evaluating joint exploration prospects for unmanned aerial systems (UAS), including the potential creation of a company to explore this segment with a majority participation of our defense and security business unit.

AVIC

In April 2011, we entered into a framework agreement with AVIC for the implementation of a Legacy 600/650 production line in China, taking advantage of the infrastructure, financial resources and workforce of Harbin Embraer Aircraft Industry Company Ltd., or HEAI, our joint venture company with Harbin Aircraft Industry (Group) Co., Ltd. and Hafei Aviation Industry Co., Ltd., both subsidiaries of AVIC. This industrial cooperation program will focus on the production of the Legacy 600/650 family in China and aims to serve the growing demand of the Chinese executive aviation market.

 

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Boeing

In April 2012, we entered into a cooperation agreement with Boeing, in which we agreed to pursue several areas of cooperation, including commercial aircraft features that enhance safety and efficiency, research and technology and sustainable aviation biofuels.

Joint Ventures

HEAI

In December 2002, we formed HEAI, a joint venture company with Harbin Aircraft Industry (Group) Co., Ltd. and Hafei Aviation Industry Co., Ltd., both subsidiaries of AVIC, to provide for the manufacture, sale and after-sale support of the ERJ 145 regional jet family. We own 51% of the equity of HEAI. We have granted HEAI a license for the exclusive rights to produce, sell and provide support for the ERJ 145 regional jet family in the Chinese markets, and we contributed US$12.4 million in cash, tooling and inventory to the joint venture. Our joint venture partners have contributed the land use rights in Harbin, China, and contributed US$10.8 million in cash and facilities to the joint venture. The roll-out of the first ERJ 145 manufactured by the joint venture occurred in December 2003, and the joint venture entered into its first sales contract for six aircraft with China Southern Airlines in February 2004. In October 2007, the 1,000th jet of the ERJ 145 family was delivered by Harbin Embraer Aircraft Industry Co. Ltd.

AIRHOLDINGS

In March 2005, a consortium formed by us and EADS acquired 65% of OGMA’s shares through a newly created holding company, named AIRHOLDING, SGPS, S.A., or AIRHOLDING. At that time we held 99% of the equity in the referred holding company and EADS held the remaining 1%. Further, in March 2006, EADS exercised its option to increase its interest to 30% of the equity in the referred holding company. We acquired 100% of EADS stake in OGMA pursuant to an agreement signed on January 27, 2012. With this new agreement, Embraer acquires control over AIRHOLDING’s 65% stake in OGMA, while the Portuguese government holds the remaining 35% through the Empresa Portuguesa de Defesa–EMPORDEF (Portuguese Defense Company). OGMA is a major representative of the aviation industry in Europe, offering services that include the maintenance, repair and overhaul of civil and military aircraft, engines and parts, assembly of structural components and engineering support.

CAE

In October 2006, we entered into an agreement with the Canadian company CAE Inc., or CAE, to form a global training joint venture, which will provide comprehensive pilot and ground crew training to customers of the Phenom 100 entry-level jet and Phenom 300 light jet aircraft. This training program has already started to be offered at CAE SimuFlite in Dallas, Texas, following the commencement of operation of the Phenom 100 in 2008, and has expanded to Burgess Hill in the U.K. in 2009. This joint venture is expected to provide entitlement training and post-entitlement training for pilots, maintenance technicians and dispatch personnel.

Liebherr Aerospace

In July 2008, we acquired for US$20.0 million a 40% interest owned by Liebherr Aerospace SAS, or Liebherr, in ELEB–Equipamentos Ltda., or ELEB, a 60%/40% joint venture that we formed with Liebherr in 1999. ELEB is an aerospace system and component manufacturer and its main products include landing gear systems, hydraulics and electro-mechanical sub-assemblies, such as actuators, valves, accumulators and pylons.

OrbiSat

In May 2011, we executed a US$25.7 million contract to purchase a 90% stake in the capital stock of the radar business of OrbiSat da Amazônia S.A., or OrbiSat, a Brazilian company that created a radar business in 2002 to develop state-of-the-art technology for air, sea and land remote sensing and aerial surveillance. This is the first acquisition made by our recently created defense and security business unit.

 

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Atech

In April 2011, we announced the acquisition for US$23.3 million of 50% of the capital stock of Atech Negócios em Tecnologias S.A., or Atech, with the purpose of increasing our capacity for developing products and services in the area of Command, Control, Communications, Computer and Intelligence, or C4I, systems and improving our capabilities of providing integrated systems for the defense and security, command and control, air defense and air traffic control markets.

AEL & Harpia

In April 2011, Embraer Defense and Security and AEL Sistemas, a subsidiary of the Israeli company Elbit Systems Ltd., announced the execution of a strategic agreement envisaging the evaluation of joint exploration of unmanned aerial systems, including the potential creation of a company with majority participation of Embraer’s defense and security department to work in the segment.

In September 2011, Embraer’s defense and security department and AEL Sistemas formalized this partnership and created a new company, Harpia Sistemas S.A., to focus on unmanned aerial systems market. We hold 51% of Harpia’s capital, and AEL holds the remaining 49%. Harpia’s activities will involve marketing, development, systems integration, manufacture, sales, and after-sale support for unmanned aerial systems, as well as simulators and the modernization of avionics systems. The company aims to provide broader solutions for complex systems, with a view to increasing the market share of Brazilian made products in the national defense and security market. As a part of this partnership, and for the purpose of participating in the process of transferring technology to Brazil, we acquired 25% of AEL’s capital for R$5.0 million.

Telebras

In November 2011, Embraer and Telecomunicações Brasileiras S.A., or Telebras, announced the signature of a memorandum of understanding for the purpose of forming a company, of which Embraer will hold a 51% stake and Telebras 49%, to work with the Brazilian federal government in order to meet the needs of Brazil’s plan for satellite development, including the National Broadband Program and strategic defense and governmental communications.

Capital Expenditures (Property, Plant and Equipment and Development)

We include our investments in both development and property, plant and equipment as part of our capital expenditures.

As part of our transition to IFRS, in 2010 we have started to capitalize our expenditures related to product development projects as non-current intangible assets on our balance sheet when it is probable that the relevant projects will generate future benefits, taking into account their commercial and technological feasibility and availability of technological and financial resources and only if their cost can be reliably measured. We amortize such assets in the form of charges to cost of sales and services on our income statement, based on the total estimated number of aircraft to be delivered for each new product development project. We also capitalize expenditures related to property, plant and equipment as non-current assets on our balance sheet and depreciate such assets in the form of charges to cost of sales and services on our income statement. For information on how we amortize our intangible assets and depreciate our property, plant and equipment, see “Item 5A. Operating and Financial Review and Prospects—Operating Results—Principal Operating Data and Components of Our Statement of Income—Cost of Sales and Services.”

Most of our development expenditures are associated with the development of new products either for the commercial or executive aviation segments. Development expenditures totaled US$207.1 million in 2011, US$162.2 million in 2010 and US$204.0 million in 2009, inclusive of cash contributions from risk-sharing partners. The increase in development expenditures in 2011 relative to 2010 is mainly a result of executive aviation. The decrease in development expenditures in 2010 relative to 2009 was mainly a result of fewer aircraft certifications in 2010, while additional development expenditures were required in 2009 in preparation of the certification of the Phenom 300 in that year.

 

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We also receive funds from risk-sharing partners to fund our cash costs for our commercial and executive aircraft development programs. Cash contributions provided by risk-sharing partners totaled US$85.8 million in 2011, US$99.4 million in 2010 and US$102.2 million in 2009. The decrease in cash contributions from risk-sharing partners in 2011 relative to 2010 is explained mainly by the contribution schedule agreed with our risk sharing partners. The reduction in cash contributions from risk-sharing partners in 2010 relative to 2009 is mainly a result of fewer such contributions in 2010 due to the certification of the Phenom 300 and the fulfillment of other contractual milestones under our risk-sharing arrangements in 2009. This reduction in cash contributions from risk-sharing partners was partially offset by contributions to the Legacy 450/500 program in 2010. See “Item 5C. Operating and Financial Review and Prospects—Research.”

Our main ongoing project is the development of the Legacy 450/500 executive jets. An estimated US$750.0 million is expected to be invested overall in property, plant and equipment and development for the Legacy 450/500 programs, which were launched by us in April 2008. The Legacy 500 executive jet is expected to enter into service in late 2013 and the Legacy 450 is expected to enter service one year after the Legacy 500.

Our total disbursements in capital expenditures related to property, plant and equipment were US$162.2 million in 2011, US$73.5 million in 2010 and US$97.1 million in 2009. These investments are related mainly to (1) construction of new facilities and (2) improvements and modifications to our plants and production facilities for the production of new aircraft models.

In 2012, we expect to invest approximately US$650.0 million in capital expenditures for research, product development and property, plant and equipment. Of this amount, approximately US$450.0 million will be invested in our research and product development activities, exclusive of contributions of risk-sharing partners, and US$200 million will be invested in property, plant and equipment. The US$200 million capital expenditures to be disbursed in connection with property, plant and equipment are primarily related to (1) improvements to our existing facilities, (2) the construction of the Melbourne, Florida plant, which was started in May 2008, and (3) the construction of two plants in Evora, Portugal, which was started in July 2008.

We expect to invest approximately 77% of our budgeted US$650.0 million capital expenditures for 2012 in Brazil, most of which will be invested in research and development activities. The remaining 23% of our capital expenditures will be invested abroad, mainly on property, plant and equipment at our new industrial facilities in the cities of Melbourne, Florida and Evora, Portugal. We do not expect to receive relevant amounts of cash contributions from the risk-sharing partners in 2012.

Our capital expenditures are generally financed by funds provided by operations, borrowings under our credit arrangements, cash contributions from risk-sharing partners, advance payments from customers and, to a lesser extent, capital increases to meet these needs. See “Item 5B. Operating and Financial Review and Prospects—Liquidity and Capital Resources—Overview” and “Item 5C. Operating and Financial Review and Prospects—Research”.

We incur few development expenditures for defense and security programs, as those are primarily funded by the Brazilian federal government and other government customers under long-term development contracts.

 

4B. Business Overview

We are one of the leading manufacturers of commercial aircraft (i.e., regional and mid-capacity jets) in the world, based on 2011 revenue arising from sales of commercial aircraft, and have a global customer base. Our focus is achieving customer satisfaction with a range of products and services addressing the commercial airline, executive jet and defense and security markets. Our commercial aviation business, including aviation-related services, accounted for 64.0% of our revenue in 2011. We are the leading supplier of defense aircraft to the Brazilian Air Force, based on number of aircraft sold, and we have sold aircraft to armed forces in Europe, Asia and Latin America. Our defense and security business, including aviation related services, accounted for 14.7% of our revenue in 2011. We have developed a line of executive jets based on one of our regional jet platforms and launched new executive jets in the entry-level, light, ultra-large and mid-light/mid-size categories: the Phenom 100/300 family, the Lineage 1000 and the Legacy 450/500 family, respectively. Our executive jet business, including aviation related services, accounted for 19.2% of our revenue in 2011. Providing high quality customer support is a key element of our customer focus and is critical to our ability to maintain long-term customer relationships. Our aviation services

 

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business accounted for 11.3% of our revenue in 2011. Other related businesses accounted for 2.1% of our revenue in 2011. For the year ended December 31, 2011, we generated revenue of US$5,803.0 million, of which approximately 90% was U.S. dollar-denominated. At December 31, 2011, we had a total firm order backlog of US$15.4 billion, which included 249 firm orders for commercial aircraft.

Our Strengths

We believe that our primary strengths are:

Leading Commercial Aircraft Manufacturer with a Global Customer Base. We are a leading manufacturer of 30-120 seat jets, based on the number of aircraft sold, with a strong global customer base. We have sold our regional and mid-capacity jets to more than 70 customers on the five continents of the world. Our customers include some of the largest and most significant regional and low-cost airlines and commercial carriers in the world.

Aircraft Design; Cost and Operating Efficiency. We conceive, develop and manufacture aircraft to provide our customers with reduced operating, maintenance and training costs due to the similarity and efficiency in design and the commonality of parts within a jet family. These similarities enable us to significantly reduce our design, development and production costs and pass these savings along to our customers in our sales price. These similarities also reduce the development time of our aircraft.

Strategic Risk-Sharing Partners. With respect to our commercial and executive aircraft, we developed strategic relationships with key risk-sharing partners. These risk-sharing partners develop and manufacture significant portions of the systems and components of our aircraft and contribute their own funds to develop these systems and components, thereby reducing our development expenses. These risk-sharing partners also fund a portion of our development expenses through direct contributions of cash or materials. We believe that these strategic relationships enable us to lower our development expenses and risks, improve our operating efficiency, enhance the quality of our products and reduce the number of our suppliers, thereby providing us with flexibility of our production process.

Funded Development of Defense Products. Historically, development expenditures related to defense aircraft have been funded in large part by certain of our customers, which in this business segment includes the governments of different countries. These customers have had an important role in our engineering and industrial development. In addition, we use well-proven platforms developed for the commercial aviation segment as a solution for certain defense products. We also sell to other military forces the proven defense products developed for the air forces of certain countries.

Flexibility of Production to Meet Market Demands. We believe the flexibility of our production processes and our operating structure, including our risk-sharing partnerships, allow us to increase or decrease our production in response to market demand.

Experienced and Highly Skilled Workforce. Our employees are experienced and highly skilled. As of December 31, 2011, engineers comprised 25.1% of our workforce. Due to the high level of knowledge and skill of our employees, and our continuous training programs, we are able to efficiently pursue new programs and provide our customers with differentiated technical expertise and guidance.

Continued Focus on Customer Satisfaction and Services. We strongly believe that a long-term relationship with our customer base is essential to our growth strategy. Providing an appropriate services portfolio for different market segments and fleet ages is a key element of our customer focus and an important tool for maintaining long-term relationships with our customers and product competitiveness.

As the number of our aircraft in operation continues to grow, we have further increased our commitment to providing our customers with an appropriate level of after-sale support, including technical assistance, training, maintenance, spare parts and other related services. This is evidenced, for example, by the worldwide expansion of our customer support facilities and our service centers network. See “Item 4B.—Customer Support and Services.”

We offer our customers several facilities for aircraft maintenance, repair and overhaul services, or MROs, around the world. We own and operate eight service centers, located in the U.S., Portugal, Brazil and France. In

 

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addition, our customers can rely on more than 50 authorized third-party centers located worldwide to meet their maintenance needs. For further information on our support and services network, see “—Customer Support and Services.”

Business Strategies

With a view to continue growing our business and increasing our profitability, we intend to continue to offer our customers cost-effective, high quality, and reliable aircraft and services. The key elements of our strategy are the following:

Continuing to Market Our Commercial Aircraft. We are fully committed to continuing to market our ERJ 145 regional jet family and to aggressively market our mid-capacity aircraft, the EMBRAER 170/190 jet family. As of December 31, 2011, we had approximately 890 units of the ERJ 145 jet in commercial operation. We believe a significant market opportunity exists for the EMBRAER 170/190 jet family with regional airlines that are seeking to expand their fleet, as well as increase their penetration in higher density markets and add longer routes. We also believe that the EMBRAER 170/190 jet family will be popular with major low-cost airlines that are right-sizing their fleet in order to adjust capacity to meet demand in less dense routes. As of December 31, 2011, we were leaders in the 61-120 seat category in terms of number of aircraft sold. Additionally, we believe that our commercial aircraft will provide us with significant opportunities to increase our competitiveness by offering our customers a full range of jets in the 30-120 seat category.

Strengthening Our Position in the Executive Jet Market. We believe that the executive jet market provides us with significant growth opportunities. We expect to offer products in all categories of the executive jet market, from the entry-level to the ultra-large categories. We developed the Legacy 600, a super midsize jet, the Phenom 100, an entry-level jet, the Phenom 300, a light jet, and the Lineage 1000, an ultra-large jet, and are developing the Legacy 450 and the Legacy 500, executive jets in the mid-light and mid-size categories, respectively. In addition, in 2010 we made the first delivery of the Legacy 650, a large executive jet that is positioned in our executive jet portfolio between the Legacy 600 and the Lineage 1000. We have endeavored to understand and respond to market and customer needs, in an effort to continuously improve the product and customer support for our executive jets.

Continue to Pursue Market Niche Opportunities in the Defense and Security Market. We currently offer products for transportation, training, light-attack, intelligence, surveillance and reconnaissance. Since our products offer multi-mission capabilities at a competitive price and are designed to be operated in any environment at low operating costs, we believe our products meet the needs of governments in countering present threats which are a global concern, such as terrorism, drug dealing and weapon smuggling.

Continued Focus on Customer Satisfaction and Support. We believe that our focus on customer satisfaction is fundamental to our entrepreneurial success and our business strategy. Providing high quality customer support and services is a key element of our customer focus and it is critical to our ability to maintain long-term relationships with our customers and keep our products competitive in the market. As the number of our aircraft in operation continues to grow, and our executive aviation business expands, we have further increased our commitment to providing our customers with an appropriate level of after-sale support, including technical assistance, training, maintenance, spare parts and other related services. This is evidenced, for example, by the expansion of our customer support and services base.

We offer our customers several MROs around the world. We own and operate eight service centers, located in the U.S., Portugal, Brazil and France. In addition, our customers can rely on more than 50 authorized third-party centers located around the world to comply with their maintenance needs. For further information on our support and services network, see “—Customer Support and Services.”

Continue to Motivate Our Employees and Improve Our Production Processes and Managerial Practices. We are constantly seeking to exceed our customers’ expectations. In order to achieve this goal, we must, on a daily basis, continuously seek to implement the most efficient production processes and best managerial practices. Because the success of our products and services is ultimately a combination of the contribution of our employees and the production processes we have developed over the years, we recognize that we must continue to motivate our employees and refine our production processes. To that effect, we have implemented, and intend to further develop,

 

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corporate programs based on a “lean manufacturing” philosophy, such as the Embraer Enterprise Excellence Program, that are designed to strengthen our internal culture of excellence and improve the efficiency of our operations.

Commercial Aviation Business

We design, develop and manufacture a variety of commercial aircraft. Our commercial aviation business is our primary business, accounting for 64.0% of our revenue for the year ended December 31, 2011.

Products

We developed the ERJ 145, a 50-passenger twin jet-powered regional aircraft, introduced in 1996, to address the growing demand among regional airlines for medium-range, jet-powered aircraft. After less than two years of development, the ERJ 135, a 37-seat regional jet based on the ERJ 145, was introduced in July 1999. In addition, we developed the 44-seat ERJ 140 as part of the ERJ 145 regional jet family, which we began delivering in the second half of 2001. We believe that the ERJ 145 regional jet family provides the comfort, range and speed of a jet at costs comparable to turboprop aircraft. We are continuing to develop the EMBRAER 170/190 jet family, our 70-124 seat platform, to serve the trend in the commercial airline market toward larger, faster and longer range jets and to further diversify our strength in the jet market. We continue to analyze new aircraft demand in the jet market to determine potentially successful modifications to aircraft we already produce.

ERJ 145 Regional Jet Family

The ERJ 145 is a twin jet-powered regional aircraft accommodating up to 50 passengers. This jet was developed in response to the increasing demand from the regional airline industry for an aircraft that offered more speed, comfort and capacity than a turboprop. The ERJ 145 was certified by the Brazilian Aviation Authority in November 1996, the FAA in December 1996, the European aviation authority in May 1997, the Australian aviation authority in June 1998 and the Civil Aviation Administration of China, or CAAC, in December 2000. We began delivering the ERJ 145 in December 1996. In October 2007, we delivered our 1,000th ERJ 145 aircraft, manufactured by Harbin Embraer Aircraft Industry Co. Ltd. to the HNA Group.

The development of the ERJ 145 aircraft was partially based on the EMB 120 Brasília and has approximately 30% commonality in terms of parts and components with that aircraft, including the nose section and cabin. The ERJ 145 has a maximum cruising speed of Mach.78, or 450 knots, and a maximum fully loaded range of 1,060 nautical miles in its standard version. The ERJ 145 is equipped with engines built by Rolls-Royce Allison. These engines are designed to operate 10,000 flight hours between major overhauls and operate at a low fuel cost. In addition, the ERJ 145 is equipped with sophisticated flight instruments, such as engine-indication instruments, crew-alert systems and digital flight control systems produced by Honeywell.

The ERJ 145 is also available in a long-range, or LR, version, and, in response to customer requests, we have developed an extra-long-range, or XR, version of the aircraft. The ERJ 145 LR features a larger fuel tank, more powerful engines and greater range than the standard version. The ERJ 145 LR, which was certified by the Brazilian Aviation Authority, the FAA and the European aviation authority in 1998, and by the CAAC in November 2000, uses engines that deliver 15% more thrust, allowing the fully loaded aircraft to operate on routes of up to 1,550 nautical miles. The ERJ 145 XR features a new and updated turbofan engine, increased capacity fuel tanks and winglets. The ERJ 145 XR, which was certified by the Brazilian Aviation Authority in August 2002 and by the FAA in October 2002, offers reduced fuel consumption, a maximum, fully loaded range of 2,000 nautical miles and enhanced operational capabilities for hot weather and high altitudes. Deliveries of the ERJ 145 LR began in February 1998, and deliveries of the ERJ 145 XR began in October 2002.

The ERJ 135 is a 37-seat regional jet based on the same design as the ERJ 145 and is manufactured on the same production line. The ERJ 135 has approximately 96% commonality in terms of parts and components with the ERJ 145, resulting in reduced spare-parts requirements and permitting the utilization of the same ground support equipment for customers that use both aircraft. The ERJ 135 was certified by the Brazilian Aviation Authority in June 1999, by the FAA in July 1999 and by the European aviation authority in October 1999. Deliveries of the ERJ 135 began in July 1999.

