Embraer-Empresa Brasileira de Aeronautica 20-F 2009
As filed with the Securities and Exchange Commission on May 1, 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
For the fiscal year ended: December 31, 2008
Date of event requiring this shell company report [ ]
For the transition period from [ ] to [ ]
Commission file number 333-132289
EMBRAER-EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
EMBRAER Brazilian Aviation Company Inc.
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act.
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
6.375% Guaranteed Notes due 2017
Number of outstanding shares of each of the issuers classes of capital or common stock as of December 31, 2008:
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 x International Financial Reporting Standards as issued by the International Accounting Standards Board ¨ 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
In this annual report, Embraer, we, us or our refer to Embraer-Empresa Brasileira de Aeronáutica S.A., formerly known as Rio Han Empreendimentos e Participações S.A. (as successor in interest to Embraer-Empresa Brasileira de Aeronáutica S.A., or former Embraer, as predecessor company, as a result of the merger of former Embraer with and into Embraer pursuant to the corporate reorganization described below), and its consolidated subsidiaries (unless the context otherwise requires). 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.
On March 31, 2006, our shareholders approved a reorganization of our corporate structure. The purpose of the reorganization was to, among other things, create a basis for the sustainability, growth and continuity of our businesses and activities by simplifying our capital structure and thereby improving our access to capital markets and increasing financing resources for the development of new products and expansion programs. For further information on our corporate reorganization, see Item 4. Information on the CompanyHistory and Development of the CompanyCorporate Reorganization.
Presentation of Financial and Other Data
Our audited financial statements at December 31, 2007 and 2008 and for each of the years ended December 31, 2006, 2007 and 2008 are included in this annual report.
Our financial statements as of and for the years ended December 31, 2004 and 2005 have not been included in this annual report.
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. Because we export more than 90% of our production and operate in an industry that uses the U.S. dollar as its currency of reference, our management believes that the U.S. dollar is our functional currency and the most appropriate currency in which to present our financial statements. As a result, amounts for all periods presented have been remeasured into U.S. dollars in accordance with the methodology set forth in Statement of Financial Accounting Standards No. 52, or SFAS 52. Our financial statements and financial data presented herein and prepared in accordance with U.S. GAAP do not reflect the effects of inflation.
Pursuant to SFAS 52 as it applies to us, non-monetary assets and liabilities, including inventories, property, plant and equipment, accumulated depreciation and shareholders equity, are remeasured at historical rates of exchange, while monetary assets and liabilities denominated in currencies other than U.S. dollars are remeasured at period-end rates. Export sales invoiced in currencies other than the U.S. dollar are remeasured at the respective exchange rate on the date of sale. Cost of sales and services, depreciation and other expenses relating to assets remeasured at historical exchange rates are calculated based on the U.S. dollar values of such assets and other non-U.S. dollar statement of income accounts are remeasured at the rate prevailing on the date of the charge or credit to income. Translation gains and losses are recorded under foreign exchange (gain) loss, net in our statement of income.
In our 2006, 2007 and 2008 financial statements, gains or losses resulting from the remeasurement of the financial statements and from foreign currency transactions have been reported in the consolidated statement of income as single line items.
In our Form 20-F/A filed with the U.S. Securities and Exchange Commission, or SEC, on November 26, 2007, we restated our financial statements for the years ended December 31, 2004, 2005 and 2006. For further information, see Item 15. Controls and Procedures.
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. Further changes were introduced in 2008 to accounting practices adopted in Brazil, or Brazilian GAAP, by the Comitê de Pronunciamentos Contábeis (Brazilian Accounting Standards Setting Board). These changes to the accounting aspects of the Brazilian Corporate Law and Brazilian GAAP impacted the basis of our distribution of minimum mandatory dividends. Other than that, such changes had no effect to our financial statements prepared in accordance with U.S. GAAP that are included in this annual report. Our financial statements prepared in accordance with the Brazilian Corporate Law, which are not included in this annual report, are not adjusted to account for the effects of inflation.
As a result of the reconciliation of amounts to the functional currency and other adjustments related to the differences in accounting principles between U.S. GAAP and Brazilian GAAP, the amounts of net income and shareholders equity as reported in our audited consolidated financial statements presented herein differ from those included in our statutory accounting records.
As a result of the listing of our common shares on the Novo Mercado segment of the Bolsa de Valores de São Paulo, or São Paulo Stock Exchange, since January 2009 we are required to either translate into English our quarterly financial statements, including cash flow statements, prepared in accordance with the Brazilian Corporate Law, or prepare such quarterly financial statements in accordance with, or reconciled to, U.S. GAAP or International Financial Reporting Standards, or IFRS.
Other Data and Backlog
In this annual report:
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 only make reference to
firm orders and not to options. When we refer in this annual report to the number or value of commercial aircraft, we exclude two EMB 145s delivered to Satena Airline, a state-owned Colombian airline, in 2004. These aircraft have been included in our defense and government data. In July 2005, we started to include the number of aircraft sold by the defense and government segment to state-owned airlines, such as TAME and Satena, 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 Securities Act, and Section 21E of the U.S. Securities Exchange Act of 1934, as amended, or 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:
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. Risk Factors, undue reliance should not be placed on these forward-looking statements.
The following table presents our selected financial and other data at and for each of the periods indicated. Selected financial data as of and for the years ended December 31, 2006, 2007 and 2008 have been derived from our audited U.S. GAAP financial statements and are included elsewhere in this annual report. The selected financial data presented for all other periods have been derived from our audited U.S. GAAP financial statements not included herein.
Prior to March 4, 2005, there were two principal legal foreign exchange markets in Brazil:
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 only be purchased 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 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. At April 20, 2009, the commercial selling rate for U.S. dollars was R$2.2350 per US$1.00. 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 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. Risk FactorsRisks Relating to Brazil.
The following table sets forth the commercial selling rate, expressed in reais per U.S. dollar, for the periods indicated.
Source: Central Bank.
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.
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 since 2001. First, the U.S. and world economies experienced an economic downturn that began in 2001 and was characterized by rapid declines in securities markets, a decline in productivity and an increase in unemployment. Second, the terrorist attacks of September 11, 2001 caused an immediate decline in airline travel and a high level of financial uncertainty among the worldwide commercial airline industry.
In addition, airline travel decreased significantly in 2003 as a result of both the commencement of military action by the United States and other countries in Iraq and the concerns over outbreaks of severe acute respiratory syndrome (SARS) in Asia and Canada. In response to these events, beginning in the fourth quarter of 2001, many airlines, including our largest customers, reduced their flight schedules for the long-term and announced significant lay-offs, and a number of airlines filed for bankruptcy protection. As a result, we agreed to modify, between 2001 and 2004, certain delivery schedules to adjust to the changes in our customers businesses and reduced scheduled commercial aircraft, executive jet and government transportation aircraft deliveries. In 2004, we reduced scheduled deliveries from 160 to 145 aircraft following US Airways second Chapter 11 filing in September 2004. In 2003 and 2004, we also re-evaluated our risk exposure related to aircraft valuations and customer credit risk, which resulted in charges to income of US$40.6 million and US$16.0 million, respectively.
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, 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 been a dramatic decrease in orders of executive jets and the lack of financing available to our customers for aircraft purchases, particularly in the commercial and executive aviation segments (see Item 4B Business OverviewAircraft Financing Arrangements). A continuation of a 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.
During the three-month period ended March 31, 2009, we reduced our personnel by 20% to reflect the new demand for commercial and executive jets in the current economic crisis. In addition, we also experienced some cancellations of aircraft orders by our customers, including the HNA Group, a Chinese airline, that reduced its firm orders for 50 ERJ 145 regional aircraft, of which 11 had already been delivered, to 25. Although these cancellations have occurred only in our executive aviation business, 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 sales and revenue, and, consequently, our profitability for that year.
We depend on key customers and key suppliers, the loss of any of which could harm our business.
Commercial aircraft. As of March 31, 2009, all of our firm orders in backlog for the ERJ 145 regional jet family were attributable to a Chinese company, the HNA Group. The aircraft will be assembled by our joint venture Harbin Embraer Aircraft Industry Company Ltd., formed with Harbin Aircraft Industry (Group) Co., Ltd. and Hafei Aviation Industry Co., Ltd., subsidiaries of China Aviation Industry Corp. II, or AVIC II.
In addition, at March 31, 2009, 57.8% of our firm orders in backlog for the EMBRAER 170/190 jet family were for JetBlue Airways and US Airways from North America, HNA Group from China, Lufthansa from Germany, JAL from Japan, LOT Polish from Poland and Azul, the new Brazilian airline founded by David Neeleman. Furthermore, in 2008 we signed firm orders with the following new clients: Air Moldova from Moldavia, the aircraft leasing company Jetscape, Inc., from the U.S., Regional, a subsidiary of Air France, EgyptAir Holding Company from Egypt, Finnair from Finland, M1 Travel Ltd. from Lebanon, ETA Star Group from Dubai, TRIP Linhas Aéreas from Brazil, Kun Peng Airlines from China, Aeroméxico from Mexico, Nasair Aviation from Saudi Arabia, and NIKI from Austria. We believe that we will continue to depend on a number of key customers, and the loss of any one of which could reduce our sales and reduce our market share. Fewer sales could reduce our profitability.
Increasingly, the commercial airline industry is experiencing consolidation and alliances through mergers and acquisitions and 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 our customers and, possibly, the number of purchases of our aircraft through cost reduction programs or otherwise.
Defense aircraft. The Força Aérea Brasileira, or Brazilian Air Force, is our largest customer of defense aircraft products. Sales to the Brazilian government accounted for approximately 42% of our defense and government sales for the year ended December 31, 2008. A decrease in defense spending by the Brazilian government due to defense spending cuts, general budgetary constraints or other factors that are out of our control could decrease our defense and government sales and defense research and development funding. We cannot assure you that the Brazilian 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 engines, which cannot be substituted by another manufacturer without significant delays and expenses. 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 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 flows.
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:
Our customers may also reschedule deliveries, particularly during an economic downturn. During the three-month period ended March 31, 2009, we experienced some cancellations of aircraft orders by our customers, including the HNA Group, a Chinese airline, that reduced its firm orders for 50 ERJ 145 regional aircraft, of which 11 had already been delivered, to 25. Although these cancellations have occurred only in our executive aviation business, 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 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.
Our aircraft sales are subject to trade-in options and financial and residual value guarantees that may require us to make significant cash disbursements in the future.
In connection with the signing of a purchase agreement for new aircraft, we may provide trade-in options to our customers. These options provide a customer with the right to trade-in existing aircraft upon the purchase of a new aircraft. In 2008, we were required to accept four aircraft for trade-in and at December 31, 2008, eight additional commercial aircraft were subject to trade-in options to be exercised until 2010. 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 ResultsCritical Accounting EstimatesGuarantees and Trade-In Rights for commercial 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 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, in the 15th year after delivery, the relevant aircraft will have a residual market value of the original sale price. 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 18% of the original sale price. In the event of an exercise by a purchaser of its residual value guarantee, we will bear the difference between the guaranteed residual value and the market value of the aircraft at the time of exercise.
Assuming all customers that 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$1,870.1 million as of December 31, 2008. For further discussion of these off-balance sheet arrangements, see Note 35 to our audited consolidated financial statements. We have deposited US$299.7 million in escrow accounts to secure a portion of our financial guarantees. Based on current estimates, we believe that the proceeds from the sale
or lease of the covered aircraft (based on resale value as of December 31, 2008) and from other offsetting collections, such as cash deposits, would be US$2,013.5 million as of December 31, 2008. As a result, we would be obligated to make substantial payments that are not recoverable through proceeds from aircraft sales or leases, particularly if in the future, we were 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.
We continually re-evaluate our risk for the 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, including information developed from similar aircraft remarketing in the secondary market, and the credit rating for the customers. For example, the last time we recorded a charge against income in connection with financial guarantees was in 2004, when we recorded an amount of US$16.0 million based on our risk assessment, on an individual aircraft basis, for the corresponding issued guarantees. Any future decrease in the market value of the aircraft covered by trade-in rights or financial guarantees would decrease our ability to recoup 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 trade-in or financial guarantee 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 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 is a system of interest rate adjustments called the Programa de Financiamento às Exportações (the Export Financing Program), or ProEx program.
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 government ultimately amended the ProEx program 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 their financing arrangements for sales of aircraft by Bombardier, a Canadian aircraft manufacturer.
Although the ProEx program is currently in compliance with WTO rules, other export financing programs available to our customers may be subject to challenge in the future. If the ProEx program or another similar program is not available in the future, or if its terms are substantially reduced, our customers financing costs could be higher and our cost-competitiveness in the regional jet market could decrease.
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.
In July 2007, Brazil and the Organization for Economic Co-operation and Development, or OECD, countries entered into an agreement to establish a level -playing field for official export financing support of aircraft. Export Credit Agencies, or ECAs, from signatory countries are required to offer the same financial terms and conditions when financing sales of competing aircraft. The effect of the agreement is 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 agreement financing support by the Brazilian government to the potential purchasers of our aircraft will contain similar terms and conditions offered by Boeing, Airbus and Bombardier to such purchasers. 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 agreement. 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.
Brazilian government budgetary constraints could reduce amounts available to our customers under government-sponsored financing programs.
From 1996 through 2008, approximately 28% of the total value of our exports sales was subject to financing by BNDES. As a government agency BNDES relies on funds allocated by the Brazilian national budget. We can not assure you that the Brazilian government will continue to provide sufficient funding in the national budget for the financing of our aircraft or that other sources of funding will be available to our customers in the market. The loss or significant reduction of funds available to our customers, without an adequate substitute, could lead to fewer sales 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 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 impede 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 managements 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, the Phenom 100/300 family and the Legacy 450/500 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$397.9 million in 2008 and we expect to receive an additional US$303.7 million in future years for the development of the Phenom 300 and Legacy 450/500 family. Cash contributions do not have to be returned by us to the risk-sharing partners if we fulfill certain milestones agreed with our risk-sharing partners. In 2008, US$353.6 million of these cash contributions had become nonrefundable. If we cancel the production of any aircraft in the EMBRAER 170/190 jet family or of the Phenom 100, or the development of the Phenom 300 or of the Legacy 450/500 family because we are unable to obtain certification or for other nonmarket related reasons, we may be required to refund US$44.3 million of the total cash contributions already received. We expect the certification of the Phenom 300 to be granted in the second half of 2009. The Legacy 450/500 executive jets are expected to enter into service in 2013 and 2012, respectively.
If we require additional financing and we are unable to obtain it, we will not be able to continue to develop and market our Phenom 300 and Legacy 450/500 aircraft family.
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 in the world, along with The Boeing Company, Airbus S.A.S. and Bombardier Inc., all of which are large international companies. Certain of these competitors have greater financial, marketing and other resources than we do. 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 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 benefits from government-sponsored export subsidies. In addition, other international aircraft manufacturers, including The Boeing Company and Airbus S.A.S., produce or are developing aircraft at the high end of the 70-120 seat category, in which our EMBRAER 170/190 jet family competes thereby increasing the competitive pressures in that
category. These companies also have significant technological capabilities and greater financial and marketing resources. Additionally, Chinese, Russian and Japanese companies are developing mid-capacity jets and already have firm orders in backlog.
As a relatively new entrant to the business jet market, we also face significant competition from companies with longer operating histories and established reputations in this industry. Some of our competitors in the business jet market may also reach the market before we do, allowing them to establish a customer base and making our efforts to gain greater market share more difficult. We cannot assure you that we will be able to compete successfully in the business jet markets in the future.
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 interest income (expenses), net item in our statements of income. As of December 31, 2008, we had obtained preliminary injunctions permitting us not to pay certain taxes, in the total amount, including interest, of US$332.1 million, which is included as a liability (taxes and payroll charges) on our balance sheet. 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 government in the future as payment for these liabilities. For an additional discussion of these liabilities, see Note 17 to our audited consolidated financial statements.