 

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The ERJ 135 has a maximum operating speed of Mach.78, or 450 knots, and a maximum fully loaded range of 1,330 nautical miles in its standard version. The ERJ 135 uses the same engines, sophisticated flight instruments, digital flight control systems and body design as the ERJ 145. The ERJ 135’s fuselage is 11.6 feet shorter than the ERJ 145’s. The ERJ 135 is also available in a LR version, with maximum fully loaded range of l,700 nautical miles. The LR version received certification simultaneously with the standard version and began deliveries in August 1999.

We developed the ERJ 140 in response to customer requests. The ERJ 140 is a 44-seat regional jet based on the same design as the ERJ 135 and is manufactured on the same production line as the ERJ 145 and ERJ 135. The ERJ 140 has approximately 96% commonality with the ERJ 145 and ERJ 135, providing our customers with significant maintenance and operational benefits. The ERJ 140 was certified by the Brazilian Aviation Authority in June 2001 and by the FAA in July 2001. The ERJ 140 has a maximum fully loaded range of 1,230 nautical miles in its standard version. The ERJ 140 is available in LR version, with maximum fully loaded range of 1,630 nautical miles. We began delivering the ERJ 140 in August 2001.

The ERJ 145 regional jet family allows for standardized pilot certification and maintenance procedures.

EMBRAER 170/190 Jet Family

The EMBRAER 170/190 jet family provides our customers with a choice of four aircraft in the mid-capacity passenger range. The EMBRAER 170 is a 70-78 seat jet and the EMBRAER 175 is a 78-88 seat jet, while the EMBRAER 190 is a 98-114 seat jet and the EMBRAER 195 is a 108-124 seat jet.

The EMBRAER 170 was certified by the Brazilian Aviation Authority, the FAA, the Joint aviation authority of Europe (the former advisory organization that made certification recommendations to non-EU national authorities), or JAA, the EASA and the authority of Poland in February 2004, and deliveries of the EMBRAER 170 began in March 2004. The EMBRAER 175 was certified by the Brazilian Aviation Authority in December 2004, by the EASA in January 2005, by TCCA, the Canadian certification authority, in July 2005 and by the FAA in August 2006. The EMBRAER 190 was certified by the Brazilian Aviation Authority in August 2005, by the FAA in September 2005 and by the EASA in June 2006. The EMBRAER 195 was certified by the Brazilian Aviation Authority in June 2006, by the EASA in July 2006 and by the FAA in June 2007.

We designed the EMBRAER 170/190 jet family to maximize the benefits of commonality. Aircraft in the family share approximately 86% of the same components. The high level of commonality in this jet family lowered our development expenses and shortened our development period. We believe that this commonality leads to significant savings to our customers in the form of easier training, less expensive parts and maintenance and lower operational costs. Due to differences in size and weight, the EMBRAER 170/190 jet family does not share the same wing design. This new mid-capacity jet family has engines fixed under its main wings—a design intended to enhance power, improve fuel economy and minimize turnaround times. All of the aircraft models of this family are powered by engines manufactured by General Electric and contain state-of-the-art avionics manufactured by Honeywell.

The EMBRAER 170/190 jet family’s principal features are:

 

   

Performance. All four jets in the EMBRAER 170/190 jet family have a maximum cruising speed of Mach.82. The EMBRAER 170 and the EMBRAER 175 have maximum fully loaded ranges of 1,700 and 1,600 nautical miles, respectively, and each is available in the long-range version, with maximum fully loaded ranges of 2,100 and 2,000 nautical miles, respectively. The EMBRAER 190 and EMBRAER 195 have maximum fully loaded ranges of 1,700 and 1,500 nautical miles, respectively, and each is available in the long-range version with maximum fully loaded ranges of 2,400 and 2,200 nautical miles, respectively.

 

   

Ground servicing. The underwing engine design and the existence of four doors, two in the front and two in the back, provide for enhanced accessibility and efficiency of ground services.

 

   

Cabin and cargo space. We have enhanced passenger safety and comfort in the EMBRAER 170/190 jet family. The aircraft’s “double-bubble” design enables a four-abreast cabin, a wide aisle, greater interior space and headroom and a larger baggage compartment than the existing mid-capacity jets of our competitors, including those mid-capacity jets that are in the development stage.

 

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EMB 120 Brasília

The EMB 120 Brasília is a pressurized twin wing-mounted turboprop aircraft that accommodates up to 30 passengers. The EMB 120 Brasília was developed in response to the commercial airline industry’s demand for a high-speed and fuel-efficient 30-seat regional aircraft. The EMB 120 Brasília was certified by the FAA in May 1985 and by the Brazilian Aviation Authority in July 1985. Since its introduction in 1985 we have delivered 352 EMB 120 Brasílias for the regional market and six EMB 120 Brasílias for the defense and security market. We currently manufacture the EMB 120 Brasília only upon customer request.

Customers

We believe we have a diverse, global customer base, mainly in the commercial airline market in Europe, the Middle East, Africa, Asia (particularly China) and the Americas. Our major customers for commercial aircraft include some of the largest regional, low-cost and mainline airlines in the world. As of December 31, 2011, our largest customers, by firm orders, were Express Jet, American Eagle, JetBlue Airways, Flybe, US Airways, Republic Airlines, Azul, HNA Group, Lufthansa, Air Canada, Air Lease, GECAS, KLM, Virgin Australia and Regional (a subsidiary of Air France).

For a discussion of these significant customer relationships, see “Item 3D. Key Information—Risk Factors—Risks Relating to Embraer—We depend on key customers and key suppliers, the loss of any of which could harm our business.”

We generally sell our commercial aircraft pursuant to contracts with our customers on a fixed-price basis, adjusted by an escalation formula that reflects, in part, inflation in the United States. These contracts generally include an option for our customers to purchase additional aircraft for a fixed price option, subject to adjustment based on the same escalation formula. In addition, our contracts include a product support package to cover the entry into service of our aircraft, as well as a general warranty for such aircraft. Other provisions for specific aircraft performance and design requirements are negotiated with our customers. Finally, some of our contracts contain cancellation provisions and trade-in options and financial and residual value guarantees. See “Item 3D. Key Information—Risk Factors—Risks Relating to Embraer—Some of our aircraft sales may be subject to financial and residual value guarantees and trade-in options that may require us to make significant cash disbursements in the future” for a more detailed discussion of these provisions.

Sales and Marketing

Our current marketing strategy is based upon our assessment of the worldwide commercial airline market and our assessment of the current and future needs of our customers. We actively market our aircraft to international airlines and regional affiliates of major global airlines through our regional offices in the United States, Europe and Asia. Our success depends, to a significant extent, on our ability to discern our customers’ needs, including needs for customer service and product support, and to fill those needs in a timely and efficient manner while maintaining the high quality of our products. Our market and airline analysts focus on the long-term trends of the market, competitive analysis, product-enhancement planning and airline analysis. In terms of direct marketing to our customers, we rely heavily on the media, as well as participating in air shows and other cost-effective events that enhance customer awareness and brand recognition. We have regional sales offices in Le Bourget, France; Fort Lauderdale, Florida; Beijing, China; and Singapore.

Production, New Orders and Options

Prior to starting production or development of a new project, we secure letters of intent representing future orders for a significant number of aircraft. We typically begin taking orders and building a backlog two years before we begin producing a new aircraft model, aiming to receive a significant number of orders before we deliver the initial aircraft. Once an order is taken, we reserve a place for that order on the production line, ensuring that we will maintain production sufficient to meet demand. Once a place is reserved on the production line, we are able to give customers delivery dates for their orders.

 

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We include an order in backlog once we have received a firm commitment, represented by a signed contract. Our backlog excludes options and letters of intent for which definitive contracts have not been executed. For the sales of our commercial aircraft, we customarily receive a deposit upon signing of the purchase agreement and progress payments in the amount of 5% of the sales price of the aircraft 18 months before scheduled delivery, another 5% twelve months before scheduled delivery and another 5% six months before scheduled delivery. For the EMBRAER 170/190 jet family, we receive an additional 5% progress payment 24 months before scheduled delivery. We typically receive the remaining amount of the sales price upon delivery of the aircraft. The deposits and the progress payments are for the most part nonrefundable in the event orders are cancelled.

Our options generally provide our customers the right to purchase an aircraft in the future at a fixed price and on a specified delivery date, subject to escalation provisions, under a purchase agreement. Once a customer decides to exercise an option, we account for it as a firm order. Occasionally, we have extended the exercise date for our options and renegotiated the delivery schedule of firm orders, as well as allowed customers to convert their firm orders or options for one aircraft into firm orders or options for another aircraft within the same commercial aircraft family.

Competition

We generally face competition from major manufacturers in the international aircraft market. Each category of our products faces competition of a different nature and generally from different companies. Some of our competitors have greater financial, marketing and other resources than we do.

30-60–seat category

The main competitors of the ERJ 145 regional jet family are:

 

   

the CRJ-100/200/440 (in October 2005, Bombardier announced its plans to stop manufacturing the CRJ-100/200/440 aircraft);

 

   

the ATR-42, a 50-seat turboprop manufactured by ATR, a joint project of Italy’s Alenia Aeronautica and EADS; and

 

   

the Q-300, a 50-seat turboprop manufactured by Bombardier, the production of which Bombardier discontinued in May 2009.

Given the success of our regional jet family, the maturity of this market segment and the significant entry barriers in this segment, due mainly to the high development expenses of a new model and the extensive and time-consuming development cycle of a new jet, we believe that we are well-positioned to maintain our market share in the 30-60–seat category with our ERJ 145 regional jet family.

61-90–seat and 91-120–seat categories

We currently face our strongest competition in the 61-90– and 91-120–seat categories. We currently compete against the following aircraft in these categories:

 

   

ATR-72, a 64-seat turboprop produced by ATR;

 

   

Q-400, a 72-seat turboprop produced by Bombardier;

 

   

CRJ-700, CRJ-900 and CRJ-1000, 70-seat, 85-seat and 98-seat regional jets produced by Bombardier, respectively;

 

   

A318, a 100-plus-seat jet produced by Airbus;

 

   

737-600, a 100-plus-seat jet produced by Boeing; and

 

   

SSJ100, a 95-seat regional jet produced by Sukhoi.

 

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We expect new developments in this market segment from current and new competitors, including:

 

   

Bombardier’s CSeries jet launched in 2008, which seats 110 to 130 passengers, and is expected to enter into service by 2014;

 

   

COMAC’s ARJ21, a 90- to 105-seat regional jet, with the 90-seat version officially scheduled to enter into service in 2012; and

 

   

Mitsubishi Heavy Industries’ MRJ, a 75- to 92-seat regional jet launched in March 2008, which is expected to enter into service by 2015.

The key competitive factors in the markets in which we participate include design and technological strength, aircraft operational costs, price of aircraft, including financing costs, customer service and manufacturing efficiency. We believe that we will be able to compete favorably on the basis of our aircraft performance, efficiency, low operating costs, product development experience, global customer base, market acceptance, cabin design and aircraft price.

Defense and Security Business

In 2011, Embraer added capabilities and broadened the scope of its corporate unit dedicated to the defense and security market. The creation of the new Embraer defense and security unit is an important step towards consolidating Embraer as a key supplier of defense and security solutions for the Brazilian federal government, as well as other governments worldwide.

We conceive, design, develop, manufacture and support a wide range of integrated solutions for the defense and security market. Our products include training/light attack aircraft, aerial surveillance platforms, military transport aircraft, government transport aircraft and Command, Control, Communications, Computer, Intelligence, Surveillance and Reconnaissance systems, or C4ISR systems. We offer a complete portfolio of customer services, ranging from maintenance and material solutions to complete Contractor Logistic Support programs. As of December 31, 2011, we had sold more than 1,150 defense aircraft, including government transport aircraft, to more than 25 armed forces and operators worldwide. We are also the leading supplier of defense aircraft to the Brazilian Air Force based on the total number of aircraft in its fleet. Our defense and security business accounted for 14.7% of our revenue for the year ended December 31, 2011.

Products

C4ISR Systems

Embraer has developed three cost-effective, reliable and flexible special-mission aircraft based on the ERJ 145 regional aircraft platform: the EMB 145 Airborne Early Warning and Control, or AEW&C, the EMB 145 Multi Intel and the EMB 145 Maritime Patrol, or MP. Since its first delivery, a total of 15 such aircraft have been manufactured for the Brazilian, Mexican and Greek Air Forces.

We believe EMB 145 AEW&C is the most advanced and affordable Airborne Early Warning and Control aircraft available in the market. It combines Embraer’s reliable and cost-effective ERJ 145 regional airplane platform with a unique, high-performance, multi-mode active phased-array AEW radar, a powerful C4I system and a comprehensive set of support systems such as self-protection and communications, including data links. The EMB 145 AEW&C is operational in the Brazilian, Mexican and Greek Air Forces. In addition, in 2008 we executed a contract with the Indian Air Force to sell them three units of our EMB 145 AEW&C aircraft. In December 2011, Embraer performed the maiden flight of the first of three EMB 145 AEW&C aircraft ordered by the Indian government. The other two such aircraft are currently being assembled in compliance with the delivery schedule for this contract.

The EMB 145 Multi Intel, also known as the EMB 145 Remote Sensing/Airborne Ground Surveillance, or RS/AGS, aircraft is designed to accomplish electronic and reconnaissance missions. It features state-of-the-art sensors for Image Intelligence (IMINT), Signal Intelligence (SIGINT), and Measurement and Signature Intelligence (MASINT), and is capable of providing real-time imagery and signals intelligence over ground objectives. It is

 

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equipped with extensive sensor suites ranging from high-performance synthetic aperture radar to electro-optical sensors, and includes communications and electronic exploitation systems capable of gathering complete intelligence information. The EMB 145 Multi Intel is currently operational in the Brazilian Air Force.

The EMB 145 MP aircraft is designed to address coastal and blue-water threats. The EMB 145 MP is designed to carry out maritime patrol by using maritime and ground surveillance radar and electro-optical sensors, as well as dedicated communications and surveillance equipment. In the ASW configuration, the EMB 145 MP is designed to carry out anti-submarine warfare missions. The EMB 145 MP is operational in the Mexican Air Force.

Embraer also develops and integrates state-of-the-art C4ISR systems for defense customers that require accurate information on a real-time basis. Our C4ISR systems operate in all three of our EMB aircraft. The information provided by C4ISR systems seeks to give top defense organizations the capability to collect, process and disseminate an uninterrupted flow of accurate and timely data that enables them to make better decisions and act faster and more effectively. We believe that the entry of Embraer in the C4ISR systems sector is made possible by Embraer’s technical understanding of several key topics such as knowledge management, visualization technologies, decision-making tools and concept-development methodologies. One practical example of Embraer’s contributions to the CS4ISR field is the definition and development of a datalink protocol delivered to the Brazilian Air Force in 2009.

Training and Light Attack – Super Tucano

The Super Tucano, designated as A-29 by the Brazilian Air Force, is a single-engine, multipurpose, military turboprop that combines effective training and operational capabilities with low acquisition and operating costs. It is an evolution of the EMB-312 Tucano, a prior trainer aircraft with a proven track record, of which 620 units were sold to 15 air forces around the world.

It offers solutions for basic to advanced weapons training, such as in-flight virtual training. It also offers operational capabilities required for border surveillance, close air support operations and counterinsurgency (COIN), missions. It offers avionics comparable to those of fourth generation fighter jets, ejection seats, an onboard oxygen-generating system and outstanding external load capability.

The Super Tucano is used for advanced pilot training and for surveillance operations in the Amazon region of Brazil in connection with the Brazilian federal government’s Sistema de Vigilância da Amazônia – SIVAM (System for the Surveillance of the Amazon) program.

The Super Tucano is still one of the highlights of our defense and security business unit due to its versatility, its excellent performance for training and operational missions and its competitive pricing, together with its low operating and maintenance costs. The Super Tucano currently has 182 firm orders, out of which 158 aircraft have already been delivered.

Throughout 2011, eight Super Tucanos were delivered, two to the Brazilian Air Force, three to the Ecuadorian Air Force and three to an undisclosed customer. In 2011, we delivered the 91st unit out of the 99 Super Tucano backlog to the Brazilian Air Force. We also completed deliveries of 18 units purchased by the Ecuadorian Air Force. In 2011, we had an outstanding contract with the Indonesian Air Force for eight Super Tucano aircraft. This sale represents the entry of the Super Tucano in the Asia Pacific market. Also in 2011, a contract to supply two Super Tucanos was signed with a new client. These aircraft are scheduled for delivery in 2012.

Military Transport – KC-390

In April 2009, Embraer signed the KC-390 development contract with the Brazilian Air Force. This new jet will meet the needs of the Brazilian Air Force, and will be in compliance with the new National Defense Strategy. The first flight of the KC-390 prototype is expected to occur in 2014, and initial deliveries are expected for 2016. Development expenditures associated with the KC-390 will be borne by the Brazilian Air Force.

The KC-390 development program is ongoing and on schedule. In 2011, the key suppliers and partners were selected to supply important systems, such as DRS training & control systems and the cargo handling & control system. These key suppliers and partners includes:

 

   

ELEB, an Embraer industrial unit, which will develop and manufacture the landing gear;

 

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Aero Vodochody, which will supply the rear fuselage II section and crew and parachutist doors, among other parts;

 

   

FAdeA, which will manufacture aerostructure parts;

 

   

AEL, which will supply the mission computer, Head-Up Display and other systems;

 

   

Rockwell Collins, which will supply the avionics systems;

 

   

Liebherr Aerospace, which will supply the environmental and cabin pressure control systems;

 

   

the multinational consortium IAE, which will supply the engines; and

 

   

Esterline Control Systems, which will supply the autothrottle system, among others parts.

Following the selection of suppliers described above, the Brazilian company, AEL Sistemas, was selected to supply three more components to the KC-390 jet: the Self-Protection System (SPS); the Directed Infrared Countermeasures (DIRCM); and the Head-Up Display (HUD). Embraer Defense and Security signed a partnership contract with our subsidiary OGMA – Indústria Aeronáutica de Portugal and the Portuguese company EEA – Empresa de Engenharia Aeronáutica. According to this agreement EEA will develop the engineering project for the KC-390’s components, which will be manufactured by OGMA.

The KC-390 program already has 52 purchase intentions: 28 aircraft for the Brazilian Air Force, 12 for the Colombian Air Force, six for the Chilean Air Force, two for the Argentinean Air Force, two for the Portuguese Air Force and two for the Air Force of the Czech Republic.

This jet will have a cargo bay equipped with an aft ramp to transport a wide variety of cargo, including armored vehicles, and will be equipped with the most modern systems for handling and launching cargos.

The KC-390 can be refueled in flight and can be used for in-flight or on-ground refueling of other aircraft. The cargo bay will allow configurations for Medical Evacuation (MEDEVAC) missions. The technical advances of the KC-390 include fly-by-wire technology, which lessens pilots’ work load by optimizing mission results and increasing safety and the capability for operating on short and rustic runways.

Government Transport Aircraft

We are marketing our wide line of commercial and executive jets, as well as derivatives of these airplanes, to defense customers. For example, in 2008, we delivered one Legacy 600 to the Ecuadorian government and in 2009 we delivered two modified versions of the EMBRAER 190 commercial aircraft to the Brazilian Air Force to serve as the presidential aircraft. These aircraft have a spacious and comfortable cabin, including space for meetings and a private area for the Brazilian president. In 2009, Embraer also delivered two ERJ 135s to the Thai Armed Forces for VIP transport and four Phenom 100s to the Pakistani Air Force. In 2010, two other aircraft for the transportation of authorities were delivered: an ERJ 135 to the Thai Navy and a Legacy 600 to the government of Panama.

In addition to these governments, our base of customers operating Embraer jets for the transportation of authorities includes Belgium, Greece, Colombia, Angola, Nigeria and India.

Modernization Programs

We offer military aircraft modernization services and we currently have three ongoing programs contracted with the Brazilian Air Force and Brazilian Navy. The first program, known as F-5BR and signed in 2000, is focused on performing structural and electronics upgrades for 46 F-5 fighter jets. As the prime contractor, we are responsible for integrating the multi-mode radar, the advanced navigation and attack systems, and the enhanced self-protection systems into the existing aircraft platform. In 2011, four modernized F-5 fighter jets were delivered, with three

 

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remaining aircraft to be delivered in 2012. In continuation of this contract, in the beginning of 2011 we signed a contract with the Brazilian Air Force to modernize 11 additional F-5 fighters jets and to supply one more flight simulator for these fighters. The first delivery of this second group of upgraded jets is scheduled for 2013.

The second program with the Brazilian Air Force, known as the A-1M modernization program, focuses on modernizing the AMX. The goal of this modernization project is to keep the fleet of 43 AMX jets on active duty for another 20 years. By the end of 2011, ten AMX jets were already at our facilities to start revitalization activities and subsequent modernization for this third program. The deliveries will begin in 2013.

The third modernization program is to upgrade 12 A-4 Skyhawk (AF-1 Brazilian Navy Designation) aircraft of the Brazilian Navy with a view to incorporating new technology for these aircraft, including new avionics, radars, power production and autonomous oxygen generating systems. We reached an important milestone at the end of 2011 with the completion of the project configuration phase. The deliveries will begin in 2013.

Defense Customer Support and Services

Our defense and security customer service portfolio involves Material Support, Training, Field Support, Technical Support and MRO–Maintenance, Repair and Overhaul.

Our Customer Support and Services department provide the support and services required by our customers for aircraft operational success, ensuring readiness and sustained mission capability. The provision of world-class support and services to our customers is essential to our business strategy and the maintenance of enduring relationships with customers.

In 2011, our sales efforts resulted in new services contracts for the air forces of Brazil, Mexico, Colombia, Peru, Argentina, Thailand and other government operators from Ecuador, Panama, Colombia and Equatorial Guinea. These services included supplies, repairs, technical assistance, training, technical publications, aircraft upgrades and supply chain management.

Competition

Our military aircraft face rigorous competition from various manufacturers from different countries in each market segment.

The Super Tucano competes in the basic/advanced training market with the Pilatus PC-9M (basic) and the PC-21 (advanced) aircraft from Switzerland, the Beechcraft T-6A/B (basic/advanced) from the U.S., and the Korea Aerospace Industries’ KT-1 (basic). In the Light Attack market, the Super Tucano competes with the Beechcraft AT-6 and Korea Aerospace Industries’ KO-1.

In the special mission aircraft market, which includes Airborne Early Warning & Control, Remote Sensing, Airborne Ground Surveillance, Maritime Patrol, Anti-Surface Warfare and Multi-mission Aircraft, there are several platforms with a wide range of sensor combinations that compete with our products: the Bombardier Global Express, Boeing 737, Northrop Grumman E-2C/D Hawkeye, Gulfstream G550, SAAB 2000, Alenia ATR 42 and 72, EADS CASA CN-235 and C-295, and the Bombardier Dash 8, among others.

In the military transport segment, our competitors include the Lockheed Martin C-130, the Airbus A400M, the Alenia C-27J and the CASA C-295.

Executive Aviation Business

We developed a line of executive jets: the Legacy 600, a super midsize jet, followed by the Phenom 100, an entry-level jet and the Phenom 300, a light jet. The Lineage 1000, an ultra-large jet, was added as the largest executive jet in our executive jet portfolio and, during 2008, we launched the Legacy 450 and Legacy 500, a mid-light and a mid-size jet, respectively, that we believe will establish our executive jet portfolio as one of the most comprehensive in the executive aviation industry. The Legacy 450 and 500 development program continues on track, with more than 650 employees fully engaged in these projects, and in December, 2011, we performed the roll-out of the Legacy 500 from our production hangar at the São José dos Campos headquarters, in Brazil. This milestone allowed development and test engineers to perform important ground tests prior to the aircraft’s first flight,

 

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scheduled for the third quarter of 2012. In 2009, we presented the new Legacy 650, a large executive jet that will be positioned in our executive jet portfolio between the Legacy 600 and the Lineage 1000. In 2010, the Legacy 650 received its certification and began operating in November 2010.

We are marketing our executive jets to companies, including fractional ownership companies, charter companies and high-net-worth individuals. Our executive aviation segment accounted for 19.2% of our revenue for the year ended December 31, 2011, resulting from the delivery of 13 Legacy 600/650 jets, 41 Phenom 100 jets, 42 Phenom 300 jets and 3 Lineage 1000. On December 31, 2011, our firm orders in backlog for our executive jets totaled US$4.47 billion.

In May 2005, we launched the Phenom 100 and Phenom 300, which are executive jets in the entry-level and light jet categories, respectively. The Phenom 100 carries from six to eight people and is powered by Pratt & Whitney Canada’s PW617F engines. It has entered into service in the second half of 2008. The Phenom 300 carries up to nine people and has a larger fuselage and wingspan and longer range than the Phenom 100. It is powered by Pratt & Whitney Canada’s PW535E engines and has entered into service in the second half of 2009. Pratt & Whitney Canada, Garmin and Eaton were our risk-sharing partners for this program.

In May 2006, we launched the Lineage 1000, an ultra-large executive jet based on the EMBRAER 190 commercial jet platform. The Lineage 1000 is configured to accommodate up to 19 people in a total cabin volume of 4,085 cubic feet (115.7 cubic meters), and is powered by GE CF34-10E7 engines. The Lineage 1000 entered into service in the first half of 2009.

In April 2008, we formally launched two new programs in the medium jet categories, namely the mid-light Legacy 450 jet, with a 2,300 nautical mile range, and the mid-size Legacy 500 jet, with a 3,000 nautical mile range. Both programs were approved by our Board of Directors in March 2008. The Legacy 450/500 jets are positioned in our executive jets portfolio between the Phenom 300 and the Legacy 600/650.

In October 2009, we presented the new Legacy 650 jet at the 62nd Annual Meeting and Convention of the National Business Aviation Association, in Orlando, Florida. The Legacy 650 is a large category jet based on the successful platform of the super midsize Legacy 600 and will have a longer range for up to 14 passengers. The Legacy 650 may fly up to 3,900 nautical miles nonstop with four passengers or 3,800 nautical miles with eight passengers, that is approximately 500 nautical miles more than the Legacy 600’s range.

The competitors of the Legacy 600 and the Legacy 650 include aircraft produced by Dassault Aviation, Bombardier, Gulfstream and Hawker Beechcraft. Phenom 100 and Phenom 300 competitors in the entry-level and light jet categories include Cessna Aircraft Co. and Hawker. Boeing and Airbus are the main competitors for the Lineage 1000 ultra-large jet.

We include an executive jet order in backlog once we have received a firm commitment, represented by a signed contract and the customer. We customarily receive a deposit at the time of order and progress payments totaling 15% to 30% of the aircraft price; the full payment of the balance is due upon delivery.

Aviation Services Business

We provide after-sales customer support and services for the fleet of our commercial, executive and defense customers. Activities in this segment include sales, inventory pooling programs, MRO services, customer training and other product support services. Revenues for the aviation services segment accounted for 11.3% of our revenue for the year ended December 31, 2011.

This business is expected to continue to grow as the number of our aircraft in service increases. Our customers require aircraft manufacturers and their suppliers to maintain adequate spare parts and ground support equipment inventories for a period of ten years after the production of the last aircraft of the same type, or until fewer than five aircraft are operated in scheduled commercial air transport service. We also established pooling programs that allows customers to exchange used parts for new or refurbished parts, such as our POOL – Flight Hour Program (for commercial aviation customers), and total support programs like our EEC – Embraer Executive Care, a total care program that includes parts exchange and complete service and maintenance packages.

 

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We expect to enhance customer support and services offered to the executive aviation segment. In this respect, we have added four wholly-owned service centers since 2007, and are revamping the authorized service center network for executive jets. At the end of 2011, we had 59 service centers to support our executive jet fleet. In 2006, we entered into an agreement with CAE to form a global training joint venture, to provide comprehensive pilot and ground crew training to customers of the Phenom 100 entry-level jet and Phenom 300 light jet aircraft. The initial training program has started to be offered at CAE SimuFlite in Dallas, Texas, as the Phenom 100 started to operate in 2008, and has expanded to Burgess Hill in the U.K. in 2009. This joint venture provides entitlement training and post-entitlement training for pilots, maintenance technicians and dispatch personnel. We also plan to continue to invest in parts inventory and logistics worldwide as our executive aircraft fleet continues to grow. In 2010, we expanded our support and services package to the Phenom 300 and the new Legacy 650, and also plan to offer our services in new regions, particularly in Asia. In 2011, we expanded our support and services package to the Legacy 600/650 and Lineage into China.

Other Related Businesses

We provide structural parts and mechanical and hydraulic systems to Sikorsky Corporation for its production of helicopters. We also manufacture, on a limited basis and upon customer request, general aviation propeller aircraft, such as executive planes and crop dusters, also known as light aircraft. Our other related businesses accounted for 2.1% of our revenue for the year ended December 31, 2011.

Subcontracting

We provide subcontracting services to Sikorsky Corporation in connection with the development and manufacture of the landing gear, fuel system and fuel tanks for the S-92 Helibus helicopter. We also act as a risk-sharing partner to Sikorsky. These contracts expire in 2015.

General Aviation Aircraft

We build general aviation propeller aircraft. These aircraft include a six-passenger aircraft that is produced only on demand for use by corporations and by air-taxi companies. We have delivered a total of 2,326 of these aircraft, and the last delivery of this type of aircraft was in 2000. We also developed a crop duster aircraft pursuant to specifications of the Brazilian Ministry of Agriculture. These aircraft are produced only on demand. Through December 31, 2011, we had delivered a total of 1,169 of these aircraft, including 54 in 2011.

Aircraft Operating Lease Activities

In order to provide better financial support to our commercial activities, as well as to manage and reduce financial risks related to the marketing of aircraft, we created, in September 2002, two wholly-owned subsidiaries: ECC Leasing and ECC-Insurance & Financial Co. Ltd.

The mission of ECC Leasing is to manage and remarket Embraer’s aircraft portfolio, which as a result of contractual obligations, may be acquired by us as trade-in transactions. We also provide re-marketing services to third parties looking to sell their Embraer manufactured aircraft.

The consolidated pre-owned aircraft business, through ECC Leasing in Ireland, has contributed accumulated net income of US$15.8 million from its inception, through December 31, 2011. We have successfully completed sales campaigns for new aircraft, where the acceptance of trade-in aircraft as part of payment were accepted. We have also generated additional revenues through the sale and lease of aircraft received as trade-ins. Furthermore, leasing operations involving EMBRAER170, EMBRAER175 and EMBRAER 190 pre-series aircraft, contributed to the current results. Since its establishment in 2002, ECC Leasing and one other Embraer wholly-owned subsidiary managed a portfolio composed of 118 aircraft, of which 25 are under operating leases, 17 are available or under lease/sale negotiations, seven are performing flight tests at Embraer, and 69 were sold to airlines, corporations and government entities in North America, South America, Asia and Europe. The 25 Citation Ultra acquired by ECC Leasing in 2010 as a result of trade-in options under an agreement executed with NetJets Inc. were sold in the second quarter of 2011.

 

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All sale and leasing transactions were executed based on market rates, thereby helping to sustain the present and future values of our products. In addition, we continue to actively work with third parties to facilitate the placement of their aircraft.

The continued improvement in financial performance is directly related to ECC Leasing’s ability to re-market aircraft in its existing portfolio with similar conditions as those currently in place, as well as to sell aircraft to operators, leasing companies and/or financial institutions, at values close to market rates and without any guarantee from Embraer.

Furthermore, we believe the results of ECC Leasing and ECC-Insurance & Financial Co. Ltd will be largely dependent on market conditions, aircraft availability levels and the demand for regional jets in the 37- to 50-seat category. Although new markets such as Eastern Europe and Latin America are important, the risks related to operator’s credit and asset repossession will continue to require an adequate financial evaluation by Embraer.

As more pre-owned aircraft begin to trade in the market, Embraer and ECC Leasing have created the “Embraer Lifetime Programme” to better support our customers. The program will allow customers to select from a wide array of services, including, among other things, training, spare parts, technical support, engine programs, technical representation, maintenance and overhaul coverage. Customers who opt into this program will pay us periodic fees, so that we can provide them with scheduled and unscheduled maintenance, support and repair services, among other things. The program will allow us to continuously improve the level of support we offer to our pre-owned aircraft customers. We believe this program represents an innovative approach, which offers our customers an attractive combination of pre-owned aircraft backed by Embraer’s comprehensive support package.

Markets

The following table sets forth our revenue by line of business and geographic region of the end users of our aircraft for the periods indicated:

 

     Year ended December 31,  
     2011      2010
(reclassified)
     2009
(reclassified)
 
     (in US$ millions)  

Commercial Aviation

        

North America

     705.5         347.3         796.8   

Latin America (except Brazil)

     540.2         426.7         157.9 (1) 

Asia Pacific

     1,049.9         773.4         815.8   

Brazil

     277.6         230.0         282.8   

Europe

     1,012.5         1,374.1         1,463.8   

Others

     128.4         106.4         268.6   
  

 

 

    

 

 

    

 

 

 

Total

     3,714.1         3,257.9         3,785.7   
  

 

 

    

 

 

    

 

 

 

Executive Aviation

        

North America

     359.6         293.6         326.0   

Latin America (except Brazil)

     83.9         123.5         47.7   

Asia Pacific

     155.0         294.7         240.7   

Brazil

     206.8         211.5         80.8   

Europe

     281.0         241.2         186.9   

Others

     27.4         45.0         54.8   
  

 

 

    

 

 

    

 

 

 

Total

     1,113.7         1,209.5         936.9   
  

 

 

    

 

 

    

 

 

 

Defense and Security

        

North America

     27.6         24.1         14.3   

Latin America (except Brazil)

     15.5         276.9         185.3   

Asia Pacific

     145.2         123.0         78.6   

Brazil

     458.2         221.9         216.2   

 

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     Year ended December 31,  
     2011      2010
(reclassified)
     2009
(reclassified)
 
     (in US$ millions)  

Europe

     175.9         129.7         158.2   

Others

     29.5         46.2         25.2   
  

 

 

    

 

 

    

 

 

 

Total

     851.9         821.8         677.8   
  

 

 

    

 

 

    

 

 

 

Other Related Businesses

        

North America

     93.5         52.9         43.9   

Latin America (except Brazil)

     0.1         0.3         0.6   

Asia Pacific

     0.6         2.5         17.2   

Brazil

     27.7         17.1         10.2   

Europe

     1.3         1.6         21.7   

Others

     0.1         0.5         3.8   
  

 

 

    

 

 

    

 

 

 

Total

     123.3         74.9         97.4   
  

 

 

    

 

 

    

 

 

 

 

(1) Includes deliveries to Azul.

Suppliers and Components; Risk-Sharing Arrangements

We do not manufacture all of the parts and components used in the production of our aircraft. More than 80% of the production costs of our aircraft consist of materials and equipment purchased from our risk-sharing partners and other major suppliers. Risk-sharing arrangements with suppliers of key components enable us to focus on our core business: design, development, manufacture and sale of aircraft and systems for the commercial aviation, executive aviation, and defense and security segments. Risk-sharing arrangements are those in which suppliers are responsible for the design, development and manufacture of major components or systems of our aircraft, such as wings, tail or fuselage. Our risk-sharing partners, therefore, must invest their own money in development and share the risk and success of our products with us.

In our commercial and executive aviation businesses, we rely on risk-sharing partners to supply vital components of our aircraft, such as the engines, hydraulic components, avionics, interior and parts of the fuselage and portions of the tail. We select suppliers on the basis of, among other factors, technical performance and quality of their products, production capacity, prior relationship and financial condition. We have had continuing relationships with most of our major suppliers since production of the Bandeirante aircraft began in 1975.

In addition, we have entered into purchase agreements with our major suppliers, which cover our requirements for five to ten years of production. These contracts contain pricing formulas that take into consideration the various factors that affect the business of our suppliers, and help us mitigate the effects of price volatility (which in some cases can be significant) of the materials, parts and components that are required for our operating activities. We are not obligated to purchase a minimum amount of materials annually under any of these supply contracts. Our ongoing supplier relationships depend on cooperation, performance and the maintenance of competitive pricing. Once we select our risk-sharing partners, and program development and aircraft production begins, it is difficult to substitute these partners. In some cases, our aircraft are designed specifically to accommodate a particular component, such as the engines, which cannot be substituted by another manufacturer without significant delay and expense. This dependence makes us susceptible to the performance, quality and financial condition of these risk-sharing partners. See “Item 3D. Key Information—Risk Factors—Risks Relating to Embraer—We depend on key customers and key suppliers, the loss of any of which could harm our business.”

ERJ 145 Regional Jet Family

Risk-sharing partners. We entered into risk-sharing arrangements with the following four suppliers in connection with the development and production of the ERJ 145 regional jet family:

 

   

Aernnova Aerospace S.A., or Aernnova, a Spanish company owned by Iberdrola S.A., a European power utility, and Banco Bilbao Vizcaya, a large Spanish financial institution, supplies the wings, engine nacelles and main landing-gear doors;

 

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Sonaca S.A.—Société Nationale de Constructions Aerospatiales, a Belgian company, supplies portions of the central and rear fuselages, the service, main and baggage doors and engine pylons;

 

   

ENAER—Empresa Nacional de Aeronáutica, a Chilean company, supplies the vertical fin, horizontal stabilizers and elevators; and

 

   

C&D Aerospace, Inc., a U.S. company, supplies the cabin and cargo compartment interiors.

Our risk-sharing partners generally receive payment for supplied components within three to five months after delivery of the components to us. The partnering relationship with these suppliers results in lower production costs and higher product quality for the ERJ 145 regional jet family. In addition, our line of executive jets benefits from the risk-sharing arrangements with Aernnova, Sonaca and ENAER. The interior of the Legacy 600 executive jet is provided by The Nordam Group, Inc., Duncan Aviation Inc. and us.

Other major suppliers. We have also entered into other agreements with numerous European, American, Canadian and Brazilian suppliers to provide key components for a number of our products, including the ERJ 145 regional jet family. These supply arrangements cover systems and components such as engines, avionics, landing gear and flight control systems. Our major suppliers include, among other companies, Rolls-Royce Allison, Parker Hannifin Corp., or Parker, BF Goodrich Co., United Technologies Corp. – Hamilton Sundstrand Division, Honeywell, Rosemount Aerospace and Alcoa Inc.

EMBRAER 170/190 Jet Family

We are continuing to improve the EMBRAER 170/190 jet family, together with risk-sharing partners that supply key systems for the aircraft. Our supplier arrangements for the EMBRAER 170/190 jet family differ from the ERJ 145 regional jet family in that we use fewer suppliers. In the EMBRAER 170/190 jet family, each risk-sharing partner is responsible for the development and production of aircraft systems, such as the landing gear, the hydraulic system and the flight control system, rather than individual components, and fewer components are supplied by companies that are not risk-sharing partners. The assumption of responsibility for systems by our risk-sharing partners lowers our capital expenditures, which thereby decreases our development risks and increases our operating efficiency by reducing the number of suppliers per product and cutting production costs. It also shortens development and production time. The primary risk-sharing partners for the EMBRAER 170/190 jet family are the following:

 

   

General Electric, which supplies CF34-8E/l0E turbofan engines, and designs, develops and manufactures the engine nacelles;

 

   

Honeywell, which supplies the avionics systems;

 

   

Liebherr, which is responsible for designing, developing and manufacturing the landing gear assemblies;

 

   

Hamilton Sundstrand, a U.S. company and a wholly-owned subsidiary of United Technologies Corp., which develops and produces the aircraft’s tail core, auxiliary power unit, electrical systems and the air management system;

 

   

Sonaca, which is responsible for the aircraft’s wing slats;

 

   

Aernnova, which is responsible for the rear fuselage and the vertical and horizontal tail surfaces;

 

   

Latecoere, a French company, which manufactures two of the three fuselage sections;

 

   

C&D Aerospace, which designs, develops and manufactures the aircraft interior; and

 

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Grimes Aerospace Company, a U.S. company and a wholly-owned subsidiary of AlliedSignal Inc., which develops and manufactures the exterior and cockpit lighting.

In addition, some of the risk-sharing partners for the EMBRAER 170/190 jet family have assumed a broader role in other aspects of the program by providing sales financing and residual guarantees, rather than simply supplying us with aircraft components.

To prepare for the expected production increase for the EMBRAER 190 and EMBRAER 195 aircraft, on June 1, 2006 we entered into an agreement with KHI and KAB, under which they transferred to us assets required for the final assembly of the wings of the EMBRAER 190 and EMBRAER 195 aircraft and paid us compensation of US$57 million. As a result, we began assembling the wings of the EMBRAER 190 and EMBRAER 195 aircraft. KHI will continue producing the wing control surfaces and the main landing gear doors for these aircraft. However, our agreement with KHI and KAB does not cover the production of parts for the EMBRAER 170 and EMBRAER 175 aircraft.

Executive Jets

The risk-sharing partners for the Legacy 600 and the Lineage 1000 are the same as those for our ERJ 145 jet family and EMBRAER 170/190 jet family, respectively. The main risk-sharing partners for the Legacy 450/500 jet family are the BMW Group, Honeywell, Rockwell Collins, Héroux-Devtek, Goodrich, B/E Aerospace and Parker, and the main risk-sharing partners for the Legacy 650 include Rolls-Royce and Honeywell. The risk-sharing partners for the Phenom 100 and Phenom 300 jets are Pratt & Whitney Canada, the supplier of the engines, Garmin, the supplier of the avionic systems, and Eaton Corporation, the supplier of hydraulic systems.

Cash contributions for the development of the EMBRAER 170/190 jet family and our Phenom 100 and Phenom 300 aircraft

We have arrangements with our risk-sharing partners pursuant to which they have contributed to us, in cash, a total of US$652.4 million through December 31, 2011. Cash contributions become nonrefundable upon the fulfillment of certain developmental milestones. The amount of US$651.4 million of these cash contributions had become nonrefundable through December 31, 2011. If we cancel the production of the Phenom 100/300 family or any aircraft in the EMBRAER 170/190 family, or if we cancel the development of the Legacy 450/500 family, because we are unable to obtain certification or for other non-market related reasons, we may be obligated to refund US$1.0 million of the total cash contributions already received. The Phenom 100 and the Phenom 300 were certified in 2008 and 2009, respectively. The Legacy 500 executive jet is expected to enter into service in late 2013 and the Legacy 450 is expected to enter service one year after the Legacy 500. We generally do not need to refund these contributions as a result of insufficient market demand. We believe that these financial commitments are a strong endorsement of our aircraft design and our ability to execute our business plan.

Customer Support and Services

Customer satisfaction is critical to our success. Our goal is to best serve our customers and, with this goal in mind, we are constantly seeking to support our customers and develop services for the enhancement of airline operations, the optimization of operating costs and the maximization of aircraft availability.

We are working on further developing our portfolio of services for Commercial Aviation customers, which comprises the following areas:

 

   

Field Support, which provides conveniently accessible team assistance for all operational and technical issues in order to maximize customer performance;

 

   

Technical Support, which serves technical needs through analytics, engineering expertise, and real-time fleet monitoring;

 

   

Flight Operations, which supports the efficiency and safety of airline operations through tailored solutions, consulting, supervision, and training resources;

 

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Aircraft Modification, which provides total execution and coordination of system upgrades for improved fleet performance and cabin modifications for enhanced onboard amenities;

 

   

Materials, which ensures availability and economy in parts and materials management for both scheduled and unscheduled maintenance;

 

   

Maintenance, which provides optimized maintenance solutions based on best practices for efficiency, safety, and effectiveness;

 

   

Training, which prepares crew, maintenance technicians, and operations personnel for the highest levels of competence; and

 

   

eSolutions, which deploys the internet as the core communication channel for 24/7 collaboration and information exchange.

We have a worldwide presence, with five regional units strategically positioned around the globe in order to provide us with greater agility in understanding the needs and desires of our customers, respecting the cultural diversity of the different regions where our customers are based. Our regional units are located as follows:

 

   

Fort Lauderdale, Florida, which supports our customers in North America;

 

   

Villepinte, France, which supports our customers in Europe, Africa and the Middle East;

 

   

Singapore, which supports our customers in the Asia Pacific region;

 

   

Beijing, China, which supports our customers in China; and

 

   

São José dos Campos, Brazil, which supports our customers in Latin America.