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 50-70 seat commercial aircraft in an airlines fleet. As a result, our opportunities for near-term growth in the U.S. regional jet market in the 30-60 and 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 products are subject to regulation in Brazil and in each jurisdiction where our customers are located. The aviation authorities in Brazil and in other countries, in which our customers are located, including the Agência Nacional de Aviação Civil, or Brazilian aviation authority, the U.S. Federal Aviation Authority, or FAA, the Joint Aviation Authority of Europe, or JAA, and the European Aviation Safety Agency, or EASA, must certify our aircraft before we can deliver them. We cannot assure you that we will be able to obtain certification of our aircraft on a timely basis or at all. 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 authorities can be both expensive and time-consuming.
Changes in government regulations and certification procedures could also delay our start of production as well as entry into the market with a new product. 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 government has frequently intervened in the Brazilian economy and occasionally has made drastic changes in policy and regulations. The Brazilian governments 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:
Uncertainty over whether the Brazilian 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.
In addition, in October 2006 elections were held in all states of Brazil and at the federal level to elect state governors and the president. The re-elected president has, to date, largely continued the policies of his previous administration; however, it is impossible to predict how new policies that may be adopted by the president or by the state governors would affect the Brazilian economy or our business.
Historically, the political scenario in Brazil has influenced the performance of the Brazilian economy in the past; in particular, political crises have affected the confidence of investors and the public in general, which adversely affected the economic development in Brazil.
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 the common shares and ADSs.
Brazil experienced extremely high rates of inflation in the past. More recently, Brazils annual rate of inflation was 1.2% in 2005, 3.8% in 2006, 7.7% in 2007 and 9.8% in 2008 as measured by the Índice Geral de Preços Mercado (General Market Price Index), or IGP-M. Inflation, and certain government actions taken to combat inflation, have in the past had significant negative effects on the Brazilian economy. Actions taken to combat inflation, coupled with public speculation about possible future governmental actions, have contributed to economic uncertainty in Brazil and heightened volatility in the Brazilian securities markets.
Future Brazilian government actions, including interest rate decreases, intervention in the foreign exchange market and actions to adjust or fix the 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 the common shares and ADSs.
Although most of our net sales and debt are 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 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.
The exchange rate (R$/US$) increased by 9.3% in 2000 and 18.7% in 2001. In 2002, the exchange rate (R$/US$) also increased 52.3%, due in part to political uncertainty surrounding the Brazilian presidential elections and the global economic slowdown. Although the exchange rate (R$/US$) decreased 18.2%, 8.1%, 11.8%, 8.7% and 17.2% in 2003, 2004, 2005, 2006 and 2007, respectively, in 2008 it increased 31.9%. 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.
Appreciation of the real against the U.S. dollar may also have an adverse impact on the competitiveness of our products as approximately 13% of our production inputs, including labor 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.
Economic developments and investor perceptions of risk in other countries, including emerging market countries, 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 to varying degrees by economic and market conditions in other countries, including 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 these other countries may have an
adverse effect on the market value of securities of Brazilian issuers. For example, the occurrence in 2008 of the global economic crisis has had a global impact on the world economy and capital markets. Such crisis is evidenced by instability in securities value and capital markets, instability of most currencies, a widespread reduction in demand, a credit crunch, inflationary pressure, 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, and could also make it more difficult for us to access the capital markets and finance our operations in the future on acceptable terms or at all.
Risks Relating to our Common Shares and ADSs
If holders of 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 custodians 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 custodians 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.
The Brazilian government has veto power over change of control, change of name, trademark or corporate purpose and over the creation or alteration of our defense programs, and its interests could conflict with the interests of the holders of our common shares or ADSs.
The Brazilian 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 programs (whether or not the Brazilian government participates in such programs). The Brazilian government may have an interest in vetoing transactions that may be in the interests of the holders of our common shares or ADSs.
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 make a public tender offer to purchase all of our shares on the terms specified in our bylaws, or to sell all of such shareholders shares that exceed the 35% limit, in either case, as required by the Brazilian government. If the request is approved, such shareholder or group of shareholders must commence the public tender offer within 60 days of the date of approval. If the request is refused, such shareholder or group of shareholders must sell such number of common shares within 30 days so that the holding of such shareholder or group of shareholders is less than 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 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 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 right 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. Memorandum and Articles of AssociationDescription of Capital StockVoting Rights of SharesLimitations 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. Memorandum and Articles of AssociationDescription of Capital StockVoting Rights of SharesLimitations on the Voting Rights of Non-Brazilian Shareholders.
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. Under the deposit agreement, ADS holders must vote by giving voting instructions to the depositary. Upon receipt of the voting instructions of 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. If we ask for voting instructions, the depositary will notify ADS holders of the upcoming vote and will arrange to deliver the proxy card. We cannot assure that ADS holders will receive the proxy card in time to ensure that they can instruct the depositary to vote the shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions. As a result, holders of ADSs may not be able to exercise their voting rights.
The relative volatility and illiquidity 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. MarketsTrading 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 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.
Embraer-Empresa Brasileira de Aeronáutica 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 government, we were privatized in 1994. In connection with our privatization, we were transformed into a publicly-held corporation and we operate under the Brazilian Corporate Law. As a result of the merger of former Embraer with and into Embraer approved on March 31, 2006, we succeeded to all rights and obligations of former Embraer. See Corporate Reorganization for more information on the merger. 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 aviation, executive jet and defense and government purposes.
Through 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 and government 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 development of 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 is comprised of 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 markets 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. For the defense market, we also offer a line of intelligence, surveillance and reconnaissance aircraft based on the ERJ 145 regional jet platform.
On March 31, 2006, our shareholders approved a reorganization of our corporate structure. The purpose of the reorganization was to, among other things, create a basis for the sustainability, growth and continuity of our businesses and activities by simplifying our capital structure and thereby improving our access to capital markets and increasing financing resources for the development of new products and expansion programs. As a result of the reorganization and merger, former Embraer, ceased to exist and:
Strategic Alliance and Growth Opportunities
Strategic Alliance with European Aerospace and Defense Group
On November 5, 1999, a group consisting of Aerospatiale Matra, currently known as European Aeronautic, Defense and Space Company N.V., or EADS, Dassault Aviation, Thomson-CSF, currently referred to by its trade name Thales TM , and Société Nationale dÉtude et de Construction de Moteurs dAviation, or Safran, 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 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 in connection with our 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 strategic shareholders of Embraer. As of March 31, 2009, each of Dassault and Safran, individually, held shares representing 0.9% and 1.1% of our total capital stock, respectively. Thales TM sold all of its shares in October 2006 and EADS sold all of its shares in a secondary offering in February 2007.
The relationship that developed as a result of our alliance between 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 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 Thales TM 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.
We intend to review strategic growth opportunities, which may include joint ventures and acquisitions, and other strategic transactions and enhance our existing relationship with significant world players in the aerospace industry, including any of the members of the European Aerospace and Defense Group.
Joint Ventures and Acquisitions
In July, 2008, we acquired for US$20.0 million a 40% interest owned by Liebherr Aerospace SAS, or Liebherr , in ELEBEquipamentos 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.
In December 2002, we formed a joint venture company with Harbin Aircraft Industry (Group) Co., Ltd. and Hafei Aviation Industry Co., Ltd., subsidiaries of China Aviation Industry Corp. II, or AVIC II, to provide for the assembly, sale and after-sale support of the ERJ 145 regional jet family in China. We own 51% of the equity of the joint venture company, Harbin Embraer Aircraft Industry Company Ltd.
In March 2005, a consortium formed by us and EADS acquired 65% of OGMAs shares through a newly created holding company, AIRHOLDING, SGPS, S.A. At that time we held 99% of the equity in the holding company and EADS held the remaining 1%. Further, in March 2006, EADS exercised its option to increase its interest and currently holds 30% of the equity in the holding 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.
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. The initial training program has started to be offered at CAE SimuFlite, Dallas, Texas, as the Phenom 100 started to operate in 2008. The joint venture is expected to provide entitlement training and post-entitlement training for pilots, maintenance technicians and dispatch personnel.
Capital Expenditures: Research and Development
We include as part of our capital expenditures our investments in both research and development and property, plant and equipment.
Capital expenditures relating only to research and development, which includes the development of products for the commercial airline, executive aviation and defense and government segments, were US$112.7 million in 2006, US$259.7 million in 2007 and US$197.0 million in 2008, net of cash contributions provided by risk-sharing partners. Research and development costs as a
percentage of net sales were 3.0% in 2006, 5.0% in 2007 and 3.1% in 2008. In 2006, 2007 and 2008, we recorded US$36.0 million, US$23.7 million and US$134.8 million, respectively, as reductions to our research and development costs in connection with payments previously received by us from our risk-sharing partners, as our EMBRAER 170/190 aircraft family and Phenom 100 received their certifications and we fulfilled other contractual milestones under our risk-sharing arrangements. See Item 5C. Research and Development.
In 2007, the real appreciated by 17.2% against the dollar, which, together with increased research and development investments in connection with the testing stages of the Lineage 1000 and Phenom 100 following their first flights in the second half of 2007, also impacted our research and development costs in that year. Our research and development costs for 2008 decreased mainly because of US$134.8 million received from risk-sharing partners in connection with the certification of the Phenom 100 and the fulfillment of other contractual milestones under our risk-sharing arrangements. We do not incur research and development expenses for defense programs as those are funded by the Brazilian government and other government customers. Most of our research and development expenses are associated with particular programs either in the commercial or executive aviation segments.
Our two main ongoing projects are the development of the Phenom 300 and the Legacy 450/500 executive jets. As the Phenom 300 uses many of the same parts and components, as well as the basic technology, of the Phenom 100, which was certified in 2008, the main milestones for the Phenom aircraft program have been fulfilled. As a result, and because the Phenom 300 is expected to be certified in the second half of 2009, the majority of the expected research and developments costs for the Phenom aircraft family have already been invested. On the other hand, an estimated US$750 million is expected to be invested overall in fixed assets, research and development for the Legacy 450/500 programs, which were launched by us in April 2008 and are expected to have their respective aircraft enter into service in 2013 and 2012, respectively.
In 2009, we expect to invest approximately US$350 million in capital expenditures for research and development and property, plant and equipment. Of this amount approximately US$200 million is expected to be invested in our research and development activities. This US$200 million amount is exclusive of contributions from risk-sharing partners, but includes estimated costs of approximately US$150 million related to the development of our new products, and approximately US$50 million related to the development of technology. We also expect to receive an additional US$303.7 million from our risk-sharing partners in future years for the development of the Phenom 300 and Legacy 450/500 family.
We expect to invest in Brazil approximately 82% of our budgeted US$350 million of total capital expenditure, which includes our investments in both research and development and property, plant and equipment.
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. Liquidity and Capital ResourcesOverview.
For a discussion of our capital expenditures relating to property, plant and equipment, see Item 4D. Property, Plant and Equipment.
We are one of the leading manufacturers of commercial aircraft in the world, based on 2008 net sales of commercial aircraft, with 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 markets and aviation services. Our commercial aviation business accounted for 66.9% of our net sales in 2008. We are the leading supplier of defense aircraft for the Brazilian Air Force based on number of aircraft sold, and we have sold aircraft to military forces in Europe, Asia and Latin America. Our defense and government business accounted for 8.0% of our net sales in 2008. 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 accounted for 13.8% of our net sales in 2008. Providing high quality customer support is a key element of our customer focus and is critical to our ability to maintain long-term relationships with our customers. Our aviation services business accounted for 9.5% of our net sales in 2008. Other related businesses, accounted for 1.8% of our net sales in 2008. For the year ended December 31, 2008, we generated net sales of US$6,335.2 million, of which more than 90% was U.S. dollar-denominated. On March 31, 2009, we had a total firm order backlog of US$19.7 billion, including 393 aircraft sold by the commercial aviation segment.
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 in the five continents of the world. Our customers include some of the largest and most significant regional, 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 among jets within a 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 research and develop these systems and components, thereby reducing our development costs. These risk-sharing partners also fund a portion of our development costs through direct contributions of cash or materials. We believe that these strategic relationships enable us to lower our development costs 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.
Benefits of Funded Development of Defense Products. Historically, research and development costs 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, which 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 March 31, 2009, approximately 23% of our workforce is comprised of engineers. 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.
Looking to continue to grow our business and to increase 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 March 31, 2009, we had more than 870 units of the ERJ 145 jet in commercial operation. We are currently evidencing increased demand for the ERJ 145 jet family in the secondary market due to its reliability and strong operating benefits. We believe that airlines can continue to benefit from this regional jet family, which we believe has helped our customers over the last ten years to pursue their goal of achieving profitable operations. We believe a significant market opportunity exists for the EMBRAER 170/190 jet family with regional airlines that are
expanding their fleet, increasing their penetration into higher density markets and adding longer routes, as well as with major and low-cost airlines that are right-sizing their fleet in order to adjust capacity to meet demand in less dense routes. As of March 31, 2009, we were leaders in the 70-120 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 have developed the Legacy 600, a super midsize, the Phenom 100, an entry-level jet, and the Lineage 1000, an ultra large jet, and are developing the Phenom 300, the Legacy 450 and the Legacy 500, executive jets in the light, mid-light and mid-size categories, respectively. We have endeavored to understand and respond to market and customer needs, continually improving the product and customer support for our executive jets.
Continue to Pursue Market Niche Opportunities in the Defense and Government 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.
Continuing 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 is a key element of our customer focus and is critical to our ability to maintain long-term relationships with our customers. 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, pilot and maintenance training and spare parts, as demonstrated by the expansion of our Nashville, Tennessee, maintenance, repair and overhaul, or MRO, facility, and the acquisition of OGMA, an MRO facility in Portugal, which we began operating in March 2005. We intend to continue to focus on providing our customers with high quality customer support by expanding our presence worldwide, both through our own operations and agreements with authorized service centers. In 2007 we created a new business area called Aviation Services. We also started the construction of a service center at Williams Gateway Airport in Mesa, Arizona.
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 that, we must, on a daily basis, continuously try to implement the most efficient production processes and best managerial practices. Because the success of our products and services are 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, corporate programs based on a lean manufacturing philosophy, such as the Embraer Entrepreneurial Excellence Program (P3E), 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 66.9% of our net sales for the year ended December 31, 2008.
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 70-122 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 Chinese aviation authority in December 2000. We began delivering the ERJ 145 in December 1996. In October 2007, we delivered our 1,000th ERJ 145 aircraft, manufactured at 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 Chinese aviation authority 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.
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 135s fuselage is 11.6 feet shorter than the ERJ 145s. 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 July 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 70-80 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 108-122 seat jet.
The EMBRAER 170 was certified by the Brazilian aviation authority, the FAA, the JAA, 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 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 EASA in June 2006. The EMBRAER 195 was certified by the Brazilian aviation authority in June 2006, by EASA in July 2006 and by the FAA in August 2007.
We designed the EMBRAER 170/190 jet family to maximize the benefits of commonality. Aircraft in the family share approximately 89% of the same components. The high level of commonality in this new jet family lowered our development costs and shortened our development period. We anticipate that this commonality will lead 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 will not share the same wing design. This new mid-capacity jet family has engines fixed under its main wingsa 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 familys principal features are:
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 industrys 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 and through December 31, 2008, we have delivered 352 EMB 120 Brasília for the regional market and six EMB 120 Brasília for the defense market. We currently manufacture the EMB 120 Brasília only upon customer request.
We believe we have a diverse, global customer base, principally in the commercial airline market in Europe, the Middle East, Africa, Asia 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, 2008, our largest customers, by firm orders, were JetBlue Airways, US Airways, HNA Group, Regional, a subsidiary of Air France, Lufthansa, and Azul, the new Brazilian airline founded by David Neeleman.