All units mentioned above have the following infrastructure:

 

   

a spare parts distribution center;

 

   

technical and material field support teams with field engineers and customer account managers;

 

   

warranty and repair administration offices; and

 

   

services sales managers.

Our headquarters in São José dos Campos also offers the following services:

 

   

spare parts customer response center available 24 hours a day, seven days a week;

 

   

spare parts planning and material engineering;

 

   

technical support, known as the Embraer Fleet Technical Center available 24 hours a day, seven days a week;

 

   

flight operations support;

 

   

maintenance support engineering;

 

   

business development;

 

   

technical publications development; and

 

   

other customer maintenance training (such as a mechanic training program offered through major training providers worldwide).

 

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In addition, we also have spare parts distribution centers in Louisville, Kentucky and Dubai, UAE.

Beyond parts fulfillment and simple rental plans, we also provide innovative programs for material planning, logistics, and acquisitions, such as:

 

   

Fleet-Hour Pool Program;

 

   

Parts Consignment Program;

 

   

Embraer Collaborative Inventory Plan (ECIP);

 

   

Embraer Parts Exchange Program (EPEP);

 

   

Customer Stock Optimization;

We also own and operate MRO facilities to support commercial aviation customers around the world, including in:

 

   

Nashville, Tennessee, where we have a Embraer Aircraft Maintenance Services (EAMS);

 

   

Alverca, Portugal, that we refer to as OGMA, which we began to operate in March 2005;

 

   

Gavião Peixoto, in the State of São Paulo, Brazil, where we have a dedicated service center for defense customers;

 

   

São José dos Campos, in the State of São Paulo, Brazil;

 

   

Fort Lauderdale, Florida;

 

   

Mesa, Arizona;

 

   

Le Bourget, France; and

 

   

Bradley, Connecticut.

The first three of the above MROs render services to various types of aircraft, including executive aircraft, while the last four of the above MROs serve only the executive aircraft fleet.

Our authorized service center network is also expanding. At December 31, 2011 we had 59 authorized service centers worldwide for our executive jet fleet in operation.

The Embraer network of MROs is expanding with our recent additions of third-party centers that have been authorized by us for the support of the commercial aviation aircraft fleet. As of December 31, 2011, these centers are

 

   

TAP Maintenance & Engineering, in Porto Alegre, in the State of Rio Grande do Sul, Brazil;

 

   

FlyBe Aviation Services, in Exeter, United Kingdom;

 

   

Tianjin Airlines, in Tianjin, China;

 

   

National Airways Corporation, or NAC, in Johannesburg, South Africa;

 

   

REGIONAL – Compagnie Aérienne Européenne, in Clermont-Ferrand, France;

 

   

Atlantic Air Industries (AAI), in Toulouse, France, with a subsidiary in Casablanca, Morocco;

 

   

LOTAMS – LOT Aircraft Maintenance Services, in Warsaw, Poland;

 

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Egyptair Maintenance & Engineering, in Cairo, Egypt.

As of December 31, 2011, there were three other third-party owned MRO centers around the world currently undergoing our qualification process. We intend to continue providing our customers with high quality customer support by expanding our presence worldwide, both through our own operations and through agreements with established and reputable authorized service centers.

We constantly monitor customer satisfaction levels and keep open communication channels with them in order to understand customer needs and define the most appropriate actions for the continuous improvement of our customer support. To do so, we make use of the following tools and forums:

 

   

a full customer experience survey performed yearly for the executive jet customers, aimed at the development of action plans that will allow us to provide effective responses to our clients;

 

   

a customer satisfaction assessment performed bi-monthly, which aims to develop action plans to allow us to provide effective responses to our clients;

 

   

a customer support satisfaction survey performed every other year in order to identify the competitive position of EMBRAER;

 

   

specific action plans and commitments with each customer, known as Customer Integrated Action Plans;

 

   

teamwork and systematic identification and integrated action plans to solve problems affecting us, our suppliers and customers;

 

   

periodic dedicated meetings at the customer’s headquarters;

 

   

Embraer Operators’ Conferences that take place yearly in the various regions of the world where we have customer operators;

 

   

a maintenance cost workshop that occurs yearly, where operators share best maintenance practices and discuss cost reduction initiatives;

 

   

events organized by customers, including the Operators’ Maintenance Forum and the European Customer Community Conference;

 

   

interactive forums for discussions in the web portal FlyEmbraer, to foster the exchange of experiences among customers and Embraer; and

 

   

an internal program named ECE (Excellence in Customer Experience), aiming to address changes in the Services & Support area of Commercial Aviation division, in order to elevate Embraer’s commercial aviation business performance, covering contemporary and future market needs, with the purpose of obtaining the highest levels of customer experience in the commercial aviation industry.

Aircraft Financing Arrangements

We generally do not provide long-term financing directly to our customers. Instead, we assist our customers in obtaining financing arrangements from different sources, including capital providers such as leasing companies, commercial banks, capital markets and the BNDES’s FGE. In addition, we have been working together with customers to develop new sources of funds, especially from nontraditional financing sources. We are also looking for long-term relationships and expect to broaden the alternatives available to support our clients’ financing needs.

Airlines may sometimes require short-term bridge financing prior to arranging long-term debt financing because, for the airlines, a quick delivery of the aircraft may be crucial to access the markets, and long-term funding may not be available for them at the time of delivery. On a case-by-case basis, we have provided interim financing, at market rates, to customers who already have their financing arrangement structured or who are in the process of negotiating such arrangements.

 

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Although we foresee leasing companies and capital markets-related sources increasing their already-significant participation in aircraft financing in the coming years, we expect that export credit agencies will continue to play an important role in aircraft financing in 2012, helping fulfill the financing needs of the commercial aviation industry as a whole. The BNDES-exim Program of financing, which is sponsored by the Brazilian federal government, provides Embraer’s customers with direct financing on financial terms and conditions which comply with the Aircraft Sector Understanding of the OECD. In 2011, approximately 37% of our commercial aviation deliveries were supported by the BNDES-exim Program. Brazilian official support only accounted for 18% of the total deliveries for the EJets program since its launch in 2004.

In 2011, Embraer delivered two additional aircraft through the “Pure Cover” Brazilian Export Credit Line. With this custom-made structured transaction, the lender benefits from a 100% guarantee issued by the Secretary of Foreign Affairs (Secretaria de Assuntos Internacionais) of the Brazilian Ministry of Finance, through the Brazilian Export Credit Insurance Agency (Seguradora Brasileira de Crédito à Exportação S.A.), or SBCE, which manages the export credit guarantee system on behalf of the Brazilian federal government. This financing structure will further enhance the credit available to Embraer’s customers, since it increases access to international financing institutions, as well as to a broader range of capital markets investors.

See “Item 3D. Key Information—Risk Factors—Risks Relating to Embraer—A downturn in commercial aviation may reduce our sales and revenue, and, consequently, our profitability, in any given year” and “Item 3D. Key Information—Risk Factors—Risks Relating to Embraer—The Brazilian federal government may reduce amounts available to our customers under government-sponsored financing programs.”

Intellectual Property

Our intellectual property, which includes designs, trade secrets, know-how and trademarks, is important to our business. We hold trademarks over our name and symbol and the names of our aircraft, some of which are registered and some of which are in the process of registration in a number of countries, including Brazil, the United States, Canada, Singapore, Hong Kong, China, European Union and Japan. At December 31, 2011, we had more than 450 trademarks. Our trademarks are generally renewed at the end of their validity period, which usually runs from ten years from the date of application for registration. We do not believe that the loss of any of our trademarks would have a material impact on our business or results of operations.

We develop our intellectual property in our research, development and production process. Under the agreements we have with some of our suppliers and risk-sharing partners, they grant us access to information and technology necessary to better develop, manufacture and market our products.

We aim to protect our intellectual property rights resulting from investments in technical research and development and in the form of inventions, industrial design, brands or computer programs.

We hold patents relating to our manufacturing technology. Currently, we hold registered patents from the appropriate registries in Brazil, the United States, the European Union, Russia, Japan and China in connection with aircraft interior design. We require that our suppliers and risk-sharing partners respect the intellectual property rights of third parties, and we believe that we have the necessary intellectual property rights to conduct our business and operations.

Government Regulation and Aircraft Certification

We are subject to regulation by regulatory aviation agencies, both in Brazil and abroad. These agencies principally regulate the type design of aircraft and their manufacturing. Besides certification in Brazil, we must obtain certification in each jurisdiction in which our aircraft operate commercially. The competent authority for the certification of our aircraft in Brazil is the Agência Nacional de Aviação Civil (National Civil Aviation Agency), created in 2005 under the Ministry of Defense to regulate, supervise and certify aircraft, aircraft parts, manufacturers and operations. The aviation authorities in other countries include the FAA in the United States, and the EASA for the European Union. Some countries simply validate and complement original certification of the Brazilian Aviation

 

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Authority or of the FAA or the EASA, in accordance with their own rules. The Brazilian Aviation Authority has a bilateral certification agreement with the FAA and European Union, under which the FAA and the EASA certification requirements are covered by the Brazilian certification process. This cooperation among regulatory authorities leads to faster certification.

Once an aircraft is certified by the Brazilian Aviation Authority, and validated by the FAA and/or the EASA, some authorities, such as those in Australia and Mexico, may opt to ratify the product certification instead of running a full domestic validation process. Other countries, such as Canada, require compliance with their own specific national requirements before certification.

Aircraft certification is a continuous process. The Brazilian Aviation Authority must approve any change in the type design of any of our aircraft. Significant changes may require a separate validation/certification by other authorities as specified in their regulations and bilateral agreements. Changes in the aircraft certification requirements do not require recertification of an aircraft already certified, but significant safety improvements may be imposed by the authorities through operational rules or airworthiness directives.

The certification history of our aircraft is as follows:

 

   

The ERJ 145 was certified to operate in the United States and Brazil in the last quarter of 1996, Europe in the second quarter of 1997, Australia in June 1998 and, for the LR version, China in November 2000.

 

   

The ERJ 145 XR version was certified by the Brazilian Aviation Authority in August 2002 and the FAA in October 2002.

 

   

The ERJ 135 was certified by the Brazilian Aviation Authority in June 1999, the FAA in July 1999 and the European aviation authority in October 1999.

 

   

The ERJ 140 was certified by the Brazilian Aviation Authority in June 2001 and the FAA in July 2001.

 

   

The Legacy 600 executive jet was certified by the Brazilian Aviation Authority in December 2001, the JAA in July 2002 and the FAA in August 2002.

 

   

The Legacy 650 executive jet was certified by the Brazilian Aviation Authority in September 2010, by the EASA in October 2010, by the FAA in February 2011 and by the CAAC in December 2011.

 

   

The EMBRAER 170 was certified by the Brazilian Aviation Authority, the FAA, the JAA, the EASA and the authority of Poland in February 2004, and deliveries of the EMBRAER 170 began in March 2004.

 

   

The EMBRAER 175 was certified by the Brazilian Aviation Authority in December 2004, the EASA in January 2005, TCCA, the Canadian certification authority, in July 2005 and the FAA in August 2006.

 

   

The EMBRAER 190 was certified by the Brazilian Aviation Authority in August 2005, the FAA in September 2005 and the EASA in June 2006.

 

   

The EMBRAER 195 was certified by the Brazilian Aviation Authority in June 2006, the EASA in July 2006 and the FAA in August 2007.

 

   

The Phenom 100 entry level executive jet was certified by the Brazilian Aviation Authority and the FAA in December 2008, the EASA in April 2009 and by the Ukraine in October 2011.

 

   

The Lineage 1000 executive jet was certified by the Brazilian Aviation Authority, the FAA and the EASA in December 2008, and by the IDGCA in April 2011.

 

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The Brazilian Aviation Authority and the FAA certified the Phenom 300 light executive jet in December 2009 and it was certified by the EASA in April 2010 and by Mexico in October 2011.

 

   

The Legacy 650 large executive jet received certification from the CAAC in December 2011, from the FAA in February 2011, and from the EASA and the Brazilian Aviation Authority in October 2010.

Seasonality

No material portion of our business is considered to be seasonal in any material respect.

 

4C. Organizational Structure

Our operations are conducted by Embraer S.A. as the controlling and principal operating company. We have a number of direct and indirect subsidiaries, none of which are considered significant. A complete list of our subsidiaries is filed as Exhibit 8.1 to this annual report.

 

4D. Property, Plant and Equipment

We own our headquarters and plant, located in São José dos Campos. Significant portions of our facilities in São José dos Campos are subject to mortgages held by the IFC – International Finance Corporation. We lease, own or have the right to use the following properties:

 

Location

  

Purpose

   Approximate
Square Footage
     Owned/
Leased
  Lease
Expiration

São José dos Campos, SP, Brazil

   Headquarters, principal assembly facility and support center      5,902,102       Owned   —  
São José dos Campos, SP, Brazil (Eugênio de Mello)    Assembly facility      3,658,884       Owned   —  

Botucatu, SP, Brazil

   Assembly facility      222,000       Owned   —  

Harbin, China

   Assembly facility      258,067       Owned(1)   —  

Gavião Peixoto, SP, Brazil

   Testing and assembly facilities      191,648,512       N/A(2)   —  

Alverca, Portugal

   Aircraft maintenance and support center      417,000       Leased   2035

São Paulo, SP, Brazil

   Administrative offices      5,963       Leased   2013

São Paulo, SP, Brazil

   Administrative offices      5,245       Leased   2012

Fort Lauderdale, Florida

   Support center      91,500       Leased   2030

Nashville, Tennessee

   Aircraft maintenance and support center      316,128       Leased   2018

(renewable

through 2028)

Le Bourget, France

   Aircraft maintenance and support center      33,500       Leased   2013

Villepinte, France

   Representative offices and support center      70,202       Leased   2014

Beijing, China

   Representative offices      3,444       Leased   2013

Singapore

   Representative offices and support center      5,910       Leased   2013

Mesa, Arizona

   Aircraft maintenance and support center      46,500       Land is
leased.
Buildings are
leasehold
improvements
owned by
Embraer
  2026

(renewable

through 2036)

 

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Location

  

Purpose

   Approximate
Square Footage
     Owned/
Leased
   Lease
Expiration

Windsor-Locks, Connecticut

   Aircraft maintenance and support center      46,500       Land is
leased.
Buildings are
leasehold
improvements
owned by
Embraer
   2026

(renewable

through
2036)

Fort Lauderdale, Florida

   Aircraft maintenance and support center      54,000       Land is
leased.
Buildings are
leasehold
improvements
owned by
Embraer
   2030

(renewable

through
2035)

Melbourne, Florida

   Assembly facility (under construction)      181,000       Land is
leased.
Buildings are
leasehold
improvements
owned by
Embraer
   2038

(renewable

through
2058)

Dallas, Texas

   Training center for pilots and aircraft maintenance personnel      8,564       Leased    2022

Burgess Hill, UK

   Training center for pilots and aircraft maintenance personnel      8,500       Leased    2022

Evora, Portugal

   Manufacturing facility for metallic aeronautical structures (under construction)      964,511       Owned    —  

Evora, Portugal

   Manufacturing facility for aeronautical structures in composite (under construction)      1,519,832       Owned    —  

Dublin, Ireland

   Administrative offices      220       Leased    2016

Amsterdam, Holland

   Management of Embraer’s investment abroad      121       Leased    2014

 

(1) The land is owned pursuant to a land use rights certificate.
(2) We currently have a temporary authorization from the State of São Paulo to use the land and expect to receive a concession for the land as soon as legal formalities are satisfied. The facilities are owned by Embraer.

In 2008, we announced construction of a new 150,000 square foot state-of-the-art facility that will house a final assembly line – the first Embraer final assembly line in the U.S. – at the Melbourne International Airport in Melbourne, Florida. It will be capable of producing both the Phenom 100 and the Phenom 300 executive jet models, and includes a paint shop and a delivery and customer design center. This production facility was inaugurated in 2011, and the delivery and customer design center commenced operations in 2011.

In 2008, we also announced plans for implementing two new industrial units dedicated to manufacturing complex airframe structures, one focused on metallic assemblies and the other on composites, both of which are to be located in the city of Evora, Portugal. The units are scheduled to begin operations in 2012.

 

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For a discussion of our capital expenditures relating to property, plant and equipment, see “Item 4A.—History and Development of the Company—Capital Expenditures (Property, Plant and Equipment and Development).”

Production

The manufacture of an aircraft consists of three principal stages: production of primary parts, assembly of major components and final assembly. Primary parts include metal sheets and plates (produced from die-cast molds, stretch forming or various chemical treatments), parts produced using computerized and non-computerized machines, and prefabricated parts. The primary parts are then assembled, or mated, with one another to produce the aircraft’s major components, which are in turn joined to create the aircraft’s basic structure. In the final assembly stage, the aircraft’s various operating systems (such as wiring and electronics) are installed into the structure and tested.

Production facilities for our commercial, executive and defense aircraft are located in São José dos Campos in the State of São Paulo, Brazil. We reduced the production time of aircraft in the ERJ 145 family from eight months in 1996 to 3.1 months in 2004. From December 31, 1999 to December 31, 2000, we increased our production from 12 to 16 ERJ 145 family aircraft per month. At March 31, 2001, our production rate was 16 aircraft per month. In response to decreased market demand after the September 11, 2001 terrorist attacks and the related global economic slowdown, we decreased our production to 11 aircraft per month and, in 2005, decreased it further to nine aircraft per month.

Production time for our EMBRAER 170 aircraft has been reduced from approximately seven months at the beginning of its production in March 2004 to approximately four months at the end of 2005. We have the flexibility to increase production in the future in response to increased demand. We achieved the production rate of 14 aircraft per month at the end of 2008 for the EMBRAER 170/190 jet family, due to the reorganization of some industrial processes, and the implementation of a third shift in our workforce. In addition, in June 2006, we entered into an agreement with KHI and KAB, pursuant to which we began assembling the wings of the EMBRAER 190 and EMBRAER 195 aircraft in order to meet demand for these types of aircraft. See “Item 4B.—Business Overview—Commercial Aviation Business—Products—EMBRAER 170/190 Jet Family.”

To accommodate our production of the ERJ 145 regional jet family and our EMBRAER 170/190 jet family, as well as any production of our executive jets, we have expanded our production facilities and acquired new facilities and will continue to coordinate with our risk-sharing partners to accommodate any future production needs. We built a new facility in Gavião Peixoto, in the State of São Paulo, Brazil, to enhance our flight-testing capabilities and provide a final assembly line for our defense aircraft and of our executive jets. This facility has been operational since November 2002 and consists of a test runway and other features to handle the assembly of our defense programs, an MRO facility, and the Phenom’s production hangar in Gavião Peixoto. We are also conducting our flight tests for the EMBRAER 170/190 jet family and have a fully operational executive jet interior factory at Gavião Peixoto. In September 2000, we purchased a new facility in São José dos Campos in the State of São Paulo, Brazil, where we currently manufacture small parts and components for our aircraft. Our China joint venture has constructed a production facility for the ERJ 145 jet family in Harbin, China.

Environmental Matters

Most environmental regulation in Brazil is established at the state rather than at the federal or municipal level, with environmental authorities in most states granting operating permits to individual facilities rather than through general regulations. We have all material permits required to operate our business. The terms of these operating permits are reviewed every year and, as of December 31, 2011, we were in compliance with our permits. In addition, we adhere internally to international ISO 14000 environmental standards. In 2011, 2010 and 2009 we invested US$5 million, US$4.1 million and US$4.5 million, respectively, in environmental projects and we expect to spend approximately US$5.5 million on environmental projects in 2012 for the modification of existing facilities relating to environmental compliance and improvements.

In addition, certain developments in current or proposed carbon emission reduction laws and regulations could in the future indirectly affect our business and results. Currently, aircraft manufacturers are not directly affected by the existing environmental regulatory framework. However, in 2010 the International Civil Aviation Organization, through its Environmental Protection Committee, began to develop carbon emission standards for

 

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airplanes. The study of these standards is being carried out concurrently with the implementation of local or regional regulations aimed at limiting carbon emissions, such as those adopted by the European Union, with its emissions market (EU ETS – European Union Emissions Trading System). This system establishes goals for emissions reduction by aviation companies. Depending on the compensatory payments and limits imposed, as well as on the cost of carbon equivalents, regulations of this nature may impact the growth potential of the air transportation industry as a whole, due to: (1) the internalization of carbon emission-related costs by air transportation companies, which would reduce their profit margins and, consequently, cut down the demand for new aircraft; or (2) higher prices of air tickets, charged by air transportation companies in an attempt to pass emission-related costs along to their passengers, who would in turn seek alternative means of transportation, reducing the demand for air travel and, as a consequence, causing aircraft sales to decline. The effects of either scenario would likely be a decrease in demand for new aircraft in the affected markets, thereby negatively affecting our results.

For information on how climate change may affect our commercial aircraft segment, see “Item 5A. Operating and Financial Review and Prospects—Operating Results—Current Conditions and Future Trends in the Commercial Airline Industry and Executive Jet Market—Commercial Aircraft.”

OGMA

During the process of due diligence prior to the acquisition of OGMA, we identified certain industrial processes that did not fully meet environmental and occupational safety standards. As part of the negotiations, it was agreed with Empresa Portuguesa de Defesa–EMPORDEF (Portuguese Defense Company), the seller, that (1) Embraer would spend €1.9 million, the amount estimated by the parties to be the amount necessary to bring the industrial processes into environmental and occupational safety compliance over a three-year period, (2) the seller would indemnify OGMA for any losses due to environmental claims over the same three-year period, (3) Embraer’s liability for pre-acquisition environmental claims would be limited to €4.1 million, and (4) any liability for other pre-acquisition environmental and occupational safety claims in excess of €4.1 million would be paid by the seller.

Insurance

We insure all of our plants and equipment for loss and replacement. We also carry insurance to cover all potential damages to our own fleet of aircraft, including those occurring during commercial and demonstration flights. In addition, we maintain a comprehensive aviation products liability policy, which covers damage arising out of the manufacture, distribution, sale and servicing of our aircraft and parts. We also carry natural disaster and business interruption insurance covering property damage and the related loss of gross income, as defined in the policy, and additional expenses, such as those incurred by us to offset the loss of production and delivery of aircraft due to partial or total interruption of our business because of material losses caused by an accident. We consider the amounts of our insurance coverage to be typical for a company of our size and adequate to meet all foreseeable risks associated with our operations.

We also maintain officers’ and directors’ liability insurance in the total amount of US$100 million. This insurance covers our officers and directors for liabilities resulting from wrongful acts, including any act or omission committed or attempted by any officer or director acting in his or her capacity as officer or director or any matter claimed against an officer or director solely by reason of his or her serving in such capacity.

 

ITEM 4.A UNRESOLVED STAFF COMMENTS

We have no unresolved staff comments.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

This discussion should be read in conjunction with our audited consolidated financial statements and notes thereto and other financial information included elsewhere in this annual report. This annual report contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including, without limitation, those set forth in “Item 3D. Key Information—Risk Factors” and the matters set forth in this annual report generally.

 

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Except as otherwise indicated, all consolidated financial information in this annual report has been prepared in accordance with IFRS as issued by IASB and presented in U.S. dollars, while, for local purposes, our consolidated financial statements are also prepared in IFRS but are presented in reais. For certain purposes, such as providing reports to our shareholders located in Brazil, filing financial statements with the CVM, and determining dividend payments and other distributions and tax liabilities in Brazil, we have prepared and will continue to be required to prepare parent company financial statements in accordance with Brazilian GAAP, presented in reais.

 

5A. Operating Results

Current Conditions and Future Trends in the Commercial Airline Industry and Executive Jet Market

The following discussion is based largely upon our current expectations about future events, and trends affecting our business, actual results for our industry and performance could differ substantially. See “Introduction—Special Note Regarding Forward-Looking Statements.” For factors which could affect our industry in the future and our own future performance, see “Item 3D. Key Information—Risk Factors.”

Commercial Aircraft

The fundamental drivers of air travel growth are a combination of economic growth and the increasing propensity to travel due to increased trade, globalization and improved airline services, driven by liberalization of air traffic rights between countries. As the air transportation industry continues its recovery from the 2008 financial crisis, selected world regions lead the return to growth in the industry and appear likely to emerge as economic powerhouses. In 2011, according to data provided by the International Air Transport Association, or IATA, passenger demand increased 5.9%, despite weak economic conditions in western economies, while the airline industry achieved net profit of US$6.9 billion. International demand increased by 6.9%, with Europe achieving the second fastest growth rates, behind Latin America. Domestic markets increased on a global basis by 4.2%, with Brazil, India and China showing double-digit growth. For 2012, the industry should face some challenges, with profit forecast at US$3.5 billion, according to IATA. European airlines are likely to be hardest hit by the economic recession in their home markets and losses are expected. North American airlines show varying performance, as capacity cuts provide protection to profitability, as do airlines in Asia where, in particular, China’s expanding domestic market generated significant profits through high load factors. The trend to replace aging fleets and trim excess capacity that was evident in North America and Europe in the last few years is now spreading towards the south and east. All eyes are on airlines in Latin America, China, the Middle East and Asia, as they discover the potential of regional flying to build their networks, right-size their fleets with smaller-gauge equipment and achieve higher levels of efficiency. We believe that from 2011 to 2030, world air travel demand should grow an average of 5% per year in terms of passenger kilometers flown. However, economic downturns, fuel price increases, natural disasters and credit shortages might impair the ability of commercial airlines, including certain of our customers, to finance aircraft acquisitions (see “Item 4B. Information on the Company—Business Overview—Aircraft Financing Arrangements”).

The world’s economies have been recovering from the recession at differing paces. Emerging markets are driving economic growth, fueled by the impressive growth of China and other Asian countries. Developed countries are growing at a much slower rate. In the long-term, the key trend is the shift in global power from West to East and, to some extent, to the South. We expect China to lead growth in air travel in the next 20 years in terms of passenger kilometers flown, with an average annual rate of around 7%, followed by Latin America and the Middle East. We expect that demand in Asia, Africa and the Commonwealth of Independent States will grow around 6%, and that growth in the North American and European markets will remain around 3% and 4%, respectively, in all cases in terms of passenger kilometers flown.

In North America, airlines have operated in a difficult environment of a mature market with lower yields, generating negative financial results. Main strategies have been focused on cost reductions, increased productivity and consolidation aiming at higher efficiency through better match of market demand with more adequate aircraft capacity. We believe that airlines are cautiously optimistic, as the industry is better positioned in comparison to the period immediately after the 2008 world financial crisis, after having undergone significant capacity rationalization and is experiencing a recent upside revenue trend. Focusing on profitability share and not on capacity share will position airlines to sustain better financial results and stability through business cycles. Regional airlines continue to provide essential hub feeder and capacity adjustments to network carriers. Low-cost airlines are no longer increasing their share in the domestic market as quickly as in the past, mainly because of the maturity of the market and the current business model focused on use of single type of aircraft.

 

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In Europe, the revenue environment will remain under pressure as a result of the economic scenario. Regional carriers are supporting network airlines’ adjustments of capacity and frequency of service by replacing larger aircraft. Environment, noise and greenhouse gas emissions issues are expected to dominate the regulatory agenda and will shape the development of new technologies in European air transportation. The aviation industry is now subject to the Emissions Trade System, or ETS, and to the imposition of other taxes such as the Airport Passenger Duty (APD). Airlines are expected to replace aging aircraft to reduce overall costs and avoid green taxes. Air transport growth will not be uniform across the European continent. In Eastern European countries, where markets are less mature, we expect there will be stronger demand since these economies should develop faster than countries in Western Europe. Airport capacity restrictions, competition from non-European hubs, introduction of the ETS, higher fuel prices and intermodal travel should promote more efficient use of resources by European airlines. Consolidation, improvement of intra-European connectivity and international expansion will be the key drivers of the European airline industry.

Latin America’s relevance is increasing in the global economy and geopolitics due to some fundamental macroeconomic reforms promoted over the past decade. We believe that passenger demand in the Latin American air transport industry remains positive, led mainly by economic growth and social policies that helped the region to achieve a robust level of business development, increased foreign investment and success in the gradual reduction of poverty. A growing middle class is demanding different services, such as discretionary expenditures in air travel. Airlines have introduced more fuel-efficient and right-sized aircraft in order to expand the intra-regional aviation system. As the region becomes more integrated through the development of an intra-regional network, there will be an opportunity for up to 120-seat jets to increase network connectivity and expand service to secondary airports.

Optimism for the Asia Pacific region is strongly correlated to the robust economic growth of China and India, but it also reflects other fast-growing markets such as Indonesia, Malaysia, Thailand, the Philippines and Vietnam. Increasing economic cooperation, leading to trade expansion within the region, is fostering not only accelerated development of local economies but also the need for intra-regional air transportation links. Overall, Asia Pacific economic prosperity, combined with robust population growth, economic decentralization and rapid rates of urbanization, will support strong local demand for air travel (especially by the middle class), which, together with air service liberalization, is expected to drive air transport demand growth. The role of regional aviation in Asia Pacific/China is not limited to matching capacity to demand, but also relates to national integration. Regional aviation provides access to smaller communities in countries like Australia, China and Indonesia. The Chinese government also understands the importance of this role and is implementing new policies to promote greater regional aviation development in the country. The regional fleet is still comprised mainly of high-capacity narrow-body aircraft, which restricts adequate deployment to medium- and low-density markets. Liberalization policies in some sub-regions tend to encourage the development of intra-regional air transport, which may generate major opportunities for regional aviation in the coming years.

Just a decade ago, the Middle East had a small share of world air traffic, with its airlines operating mostly in local markets. Today, Middle Eastern carriers have become global players, driven by the emergence of global hubs with high frequency flights connecting long-haul East-West passengers. Strong interest in business and tourism, together with a sizeable expatriate workforce, has promoted the development of intra-regional markets. Intra-Middle Eastern flights have increased significantly in the past years with the acquisition of new smaller aircraft to feed international hubs and cover underserved markets.

In Africa, regional integration and growing foreign direct investment are fostering regional aviation through new links among capitals and improved levels of service. Challenges in infrastructure, lack of financing and a highly regulated environment are being addressed, although at a slower pace than required, restricting the air transport development. As a result of liberalization in some countries, some airlines are introducing new aircraft and expanding their intra-regional system, which helps support the regional aviation development.

The air transport industry in the Commonwealth of Independent States is diverse, consisting of aged fleets belonging to several small, state-owned airlines. In Russia, import taxes represent a significant barrier for airlines that intend to renew their fleet with Western aircraft. Airline consolidation is in progress in the region and is focused on the improvement of air transport system efficiency. Opportunities for regional aviation rely on the replacement of the old and inefficient fleet of the former Soviet Union.

 

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We estimate a global demand for around 7,200 jets in the 30- to 120-seat-capacity category over the next 20 years, which may generate global sales of new aircraft of around US$320 billion. The 30 to 120-seat segment plays an important role in aviation, providing flexibility to airlines to deal with the volatility of the market, complementing larger aircraft operation with appropriate capacity, as well as allowing airlines to open new low- to medium-density markets.

The 30- to 60-seat-capacity category has been impacted by high fuel prices and an environment of low yields. However, this category is still essential for the North American hub-feeding system and will support regional aviation development in some other world regions, such as the Commonwealth of Independent States, Africa and Latin America.

The 61- to 120-seat capacity category has been providing much needed flexibility and efficiency improvements to airlines by right-sizing larger jets, replacing aging aircraft, developing new markets, expanding from smaller regional jets and supporting the natural growth of regional airlines on high-demand routes operated by smaller jets.

We believe that environmental requirements, such as reduction of greenhouse gas emissions, are becoming one of the main drivers of airline fleet decisions and will influence future aircraft developments. We estimate that around 700 units of the current 30- to 120-seat fleet in service are over 20 years old, and should soon be replaced by new jets, such as Embraer’s commercial aircraft, with a view to reducing the impact of such emissions on the environment.

Executive Aircraft

Market Overview

2011 was marked by new signs of recession, mainly from Europe, where various countries experienced sovereign debt repayment issues. The global economic slowdown which has affected the executive aviation market since mid-2008 resulted in one of the most severe reductions in world sales of its history, surpassing the impacts caused by the recession of the 1980s and the September 2001 terrorist attacks. The recovery of new jet sales is being threatened by the combination of low economic activity, the lack of attractive financing alternatives, low consumer confidence and a large supply of slightly used or almost new pre-owned aircraft at very competitive prices. Currently, there are almost 700 executive jets aged up to ten years for sale, negotiated at an average discount of 30%, when compared to what we consider to be the fair market value for those aircraft. These factors, in addition to the uncertainties surrounding economies worldwide, make it more difficult to foresee a demand upsurging in the short- to mid-term period.

The North American market still does not show relevant signs of recovery, although corporate profits – one of the main recovery drivers for new executive jets sales – reached new historic levels in the second quarter of 2011. However, investors are still disappointed that other drivers, such as GDP and stock markets, have not yet shown clear signs of recovery. Thus, we understand that corporations will continue to be more reluctant to spend on travel alternatives, at least in the short-term.

We may not see many order cancellations and postponement during 2012, as sales have already shown some momentum. However, we expect that market sales will remain flat until 2014, within the revenue range of US$16 billion to US$17 billion per year. Over the next ten years, according to our internal research, market forecasts indicate that 8,000 aircraft will be delivered, totaling US$205 billion in the period.

We estimate compound annual revenue growth for the executive jet segment from 2012 to 2021 to reach 4.3%. In terms of units delivered, growth expectancy will reach 3.4%. The expectations for 2012 are that deliveries will be slightly greater than 2011 in terms of units and revenues, but there are considerable risks due to uncertainties regarding global economic recovery. We believe that a sales recovery in the executive jet market may begin only in the second quarter of 2012 and, as result, executive jet manufacturers will continue to adjust production capacity and product pricing.

 

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Emerging markets are demonstrating counter-cyclical behavior in the executive jets market. While global demand cools, Brazil and China are increasing their share of business jet deliveries. Demand from those markets, though increasing, is still small when compared to that of the two main markets, the U.S. and Europe. In terms of units, it is expected that the U.S. will remain as the biggest market for the executive business aviation and will be responsible for 40% of the predicted total industry revenue for the next ten years, followed by Europe, Africa and the Middle East, which is expected to account for 33% of revenues.

Latin America, Asia-Pacific and China are expected to show the highest growth rates in deliveries in the medium-to-long terms. Lighter jet categories have generally been well accepted, particularly in Latin America, as they are more suitable to local needs. Thus, we believe that sales of light and entry-level jets will be key to sustaining the expected growth in Latin America. While the Latin American growth stems mainly from substitution of the turboprop fleet, we believe that Asian growth rates will be sustained by the region’s economic performance and by the prospect of diminishing regulatory and fiscal barriers, which, until now, have dampened demand. These factors should favor demand for aircraft with larger cabins and longer ranges within the region.

Although China has experienced a recent growth in demand based on overall strong economic performance in the region, the tight government control over air space and the lack of a sufficient civilian airport infrastructure are still major hurdles that we believe will continue to hamper the Chinese executive aviation market in the short-term. In the medium term, the Chinese market is poised to grow, fueled by the growing consumption levels of Chinese high net worth individuals and the globalization of Chinese conglomerates.

Our Executive Aircraft

Overview

We continued to make solid progress throughout 2011, achieving important milestones in each program of our product portfolio and advancing in the development of our integrated solutions for the executive aviation market.

Since launching the Phenom 100, Phenom 300 and Lineage 1000, we have continued to evaluate and explore opportunities in the executive aviation market. In April 2008, we formally launched the mid-light Legacy 450 jet and the mid-size Legacy 500 jet. The Legacy 450/500 jets will be positioned in our executive jets portfolio between the Phenom 300 and the Legacy 600/650.

In February 2011, according to data released by GAMA, Embraer was the company that stood out in the executive aviation market in 2010. We delivered 145 executive jets during the year, an increase of 23 aircraft over 2009, the highest increase in absolute terms among all manufacturers. Embraer’s 2010 market share reached 19%, meaning that almost one in every five executive jets delivered worldwide was produced by Embraer.

In July 2011, Embraer and Minsheng Financial Leasing Co., Ltd., a subsidiary of China Minsheng Banking Co., Ltd., and one of the largest financial institutions providing executive jet leasing services in China, signed a Memorandum of Understanding in a ceremony held at Embraer’s headquarters in São José dos Campos. According to this memorandum of understanding, Minsheng Financial Leasing intends to purchase up to 20 of Embraer’s full line of executive jets. The deal is expected to be fully converted into firm orders in the next five years

Legacy 600/650

In October 2009, we presented the new Legacy 650 jet at the 62nd Annual Meeting and Convention of the National Business Aviation Association, in Orlando, Florida. The large executive jet category Legacy 650 is based on the successful platform of the super midsize Legacy 600, having a longer range for up to 14 passengers. The Legacy 650 can fly up to 3,900 nautical miles nonstop with four passengers, or 3,800 nautical miles with eight passengers, meaning approximately 500 nautical miles farther than the Legacy 600.

In February and December 2011, Embraer’s Legacy 650 large executive jet received certification from the FAA and CAAC, respectively. In October 2010, Brazilian Aviation Authority and the EASA had already granted their certifications.

 

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In March 2011, Embraer’s Legacy 650 large executive jet demonstrated its range capability by completing a round trip between São Paulo and Fort Lauderdale/Hollywood International Airport.

In May 2011, Embraer and Comlux The Aviation Group announced a contract for the acquisition of three large Legacy 650 executive jets for the Fly Comlux Division in Kazakhstan. The agreement was announced at the 11th Annual European Business Aviation Convention & Exhibition, or EBACE 2011, in Geneva, Switzerland, and includes options for another four aircraft. The total value of the deal, at list price, comes to US$90.7 million, and could reach US$211.7 million if all options are confirmed.

In October 2011, Embraer signed a firm order for 13 Legacy 650 executive jets with China’s Minsheng Financial Leasing Co., Ltd., in a ceremony held at the 64th Annual NBAA Meeting & Convention, in Las Vegas, Nevada. The first aircraft was delivered by the end of 2011, with the remainder scheduled for delivery within the next four years.

In the same month, Embraer announced that movie star Jackie Chan would soon join the family of Legacy 650 customers and become a brand ambassador of Embraer’s executive jets.

In December 2011, Embraer’s large Legacy 650 executive jet was type certified by the CAAC with the revised Validation Type Certificate Data Sheet, which paved the way for customers to register and operate the Legacy 650 in China.

The Legacy 600/650 family has entered its tenth year of production and still has broad market acceptance, mainly among customers in Europe. Deliveries of the Legacy 600/650 increased to 16 units in 2011 from 10 units in 2010. With a fleet of 190 jets in 37 countries, the Legacy 600/650 is expected to capture a good portion of the super midsize and large jets market.

Legacy 450 and Legacy 500

An estimated US$750 million is expected to be invested in property, plant and equipment and development expenditures for the new Legacy 500 and Legacy 450 models. The Legacy 500 executive jet is expected to enter into service in late 2013 and the Legacy 450 is expected to enter service one year after the Legacy 500. We believe that these two aircraft programs will help strengthen our position in the market and set our portfolio as one of the most comprehensive of the executive aviation industry.

In June 2011, Embraer participated in the Cannes Airshow 2011, held in France. Embraer exhibited the newest full-scale mock-up of the midsize Legacy 500, alongside the entry level Phenom 100 and the Phenom 300 executive light jet.

In July 2011, Embraer achieved another milestone in its development of the new Legacy 500 midsize executive jet, with the joining of the aircraft’s three fuselage sections: cockpit, center fuselage and aft fuselage. The Legacy 500 final assembly will take place at Embraer’s facilities in São José dos Campos.

In August 2011, Embraer participated in the eighth Latin American Business Conference and Exhibition at Congonhas Airport (CGH) in the city of São Paulo, Brazil. We showed the midsize Legacy 500 mock-up with a near-production interior, along with the entry-level Phenom 100, the light Phenom 300, and the large Legacy 650 executive jets.

In December 2011, Embraer rolled out its Legacy 500 from the production hangar at the São José dos Campos headquarters. This milestone allowed development and test engineers to perform important ground tests, prior to the aircraft’s first flight, which is scheduled for the third quarter of 2012.

Phenom 100 and Phenom 300

The Phenom 100 executive jet, an entry-level jet, ranked first in the list of the most delivered aircraft in 2010. Together with other executive jets of Embraer’s portfolio, we believe that the Phenom 100’s qualities contributed to Embraer’s increased market share in this segment, one of the largest in terms of delivered units in the executive aviation industry according to GAMA.

 

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In January 2011, the Phenom 300 was certified by the Brazilian Aviation Authority, the FAA and the EASA to use synthetic vision technology from Garmin (Synthetic Vision Technology ™ - SVT). This aircraft is the first in the entry-level jet category to offer this advanced functionality in the cockpit.

A series of accomplishments were made by the Phenom family in February 2011. The Phenom 300 light jet earned a reputation as a game changer in its first year of operation. The editors of Flying Magazine announced that the executive jet was granted their Choice Award as one of the year’s most remarkable accomplishments, in terms of vision, innovation and determination. At the end of each year, Flying Magazine editors traditionally review all aircraft, avionics, pilot services and equipment in search of a fully certified and outstanding operational-within-the-year product. The award is not presented to theoretical projects; it is intended to show the nominee’s value in the real world of flying.

In the same month, Embraer signed a contract for the sale of one Phenom 300 jet to Amil Assistência Médica, a major Brazilian health care plan operator. This was the first Medical Evacuation (MEDEVAC) version of the Phenom 300 executive jet, and it commenced operations in Brazil in May 2011.

Moreover, Embraer received certification from the Brazilian Aviation Authority and the EASA for the belted toilet of its entry level Phenom 100 executive jet. This feature further improves the jet’s flexibility, since customers who select this option will be able to carry up to seven occupants.

In March 2011, the Phenom jets received the Prodigy™ flight deck, powered by Garmin avionics, which can be used to provide two-way short message service (SMS) and e-mail texting on the Phenom 100 and Phenom 300 executive jets.

In May 2011, Embraer and Portugal’s Ricon Group announced a contract for the acquisition of one Phenom 300 executive jet for its newly created subsidiary Everjets. The agreement was announced at the EBACE 2011 event in Geneva, Switzerland. The deal also includes an option for a second unit of the same type.

In the same month, Embraer delivered its 200th Phenom 100 jet in a ceremony held at our headquarters in São José dos Campos. The aircraft was received by U.S.-based Swift Aviation Group, Inc., from Phoenix, Arizona, a private company that provides a wide array of aviation services such as aircraft charter and charter sales management, among others.

In July 2011, Embraer received type certification from Australia’s Civil Aviation Safety Authority, or CASA, for the Phenom 300 light jet to operate in that country.

In September 2011, Embraer received type acceptance for its Phenom 300 light executive jet from India’s Directorate General of Civil Aviation, or IDGCA. In addition, the model was also certified by the FAA for the optional belted lavatory seat, an option that has been widely requested by customers.

In October 2011, Embraer received certification for the Phenom 300 light executive jet to operate in Mexico and for the Phenom 100 entry-level jet to operate in the Ukraine.

In December 2011, Embraer delivered the first entry level Phenom 100 jet produced in its new U.S. assembly plant to longtime customer Executive AirShare during a ceremony held in Melbourne, Florida.

By the end of 2011, the Phenom 100 fleet consisted of 239 units distributed in 25 countries. In the same period, the Phenom 300 fleet was composed of 69 units distributed in 13 countries.