For a discussion of these significant customer relationships, see Item 3D. Risk FactorsRisks Relating to EmbraerWe depend on key customers and key suppliers, the loss of any of which could harm our business. See also Note 7 to our audited consolidated financial statements for additional information on our largest customers.
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 option price, subject to adjustment based on the same escalation formula. In addition, our contracts provide for after-sales spare parts and services, as well as warranties of our aircraft and spare parts. 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. Risk FactorsRisks Relating to EmbraerOur aircraft sales are subject to trade-in options and financial and residual value guarantees 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 airlines and regional affiliates of major 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; Ft. Lauderdale, Florida; Beijing, China and Singapore. We sell our ERJ 145 regional jet family in the Chinese market exclusively through our joint venture in China, which had 66 firm orders from Chinese airlines since the beginning of 2004, 22 of which had been delivered as of March 31, 2009.
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.
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 nonrefundable for the most part if 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.
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.
The main competitors of the ERJ 145 regional jet family are:
Given the success of our regional jet family and the significant barriers to entry into the market, due mainly to the high development costs 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 for the ERJ 145 regional jet family.
61-90seat and 91-120seat categories
We currently face our strongest competition in the 61-90 and 91-120seat categories. We currently compete against the following aircraft in these categories:
We expect new developments in this market segment from current and new competitors, including:
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, low operating costs, product development experience, global customer base, market acceptance, cabin design and aircraft price.
Defense and Government Business
We conceive, design, develop, manufacture and support a wide range of integrated solutions for the defense and government market. Our products include training/light attack aircraft, C4ISR (Command and Control, Intelligence, Surveillance and Reconnaissance) systems, aerial surveillance platforms and transport airplanes. We offer a complete portfolio of customer services, ranging from maintenance and material solutions to complete Contractor Logistic Support programs. As of December 31, 2008, we had sold more than 680 defense aircraft to 20 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. At December 31, 2008, we had orders for more than 255 defense aircraft for the Brazilian government. Our defense and government business accounted for approximately 8.0% of our net sales for the year ended December 31, 2008.
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 (AEW&C), the EMB 145 Multi Intel and the EMB 145 MP (Maritime Patrol). Since its first delivery, a total of 14 such aircraft have been manufactured for the Brazilian Air Force, the Mexican Air Force and the Hellenic Air Force.
We believe EMB 145 AEW&C is the most advanced and affordable Airborne Early Warning and Control aircraft available in the market. It combines Embraers reliable and cost-effective ERJ 145 regional airplane platform with a unique, high-performance, multi-mode active phased-array AEW radar, a powerful command and control 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 Hellenic Air Forces. In addition, in 2008 we signed a contract with the Indian Air Force to sell them four units of our AEW&C aircraft.
The EMB 145 Multi Intel, also known as the EMB 145 RS/AGS (Remote Sensing/Airborne Ground Surveillance) aircraft, is designed to accomplish the electronic and reconnaissance missions. It features state of the art sensors for IMINT (Image Intelligence), SIGINT (Signal Intelligence) and MASINT (Measurement and Signature Intelligence), and is capable of providing real-time imagery and signals intelligence over ground objectives. It is 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 and anti-submarine warfare missions using maritime and ground surveillance radar, electro-optical sensors, as well as dedicated communications and surveillance equipment. The EMB 145 MP is operational in the Mexican Air Force.
Embraer also develops and integrates state-of-the-art Command and Control, Intelligence, Surveillance and Reconnaissance (C4ISR) systems for defense and government 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 Embraers technical understanding of several key topics such as knowledge management, visualization technologies, decision-making tools and concept-development methodologies. One recent practical example of Embraers participation in the C4ISR field is the definition and development of a new datalink protocol, the Link BR2, for the Brazilian Air Force.
Tucano Family; Super Tucano
The Tucano is a single engine turboprop aircraft used for pilot training and armed reconnaissance missions. Although no longer manufactured, over 317 EMB 312 Tucanos were manufactured to ten air forces worldwide, including those of Brazil, the United Kingdom, France, Argentina, Egypt, Colombia, Paraguay, Peru and Venezuela.
We have also developed the 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 offers solutions for basic to advanced weapons training, such as in-flight virtual training. It also offers operational capabilities required for successful internal security, operation support and counterinsurgency (COIN) missions. It offers an engine with twice the power of the Tucanos standard engine, fighter standard avionics, ejection seats, an onboard oxygen-generating system and enhanced range and external load capability. The Super Tucano was originally developed under an agreement with the Brazilian Air Force and with the Financiadora de Estudos e Projetos (the Brazilian Financier for Studies and Projects), or FINEP, which provided the initial research and development funding in 2005. The Super Tucano has sophisticated navigation and attack systems, night-operations capability and the ability to operate under severe weather conditions. These aircraft are also used for advanced pilot training and for defense operations in the Amazon region of Brazil in connection with the Brazilian governments Sistema de Vigilância da Amazônia SIVAM (System for the Surveillance of the Amazon) program. Since its first delivery until December 31, 2008, 63 Super Tucano aircraft were manufactured to the Brazilian Air Force. As of March 31, 2009, we had a backlog of 32 firm orders for Super Tucano aircraft from the Brazilian Air Force. In December 2005, we received firm orders for 25 Super Tucano aircraft from the Colombian government and by the end of 2008 all aircraft had been delivered to that customer.
The Super Tucano has so far been manufactured for the Brazilian and Colombian Air Forces, and has been recently ordered by the Chilean, Ecuadorian and Dominican Air Forces.
In April 2009, Embraer began the development of the KC 390, a new military cargo aircraft based on the EMB 190 platform. The KC 390 is being designed to transport a wide variety of cargo, including small armored cars. This aircraft will be designed so that it can be built in different configurations, including versions that will allow it to conduct medical evacuation (MEDEVAC) missions. The KC 390 will be equipped with some of the most modern technology available, including systems for handling and launching cargos, and a fly-by-wire technology that reduces pilots workload and allows the aircraft to operate on short and unpaved runways.
Government Transport Aircraft
We are marketing our aircraft modified to meet added security needs to the Brazilian and other governments. In 2007, we delivered one Legacy 600 to the Angolan government, and one ERJ 145 to the Nigerian government. In 2008, we signed a contract with the Brazilian Air Force to develop and deliver a modified version of the EMBRAER 190 commercial aircraft for presidential air transportation. In 2008, we delivered one Legacy 600 to the Ecuadorian government. In addition, our EMB aircraft family has in the past been sold to the air forces of Belgium, Greece and Colombia. Our Legacy 600 aircraft has been sold in the past to the governments of Nigeria and India.
Brazilian Navy Aircraft Modernization Program
In April 2009, Embraer entered into an agreement with the Brazilian navy to modernize 12 of its A-4 Skyhawk aircraft. This upgrade will incorporate new technology to those aircraft, including new avionics, radar, power production and autonomous oxygen generating systems.
Other Projects and Activities
We offer military aircraft modernization services and we currently have two ongoing programs contracted with the Brazilian Air Force. The first one, known as F-5BR, is focused on performing structural and electronics upgrades on 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. The second ongoing contract, known as the A-1M modernization program, focuses on modernizing the AMX. The goal of the modernization project for the AMX jets is to keep the fleet of 43 on active duty for another 20 years.
Our defense systems aircraft face stiff competition from various manufacturers, from different countries in each market segment, many of which have greater resources than we do.
The Super Tucano competes in the basic/advanced training market with the Pilatus PC-9M (basic) and 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 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, namely, 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.
Executive Aviation Business
We have developed a line of executive jets, the Legacy 600, and are developing additional executive jets in the entry-level, light and ultra-large categories: the Phenom 100, Phenom 300 and Lineage 1000, respectively. We are marketing our executive jets to companies, including fractional ownership companies, charter companies and air-taxi companies, and high-net-worth individuals. Our executive aviation segment accounted for 13.8% of our net sales for the year ended December 31, 2008, resulting from the delivery of 35 Legacy 600 jets. On March 31, 2009, our firm orders in backlog for our executive jets totaled US$6.8 billion from more than 210 customers.
We developed the Legacy 600 by building upon our regional jet design and manufacturing experience. For example, with the exception of the interior of the aircraft, the fuel tank, controller and indication system and the winglets, the Legacy 600 has the same components as the ERJ 135 and is capable of being manufactured on the same production line. The executive version of the Legacy 600 was certified by the Brazilian aviation authority in December 2001, by the JAA in July 2002 and by the FAA in August 2002.
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 300 will carry up to nine people and have a larger fuselage and wingspan and longer range than the Phenom 100. It will be powered by Pratt & Whitney Canadas PW535E engine and is expected to enter into service in the second half of 2009. Pratt & Whitney Canada, Garmin and Eaton are our risk-sharing partners for this program. The Phenom 100 jet carries from six to eight people and is powered by Pratt & Whitney Canadas PW617F engine. In the second half of 2008, the Phenom 100 entered into service.
In May 2006, we launched the Lineage 1000, an ultra-large executive jet based on the EMBRAER 190 commercial jet platform. The Lineage 1000 will be configured to accommodate up to 19 people in a total cabin volume of 4,085 cubic feet (115.7 cubic meters), and will be powered by GE CF34-10E7 engines. The Lineage 1000 is expected to enter into service in mid-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 miles range, and the mid-size Legacy 500 jet, with a 3,000 nautical miles range. Both programs were approved by our Board of Directors in March 2008. The Legacy 450/500 jets are expected to enter into service in 2013 and 2012, respectively, and will be positioned in our executive jets portfolio between the Legacy 600 and the Phenom 300. We believe that these two aircraft programs will help strengthen our position in the market and establish our portfolio as one of the most comprehensive of the executive aviation industry.
We face significant competition from companies with longer operating histories and established reputations in the mature executive jet industry. Many of these manufacturers have greater financial, marketing and other resources than we do. Legacy 600 competitors include aircraft produced by Dassault Aviation, Bombardier Inc., General Dynamics and Raytheon. Phenom 100 and Phenom 300 competitors in the entry-level and light jet categories include Cessna Aircraft Co. and Raytheon. Boeing and Airbus are the main competitors of 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. We customarily receive a deposit at the time of order, progress payments totaling 15% to 30% of the aircraft price, and the full payment of the balance is due upon delivery. We generally receive between US$10,000 and US$200,000 for each option to purchase an executive jet.
We provide after-sales customer support services and manufacture and market spare parts for the fleets of our commercial, executive and defense and government customers. Activities in this segment include the sale of spare parts, maintenance and repair, training and other product support services. Revenues for the aviation services segment accounted for 9.5% of our net sales for the year ended December 31, 2008. Our after-sales customer support and spare parts business falls into several categories:
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 established a pooling program that allows customers to exchange used parts for new or refurbished parts.
We expect to enhance customer support and services offered to the executive aviation segment. We intend to add four wholly owned service centers in the next three years, and are revamping the authorized service center network for executive jets. By the end of 2009, we estimate that we will have 35 service centers to support our executive jet fleet. In October 2006, we entered into an agreement with 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. The initial training program has started to be offered at CAE SimuFlite, Dallas, Texas, as the Phenom 100 started to operate in 2008. Plans for the joint venture will provide entitlement training and post-entitlement training for pilots, maintenance technicians and dispatch personnel. We entered into an agreement with CAE to for a global training joint venture, which will provide comprehensive training to customers of the Phenom jets. We also plan to invest in parts inventory and logistics, as well as in the improvement of our special maintenance programs.
Other Related Businesses
We recognize revenues related to the selling or leasing of used aircraft to customers primarily through our leasing subsidiary, ECC Leasing Co. Ltd. In addition, 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 1.8% of our net sales for the year ended December 31, 2008.
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. At December 31, 2008, we had delivered a total of 2,326 of these aircraft. 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, 2008, we had delivered a total of 1,042 of these aircraft, including 23 in 2008. We had no crop duster aircraft in backlog at December 31, 2008.
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 Co. Ltd. and ECC-Insurance & Financial Co. Ltd.
The mission of ECC Leasing Co. Ltd is to manage and remarket Embraers aircraft portfolio, which as a result of contractual obligations, may be acquired by us as trade-in and/or repurchase 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 Co. Ltd. in Ireland, has contributed accumulated net income of US$43.4 million since its inception through December 31, 2008. Sales campaigns of new aircraft, where the acceptance of trade-in aircraft as part of payment were accepted, have been successfully completed. Additional revenues have also been generated through the sale and lease of aircraft received as trade-in. Furthermore, leasing operations, involving EMBRAER170, EMBRAER175 and EMBRAER 190 pre-series aircraft, contributed to the current results. During this period, ECC Leasing and two other Embraer wholly owned subsidiaries managed a portfolio comprised of 71 aircraft, of which 24 are under operating leases, seven are available or under lease/sale negotiations, nine are performing flight tests at Embraer, and 31 were sold to airlines, corporations and government entities in North America, South America, Asia and Europe.
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 Leasings 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 Co. Ltd 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 operators credit and asset repossession require an adequate evaluation by Embraer.
As more pre-owned aircraft begin to trade in the market, Embraer and ECC Leasing Co. Ltd. have created the Embraer Lifetime Program to better support our customers. The program will allow customers to select from a wide array of services, including training, spare parts, technical support, engine programs, technical representation, maintenance and overhaul coverage, among others. 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 others. The program will allow us to improve continuously 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 Embraers comprehensive support package.
The following table sets forth our net sales by line of business and geographic region of the end users of our aircraft for the periods indicated.
We formed a joint venture company in December 2002 with Harbin Aircraft Industry (Group) Co., Ltd. and Hafei Aviation Industry Co., Ltd., subsidiaries of China Aviation Industry Corp. II, or AVIC II, to provide for the manufacture, sale and after-sale support of the ERJ 145 regional jet family. We own 51% of the equity of the joint venture company Harbin Embraer Aircraft Industry Company Ltd. We have granted the joint venture 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. As of March 31, 2009, Harbin Embraer Aircraft Industry Company Ltd. had secured contracts with five Chinese airlines for a total of 71 ERJ 145 aircraft, 32 of which were delivered as of March 31, 2009. In October 2007, the 1,000th jet of the ERJ 145 family was delivered at Harbin Embraer Aircraft Industry Co. Ltd.
In October 2006, we entered into an agreement with 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. The initial training program has started to be offered at CAE SimuFlite, Dallas, Texas. The joint venture is expected to provide entitlement training and post-entitlement training for pilots, maintenance technicians and dispatch personnel.
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 ERJ 145 regional jet family, EMBRAER 170/190 family and Legacy 600 executive jet, depending on aircraft model, 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 and production of commercial aircraft. 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 research and 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. Risk FactorsRisks Relating to EmbraerWe 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:
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 Gamesa, 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., 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:
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, the referred agreement referred to above does not cover the production of parts for the EMBRAER 170 and EMBRAER 175 aircraft.
The risk-sharing partners for our 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 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$397.9 million in 2008 and we expect to receive an additional US$303.7 million in future years for the development of the Phenom 300 and Legacy 450/500 family. Cash contributions become nonrefundable upon the fulfillment of certain developmental milestones. In 2008, US$353.6 million of these cash contributions had become nonrefundable. If we cancel the production of the Phenom 100 or any aircraft in the EMBRAER 170/190 jet family or the development of the Phenom 300 or the Legacy 450/500 jet family because we are unable to obtain certification or for other nonmarket related reasons, we may be obligated to refund US$44.3 million of the total cash contributions already received. We expect the certification of the Phenom 300 to be granted in the second half of 2009. The Phenom 100 was certified in 2008. The Legacy 450/500 jets are expected to enter into service in 2013 and 2012, respectively. 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 Service and Product Support
Customer satisfaction and service is critical to our success. Through our customer focus, we aim to enhance customer loyalty and, ultimately, increase sales. We will continue to focus on the development of closer, long-term relationships with our customers by meeting their aircraft requirements, providing after-sale support and spare parts and meeting maintenance requirements. We identify at the time of purchase the appropriate level of after-sale regional or on-site customer support and coordinate regional inventory levels to address expected spare parts and maintenance requirements. To maintain and increase our responsiveness, we have established five support centers worldwide. We provide technical assistance, support and distribution to our Brazilian and other Latin American customers through our facility in São José dos Campos and Gavião Peixoto. In March 2002, we established a distribution center in Beijing, China, together with China Aviation Supplies Import and Export Corporation, or CASC. We also intend to provide support services through our joint venture in China for aircraft sold by the joint venture. In addition, we operate an MRO facility in Nashville, Tennessee, and an MRO facility in Alverca, Portugal. We provide full-service maintenance and repair services for our commercial and executive aircraft at these service centers, enhancing our level of service to our customers in the United States and Europe. In addition, we have concluded the construction of a service center at Williams Gateway Airport in Mesa, Arizona.