Lineage 1000

Launched in May 2006, the Lineage 1000 is the largest and most refined executive jet in Embraer’s portfolio. The aircraft is based on the EMBRAER 190 commercial jet, which was certified in August 2005. The Lineage 1000 represents the fourth family of our executive jets, and currently operates in seven countries. In 2011, we delivered three Lineage 1000 aircraft to our executive aviation customers.

 

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In April 2011, Embraer received from the IDGCA the type certification for its ultra-large Lineage 1000 executive jet. This certification complements the type certifications already awarded to the aircraft by the Brazilian Aviation Authority and the EASA in December 2008, as well as by the FAA in January 2009.

In August 2011, Embraer’s ultra-large Lineage 1000 executive jet received the type certification from the CAAC, which paved the way to register and operate the Linage 1000 in China, and marked an important step for Embraer’s commitment to the Chinese executive aviation market.

By the end of 2011, the Lineage 1000 fleet was composed of 14 units distributed in seven countries.

Customer Service Centers Network for the Executive Aviation

We have further developed our customer support and services structure to enhance our customers’ satisfaction in operating our executive jets. In 2011, we completed the certification of approximately 20 new authorized service centers in Brazil, India, U.A.E., U.S., Australia, Russia and Indonesia.

We also celebrated the second anniversary of our Executive Jets Service Center in São José dos Campos, Brazil, and expanded its operation to a larger hangar.

In 2010, we reinforced our partnership with Inflite, in UK, by signing an agreement to extend its maintenance capabilities to the ultra-large Lineage 1000 executive jet.

Our owned service center in Fort Lauderdale and Mesa in the United States have both received for the third time the FAA Diamond award, a certificate of excellence related to maintenance technician training.

In 2009, we announced our new Customer Support Contact Center dedicated to executive jets and offering complete and timely assistance for their operational, technical and maintenance needs. This Customer Support Contact Center is based at Embraer’s headquarters, in São José dos Campos. Its priority is to minimize downtime, from the customer’s first contact to the final solution, by quickly and efficiently applying appropriate resources to critical needs, thus assuring that customers have expert assistance anywhere in the world.

Embraer’s executive jets customer support and services structure is ready for the Phenom 300’s entry into service and to support operations of the Phenom 100, the Legacy 600, the Legacy 650 and the Lineage 1000 operations. The Embraer executive jets service centers network currently consists of 59 authorized service centers, including five centers owned by us.

Brazilian Economic Environment

Despite recent signs of mild economic recovery, the global economic slowdown, including the events negatively affecting the commercial and executive airline industry and the U.S., has adversely affected the global and Brazilian economies and securities markets, and has resulted in:

 

   

increased volatility in the market price of securities;

 

   

significant decline in corporate earnings estimates;

 

   

substantial losses in important industries, including the air transport and insurance industries; and

 

   

significant erosion of consumer confidence.

As discussed below, any uncertainty surrounding the U.S., Brazilian and global economies could result in the Brazilian federal government changing existing laws or regulations or imposing new ones, and/or the Central Bank changing base interest rates, which could adversely affect our operations.

The Brazilian federal government has frequently intervened in the Brazilian economy and occasionally made drastic changes in policy and regulations. The Brazilian federal government’s actions to control inflation and affect other policies and regulations have often involved, among other measures, increases in interest rates, changes in tax policies, price controls, currency devaluations, capital controls and limits on imports. For example, the

 

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Brazilian federal government has the authority, when a serious imbalance in Brazil’s balance of payments occurs, to impose restrictions on the remittance to foreign investors of the proceeds of their investments in Brazil and on the conversion of Brazilian currency into foreign currencies. Changes in Brazil’s monetary, credit, tariff and other policies could adversely affect our business, as could inflation, currency and interest-rate fluctuations, social instability and other political, economic or diplomatic developments in Brazil, as well as the Brazilian federal government’s response to such developments.

Rapid changes in Brazilian political and economic conditions that have occurred and may occur in the future will require a continued assessment of the risks associated with our activities and the adjustment of our business and operating strategy accordingly. Future developments in Brazilian federal government policies, including changes in the current policy and incentives adopted for financing the export of Brazilian goods, or in the Brazilian economy, over which we have no control, may have a material adverse effect on our business.

Brazilian economic conditions may also be negatively affected by economic and political conditions elsewhere, particularly in other Latin American and emerging-market countries. Although economic conditions in such countries may differ significantly from economic conditions in Brazil, the reaction of investors to developments in such countries may have an adverse effect on the market value of securities of Brazilian issuers. For example, the recent uncertainty in the economies of U.S. and other OECD countries has caused a retraction of credit on a worldwide basis, significant volatility in the international capital markets (including Brazil) and diminished investor interest in securities of Brazilian issuers, including ours. Crises in other emerging-market countries also have at times significantly affected the availability of credit in the Brazilian economy and resulted in considerable outflows of funds and declines in the amount of foreign currency invested in Brazil.

In 2007, Brazil’s GDP increased 5.4%, and the real appreciated 17.2% against the U.S. dollar, to R$1.7713 per US$1.00 at December 31, 2007. Inflation in 2007, as measured by the IPCA, was 4.46%, and the CDI average was 11.9% in the same period.

In 2008, Brazil’s GDP increased 4.8% and the real exchange rate decreased by 31.9% against the U.S. dollar, to R$2.3370 per US$1.00 at December 31, 2008. Inflation in 2008, as measured by the IPCA, was 5.90% and the average CDI interest rate was 12.0% in the same period.

In 2009, the Brazilian economy demonstrated resilience to the economic crisis in comparison with certain other countries. Several macroeconomic indicators improved during the year, and despite the deceleration of GDP growth for 2009, the Central Bank reported in its Focus Report published on January 8, 2010 its expectation of only a small decrease in Brazilian GDP of 0.3% in 2009. In addition, solid macroeconomic conditions and greater economic stability allowed the Central Bank to return to the strategy of reducing interest rates, with the effective cumulative SELIC rate reaching 8.75% by the end of July 2009, its lowest historical level. Similarly, the real strengthened and appreciated by 25.5% against the U.S. dollar during 2009. According to the Central Bank, international reserves remained above US$200 billion throughout the year (US$238 billion as of December 31, 2009), which represented a significant increase relative to the end of 2008.

In 2010, the Brazilian GDP increased 7.5%. The real continued its appreciation trend of 2009, having advanced 4.3% against the U.S. dollar. Brazilian international reserves were higher in 2010 than in 2009, having increased to US$288.6 billion as of December 31, 2010 from US$239.1 billion as of December 31, 2009.

In 2011, Brazil’s GDP increased 2.7%. The real appreciated against the U.S. dollar in the first several months of 2011, but began to depreciate in August of 2011, reaching R$1.88 per US$1.00 on December 31, 2011, representing a 12.6% depreciation against the U.S. dollar. The Brazilian economy was characterized by continued inflation during the year 2011, but fears of a global economic slowdown prompted the Central Bank to begin reducing the SELIC rate near the end of the period. The SELIC rate was at 11.0% on December 31, 2011. Inflation in 2011, as measured by the IPCA was 6.50% and the CDI average was 9.3% in the same period.

According to the Focus report published by the Central Bank on April 5, 2012, positive growth of 3.2% is estimated for Brazilian GDP in 2012 and an inflation rate of 5.06% is expected for the same year.

 

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Effects of Inflation and Currency Exchange Fluctuations

Until the adoption of the Real Plan in 1994, Brazil had for many years experienced very high, and generally unpredictable, rates of inflation and steady devaluation of its currency relative to the U.S. dollar. The following table sets forth, for the periods shown, more recent rates of inflation in Brazil, as measured by the IPCA and published annually by the Instituto Brasileiro de Geografia e Estatística - IBGE, and the fluctuation of the real against the U.S. dollar as measured by comparing the daily exchange rates published by the Central Bank on the last day of each period:

 

     2011     2010     2009     2008     2007  

Inflation (National Consumer Price Index)

     6.5     5.91     4.31     5.90     4.46

Exchange Rate Variation (R$/US$)

     (12.6 )%      4.3     25.5     (31.9 )%      17.2

Inflation and exchange-rate variations have had, and may continue to have, substantial effects on our financial condition and results of operations. Inflation and exchange-rate variations affect our monetary assets and liabilities denominated in reais. The value of such assets and liabilities as expressed in U.S. dollars declines when the real devalues against the U.S. dollar and increases when the real appreciates. In periods of devaluation of the real, we report (a) a remeasurement loss on real-denominated monetary assets and (b) a remeasurement gain on real-denominated monetary liabilities.

Critical Accounting Estimates

The preparation of financial statements requires management to make estimates and adopt assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the fair value of financial instruments on the balance sheet dates and the reported amounts of revenues and expenses during the reporting period. Significant estimates for which changes in the near term are considered reasonably possible and that may a material impact on the financial statements. Therefore, in connection with the preparation of the financial statements included in this annual report, we have relied on variables and assumptions derived from historical experience and various other factors that we deemed reasonable and relevant. Although we review these estimates and assumptions in the ordinary course of business, the presentation of our financial condition and results of operation often requires us to make judgments regarding the effects of matters that are inherently uncertain. Actual results may differ from those estimated under different variables, assumptions or conditions. Note 3 to our audited consolidated financial statements includes a summary of the significant accounting policies applied in the preparation of these financial statements.

In order to provide an understanding about how management forms its judgments about future events, including the variables and assumptions underlying the estimates, and the sensitivity of those judgments to different variables and conditions, we have included below a discussion of our more significant accounting policies.

Sales and Other Operating Revenues

We recognize revenues from sales made by the commercial and executive business segments when benefits and risks of ownership are transferred to customers, which, in the case of aircraft, occurs when delivery is made, and, in the case of services, when the service is provided to the customer. Services revenues are included in their respective aviation business segment revenue, because provision of services related to each business unit is managed within each business unit.

We also recognize rental revenue for leased aircraft, classified as operating leases on a straight-line basis over the lease term and, when presenting information by operating segment, we record such rental revenue under the respective business unit (commercial or executive) as it relates to the used aircraft type.

In the defense and security segment, a significant portion of revenues is derived from long-term development contracts with Brazilian and foreign governments, for which we recognize revenues based on the percentage-of-completion, or POC, method. These contracts contain provisions for price escalation based on a mix of indices related to raw material and labor cost. From time to time, we reassess the expected margins of certain long-term contracts, adjusting revenue recognition based upon projected costs to completion. Use of the POC method requires us to estimate the total costs to be incurred on the contracts. Were the total costs to be incurred to

 

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fall by 10% from management’s estimates, the amount of revenue recognized in the year would be increased by US$72.7 million and if the total costs were to rise by 10%, the amount of revenue recognized in the year would be decreased by US$77.7 million.

Revenue under exchange pool programs is recognized monthly over the contract term and consists partly of a fixed fee and partly of a variable fee directly related to actual flight hours of the covered aircraft.

We enter into transactions that represent multiple-element arrangements, such as training, technical assistance, spare parts and others concessions, which are included in the aircraft purchase price. Multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting if all of the following criteria are met:

 

   

the delivered item has value to the client on a stand-alone basis;

 

   

there is objective and reliable evidence of the fair value of the undelivered item; and

 

   

if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially under our control.

If these criteria are not met, the arrangement is accounted for as one unit of accounting, which results in revenue being deferred until the earlier of when such criteria are met or when the last undelivered element is delivered. If these criteria are met for each element and there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value.

Product Warranties

Generally, aircraft sales are accompanied by a standard warranty for systems, accessories, equipment, parts and software manufactured by us and/or by our risk-sharing partners and suppliers. We recognize warranty expense, as cost of sales and services, at the time of sale based on the estimated amounts of warranty costs anticipated to be incurred. These estimates are based on a number of factors, including historical warranty claims and cost experience, the type and duration of the warranty coverage, volume and mix of aircraft sold and in service and warranty coverage available from the related suppliers. Actual product warranty costs may have different patterns from past experience, mainly when a new family of aircraft enters service, which could require us to increase the product warranty reserve. The warranty period is three years for spare parts and five years for components that are a part of the aircraft when sold.

Guarantees and Trade-in Rights

We may provide financial and residual value guarantees and trade-in rights related to our aircraft. We review the value of these commitments relative to the aircraft’s anticipated future fair value and, in the case of financial guarantees, the creditworthiness of the obligor. Provisions and losses are recorded when and if payments become probable and are reasonably estimable. We estimate future fair value using third-party appraisals of aircraft valuations, including information developed from the sale or lease of similar aircraft in the secondary market. We evaluate the creditworthiness of obligors for which we provide credit guarantees by analyzing a number of factors, including third-party credit ratings and the estimated obligors’ borrowing costs. All guarantee financial contracts, including third-party guarantees, are recorded on Embraer’s balance sheet at fair value. The accounting policy for guarantees has the general effect of delaying recognition of a portion of the revenue for product sales that are accompanied by certain third-party guarantees. See “Item 3D. Key Information–Risk Factors–Risks Relating to Embraer–Some of our aircraft sales may be subject to financial and residual value guarantees and trade-in options that may require us to make significant cash disbursements in the future.”

Sale of Residual Interests in Aircraft

In structured financing arrangements, an entity purchases an aircraft from us, pays us the full purchase price on delivery or at the conclusion of the sales financing structure, and leases the related aircraft to the ultimate customer. A third-party financial institution facilitates the financing of an aircraft, and a portion of the credit risk remains with that third party.

 

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We apply the accounting guidance for consolidation of variable interest entities, or VIEs, and consolidate special purpose entities, or SPEs, in which we have a variable interest that will absorb a majority of the entity’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both. Although we have no equity interests on the SPEs, we control their operations or take a majority interest position in their risks and rewards. Accordingly, the SPEs owned by third parties where we have control are consolidated. When we no longer hold control, the assets and liabilities related to the aircraft are deconsolidated from our balance sheet.

We evaluate control over the SPE principally based on a qualitative assessment of the SPE. This includes a review of the SPE’s capital structure, contractual relationships and terms, nature of the SPE’s operations and purpose, nature of the SPE’s interests issued, and their interests in the entity which either create or absorb variability. We evaluate the design of the SPE and the related risks the entity and the variable interest holders are exposed to in evaluating consolidation. In limited cases, when it is unclear from a qualitative standpoint if who has control over the SPE, we use a quantitative analysis to calculate the probability-weighted expected losses and probability-weighted expected residual returns using cash flow and statistical risk measurement modeling.

Impairment

Long-lived assets held for use are subject to an impairment assessment if facts and circumstances indicate that the carrying value is no longer recoverable based upon the discounted future cash flows of the asset or its net realizable value. Assets are grouped based on families of aircraft, which are our cash-generating units. We use assumptions to determine the expected discounted cash flows, including the forecasts of future cash flows and the net realizable values, which are based on our best estimate of future sales and operating costs, which depends primarily on existing firm orders, expected future orders, contracts with suppliers and general market conditions. Changes in these forecasts could significantly change the amount of impairment recorded, if any. We register the net accounting value of the underlying assets if the sum of the expected future cash flows or the net realizable value is less than accounting value. These reviews to date have not indicated the need to recognize any impairment.

Fair Value of Financial Instruments

The fair value of financial instruments that are not traded in an active market is determined by using valuation techniques. We use our judgment to select a variety of methods and make assumptions that are mainly based on market conditions existing at the end of each reporting period.

Income Taxes

We are subject to income taxes in numerous jurisdictions. Significant judgment is required in determining the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain. We recognize liabilities based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the current and deferred income tax assets and liabilities in the period in which such determination is made.

Because the majority of the our tax basis is in reais and our functional currency is the U.S. dollar, the income tax expense line item is highly sensitive to the effects of changes in exchange rates particularly from the comparative bases of its nonmonetary assets. As at December 31, 2011, if the real depreciated or appreciated by 10% against the U.S. dollar, the deferred income tax expense would have increased by approximately US$112.0 million or decreased by US$112.0 million, respectively.

 

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Principal Operating Data and Components of Our Statement of Income

Operating Data

The following chart sets forth statistical data for our deliveries and backlog of our aircraft at the end of the respective periods. Deliveries consist of aircraft that have been delivered to customers and for which the corresponding revenue has been recognized. Our backlog consists of all firm orders that have not yet been delivered. A firm order is a contractual commitment from a customer, customarily accompanied by a down payment, for which we have reserved a place on one of our production lines. See “Item 5D.—Trend Information” for certain information on our firm orders and options.

 

     At and for the year ended December 31,  
     2011      2010      2009  

Commercial Aviation

        

Deliveries

     105         100         122   

ERJ 145

     2         6         7   

EMBRAER 170(1)

     1         9/2         22   

EMBRAER 175

     10         8         11   

EMBRAER 190

     68         58         62   

EMBRAER 195

     24         17         20   

Defense and Security(2)

        

Deliveries

     —           2         7   

Executive Aviation

        

Deliveries

     99         144         115   

Other Operating Information

        

Total Backlog (in millions)

   US$ 15,441.2       US$ 15,543.2       US$ 16,634.8   

 

(1) Figures appearing after a forward slash (/) refer to aircraft delivered under operating leases.
(2) Includes only aircraft delivered to state-owned airlines and for government transportation and, therefore, excludes deliveries of Tucano family aircraft, as such aircraft are not for transportation purposes.

Revenue

We generate revenue primarily from sales of commercial and executive aircraft products. We also generate revenue from the sale of defense aircraft and systems. Of total revenues, 85.4 % are generated through aircraft sales. Revenue arising from the sale of commercial and executive aircraft is denominated in U.S. dollars. In 2011, total defense and security revenue included 46.2% of revenue denominated in foreign currency, predominantly in U.S. dollars, and 53.2% denominated in Brazilian reais. In addition, we generate revenue from our aviation services which include after-sales support (including the sale of spare parts, maintenance and repair, training and other product support services). In 2011, total aviation services revenue included 90.1% of revenue denominated in U.S. dollars and other foreign currencies and 9.9% in Brazilian reais. Finally, we generate revenue from our other related businesses, which include single-source supply of structural parts and mechanical and hydraulic systems to other aircraft manufacturers.

We generally recognize revenue for the sale of our commercial and executive aircraft when the aircraft is delivered to the customer. We customarily receive a deposit upon signing of the purchase agreement for the sale of our commercial aircraft and progress payments in the amount of 5% of the sales price of the aircraft 18 months, 12 months and six months before scheduled delivery. We receive a 5% deposit upon signing of a purchase agreement for our executive aircraft and an additional deposit of 30% to 50% of the purchase price prior to delivery, depending on the specific terms of the purchase agreement and the aircraft sold. For the EMBRAER 170/190 jet family, we receive an additional 5% progress payment 24 months before scheduled delivery. We typically receive the remaining amount of the sales price upon delivery. Payments in advance of delivery are recorded under advances from customers as a liability on our balance sheet and, when we deliver the aircraft, these payments are recorded against trade account receivables of such aircraft. See “Item 5A.—Operating Results—Critical Accounting Estimates—Sales and Other Operating Revenues.”

 

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Our sales contracts with our customers typically include adjustments to the purchase price of the aircraft based on an escalation formula which is based on a mix of indices related to raw material and labor costs. The deposits, progress payments and option payments are nonrefundable for the most part. Once a customer decides to exercise an option, we account for it as a firm order, and we begin to receive progress payments and recognize revenue upon delivery as discussed above.

We recognize revenue from the sale of our defense aircraft, including the research and development for specific programs, in accordance with the percentage of completion method. Certain contracts contain provisions for the redetermination of price based upon future economic conditions. Our defense customers continue to provide customer advances, which are converted into revenue as we fulfill pre-determined stages of completion of the project, such as conception, development and design, and engineering, systems integration and customization. These installments are nonrefundable for the most part.

Cost of Sales and Services

Cost of sales and services consist of the cost of the aircraft, spare parts and services rendered, comprising:

 

   

Raw materials. Substantially all materials costs are covered by contracts with suppliers. Prices under these contracts are generally adjusted based on an escalation formula which reflects, in part, inflation in the United States.

 

   

Labor. These costs are primarily real-denominated.

 

   

Depreciation. Property, plant and equipment is depreciated over their useful lives, ranging from five to 48 years, on a straight-line basis. On average, property, plant and equipment is depreciated over 16 years. Depreciation of aircraft under operating leases is recorded in cost of sales and services from the beginning of the lease term using the straight-line method over the estimated useful life and considering a residual value at the end of the lease term.

 

   

Amortization: Internally-generated intangible assets are amortized in accordance with the estimated sales of the series of aircraft. Intangible assets acquired from third parties are amortized on straight-line bases over the estimated useful lives of the assets.

In accordance with the accounting standard for contingencies, we accrue a liability for the obligations associated with product warranties at the aircraft delivery date, which is estimated based on historical experience and recorded in cost of sales and services.

We enter into transactions that represent multiple-element arrangements, such as training, technical assistance, spare parts and other concessions. These costs are recognized when the product or service is provided to the customer.

Recent Developments

In January 27, 2012, we signed an agreement to acquire 30% of the shares representing the capital of AIRHOLDING, from EADS. AIRHOLDING is a consortium formed in 2005 by Embraer and EADS, incorporated in Portugal with the specific purpose of holding a 65% stake in OGMA. Under this new agreement, Embraer acquired control over AIRHOLDING, while the Portuguese government holds the remaining 35% of the shares of OGMA through EMPORDEF – Portuguese Defense Company.

In December, 2011, the U.S. Air Force, or USAF, announced that it had selected the Super Tucano for the Light Air Support (LAS) program. The aircraft would be supplied in partnership with Sierra Nevada Corporation (SNC) as the prime contractor. However, in February, 2012, the USAF set aside the awarded contract. We will await further clarification in connection with this issue in order to determine the next steps to be taken.

In April 2012, we entered into a cooperation agreement with Boeing, in which we agreed to pursue several areas of cooperation, including commercial aircraft features that enhance safety and efficiency, research and technology and sustainable aviation biofuels.

 

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Backlog

Overview

We continue to implement improvements to our industrial processes, reaffirming the commitment made to our shareholders, customers and suppliers. We currently maintain our estimates to deliver 105 commercial aircraft, 75 light executive jets and 15 large executive jets during 2012.

Results of Operations

The following table presents statement of income data by business segment for the periods indicated:

 

     Year ended December 31,  
     2011     2010
(reclassified)
    2009
(reclassified)
 
     (in US$ millions)  

Revenue

  

Commercial aviation

     3,714.1        3,257.9        3,785.7   

Executive aviation

     1,113.7        1,209.5        936.9   

Defense and security

     851.9        821.8        677.8   

Other related businesses

     123.3        74.9        97.4   
  

 

 

   

 

 

   

 

 

 

Total

     5,803.0        5,364.1        5,497.8   

Cost of sales and services

  

Commercial aviation

     (2,895.8     (2,680.8     (3,072.2

Executive aviation

     (882.5     (987.3     (750.8

Defense and security

     (644.5     (599.5     (520.1

Other related businesses

     (73.1     (70.5     (85.3
  

 

 

   

 

 

   

 

 

 

Total

     (4,495.9     (4,338.1     (4,428.4

Gross profit

  

Commercial aviation

     818.3        577.1        713.5   

Executive aviation

     231.2        222.2        186.1   

Defense and security

     207.4        222.3        157.7   

Other related businesses

     50.2        4.4        12.1   
  

 

 

   

 

 

   

 

 

 

Total

     1,307.1        1,026.0        1,069.4   

Operating expenses

  

Commercial aviation

     (672.5     (345.3     (400.0

Executive aviation

     (174.8     (142.3     (172.9

Defense and security

     (125.5     (115.6     (89.6

Other related businesses

     (16.1     (31.1     (27.5
  

 

 

   

 

 

   

 

 

 

Total

     (988.9     (634.3     (690.0
  

 

 

   

 

 

   

 

 

 

Operating profit before finance income (expense)

     318.2        391.7        379.4   
  

 

 

   

 

 

   

 

 

 

The following table sets forth statement of income information, and such information as a percentage of our revenue, for the periods indicated:

 

     Year ended December 31,  
      2011     2010     2009  
     (in US$ millions, except percentages)  

Consolidated Statements of Income

  

Revenue

     5,803.0        100.0     5,364.1        100.0     5,497.8        100.0

Cost of sales and services

     (4,495.9     77.5        (4,338.1     80.9        (4,428.4     80.5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     1,307.1        22.5        1,026.0        19.1        1,069.4        19.5   

Operating income (expense)

            

Administrative

     (262.5     4.5        (197.5     3.7        (191.3     3.5   

Selling

     (419.3     7.2        (374.1     7.0        (304.6     5.5   

Research

     (85.3     1.5        (72.1     1.3        (55.6     1.0   

Other operating (expense) income, net

     (221.5     3.8        9.4        0.2        (138.5     2.5   

Equity

     (0.3     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating profit before financial income (expense)

     318.2        5.5        391.7        7.3        379.4        6.9   

Financial expenses, net

     (90.7     1.6        17.5        0.3        10.2        0.2   

Foreign exchange gain (loss), net

     20.0        0.3        (1.1     —          (68.8     1.3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit before taxes on income

     247.5        4.3        408.1        7.6        320.8        5.8   

Income taxes expense (benefit)

     (127.1     2.2        (62.7     1.2        158.1        2.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     120.4        2.1        345.4        6.4        478.9        8.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Attributable to:

            

Owners of Embraer

     111.6        1.9        330.2        6.2        465.2        8.5   

Noncontrolling interest

     8.8        0.2        15.2        0.2        13.7        0.2   

 

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2011 Compared with 2010

Revenue

Revenue increased 8.2%, to US$5,803.0 million in 2011 from US$5,364.1 million in 2010. Revenue in the commercial aviation segment increased 14.0%, to US$3,714.1 million in 2011 from US$3,257.9 million in 2010. Executive aviation revenues decreased 7.9%, to US$1,113.7 million in 2011, from US$ 1,209.5 million in 2010. Defense and security revenues increased by 3.7%, to US$851.9 million in 2011 from US$821.8 million in 2010. Other related businesses revenue increased 64.6%, to US$123.3 million in 2011 from US$74.9 million in 2010. Total service revenues, included in our commercial aviation, executive aviation and defense and security segments, described above, reached US$657.4 million in 2011, compared to US$563.7 million in 2010.

The increase in revenue in the commercial aviation segment is primarily a consequence of increased deliveries in this segment in 2011, coupled with a better product mix. We delivered 105 commercial aircraft in 2011 as compared to 100 aircraft in that segment in 2010, an increase of 5 commercial aircraft, or 5%. We delivered a total of 92 EMBRAER 190/195 aircraft in 2011, compared to 75 aircraft of the same models in 2010. The increase in the number of deliveries in the commercial aviation segment in 2011 reflects the market recovery that continued to take place in this segment through 2011. On the other hand, the decrease in executive aviation revenues is a result of the continued pressures faced in this segment throughout 2011, which resulted in a reduction of 31.3% in deliveries of executive jets in 2011, or 45 jets, to 99 executive jets in 2011 (including 13 Legacy 600/650, 41 Phenom 100, 42 Phenom 300 and three Lineage 1000) from 144 in 2010 (including 10 Legacy 600/650, 100 Phenom 100, 26 Phenom 300, eight Lineage 1000 and Embraer 190 Shuttle). As a consequence of the aircraft deliveries that took place in 2011, coupled with the on-going utilization of the installed fleet, revenues from services increased 16.6% in 2011 when compared to 2010. Defense and security revenues remained stable, primarily as a result of the mix of revenues from the business. In 2010, we delivered an unusually high number of Super Tucano aircraft, which came down to a more normal level in 2011. However, this decrease was offset by an increase in revenues from other products in this segment, primarily the KC-390.

Cost of Sales and Services

Cost of sales and services increased 3.6%, to US$4,495.9 million in 2011 from US$4,338.1 million in 2010, below the 8.2% increase in revenue during 2011. Cost of sales and services as a percentage of revenue decreased to 77.5% in 2011, from 80.9% in 2010. These reductions in cost of sales and services are a result of a more favorable product and revenue mix in 2011, as well as our ongoing efforts to improve efficiency and productivity.

Cost of sales and services in the commercial aviation segment increased 8.0%, to US$2,895.8 million in 2011 from US$2680.8 million in 2010, in line with the increase of 14.0% in revenues in this segment, since most of our commercial aviation costs are variable. Cost of sales and services in the executive aviation segment was reduced by 10.6%, to US$882.5 million in 2011 from US$987.3 million in 2010, in line with the 7.9% decrease in revenues for this segment, since most of our executive aviation costs are variable. Cost of sales and services in the defense segment increased slightly by 7.5% to US$644.5 million in 2011 from US$599.5 million in 2010, while revenues in this segment increased by 3.7%. This increase comes primarily as a result of the different revenue and product mix

 

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delivered in this segment. Cost of sales and services in other related businesses increased 3.7%, to US$73.1 million in 2011 from US$70.5 million in 2010, while revenues for this segment increased 64.6%. Total cost of sales and services related to revenues from services, which are included in the revenue of our commercial aviation, executive aviation and defense and security segments, described above, totaled US$411.8 million in 2011, compared to US$403.5 million in 2010.

Gross Profit

As a result of the foregoing factors, our gross profit increased 27.4%, to US$1,307.1 million in 2011 from US$1,026.0 million in 2010. Our gross margin also increased to 22.5% in 2011 from 19.1% in 2010.

Operating Income (Expense)

As further discussed below, operating expense increased 55.9%, to US$988.9 million in 2011 from US$634.3 million in 2010. Operating expenses as a percentage of revenue increased to 17% in 2011 from 11.8% in 2010. This increase comes primarily as a result of non-recurring events, which totaled US$317.5 million in 2011, related to provisions of financial guarantees and residual value guarantee obligations and the effects from the American Airlines Chapter 11 filing in these obligations (see Note 38 to our audited consolidated financial statements for further information on these non-recurring events). Furthermore, we continued to make investments throughout 2011 to develop our customer support network, especially in the executive aviation segment, and have implemented changes in the defense and security organization, as well as intensified our efforts to define the product strategy in our commercial aviation segment, all of which impacted our Selling and Administrative expenses for the year.

In addition to the events mentioned above, this increase was also caused by the increase in real denominated expenses (primarily labor expenses), resulting from the appreciation of the real against the U.S. dollar of 12.6%, coupled with an increase of approximately 10% in wages at the end of 2010, as result of the annual settlement between the labor union and our company. See “Item 5A. Operating and Financial Review and Prospects—Operating Results—Brazilian Economic Environment.”

Administrative. Administrative expenses increased, by 32.9%, to US$262.5 million in 2011 from US$197.5 million in 2010, primarily as a result of the items mentioned above.

Research. Research expenses increased 18.3%, to US$85.3 million in 2011 from US$72.1 million in 2010. This increase is explained mainly by additional research efforts related to product strategy services, primarily in the commercial aviation segment as well as the impact explained under Operating Income (expense).

Selling. Selling expenses increased 12.1%, to US$419.3 million in 2011 from US$374.1 million in 2010. This increase is due mainly to Embraer’s efforts to take advantage of market improvements to generate sales, and as our worldwide fleet continued to grow through 2011, mainly in the executive aviation market, its customer support infrastructure was scaled upwards to support such fleet growth. Additionally, selling expenses were affected by the number of aircraft deliveries and product mix.

Other operating (expense) income, net. Other operating (expense) income, net decreased to net other operating expense of US$221.5 million in 2011 from net other operating income of US$9.4 million in 2010, primarily due to the effects of the non-recurring events in connection with the provisions of financial guarantees and residual value guarantee obligations and the effects from the American Airlines Chapter 11 bankruptcy filing in these obligations See Note 38 to our audited consolidated financial statements for further information on these non-recurring events.

Equity. In August of 2011, through our wholly-owned subsidiary in the United States of America, Embraer Aircraft Holding, Inc., we acquired a non-controlling stake in Aero Seating Technologies LLC (AST). Since we do not hold a controlling stake, under IFRS, we do not consolidate AST’s results and are required to show these results under equity method. Therefore, there are no comparative figures for equity in 2010 and 2009. In 2011, equity totaled negative US$0.3 million.

 

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Operating Profit before financial income (expense)

As a result of the foregoing factors, our consolidated operating profit decreased 18.7%, to US$318.2 million in 2011 from US$391.7 million in 2010. Our operating margin decreased to 5.5% in 2011 from 7.3% in 2010.

Operating profit by segment for 2011 for the commercial aviation, executive aviation, defense and security and others segments was US$145.8 million, US$56.4 million and US$81.9 million and US$34.1 million, respectively. For 2010, the respective operating profit (loss) for these segments was US$231.8 million, US$79.9 million, US$106.7 million and negative US$26.7 million. See Note 42 to our audited consolidated financial statements for operating profit by segment. Total operating profit related to revenues from services, which are included in the revenue of our commercial aviation, executive aviation and defense and security segments described above, totaled US$245.6 million and US$160.3 million for 2011 and 2010, respectively.

Financial Income (Expense), Net

Financial income (expense), net, decreased to net financial expense of US$90.7 million in 2011 compared to net financial income of US$17.5 million in 2010, a 518.3% decrease in net financial income (expense), primarily as a result of the effects of the non-recurring events in connection with the provisions of residual value guarantee obligations mainly related to the American Airlines Chapter 11 bankruptcy filing. See Note 38 to our audited consolidated financial statements for further information on these non-recurring events.

If not for such non-recurring events, our 2011 financial income (expense), net, would have been a net financial income of US$16.7 million.

Foreign Exchange Gain (Loss), Net

Foreign exchange gain, net increased to US$20.0 million in 2011 from a net foreign exchange loss of US$1.1 million in 2010, reflecting net foreign exchange rate changes on monetary assets and liabilities denominated in other currencies which are translated into our functional currency, the U.S. dollar.

Profit Before Taxes on Income

As a result of the foregoing factors, profit before taxes on income decreased 39.3%, to US$247.7 million in 2011 from US$408.1 million in 2010.

Income Taxes Benefit (Expense)

Income taxes represented an expense of US$127.1 million in 2011, compared to an expense of US$62.7 million in 2010, mainly as a result of the effects of foreign exchange changes on our nonmonetary assets.

Our effective tax rate increased to 51.4% in 2011 compared to an effective tax credit rate of 15.4% of our profit before taxes on income in 2010, due to the impact of the exchange rate variation on the tax base of non-monetary assets (inventories, property, plant and equipment and intangible assets) unrealized at the year-end and the tax on profits of overseas subsidiaries.

Net Income

As a result of the foregoing factors, our net income after taxes decreased 65.1% to US$120.4 million in 2011 from US$345.4 million in 2010. As a percent of revenue, net income after taxes decreased to 2.1% in 2011 from 6.4% in 2010.

2010 Compared with 2009

In 2011, we changed our segment presentation to absorb our Aviation Services segment back into our business segments: Commercial aviation, Executive aviation and Defense and security.

The operating leases previously allocated to Others were also aggregated to the business units. This change was made to report the results of operations of the business segments in a manner consistent with the manner that we have managed them as from 2011. Prior year presentations have been restated to reflect these classifications. The

 

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amounts that are not directly recorded to the business segments are allocated based on the criteria deemed appropriate by our management. For further information, see Note 42 to our audited consolidated financial statements.

Revenue

Revenue decreased 2.4% to US$5,364.1 million in 2010 from US$5,497.8 million in 2009. Revenue in the commercial aviation segment decreased 13.9% to US$3,257.9 in 2010 from US$3,785.7 million in 2009. Revenue in the executive aviation segment increased 29.1% to US$1,209.5 in 2010 from US$936.9 million in 2009. Defense revenue increased 21.2% to US$821.8 in 2010 from US$677.8 million in 2009. Other related businesses revenue decreased 23.1% to US$74.9 in 2010 from US$97.4 million in 2009. Total service revenues, included in our commercial aviation, executive aviation and defense and security segments, described above, reached US$567.3 million, compared to US$604.6 million in 2009.

The decrease in revenue in the commercial aviation revenue is primarily a consequence of reduced deliveries in this segment in 2010. We delivered 100 commercial aircraft in 2010 as compared to 122 aircraft in that segment in 2009, a decrease of 22 commercial aircraft, or 18%. The decrease in the number of deliveries in the commercial aviation segment in 2010 reflects the effects of the recent financial crisis and its ongoing impacts on the global airline business, which in turn affected demand for commercial aircraft. The increase in executive aviation revenue resulted from a 25.2% increase in deliveries of executive jets in 2010, or 29 jets, to 144 executive jets in 2010 (including 10 Legacy 600/650, 100 Phenom 100, 26 Phenom 300 and five Lineage 1000 and three Embraer 190 Shuttle) from 115 in 2009 (including 18 Legacy 600, 93 Phenom 100, one Phenom 300 and three Lineage 1000). The increase in defense and security revenue is mainly a result of an atypical delivery schedule for Super Tucanos in 2010, resulting in more Super Tucanos being delivered in that year than in previous years.

Cost of Sales and Services

Cost of sales decreased 2.0% to US$4,338.1 million in 2010 from US$4,428.4 million in 2009, in line with the 2.4% decrease in revenue during 2010. Cost of sales and services as a percentage of revenue increased slightly to 80.9% in 2010 from 80.5% in 2009.

Cost of sales and services in the commercial aviation segment decreased 12.7% to US$2,680.8 million in 2010 from US$3,072.2 million in 2009, in line with the reduction in sales for this segment, since most of our commercial aviation costs are variable. Cost of sales and services in the executive aviation segment increased 31.5% to US$987.3 million in 2010 from US$750.8 million in 2009. This increase in cost of sales and services at a higher rate than the increase in revenue in the executive aviation segment is mainly a result of the addition of new aircraft (particularly the Phenom 300) to our executive aviation assembly line, which is associated with an inherent assembly learning curve that is overcome with time, as the production process of this aircraft becomes more efficient. An increase in deliveries of the Lineage 1000 and Embraer 190 shuttle also contributed to the increase in cost of sales and services in the executive aviation segment. Cost of sales and services in the defense segment increased 15.3% to US$599.5 million in 2010 from US$520.1 million in 2009, which is also a result of higher Super Tucano deliveries in 2010. Cost of sales and services in other related businesses decreased 17.4% to US$70.5 million in 2010 from US$85.3 million in 2009 in line with the decrease in revenue from that business segment. Total cost of sales and services related to revenues from services, which are included in the revenue of our commercial aviation, executive aviation and defense and security segments, described above, totaled US$403.5 million in 2010, compared to US$427.4 million in 2009.

Gross Profit

As a result of the foregoing, factors our gross profit decreased 4.1% to US$1,026.0 million in 2010 from US$1,069.4 million in 2009. Our gross margin slightly decreased to 19.1% in 2010 from 19.5% in 2009.

Operating Income (Expense)

As further explained below, operating expense decreased 8.1% to US$634.3 million in 2010 from US$690.0 million in 2009. Operating expenses as a percentage of revenue decreased to 11.8% in 2010 from 12.6% in 2009. See Note 42 to our audited consolidated financial statements for operating profit by segment. The operating profit for services decreased 9.5% to US$160.3 in 2010 from US$177.2 in 2009.

 

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Administrative. Administrative expenses increased slightly, 3.2%, to US$197.5 million in 2010 from US$191.3 million in 2009. This increase is mainly caused by increased costs associated with the appreciation of the real against the U.S. dollar, which were partially offset by cost reduction attributable to more efficient administrative routines.

Research. Research expenses increased 29.7% to US$72.1 million in 2010 from US$55.6 million in 2009. This increase is explained mainly because research projects entered into experimental stages, which demand more resources.

Selling. Selling expenses increased 22.8% to US$374.1 million in 2010 from US$304.6 million in 2009. This increase is due mainly to Embraer’s efforts to take advantage of market improvements to generate sales, and as our worldwide fleet continued to grow through 2010, mainly in the executive aviation market, its customer support infrastructure was scaled upwards to support such fleet growth.

Other operating (expense) income, net. Other operating (expense) income, net increased to net other operating income of US$9.4 million in 2010 from net other operating expense of US$138.5 million in 2009, mainly due to the fact that in 2010 there was no similar charge against income as the US$103 million provision made by us in connection with the Mesa Air Group bankruptcy Chapter 11 filling in January 2010 for which the impairment charge was recorded in 2009. See Note 38 to our audited consolidated financial statements.

Operating Profit before financial income (expense)

As a result of the foregoing factors, operating profit increased 3.2% to US$391.7 million in 2010 from US$379.4 million in 2009. Our operating margin increased to 7.3% in 2010 from 6.9% in 2009.

Operating profit (loss) by segment for 2010 for the commercial aviation, executive aviation, defense and security and others segments was US$231.8 million, US$79.9 million and US$106.7 million and negative US$26.7 million, respectively. For 2009, the respective operating profit (loss) by segment was US$313.5 million, US$13.2 million, US$68.1 million and negative US$15.4 million. See Note 42 to our audited consolidated financial statements for operating profit by segment. Total operating profit related to revenues from services, which is included in the revenue of our commercial aviation, executive aviation and defense and security segments described above, totaled US$160.3 million and US$177.2 million for 2010 and 2009, respectively.

Financial Expense, Net

Financial expense, net, increased to net financial income of US$17.5 million in 2010 compared to net financial income of US$10.2 million in 2009, a 71.6% increase in net financial income, primarily as a result of (1) the effective management of our indebtedness, resulting in a 66.9% decrease in our short-term loans and financings to a weighted averaged of US$235.6 million in short-term loans and financings during 2010 from a weighted average of US$711.4 million during 2009, thereby further reducing our financial expenses in 2010, (2) the appreciation of the real relative to the U.S. dollar in 2010, which enhanced our financial income from our investment of real-denominated cash and cash equivalents in 2010 and (3) higher interest rates in Brazil in 2010 which provided additional financial income on our investments of our cash and cash equivalents.

Foreign Exchange Gain (Loss), Net

Foreign exchange loss, net decreased to US$1.1 million in 2010 from a net foreign exchange loss of US$68.8 million in 2009, reflecting net foreign exchange rate changes on monetary assets and liabilities denominated in other currencies which are translated into our functional currency, the U.S. dollar.

Profit Before Taxes on Income

As a result of the foregoing factors, profit before taxes on income increased 27.2% to US$408.1 million in 2010 from US$320.8 million in 2009.

 

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Income Taxes Benefit (Expense)

Income taxes represented an expense of US$62.7 million in 2010 compared to a tax credit of US$158.1 million in 2009, mainly as a result of the effects of foreign exchange changes on our nonmonetary assets.

Our effective tax rate increased to 15.4% in 2010 compared to an effective tax credit rate of 49.3% of our profit before taxes on income in 2009.

Net Income

As a result of the foregoing factors, our net income after taxes decreased 27.9% to US$345.4 million in 2010 from US$478.9 million in 2009. As a percent of revenue, net income after taxes decreased to 6.4% in 2010 from 8.7% in 2009.

 

5B. Liquidity and Capital Resources

Overview

Our liquidity needs arise principally from research, capital expenditures, principal and interest payments on our debt, working capital requirements and distributions to shareholders. We generally rely on funds provided by operations, borrowings under our credit arrangements, cash contributions from risk-sharing partners, advance payments from customers and, to a lesser extent, issuance of debt and equity securities in the capital markets in order to meet these needs. For further information, see “Item 4B. Information on the Company—Business Overview—Suppliers and Components; Risk-Sharing Arrangements” and “Item 4B. Information on the Company—Business Overview—Commercial Aviation Business—Production, New Orders and Options” and “—Credit Facilities and Lines of Credit.”

As of the date of this annual report, we believe that our traditional sources of funds are sufficient to meet our foreseeable working capital requirements, including to (1) continue to improve the EMBRAER 170/190 jet family, the Phenom 100, the Phenom 300 and the Lineage 1000 executive jets, (2) further develop our new Legacy 450/500/650 executive jets, (3) make other planned capital expenditures and (4) pay dividends and interest on shareholders’ equity. At this point, our access to liquidity sources has not been materially impacted by the current credit environment, and we do not expect that such access will be materially impacted in the near future. However, there can be no assurance that our traditional sources of funds, or that the cost or availability of our credit facilities or future borrowing sources, will not be materially impacted by the ongoing market disruptions.