We have dedicated teams in the United States, Europe and Brazil to focus exclusively on enhancing customer support. In addition, for each of our key customers, we have assigned senior relationship managers that are responsible for enhancing our relationships with these customers. We also provide direct field support with on-site technical representatives at several of our major customers facilities. These on-site representatives are assigned to major customers prior to the first delivery of their aircraft and provide advice on maintenance and operation. They also monitor our customers spare part needs and maintain customers inventories.
We operate support centers that are available 24 hours a day, seven days per week, in our São José dos Campos facility, as well as in Ft. Lauderdale, Florida, and Le Bourget, France. We train pilots, copilots, flight attendants and mechanics at these locations. We operate advanced flight simulators for our ERJ 145 regional jet family and for the Legacy 600 at our Florida facility under an agreement with FlightSafety International, Inc., which specializes in flight simulation. We have entered into an agreement with GE Capital Aviation Training Limited, or GECAT, a joint venture between General Electric Company and Thales, whereby GECAT provides training for the EMBRAER 170/190 jet family on a non-exclusive basis. We also provide field service and on-the-job
training for airline personnel. For example, we routinely dispatch one of our pilots to fly with an operators crew during the introduction of an aircraft into a customers regular routes. We also provide technical publications with up-to-date technical information on our aircraft.
Aircraft Financing Arrangements
In the past, we generally did not provide long-term financing directly to our customers. Instead, we assisted our customers in obtaining financing arrangements from different sources, including capital providers such as leasing companies, commercial banks, capital markets and the BNDES. In that regard, until 2008 customers could generally obtain financing for their aircraft purchases. However, the current economic downturn is requiring a higher level of involvement from manufacturers, since most of the financing sources have dried up. As a response to the current credit shortage due to the global economic crisis, we are working together with customers to develop new sources of funds, especially from nontraditional financiers. We are also looking for long-term relationships and expect to broaden the alternatives available to support our clients financing needs, therefore contributing to reduce the funding gap caused by the current tight credit markets.
Airlines sometimes require short-term bridge financing prior to arranging long-term debt financing because, for the airlines, the quickest 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 have completed or are negotiating other financing arrangements and have not received funding at the time of the aircraft delivery.
In July 2007, Brazil and the OECD countries entered into an agreement to establish a level playing field for official export financing support of aircraft. ECAs from signatory countries are required to offer the same financial terms and conditions when financing sales of competing aircraft. The effect of the agreement is to focus customers 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 agreement, financing support by the Brazilian government to the potential purchasers of our aircraft contain similar terms and conditions offered by Boeing, Airbus and Bombardier to such purchasers.
The BNDES-exim sponsored Program, a Brazilian government program, provides our customers with direct financing. From 1996 through 2008, approximately 28% of the total value of our export sales was financed by the BNDES-exim Program. In 2008 approximately 11% of commercial aviation revenues were supported by the BNDES, which also provided support to the EMBRAER 170/190 jet family for the first time.
Because of the high acceptance of the EMBRAER 170/190 family by the aircraft finance community and the value of these assets as collateral (including in terms of residual values), as of December 31, 2008, we had been able to deliver, for the commercial aviation segment, 95% of the jets of the EMBRAER 170/190 family with no government or official financing. The market used to offer many different structures to finance those jets, although the most common ones were debt and lease financing. Debt financing represented approximately 40% of the total aircraft delivered between 1995 and 2008 with funds provided to our customers by commercial banks, capital markets and the BNDES. Since the recent global crisis began, commercial banks have reduced new financing offers, and fewer financial institutions remain active in the market. Banks were responsible for financing approximately 50% of our commercial aircraft deliveries in 2008 and we believe they may reduce new funding for our commercial aircraft in 2009 by approximately another 50%.
Leasing arrangements generally involve the purchase of our aircraft by a leasing company under a customers purchase contract and the lease of that aircraft to that customer. Leasing companies are also facing liquidity issues and the sector is undergoing a consolidation. In 2008, approximately 40% of our commercial aircraft were delivered through leasing arrangements. However, due to the effects of the global economic crisis, a reduction of deliveries financed by this type of structure is also expected.
We believe the decline in funding from traditional sources will be partially offset by financing from BNDES to the airlines.
See Item 3D. Risk FactorsRisks Relating to EmbraerA downturn in commercial aviation may reduce our sales and revenue, and, consequently, our profitability, in any given year and Item 3D. Risk FactorsRisks Relating to EmbraerBrazilian government budgetary constraints could reduce amounts available to our customers under government-sponsored financing programs.
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, 2008, we had 387 trademarks. Our registered 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 invention, 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, including the patent for the seat leaning system used in the Legacy 450/500 jet family. We require that our suppliers and risk-sharing partners respect the intellectual property rights of third parties, and we believe that we have the intellectual property rights necessary for 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 certification of aircraft and aircraft manufacturers. 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 Departamento de Aviação Civil (Civil Aviation Department), through the Centro Técnico Aeroespacial (Aerospace Technical Center), under the Ministry of Defense. In 2005, a new regulatory agency was created, the Brazilian aviation authority, becoming the main Brazilian authority for the regulation, supervision and certification of aircraft, aircraft parts, manufacturers and operations. The aviation authorities in other countries include the FAA in the United States, the recently created EASA for the European Union, or EU, and the JAA for the other European countries. Some countries simply validate and complement the Brazilian aviation authoritys original certification, in accordance with their own rules. The Brazilian aviation authority has a bilateral certification agreement with the FAA under which the FAA 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 FAA, some authorities, such as those in Australia and Mexico, ratify the certification. Other countries, such as Canada, require compliance with their own specific national requirements before certification. In Europe, since September 2003, EASA has become the regulatory authority for EU countries, including Germany, Italy, France, the United Kingdom, Spain and The Netherlands. Most of the remaining non-EU countries, such as Switzerland, still operate under the rules of the JAA. The JAA is not a certification authority, but rather an advisory organization that makes recommendations to the non-EU national authorities. A recommendation by the JAA is a requirement for certification of an aircraft by most of these authorities. Before the creation of EASA, 27 national authorities were JAA members. As EASA is a new organization, it is currently using the JAA technical structure and following the JAAs recommendations for issuance of EASA certificates for aircraft.
Aircraft certification is an ongoing process. Any change in the design of any of our aircraft must be approved by the Brazilian aviation authority. Significant changes may require a separate certification by other authorities. 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 certification of the Phenom 300 is expected to occur in the second half of 2009.
No material portion of our business is considered to be seasonal in any material respect.
Our operations are conducted by Embraer-Empresa Brasileira de Aeronáutica 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.
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:
Our total disbursements in capital expenditures related to property, plant and equipment were equal to US$90.8 million in 2006, US$208.9 million in 2007 and US$235.0 million in 2008. These investments are related mainly to construction of facilities, improvements to our plant and production facilities and modifications for the production of new aircraft models. In 2009, we expect disbursements in capital expenditures related to property, plant and equipment to total approximately US$150 million, which will be primarily related to (1) improvements for our existing facilities, including to the Phenom 100 and Phenom 300 assembly lines, (2) the construction of the Melbourne, Florida plant, which was started in May 2008 and (3) the construction of two plants in Alverca, Portugal, which was started in July 2008. Due to the recent start dates of the construction of these plants, no material disbursements have yet been made in connection with them.
In the first quarter of 2009, we reduced our expected investments in property, plant and equipment which we had originally estimated at US$240.0, in light of the impact of the current global economic downturn.
Under U.S. GAAP, our capital expenditures related to property, plant and equipment are recorded as a non-current asset in our balance sheet.
The actual manufacture of an aircraft consists of three principal stages: fabrication 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 joined, or mated, with one another to produce the aircrafts major components, which are in turn joined to create the aircrafts basic structure. In the final assembly stage, the aircrafts 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 aircraft 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 2008. 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 Commercial Aviation BusinessProductsEMBRAER 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 and government programs, an MRO facility, and the Phenoms 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.
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 March 31, 2009, we were in compliance with our permits. In addition, we adhere internally to international ISO 14000 environmental standards. In 2006, 2007 and 2008, we invested US$4.6 million, US$5.1 million and US$5.6 million, respectively, in environmental matters and we expect to spend approximately US$5.3 million on environmental matters in 2009 for the construction of new facilities and modification of existing facilities relating to environmental compliance and improvements.
During the process of due diligence prior to the acquisition of OGMA, we identified some industrial processes that did not meet environmental and occupational safety standards. As part of the negotiations, it was agreed with Empresa Portuguesa de DefesaEMPORDEF (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) Embraers 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.
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 damages 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.
We have no unresolved staff comments.
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. Risk Factors and the matters set forth in this annual report generally.
Except as otherwise indicated, all financial information in this annual report has been prepared in accordance with U.S. GAAP and presented in U.S. dollars. 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 financial statements in accordance with the Brazilian GAAP.
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 IntroductionSpecial Note Regarding Forward-Looking Statements. For factors which could affect our industry in the future and our own future performance, see Item 3. Risk Factors.
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. Despite the current market uncertainties, we believe that from 2009 to 2028 world air travel demand should grow an average of 5% per year in terms of passengers flown. We believe that the air transportation industry will recover after the end of the current economic crisis, and that the long-term growth trend will be restored. However, the current global economic downturn may cause a decrease in global demand for air travel in the short-term. This, in turn, may cause financial difficulties for some major commercial airlines, including certain of our customers in the commercial aviation business, causing a reduction in the demand for commercial aircraft, including those manufactured by Embraer. In addition, the current global economic downturn resulted in a credit shortage that might impair the ability of commercial airlines, including certain of our customers in the commercial aviation business, to finance their aircraft acquisition (see Item 4B. Business OverviewAircraft Financing Arrangements).
We expect China to lead growth in air travel in the next 20 years in terms of passengers flown, with an average annual rate of more than 7.5%, followed by Latin America, Russia and the Commonwealth of Independent States. We expect that the rate of passengers flown in Asia and Africa will grow approximately 5%, and the European and North American markets approximately 4%.
In North America, it is expected that in 2009 a number of airlines will operate in an environment of tighter margins. Main strategies have been focused on cost reductions, increased productivity and improved efficiency through better match of market demand with more adequate aircraft capacity. We believe that airlines are cautiously optimistic, even though industry revenue is expected to decline, mainly due to the reduction in demand. 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 fast as in the past, mainly because of weaker economic and market demand scenarios.
In Europe, revenue environment will remain under pressure as a result of the economic scenario. Regional carriers are supporting network airlines adjustment of capacity and frequency of services 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. Aviation industry will be subject to the Emissions Trade System, or ETS, and to the imposition of potential green taxes which tend to be implemented under more stringent regulatory measures. Airlines are expected to be replace aging aircraft to avoid green taxes.
Despite current uncertainties concerning the short-term outlook of the commercial aviation industry, we believe that passenger demand in the Latin American air transport industry remains positive, led mainly by Brazil and Mexico. Airlines have introduced more fuel-efficient and right-sized aircraft in order to expand the intra-regional aviation system. More regional integration is increasing the demand for smaller-capacity aircraft to operate on medium- and low-density markets.
In the Asia-Pacific region, airlines are suffering with the decrease in international passenger and cargo demand caused by the economic crisis. The Asia-Pacific fleet is still comprised mainly of high-capacity narrow-body aircraft, which restricts adequate deployment to medium- and low-density markets. Liberalization initiatives in some sub-regions, combined with public policies, tend to encourage the development of regional air transport and to generate major opportunities for regional aviation in the coming years.
The reduction of Chinas economic growth is affecting the demand in the air transport industry. The Chinese air transport industry is mainly concentrated in high-capacity aircraft, which do not have the adequate capacity to serve properly most of the medium- and low-density markets. Nevertheless, the Chinese government is implementing new policies to promote regional aviation development.
In the Middle East increased air transport demand is mainly due to the expansion of long-haul international services. The intra-regional aviation system is being developed in order to support regional integration and feed international flights.
Air transportation in Africa is characterized by a regulated environment, aging fleet, lack of infrastructure and financial resources, resulting in poor connectivity in the intra-regional system. Nonetheless, 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 Commonwealth of Independent States, or CIS, air transport industry is diverse. At CIS, there are several small, state-owned airlines searching for narrow-body aircraft for fleet renewal. In Russia, import taxes higher than 40% represent a significant setback for airlines that intend to renew their fleet with western aircraft. Airline consolidation is in progress in the region, focusing on the improvement of air transport system efficiency. Opportunities for regional aviation rely on the replacement of the huge, old and inefficient Soviet fleet.
We estimate a global demand for 6,750 jets in the 30- to 120-seat-capacity category over the next 20 years, which may generate global sales of new aircraft totaling US$220 billion. Of this total, we expect that 2,950 jets should be delivered between 2009 and 2018, and the remaining 3,800 jets should be delivered between 2019 and 2028, as detailed below:
Estimates indicate that the 30- to 60-seat-capacity category has reached maturity, but will remain the backbone of the U.S. and Europe hub-feeding system and will support the regional aviation development in some other world regions, such as Russia/CIS, Mexico, Africa and South America.
The 61- to 120-seat capacity category will continue to help airlines match aircraft capacity to market demand with improved service levels, through the right-sizing of low load factor narrow-body flights. Furthermore, the jets in this category also tend to be used to substitute older fleets, expand into new markets and aid the natural growth of regional airlines on high-demand routes operated by smaller jets.
We believe that emission is becoming one of the main drivers of airline fleet decisions and will influence future aircraft developments. We estimate that more than 700 units of the 30- to 120-seat fleet currently operating are over 20 years old. Such aircraft should soon be replaced, which should result in significant environmental benefits. The Embraer executive jets family provides a reduction of as much as 50% in carbon dioxide emissions and may be well positioned in this scenario.
The global economic crisis has rapidly and severely affected the executive aviation market, especially in the last quarter of 2008. As a result, we believe 2009 will mark a reversal of the growth cycle that began four years ago.
In the short-term, we believe issues such as the decreasing buying power of companies and individuals, the surging inventory of pre-owned jets for sale, the shrinking number of financing sources and the restricted financing conditions will be key to determine the behavior of demand for executive jets. In addition, we believe that in the current economic downturn public opinion is beginning to view executive jet travel as superfluous or excessive.
Charters and fractional ownership providers, which have grown considerably in the last couple of years, are now suffering the effects of the global economic crisis. In addition, corporations are reducing the travel costs associated with corporate jets. Data published by the FAA and Eurocontrol in December 2008 showed that in 2008 business aviation traffic in the U.S. and Europe, measured in terms of number of executive jet flights, decreased 21.3% and 16%, respectively.
According to the General Aviation Manufacturers Association, in 2008 the executive aviation market reported approximately 1,154 executive jet deliveries, and a 11% increase from 2007. However, we believe it will be difficult for the industry to sustain the same level of deliveries in 2009. A high number of order cancellations may continue to occur, which should lead to a significant reduction of deliveries in 2010 and 2011. We believe a recovery in the executive jet segment will begin in 2011-2012, and, as a result, executive jets manufacturers will have to adjust production capacity and product pricing throughout 2009 and 2010.