Our customers may reschedule deliveries, fail to exercise options or cancel firm orders as a result of the economic downturn and the financial volatility in the commercial airline industry. In addition, our risk-sharing partners’ cash contributions are refundable under certain limited circumstances and we may need to find replacement sources of capital.

Net Cash Generated by Operating Activities and Working Capital

2011

In 2011, net cash generated by operating activities was US$480.2 million, compared to net cash generated by operating activities of US$873.8 million in 2010. The decrease in the inflow of cash generated by operating activities in 2011 is primarily a result of lower net income and changes in financial assets of US$124.3 million.

We had working capital of US$2,327.7 million at December 31, 2011 and US$2,594.1 million at December 31, 2010. Our working capital needs decreased in 2011, as a result of an increase in loans and financing coupled with an increase in non-recourse and recourse debt.

2010

In 2010, net cash generated by operating activities was US$873.8 million compared to net cash generated by operating activities of US$3.6 million in 2009. The increase in the inflow of cash generated by operating activities in 2010 is primarily a result of a reduction in financial assets variations (especially U.S.-indexed investments), a reduction in inventory and an increase in trade accounts payable.

 

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We had working capital of US$2,594.1 million at December 31, 2010 and US$2,892.1 million at December 31, 2009. Our working capital needs decreased in 2010, for the same reasons that explain the increase in cash inflow from operating activities in 2010, as previously explained.

Net Cash Used in Investing Activities

2011

In 2011, net cash used in investing activities was US$602.0 million, compared to net cash used in investing activities of US$288.3 million in 2010.

We experienced an outflow of cash to investing activities in 2011, mainly as a result of a increase in investments in intangible assets and property, plant and equipment.

2010

In 2010, net cash used in investing activities was US$288.3 million compared to net cash used in investing activities of US$378.0 million in 2009.

We experienced an outflow of cash to investing activities in 2010 mainly as a result of a decrease in investments in intangible assets and property, plant and equipment.

Net Cash Generated by (Used in) Financing Activities and Total Debt

2011

In 2011, net cash generated by financing activities was US$96.4 million, compared to net cash used in financing activities of US$802.2 million in 2010. During 2011, we raised new financings of US$2,362.5 million compared to new borrowings of US$942.8 million in 2010. Furthermore, we also repaid US$2,082.7 million of our indebtedness in 2011 compared to debt repayments in the aggregate amount of US$1,583.4 million in 2010. In 2011, we distributed US$183.4 million in interest on shareholders’ equity or dividends compared to US$161.6 million in 2010. In 2011, like in 2010, we did not spend any amounts in connection with share buyback programs.

At December 31, 2011, we had total debt of US$1,658.1 million under our financing arrangements described below, 84.8% of which was long-term debt and 15.2% of which consisted of short-term debt. In comparison, we had total debt of US$1,434.8 million at December 31, 2010, consisting of 94.9% of long-term debt. Our total debt increase in 2011 in comparison with 2010, largely due to an increase in expenditures related to research and product development coupled with capital expenditures.

2010

In 2010, net cash used in financing activities was US$802.2 million compared to net cash used in financing activities of US$23.9 million in 2009. During 2010, we raised new financings of US$942.8 million compared to new borrowings of US$1,474.6 million in 2009. Furthermore, we also repaid US$1,583.4 million of our indebtedness in 2010 compared to debt repayments in the aggregate amount of US$1,498.5 million in 2009. In 2010, we distributed US$161.6 million in interest on shareholders’ equity or dividends compared to no such distributions in 2009. In 2010, like in 2009, we did not spend any amounts in connection with share buyback programs.

At December 31, 2010, we had total debt of US$1,434.8 million under our financing arrangements described below, 94.9% of which was long-term debt and 5.1% of which consisted of short-term debt. In comparison, we had total debt of US$2,058.3 million at December 31, 2009, consisting of 71.2% of long-term debt. Our total debt decreased in 2010 in comparison with 2009 largely due to short-term debts payments and the renegotiation, in September 2010, of the our standby syndicated credit line. The renegotiation involved the prepayment of US$250 million borrowed in March and April 2009, which was originally scheduled to expire in March and April 2011, respectively.

 

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Credit Facilities and Lines of Credit

Long-term Facilities

In October 2006, our wholly owned finance subsidiary, Embraer Overseas Limited, or Embraer Overseas, issued US$400 million 6.375% guaranteed notes due 2017 and, as of December 31, 2011, US$386.5 million was outstanding (US$10.6 million in the short-term), including principal and accrued interest. Interest will be paid semiannually. The notes are unconditionally guaranteed by us. The notes have been listed on the Luxembourg Stock Exchange. On April 5, 2007, we and Embraer Overseas commenced an exchange offer to exchange the notes for new notes registered with the SEC. The exchange offer was successfully completed as of May 18, 2007 and, as a consequence, US$376.3 million or approximately 95% of the notes were registered. The indenture under which the notes were issued contains customary covenants and restrictions such as limitation on liens, consolidation, merger or transfer of assets. By December 31, 2011, Embraer had repurchased and canceled 19,908 (5.0%) of these bonds, totaling US$15.2 million, with a face value of US$19.9 million. These bonds were purchased by Embraer Overseas through open market transactions.

In November 2006, December 2007 and October 2008, we entered into certain credit facilities in the aggregate amount of US$60.0 million with the FINEP to support the research and development expenses of the Phenom 100 and Phenom 300 aircraft, which were totally disbursed in 2007. The facility bears interest at TJLP plus 5.0% per annum and is fully secured by a pledge of certain machines and equipment and by a bank standby letter of credit. The credit facility is repayable from December 2008 to December 2015. As of December 31, 2011, we had outstanding US$33.2 million under our credit facilities with the FINEP, of which US$12.7 million is due in the short-term, including principal and accrued interest. The FINEP credit facilities are denominated in reais, and amounts appearing herein have been converted into U.S. dollars, our functional currency, for purposes of preparing our IFRS financial statements.

In August and September 2009, August 2010 and June 2011, we entered into various credit agreements with the BNDES for a long-term pre-export credit financing. At December 31, 2011, we have US$405.1 million outstanding under these arrangements, of which US$165.2 million is due in the short-term, including principal and accrued interest, bearing a fixed interest rate of 4.5% to 9.0% per annum with final maturity on June 17, 2013. These BNDES credit facilities are denominated in reais, and amounts appearing herein have been converted into U.S. dollars, our functional currency, for purposes of preparing our IFRS financial statements.

In October 2009, Embraer Overseas issued US$500 million 6.375% guaranteed notes due 2020 and, as of December 31, 2011, US$503.7 million was outstanding (US$7.3 million in the short-term), including principal and accrued interest. Interest will be paid semiannually. The notes are unconditionally guaranteed by us. The notes have been registered with the SEC and listed on the New York Stock Exchange. The indenture under which the notes were issued contains customary covenants and restrictions such as limitation on liens, consolidation, merger or transfer of assets.

We may from time to time seek to retire or purchase our outstanding debt, including our guaranteed notes due 2017 and 2020, through cash purchases and/or exchanges for other securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material, and notes repurchased may be cancelled or resold, but will only be resold in compliance with applicable requirements or exemptions under the relevant securities laws.

In September 2010, we renegotiated the stand by credit agreements that we had entered into in August 2006 with Banco BNP Paribas, in each case as administrative agent for the lenders, in an aggregate amount of US$1.0 billion. Each drawdown is fully repayable in two years from the borrowing date. The first loan, a secured export finance with two years availability period expiring in September 2012, has not yet been disbursed and provides for US$500.0 million in loans for export purposes. The loan shall bear interest on the outstanding principal amount thereof for each interest period at a rate per annum equal to LIBOR for such interest period plus 1.65% per annum. The other loan, a working capital facility credit agreement, segregated in two tranches with two-year availability periods expiring in September, 2012, provides US$500.0 million as working capital, and has also not yet been disbursed. This working capital credit facility will bear interest on the outstanding principal amount thereof for each interest period at a rate per annum equal to LIBOR for such interest period plus 1.85% per annum. We record the

 

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commitment fees for these credit facilities as a financial expense. Both loans contain customary covenants and restrictions, including, but not limited to, those that require us to maintain defined debt liquidity and interest expense coverage ratios. As at December 31, 2011, no disbursement had been made under these facilities.

In March 2011, we entered into certain credit facilities with the FINEP in the aggregate amount of US$50.0 million, to support the research and development expenses of the Legacy 500 aircraft, all of which were totally disbursed in 2011. The facility bears interest at 3.5% per annum and is fully secured by a pledge of certain machines and equipment and by a bank standby letter of credit. The credit facility is repayable from May 2013 to April 2018. As of December 31, 2011, we had US$50.1 million outstanding under our credit facilities with the FINEP, of which US$0.1 million is due in the short-term, including principal and accrued interest. The FINEP credit facilities are denominated in reais, and amounts appearing herein have been converted into U.S. dollars, our functional currency, for purposes of preparing our IFRS financial statements.

In March 2011, we entered into certain credit facilities with the BNDES in the aggregate amount of US$247.9 million, to support the research and development expenses of the Legacy 500 aircraft, including conceptual study and project and development, which were totally disbursed in 2013. The facility bears interest at TJLP plus 1.92% and 3.5% to 4.5% per annum and is fully secured by a pledge of certain machines and equipment and by a bank standby letter of credit. The credit facility is repayable from May 2013 to April 2018. As of December 31, 2011, we had US$121.4 million outstanding under our credit facilities with the BNDES, of which US$0.9 million is due in the short-term, including principal and accrued interest. The BNDES credit facilities are denominated in reais, and amounts appearing herein have been converted into U.S. dollars, our functional currency, for purposes of preparing our IFRS financial statements.

In March 2012, we signed a contract for a non-reimbursable revolving credit line with four financial institutions of the Brazilian market in the total aggregate amount of R$1 billion, equivalent to US$533 million, with maturity on March 8, 2015. Each institution committed R$250 million, and we may disburse up to the total amount between March 9, 2012 and February 7, 2015. This working capital credit facility will bear interest on the disbursed outstanding principal amount at a rate per annum equal to the CDI (Brazilian Federal Government Rate) plus 1.30% per annum. The maintenance costs will be included in the financial result of Company.

We have various other long-term loans and credit agreements with aggregate outstanding borrowings of US$114.9 million at December 31, 2011. See Note 19 to our audited consolidated financial statements for further information on these financing arrangements.

Some of our long-term financing agreements include customary covenants and restrictions, including those that require us to maintain: (1) a maximum leverage ratio, calculated as net debt to earnings before interest, taxes, depreciation and amortization, or EBITDA, of 3.5:1 and (2) a minimum net debt service coverage ratio, calculated as EBITDA to financial expenses, of 2.25:1. Other restrictions included in our long-term financings include negative pledge covenants and restrictions on significant changes in control, sales of substantially all of our assets, dividend payments during events of default and certain transactions with our affiliates. As of December 31, 2011, we were in compliance with all restrictive covenants contained in our financing agreements.

At December 31, 2011, US$215.6 million of our total debt was secured by a combination of mortgages on certain of our real estate, liens on certain of our machinery and equipment and by an escrow account.

Short-term Facilities

We have various short-term loans and credit agreements with aggregate outstanding borrowings of US$251.8 million at December 31, 2011. See Note 19 to our audited consolidated financial statements for further information on our short-term financing arrangements.

Accounting Pronouncements Not Yet Adopted

The following standards and amendments to the existing standards have been issued and are mandatory for accounting periods beginning on or after January 1, 2013 and for subsequent periods. These standards and amendments have not been early adopted by us.

 

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In June 2011, the IASB issued a revised accounting standard on “Employee benefits”, or IAS 19. The main changes included in this standard are (i) elimination of the corridor approach, (ii) recognition of actuarial gains or losses in Other comprehensive income as they occur, (iii) immediate recognition of past services in the income statement and (iv) substitution of expected participation cost and return over the plan assets for a net participation amount. This new accounting standard applies as from January 1, 2013. We do not expect this change impact the financial statements.

In November 2009 and October 2010 the IASB issued a new accounting standard on “Financial Instruments” IFRS 9, This standard is the first step in the process of substitution of IAS 39 “Financial instruments : Recognition and Measurement.” IFRS 9 introduces new requirements for classification and measurement of financial assets. IFRS 9 requires the financial assets to be measured at fair value or amortized cost. The designation is made at the time of initial recognition. The classification depends on both the entity’s business model and the cash flow characteristics of the financial instrument. Regarding financial liabilities, the standard does not change most of the established demands in IAS 39. The main change in IAS 39 states that, in case the company opts to adopt the fair value model for financial liabilities, the portion of change in fair value due to credit risk should be posted in Other comprehensive results, instead being posted in the income statement, except when there is an accounting mismatch. We are analyzing the impacts of this standard on our financial statements. The standard will be effective as of January 1, 2015.

In May 2011 the IAS issued a new accounting standard on “Consolidated Financial Statements,” IFRS 10, reling on existing concepts, stating that “control” is the main indicator of whether an entity should or should not be consolidated in the consolidated financial statements of the parent company. The standard provides additional instructions to determine control. We do not expect this change to impact our financial statements. This standard will be effective as of January 1, 2013.

In May 2011 the IAS issued a new accounting standard on “Joint Arrangements,” IFRS 11. The standard provides considerations regarding joint arrangements, focusing more on contractual rights and obligations than on the contractual legal formats. There are two types of joint arrangements: (i) joint operations, a situation in which an operator has assets and contractual obligations and, as a consequence, it recognizes its share in the assets and liabilities, revenues and expenses and (ii) joint control, a situation in which an operator has the right over the contractual net assets and as a consequence it recognizes the investment using the equity method. The proportional consolidation method will no longer be allowed for joint control operations. This standard will be effective as of January 1, 2013, as of which we will no longer consolidate the joint operation Atech Negócios em Tecnologia S.A. (Note 14). This change will not change our net result, but will affect the intermediate items of the income statement that will instead be presented in equity results.

In May 2011 the IAS issued a new accounting standard on “Disclosure of interest in other entities,” IFRS 12, which addresses the disclosure demands for all types of interests held in other entities, including joint arrangements, associates, interests with a specific intent and other interests not registered in the financial statements. We are analyzing the impacts of this standard in its financial statements. This standard will be effective as of January 1, 2013.

In May 2011 the IAS issued a new accounting standard on “Fair value measurement,” IFRS 13. The objective of this standard is to improve the consistency and decrease the level of complexity of fair value measurements, by providing a more accurate and single source of fair value measurement as well as additional disclosure requirements. The provision, largely aligned with US GAAP (United States Generally Accepted Accounting Principles), does not expand the applicability of fair value measurement, but provides orientation on their application when IFRS and US GAAP require it. We are analyzing the impacts of this standard on our financial statements. This standard will be effective as of January 1, 2013.

 

5C. Research

We incur research expenses related to the creation of new technologies that may be applied to our aircraft in the future. Such expenses are not associated with any particular aircraft and include the implementation of quality assurance initiatives, improvements to the productivity of production lines and studies to determine the latest developments in technology and quality standards. Under IFRS, research costs are expensed as incurred in the research line item of our statement of income.

 

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Research expenses totaled US$85.3 million in 2011 and US$72.1 million in 2010. This increase in research expenses in 2011 is a result of a larger number of research projects that entered into their experimental stages in 2011, thereby demanding more research resources.

In 2012, we expect to invest approximately US$100 million in our research activities.

For information on our capital expenditures, comprising investments in development and property, plant and equipment, see “Item 4A. Information on the Company—History and Development of the Company—Capital Expenditures (Property, Plant and Equipment and Development).”

 

5D. Trend Information

The following table summarizes our order book for the commercial aviation segment at December 31, 2011. Our total firm order backlog at that date, including executive jets and defense aircraft, was US$15.4 billion.

 

Commercial Aviation

   Firm
Orders
     Options      Deliveries      Firm Order
Backlog
 

EMB 120 Brasília

     352         —           352         —     

ERJ 135

     108         —           108         —     

ERJ 140

     74         —           74         —     

ERJ 145

     704         —           704         —     

EMBRAER 170

     184         22         178         6   

EMBRAER 175

     189         290         143         46   

EMBRAER 190

     548         355         386         162   

EMBRAER 195

     123         28         88         35   

The following tables set forth our commercial aviation order book at December 31, 2011 by aircraft type, customer and country.

ERJ 135:

 

Customer

   Firm Orders      Delivered      Firm Order
Backlog
 

American Eagle (USA)

     40         40         —     

British Midland (UK)

     3         3         —     

City Airline AB (Sweden)

     2         2         —     

ExpressJet (USA)

     30         30         —     

Flandair (France)

     3         3         —     

Jet Magic (Ireland)

     1         1         —     

Luxair (Luxembourg)

     2         2         —     

Pan Européenne (France)

     1         1         —     

Proteus (France)

     3         3         —     

Regional Airlines (France)

     3         3         —     

Republic Airways (USA)

     15         15         —     

South Africa Airlink (South Africa)

     5         5         —     
  

 

 

    

 

 

    

 

 

 

Total

     108         108         —     
  

 

 

    

 

 

    

 

 

 
ERJ 140:         

Customer

   Firm Orders      Delivered      Firm Order
Backlog
 

American Eagle (USA)

     59         59         —     

Republic Airways (USA)

     15         15         —     
  

 

 

    

 

 

    

 

 

 

Total

     74         74         —     
  

 

 

    

 

 

    

 

 

 

 

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ERJ 145:

 

Customer

   Firm Orders      Delivered      Firm  Order
Backlog
 

Aerolitoral (Mexico)

     5         5         —     

Air Caraibes (Guadalupe)

     2         2         —     

Alitalia (Italy)

     14         14         —     

American Eagle (USA)

     118         118         —     

Axon (Greece)

     3         3         —     

British Midland (UK)

     9         9         —     

British Regional Airlines (UK)

     23         23         —     

Brymon (UK)

     7         7         —     

China Southern (China)

     6         6         —     

China Eastern Jiangsu (China)

     5         5         —     

China Eastern Wuhan (China)

     5         5         —     

Cirrus (Germany)

     1         1         —     

ExpressJet (USA)

     245         245         —     

ERA (Spain)

     2         2         —     

Flandre Air (France)

     5         5         —     

GECAS (PB Air - Thailand)

     2         2         —     

HNA Group (China)

     25         25         —     

KLM EXEL (Holland)

     2         2         —     

Lot Polish (Poland)

     14         14         —     

Luxair (Luxembourg)

     9         9         —     

Mesa (USA)

     36         36         —     

Nigeria (Nigeria)

     1         1         —     

Portugalia (Portugal)

     8         8         —     

Proteus (France)

     8         8         —     

Regional (France)

     15         15         —     

Republic Airways (USA)

     60         60         —     

Rheintalflug (Austria)

     3         3         —     

Rio Sul (Brazil)

     16         16         —     

Satena (Colombia)

     3         3         —     

Sichuan (China)

     5         5         —     

Skyways (Sweden)

     4         4         —     

Swiss (Switzerland)

     25         25         —     

Transtates (USA)

     22         22         —     
  

 

 

    

 

 

    

 

 

 

Total

     708         708         —     
  

 

 

    

 

 

    

 

 

 
EMBRAER 170:         

Customer

   Firm Orders      Delivered      Firm  Order
Backlog
 

Alitalia (Italy)

     6         6         —     

BA CityFlyer (UK)

     6         6         —     

Cirrus (Germany)

     1         1         —     

ECC (Ireland)(1)

     6         6         —     

Egypt Air (Egypt)

     12         12         —     

ETA Star Aviation (India)

     5         —           5   

Finnair (Finland)

     10         10         —     

Gecas (USA)

     9         9         —     

JAL (Japan)

     10         10         —     

Jetscape (USA)

     1         1         —     

Lot Polish (Poland)

     6         6         —     

Petro Air (Libya)

     2         2         —     

Regional (France)

     10         10         —     

Republic Airline (USA)

     48         48         —     

 

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Customer

   Firm Orders      Delivered      Firm  Order
Backlog
 

Satena (Colombia)

     1         1         —     

Saudi Arabian Airlines (Saudi Arabia)

     15         15         —     

Sirte Oil (Libya)

     1         1         —     

Air North

     1         —           1   

Suzuyo (Japan)

     2         2         —     

TAME (Ecuador)

     2         2         —     

US Airways (USA)

     28         28         —     

Virgin Blue (Australia)

     6         6         —     
  

 

 

    

 

 

    

 

 

 

Total

     188         182         6   
  

 

 

    

 

 

    

 

 

 

 

(1) Customer is Embraer’s ECC Leasing, which delivered one aircraft to Cirrus, two to Gulf Air, two to Paramount and one to Satena.

 

EMBRAER 175:

  

Customer

   Firm Orders      Delivered      Firm Order
Backlog
 

Air Canada (Canada)

     15         15         —     

ECC (Ireland)(1)

     1         1         —     

Flybe (UK)

     35         4         31   

Gecas (USA)

     5         5         —     

Jetscape (USA)

     1         1         —     

Lot Polish (Poland)

     12         12         —     

Northwest Airlines (USA)

     36         36         —     

Oman Airlines

     5         3         2   

Republic Airlines (USA)

     54         54         —     

Royal Jordanian (Jordan)

     2         2         —     

TRIP (Brazil)

     5         5         —     

Suzuyo (Japan)

     3         3         —     

Alitália

     10         —           10   

Air Lease

     5         2         3   

Undisclosed

     1         —           —     
  

 

 

    

 

 

    

 

 

 

Total

     189         143         46   
  

 

 

    

 

 

    

 

 

 

 

(1) Customer is Embraer’s ECC Leasing, which delivered one aircraft to Air Caraibes.

 

EMBRAER 190:

  

Customer

   Firm Orders      Delivered      Firm Order
Backlog
 

Aero Republica (Colombia)

     5