We estimate that the global executive aviation market between 2009 and 2018 will be valued at approximately US$188 billion (an 8% decrease over Embraers 2008 projections).
According to our post-crisis market perspective, compound annual revenue growth for the executive jet segment from 2009 to 2018 is expected to be stagnant. In terms of units delivered, growth expectancy will narrow to 0.9%, which is lower than our last years 3.1% forecast.
Since 2005, the industry has witnessed an increase in the participation of nontraditional markets (i.e., outside the U.S. and Western Europe) in overall sales levels. Recently, some manufacturers have registered 70% of orders coming from outside the U.S. market. However, due to impairment of the emerging economies caused by the global economic crisis, we anticipate that the steep reduction in sales of executive aviation in the U.S. will not be offset by the growth of demand in nontraditional markets. Revenue from non-U.S. orders are believed to account for 55% of total industry revenue during the next ten years, representing an increase of ten percentage points from our last years estimate.
Despite overall forecast reduction, Latin America, Asia-Pacific and China are expected to show growth in revenues for this segment, mainly in the medium-to-long terms. Lighter jets 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 regions 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-and medium-terms.
Our Executive Aircraft
We continued to make solid progress throughout 2008, 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.
New sales of the Phenom executive jets family increased the number of firm contracts to over 800 aircraft during 2008. In addition, over 20 Lineage 1000 jets have been sold around the world and Legacy 600 sales performed well throughout the three first quarters, registering a slowdown towards the last quarter of 2008.
We also had one Embraer 175 sold as a corporate shuttle and delivered to an executive aviation customer in North America, although it is not a typical sales target.
Legacy 450 and Legacy 500
In April 2008, we formally launched two new programs in the medium jet categories: the mid-light Legacy 450 jet and the mid-size Legacy 500 jet. Both programs were approved by our Board of Directors in March 2008. The Legacy 450/500 jets will be positioned in our executive jets portfolio between the Legacy 600 and the Phenom 300.
An estimated US$750 million is expected to be invested overall in fixed assets, research and development for the new Legacy 500 and Legacy 450 models, which are expected to enter into service in 2012 and 2013, respectively. 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. During 2008, we started the development of the Legacy 500 by conducting wind-tunnel tests, and by initiating the programs joint definition phase and program design review with our suppliers.
The Phenom 100 was awarded the type certification by the Brazilian aviation authority on December 9, 2008 and by the U.S. Federal Aviation Administration two days later. Both certificates were issued without restrictions. EASA certification of Phenom 100 is expected for the second quarter of 2009. The first two Phenom 100 units were delivered in December 2008 to U.S. customers.
The take-off field length requirement, the hot and high capabilities, speed and landing distance targets of the Phenom 100 have been improved, which leads us to believe that this product will be better positioned to meet our customers expectations.
In 2008, the editors of Robb Report magazine, in the U.S., voted the Phenom 100 the Best of the Best Business Jet.
The Lineage 1000 executive jet has also been awarded type certification by the Brazilian aviation authority and by EASA. The interior supplemental type certification was awarded in early 2009, completing the development cycle.
The Lineage 1000 has also exceeded development targets. Tests conducted with the Lineage 100 demonstrated that its initially projected range has been surpassed by approximately 5%, which will result in lower operating costs and, as a consequence, will allow a better market penetration for the Embraers ultra-large model.
In the first half of 2008, Phenom 300 successfully made its maiden flight and started its flight test campaign. Several tests were performed throughout 2008 and the Phenom 300 is expected to enter into service in the second half of 2009, with European deliveries starting in 2010.
The Legacy 600 has entered its seventh year of production and still has broad market acceptance, principally among customers in Europe. The aircraft has also a good acceptance in the Middle East, with a fleet of 14 aircraft spread within the region. Legacy 600 deliveries declined from 35 units in 2007 to 33 units in 2008 for executive aviation customers only. With a fleet of more than 150 jets in 24 countries, the Legacy 600 holds a 15.2% market share in the super midsize category.
We have further refined the Legacy 600 design in 2008, with improvements in its capability, interior acoustic and overall structure.
We believe that Embraers executive jet fleet may help expand our market share in this segment as a result of the expansion of our product portfolio with the entry into service of these new executive jets in 2008 and 2009.
From 2007 to 2009, we plan to have invested more than US$100 million in infrastructure and organization to support our business jet customers throughout the world. We have opened two new company-owned service centers during 2008. The first is located in Mesa, Arizona, at PhoenixMesa Gateway Airport and the second is located in Fort Lauderdale, Florida, at Fort LauderdaleHollywood International Airport. These new facilities are capable of providing our customers with full service for our executive jets.
In 2008, our new Executive Jets Center at Le Bourget Airport, in France, received the European Aviation Safety Agencys Part 145 Approval Certificate to operate in Europe. The facility is dedicated exclusively to our executive jets fleet, and joins the existing service center network that includes OGMA in Portugal, and another four Embraer authorized service centers in the region. Embraer also named Falcon Aviation Services in Abu Dhabi, United Arab Emirates, an authorized service center dedicated to support its Phenom, Legacy and Lineage customers in the Middle East. Field support representatives have also been assigned to both Abu Dhabi and Dubai, and an inventory of parts will be in place in Dubai by the end of the first quarter of 2009.
In addition, we have entered into a contract with one of the worlds largest logistics company, UPS Supply Chain Solutions, located in Louisville, KY, USA, to optimize the service cycles for parts, from the warehouse to the service centers and to customers.
During 2008, we have reinforced our sales force for the Latin American market by adding three new sales managers, all of them based in São Paulo, Brazil. The number of Authorized Sales Representatives, or ASRs, in the region was also increased with the nomination of three new ASRs in Guatemala, Venezuela and Mexico. Our sales team in Asia-Pacific was also strengthened with a new Vice-President of Sales.
Brazilian Economic Environment
The current economic crisis, including the events negatively affecting the commercial airline industry and the ensuing negative effects on the U.S. economy have adversely affected the global and Brazilian economies and securities markets, and have resulted in:
As discussed below, any uncertainty surrounding the U.S., Brazilian and global economies could result in the Brazilian 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 government has frequently intervened in the Brazilian economy and occasionally has made drastic changes in policy and regulations. The Brazilian governments 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 Brazilian government has the authority, when a serious imbalance in Brazils 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 Brazils 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 governments 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 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 materially adversely affect 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 2004, Brazils GDP increased 5.2% to US$559.6 billion and the country achieved a trade surplus of US$33.7 billion. Inflation in 2004, as measured by the IGP-M, was 12.4%. Interest rates continued to be maintained at high levels, with the rates for Certificados de Depósito Interbancário (Interbank Certificates of Deposit), or CDI, averaging 16.2% in 2004.
Given the positive 2004 results, investor confidence continued to be strong in 2005. The real appreciated by 8.1% and 11.8% against the U.S. dollar in 2004 and 2005, respectively, to R$2.3407 per US$1.00 at December 31, 2005. In 2005, Brazils GDP increased 3.1% to US$734.4 billion and the country achieved a record trade surplus of US$44.8 billion. Inflation in 2005, as measured by the IGP-M, was 1.2%. Interest rates continued to be maintained at high levels, with the CDI averaging 19.1% in 2005.
According to the Central Bank, in 2006 the GDP grew only 2.7% primarily as a result of high interest rates. Also in 2006, the real appreciated 8.7% against the U.S. dollar, reaching R$2.138 per US$1.00 at December 31, 2006.
In 2007, Brazils 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 IGP-M, was 7.7%, and the CDI average was 11.9% in the same period.
In 2008, Brazils GDP increased 4.8% and the real depreciated 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 IGP-M, was 9.8% and the average CDI interest rate was 12.0% in the same period.
The global economic crisis has reduced expectations for growth of the Brazilian economy for 2009. These reduced expectations triggered the depreciation of the real, particularly since October 2008, as well as tighter availability of credit to consumers and companies, a sharp devaluation of securities of Brazilian companies and a reduction in industrial output.
According to the Focus report published by the Brazilian Central Bank, or BACEN, in April 9, 2009, negative growth of 0.30% is estimated for Brazilian GDP in 2009 and an inflation rate of 4.25% for the same period.
According to the BACEN, Brazilian international reserves continue above R$200.0 billion (R$201.6 billion at April 20, 2009), slightly lower than 2008 year-end levels. In response to the global economic crisis, the Brazilian government has implemented macroeconomic measures, particularly reductions of the Brazilian base interest rate, tax reductions and social programs to foster investment and consumption by both individuals and companies.
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 IGP-M and published annually by Fundação Getulio Vargas , 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:
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 in conformity with U.S. GAAP requires us to use estimates and adopt assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and accounting disclosures. 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 brief discussion of our more significant accounting policies.
Sales and Other Operating Revenues
We recognize revenues from sales by the commercial, executive aircraft and aviation services segments when title and risk of loss is transferred to customers, which, in the case of aircraft, occurs when delivery is made, and in the case of aviation services, when the service is provided to the customer.
We also recognize rental revenue for lease aircraft as operating leases, ratably over the lease term and recorded as net sales in the other segments.
In the defense and government segment, a significant portion of revenues is derived from long-term development contracts with the Brazilian and foreign governments, for which we recognize revenues under the percentage of completion, or POC, method. Such 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.
Revenues under exchange pool programs are recognized monthly over the contract term and consist 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:
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 units relative fair value.
Sales deductions comprise indirect sales taxes and contractual concessions.
We offer contractual concessions that provide its customers with a reduction in the amount paid for the aircraft. The concessions are recorded as sales deductions in accordance with EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer, because the concessions represents a reduction of the sales price. In addition, the recovery of the concessions through the export incentive program is recognized as revenue associated with the sale and exportation of the aircraft and recorded as net sales.
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. 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 our historical warranty claim 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 our past experience, mainly when a new family of aircraft begins its revenue services, which could require us to increase the product warranty reserve. The warranty period ranges from two years for spare parts to five years for components that are a part of the aircraft when sold.
Guarantees and Trade-In Rights
We have provided financial and residual value guarantees and trade-in rights related to our aircraft. We review the value of these commitments relative to the aircrafts 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 have provided credit guarantees by analyzing a number of factors, including third party credit ratings and estimated obligors borrowing costs.
In accordance with FASB Interpretation No. 45, or FIN 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness of Others, we record third-party guarantees on our balance sheet at their fair value. FIN 45 has the general effect of delaying the recognition of the portion of our revenue sales that are accompanied by certain third-party guarantees. These estimates of fair value are based on certain assumptions, including the probability of default by the ultimate obligor and the market value of the mortgaged assets. As a result, actual losses derived from financial guarantees may differ from the amounts recognized on our balance sheet, and, consequently, could negatively affect future operating results. During 2007 and 2008, the fair value of guarantees recorded generated a sales income of US$2.5 million and a sales deduction of US$2.9 million, respectively.
Sale of Residual Interests in Aircraft
In structured financings, 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. We may provide financial guarantees in favor of the financial institution, and may also act as the equity participant in such financial structuring process. According to FIN 46-R Consolidation of Variable Interest Entities an interpretation of ARB 51, an enterprise shall consolidate a variable interest entity if that enterprise has a variable interest that will absorb a majority of the entitys expected losses if they occur, receive a majority of the entitys expected residual returns if they occur, or both. Therefore, we have been consolidating certain entitys transaction through the third parties where we are the primary beneficiary.
We also effect transactions with third parties through which we transfer the risks and rewards in leased aircraft. When we determine that we are no longer the primary beneficiary, based on managements evaluation of expected loss variability, we deconsolidate the related collateralized accounts receivables and corresponding recourse and non-recourse debt.
Recoverability of Long-lived Assets
We review our long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying value of an asset or group of assets may not be recoverable on the basis of undiscounted future cash flows, as required by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. These reviews are carried out at the lowest level of groups of assets to which we are able to attribute identifiable future cash flows. Assets are grouped based on our various aircraft families. We use various assumptions when determining the expected undiscounted cash flow including the forecasts of future cash flows, which are based on our best estimate of future sales and operating costs, based 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 adjust the net book value of the underlying assets if the sum of the expected future cash flows is less than book value. These reviews to date have not indicated the need to recognize any impairment.
Fair value of Financial Instruments and Hedge
For financial instruments, we make assumptions as to future foreign exchange and interest rates to recognize the fair value of each instrument. See Notes 32 and 34 to our audited consolidated financial statements. For further information related to the possible impact of fluctuations in the foreign exchange and interest rates on our principal financial instruments and positions, see Item 11. Quantitative and Qualitative Disclosures About Market Risk.
Allowance for doubtful accounts
We have to periodically assess the amounts and probabilities of losses we may experience as a result of customer default. The balance represents an estimate of probable but unconfirmed losses in the receivables portfolio. The estimate is based on various qualitative and quantitative factors, including results of individual credit and collectibility reviews. The allowance for doubtful accounts is recorded in an amount we consider sufficient to cover any expected losses on realization of our accounts receivable from our customers and is included under selling expenses. No adjustment is made to net operating revenues.
Principal Operating Data and Components of our Income Statement
The following chart sets forth statistical data concerning our deliveries and backlog for 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.
We generate revenue primarily from sales of commercial aircraft. We also generate revenue from the sale of defense aircraft, and from the sale of our Legacy 600 and Phenom 100 executive jets. Net sales of commercial and executive aircraft are denominated in U.S. dollars. In 2008, total defense and government net sales included approximately 75.6% of net sales denominated in foreign currency, predominantly in U.S. dollars, and 24.4% denominated in Brazilian reais but indexed to the U.S. dollar through price adjustment indices. 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 2008, total aviation services net sales included approximately 97.6% of net sales denominated in U.S. dollars and other foreign currencies and 2.4% in Brazilian reais but indexed to the U.S. dollar through price adjustment indices. Finally, we generate revenue from our other related businesses, which include operating leases and 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 Critical Accounting EstimatesSales and Other Operating Revenues.
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 and government 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 and of services rendered, comprising:
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.
In accordance with SFAS 5, Accounting for Contingencies, we accrue a liability for the obligations associated with product warranties, which is recorded on the aircraft delivery date and estimated based on historical experience which are recorded in the consolidated statement of income under 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 will be recognized when the product or service is provided to the customer.
Our firm order backlog for the commercial aviation, executive aviation, and defense and government segments decreased by US$1.2 billion during the first quarter in 2009, totaling US$19.7 billion. During the first quarter of 2009, we delivered 40 aircraft in total, comprising 32 jets to the Airline Market and eight jets to the executive aviation segment. After delivering a record number of aircraft in 2008, we continue to implement improvements to our industrial processes, affirming the commitment assumed with our shareholders, customers and suppliers. As our production rate has been maintained at the 14 E-jets per month level, we currently maintain our estimates to deliver 242 aircraft in 2009 within our commercial and executive aviation businesses.
New Brazilian Airline
In March 2008, we entered into an agreement with Azul, the new Brazilian airline formed by a group of investors led by David Neeleman, the founder of JetBlue, for the sale of 36 EMBRAER 195 jets. The agreement includes options for an additional 20 aircraft and purchase rights for an additional 20 aircraft. The total value of the order, at list price, is US$1.4 billion, and could reach US$3 billion, if all of options and purchase rights are confirmed. By March 31, 2009, we had already delivered four aircraft to Azul.
Legacy 450 and Legacy 500 Executive Jets
In April 2008, we formally introduced our new Legacy 450/500 executive jet programs. The mid-size Legacy 500, with a 3,000 nautical miles range, and the mid-light Legacy 450, with a 2,300 nautical miles range, will be positioned between the Legacy 600 and the Phenom 300 in our executive jets portfolio. An estimated US$750 million is expected be invested in research and development for the new Legacy 450/500 models, which are expected to enter into service in 2013 and 2012, respectively.
In April 2009, Embraer started to develop the KC 390, a new military cargo aircraft based on the EMB 190 platform. The KC 390 is being designed to transport a wide variety of cargo, including small armored cars. This aircraft will be designed so that it can be built in different configurations, including versions that will allow it to conduct medical evacuation (MEDEVAC) missions. The KC 390 will be equipped with some of the most modern technology available, including systems for handling and launching cargos, and a fly-by-wire technology that reduces pilots workload and allows the aircraft to operate in short and unpaved runways.
Brazilian Navy Aircraft Modernization Program
In April 2009, Embraer entered into an agreement with the Brazilian navy to modernize 12 of its A-4 Skyhawk aircraft. The modernization will incorporate new technology in those aircraft, including new avionics, radar, power production and autonomous oxygen-generating systems.
Results of Quarter ended March 31, 2009
On April 29, 2009, we announced our unaudited financial results for the first quarter of 2009. For further information, see our report on Form 6-K filed with the SEC on April 30, 2009.
Cancellation of Orders for ERJ 145 Regional Aircraft
In April 2009, we entered into an agreement with the HNA Group, a Chinese airline, to reduce its firm orders for 50 ERJ 145 regional aircraft, of which 11 had already been delivered, to 25. See Item 3D. Risk FactorsRisks Relating to EmbraerA downturn in commercial aviation may reduce our sales and revenue, and, consequently, our profitability, in any given year.
Results of Operations
The following table presents statement of income data by business segment for the periods indicated.
The following table sets forth statement of income information, and such information as a percentage of our net sales, for the periods indicated.
2008 Compared with 2007
Net sales. Net sales increased 20.8% from US$5,245.2 million in 2007 to US$6,335.2 million in 2008. Net sales in the commercial aviation segment increased 25.5% from US$3,376.6 million in 2007 to US$4,237.5 million in 2008. Net sales in the executive aviation segment increased 4.3% from US$838.0 million in 2007 to US$874.0 million in 2008. Net sales from aviation services increased 14.0% from US$528.3 million in 2007 to US$602.4 million in 2008. Defense and government net sales increased 45.6% from US$346.4 million in 2007 to US$504.5 million in 2008. Other related businesses net sales decreased 25.1% from US$155.9 million in 2007 to US$116.8 million in 2008.
The increase in commercial aviation net sales is primarily due to a higher number of deliveries during the period. We delivered 162 aircraft in 2008, compared to 130 aircraft in 2007 for that segment, with a more favorably priced product mix. This increase in the number of deliveries for all segments is due to positive results obtained by us from measures implemented in 2007, which continued to be perfected in 2008, with a view to adjusting our industrial processes in order to meet our delivery schedule. The
increase in executive aviation net sales resulted from the delivery of 36 executive jets in 2008, including 33 Legacy 600, two Phenom 100 and one Embraer 175, compared to 35 Legacy 600 delivered in 2007. In addition, the product mix of the executive aircraft that we delivered in 2008 was more favorably priced than the product mix of executive aircraft delivered in 2007. The increase in net sales from aviation services is mostly a result of the fact that the aircraft fleet that we serviced in 2008 was larger than the fleet serviced in 2007. The increase in defense and government net sales is due to increased sales in South America, including sales of Super Tucano aircraft to Chile, Ecuador and the Dominican Republic, and of the sale of an airborne early warning and control (AEW&C) system to India. Defense and government net sales increased in 2008 as a result of further progress made by us in certain projects, allowing us to increase the revenue we record under the corresponding long-term development contracts we have with our customers, which revenues are recognized pursuant to the percentage of completion method.
Cost of sales and services. Cost of sales and services increased 21.9% from US$4,093.5 million in 2007 to US$4,991.7 million in 2008, primarily due to the 30% increase in deliveries during 2008. As most of our costs are variable, a significant increase in deliveries will tend to cause a corresponding increase in our cost of sales and services. In addition, the fixed component of our cost of sales and services experienced an increase as a result of a 10.1% across-the-border salary increase approved for our workforce in September 2008. Cost of sales and services as a percentage of net sales increased from 78.0% in 2007 to 78.8% in 2008.
Gross profit. As a result of the foregoing, our gross profit increased 16.7% from US$1,151.7 million in 2007 to US$1,343.5 million in 2008. Our gross margin decreased from 22.0% in 2007 to 21.2% in 2008.
Operating expenses. As further explained below, operating expenses increased 3.7% from US$777.5 million in 2007 to US$806.5 million in 2008. Operating expenses as a percentage of net sales decreased from 14.8% in 2007 to 12.7% in 2008.
Research and Development. Research and development expenses decreased 24.1% from US$259.7 million in 2007 to US$197.0 million in 2008. This decrease relates mainly to the reduced spending for the development of new products for the executive aviation segment and for the research for improvements to all our products. Amounts received from our risk-sharing partners related to the fulfillment of certain contractual milestones, which offset our research and development expenses, increased 468.8% from US$23.7 million in 2007 to US$134.8 million in 2008.
Selling expenses. Selling expenses increased 8.8% from US$361.3 million in 2007 to US$393.1 million in 2007 due to higher marketing campaign expenses related to our executive aviation products, as well as an increase in variable sales expenses in 2008 because of the higher number of deliveries.
General and administrative expenses. General and administrative expenses decreased 1.0% from US$234.8 million in 2007 to US$232.4 million in 2008, mainly due to savings obtained from the implementation of a process optimization program, known as the P3E (Embraer Entrepreneurial Excellence Program), focused on cost and expense control and gains in productivity, which program started to be implemented in 2007 and continued to be perfected in 2008. This decrease in general and administrative expenses was partially offset by the 10.1% salary increase, which was also applicable to our administrative personnel.
Other operating income (expenses), net. Other operating income, net decreased 79.6% from US$78.3 million in 2007 to US$16.0 million in 2008, mainly due to the reversal in 2007 of a contingency provision in the amount of US$104.8 million, as a result of a final Supreme Court that was granted in our favor in a lawsuit in which we challenged the broader taxable basis for calculating PIS/COFINS taxes. See Item 8A. Consolidated Statements and Other Financial InformationLegal Proceedings and Note 17 to our audited consolidated financial statements.
Income from operations. As a result of the foregoing factors, operating income increased 43.5% from US$374.2 million in 2007 to US$537.0 million in 2008. Our operating margin increased from 7.1% in 2007 to 8.5% in 2008.
Financial income (expense), net. Financial income (expense), net, decreased from a net financial income of US$163.4 million in 2007 to a net financial expense of US$171.4 million in 2008, primarily as a result of:
Foreign exchange gain (loss), net. Foreign exchange gain (loss), net increased from a net foreign exchange loss of US$37.7 million in 2007 to a net foreign exchange gain of US$71.7 million in 2008, reflecting net foreign exchange rate variations on monetary assets and liabilities denominated in other currencies which are translated into our functional currency, the U.S. dollar.
Income tax expense. Income tax expenses increased from US$2.7 million in 2007 to US$41.1 million in 2008, mainly as a result of:
The effective tax rate increased from 0.5% in 2007 to 9.4% in 2008.
Net income. As a result of the foregoing factors, our net income decreased 20.6% from US$489.3 million in 2007 to US$388.7 million in 2008. As a percent of net sales, net income decreased from 9.3% in 2007 to 6.1% in 2008.
2007 Compared with 2006
Net sales. Net sales increased 39.5% from US$3,759.5 million in 2006 to US$5,245.2 million in 2007. Net sales in the commercial aviation segment increased 43.5% from US$2,353.2 million in 2006 to US$3,376.6 million in 2007. Net sales in the executive aviation segment increased 44.0% from US$582.1 million in 2006 to US$838.0 million in 2007. Net sales from aviation services increased 10.1% from US$479.8 million in 2006 to US$528.3 million in 2007. Defense and government net sales increased 52.8% from US$226.7 million in 2006 to US$346.4 million in 2007. Other related businesses net sales increased 32.5% from US$117.7 million in 2006 to US$155.9 million in 2007.
The increase in commercial aviation net sales is primarily due to a higher number of deliveries during the period. We delivered 130 aircraft in 2007, compared to 98 aircraft in 2006 for that segment, with a more favorably priced product mix. This increase in the number of deliveries for all segments is due to positive measures we undertook during 2007 to adjust our industrial processes to meet the deliveries scheduled for the period. These measures included the hiring of new employees, implementing a third shift for some production processes and introducing the lean manufacturing system. The increase in executive aviation net sales resulted from the delivery of 35 Legacy 600 executive jets in 2007 compared to 27 aircraft of the same model delivered in 2006. The increase in net sales from aviation services is mostly due to an increase in revenues from spare parts sales and services rendered, since the fleet of our jets is increasing. The increase in defense and government net sales is due to higher revenue during 2007 compared to 2006 as recognized from programs subject to the percentage of completion method of revenue recognition, principally the ALX program, when we delivered 28 aircraft in 2007, compared with 14 deliveries of the same model in 2006.
Cost of sales and services. Cost of sales and services increased 45.8% from US$2,806.8 million in 2006 to US$4,093.5 million in 2007, primarily due to the 30.0% increase in deliveries during the period, the costs related to hiring and training approximately 4,500 new employees, and overtime costs. Approximately 13% of our cost of sales and services is denominated in reais. Cost of sales and services as a percentage of net sales increased to 78.0% in 2007, compared to 74.7% in 2006.
Gross profit. As a result of the foregoing, our gross profit increased 20.9% from US$952.7 million in 2006 to US$1,151.7 million in 2007. Our gross margin decreased from 25.3% in 2006 to 22.0% in 2007.
Operating expenses. As further explained below, operating expenses increased 27.5% from US$609.9 million in 2006 to US$777.5 million in 2007. Operating expenses as a percentage of net sales decreased from 16.2% in 2006 to 14.8% in 2007.
Research and development. Research and development expenses increased 130.4% from US$112.7 million in 2006 to US$259.7 million in 2007. This increase is mainly attributable to the development of new products for the executive aviation segment and the research for improvements to all our products. The amounts received from our risk-sharing partners related to the fulfillment of certain contractual milestones, which offset our research and development expenses, totaled US$23.7 million in 2007 compared to US$36.0 million in 2006.
Selling expenses. Selling expenses increased 63.8% from US$220.6 million in 2006 to US$361.3 million in 2007 mainly due to higher marketing campaign expenses related to our executive aviation products and variable sales expenses in the period because of the higher number of deliveries.
General and administrative expenses. General and administrative expenses decreased 0.3% from US$235.5 million in 2006 to US$234.8 million in 2007, mainly due to the savings from the implementation of a process optimization program, the P3E (Embraer Entrepreneurial Excellence Program), an internal plan focused on costs and expense control and gains in productivity.
Other operating income (expense), net. Other operating income, net represented increased from US$1.6 million in 2006 to US$78.3 million in 2007, mainly due to the reversal of a contingency provision in the amount of US$104.8 million, as a result of a final Supreme Court decision that was granted in our favor in a lawsuit in which we challenged the broader taxable basis for calculating the PIS/COFINS taxes. See Item 8A. Consolidated Statements and Other Financial InformationLegal Proceedings and Note 17 to our audited consolidated financial statements.
Income from operations. As a result of the foregoing factors, operating income increased 9.2% from US$342.8 million in 2006 to US$374.2 million in 2007. Our operating margin decreased from 9.1% in 2006 to 7.1% in 2007.
Financial income (expense), net. Financial income, net, increased 55.0% from US$105.4 million in 2006 in US$163.4 million in 2007, primarily as a result of a US$89.4 million reversal of interest expenses and penalties related to our PIS/COFINS contingency provision, as a result of a final Supreme Court decision that was granted in our favor in 2007 in a lawsuit in which we challenged the broader taxable basis for calculating the PIS/COFINS taxes. See Item 8A. Consolidated Statements and Other Financial InformationLegal Proceedings.
Foreign exchange gain (loss), net. Foreign exchange loss, net, increased from US$4.0 million in 2006 to US$37.7 million in 2007, reflecting the net foreign exchange variations on monetary assets and liabilities denominated in other currencies which are translated into our functional currency, the U.S. dollars.
Income tax expense. Income tax expenses decreased 93.9% from US$44.4 million in 2006 to US$2.7 million in 2007, mainly due to higher benefits from having made tax-deductible distributions in the form of interest on shareholders equity, from higher research and development tax incentives and from differences in foreign jurisdiction tax rates. The effective tax rate decreased from 10.0% in 2006 to 0.5% in 2007.
Net income. As a result of the foregoing factors, our net income increased 25.4% from US$390.1 million in 2006 to US$489.3 million in 2007. As a percent of net sales, net income decreased from 10.4% in 2006 to 9.3% in 2007.
Our liquidity needs arise principally from research and development, 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, capital increases to meet these needs. For further information, see Item 4B. Business OverviewSuppliers and Components; Risk-Sharing Arrangements and Item 4B. Business OverviewCommercial Aviation BusinessProduction, New Orders and Options.
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 and the Lineage 100 executive jets, (2) develop our new Phenom 300 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 Provided by Operating Activities and Working Capital
In 2008, net cash provided by operating activities was US$321.8 million, compared to net cash provided by operating activities of US$580.4 million in 2007, and net cash provided by operating activities of US$386.9 million in 2006. The decrease in the inflow of cash from operating activities in 2008 is mainly a result of a 350 basis point decrease in our gross profit margin in that year.
We had a working capital surplus of US$2,310.3 million at December 31, 2007 and US$2,371.2 million at December 31, 2008. Working capital increased mainly due to an increase in our inventories in line with the increase in our aircraft production and in our spare parts to support the greater number of aircraft in service.
Net Cash Provided by (Used in) Investing Activities
In 2008, net cash provided by investing activities was US$168.9 million compared to net cash used in investing activities of US$784.3 million in 2007 and US$179.5 million in 2006.
Despite our investments in research and development and property, plant and equipment in 2008, we experienced an inflow of cash from investing activities mainly as a result of increased net sales and redemptions of temporary cash investments in that year. In that connection, our average stock of temporary cash investments decreased, starting at US$1,185.7 million as of December 31, 2007 and ending at US$810.1 million as of December 31, 2008, as a result of sales and redemptions of those instruments, which, in turn, contributed to the net inflow of cash from investing activities in 2008.
Net Cash Provided by (Used in) Financing Activities and Total Debt
Net cash used in financing activities was US$395.1 million in 2006 compared to net cash provided by financing activities of US$137.0 million in 2007 and net cash used in financing activities of US$314.5 million in 2008. In addition, during 2008 we raised new borrowings of US$1,886.2 million, compared to new borrowings of US$1,772.0 million and US$1,258.2 million during 2007 and 2006, respectively. Furthermore, we also repaid US$1,770.4 million of our indebtedness in 2008, compared to repayment in the aggregate amount of US$1,471.9 million and US$1,497.7 million in 2007 and 2006, respectively. In 2008, we distributed US$242.7 million in the form of interest on shareholders equity and dividends compared to US$163.5 million and US$157.8 million distributed in 2007 and 2006, respectively. Also in 2008, we spent US$183.0 million in connection with our share buyback program compared to a negligible amount spent in 2007. In 2006 we did not spend any amounts in connection with the share buyback programs.
At December 31, 2008, we had total debt of US$1,825.4 million under our financing arrangements described below, 71.0% of which was long-term debt and 29.0% of which consisted of short-term debt. In comparison, we had total debt of US$1,753.0 million at December 31, 2007 and US$1,349.1 million at December 31, 2006, consisting of 46.8% and 62.7% of long-term debt, respectively. Our total debt increased from 2007 to 2008 largely due to new long-term borrowings.
Credit Facilities and Lines of Credit
In December 2002, we entered into a US$100.0 million credit facility with Santander Central Hispano Benelux S.A. that has been fully disbursed to fund our purchases of wings and other equipment from Gamesa. As of December 31, 2008, US$0.4 million was outstanding under this facility, all of which is due in the short-term, which bears interest at a fixed rate of 4.79% per annum with final maturity in February 2009.
In March 2005, we entered into a credit agreement with Bladex Banco Latino Americano de Exportaciones S.A. for an import financing facility of US$51.0 million at a cost of LIBOR plus 1.88% per annum with final maturity in March 2010, of which US$25.8 million remained outstanding as of December 31, 2008 (US$17.3 million in the short-term including principal and accrued interest). The spread over LIBOR was renegotiated and from March 2007 the spread is 1.10% per annum.
In April 2005, we entered into an Export Credit Note with Banco Votorantim S.A. of US$50.0 million, at a fixed rate of 7.81% per annum with final maturity in April 2010, of which US$50.8 million remained outstanding as of December 31, 2008 (US$0.8 million is currently short-term) including principal and accrued interest.
In June 2005, we entered into an IFC International Finance Corporation A/B Loan Secured Facility for a total amount of US$180.0 million, which includes the A loan for up to US$35.0 million, the B1 loan for up to US$60.0 million and the B2 loan for up to US$85.0 million. The terms of the loans are 12, ten and eight years, respectively, and the loans bear interest at an average rate of six-month LIBOR plus 2.9% per annum. The facility is secured by a combination of mortgages on our main industrial facility in Brazil, three EMBRAER 170/190 pre-series aircraft and a bank account pledge agreement in an amount equivalent to 12 months interest coverage. In addition to the customary covenants and restrictions, including but not limited to those that require us to maintain defined debt liquidity and interest expense coverage ratios, the facility has covenants related to compliance with IFC general environmental, health and safety guidelines. We also agreed to a mandatory pre-payment provision, which limits our net revenues generated by selling and supporting offensive attack aircraft to 12.5% of our total net revenues. As of December 31, 2008, US$133.6 million remained outstanding under this facility (US$26.4 million in the short-term) including principal and accrued interest. We renegotiated the spread over LIBOR and since May 2007 the spread is 1.21% per annum. In addition, as of December 17, 2007 we have negotiated the release of the mortgage over three EMBRAER 170/190 pre-series aircraft.
In August 2006, we entered into two separate syndicated credit agreements with Banco BNP Paribas Brasil S.A., in each case as administrative agent for the lenders under each facility in an aggregate amount of US$500.0 million. The trade finance credit facility provides for US$250.0 million in loans to finance certain of our exports and imports, to be allocated at our discretion, provided that the aggregate amount does not exceed the US$250.0 million. This amount is available for multiple drawdowns on a non-revolving
basis until August 25, 2009, unless fully disbursed prior to that date. Each drawdown is repayable in full in two years from the borrowing date. The trade finance credit facility is subject to a commitment fee of 25 basis points over the unused portion and, if disbursed, will bear interest at six-month LIBOR plus 40 and 45 basis points, respectively, for export or import finance disbursements thereof. The other agreement is a US$250.0 million syndicated revolving credit facility, with a five-year availability period. Disbursements under the revolving credit facility will be repayable on August 25, 2011. This revolving credit facility is subject to a commitment fee of 30 basis points per annum and, if disbursed, will bear interest at one-, two-, three- or six-month LIBOR plus 60 basis points per annum, as specified by us on each drawdown notice. We record the commitment fees for these credit facilities as an expense. Both facilities contain customary covenants and restrictions, including, but not limited to, those that require us to maintain defined debt liquidity and interest expense coverage ratios. In addition, in the event the Brazilian government imposes restrictions on foreign exchange transactions, only disbursements under the trade finance credit facility will be available to us. If we make any disbursements under another export finance transaction, we will be required to grant a first priority pledge on certain of our export receivables, as determined by us at the disbursement date. As of December 31, 2008, no disbursements had been made under either of these facilities. However, we borrowed US$96.8 million under the trade finance credit facility in March 2009 and another US$153.2 million under that facility in April 2009, totaling US$250.0 million.
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, 2008, US$408.9 million was outstanding (US$11.1 million is currently 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. On March 31, 2009, Embraer repurchased and canceled 19,908 (4.97%) bonds, totaling US$15.2 million (face value of US$19.9 million). These bonds were purchased by Embraer Overseas through open market transactions. We may from time to time seek to retire or purchase our outstanding debt, including our guaranteed notes, through cash purchases and/or exchange for equity 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.
In November 2006, we entered into a credit facility in the amount equivalent of US$37.0 million with the FINEP to support the development costs of 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 first priority mortgage of our Eugênio de Melo facility and a chattel mortgage of certain machines and equipment. The credit facility is repayable from December 2008 to December 2013. As of December 31, 2008, we had outstanding US$59.7 million under our credit facilities with the FINEP, of which US$9.9 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 U.S. GAAP financial statements.
In December 2008, we entered into various credit agreements with BNDES for a long-term pre-export credit financing. At December 31, 2008, we had US$534.4 million outstanding under these arrangements, bearing an average spread of 2.433% per annum over TJLP, with maturities from February 15, 2010 to June 15, 2010. 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 U.S. GAAP financial statements.
We have various other loans and credit agreements with aggregate outstanding borrowings of US$182.7 million at December 31, 2008. See Note 20 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 debt to earnings before interest, taxes, depreciation and amortization, or EBITDA, of 3.5:1; (2) a minimum debt service coverage ratio, calculated as EBITDA to financial expenses, of 3:1; and (3) minimum shareholders equity of R$2.3 billion. 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, 2008, we were in compliance with all restrictive covenants contained in our financing agreements. The only exception related to a financing instrument in the amount of US$8.8 million, which was entered into by OGMA, one of our subsidiaries. As of December 31, 2008, OGMA had a financial debt to EBITDA ratio of 2.74:1, which exceeded the 1.8:1 ratio required under the financing instrument. In February 26, 2009, OGMAs creditor under this facility granted OGMA a waiver of compliance with this covenant valid until December 31, 2009. The non-compliance by OGMA with the 1.8:1 financial debt to EBITDA ratio, as waived, did not trigger any cross-default clauses in any of our other agreements.
As of December 31, 2008 we have US$332.9 million in short-term pre-export financing loans from Banco do Brasil S.A., or Banco do Brasil, and Banco Bradesco S.A. These loans bear an average fixed interest rate of 5.71% per annum and are denominated in reais. They have been converted into U.S. dollars, our functional currency, for purposes of preparing our U.S. GAAP financial statements.
We have various other short-term loans and credit agreements with aggregate outstanding borrowings of US$96.6 million at December 31, 2008. See Note 20 to our audited consolidated financial statements for further information on our short-term financing arrangements.
Recently Issued Accounting Pronouncements
Adopted Accounting Pronouncements
In September 2006, the FASB issued SFAS 157, Fair Value Measurements, which is effective for financial statements issued for fiscal years beginning after November 15, 2007. This standard clarifies the definition of fair value, establishes a framework for using fair value to measure assets and liabilities, and expands the disclosures on fair value measurements. This standard also responds to investors requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. We adopted SFAS 157 in 2008 without any material impact to our financial position.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of SFAS no. 115. SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value in order to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The adoption of SFAS 159 did not generate a material impact on our financial position, as we did not elect to adopt the fair value option for any of our financial assets or liabilities at January 1, 2008. In connection with this amendment to SFAS 115 contained in SFAS 159, we changed our statement of cash flows classification policy for trading securities and classified purchases and sales of trading securities under investing activities.
In September 2008, the FASB issued an FASB Staff Position, or FSP, that introduces new disclosure requirements for credit derivatives and guarantees and clarifies the effective date of SFAS 161, Disclosures about Derivative Instruments and Hedging Activities. The new disclosure requirements are designed to result in similar disclosures for financial instruments with similar risks and rewards relating to credit risk, regardless of their legal form. For some companies, the additional disclosures may be significant, particularly given the increased use in recent years of credit default swaps to manage and gain exposure to particular credit risks. We adopted this FSP in 2008 without any material impact to our financial disclosures.
Accounting Pronouncements Not Yet Adopted
In December 2007, the FASB issued SFAS 141 (revised 2007), Business Combination, which replaces SFAS 141, Business Combinations. SFAS 141(R) retains the fundamental requirements in SFAS 141 that the acquisition method of accounting (which SFAS 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control. SFAS 141(R) did not define the acquirer, although it included guidance on identifying the acquirer. SFAS 141(R)s scope is broader than that of SFAS 141, which applied only to business combinations in which control was obtained by transferring consideration. The result of applying SFAS 141s guidance on recognizing and measuring assets and liabilities in a step acquisition was to measure them at a blend of historical costs and fair values. In addition, SFAS 141(R) requires measuring the non-controlling interest in the acquiree at fair value, which results in recognizing the goodwill attributable to the non-controlling interest in addition to that attributable to the acquirer. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 (that is, in our case, January 1, 2009). Therefore, we will apply such pronouncement on a prospective basis for each new business combination.
In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51, which clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 has become effective for us in January 1, 2009. Although its earlier adoption is prohibited, the presentation and disclosure requirements shall be applied retrospectively for all periods presented.
In March 2008, the FASB issued FASB SFAS161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entitys financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.
In May 2008, the FASB issued SFAS 162, The Hierarchy of Generally Accepted Accounting Principles, which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. GAAP. This Statement shall be effective 60 days following the SECs approval of the Public Company Accounting Oversight Board - PCAOB amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.
We incur research and development costs related to our aircraft and aircraft components. We also incur research and development costs that are not associated with the development of any particular aircraft. Such costs include the implementation of quality assurance initiatives, production line productivity improvements and studies to determine the latest developments in technology and quality standards. Research and development expense is the cost associated with the design and development of the aircraft less amounts earned from cash contribution from risk-sharing partners based on meeting performance milestones. Under U.S. GAAP, these costs are recorded as an operating expense in our income statement and are expensed in the year in which they are incurred.
We invest significantly in the development of new projects. Total research and development expenses for 2006, 2007 and 2008, including expenses related to the improvement of the EMBRAER 170/190 jet family and to the development of our new Phenom 100, Phenom 300, Lineage 1000, Legacy 450 and Legacy 500 executive jets, were US$112.7 million, US$259.7 million and US$197.0 million, respectively, net of cash contributions provided by risk-sharing partners. Research and development costs as a percentage of net sales were 3.0% in 2006, 5.0% in 2007 and 3.1% in 2008. In 2006, 2007 and 2008, we recorded US$36.0 million, US$23.7 and US$134.8 million, respectively, as reductions to our research and development costs in connection with payments previously received by us from our risk-sharing partners, as our EMBRAER 170/190 aircraft family and Phenom 100 received their certifications and we fulfilled other contractual milestones under our risk-sharing arrangements.
In 2007, the real appreciated by 17.2% against the dollar, which, together with increased research and development investments in connection with the testing stages of the Lineage 1000 and Phenom 100 following their first flights in the second half of 2007, also impacted our research and development costs in that year. Our research and development costs for 2008 decreased mainly because of US$134.8 million received from risk-sharing partners in connection with the certification of the Phenom 100 and the fulfillment of other contractual milestones under our risk-sharing agreements. We do not incur research and development expenses for defense programs as those are funded by the Brazilian government and other government customers. Most of our research and development expenses are associated with particular programs either in the commercial or executive aviation segments (see Item 4. Information on the CompanyHistory and Development of the CompanyCapital Expenditures: Research and Development).
In 2009, we expect our research and development costs to total approximately US$200 million, excluding contributions from risk-sharing partners, but including estimated costs of approximately US$150 million related to development of our new products, and approximately US$50 million related to development of technology. We receive additional funds from risk-sharing partners to fund our cash costs for our commercial and executive aircraft research and development. We expect to receive US$303.7 million from our risk-sharing partners in future years for the development of the Phenom 300 and Legacy 450/500 family. In addition, the Brazilian and other governments fund substantially all of our defense and government research and development costs under long-term development contracts.
The following table summarizes our order book for the commercial aviation segment at March 31, 2009. Our total firm order backlog at that date, including executive jets and defense aircraft, was US$19.7 billion (US$20.9 billion at December 31, 2008).
The following tables set forth our commercial aviation order book at March 31, 2009 by aircraft type, customer and country.
For additional information regarding trends in our business, see Item 4B. Business OverviewBusiness Strategies and Item 5A. Operating ResultsCurrent Conditions and Future Trends in the Commercial Airline Industry and Executive Jet Market. For risks affecting our business, see Item 3D. Risk Factors.
In the normal course of our business, we enter into certain off-balance sheet arrangements, including guarantees, trade-in obligations, financial and residual value guarantees and product warranty commitments. We also have a number of swap transactions that are described in Item 11. Quantitative and Qualitative Disclosures about Market Risk.
Despite the current global economic crisis, we have not yet experienced any material effects to our financial condition or results of operations, as a result of the exercise of trade-in option or guarantees that we have extended to third parties. However, there can be no assurance that we would not be materially impacted by the exercise of these trade-in options or guarantees if the current global economic downturn became more severe. See also Note 35 to our audited consolidated financial statements for additional information on our off-balance sheet arrangements. In addition, see Item 3D. Risk FactorsRisks Relating to EmbraerOur aircraft sales are subject to trade-in options and financial and residual value guarantees that may require us to make significant cash disbursements in the future.
In connection with the signing of a purchase contract for new aircraft, we may provide trade-in options to our customers. These options provide a customer with the right to trade-in existing aircraft upon the purchase and acceptance of a new aircraft. In 2008, we entered into a total of 15 trade-in aircraft options. Of these 15 trade-in options, 12 rights had been exercised through December 31, 2008. Of these 12 aircraft, four were received in fiscal year ending 2008 and the remaining eight will be received in 2009. Our obligation to receive the remaining three aircraft as trade-ins are directly tied to contractual obligations with our customer of them actually taking delivery of certain new aircraft. The trade-in price for commercial aircraft is determined in the manner discussed under Item 5A. Operating ResultsCritical Accounting EstimatesGuarantees and Trade-In Rights. We continue to monitor all trade-in commitments to anticipate any adverse economic impact they may have in our financial condition. Based on our current evaluation and on third parties appraisals, we believe that any aircraft accepted in connection with trade-in commitments may be sold or leased in the market without significant profits or losses.
At December 31, 2008, three commercial aircraft were subject to trade-in options, and additional aircraft may become subject to trade-in options due to new sales contracts. See Item 5A. Operating ResultsCritical Accounting EstimatesGuarantees and Trade-In Rights. We may be required to accept trade-ins at prices that are slightly above the then-market price of the aircraft, which would result in financial loss for us when we resell the aircraft. Based on our current estimates and third party appraisals, we believe that any aircraft accepted for trade-in could be sold without any material gain or loss. However, there can be no assurance that we would not experience material losses in these cases, particularly if the current global economic downturn were to exert material downward pressures to the pre-owned aircraft market.
Financial guarantees are triggered if customers do not perform their obligation to service the debt during the term of the financing under the relevant financing arrangements. Financial guarantees provide credit support to the guaranteed party to mitigate default-related losses. The underlying assets collateralize these guarantees. The value of the underlying assets may be adversely affected by an economic or industry downturn. Upon an event of default, we are usually the agent for the guaranteed party for the refurbishment and remarketing of the underlying asset. We may be entitled to a fee for such remarketing services. Typically a claim under the guarantee shall be made only upon surrender of the underlying asset for remarketing.
Residual value guarantees provide a third party with a specific guaranteed asset value at the end of the financing agreement. In the event of a decrease in market value of the underlying asset, we shall bear the difference between the specific guaranteed amount and the actual fair market value. Our exposure is mitigated by the fact that, in order to benefit from the guarantee, the guaranteed party has to make the underlying assets meet stringent specific return conditions.
The following table provides quantitative data regarding guarantees we render to third parties. The maximum potential payments represent the worst-case scenario and do not necessarily reflect the results expected by us. Estimated proceeds from performance guarantees and underlying assets represent the anticipated values of assets we could liquidate or receive from other parties to offset our payments under guarantees.
As discussed in Note 35 of our audited consolidated financial statements included, as of December 2007 and December 2008, we maintained escrow deposits in the total amount of US$287.5 million and US$299.7 million, respectively, in favor of third parties for whom we have provided financial and residual value guarantees in connection with certain aircraft sales financing structures.
Financial and Residual Value Guarantees
We have guaranteed the financial performance of a portion of the financing for, and the residual value of, some of our aircraft which 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.
Assuming all customers supported by 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 not able to remarket any of the aircraft to offset our obligations, our maximum exposure under these guarantees (less provisions and liabilities) would have been US$1,870.1 million as of December 31, 2008. For further discussion of these off-balance sheet arrangements, see Note 35 to our audited consolidated financial statements.
At December 31, 2008, we had US$299.7 million deposited in escrow accounts as collateral for financing and residual value guarantees of certain aircraft sold. If the guarantor of the debt (an unrelated third party) is required to pay the creditors of such financing arrangement or the residual value guarantee, the guarantor has the right to withdraw from the escrow account. Based on current estimates, we believe that the proceeds from the sale or lease of the covered aircraft (based on resale value as of December 31, 2008) and from other offsetting collections, such as cash deposits, would be US$2,013.5 million. The deposited amounts will be released when the financing contracts mature (from 2013 to 2021) if no default by the buyers of the aircraft occurs or the aircraft market price is above the residual value guarantee.
The interest earned on the escrow funds is added to the balance in escrow and is recorded as interest income by us. In order to earn a better interest rate on such guarantee deposits, at December 31, 2008, we had invested part of the US$299.7 million deposited in escrow accounts in 14-year structured notes in a total amount of US$123.4 million with the depositary bank, which generated interest in the amount of US$7.6 million in 2008 that was added to the principal amount and recognized in our consolidated statements of income and comprehensive income. This yield enhancement was obtained through a credit default swap (CDS) transaction, which provides the right of early redemption of the note in case of a credit event by us. Upon such a credit event, the note may be redeemed by the holder at the greater of the notes market value or its original face amount, which would result in a loss of all
interest accrued on such note to date. Credit events include obligation and payment defaults under the terms of the guarantees above specified thresholds, events related to the restructuring of the obligations above a specified threshold, bankruptcy and a repudiation of and/or moratorium on the obligations above a specified threshold. See Note 11 to our audited consolidated financial statements.
Residual value guarantees typically ensure that, in the 15th year after delivery, the relevant aircraft will have a residual market value of a percentage of the original sale price. Most of our residual value guarantees are subject to a limitation (a cap) and, therefore, in average our guaranteed residual value is 18% of the original sale price. In the event of a decrease in the market value of the underlying aircraft and an exercise by the purchaser of the residual value guarantee, we will bear the difference between the guaranteed residual value and the market value of the aircraft at the time of exercise. Our exposure is mitigated by the fact that the guaranteed party, in order to benefit from the guarantee, must make the aircraft meet specific return conditions.
We continually re-evaluate our risk under our 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, including information developed from the sale or lease of similar aircraft in the secondary market, and the credit rating of customers.
The following table and discussion provide additional disclosure regarding our material contractual obligations and commercial commitments as of December 31, 2008.
The above table shows the sum of the outstanding principal and anticipated interest due at maturity date. For the fixed rate loans, the interest expenses were calculated based on the rate established in each debt contract. For the floating rate loans, the interest expenses were calculated based on a market forecast for each period (LIBOR 6m 12m), dated on December 31, 2008. This floating rate exposure is managed through derivatives operations. See Item 11. Quantitative and Qualitative Disclosures About Market Risk.
The above table does not reflect contractual commitments related to trade-in options and financial and residual value guarantees discussed in Item 5E. Off-Balance Sheet Arrangements above. See Item 3D. Risk FactorsRisks Relating to EmbraerOur aircraft sales are subject to trade-in options and financial and residual value guarantees that may require us to make significant cash disbursements in the future.
Purchase obligations consist of trade accounts payable and insurance payables.
Other long-term liabilities include taxes and social charges payable in the total amount of US$401.4 million at December 31, 2008. The above table does not reflect any information about our derivative instruments, which are discussed more fully in Item 11. Quantitative and Qualitative Disclosures About Market Risk.
We are managed by our Conselho de Administração, or Board of Directors, composed of 11 members, and our Diretoria, or executive officers, composed of at least four and at the most 11 members (each an executive officer). We have a permanent Conselho Fiscal, which is composed of five members and an equal number of alternates.
There are no family relationships among the members of our Board of Directors and/or our executive officers.
Board of Directors
Our Board of Directors ordinarily meets four times a year and extraordinarily when called by the chairman or by the majority of members of the Board. It has responsibility, among other things, for establishing our general business policies and for electing our executive officers and supervising their management.
Our Board of Directors is appointed by our shareholders for a two-year term, reelection being permitted, having three reserved seats as follows: (1) one to be appointed by the Brazilian government, as holder of the golden share, and (2) two to be appointed by our employees. The remaining eight directors are elected in accordance with the slate voting or cumulative voting rules contained in our bylaws. See Item 10B. Memorandum and Articles of AssociationBoard of DirectorsElection of Board of Directors for a detailed description of the rules and procedures regarding the nomination and election of our Board members. The Brazilian Corporate Law requires that each director to hold at least one of our shares. There is no mandatory retirement age for our directors.
Under the rules of the Novo Mercado, the members of our Board of Directors have agreed to comply with the Novo Mercado Regulations and with the rules of the São Paulo Stock Exchange Arbitration Chamber before taking office, and for such purpose have executed a Term of Agreement of Management (Termo de Anuência dos Administradores).
Set forth below are the names, ages, positions, the year first elected and brief biographical descriptions of the members of our Board of Directors elected at our annual shareholders meeting held on April 29, 2009.
Maurício Novis Botelho. Mr. Botelho has been the Chairman of the Board of Directors of Embraer since March 2006. He has served as our President and Chief Executive Officer since September 1995 and has led the company after its privatization, instituting a new entrepreneurial corporate culture focused on customer satisfaction, which resulted in a successful turnaround and positioning of Embraer as one of the world leaders in the aeronautical market. Mr. Botelho served as CEO of Stelar Telecom, former OTL Odebrecht Automação & Telecomunicações Ltda., a telecommunications company, from 1988 to 1995. He also served as CEO of CMW Equipamentos S.A., an industrial automation company, from 1985 to 1995, STL Engenharia de Sistemas Ltda., a project engineering company, from 1985 to 1995, and Soluções Integradas PROLAN Ltda., a corporate network company, from 1994 to 1995. Mr. Botelho was the executive vice-president of TENENGE Técnica Nacional de Engenharia Ltda., a construction company,
during 1992 and an executive officer of Cia. Bozano during 1995. In addition to his position as Chairman of our Board of Directors, he is the President of Mogno Consultoria de Negócios Ltda., a business consulting company, and is a board member of various companies and organizations, such as Perdigão S.A., one of the largest meat and milk processing companies in Brazil, CBMM - Companhia Brasileira de Metalurgia e Mineração, the largest world producer of niobium, Deutsche Bank, and CDES, a strategic advisory board to the Presidency of Brazil. Mr. Botelho has been awarded, among others, the Ordem do Rio Branco (the highest condecoration from the Brazilian government), Commander, and the Legion dHonneur, Chevalier from France.
Sérgio Eraldo de Salles Pinto. Mr. Salles Pinto has been a member of the Board of Directors of Embraer since April 2009. Mr. Salles Pinto has been the Executive Manager of Cia. Bozano and of Bozano Holdings since 2000, being responsible for the administration of the companies funds through several financial instruments. From 1988 to 2000, he worked at several companies of Banco Bozano, Simonsen S.A. Mr. Salles Pinto earned undergraduate degrees in Economics and Electrical Engineering from the Center of Unified Teaching of Brasília (CEUB) and the University of Brasília (UnB), respectively. He holds a Master degree in Economics from Fundação Getúlio Vargas - Rio de Janeiro (EPGE) and a Master degree in Administration from the Catholic University of Rio de Janeiro (PUC).
Cecília Mendes Garcez Siqueira. Mrs. Siqueira has been a member of the Board of Directors of Embraer since April 2009. Mrs. Siqueira is the Vice Chairman of the Board of Directors of CPFL Energia, or CPFL, a major Brazilian energy company, and Executive Officer of Business Planning of the Caixa de Assistência dos Funcionários do Banco do Brasil (Pension Fund of Banco do Brasils Employees), or PREVI. She was a board member of PREVI from 2002 to 2004 and of Neoenergia, a Brazilian renewable energy company, from 2002 to 2005. Mrs. Siqueira earned an undergraduate degree in Education from the University of Brasília - DF and in Psychology at the Foundation of Higher Education of São João del Rei (FUNREI) - MG. She holds a postgraduate degree in Business and Pension Fund Management, both from the Fundação Getúlio Vargas - DF. She is also a specialist in Pension Fund Management at Wharton School of Business and a Masters in Administration from IBMEC - RJ.
Wilson Carlos Duarte Delfino. Mr. Delfino has been a member of the Board of Directors of Embraer since 2004. Mr. Delfino has been President and CEO of Fundação Sistel de Seguridade Social (Pension Fund of Brazilian Telecomunication Companies Employees), or SISTEL, a pension fund, since January 2004, and has served as executive officer of Planning, Controlling and Administrative Offices of SISTEL since March 2000. From September 1993 to September 1994 Mr. Delfino served as assistant to the executive officer and was responsible for the Coordination of the Committee of Investments of SISTEL. From October 1994 to March 2000 he was Manager of the Investment Analysis Department of SISTEL. He was also a member of the board of directors of Paranapanema, a mining company, from April 1998 to April 2006 and a member of the board of directors of Perdigão S.A from April 2004 to April 2006.
Neimar Dieguez Barreiro. Mr. Barreiro has been a member of the Board of Directors of Embraer since 2004. Mr. Barreiro has been a Lieutenant Brigadier in the Brazilian Air Force since November 2005 and Secretary of Economy and Financing of the Brazilian Air Force since August 2001. He is also the representative of the Air Force in the Interministerial Follow-up Group of the Strengthening Program of Control of the Brazilian Air Space. He has served in the Brazilian Air Force since 1963. He is the representative of the Brazilian government in our Board of Directors, as a result of the governments ownership of our golden share.
Israel Vainboim. Mr. Vainboim has been a member of the Board of Directors of Embraer since April 2009. Mr. Vainboim is a member of the Board of Directors of Itaú Unibanco Banco Múltiplo S.A., Souza Cruz S.A., Cia. Iochpe-Maxion, the leading Brazilian manufacturer of wheels and frames for commercial vehicles and railway freight cars, the Museu de Arte Moderna de São Paulo (Museum of Modern Art of São Paulo), the alumni association of the Federal University of Rio de Janeiro, and the Albert Einstein Hospital in São Paulo. He is also Vice President of the Board of the House of Culture of Israel in São Paulo and a member of the International Advisory Council of the General Atlantic Partners, located in New York, New York. Mr. Vainboim was also the President of Unibanco União de Banco Brasileiros S.A. from 1988 to 1992, President of Unibanco Holdings S.A. from 1994 to 2007, Chairman of the Board of Directors and the President of the Audit Committee of Unibanco Holdings S.A. from 2007 to February 2009. Mr. Vainboim earned an undergraduate degree in Mechanical Engineering from the Federal University of Rio de Janeiro and holds an MBA from Stanford University.
Wilson Nélio Brumer. Mr. Bruner has been a member of the Board of Directors of Embraer since April 2009. Mr. Brumer is the co-founder and has been partner of Winbros Participações, Gestão e Empreendimentos Ltda. since April 2007. He is co-founder and Chairman of the Board of Directors of Omega Energia Renovável, an energy company, since March 2008. He is also Chairman of the Board of Directors of Usiminas S.A., and member of the Board of Directors of Localiza S.A, a car rental company. He was CEO of CVRD Companhia Vale do Rio Doce, or CVRD, from 1990 to 1992 and Acesita Companhia Aços Especiais Itabira from November 1992 to October 1998. He participated in the administration of the Government of the State of Minas Gerais as Secretary of Economic Development. Mr. Brumer earned an undergraduate degree in Business from the School of Administrative and Accounting Economical Sciences of FUMEC MG.
Hermann Wever. Mr. Wever has been a member of Embraers Board of Directors of Embraer since 2006. He was also the president of the Consulting Board of Siemens Ltda. since 2001. From 1987 to 2001, Mr. Wever was president of Siemens do Brasil. He was also Officer of Energy and Installations at Siemens do Brasil from 1980 to 1987. Prior to that, Mr. Wever held several positions at General Electric, including Industrial Officer of the department of light bulbs and lighting from 1968 to 1974, and Vice President of Domestic Appliances from 1974 to 1978.
Samir Zraick. Mr. Zraick has been a member of the Board of Directors of Embraer since 2006. Mr. Zraick was chief financial officer of CVRD, and head of its U.S. affiliate from 1971 to 1986. He was also a Board Member of CVRD in 2000 and served as a Special Advisor and member of CVRDs Strategic Committee from 2001 to 2004. He was CFO and VP Business Development of Caemi Mineração e Metalurgia S.A., a Brazilian mining company, from 1986 to 1998. He was a member of the Board of Directors and Chairman of the Marketing Committee of Quebec Cartier Mining, in Montreal, Quebec, from 1990 to 1999. He served as a Board Member of Canico Resources in Vancouver, British Columbia, from July 2004 to March 2006. Mr. Zraick is also member of the Board of Directors of Mineração e Metálicos S.A. - MMX, a Brazilian mining company, MPX Energia S.A., a Brazilian energy company, and LLX Logística S.A., a Brazilian logistics company.
Paulo Cesar de Souza Lucas. Mr. Lucas has been a member of the Board of Directors of Embraer since 1999. Mr. Lucas has participated in our strategic planning division since 1998 and was implementation coordinator of Embraers modernization and cost-reduction strategy from 1990 to 1996. Mr. Lucas has been working at Embraer for more than 17 years and is a representative of our shareholder employees.
Claudemir Marques de Almeida. Mr. Almeida has been a member of the Board of Directors of Embraer since 2004. Mr. Almeida has been an employee of Embraer since 1987, and currently holds the position of Quality Controller I at Embraer. He previously served as a member of our Board of Directors from January 1995 to April 2001. Mr. Almeida is the representative of our non-shareholder employees.
Three committees were formed to assist the Board of Directors in its duties and responsibilities:
Our executive officers are responsible for our day-to-day management. The executive officers have individual responsibilities established by our bylaws and by the Board of Directors.
The terms of office for members of our Board of Directors and for our executive officers is two years, with each executive officer eligible for reelection.
Until the annual general meeting of our shareholders to be held in 2009, a majority vote of the members of our Board of Directors will be necessary to remove an officer. After the annual general meeting of our shareholders, a vote of at least seven members of our Board of Directors will be necessary to remove an officer.
Our bylaws forbid any executive officer from also serving at the same time as a member of our Board of Directors. Our bylaws contain a provision that our CEO will participate in meetings of the Board of Directors, but shall not vote on resolutions of the Board of Directors.
Under the rules of the Novo Mercado, our executive officers have agreed to comply with the Novo Mercado Regulations and to the rules of the São Paulo Stock Exchange Arbitration Chamber before taking office and for such purpose have executed a Term of Agreement of Management (Termo de Anuência dos Administradores).
Set forth below are the names, ages, positions, the year first elected and brief biographical descriptions of our executive officers elected at our Board of Directors meeting held on April 29, 2009: