##### Table of Contents



As filed with the Securities and Exchange Commission on June 30, 2004 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 
 FORM 20-F
 
 [   ]
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
 OR [x]
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended: December 31, 2003
 OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from [ ] to [ ]
 Commission file number 1-15102 EMBRAER-EMPRESA BRASILEIRA DE AERONÁUTICA S.A.  EMBRAER  Brazilian Aviation Company Inc.  Federative Republic of Brazil
(Jurisdiction of Incorporation) Avenida Brigadeiro Faria Lima, 2170
12227-901 São José dos Campos, São Paulo, Brazil
(Address of principal executive offices)   Securities registered or to be registered pursuant to Section 12(b) of the Act: Title of each class:
    
    Name of each exchange on which registered:Preferred shares, without par value
    
    New York Stock Exchange*American Depositary Shares (as
evidenced by American Depositary Receipts), each representing four
preferred shares
    
    New York Stock Exchange
   *
    
    Not for trading purposes, but only in connection with the
registration of American Depositary Shares pursuant to the requirements
of the Securities and Exchange Commission. Securities registered or to be registered pursuant to Section 12(g) of the Act.
None.   Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
None.   Indicate the number of outstanding shares of each of the issuers classes
of capital or common stock as of the close of the period covered by the annual
report: 242,544,448 common shares, without par value
473,501,135 preferred shares, without par value Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or15(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 which financial statement item the registrant has elected to follow. Item 17 [  ] Item 18 [x]




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TABLE OF CONTENTS PagePART IITEM 1.
    
    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
    
    
    1ITEM 2.
    
    OFFER STATISTICS AND EXPECTED TIMETABLE
    
    
    1ITEM 3.
    
    KEY INFORMATION
    
    
    1ITEM 4.
    
    INFORMATION ON THE COMPANY
    
    
    17ITEM 5.
    
    OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    
    
    35ITEM 6.
    
    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    
    
    53ITEM 7.
    
    MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    
    
    61ITEM 8.
    
    FINANCIAL INFORMATION
    
    
    65ITEM 9.
    
    THE OFFER AND LISTING
    
    
    70ITEM 10.
    
    ADDITIONAL INFORMATION
    
    
    73ITEM 11.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    89ITEM 12.
    
    DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    
    
    91PART IIITEM 13.
    
    DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
    
    
    92ITEM 14.
    
    MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
    
    
    92ITEM 15.
    
    CONTROLS AND PROCEDURES
    
    
    92ITEM 16A.
    
    AUDIT COMMITTEE FINANCIAL EXPERT
    
    
    92ITEM 16B.
    
    CODE OF ETHICS
    
    
    92ITEM 16C.
    
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    92PART IIIITEM 17.
    
    FINANCIAL STATEMENTS
    
    
    94ITEM 18.
    
    FINANCIAL STATEMENTS
    
    
    94ITEM 19.
    
    EXHIBITS
    
    
    94BYLAWS OF EMBRAERLIST OF SUBSIDIARIESCODE OF ETHICS AND CONDUCTCERTIFICATIONCERTIFICATIONCERTIFICATIONCERTIFICATIONCONSENT OF DELOITTE TOUCHE TOHMATSU
  (i)




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INTRODUCTION In this annual report, Embraer, we, us or our refer to
Embraer-Empresa Brasileira de Aeronáutica S.A. 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. Presentation of Financial and Other Data Financial Data Our audited financial statements at and for the years ended December 31,
2001, 2002 and 2003 are included in this annual report and have been audited by
Deloitte Touche Tohmatsu. 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.
Accordingly, we decided to present our primary U.S. GAAP financial statements
in U.S. dollars. As a result, amounts for all periods presented have been
remeasured or translated into U.S. dollars in accordance with the methodology
set forth in Statement of Financial Accounting Standards No. 52, or SFAS 52. Prior to 2001, we presented our financial statements in accordance with
accounting principles generally accepted in Brazil, or Brazilian GAAP, stated
in Brazilian reaisand adjusted for the effects of inflation. Previously,
amounts of net income and shareholders equity under Brazilian GAAP were
reconciled to those that would have been reported under U.S. GAAP. 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. In our 2001, 2002 and 2003 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. See Note 2 to our consolidated financial statements. Effective January 1, 2002, we decided to reclassify certain costs related
to information technology, support, training and education as general and
administrative expenses, instead of as cost of sales and services. All amounts
for prior periods presented in this annual report have been restated to give
effect to this reclassification. These reclassified costs equaled US$11.4
million in 1999, US$21.3 million in 2000, US$30.5 million in 2001 and US$32.2
million in 2002. Effective January 1, 2002, we also began netting research and
development related contributions that we receive from certain of our suppliers
against our research and development expense, instead of recording these
contributions as other operating income. All amounts for prior periods
presented in this annual report have been restated to give effect to this
reclassification. These reclassified amounts equaled US$14.1 million in 2001
and US$1.0 million in 2002. Subsequent to the issuance of our consolidated financial statements for
the years ended December 31, 2001 and 2002, we determined that certain cash
flows had been misclassified in the consolidated statements of cash flows for
the years ended December 31, 2001 and 2002. Cash flows from operating
activities, investing activities and (ii)




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financing activities have been restated to reflect the adjustments in our
consolidated statements of cash flows. These changes did not impact the total
amount of cash and cash equivalents reported in 2001 and 2002. The principal misclassifications relate to (i) the effect of exchange rate
changes on cash, which had been classified in cash flows from operating
activities, and (ii) the payment of interest, which had been reflected in cash
flows from financing activities. Other minor reclassifications have been made
in order to better conform our presentation to typical cash flow item
characteristics. The effects on the consolidated statements of cash flows of all
adjustments are detailed as follows: 2001
    
    2002As Previously
    
    
    
    
    
    As PreviouslyReported
    
    As Restated
    
    Reported
    
    As Restated(in millions of dollars)Net cash provided by (used in)
operating activities
    
    US$
    (263.2
    )
    
    US$
    (207.4
    )
    
    US$
    507.7
    
    
    US$
    575.6Net cash used in investing activities
    
    
    (275.2
    )
    
    
    (162.7
    )
    
    
    (200.8
    )
    
    
    (104.2
    )Net cash provided by (used in)
financing activities
    
    
    98.4
    
    
    
    134.4
    
    
    
    (399.4
    )
    
    
    (352.4
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    (204.2
    )
    
    
    
    
    
    
    (211.5
    )
 For certain purposes, such as providing reports to our Brazilian
shareholders, filing financial statements with the Comissão de Valores
Mobilários, or CVM, the Brazilian securities commission, 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 the
Brazilian Corporate Law. Our financial statements prepared in accordance with
the Brazilian Corporate Law are not adjusted to account for the effects of
inflation. As a result of the remeasurement 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 consolidated financial statements presented herein
differ from those included in our statutory accounting records. Other Data Some of the financial data contained in this annual report reflects the
effect of rounding. Aircraft ranges are indicated in nautical miles. One
nautical mile is equal to approximately 1.15 ordinary or statute miles, or
approximately 1.85 kilometers. Aircraft speeds are indicated in nautical miles
per hour, or knots, or in Mach, which is a measure of the speed of sound. The
term regional jets refers to narrow body jet aircraft with 30-60 passenger
seats. The term mid-capacity jets refers to jet aircraft with 70-120
passenger seats. All of our regional and mid-capacity jet aircraft are sold in
the commercial airline segment. As used in this annual report, the term
commercial aircraft, as it applies to Embraer, refers to our regional jets
and mid-capacity jets. 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, customarily accompanied by a down
payment, where 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 regional aircraft, we exclude one EMB 145 and two EMB 135s
delivered to the Belgian government in 2001, one EMB 145 delivered to the
Belgian government in 2002, one EMB 135 aircraft delivered to the Greek
government in 2000, and one EMB 145 delivered to Satena Airline, a state-owned
Colombian airline, in 2003. These aircraft have been included in our defense
data. Special Note Regarding Forward-Looking Statements This annual report includes forward-looking statements, within the meaning
of Section 27A of the U.S. Securities Act of 1933, as amended, or the
Securities Act, and Section 21E of the U.S. Securities Exchange Act of (iii)




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##### Table of Contents



1934, as amended, or the Exchange Act, principally in Items 3 through 5
and Item 11 of this annual report. We have based these forward-looking
statements largely on our current expectations and projections about future
events and financial trends affecting our business. These forward-looking
statements are subject to risks, uncertainties and assumptions, including,
among other things:  
    
    general economic, political and business conditions, both in Brazil and in our markets;
    
    changes in competitive conditions and in the general level of demand for our products;
    
    managements expectations and estimates concerning our future
financial performance, financing plans and programs, and the effects
of competition;
    
    continued successful development and marketing of the EMBRAER
170/190 jet family, our line of corporate jets and our defense
aircraft;
    
    our level of debt;
    
    anticipated trends in our industry and our short- and
long-term outlook for the 30-120 seat commercial aircraft market;
    
    our expenditure plans;
    
    inflation and fluctuations in exchange rates;
    
    our ability to develop and deliver our products on a timely basis;
    
    availability of sales financing for our existing and potential customers;
    
    existing and future governmental regulation; and
    
    other risk factors as set forth under Item 3D. Risk Factors. The words believe, may, will, estimate, 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. (iv)




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PART I 
 ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS Not applicable. 
 ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE Not applicable. 
 ITEM 3. KEY INFORMATION 3A. Selected Financial Data The following table presents our selected financial and other data at and
for each of the periods indicated. The selected financial data at December 31,
2002 and 2003 and for the three years ended December 31, 2003 are derived from
our consolidated U.S. GAAP financial statements audited by Deloitte Touche
Tohmatsu, an independent registered public accounting firm, included elsewhere
in this annual report. The selected financial data presented for all other
periods have been derived from our U.S. GAAP financial statements audited by
Deloitte Touche Tohmatsu. 1




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At and for the year ended December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003(in thousands, except per share /ADS data)Income Statement DataNet sales
    
    US$
    1,837,277
    
    
    US$
    2,762,162
    
    
    US$
    2,926,995
    
    
    US$
    2,525,800
    
    
    US$
    2,143,460Cost of sales and services
    
    
    (1,248,675
    )
    
    
    (1,879,318
    )
    
    
    (1,769,234
    )
    
    
    (1,531,720
    )
    
    
    (1,335,032
    )Gross profit
    
    US$
    588,602
    
    
    US$
    882,844
    
    
    US$
    1,157,761
    
    
    US$
    994,080
    
    
    US$
    808,428Operating expensesSelling expenses
    
    US$
    (119,234
    )
    
    US$
    (193,420
    )
    
    US$
    (212,057
    )
    
    US$
    (211,015
    )
    
    US$
    (206,246
    )Research and development
    
    
    (18,808
    )
    
    
    (69,593
    )
    
    
    (99,566
    )
    
    
    (158,499
    )
    
    
    (173,216
    )General and administrative
    
    
    (55,948
    )
    
    
    (96,645
    )
    
    
    (120,787
    )
    
    
    (109,673
    )
    
    
    (114,743
    )Employee profit sharing
    
    
    (20,437
    )
    
    
    (41,770
    )
    
    
    (43,746
    )
    
    
    (25,222
    )
    
    
    (20,399
    )Other operating expense, net
    
    
    (6,065
    )
    
    
    (20,028
    )
    
    
    (30,537
    )
    
    
    (20,498
    )
    
    
    (29,060
    )Equity on income (loss) from affiliates
    
    
    (142
    )
    
    
    753
    
    
    
    310
    
    
    
    389
    
    
    
    51Total operating expenses
    
    US$
    (220,634
    )
    
    US$
    (420,703
    )
    
    US$
    (506,383
    )
    
    US$
    (524,518
    )
    
    US$
    (543,613
    )Income from operations
    
    US$
    367,968
    
    
    US$
    462,141
    
    
    US$
    651,378
    
    
    US$
    469,562
    
    
    US$
    264,815Non-operating income (expense)Interest income (expense)
    
    US$
    14,779
    
    
    US$
    (6,874
    )
    
    US$
    47,502
    
    
    US$
    80,456
    
    
    US$
    (140,755
    )Foreign
exchange loss, net
    
    
    (65,226
    )
    
    
    (24,637
    )
    
    
    (148,637
    )
    
    
    (135,647
    )
    
    
    (16,500
    )Other non-operating income (expense), net
    
    
    (13,361
    )
    
    
    5,955
    
    
    
    (8,426
    )
    
    
    (1,394
    )
    
    
    711Total non-operating income (expense)
    
    US$
    (63,808
    )
    
    US$
    (25,556
    )
    
    US$
    (109,561
    )
    
    US$
    (56,585
    )
    
    US$
    (156,544
    )Income before income taxes
    
    US$
    304,160
    
    
    US$
    436,585
    
    
    US$
    541,817
    
    
    US$
    412,977
    
    
    US$
    108,271Income tax
benefit (expense)
    
    
    (69,620
    )
    
    
    (117,379
    )
    
    
    (218,394
    )
    
    
    (188,502
    )
    
    
    27,990Income before minority interest
    
    US$
    234,540
    
    
    US$
    319,206
    
    
    US$
    323,423
    
    
    US$
    224,475
    
    
    US$
    136,261Minority interest
    
    
    
    
    
    
    1,522
    
    
    
    (423
    )
    
    
    (1,883
    )
    
    
    (217
    )Income before cumulative effect of
accounting change
    
    US$
    234,540
    
    
    US$
    320,728
    
    
    US$
    323,000
    
    
    US$
    222,592
    
    
    US$
    136,044Cumulative effect of accounting change,
net of tax
    
    
    
    
    
    
    
    
    
    
    5,440
    
    
    
    
    
    
    
    Net income
    
    US$
    234,540
    
    
    US$
    320,728
    
    
    US$
    328,440
    
    
    US$
    222,592
    
    
    US$
    136,044Earnings per shareCommon share  basic (1) (3) (6)
    
    US$
    0.43
    
    
    US$
    0.55
    
    
    US$
    0.48
    
    
    US$
    0.30
    
    
    US$
    0.18Preferred share  basic (1) (3) (6)
    
    
    0.48
    
    
    
    0.61
    
    
    
    0.53
    
    
    
    0.33
    
    
    
    0.20ADS  basic (1) (3) (6)
    
    
    1.90
    
    
    
    2.43
    
    
    
    2.11
    
    
    
    1.32
    
    
    
    0.79Common share  diluted (2) (3) (6)
    
    
    0.38
    
    
    
    0.48
    
    
    
    0.46
    
    
    
    0.30
    
    
    
    0.18Preferred share  diluted (2) (3) (6)
    
    
    0.42
    
    
    
    0.53
    
    
    
    0.50
    
    
    
    0.33
    
    
    
    0.20ADS  diluted (2) (3) (6)
    
    
    1.66
    
    
    
    2.10
    
    
    
    2.01
    
    
    
    1.31
    
    
    
    0.78Dividends per shareCommon share (3) (4) (5)
    
    US$
    0.033589
    
    
    US$
    0.220623
    
    
    US$
    0.235248
    
    
    US$
    0.173256
    
    
    US$
    0.088174Preferred share (3) (4) (5)
    
    
    0.036812
    
    
    
    0.242686
    
    
    
    0.258763
    
    
    
    0.190578
    
    
    
    0.096991ADS (3) (4) (5)
    
    
    0.147248
    
    
    
    0.970744
    
    
    
    1.035052
    
    
    
    0.762312
    
    
    
    0.387964Weighted averaged number of shares outstandingCommon share  basic (3)
    
    
    242,544
    
    
    
    242,544
    
    
    
    242,544
    
    
    
    242,544
    
    
    
    242,544Preferred share  basic (3)
    
    
    272,590
    
    
    
    308,401
    
    
    
    402,035
    
    
    
    454,414
    
    
    
    471,228Common share  diluted (3)
    
    
    242,544
    
    
    
    242,544
    
    
    
    242,544
    
    
    
    242,544
    
    
    
    242,544Preferred share  diluted (3)
    
    
    347,064
    
    
    
    392,954
    
    
    
    433,386
    
    
    
    459,415
    
    
    
    474,840Balance Sheet DataCash and cash equivalents
    
    US$
    304,085
    
    
    US$
    1,189,231
    
    
    US$
    749,302
    
    
    US$
    656,822
    
    
    US$
    1,265,820Other current assets
    
    
    986,961
    
    
    
    920,278
    
    
    
    1,816,046
    
    
    
    1,856,301
    
    
    
    2,068,184Property, plant and equipment, net
    
    
    162,429
    
    
    
    254,965
    
    
    
    366,481
    
    
    
    436,715
    
    
    
    402,663Other long-term assets
    
    
    757,463
    
    
    
    528,942
    
    
    
    628,958
    
    
    
    1,335,626
    
    
    
    2,219,331Total assets
    
    US$
    2,210,938
    
    
    US$
    2,893,416
    
    
    US$
    3,560,787
    
    
    US$
    4,285,464
    
    
    US$
    5,955,998Short-term loans
    
    
    556,272
    
    
    
    365,043
    
    
    
    526,550
    
    
    
    244,526
    
    
    
    517,014Other current liabilities
    
    
    561,897
    
    
    
    967,283
    
    
    
    1,161,313
    
    
    
    1,397,407
    
    
    
    1,916,649Long-term loans
    
    
    80,597
    
    
    
    90,969
    
    
    
    245,186
    
    
    
    308,110
    
    
    
    526,728Other long-term liabilities
    
    
    647,271
    
    
    
    677,013
    
    
    
    599,212
    
    
    
    1,237,015
    
    
    
    1,813,771Minority interest
    
    
    
    
    
    
    7,748
    
    
    
    8,170
    
    
    
    8,226
    
    
    
    12,611Shareholders equity
    
    
    364,901
    
    
    
    785,360
    
    
    
    1,020,356
    
    
    
    1,090,180
    
    
    
    1,169,225Total liabilities and shareholders equity
    
    US$
    2,210,938
    
    
    US$
    2,893,416
    
    
    US$
    3,560,787
    
    
    US$
    4,285,464
    
    
    US$
    5,955,998
 2




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At and for the year ended December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003(in thousands, except per share /ADS data)Other Financial Data(7)Net cash provided by (used
in) operating activities
(restated)
    
    US$
    158,614
    
    
    US$
    1,103,674
    
    
    US$
    (207,388
    )
    
    US$
    575,653
    
    
    US$
    239,634Net cash used in investing
activities (restated)
    
    
    (54,621
    )
    
    
    (90,996
    )
    
    
    (162,760
    )
    
    
    (104,216
    )
    
    
    (72,667
    )Net cash provided by (used
in) financing activities
(restated)
    
    
    (2,930
    )
    
    
    (85,250
    )
    
    
    134,379
    
    
    
    (352,435
    )
    
    
    403,791Depreciation and amortization
    
    
    25,076
    
    
    
    30,596
    
    
    
    46,417
    
    
    
    55,602
    
    
    
    58,877
   (1)
    
    Based on weighted average number of shares outstanding. See Note 24 to
our consolidated financial statements.(2)
    
    Based on weighted average number of shares outstanding and the
effects of potentially dilutive securities. See Note 24 to our
consolidated financial statements.(3)
    
    Restated to give effect to the reverse stock split, on April 30,
1999, of one newly issued common or preferred share for 100 outstanding
preferred shares or 100 outstanding common shares, respectively. Also
restated to give effect to the issuance on March 1, 2002, in the form
of a preferred share dividend, of 0.142106 new preferred share for each
existing preferred or common share.(4)
    
    Includes interest on shareholders equity.(5)
    
    Translated from nominal reaisinto U.S. dollars at the commercial
selling rates in effect on the dates that distributions were approved
during the period. The dividends to the ADSs were adjusted from the
total amount paid to the preferred shares multiplied by four.(6)
    
    In 2001, we adopted SFAS No. 133 Accounting for Derivative
Instruments and Hedging Activities, as amended. As a result, we
recognized a gain of US$5.4 million, net of related taxes, as a
cumulative effect of a change in accounting. The following summarizes
the earnings per share impact related to the adoption of SFAS No. 133. 2001Effect of tax adjustments
    
    
    Effect of cumulative effect of change
in accounting
    
    
    5,440Total
    
    
    5,440Basic earnings per common share
    
    
    0.01Basic earnings per preferred share
    
    
    0.01Basic earnings per ADS
    
    
    0.04Diluted earnings per common share
    
    
    0.01Diluted earnings per preferred share.
    
    
    0.01Diluted earnings per ADS
    
    
    0.04
  (7)
    
    For a discussion of the restatement of our consolidated cash flows
for the years 2001 and 2002, see IntroductionPresentation of
Financial and Other DataFinancial Data. Cash flows for
the years 1999 and 2000 have been restated for comparison purposes
only. 3




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##### Table of Contents



At and for the year ended December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003Other Data:Aircraft delivered during period:To the Commercial Airline MarketEMB 120 Brasília
    
    
    7
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    ERJ 145
    
    
    80
    
    
    
    112
    
    
    
    104
    
    
    
    82
    
    
    
    57ERJ 135
    
    
    16
    
    
    
    45
    
    
    
    27
    
    
    
    3
    
    
    
    14ERJ 140
    
    
    
    
    
    
    
    
    
    
    22
    
    
    
    36
    
    
    
    16To the Defense MarketEMB 120 Brasília
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Legacy
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    EMB 135
    
    
    
    
    
    
    1
    
    
    
    2
    
    
    
    
    
    
    
    EMB 145
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1
    
    
    
    1EMB 145 AEW&C/RS/MP
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    3EMB 312 Tucano
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    AM-X
    
    
    3
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    To the Corporate Market(1)Legacy
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    11EMB 135
    
    
    
    
    
    
    2
    
    
    
    5
    
    
    
    
    
    
    
    2To the General Aviation MarketLight Aircraft
    
    
    17
    
    
    
    17
    
    
    
    11
    
    
    
    25
    
    
    
    46Total delivered
    
    
    123
    
    
    
    178
    
    
    
    174
    
    
    
    161
    
    
    
    150Aircraft in backlog at the end of period:In the Commercial Airline Market(2)EMB 120 Brasília
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    ERJ 145
    
    
    176
    
    
    
    261
    
    
    
    159
    
    
    
    109
    
    
    
    144ERJ 135
    
    
    124
    
    
    
    85
    
    
    
    53
    
    
    
    31
    
    
    
    17ERJ 140
    
    
    
    
    
    
    133
    
    
    
    152
    
    
    
    116
    
    
    
    20EMBRAER 170
    
    
    40
    
    
    
    90
    
    
    
    82
    
    
    
    88
    
    
    
    120EMBRAER 190
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    110EMBRAER 195
    
    
    30
    
    
    
    30
    
    
    
    30
    
    
    
    30
    
    
    
    15In the Defense MarketEMB 145 AEW&C/RS/MP
    
    
    12
    
    
    
    12
    
    
    
    15
    
    
    
    10
    
    
    
    7EMB 312 Tucano/EMB 314
Super Tucano
    
    
    
    
    
    
    
    
    
    
    86
    
    
    
    86
    
    
    
    76AM-X
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    EMB 145
    
    
    
    
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    1EMB 135
    
    
    1
    
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    Legacy
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5In the Corporate MarketLegacy/EMB 135
    
    
    
    
    
    
    29
    
    
    
    66
    
    
    
    58
    
    
    
    27In the General Aviation MarketLight aircraft
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11Total backlog (in aircraft)
    
    
    386
    
    
    
    646
    
    
    
    645
    
    
    
    528
    
    
    
    542Total backlog (in millions)
    
    US$
    6,365
    
    
    US$
    11,421
    
    
    US$
    10,693
    
    
    US$
    9,034
    
    
    US$
    10,591
   (1)
    
    Of the 13 total deliveries to the Corporate Market in 2003, two were
delivered under operating leases.(2)
    
    Since December 31, 2003, we received 22 additional firm orders for
our ERJ 145 regional jet family and 28 additional firm orders for our
EMBRAER 170/190 jet family. 4




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Exchange Rates There are two foreign exchange markets in Brazil that are subject to
regulation by the Brazilian Central Bank, or the Central Bank, both of which
operate at free-floating rates:  
    
    the free rate foreign exchange market, also known as the commercial market, and
    
    the floating rate foreign exchange market. In 1999, the Central Bank unified the operational limits applicable to
both markets. However, each market continues to have a specific regulation.
Most trade and financial foreign exchange transactions, including transactions
relating to the purchase or sale of preferred shares or the payment of
dividends with respect to preferred shares or ADSs, are carried out on the
commercial market at the applicable commercial market rate. Purchase of
foreign currencies in the commercial market may be carried out only through a
Brazilian bank authorized to buy and sell currency in that market. In both
markets, rates are freely negotiated but may be strongly influenced by Central
Bank intervention. Between March 1995 and January 1999, the Central Bank permitted the
gradual devaluation of the realagainst the U.S. dollar pursuant to an exchange
rate policy that established a band within which the real/U.S. dollar exchange
rate could fluctuate. Responding to pressure on the real, on January 13, 1999, the Central Bank
widened the foreign exchange band. Because the pressure did not ease, on
January 15, 1999, the Central Bank allowed the realto float freely. Since
that date, the realreached a low of R$1.4659 per US$1.00 on January 15, 1999
and a high of R$3.9552 per US$1.00 on October 22, 2002. In 2002, the real
depreciated 52.3% against the U.S. dollar. In 2003, the realappreciated by
18.2% against the U.S. dollar. At June 24, 2004, the commercial market rate
for purchasing U.S. dollars was R$3.1030 to US$1.00. We cannot assure you that
the realwill not appreciate or devalue substantially in the near future. The following table shows the commercial selling rate for U.S. dollars for
the periods and dates indicated. Exchange Rate of Reais to US$1.00Low
    
    High
    
    Average (1)
    
    Period-endYear ended December 31,1999
    
    
    1.2078
    
    
    
    2.1647
    
    
    
    1.8158
    
    
    
    1.78902000
    
    
    1.7234
    
    
    
    1.9847
    
    
    
    1.8295
    
    
    
    1.95542001
    
    
    1.9357
    
    
    
    2.8500
    
    
    
    2.3532
    
    
    
    2.32042002
    
    
    2.2709
    
    
    
    3.9552
    
    
    
    2.9309
    
    
    
    3.53332003
    
    
    2.8219
    
    
    
    3.6623
    
    
    
    3.0715
    
    
    
    2.8892
 Exchange Rate of Reais to US$1.00Low
    
    HighMonth endedDecember 31, 2003
    
    
    2.8883
    
    
    
    2.9434January 31, 2004
    
    
    2.8022
    
    
    
    2.9409February 29, 2004
    
    
    2.9042
    
    
    
    2.9878March 31, 2004
    
    
    2.8752
    
    
    
    2.9410April 30, 2004
    
    
    2.8743
    
    
    
    2.9522May 31, 2004
    
    
    2.9569
    
    
    
    3.1291June 30, 2004 (through June 24)
    
    
    3.1030
    
    
    
    3.1651
   Source: Central Bank.(1)
    
    Represents the daily average exchange rate during each of the
relevant periods. 5




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We will pay any cash dividends and make any other cash distributions with
respect to the preferred shares in Brazilian currency. Accordingly, exchange
rate fluctuations may affect the U.S. dollar amounts received by the holders of
ADSs on conversion by the depositary of such distributions into U.S. dollars
for payment to holders of ADSs. Fluctuations in the exchange rate between the
realand the U.S. dollar may also affect the U.S. dollar equivalent of the real
price of the preferred shares on the São Paulo Stock Exchange. 3B. Capitalization and Indebtedness Not applicable. 3C. Reasons for the Offer and Use of Proceeds Not applicable. 3D. Risk Factors Risks Relating to Embraer A downturn in the commercial airline market 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 ERJ 145 regional
jet family and 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 aviation industry has been negatively impacted by a number
of factors beginning in 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 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. As a result, we agreed to
modify certain delivery schedules to adjust to the changes in our customers
businesses and reduced scheduled commercial airline, corporate and government
transportation aircraft deliveries. In 2002, we reduced our delivery schedule
to 131 aircraft as compared to planned 2002 deliveries of 205 at August 31,
2001. We also reduced our 2003 scheduled deliveries from 148 aircraft
originally planned to 101 actual deliveries. We have also re-evaluated our
risk exposure related to aircraft valuations and customer credit risk, which
resulted in charges to income. Although the U.S. and world economies appear to
be recovering in 2004, many airlines continue to face weak demand, escalating
insurance costs, increased security costs, credit downgrades, liquidity
concerns and bankruptcy, and, more recently, sharply higher fuel costs. A
further downturn in general economic conditions could result in further
reduction in the passenger aircraft market and decreased orders for our
commercial aircraft. We cannot, at this time, predict the magnitude or duration of the impact
that the above events will have on the airline industry as a whole and on our
business in particular. If one of our customers experiences a business
downturn, cannot obtain financing or otherwise seeks to limit its capital
expenditures, that customer could defer or cancel its purchase of our
commercial aircraft or change its operating requirements. Because our
commercial aircraft represent the majority of our net sales, sales of our other
products would not be able to offset a reduction in sales of our commercial
aircraft. Future delays or decreases in the number of commercial aircraft
delivered in any year would likely reduce our sales and revenue, and
consequently our profitability, for that year. 6




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We depend on a small number of key customers and key suppliers, the loss
of any of which could harm our business. Civil aircraft. As of March 31, 2004, 58.2% of our firm orders in backlog
for the ERJ 145 regional jet family were attributable to ExpressJet and
American Eagle. In addition, at the same date, 72.4% of our firm orders in
backlog for the EMBRAER 170/190 jet family were attributable to US Airways,
which is currently facing financial difficulty, and JetBlue Airways and 63.0%
of our firm orders in backlog for the Legacy were from Swift Aviation Services.
We believe that we will continue to depend on a limited number of large
customers, 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 Brazilian Air Force is our largest customer of
defense aircraft products. Sales to the Brazilian government accounted for
39.3% of our defense sales for the year ended December 31, 2003. 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 sales and defense research and development funding.
Given past statements by the Brazilian government of its intent to reduce its
overall level of spending, 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, wings, 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 expense. This dependence makes us
susceptible to the risks of performance, product quality and financial
condition of these risk-sharing partners. We cannot assure you that we will not experience significant delays in
obtaining key equipment in our manufacturing process in the future. 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 could affect our ability to deliver new aircraft to
customers in a timely manner. Our aircraft sales are subject to cancellation provisions, repurchase,
trade-in and trade-up options and financial and residual value guarantees that
may reduce our cash flow or require us to make significant cash disbursements
in the future. A portion of our aircraft firm orders is subject to significant
contingencies, both before and after delivery. Prior to delivery, some of our
purchase contracts may be terminated, or all or a portion of a particular firm
order may be canceled, for different reasons, including:  
    
    extended delays in delivering aircraft or failure to obtain
certification of the aircraft or otherwise meet performance
milestones and other requirements;
    
    failure of a customer to receive financing, when required,
with respect to any aircraft at the scheduled delivery date, in
which case the customer can cancel the order for the particular
aircraft to be delivered or terminate the contract with respect to
all undelivered aircraft; or
    
    production rate shortfalls. 7




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Our customers may also reschedule deliveries, particularly during an
economic downturn. 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. We may have to repurchase a number of our aircraft. Under the relevant
purchase contracts, the price per aircraft of any required repurchase is less
than the original purchase price of the aircraft and less than our estimate at
that time of the market value of the relevant aircraft type in future years
(based on third party appraisals of aircraft valuations). If we are required
to repurchase all of the relevant aircraft under our repurchase obligation,
which covers the period from 2004 to 2006, we could be required to pay up to
approximately US$500 million for these aircraft. In connection with the signing of a purchase contract for new aircraft, we
may provide trade in and or trade up options to our customers. These options
provide a customer with the right to trade in or trade up existing aircraft
upon the purchase of a new aircraft. At December 31, 2003, six commercial
aircraft were subject to trade-in options, and additional aircraft may become
subject to trade-in options upon delivery. The trade-in price is determined in
the manner discussed above for commercial jets. In addition, one corporate jet
customer has trade-up options relating to 11 aircraft, which provide that if
and when we launch a new corporate jet model, this customer has the right to
trade up to the new model. The trade-up price is determined as a percentage of
the original purchase price of our corporate jets. We may be required to
accept trade-ins or trade-ups at prices that are above the then-market price of
the aircraft, which would result in financial loss for us when we resell the
aircraft. We have guaranteed 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. Our residual value guarantees typically ensure that in the 15th year after
delivery, the relevant aircraft will have a residual market value of 10% to 27%
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. Assuming
all customers 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 residual value guarantees and we
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$1.4 billion as of December 31, 2003. For further discussion of
these off-balance sheet arrangements, see Note 34 of our consolidated financial
statements. We have deposited US$192.7 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, 2003) and from other offsetting collections,
such as cash deposits, would exceed our exposure by US$253.1 million. Although
we believe that the estimated value of the covered aircraft, on an aggregate
basis, is currently sufficient to cover our exposure, we may be obligated to
make substantial payments that are not recoverable through proceeds from
aircraft sales or leases, particularly if the future value of the relevant
aircraft is significantly lower than the guaranteed amount 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 recorded a charge against income in an amount of US$40.6 million in
2003, based on our risk assessment, on an individual aircraft basis, for the
issued guarantees. We continually re-evaluate our risk for the guarantees and
repurchase and trade-in and trade-up 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
remarket in the secondary market, and the credit rating for the customers. Any
future decrease in the market value of the aircraft covered by repurchase
obligations, trade-in or trade-up rights or 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 or repurchase obligations, 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
then-prevailing market conditions would allow us to resell or lease the 8




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##### Table of Contents



underlying aircraft at its anticipated fair value or in a timely manner.
Consequently, honoring our repurchase, trade-in, trade-up or 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, or Export Financing Program, known as the ProEx program. In July 1998, the Canadian government initiated a proceeding at the World
Trade Organization, or WTO, accusing the Brazilian government of granting
prohibited export subsidies relating to sales of aircraft to foreign purchasers
under the ProEx program. The Brazilian government countered, accusing the
Canadian government of granting prohibited export subsidies to the Canadian
aircraft industry. On April 14, 1999, the WTO declared the portions of the
ProEx program relating to Brazilian aircraft financing, and some aspects of the
Canadian aircraft financing programs, to be prohibited export subsidies.
Following appeals, the WTO formally decided on August 20, 1999 to give Brazil
until November 18, 1999 to withdraw the prohibited export subsidies or make any
necessary adjustments to bring the program into compliance with WTO rules. On
April 28, 2000, the WTO concluded that Brazil had failed to comply with the
earlier ruling to remove prohibited subsidies by November 18, 1999. In
particular, the WTO concluded that the issuance of ProEx benefits after
November 18, 1999 pursuant to letters of commitment issued by the Brazilian
government to our customers prior to November 18, 1999 were prohibited export
subsidies. The WTO also concluded that the amended version of the ProEx
program, adopted in response to the WTOs August 1999 ruling, still decreased
effective interest rates for regional aircraft to below commercial market
levels and thus continued to provide a prohibited export subsidy. In July
2000, the WTO confirmed this decision after an appeal by the Brazilian
government. The Brazilian government publicly announced that it would honor
its contractual commitments to our customers. As a result of Brazils
continuing to provide ProEx benefits under its contractual commitments, the WTO
dispute settlement body granted Canada the authority to impose up to US$1.4
billion in trade sanctions over five to six years against Brazil. Canada has
not yet imposed sanctions. We cannot predict what form, if any, these
sanctions will take and whether such sanctions will adversely affect our
business. The Brazilian government subsequently amended the ProEx program so
that any ProEx payments would not decrease the effective interest rate below
the interest rate permitted by the WTO. On August 23, 2001, the dispute
settlement body of the WTO determined the revised ProEx program was in full
compliance with WTO rules. Although this ruling confirms ProExs 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. In 2001, the Canadian government agreed to provide up to US$1.1 billion of
low-interest financing to Air Wisconsin, an affiliate of United Airlines, to
fund its purchase of Bombardier regional jets. The Brazilian government
challenged these subsidies and, in January 2002, a WTO panel declared that such
subsidies were illegal and required Canada to withdraw the funds. The panel
also found that, since 1996, two airlines in addition to Air Wisconsin had been
recipients of illegal subsidies. As a result, the dispute settlement body of
the WTO authorized Brazil to apply retaliatory measures against Canada in the
amount of US$248 million. Officials of the Canadian government have indicated
that they intend to continue providing support to Bombardier. Any future
subsidies supporting Bombardier or any of our other major competitors may cause
the cost-competitiveness of our aircraft to suffer and our sales to decline. The Brazilian and Canadian governments have entered into negotiations
regarding government support for aircraft exports. We cannot assure you that
any agreement will be reached. 9




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Brazilian government budgetary constraints could reduce amounts available
to our customers under government-sponsored financing programs. In addition to the ProEx program, we rely on the BNDES-eximprogram, also
a government-sponsored financing program, to assist customers with financing.
This program provides our customers with direct financing for Brazilian exports
of goods and services. From 1996 through 2003, approximately 48% of the total
value of our export sales was subject to financing by the BNDES-eximprogram.
As government-sponsored programs, the ProEx program and the BNDES-eximprogram
rely on funds allocated from the Brazilian national budget. Therefore, the
funds available to our customers under these programs will be affected by
currency fluctuations and other political and economic developments in Brazil
and the international capital markets. See Risks Relating to Brazil. For
example, a recent decrease in the amounts available under the ProEx program
caused us to make other financing arrangements for affected customers. In
addition, from time to time, government-sponsored financing programs such as
BNDES-eximcan be subject to challenge. We cannot assure you that the
Brazilian government will continue to sponsor and/or fund these programs or
that funds under these or other similar programs will be available to our
customers. The loss or significant reduction of funds available under one or
either of these programs, without an adequate substitute, could lead to fewer
sales and has caused and may continue to cause us to compensate our customers
for their additional financing costs, resulting in lower profitability for
Embraer. 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 the EMBRAER 170/190 jet family, we will have to
continue reallocating existing resources and coordinating 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 managements focus from our ongoing business. We
cannot assure you that we will be able to meet these challenges or that our
business will not face disruptions. We may have to refund cash contributions after the development of the
EMBRAER 170/190 jet family if certification for each of these aircraft is not
obtained. Our risk-sharing partners have contributed to us a total of US$244.3
million for the development of the EMBRAER 170/190 jet family as of December
31, 2003. Cash contributions become non-refundable upon the achievement of
certain developmental milestones. As of December 31, 2003, US$14.2 million of
these cash contributions had become non-refundable, and with the conclusion of
the certification of the EMBRAER 170 in February 2004 by the Brazilian, U.S.
and European authorities, an additional US$88.7 million of these cash
contributions became non-refundable. If we cancel the development and
production of any of the remaining aircraft in the EMBRAER 170/190 jet family
because we are unable to obtain certification or for other non-market related
reasons, we may be obligated to refund US$141.4 million of these cash
contributions. If we require additional financing and we are unable to obtain
it, we will not be able to continue to develop and market the remaining
aircraft in our EMBRAER 170/190 jet 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 Industrie and Bombardier Inc.,
all of which are large international companies. These and other of our
competitors have greater financial, marketing and other resources than we do.
Although we have achieved 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 10




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ability to maintain market share and remain competitive in the commercial
aircraft market over the long term requires continued technological and
performance enhancements 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, financial and marketing
resources and benefits from government-sponsored export subsidies. In
addition, other international aircraft manufacturers, including The Boeing
Company and Airbus Industrie, produce or are developing aircraft at the high
end of the 70-120 seat segment, in which our EMBRAER 170/190 jet family will
compete, thereby increasing the competitive pressures in that segment. These
companies also have significant technological capabilities and greater
financial and marketing resources. Some of our competitors 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. For example, in 2001, Bombardier commenced delivery of
its 70-seat regional jet, prior to the initial deliveries of the EMBRAER 170.
As a relatively new entrant to the corporate jet market, we also face
significant competition from companies with longer operating histories and
established reputations in this industry. We cannot assure you that we will be
able to compete successfully in our markets in the future. We may have to make significant payments as a result of unfavorable
outcomes of pending challenges to various taxes and social charges. We have challenged the constitutionality of the nature of and
modifications in rates and the increase in the calculation base of certain
Brazilian taxes and social charges. Interest on the total amount of these
unpaid taxes and social charges accrues monthly based on the Selic rate, the
key lending rate of the Central Bank, and we make an accrual as part of the
interest income (expense) item of our statements of income. As of December 31,
2003, we had obtained preliminary injunctions for not paying or recovering past
payments in the total amount, including interest, of US$302.6 million, which is
included as a liability on our balance sheet. 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 16 to our consolidated financial statements. Risks Relating to the Commercial Aircraft 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 airlines fleet. As a result, our opportunities
for near-term growth in the U.S. regional jet market in the 40-59 and 60-80
seat segments are 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 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 would
prohibit the use 11




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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. 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
preferred shares and the ADSs. We believe that our reputation and the safety record of our aircraft are
important selling points for our aircraft. 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. Due to our relative position in the aircraft market and because
we have focused on products in the regional and mid-capacity jet segments, the
occurrence of one or more catastrophic events involving one of our aircraft
could adversely affect our entire commercial jet family as well as our
reputation and future sales. Risks Relating to Brazil Brazilian political and economic conditions have a direct impact on our
business and the market price of our preferred shares and the ADSs. The Brazilian economy has been characterized by frequent, and occasionally
drastic, intervention by the Brazilian government and by volatile economic
cycles. The Brazilian governments actions to control inflation and affect
other policies have involved price controls, currency devaluations, capital
controls and limits on imports, among other things. Our business, financial
condition, results of operations and the market price of the preferred shares
and the ADSs may be adversely affected by changes in policy involving tariffs,
exchange controls and other matters, as well as other factors outside of our
control such as:  
    
    fluctuations in exchange rates;
    
    base interest rate fluctuations;
    
    inflation and price instability;
    
    liquidity of domestic capital and lending markets;
    
    tax policy;
    
    structural and investment deficiencies in the energy sector; and
    
    other political, diplomatic, social and economic developments in or affecting Brazil. Rapid changes in Brazilian political and economic conditions that have
already occurred and that might continue will require continued emphasis on
assessing the risks associated with our activities and adjusting our business
and operating strategy. 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, financial condition
and results of operations. Our business could be significantly affected by political instability in
Brazil. In the elections in October 2002, Brazilian voters elected a new
president from the Workers Party, Luís Inácio Lula da Silva. In the period
leading up to and following his election, there was substantial uncertainty
relating to the policies that the new 12




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government would pursue, including the potential implementation of
macroeconomic policies that differed significantly from those of the prior
administration. This uncertainty resulted in a loss of confidence in the
Brazilian capital markets and a 52.3% devaluation of the realin 2002.
Although the new government has not yet departed in any material way from
previous policies, we cannot predict whether the government will continue its
current policies or will pursue different policies, or whether such new
policies, if implemented, will be effective. Uncertainty over whether current
policies will be continued or whether the Brazilian government will adopt
different policies in the future may contribute to economic uncertainty in
Brazil and to heightened volatility in the Brazilian securities markets and

securities issued abroad that are supported by Brazilian issuers. These and other future uncertainties regarding the Brazilian economy and
government could adversely affect our business, operations and the market price
of our preferred shares and ADSs. Inflation and certain governmental measures 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 preferred shares and the ADSs. Brazil has experienced extremely high rates of inflation in the past.
More recently, Brazils annual rate of inflation was 20.1% in 1999, 9.9% in
2000, 10.4% in 2001, 25.3% in 2002 and 8.7% in 2003 (as measured by Índice
Geral de Preços  Mercadoor the IGP-M). Inflation, and certain
governmental measures to combat inflation, as well as public speculation about
possible future measures, have in the past had significant negative effects on
the Brazilian economy, contributing to economic uncertainty in Brazil and to
heightened volatility in the Brazilian securities markets. Since the reals introduction in July 1994 under the RealPlan, Brazils
inflation rate has been substantially lower than in previous periods. If
Brazil experiences substantial 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 the preferred
shares and ADSs may fall. Exchange rate instability may result in uncertainty in the Brazilian
economy and the Brazilian securities markets and could lower the market value
of the preferred shares and the ADSs. Although most of our net sales and debt are U.S. dollar-denominated, the
relationship of the realto the value of the U.S. dollar, and the rate of
depreciation of the realrelative to the prevailing rate of inflation, may
adversely affect us. As a result of inflationary pressures, the Brazilian currency has been
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 realdepreciated against the U.S. dollar by 9.3% in 2000 and 18.7% in
2001. During 2002, the realdepreciated 52.3%, due in part to continued
economic and political uncertainties in emerging markets and the global
economic slowdown. From January through December 31, 2003, the real
appreciated 18.2% against the U.S. dollar. During the first five months of
2004, the realdepreciated 8.3% against the U.S. dollar. We cannot predict the
extent to which the realwill depreciate or appreciate against the U.S. dollar. Depreciations create 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 realagainst 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 realrelative to the U.S. dollar would also reduce the
U.S. dollar value of distributions and dividends on the 13




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ADSs and may also reduce the market value of the preferred shares and the
ADSs. The potential impact of the floating exchange rate and of measures of
the Brazilian government aimed at stabilizing the realis uncertain. Developments in other countries, particularly other emerging market
countries, may adversely affect the Brazilian economy, may make it more
difficult or expensive for us to obtain additional debt financing and,
therefore, may affect the market price of the preferred shares and the ADSs. Securities of Brazilian issuers have been, to varying degrees, influenced
by economic and market conditions in other countries, particularly emerging
market countries. Although economic conditions are different in each country,
the reaction of investors to developments in one country may cause the capital
markets in another country, including Brazil, to destabilize. Developments or
conditions in other emerging market countries have at times significantly
affected the availability of credit in the Brazilian economy and have resulted
in considerable outflows of funds and declines in the amount of foreign
currency invested in Brazil. For example, since the fourth quarter of 1997, the international financial
markets have experienced significant volatility, and a large number of market
indices, including those in Brazil, have declined significantly. The recent
political crisis in Venezuela and recession in Argentina, the terrorist attacks
in 2001, the war in Iraq, and the related deterioration of worldwide market
conditions, as well as the Russian economic crisis in 1998 and the Asian
economic crisis in 1997, triggered market volatility in the securities markets
of Brazil and other emerging market countries. See Item 5A. Operating
ResultsBrazilian Economic Environment. As a result, investors have viewed
investments in emerging markets with heightened caution. These events have
also discouraged investment worldwide, including international investment in
Brazil, and, more directly, have caused a decline in the market for our
preferred shares and ADSs. Further negative developments in the international financial markets,
especially in other emerging markets, may adversely affect our financial
condition and our ability to obtain debt financing on acceptable terms or at
all. Risks Relating to the Preferred Shares and the ADSs Exchange controls and restrictions on remittances abroad may adversely
affect the holders of our ADSs. The Brazilian government may impose temporary restrictions on the
conversion of Brazilian currency into foreign currencies and on the remittance
to foreign investors of proceeds from their investments in Brazil. The
Brazilian government imposed remittance restrictions for a number of months in
1989 and early 1990. These restrictions would hinder or prevent the conversion
of dividends, distributions or the proceeds from any sale of preferred shares,
as the case may be, from reaisinto U.S. dollars and the remittance of the U.S.
dollars abroad. We cannot assure you that the Brazilian government will not
take similar measures in the future. Holders of our ADSs could be adversely
affected by delays in, or refusals to grant, any required governmental approval
for conversion of realpayments and remittances abroad in respect of the
preferred shares underlying the ADSs. In such a case, the depositary for the
ADSs will hold the reaisit cannot convert for the account of the ADR holders
who have not been paid. The depositary will not invest the reaisand will not
be liable for interest on those amounts. If holders of ADSs exchange the ADSs for preferred shares, they risk
losing the ability to remit foreign currency abroad and Brazilian tax
advantages. The Brazilian custodian for the preferred 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 preferred shares or upon the disposition of the preferred
shares. If holders of ADSs decide to exchange their ADSs for the underlying
preferred shares, they will be entitled to continue to rely on the custodians
electronic certificate of registration for five business days from the date of
exchange. Thereafter, such holders of ADSs may not be able to obtain and remit
foreign currency abroad upon the disposition of, or distributions relating to,
the preferred shares unless they obtain their own electronic certificate of
registration or register their investment in the preferred 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 preferred shares. If holders of ADSs attempt 14




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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 preferred shares
or the return of their capital in a timely manner. In addition, we cannot
assure you that the custodians electronic certificate of registration or any
certificate of foreign capital registration obtained by a holder of ADSs will
not be affected by future legislative or other regulatory changes, or that
additional restrictions applicable to such holder, to the disposition of the
underlying preferred shares or to the repatriation of the proceeds from such
disposition will not be imposed in the future. The relative volatility and illiquidity of the Brazilian securities
markets may substantially limit the ability of holders of our preferred shares
or ADSs to sell the preferred shares underlying the ADSs at the price and time
they desire. Investing in securities, such as the preferred 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 preferred shares or ADSs to sell the preferred shares
underlying 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. MarketsTrading on the São Paulo Stock Exchange. Because we are subject to different corporate rules and regulations as a
Brazilian company, holders of our ADSs have fewer and less well-defined
shareholders rights. Our corporate affairs are governed by our bylaws and Brazilian Corporate
Law, which differ from the legal principles that would apply if we were
incorporated in a jurisdiction in the United States, such as Delaware or New
York, or in other jurisdictions outside Brazil. As a result, the holders of
the ADSs or the holders of our preferred shares may have fewer and less
well-defined rights under Brazilian Corporate Law with which to protect their
interests against actions by our board of directors and our principal
shareholders than under the laws of those jurisdictions outside Brazil. Although Brazilian Corporate Law imposes restrictions on insider trading
and price manipulation, the Brazilian securities markets are not as highly
regulated and supervised as the U.S. securities markets or markets in other
jurisdictions. In addition, rules and policies against self-dealing and
regarding the preservation of minority shareholder interests may be less
well-defined and enforced in Brazil than in the United States, putting holders
of the preferred shares and ADSs at a potential disadvantage. Corporate
disclosures may be less complete or informative than what may be expected of a
U.S. public company. Specifically, among other differences when compared to,
for example, Delaware general corporation law, Brazilian Corporate Law and
practice has less detailed and well-established rules and judicial precedents
relating to the review of management decisions against duty of care and duty of
loyalty standards in the context of corporate restructurings, transactions with
related parties and sale-of-business transactions. In addition, Brazilian
Corporate Law provides that shareholders must hold 5% of the outstanding share
capital of a corporation to have standing to bring shareholders derivative
suits, and shareholders ordinarily do not have standing to bring a class
action. Also, in accordance with Brazilian Corporate Law, holders of our preferred
shares, and therefore our ADSs, are not entitled to vote at meetings of our
shareholders except in limited circumstances. See Item 10B. Memorandum and
Articles of IncorporationDescription of Capital StockVoting Rights of the
Preferred Shares. 15




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The Brazilian government has veto power over major corporate actions, and
our controlling shareholders act in concert to control Embraer; their interests
could conflict with the interests of the holders of ADSs. The Brazilian government holds one special class of our common stock,
called a golden share, which carries veto power over, among other things,
change of control, change of corporate purpose and creation and alteration of
defense programs (whether or not the Brazilian government participates in such
programs). In addition, under the terms of a shareholders agreement, our
controlling shareholdersCia. Bozano, Caixa de Previdência dos Funcionários do
Banco do BrasilPREVI, also known as PREVI, and Fundação SISTEL de Seguridade
Social, also known as SISTELact in concert to vote 60% of the outstanding
shares of our common stock, allowing them to elect a majority of the members of
our board of directors and to determine the outcome of any actions requiring
shareholder approval, including corporate reorganizations and the timing and
payment of future dividends. The Brazilian government may have an interest in
vetoing transactions that may be in the interests of the holders of the ADSs.
Our controlling shareholders may have an interest in pursuing acquisitions,
dispositions, financings or similar transactions that could conflict with the
interests of the holders of the ADSs. The sale of a substantial number of preferred shares, or the belief that
this may occur, could decrease the trading price of the preferred shares and
the ADSs; holders of our preferred 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 preferred shares, or the belief that this
may occur, could decrease the trading price of our preferred shares and our
ADSs. As of December 31, 2003, we had 473,501,135 preferred shares
outstanding. Of this amount, holders of exchangeable notes that were issued in
June 2001 by Banco Nacional de Desenvolvimento Econômico e SocialBNDES, the
Brazilian National and Social Development Bank, also known as BNDES, have the
right to acquire, at any time prior to the maturity of the notes, an aggregate
of 7,279,200 ADSs, representing 29,116,800 preferred shares currently owned by
BNDES Participações S.A.BNDESPAR, also known as BNDESPAR, a wholly owned
subsidiary of BNDES, subject to adjustment. As a consequence of the issuance
of preferred shares or sales by existing shareholders, the market price of the
preferred shares and, by extension, the ADSs may decrease significantly. As a
result, the holders of our ADSs and/or preferred shares may not be able to sell
their securities at or above the price they paid for them. Our share price may be affected by potential dilution of our preferred
shares and the ADSs. The issuance of preferred shares pursuant to our stock option plan could
substantially dilute the preferred shares. Under the terms of our stock plan,
we were authorized to grant options to purchase up to 25,000,000 preferred
shares over the five-year period from the date of the first grant of options
pursuant to the plan. As of the end of this five-year period in May 2003, we
had granted options for an aggregate of 20,237,894 preferred shares, including
662,894 options granted in connection with our preferred stock dividend in
2002. No additional options may be granted
pursuant to the plan. The options granted to each employee generally vest as
follows: 30% after three years from the date granted, an additional 30% after
four years and the remaining 40% after five years. Employees may exercise
their options for up to seven years from the date they are granted. As of
December 31, 2003, options representing 10,252,541 preferred shares have
already been exercised and options representing 6,257,758 preferred shares are
exercisable in 2004. Holders of our ADSs might be unable to exercise preemptive rights with
respect to the preferred shares. Holders of our ADSs may not be able to exercise the preemptive rights
relating to the preferred 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. 16




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ITEM 4. INFORMATION ON THE COMPANY 4A. History and Development of the Company General 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.
Our principal executive offices are located at Avenida Brigadeiro Faria Lima,
2170, 12227-901 São José dos Campos, São Paulo, Brazil. Our telephone number
is 55-12-3927-1216. Our agent for service of process in the United States is
our subsidiary, Embraer Aircraft Holding, Inc., with offices at 276 S.W. 34th
Street, Ft. Lauderdale, Florida 33315. We have grown from a government-controlled company established to develop
and produce aircraft for the Brazilian Air Force into a public company that
produces aircraft for commercial, corporate and defense 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 business to develop our commercial aircraft 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 markets
trend towards larger, higher volume and longer range jets. The first member of
this family, the EMBRAER 170, was certified in February 2004. We are also
marketing and selling the Legacy, a line of corporate jets based on our ERJ 135
regional jet, but with several differences including longer range. The Legacy
has one of the highest-volume cabins in its category. For the defense market,
we also offer a line of intelligence, surveillance and reconnaissance aircraft
based on the ERJ 145 regional jet. 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 ThalesTM, and
Société Nationale dÉtude et de Construction de Moteurs dAviation, or SNECMA,
which we refer to collectively as the European Aerospace and Defense Group,
purchased as a group 20% of the outstanding common stock of Embraer from our
existing common shareholders, a majority of which was from our controlling
shareholders. We believe that this alliance will continue to assist us in the
development of solutions for the defense market and enable us to expand our
defense activities. For example, we integrated ThalesTM mission systems and
electronic equipment in some of our EMB 145 AEW&C aircraft. Joint Ventures and Acquisitions In 2000, we entered into a joint venture with Liebherr International AG to
develop and manufacture landing gear and high precision hydraulic equipment and
provide related services for Embraer and other clients around the 17




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world. In connection with this joint venture, we formed a new subsidiary,
ELEB  Embraer Liebherr Equipamentos do Brasil S.A. In March 2002, we acquired the operating assets of Celsius Aerotech Inc.
in Nashville, Tennessee from Reliance Aerotech Inc. in order to provide full
service maintenance and repair services for our commercial and corporate
aircraft in the United States. In December 2002, we entered into a joint venture with Harbin Aircraft
Industry (Group) Co., Ltd. and Hafai 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. Research and Development Costs and Capital Expenditures Research and development costs, including the development of the EMBRAER
170/190 jet family, were US$99.6 million in 2001, US$158.5 million in 2002 and
US$173.2 million in 2003. Research and development costs as a percentage of
our net sales were 3.4% in 2001, 6.3% in 2002 and 8.1% in 2003. The increases
in research and development costs as a percentage of our net sales in 2002 and
2003 reflect principally the costs related to the EMBRAER 170/190 jet family. Our investments in property, plant and equipment totaled US$143.8 million
in 2001, US$111.0 million in 2002 and US$64.7 million in 2003. The investments
in 2002 and 2003 related mainly to construction of facilities, improvements to
our plant and production facilities and modifications for the production of new
aircraft models. We expect our future research and development costs to remain at current
levels as a result of the continued development of the EMBRAER 170/190 jet
family. In 2004, we expect research and development costs to total
approximately US$174.0 million and we expect investments in property, plant and
equipment to total approximately US$64.0 million, which will primarily be
related to construction of facilities, improvements to our plant and production
facilities, in particular for the production of the EMBRAER 170/190 jet family,
as well as our defense aircraft and corporate jets. 4B. Business Overview We are one of the leading manufacturers of commercial aircraft in the
world, based on 2003 net sales of commercial aircraft, with a global customer
base. We focus primarily on manufacturing commercial aircraft, which accounted
for 71.2% of our net sales in 2003. We are the leading supplier of defense
aircraft for the Brazilian Air Force based on number of aircraft sold, and we
have also sold aircraft to military forces in Europe and Latin America. In
addition, we have developed a line of corporate jets based on one of our
regional jets. For the year ended December 31, 2003, we generated net sales of
US$2,143.5 million, of which more than 90% was U.S. dollar-denominated. At
March 31, 2004, we had a total firm backlog in orders of US$10.9 billion,
including 439 commercial jets. Our Strengths We believe that our primary strengths are: Leading Commercial Aircraft Manufacturer with a Global Customer Base.We
are a leading manufacturer of regional and mid-capacity jets with a strong
global customer base. We have sold our regional and mid-capacity jets to 40
customers in 22 countries. Our customers include some of the largest regional
and low-cost airlines 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 18




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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 our regional and mid-capacity jet
families, 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 contributed their own funds to
research and develop these systems and components, thereby reducing our
development costs. These risk-sharing partners also funded 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. Benefits of Funded Development of Defense Technology.Research and
development costs related to defense aircraft historically have been funded in
large part by Brazilian government contracts. We are able to apply the
technological developments we acquire from our defense technology to
applications in our commercial aircraft business. For example, we developed
our regional jet family using technology from the AM-X program developed for
the Brazilian Air Force. In addition, we sell proven defense products
developed for the Brazilian Air Force to other military forces. Flexibility of Production to Meet Market Demands. We believe the
flexibility of our production processes and our operating structure, including
our risk-sharing partnerships that are designed to minimize costs, allow us to
increase or decrease our production in response to market demand without
significantly impacting our margins. Experienced and Highly Skilled Workforce. Our employees are experienced
and highly skilled. Approximately 25% of our workforce is comprised of
engineers. Due to the high level of knowledge and skill possessed by our
employees, we are able to efficiently pursue new programs and provide our
customers with additional technical expertise and guidance. Business Strategies Continuing
to Aggressively Market our ERJ 145 Regional Jet Family. We are fully
committed to continuing to aggressively market our ERJ 145 regional
jet family. The ERJ 145 regional jet family is the backbone of our
operations, with almost 800 units in operation and a history of good
service. We believe that airlines can continue to benefit from this
regional jet family, which we believe has assisted our customers over
the last eight years in pursuing their goal of achieving profitable
operations. We believe a significant market opportunity exists for
the ERJ 145 regional jet family with airlines that are seeking to
expand hub and spoke and point-to-point operations, increase flight
frequencies, explore new market opportunities, stimulate demand,
develop secondary hubs and replace turboprop operations. Aggressively Marketing Our Mid-capacity Jet Family.We are aggressively
marketing our mid-capacity platform, the EMBRAER 170/190 jet family. 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, and also with
other airlines that are optimizing their fleet in order to adjust capacity to
meet demand in less dense routes. Additionally, we believe that our new
mid-capacity jet family will provide us with significant opportunities to
increase our competitiveness by offering our customers a full range of
commercial aircraft. Developing Our Strategic Alliance with European Aerospace and Defense
Group.We believe our strategic alliance with the European Aerospace and
Defense Group will enhance our defense business. We intend to enhance our
technological capabilities and increase our production and marketing of
innovative defense products. We also intend to increase our international
marketing presence for our defense products through joint marketing efforts
with members of the European Aerospace and Defense Group. Increasing Focus on Customer Support.Providing high quality customer
support is critical to our ability to maintain long-term relationships with our
customers. As the number of our aircraft in operation continues to grow, we
have 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 our 2002 acquisition
of a Nashville, Tennessee aircraft service center. We intend to continue to
focus on providing our customers with high quality customer support. Expanding Risk-Sharing Arrangements.We intend to maintain or expand the
role of risk-sharing partners in the production process for our aircraft in
order to reduce production costs and streamline the management of our
suppliers. Having fewer suppliers enables us to minimize our production costs
while allocating additional risk for the production of integrated systems to
our risk-sharing partners and increasing our flexibility. 19




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Diversifying Revenues.We intend to diversify our revenues through our
defense segment and our corporate segment.  
    
    Increasing Penetration into the Defense Market.We plan to
develop and market additional defense products and thereby increase
sales in this segment of our business. We intend to increase our
participation in the international defense market by actively
marketing our existing products initially developed for the
Brazilian Air Force, including the EMB 145 AEW&C, the EMB 145 RS,
the EMB 145 MP and the Super Tucano (ALX).
    
    Cost-Effectively Developing a Line of Corporate Jets.We
have developed the Legacy, a line of corporate jets based on the ERJ
135 regional jet, to provide to businesses, including fractional
ownership companies, a cost-effective alternative to commercial
airline travel. In developing the Legacy, we used the same design
and risk-sharing arrangements of our ERJ 135 regional jet. As a
result, we were able to develop the Legacy without the substantial
financial investment normally associated with a new product launch. Pursuing Strategic Growth Opportunities.We intend to pursue strategic
growth opportunities, which may include joint ventures, acquisitions and other
strategic transactions. For example, we intend to expand our presence in China
through our joint venture with AVIC II. We believe that the market for
regional aircraft in China is strong and currently underserved. We believe
this market will create incremental growth for our future revenues. Commercial Airline Business We design, develop and manufacture a variety of commercial aircraft. Our
commercial airline business is our primary business, accounting for 71.2% of
our net sales for the year ended December 31, 2003. Products We developed the ERJ 145, a 50-passenger twin turbofan-powered regional
jet, 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-passenger 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 our 70-108 seat platform, the EMBRAER 170/190 jet
family, 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 turbofan-powered regional jet 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 and the Australian aviation authority in June
1998. We began delivering the ERJ 145 in December 1996. 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. 20




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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 at 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 135s fuselage
is 11.6 feet shorter than the ERJ 145s. The ERJ 135 is also available in a
long-range, or LR, version, which features a larger fuel tank, more powerful
engines and significantly greater maximum fully loaded range (l,700 nautical
miles) than the standard version. 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 a
long-range, or LR, version, which features a larger fuel tank, more powerful
engines and significantly greater maximum fully loaded range (1,630 nautical
miles) than the standard version. 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 70-78
seat jet, and the EMBRAER 175 will be a 78-86 seat jet, while the EMBRAER 190
series will include the 98-106 seat EMBRAER 190 and the 108-118 seat EMBRAER
195. 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. We expect to receive certification of
the EMBRAER 175 by the end of 2004, the EMBRAER 190 in 2005 and the EMBRAER 195
in 2006. We have completed the joint design definition phase and have produced
the first prototypes of the EMBRAER 175 and EMBRAER 190. The EMBRAER 175 made
its maiden flight on June 14, 2003 and the EMBRAER 190 made its maiden flight
on March 12, 2004. We designed the EMBRAER 170/190 jet family to maximize the benefits of
commonality, with aircraft in the family sharing 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 21




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the same wing design. This new mid-capacity jet family has engines fixed
under its main wingsa design intended to enhance power, improve fuel economy
and minimize turnaround times. All of the aircraft models of this family are
powered by engines manufactured by General Electric and contain
state-of-the-art avionics manufactured by Honeywell. The EMBRAER 170/190 jet familys principal features are:  
    
    Performance.All four jets in the EMBRAER 170/190 jet family
have a maximum cruising speed of Mach .8, or 470 knots. The EMBRAER
170 and the EMBRAER 175 have maximum fully loaded ranges of 1,800
and 1,600 nautical miles, respectively, and the EMBRAER 170 is, and
the EMBRAER 175 will be, also available in long-range, or LR,
versions, with maximum fully loaded ranges of 2,100 and 1,900
nautical miles, respectively. The EMBRAER 190 and EMBRAER 195 have
maximum fully loaded ranges of 1,800 and 1,400 nautical miles,
respectively, and will be available in LR versions with maximum
fully loaded ranges of 2,300 and 1,800 nautical miles, respectively.
The LR versions of all four jets in the EMBRAER 170/190 jet family
will feature larger fuel tanks and more powerful engines than the
standard versions of these aircraft.
    
    Ground servicing.The under-wing engine design and the
existence of four doors, two in the front and two in the back,
provide for enhanced accessibility and efficiency of ground
services.
    
    Cabin and cargo space.We have enhanced passenger safety and
comfort in the EMBRAER 170/190 jet family. The aircrafts
double-bubble design enables a four-abreast cabin, a wide aisle,
greater interior space and headroom and a larger baggage compartment
than the existing mid-capacity jets of our competitors, including
those mid-capacity jets that are in the development stage. 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 regional aircraft industrys demand for a high-speed and
fuel-efficient 30-seat regional aircraft. The EMB 120 Brasília was certified
by the FAA in May 1985 and by the Brazilian aviation authority in July 1985.
Since its introduction in 1985 and through December 31, 2003, we have delivered
352 EMB 120 Brasílias for the regional market and five EMB 120 Brasílias for
the defense market. We currently manufacture the EMB 120 Brasília only upon
customer request. Customers While we have focused our efforts on the U.S. and European markets to
date, we have achieved a diverse, global customer base for our aircraft,
principally in the commercial airline market. Our major customers of
commercial aircraft include some of the largest regional and low-cost airlines
in the world. As of March 31, 2004, our largest customers are ExpressJet,
American Eagle, Republic Airways, JetBlue Airways and US Airways. For a
discussion of these significant customer relationships, see Item 3D. Risk
FactorsRisks Relating to EmbraerWe depend on a small number of key customers
and key suppliers, the loss of any of which could harm our business. Since
2002, we have also intensified our marketing efforts on potential customers in
China and other Asian markets. 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,
repurchase, trade-in and trade-up options and financial and residual value
guarantees. See Item 3D. Risk FactorsRisks Relating to EmbraerOur aircraft
sales are subject to cancellation provisions, repurchase, trade-in and trade-up
options and financial and residual value guarantees that may reduce our cash
flow or require us to make significant cash disbursements in the future for a
more detailed discussion of these provisions. 22




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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 addressing 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, Melbourne, Australia, Ft. Lauderdale, Florida, Beijing, China,
and Singapore. We sell our ERJ 145 regional jet family in the Chinese market
exclusively though our joint venture in China, which secured its first order
from a Chinese airline in February 2004. 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 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 generally non-refundable 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 contract. Once a customer
decides to exercise an option, we account for it as a firm order. On occasion,
we have extended the exercise date for our options and renegotiated the
delivery schedule of firm orders. On occasion, we have allowed customers to
convert their firm orders or options for one aircraft into firm orders or
options for another aircraft within the same commercial jet family. Competition We generally face competition from major manufacturers in the
international aircraft market. Each category of our products faces competition
of a different nature and generally from different companies. Some of our
competitors have greater financial, marketing and other resources than we do.
In the 30-60 seat category, the main competitor of the ERJ 135 and the EMB 120
Brasília aircraft is the De Havilland DHC-8-200, a turboprop aircraft. The
main competitors of the ERJ 145 regional jet family are:  
    
    the CRJ-100/200/440, manufactured by Bombardier;
    
    the 328Jet, previously developed and manufactured by
Fairchild Dornier and now manufactured to order by Avcraft Aviation
LLC;
    
    the ATR-42, manufactured by ATR G.I.E., a joint project of
Italys Alenia Aerospaziale and EADS; and 23




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
    
    the DHC-8-300, manufactured by De Havilland. Only Bombardiers CRJ-100/200/440 aircraft are jets. Fairchild Dornier
filed for bankruptcy protection in April 2002, and the 328Jet is currently
marketed and manufactured to order by Avcraft Aviation LLC. Given the success
of our regional jet family and the significant barriers to entry into the
market, due principally 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 increase our market share for the ERJ 145 regional jet
family. We face our strongest competition in the 61-90 and 91-120 seat categories.
Currently, there are three aircraft in the segment: De Havillands DHC-8-400,
a 72-seat turboprop, ATRs ATR72, a 72-seat turboprop, and Bombardiers
CRJ-700, a 70-seat regional jet, which was first delivered in January 2001.
Bombardier has also launched the larger CRJ-900 aircraft, which seats 85
passengers and began deliveries in January 2003, before the expected delivery
of our EMBRAER 175. In the higher end of the 91-120 seat category, Boeing has
launched the 717-200, a 106-112 seat jet. Furthermore, Airbus developed a
100-plus seat jet, the A318, which was certified by the JAA in May 2003. 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 with our
competitors on the basis of our aircraft performance, low operating costs,
product development experience, global customer base, market acceptance, cabin
design and aircraft price. Defense Business We design, develop, integrate and manufacture a wide range of defense
products, principally transport, training, light attack and surveillance
aircraft. We are the leading supplier of defense aircraft to the Brazilian Air
Force based on the total number of aircraft in its current fleet. We also have
sold defense aircraft to military forces of 16 other countries in Europe and
Latin America, including the United Kingdom, France, Greece and Mexico. At
December 31, 2003, we had sold 522 defense aircraft to the Brazilian government
and 526 defense aircraft to other military forces. Our defense business
accounted for 12.2% of our net sales for the year ended December 31, 2003. Products Tucano Family; AL-X The Tucano is a single engine turboprop aircraft used for pilot training
and armed reconnaissance missions. Although no longer manufactured, over 650
EMB 312 Tucanos are in operation in 15 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, which has a light attack version,
known as the AL-X (Aeronave Leve de Ataque, or Light Attack Aircraft). The
Super Tucano and the AL-X offer an engine with twice the power of the Tucanos
standard engine, fighter standard avionics, ejection seats, an on-board
oxygen-generating system and enhanced range and external loads capability. The
AL-X was developed under a contract with the Brazilian Air Force, with FINEP
providing US$21.7 million in research and development debt financing, of which
US$3.5 million was outstanding as of December 31, 2003. The AL-X has
sophisticated navigation and attack systems, night operations capability and
the ability to operate under severe weather conditions. We have received firm
orders for 76 AL-X aircraft and an additional 23 options from the Brazilian Air
Force. The first delivery of the AL-X was made to the Brazilian Air Force in
December 2003. These aircraft are expected to be used for advanced pilot
training and for defense operations in the Amazon region of Brazil in
connection with the Brazilian governments SIVAM (Sistema de Vigilância da
Amazônia, or System for the Surveillance of the Amazon) program. EMB 145 AEW&C; EMB 145 RS; EMB 145 MP We have configured a special version of the ERJ 145 with an advanced early
warning and control system to create the EMB 145 AEW&C, with ground remote
sensing capability to create the EMB 145 RS, and with marine 24




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remote sensing capability to create the EMB 145 MP. The EMB 145 AEW&Cs
advanced phased-array radar and mission system, developed by Ericsson, is
capable of conducting surveillance and providing air traffic control in support
of aviation authorities. The EMB 145 RS is designed to carry out ground
surveillance and environmental protection activities using advanced synthetic
aperture radar, capable of providing day/night and all weather images of the
ground over large areas, with multi-spectral sensors developed by
subcontractors in the United States. 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, and communications and other
surveillance equipment developed by Ericsson and ThalesTM. We, Ericsson and
ThalesTM are jointly marketing these aircraft worldwide. At December 31, 2003,
the Brazilian government had ordered a total of eight EMB 145 AEW&C/RS aircraft
to conduct surveillance and monitor ground activities in the Amazon region, all
of which were delivered as of such date. In October 1999, the Greek
government, through the Hellenic Air Force, ordered four EMB 145 AEW&C aircraft
that will be used in the Greek governments aerospace early warning and control
system, two of which were delivered in the first quarter of 2004. In February
2001, the Mexican government ordered one EMB 145 AEW&C aircraft and two EMB 145
MP aircraft. AM-X; AMX-T The AM-X is a subsonic ground attack and close air support aircraft
developed under an international cooperation agreement with Alenia Un Azienda
Finmecanica S.p.A. and Aermacchi Aeronautica Macchi S.p.A. and sponsored by the
Brazilian and Italian governments. Under the agreement, each of the parties is
responsible for key systems of the aircraft. The AM-X is assembled in both
Brazil and Italy. Embraer and the Italian partners supply each other with
different key components and systems of the aircraft. In addition, Embraer and
the Italian partners are each free to market the aircraft independently and
each receives 100% of the proceeds of its sales. Approximately 170 AM-X
aircraft are currently in operation in the air forces of Brazil and Italy, 55
of which were sold by us. We have also developed, with the participation of Alenia and Aermacchi,
the AMX-T, an enhanced version of the AM-X, currently being offered
internationally. The AMX-T program operates under the same principles as the
AM-X program, with the exception that Alenias role is greater than
Aermacchis, which participates only as a subcontractor. In September 1999, we
won the bid for a US$70.0 million contract for the sale of AMX-Ts to the
Venezuelan government. Authority Transport Aircraft We are marketing our Legacy line of corporate jets, modified to meet added
security needs, to the Brazilian and other governments. We entered into a
contract with the Belgian Air Force for two EMB 135s and two EMB 145s modified
to transport government officials, of which two EMB 135s and one EMB 145 were
delivered in 2001 and one EMB 145 was delivered in 2002. In 1999, we entered
into a contract with the Greek government through the Hellenic Air Force for
one EMB 135 aircraft for special transportation and support needs, which was
delivered in 2000, and one Legacy, which was delivered in 2002. In addition,
in 2003, Satena Airline, the state-owned Colombian airline, ordered two EMB
145s, which were delivered in December 2003 and January 2004. We also have a
contract with the Indian government for the sale of five Legacy aircraft in a
special configuration. Other Projects and Activities In December 2000, we were selected by the Brazilian government to perform
a structural and electronics upgrade of the Brazilian Air Forces F-5 fighter
jets. As the prime contractor, we are integrating multi-mode radar, advanced
navigation and attack systems and enhanced self-protection systems into the
existing aircraft under a program known as F-5BR. The first upgraded
aircraft was presented to the Brazilian Air Force in 2003. In March 2002, we formed a consortium with Dassault, ThalesTM and SNECMA
to bid on the development and manufacture of up to 24 fighter jets for the
Brazilian Air Force. The planned jet, the Mirage 2000 BR, is modeled on the
Dassault Mirage 2000-5 supersonic jet. As leaders of the consortium, we would
have coordination and management responsibilities in the program. As a result
of this consortium and as part of our strategic alliance 25




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agreement, Dassault would transfer to us the technology for the Mirage,
enabling us to have full control over the project technology as well. In July 2003, we joined a team organized by Lockheed Martin in a proposal
to supply the U.S. Army with a next-generation battlefield surveillance system
known as Aerial Common Sensor (ACS). If this bid is successful, we would
supply the airborne platform based on the ERJ/EMB 145 regional jet. The
platform would be produced at a facility in Jacksonville, Florida, the
establishment of which is dependent on the success of this bid. If
established, the Jacksonville facility would be exclusively for the assembly of
aircraft intended for the U.S. defense and national securities markets and
would qualify us as a supplier for U.S. government programs. Competition Our defense products face competition from various manufacturers, many of
which have greater financial, marketing and other resources than we do. The
Super Tucano and the AL-X compete with the Pilatus PC-9M and the Raytheon T-6A
Texan II. The EMB 145 AEW&C competes against the Northrop-Grumman E-2C II
Hawkeye 2000 and the Lockheed-Martin C-130J AEW&C. In addition, Boeing has
announced that it will develop the B737 AEW&C aircraft, with advanced warning
and remote sensor capabilities, which is expected to enter the market in 2005.
The AM-X/AMX-T competes with the British Aerospace Hawk-100, the Aermacchi
MB-339FD and the Aero Vodochody L-159. Corporate Jet Business We have developed a line of corporate jets, the Legacy, based on our ERJ
135 regional jet. We are marketing the new line of corporate jets to
businesses, including fractional ownership companies. Our corporate jet
business accounted for 8.2% of our net sales for the year ended December 31,
2003, resulting from the delivery of 13 Legacy jets, two of which were
delivered under operating leases. The Legacy was designed to provide customers with a cost-effective
alternative to commercial airline travel. We offer our line of corporate jets
in two versions: executive and corporate shuttle. The executive version
features a highly customized interior based on the customers specific
requirements. The corporate shuttle version is partially customized and is
generally intended to have business class type seating and in-flight office
design features. Both versions of our line of corporate jets have a maximum
cruising speed of Mach .8, or 470 knots. We developed our line of corporate jets 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 has the same components as the ERJ 135 and is capable
of being manufactured on the same production line. Furthermore, the corporate
shuttle version of the Legacy does not require separate FAA, European aviation
authority or Brazilian aviation authority approval. The executive version of
the Legacy was certified by the Brazilian aviation authority in December 2001,
by the JAA in July 2002 and by the FAA in August 2002. We face significant competition from companies with longer operating
histories and established reputations in the corporate jet industry. Many of
these manufacturers have greater financial, marketing and other resources than
we do. These competitors include Dassault Aviation, Cessna Aircraft Co.,
Bombardier Inc., Israel Aircraft Industries, General Dynamics and Raytheon. We take orders and build backlog for our line of corporate jets in the
same manner as for our commercial aircraft. We include an 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, three 5% progress payments
and full payment of the balance due upon delivery, in the same manner as for
our commercial aircraft. We generally receive US$100,000 for each option to
purchase a corporate jet, with the terms of the options being substantially the
same as those for our commercial aircraft. 26




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Other Related Businesses We also provide after-sales customer support services and manufacture and
market spare parts for the aircraft we produce. Activities in this segment
include the sale of spare parts, maintenance and repair, training and other
product support services, as well as revenues related to aircraft leased to
customers primarily through our leasing subsidiary. 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
aircraft and crop dusters, also known as light aircraft. Our other related
businesses accounted for 8.4% of our net sales for the year ended December 31,
2003. After-Sales Customer Support; Spare Parts Business We also provide after-sales customer support services and manufacture and
market spare parts for the fleets of our commercial, corporate and defense
customers. Our after-sales customer support and spare parts business falls
into several categories:  
    
    field support;
    
    material support, which includes spare parts sales and distribution;
    
    product warranty and repair administration;
    
    technical support, which includes engineering support,
maintenance engineering and technical publications; and
    
    training. This business is expected to continue to grow as the number of our
aircraft in service grows. Our customers require aircraft manufacturers and
their suppliers to maintain adequate spare parts and ground support equipment
inventories for a period of 10 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 recently established a pooling program
that allows customers to exchange used parts for new or refurbished parts. Subcontracting We provide subcontracting services to Sikorsky Corporation in connection
with the development and manufacture of the landing gear, fuel system and fuel
tanks for the S-92 Helibus helicopter. We also act as a risk-sharing partner
to Sikorsky. The contracts expire in 2015. General Aviation Aircraft We build general aviation propeller aircraft, also known as light
aircraft. These six-passenger aircraft are produced only on demand and are
used by corporations as executive aircraft and by air-taxi companies. At
December 31, 2003, we had delivered a total of 2,326 of these aircraft. We
also developed a crop duster aircraft pursuant to specifications of the
Brazilian Ministry of Agriculture. These aircraft are produced only on demand.
At December 31, 2003, we had delivered a total of 908 of these aircraft,
including 46 in 2003, and had 11 crop duster aircraft in backlog. Aircraft Operating Lease Activities We established a subsidiary in 2002, ECC Leasing Co. Ltd., or ECC,
responsible for managing and remarketing certain aircraft, such as pre-series
aircraft that are not otherwise sold after the completion of the certification
process for such aircraft type, aircraft that we may accept as a result of the
exercise by customers of repurchase, trade-in or trade-up options, and aircraft
that we may reacquire in connection with our financial 27




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guarantees. As of December 31, 2003, ECC and two other subsidiaries had a
total portfolio of 23 aircraft, 11 of which were under operating leases. Markets 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. Year ended December 31,2001
    
    2002
    
    2003(in millions of dollars)Commercial Airline:Americas (excluding Brazil)
    
    US$
    1,800.7
    
    
    US$
    1,772.2
    
    
    US$
    1,457.8Europe
    
    
    644.5
    
    
    
    290.5
    
    
    
    68.6Brazil
    
    
    18.1
    
    
    
    
    
    
    
    Other
    
    
    89.2
    
    
    
    47.6
    
    
    
    Total
    
    US$
    2,552.5
    
    
    US$
    2,110.3
    
    
    US$
    1,526.4CorporateAmericas (excluding Brazil)
    
    
    72.6
    
    
    
    86.6
    
    
    
    139.2Europe
    
    
    
    
    
    
    58.3
    
    
    
    36.2Total
    
    US$
    72.6
    
    
    US$
    144.9
    
    
    US$
    175.4DefenseAmericas (excluding Brazil)
    
    
    6.9
    
    
    
    13.3
    
    
    
    106.6Europe
    
    
    74.0
    
    
    
    73.5
    
    
    
    52.6Brazil
    
    
    43.1
    
    
    
    40.5
    
    
    
    102.5Other
    
    
    
    
    
    
    
    
    
    
    0.7Total
    
    US$
    124.0
    
    
    US$
    127.3
    
    
    US$
    262.4Other Related Business
    
    US$
    177.9
    
    
    US$
    143.3
    
    
    US$
    179.3
 Joint Ventures We entered into a joint venture with Liebherr International AG to develop
and manufacture landing gear and high precision hydraulic equipment and provide
related services for Embraer and other clients around the world. In connection
with this joint venture, we formed a new subsidiary, ELEB, to which we
transferred all of our landing gear manufacturing activities, the employees and
some liabilities related to those activities. On May 22, 2000, Liebherr
International AG, acting in coordination with its subsidiary, Liebherr
Aerospace Lindenberg GmbH, and through its Brazilian affiliate, purchased 40%
of the capital stock of ELEB. Liebherr-Aerospace SAS is our risk-sharing
partner responsible for designing, developing and manufacturing the landing
gear assemblies for the new EMBRAER 170/190 jet family. In addition, we entered into a joint venture in December 2002 with Harbin
Aircraft Industry (Group) Co., Ltd. and Hafai 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 licensed to the joint venture 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 in 2003. 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 in 2003. The roll-out for
the first ERJ 145 manufactured by the joint venture occurred in December 2003
and the joint venture entered into its first sales contract for sales to China
Southern Airlines in February 2004. 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 and our Legacy corporate aircraft, depending on
aircraft model, consist of materials and equipment purchased from our
risk-sharing partners and other major 28




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suppliers. We expect to purchase approximately the same percentage of
materials and equipment for the EMBRAER 170/190 jet family 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 corporate aircraft business, we rely on risk-sharing
partners to supply vital components of our aircraft, such as the engines,
hydraulic components, avionics, wings, sections of the fuselage and portions of
the tail. 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. 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:  
    
    Grupo Auxiliar Metalúrgico S.A., or Gamesa, a Spanish company
owned by Iberdrola S.A., a European power utility, and Banco Bilbao
Vizcaya, a large Spanish financial institution, supplies the wings,
engine nacelles and main landing-gear doors;
    
    Sonaca S.A.Société Nationale de Constructions Aerospatiales,
a Belgian company, supplies portions of the central and rear
fuselages, the service, main and baggage doors and engine pylons;
    
    ENAEREmpresa Nacional de Aeronáutica, a Chilean company,
supplies the vertical fin, horizontal stabilizers and elevators; and
    
    C&D Aerospace, Inc., a U.S. company, supplies the cabin and
cargo compartment interiors. Our risk-sharing partners generally receive payment for supplied
components within three to five months after delivery of the components to us.
The partnering relationship with these suppliers results in lower production
costs and higher product quality for the ERJ 145 regional jet family. In
addition, our line of corporate jets benefits from the risk-sharing
arrangements with Gamesa, Sonaca and ENAER. The interior of the executive
version of the Legacy is provided by The Nordam Group, Inc. and Duncan
Aviation, Inc. 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. 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. We have entered into purchase agreements with our major
suppliers, which cover our requirements for five to ten years of production.
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. 29




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EMBRAER 170/190 Jet Family We are continuing to develop the EMBRAER 170/190 jet family together with
risk-sharing partners that supply key systems for the aircraft. Our supplier
arrangements for the EMBRAER 170/190 jet family differ from the ERJ 145
regional jet family in that we use fewer suppliers. In the EMBRAER 170/190 jet
family, each risk-sharing partner is responsible for the development and
production of aircraft systems, such as the landing gear, the hydraulic system
and the flight control system, rather than individual components, and fewer
components are supplied by companies that are not risk-sharing partners. The
assumption of responsibility for systems by our risk-sharing partners lowers
our capital expenditures, which thereby decreases our development risks and
increases our operating efficiency by reducing the number of suppliers per
product and cutting production costs. It also shortens development and
production time. The primary risk-sharing partners for the EMBRAER 170/190 jet
family are the following:  
    
    General Electric supplies CF34-8E/l0E turbofan engines and
designs, develops and manufactures the engine nacelles;
    
    Honeywell supplies the avionics systems;
    
    Liebherr is responsible for designing, developing and manufacturing the landing gear assemblies;
    
    Kawasaki, a Japanese company, develops and manufactures the
aircraft wing stub, engine pylon, fixed landing and trailing edge
assemblies, flaps, spoilers and the wings flight control surfaces;
    
    Hamilton Sundstrand, a U.S. company and a wholly owned
subsidiary of United Technologies Corp., develops and produces the
aircrafts tail core, auxiliary power unit, electrical systems and
the air management system;
    
    Sonaca is responsible for the aircrafts wing slats;
    
    Gamesa is responsible for the rear fuselage and the vertical and horizontal tail surfaces;
    
    Latecoere, a French company, manufactures two of the three fuselage sections;
    
    C&D Aerospace designs, develops and manufactures the aircraft interior; and
    
    Grimes Aerospace Company, a U.S. company and a wholly owned
subsidiary of AlliedSignal Inc., develops and manufactures the
exterior and cockpit lighting. Our risk-sharing partners have contributed to us a total of US$244.3
million for the development of the EMBRAER 170/190 jet family as of December
31, 2003. Cash contributions become non-refundable upon the achievement of
certain developmental milestones. As of December 31, 2003, US$14.2 million of
these cash contributions had become non-refundable, and with the conclusion of
the certification of the EMBRAER 170 in February 2004 by the Brazilian, U.S.
and European authorities, an additional US$88.7 million of these cash
contributions became non-refundable. If we cancel the development and
production of any of the remaining aircraft in the EMBRAER 170/190 jet family
because we are unable to obtain certification or for other non-market related
reasons, we may be obligated to refund US$141.4 million of these cash
contributions. 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. Furthermore, 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. 30




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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. In March 2002, we established a distribution center in
Beijing, China, together with China Aviation Supplies Import and Export
Corporation (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 a maintenance, repair and overhaul facility, Embraer Aircraft
Maintenance Services, in Nashville, Tennessee. We provide full service
maintenance and repair services for our commercial and corporate aircraft at
this service center, enhancing our level of service to our customers in the
United States. 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 parts 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, Le Bourget, France, and Melbourne, Australia. We train pilots,
co-pilots, flight attendants and mechanics at these locations. We operate
advanced flight simulators for our ERJ 145 regional jet family and for the
Legacy at our Florida facility under an agreement with FlightSafety
International, Inc., a business specializing 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 operators
crew during the introduction of an aircraft into a customers regular routes.
We also provide technical publications with up-to-date technical information on
our aircraft. Aircraft Financing Arrangements We generally do not provide long-term financing directly to our customers.
We assist our customers in obtaining financing arrangements through different
sources such as leasing arrangements and the BNDES-eximprogram. In addition,
we help our customers qualify for the ProEx program. 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 in time for delivery. We have also provided guarantees for a portion
of the financing of aircraft for certain of our customers. See Notes 7, 8 and
34 to our consolidated financial statements. The BNDES-eximprogram, a Brazilian government-sponsored program, provides
our customers with direct financing for Brazilian exports of goods and
services. From 1996 through 2003, approximately 48% of the total value of our
export sales was financed by the BNDES-eximprogram. In addition to the BNDES-eximprogram, we also assist customers in their
aircraft financing through other arrangements, including leasing arrangements,
principally through leasing companies, U.S. leveraged leases, U.K. tax leases
and French tax leases. These arrangements accounted for approximately 52% of
the total value of our export sales from 1996 through 2003. Leasing
arrangements through leasing companies generally involve the purchase by a
leasing company of our aircraft under a customers purchase contract and the
lease of that aircraft to that customer. In leveraged leasing transactions, an
investor will borrow a portion of the aircraft purchase price from a third
party lender, which can also be BNDES-exim, purchase our aircraft and lease it
to our customer. See Note 8 to our consolidated financial statements. 31




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Our customers also benefit from the ProEx program, a Brazilian
government-sponsored program of interest rate adjustments. Under the ProEx
program, which is intended to offset Brazils country risk, foreign customers
that buy selected products made in Brazil, such as our aircraft, receive the
benefits of interest rate discounts. A substantial percentage of our customers
benefit from the ProEx program. See Item 3D. Risk FactorsRisks Relating to
Embraer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 for a discussion of
challenges to and pending negotiations regarding the ProEx program. Intellectual Property Our intellectual property, which includes designs, trade secrets, know-how
and trademarks, is important to our business. We hold trademarks over our name
and symbol, and the names of our aircraft, some of which are registered and
some of which are in the process of registration in a number of countries,
including Brazil, the United States, Canada, Singapore, Hong Kong, China and in
the European Union. At December 31, 2003, we had approximately 44 trademarks.
Our registered trademarks are generally renewed at the end of their validity
period, which usually runs from 10 years from the date of application for
registration. Brazil provides mechanisms to protect trademarks that are
similar to the federal registration systems available in the United States. 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, or DAC (Civil Aviation
Department), through the Centro Técnico Aeroespacial, or CTA (Aerospace
Technical Center) under the Ministry of Defense. The Brazilian Congress is
considering a proposed law to create a regulatory agency, Agência Nacional de
Aviação Civil, or ANAC (National Civil Aviation Agency), which, if approved,
will become the principal 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 European Union, or EU, countries and the
JAA for the other European countries. Some countries simply validate and
complement the Brazilian aviation authoritys 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. The ERJ 145 was certified to operate in the United States and Brazil in
the last quarter of 1996, in Europe in the second quarter of 1997, in Australia
in June 1998 and, for the LR version, in China in November 2000. The ERJ 145
XR version was certified by the Brazilian aviation authority in August 2002 and
by the FAA in October 2002. 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. The ERJ 140 was certified by the Brazilian
aviation authority in June 2001 and by the FAA in July 2001. The executive
version of the Legacy was certified by the Brazilian aviation authority in
December 2001, by the JAA in July 2002 and by the FAA in August 2002. The
EMBRAER 170 was certified by the Brazilian aviation authority, the FAA, EASA,
the JAA and the authority of Poland in February 2004. Once an aircraft is certified by the CTA 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 is 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 JAAs recommendations for
issuance of EASA type certificates for aircraft. 32




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Aircraft
certification is an ongoing process. Any change in the
design of any of our aircraft must be approved by the Brazilian 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. 4C. Organizational Structure 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 has been filed as Exhibit 8.1 to this annual
report. 4D. Property, Plants and Equipment We own our headquarters and plant, located in São José dos Campos.
Significant portions of our facilities in São José dos Campos are subject to
mortgages held by BNDES. We lease, own or have the right to use the following
properties: Approximatesquare
    
    Owned/
    
    LeaseLocation
    
    Purpose
    
    footage
    
    Leased
    
    ExpirationSão José
 dos Campos, SP, Brazil
    
    Headquarters, principal manufacturing facility and support center
    
    
    5,902,102
    
    
    Owned
    
    
    São José dos Campos, SP, Brazil
(Eugênio de Mello)
    
    Manufacturing facility
    
    
    3,658,884
    
    
    Owned
    
    
    Botucatu, SP, Brazil
    
    Manufacturing facility
    
    
    222,000
    
    
    Owned
    
    
    Harbin, China
    
    Manufacturing facility
    
    
    258,067
    
    
    Owned*
    
    
    Gavião Peixoto, SP, Brazil
    
    Testing and manufacturing facilities
    
    
    191,648,512
    
    
    **
    
    
    São Paulo, SP, Brazil
    
    Administrative offices
    
    
    5,245
    
    
    Leased
    
    
    2007Ft. Lauderdale, Florida, U.S.A.
    
    Support center
    
    
    91,500
    
    
    Leased
    
    
    2020West Palm Beach, Florida, U.S.A.
    
    Engineering offices
    
    
    16,800
    
    
    Leased
    
    
    2005Nashville, Tennessee, U.S.A.
    
    Aircraft maintenanceand support center
    
    
    125,260
    
    
    Leased
    
    
    2018Le Bourget, France
    
    Support center
    
    
    33,500
    
    
    Leased
    
    
    2008Melbourne, Australia
    
    Support center
    
    
    12,126
    
    
    Leased
    
    
    2004Beijing, China
    
    Representative offices
    
    
    1,709
    
    
    Leased
    
    
    2004Singapore
    
    Representative offices
    
    
    2,239
    
    
    Leased
    
    
    2004
   *
    
    Land owned pursuant to a land use rights certificate.**
    
    We currently have a temporary authorization from the State of São
Paulo to use the land and expect to receive a concession for the land
as soon as legal formalities are satisfied. The facilities are owned
by Embraer. Production 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 pre-fabricated parts. The
primary parts are then joined, or mated, with one another to produce the
aircrafts major components, which are in turn joined to create the aircrafts
basic structure. In the final assembly stage, the aircrafts various operating
systems (such as wiring and electronics) are installed into the structure and
tested. 33




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Production facilities for our commercial, corporate and defense aircraft
are located in São José dos Campos in the State of São Paulo, Brazil. We
reduced the aircraft production time of our regional jet aircraft from eight
months in 1996 to 3.4 months in 2003. From December 31, 1999 to December 31,
2000, we increased our production rate from 12 to 16 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 2003, decreased it further to nine aircraft per month. We
have the flexibility to increase production in the future in response to
increased demand. We build the EMB 120 Brasília according to market demand and
adjust production accordingly. To accommodate our production of the ERJ 145
regional jet family and our EMBRAER 170/190 jet family, as well as any
production of the line of corporate 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 and corporate aircraft. As of December 31, 2003, we had
invested US$43.9 million in the construction of this new facility. This
facility has been operational since November 2002 and consists of a runway and
other features to handle our development of supersonic aircraft technology. We
are also conducting our flight tests for the EMBRAER 170/190 jet family at this
facility. In addition, we are constructing a corporate jet furniture factory
in Gavião Peixoto for the production of the interior of our Legacy corporate
jet. We expect this facility to be fully operational by July 2004. In September 2000, we purchased a new facility in São José dos Campos in
the State of São Paulo, Brazil, where we currently manufacture small parts and
components for our aircraft. Our China joint venture has constructed a
production facility for the ERJ 145 jet family in Harbin, China. Environmental Matters Most environmental regulation in Brazil is established at the state rather
than at the federal or municipal level, with environmental authorities in most
states granting operating permits to individual facilities rather that through
general regulations. We have all material permits required to operate our
business. The terms of these operating permits are reviewed every year and we
are in compliance with our permits. In addition, we adhere internally to
international ISO 14000 environmental standards. In 2001, 2002 and 2003, we
invested US$1.1 million, US$1.0 million and US$1.7 million, respectively, in
environmental matters and we expect to spend approximately US$2.1 million on
environmental matters in 2004 for expenditures relating to the portion of
construction of new facilities and modification of existing facilities relating
to environmental compliance and improvements. Insurance We insure all of our plants and equipment for loss and replacement. We
also carry insurance to cover all potential damages to our own fleet of
aircraft, including those occurring during commercial and demonstration
flights. In addition, we maintain a comprehensive aviation products liability
policy, which covers damages arising out of the manufacture, distribution, sale
and servicing of our aircraft and parts. We have been increasing our coverage
for aviation products liability as our fleet has grown. 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$50.0 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. 34




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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS This discussion should be read in conjunction with our 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 Comissão de Valores
Mobilários, or CVM, the Brazilian securities commission, 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 Corporate Law. 5A. Operating Results Current Conditions and Future Trends in the Airline Industry The commercial aviation industry has been negatively impacted by a number
of factors beginning in 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 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. As a result, we agreed to
modify certain delivery schedules to adjust to the changes in our customers
businesses and reduced scheduled commercial airline, corporate jet and
government transportation aircraft deliveries. In 2002, we reduced our
delivery schedule to 131 aircraft as compared to planned 2002 deliveries of 205
at August 31, 2001. We also reduced our 2003 scheduled deliveries from 148
aircraft originally planned to 101 actual deliveries. We have also
re-evaluated our risk exposure related to aircraft valuations and customer
credit risk, which resulted in charges to income. Although the U.S. and world
economies have begun to recover in 2004, many airlines continue to face weak
demand, escalating insurance costs, increased security costs, credit
downgrades, liquidity concerns and bankruptcy, and, more recently, sharply
higher fuel costs. A further downturn in general economic conditions could
result in further reduction in the passenger aircraft market and decreased
orders for our commercial aircraft. See Item 3D. Risk FactorsRisks Relating
to EmbraerA downturn in the commercial airline market may reduce our sales and
revenue, and consequently our profitability, in any given year. We believe that the recent volatility in demand for air travel has
demonstrated the demand to match aircraft capacity to market demand more
accurately. Similarly, we believe there is the need for aircraft that can be
deployed strategically across a full range of seat capacities. As airlines act
to right-size their fleets to serve these needs, equipment distribution in
fleets around the world will change. We expect this equipment distribution to
take advantage of new and existing products in the 30-120 seat category. We
believe that the 30-60, 61-90 and 91-120 seat segments will play important but
different roles. We currently believe:  
    
    airlines will continue to deploy 30-60 seat aircraft to
expand hub areas, increase frequencies, explore new market
opportunities, stimulate demand, develop secondary hubs, replace
turboprops and fly non-stop, point-to-point routes;
    
    the 61-90 seat segment will allow airlines to add capacity in
markets where the natural growth of regional jet routes requires
larger jets. Aircraft in this seat segment will also help airlines
to right-size their mainline fleets by diminishing the need to
operate larger jets on routes with an excess of passenger demand;
and 35




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
    
    the 91-120 seat segment will benefit those markets currently
being served by old, over-sized or inefficient jet fleets and will
relieve higher-capacity aircraft to serve large-market, high-volume
city pairs over longer routes. We also believe that aircraft retirement will impact future fleet
composition. We estimate that during the next 20 years, nearly 2,000 aircraft
in the 30-120 seat segment are scheduled to be retired. Among existing
aircraft in the 61-90 seat segment, we estimate that 63% will be out of service
by 2023. Similarly, we estimate that 85% of the aircraft in the 91-120 seat
segment will be retired during the same period. We expect that in the near future deliveries will be evenly distributed
among the three seat categories with North America maintaining the greatest
share of total deliveries, followed by Europe. We also believe that Latin America, which has the oldest jet fleet,
represents a potential replacement opportunity for our products. We expect low-fare airlines, which traditionally have focused on short-
and medium-haul routes and which have been relatively successful during the
recent industry downturn, to continue to expand their market penetration in the
low-density and low-capacity markets independently of alliances. We believe
that the mid-capacity jets will be an important tool for these low-fare
airlines in their expansion efforts. Brazilian Economic Environment The recent events negatively affecting the commercial aviation industry
and the ensuing negative effects on the U.S. economy have also adversely
affected the global and Brazilian economies and securities markets, and have
resulted in:  
    
    increased volatility in the market price of securities;
    
    significant decline in corporate earnings estimates;
    
    substantial losses in important industries, including the air transport and insurance industries; and
    
    significant erosion of consumer confidence. As discussed below, the uncertainty surrounding the U.S., Brazilian and
global economies could in turn lead to 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 economy has been characterized by frequent and occasionally
drastic intervention by the Brazilian government and by volatile economic
cycles. The Brazilian government has often changed monetary, taxation, credit,
tariff and other policies to influence the course of Brazils economy. For
example, the Brazilian government has the authority, when a serious imbalance
in Brazils balance of payments occurs, to impose restrictions on the
remittance to foreign investors of the proceeds of their investments in Brazil
and on the conversion of Brazilian currency into foreign currencies. Changes
in monetary, taxation, 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, as
well as the Brazilian governments response to such developments. See Item
3D. Risk FactorsRisks Relating to Brazil. Rapid changes in Brazilian political and economic conditions that have
occurred and may occur in the future will require continued emphasis on
assessing the risks associated with our activities and adjusting 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. See Item 3D. Risk Factors  Risks Relating to Brazil. 36




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Brazilian economic conditions may also be negatively affected by economic
and political conditions elsewhere, particularly in other South American and
emerging market countries. Although economic conditions are different in each
country, the reaction of investors in one country may cause the capital markets
in other countries to fluctuate. Developments or conditions on other emerging
market countries 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. For example, since 1999, the Argentine economy has been in a recession
marked by reduced levels of consumption and investment, increasing unemployment
and declining gross domestic product. During late 2001, Argentine depositors
withdrew their money from banks and sought to remit such funds abroad. In
early December 2001, the government restricted the rights of such depositors to
withdraw their funds. The economic crisis gave rise to increasing political
instability and eventually led to the announcement by Argentina that it would
impose a moratorium on the payment of its foreign debt. On January 3, 2002,
Argentina formally defaulted on debt held by certain foreign creditors. On
January 7, 2002, Argentina announced that it was devaluing its peso by 29%,
ending the pesos decade-old one-to-one peg with the U.S. dollar. In 2002, the
Argentine peso experienced a devaluation of over 200% against the U.S. dollar.
Although the Argentinean economic scenario has improved during 2003, the
political and economic crises in Argentina have negatively affected investors
perceptions of risks in Brazil. The recent political crisis in Venezuela has also influenced investors
perception of risk in Brazil. Although market concerns that similar crises
would ensue in Brazil have not become a reality to date, the volatility in
market prices for Brazilian securities increased in 2001 and 2002. Instability
in the Brazilian financial markets caused by the Argentine and Venezuelan
crises and other developments in the international financial markets, including
the deterioration of worldwide market conditions caused by the war in Iraq, may
adversely affect our financial condition and, specifically, our ability to
raise capital when needed and the market price of the preferred shares and
ADSs. The Brazilian government has also proposed a broad tax reform in Brazil,
mainly designed to reduce the public deficit through the increase in tax
collection. It is anticipated that the reform will include the creation of a
value-added tax on goods and services that would replace six existing taxes
(including contribution for social purposes, the federal tax on industrial
products and the state tax on circulation of goods and services). In addition,
the Contribuição Provisória sobre Movimentação Financeira-CPMF, a provisional
levy on checking account transactions, would be replaced by a permanent federal
tax on financial transfers. We may have a higher tax burden if the tax reform
bill is approved and implemented. Effects of Inflation and Currency Exchange Fluctuations Until July 1994, Brazil had for many years experienced 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, Brazilian inflation as measured by the General Market Index and
published annually by Fundação Getúlio Vargas and the devaluation 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 year: 1999
    
    2000
    
    2001
    
    2002
    
    2003Inflation (General Market
Price Index)
    
    
    20.1
    %
    
    
    9.9
    %
    
    
    10.4
    %
    
    
    25.3
    %
    
    
    8.7
    %Devaluation (appreciation)
(R$ vs. US$)
    
    
    48.0
    %
    
    
    9.3
    %
    
    
    18.7
    %
    
    
    52.3
    %
    
    
    (18.2
    )%
 Inflation and exchange rate variations have had, and may continue to have,
substantial effects on our financial condition and results of operations. Inflation and exchange rate variations affect our monetary assets and
liabilities denominated in reais. The value of such assets and liabilities as
expressed in U.S. dollars declines when the realdevalues against the U.S.
dollar and increases when the realappreciates. 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. 37




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Finally, because revenues in our defense business were historically
denominated principally in reais, while our costs for materials for this
segment were principally denominated in U.S. dollars, devaluation of the real
adversely affected margins in our defense business. However, because our
defense business has become more international, revenues have principally been
denominated in U.S. dollars over the last three years. As a consequence, our
exposure to exchange rate variations has been reduced to only 20% of our total
defense sales in 2002, compared to 30% in 2001 and 2002. In addition, some of
our real-denominated defense contracts have been adjusted to reflect the
effects of both Brazilian inflation and R$/US$ exchange rate variations, which
has the effect of further decreasing the exposure of our defense business to
devaluation of the real. Critical Accounting Estimates 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 portrayal of our financial condition and results of
operation often requires our management 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
consolidated financial statements includes a summary of the significant
accounting policies and methods used 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 generally recognize sales of our commercial and corporate aircraft as
deliveries are made. In our defense aircraft segment, we perform work under
long-term development contracts for the Brazilian government and other
governments, and we recognize revenue in accordance with the percentage of
completion method. Revenue recognized under this method is based on actual
costs incurred and an estimate of the total remaining costs to be incurred
prior to completion of the contract. Certain contracts contain provisions for
the redetermination of price based upon future economic conditions.
Anticipated losses, if any, under these contracts are accrued when known and
are recorded based on managements estimate of such losses. Product Warranties Generally, aircraft sales are accompanied by a standard warranty for
systems, accessories, equipment, parts and software manufactured by us. We
recognize warranty expense, as a component of selling expenses, at the time of
sale based on the estimated amounts of warranty costs expected to be incurred,
which are typically expressed as a percentage of the sales price of the
aircraft. 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. The warranty period ranges from
two years for spare parts to five years for components that are a part of the
aircraft when sold. We have provided guarantees of specified minimum levels of aircraft
performance based on pre-determined operational targets. Costs resulting from
a failure to meet these targets cannot be established until after delivery of
the aircraft. In the event that these target levels are not met, we may be
obligated to pay amounts to the affected customers as reimbursement for their
incremental operating or service costs. Losses related to such performance
guarantees are recorded at the time they are known, or when circumstances
indicate that the aircraft is not expected to meet the minimum performance
requirements, based on managements estimate of our ultimate obligation under
the guarantee. In some cases, we may also be obligated to make modifications
after aircraft delivery due to improvement or performance of aircraft. The
costs related to these modifications are accrued when known. Guarantees, Repurchase Commitments and Trade-In and Trade-Up Rights We have provided sales incentives in the form of financial and residual
value guarantees, repurchase commitments and trade-in and trade-up rights
related to our aircraft. We review the value of these commitments relative to
the aircrafts anticipated future fair value and, in the case of financial
guarantees, the creditworthiness of 38




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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 of Interpretation No. 45, or FIN 45, Guarantors
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 under financial guarantees may differ from the amounts recognized
on our balance sheet, and, consequently, could negatively affect future
operating results. During 2003, we do not believe that the fair value of the
guarantees we recorded was material. Overview Basis of Presentation The consolidated financial statements have been prepared in accordance
with U.S. GAAP. See Introduction  Presentation of Financial and Other Data
 Financial Data for a discussion of factors affecting our financial data. Operating Data 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. At December 31,2001
    
    2002
    
    2003Commercial AirlineDeliveriesERJ 145
    
    
    104
    
    
    
    82
    
    
    
    57ERJ 135
    
    
    27
    
    
    
    3
    
    
    
    14ERJ 140
    
    
    22
    
    
    
    36
    
    
    
    16EMB 120 Brasília
    
    
    2
    
    
    
    
    
    
    
    DefenseDeliveries
    
    
    3
    
    
    
    7
    
    
    
    4CorporateDeliveries (1)
    
    
    5
    
    
    
    8
    
    
    
    13Other Operating InformationTotal backlog (in millions)(2)
    
    US$
    10,693
    
    
    US$
    9,034
    
    
    US$
    10,591
   (1)
    
    Of the 13 corporate deliveries in 2003, two were delivered under
operating leases.(2)
    
    Since December 31, 2003, we received 22 additional firm orders for
our ERJ 145 regional jet family and 28 additional firm orders for our
EMBRAER 170/190 jet family. Net Sales 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 corporate jets. Net sales of commercial and corporate aircraft are
denominated in U.S. dollars. Of defense net sales, sales to the Brazilian
government are partially indexed to the U.S. dollar and accounted for 39.3% in
2003. Finally, we generate revenue from our other related businesses, which 39




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include after-sales support (including the sale of spare parts,
maintenance and repair, training and other product support services), 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
corporate 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 and corporate 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. 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 customer advances as a
liability on our balance sheet and, when we deliver the aircraft, these
payments are recorded as net sales. As a result of a decrease in the amounts available under the ProEx program
in 1999, we assisted some of our affected customers in restructuring their
financing arrangements. In cases in which we were not able to restructure
these arrangements, we provided special price adjustments to these customers to
maintain the effective interest rates in their original financing arrangements. Our sales contracts with our customers typically include adjustments to
the purchase price of the aircraft based on an escalation formula which
reflects, in part, inflation in the United States. The deposits, progress
payments and option payments are generally non-refundable. 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
funding of the research and development for specific programs, in accordance
with the percentage of completion method. Certain contracts contain provisions
for the redetermination of price based upon future economic conditions. Our
defense customers continue to provide customer advances, which are converted
into revenue as we achieve pre-determined stages of completion of the project,
such as conception, development and design, and engineering, systems
integration and customization. These installments are generally
non-refundable. Cost of Sales and Services Our cost of sales and services consists primarily of:  
    
    Material These costs are primarily U.S.
dollar-denominated. Substantially all of our materials costs are
covered by contracts with our suppliers. Prices under these
contracts are generally adjusted based on an escalation formula
which reflects, in part, inflation in the United States.  
    
    Labor These costs are primarily real-denominated.  
    
    Depreciation We depreciate our property, plant and
equipment over their useful lives, ranging from five to 48 years, on
a straight line basis. On average, our property, plant and
equipment is depreciated over 13 years. Recent Developments On May 14, 2004, we announced our unaudited financial results for the
first quarter of 2004. We delivered 23 aircraft, including the first eight
EMBRAER 170 aircraft, during this period, the same total number of aircraft as
were delivered in the first quarter of 2003. Our net sales for the quarter were US$626.2 million, an increase of 28.1%
compared to the same period in 2003. Commercial airline net sales increased
13.8%, from US$389.3 million in the first quarter of 2003 to US$443.2 million
in the first quarter of 2004, due to the first deliveries of the EMBRAER 170,
which has a higher average sales price than the aircraft in the ERJ 145 jet
family. Defense segment net sales increased 136.8%, from 40




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US$55.2 million in the first quarter of 2003 to US$130.7 in the first
quarter of 2004, due the recognition of revenues related to the Mexican and
Greek government programs as well as Brazilian government programs for the EMB
AEW&C and the F-5. Other related business segment net sales increased 80.3%
from US$29.0 million in the first quarter of 2003 to US$52.3 million in the
first quarter of 2004. We did not recognize any sales in our corporate segment
during the quarter. Costs of sales and services for the quarter totaled US$424.2 million,
compared to US$294.7 million in the first quarter of 2003, resulting in a gross
margin of 32.3%, compared to 39.7% in the first quarter of 2003. Gross margin
decreased as a result of the costs associated with the commencement of the
production of the EMBRAER 170, eight of which were delivered in the first
quarter of 2004, and the 1.2% negative impact of the reassessment of future
costs related to certain defense contracts, for which costs are recognized
under the percentage of completion method. Operating expenses for the first quarter of 2004 were US$49.0 million, a
decrease of 55.9% compared to the first quarter of 2003. This decrease was
mainly due to the recognition as operating income of US$88.7 million in
payments received from our risk-sharing partners as a result of the achievement
of certain EMBRAER 170/190 jet family development contractual milestones. As a result, our net income for the first quarter of 2004 was US$103.3
million, compared to US$44.0 million in the first quarter of 2003. Net income
as a percentage of net sales was 16.5%, compared to 9.0% in the first quarter
of 2003. Results of Operations The following table presents income statement data by business segment. Summary Financial Data by Business Operating incomeYear ended December 31,2001
    
    2002
    
    2003(in millions of dollars)Net sales:Commercial Airline
    
    US$
    2,552.5
    
    
    US$
    2,110.3
    
    
    US$
    1,526.4Defense
    
    
    124.0
    
    
    
    127.3
    
    
    
    262.4Corporate
    
    
    72.6
    
    
    
    144.9
    
    
    
    175.4Other related businesses
    
    
    177.9
    
    
    
    143.3
    
    
    
    179.32,927.0
    
    
    
    2,525.8
    
    
    
    2,143.5Cost of sales and services:Commercial Airline
    
    
    (1,536.8
    )
    
    
    (1,243.9
    )
    
    
    (924.9
    )Defense
    
    
    (105.2
    )
    
    
    (79.5
    )
    
    
    (205.8
    )Corporate
    
    
    (47.0
    )
    
    
    (104.6
    )
    
    
    (124.4
    )Other related businesses
    
    
    (80.2
    )
    
    
    (103.7
    )
    
    
    (79.9
    )(1,769.2
    )
    
    
    (1,531.7
    )
    
    
    (1,335.0
    )Gross profit:Commercial Airline
    
    
    1,015.7
    
    
    
    866.4
    
    
    
    601.5Defense
    
    
    18.8
    
    
    
    47.8
    
    
    
    56.6Corporate
    
    
    25.6
    
    
    
    40.3
    
    
    
    51.0Other related businesses
    
    
    97.7
    
    
    
    39.6
    
    
    
    99.41,157.8
    
    
    
    994.1
    
    
    
    808.5Operating expenses:Commercial Airline
    
    
    (258.6
    )
    
    
    (335.6
    )
    
    
    (345.7
    )Defense
    
    
    (23.4
    )
    
    
    (15.7
    )
    
    
    (15.7
    )Corporate
    
    
    (9.3
    )
    
    
    (28.4
    )
    
    
    (38.6
    )Other related businesses
    
    
    (61.4
    )
    
    
    (31.2
    )
    
    
    (34.1
    )Unallocated corporate expenses
    
    
    (153.7
    )
    
    
    (113.6
    )
    
    
    (109.6
    )(506.4
    )
    
    
    (524.5
    )
    
    
    (543.7
    )Income from operations
    
    US$
    651.4
    
    
    US$
    469.6
    
    
    US$
    264.8
 41




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The following table sets forth income statement information, and such
information as a percentage of our net sales, for the periods indicated. Year ended December 31,2001
    
    2002
    
    2003(in millions of dollars, except percentages)Net sales
    
    US$
    2,927.0
    
    
    
    100.0
    %
    
    US$
    2,525.8
    
    
    
    100.0
    %
    
    US$
    2,143.4
    
    
    
    100.0
    %Cost of sales and services
    
    
    (1,769.2
    )
    
    
    60.4
    
    
    
    (1,531.7
    )
    
    
    60.6
    
    
    
    (1,335.0
    )
    
    
    62.3Gross profit
    
    
    1,157.8
    
    
    
    39.6
    
    
    
    994.1
    
    
    
    39.4
    
    
    
    808.4
    
    
    
    37.7Operating expenseSelling expenses
    
    
    (212.1
    )
    
    
    7.2
    
    
    
    (211.0
    )
    
    
    8.4
    
    
    
    (206.2
    )
    
    
    9.6Research and development
    
    
    (99.6
    )
    
    
    3.4
    
    
    
    (158.5
    )
    
    
    6.3
    
    
    
    (173.2
    )
    
    
    8.1General and administrative
    
    
    (120.8
    )
    
    
    4.1
    
    
    
    (109.7
    )
    
    
    4.3
    
    
    
    (114.7
    )
    
    
    5.3Employee profit sharing
    
    
    (43.7
    )
    
    
    1.5
    
    
    
    (25.2
    )
    
    
    1.0
    
    
    
    (20.4
    )
    
    
    1.0Other operating expenses, net
    
    
    (30.5
    )
    
    
    1.1
    
    
    
    (20.5
    )
    
    
    0.8
    
    
    
    (29.1
    )
    
    
    1.4Equity on income (loss) from affiliates
    
    
    0.3
    
    
    
    
    
    
    
    0.4
    
    
    
    
    
    
    
    
    
    
    
    Income from operations
    
    
    651.4
    
    
    
    22.3
    
    
    
    469.6
    
    
    
    18.6
    
    
    
    264.8
    
    
    
    12.3Non-operating income (expense)Interest income (expense)
    
    
    47.5
    
    
    
    1.6
    
    
    
    80.5
    
    
    
    3.2
    
    
    
    (140.8
    )
    
    
    6.6Foreign exchange loss, net
    
    
    (148.6
    )
    
    
    5.1
    
    
    
    (135.6
    )
    
    
    5.4
    
    
    
    (16.5
    )
    
    
    0.8Other non-operating income (expense),
net
    
    
    (8.5
    )
    
    
    0.3
    
    
    
    (1.5
    )
    
    
    
    
    
    
    0.7
    
    
    
    Income before income taxes
    
    
    541.8
    
    
    
    18.5
    
    
    
    413.0
    
    
    
    16.4
    
    
    
    108.2
    
    
    
    5.0Income tax
benefit (expense)
    
    
    (218.4
    )
    
    
    7.5
    
    
    
    (188.5
    )
    
    
    7.5
    
    
    
    28.0
    
    
    
    1.3Income before minority interest
    
    
    323.4
    
    
    
    11.0
    
    
    
    224.5
    
    
    
    8.9
    
    
    
    136.2
    
    
    
    6.3Minority interest
    
    
    (0.4
    )
    
    
    
    
    
    
    (1.9
    )
    
    
    0.1
    
    
    
    (0.2
    )
    
    
    Income before cumulative effect of
accounting change
    
    
    323.0
    
    
    
    11.0
    
    
    
    222.6
    
    
    
    8.8
    
    
    
    136.0
    
    
    
    6.3Cumulative effect of accounting
change, net of tax
    
    
    5.4
    
    
    
    0.2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income
    
    US$
    328.4
    
    
    
    11.2
    %
    
    US$
    222.6
    
    
    
    8.8
    %
    
    US$
    136.0
    
    
    
    6.3
    %
 2003 Compared with 2002 Net sales.Net sales decreased 15.1% from US$2,525.8 million in 2002 to
US$2,143.4 million in 2003. Net sales in the commercial airline segment
decreased 27.7% from US$2,110.3 million in 2002 to US$1,526.4 in 2003. Defense
net sales increased 106.1% from US$127.3 million in 2002 to US$262.4 million in
2003. Corporate net sales increased 21.0% from US$144.9 million in 2002 to
US$175.4 million in 2003. Net sales from other related businesses increased
25.1% from US$143.3 million in 2002 to US$179.3 million in 2003. The decrease in commercial airline sales is primarily due to fewer
aircraft deliveries to the commercial airline market in 2003 as a consequence
of the continuing worldwide airline crisis. The increase in corporate net
sales resulted from increased deliveries of the Legacy in 2003. The increase
in net sales from other related businesses is mainly due to an increase in
sales of spare parts, as a result of an increase in aircraft in service,
partially offset by our customers continued cost cutting measures, as well as
an increase in sales revenues related to operating leases. The increase in
defense net sales is primarily due to the recognition of sales under the
Mexican 42




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and Greek government programs for the EMB 145 and AEW&C, and under the
Brazilian governments programs for the EMB 145AEW&C, ALX and F-5. Cost of sales and services.Cost of sales and services decreased 12.8%
from US$1,531.7 million in 2002 to US$1,335.0 million in 2003, due to the
reduction in number of aircraft delivered to the commercial airline market
during 2003, partially offset by an increase in costs in the defense and
corporate segments. Cost of sales and services as a percentage of net sales
increased slightly to 62.3% in 2003, compared to 60.6% in 2002. Gross profit.Our gross profit decreased 18.7% from US$994.1 million in
2002 to US$808.4 million in 2003, primarily as a result of the reduction in
deliveries in the commercial airline market. As a result of the decline in
cost of sales and services, our gross margin decreased from 39.4% in 2002 to
37.7% in 2003. Operating expenses.Operating expenses increased by 3.6% from US$524.5
million in 2002 to US$543.6 million in 2003. This increase was attributable
primarily to an increase of 9.2% in research and development from US$158.5
million in 2002 to US$173.2 million in 2003, principally related to higher
development costs for the EMBRAER 170/190, which is approaching the later
stages of development, and to improvements to our corporate jets. Research and
development is presented net of contributions from suppliers, which are earned
based on meeting specified milestones. In 2003, selling expenses were relatively stable as compared to 2002. As
a percentage of net sales, selling expenses increased from 8.4% in 2002 to 9.6%
in 2003 despite lower deliveries, due to an increase in the non-cash charge
related to financial guarantees of US$26.2 million and an increase of US$12.6
million related to salaries and benefits attributable to the new commercial
aircraft sales force structure created to support the EMBRAER 170/190, offset
by a decrease of US$23.9 million in our provision for product warranties, as
well as a US$31.2 million decrease in customer training and technical
assistance expenses. The increase of US$26.2 million in our non-cash charge
was caused by the effect of the economic downturn in the airline industry on
our risk analysis of financial guarantees. General and administrative expenses increased 4.6% from US$109.7 million
in 2002 to US$114.7 million in 2003, due to the effects on the real-denominated
portion of this item resulting from the 18.2% appreciation of the realduring
2003, offset by a 19.1% decrease in profit sharing related to the reduction in
net income and dividends. Other operating expense, net, increased US$8.6
million, due to an expense of US$10.1 million primarily related to an expense
associated with a repossession of certain aircraft intended for Indigo, which
had its contract cancelled in August 2003. Operating expenses as a percentage of net sales increased from 20.8% in
2002 to 25.4% in 2003, primarily as a result of the decrease in net sales
combined with the increases in research and development expenses as well as the
non-cash charge for guarantees and the expenses associated with the
repossession. Interest income (expense), net.Interest income (expense), net, decreased
from US$80.5 million in 2002 to an expense of US$140.8 million in 2003, despite
higher average cash balances available in 2003, primarily related to losses of
US$99.5 million on derivative financial transactions and a US$25.9 million
expense related to net monetary and exchange variations due to the effects of
the appreciation of the realon net liabilities in foreign currency, primarily
taxes and social charges in dispute. See Notes 16 and 20 to our consolidated
financial statements. Foreign exchange (loss), net. Foreign exchange loss, net, decreased from
US$135.6 million in 2002 to US$16.5 million in 2003. These amounts reflect the
remeasurement of non-U.S. dollar-denominated assets and liabilities into U.S.
dollars and the decrease in net assets denominated in reais, partially offset
by a higher rate of appreciation of the reaisin 2003. Income tax benefit (expense).Income tax decreased from a provision of
US$188.5 million in 2002 to a benefit of US$28.0 million in 2003 as a result of
a US$22.9 million benefit from payments of interest attributed to shareholders
equity and a US$49.7 million benefit related to foreign exchange gain/loss on
translation to U.S. dollars, which, in accordance with U.S. GAAP, is our
functional currency. Our statutory tax rate in 2002 and 2003 was 34%. 43




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Net income.As a result of the foregoing factors, our net income
decreased 38.9% from US$222.6 million in 2002 to US$136.0 million in 2003. Net
income decreased as a percentage of net sales. In 2003, net income was 6.3% of
net sales as compared to 8.8% in 2002. 2002 Compared with 2001 Net sales.Net sales decreased 13.7% from US$2,927.0 million in 2001 to
US$2,525.8 million in 2002. Commercial airline net sales decreased 17.3% from
US$2,552.5 million in 2001 to US$2,110.3 million in 2002. Defense net sales
increased 2.7% from US$124.0 million in 2001 to US$127.3 million in 2002.
Corporate net sales increased 99.6% from US$72.6 million in 2001 to US$144.9
million in 2002. Net sales from other related businesses decreased 19.4% from
US$177.9 million in 2001 to US$143.4 million in 2002. The decrease in commercial airline sales is primarily due to the
rescheduling of customer deliveries from 2002 to 2003 and thereafter, partially
offset by a better product mix and a higher average unit price. The increase
in corporate net sales resulted from the start of deliveries of the Legacy at
the end of 2001. The decrease in net sales from other related businesses is
mainly due to a decrease in sales of spare parts, despite an increase in
aircraft in service, due to the economic downturn and our customers cost
cutting measures. Cost of sales and services.Cost of sales and services decreased 13.4%
from US$1,769.2 million in 2001 to US$1,531.7 million in 2002, principally due
to the reduction in number of aircraft delivered during 2002. Cost of sales
and services as a percentage of net sales was relatively stable at 60.6% in
2002, in comparison to 60.4% in 2001. Gross profit.Our gross profit decreased 14.1% from US$1,157.8 million in
2001 to US$994.1 million in 2002, primarily as a result of the reduction in
deliveries in the commercial airline market. As a result of the decline in
cost of sales and services, our gross margin remained relatively stable at
39.6% in 2001 compared to 39.4% in 2002. Operating expenses.Operating expenses increased 3.6% from US$506.4
million in 2001 to US$524.5 million in 2002. This increase was attributable
primarily to an increase of 59.1% in research and development from US$99.6
million in 2001 to US$158.5 million in 2002, principally related to higher
development costs for the EMBRAER 170/190 and the new versions of our regional
and corporate jets as we approach the later stages of development. Research
and development is presented net of contributions from suppliers, which are
earned based on meeting specified milestones. In 2002, selling expenses
remained relatively stable, despite lower deliveries, due to both a non-cash
charge of US$14.5 million related to financial guarantees and a US$11.6 million
increase in our provision for warranties relating to extended warranty terms
for new aircraft deliveries. The US$14.5 million non-cash charge was caused by
the effect of the economic downturn in the airline industry on our risk
analysis of financial guarantees. This increase in operating expenses was partially offset by a 9.2%
decrease in general and administrative expenses, from US$120.8 million in 2001
to US$109.7 million in 2002, a 42.3% decrease in profit sharing, from US$43.7
million in 2001 to US$25.2 million in 2002, and a 32.8% reduction in other
operating expenses, net, from US$30.5 million in 2001 to US$20.5 million in
2002. The decrease in general and administrative expenses is primarily due to
the effects on the real-denominated portion of this item resulting from the
52.3% devaluation of the realduring 2002. The decrease in profit sharing is
related to the reduction in net income and dividends. Operating expenses as a
percentage of net sales increased from 17.3% in 2001 to 20.8% in 2002,
primarily as a result of the increases in research and development expenses as
well as the non-cash charge for guarantees and the increase in our provision
for warranties. Interest income (expense), net.Interest income increased from US$47.5
million in 2001 to US$80.5 million in 2002, despite lower average cash balances
primarily due to an increase of US$65.3 million in unearned gains on derivative
financial transactions and an increase in net monetary and exchange variations
due to the effects of the devaluation of the realon increased indexed net
liabilities in foreign currency, primarily taxes and social charges in dispute.
See Notes 16 and 20 to our consolidated financial statements. 44




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##### Table of Contents



Foreign exchange (loss), net. Foreign exchange loss, net, decreased from
US$148.6 million in 2001 to US$135.6 million in 2002. These amounts reflect
the remeasurement of non-U.S. dollar-denominated assets and liabilities into U.S.
dollars and the decrease in net assets denominated in reais, partially offset
by a higher rate of devaluation of the reaisin 2002. Other non-operating income (expense), net.Other non-operating expense,
net, decreased from US$8.4 million in 2001 to US$1.4 million in 2002. The
decrease in 2002 was primarily due to a decrease in provisions for losses on
tax incentive investments from US$8.6 million in 2001 to US$0.7 million in
2002. Income tax benefit (expense).Our provision for income taxes decreased
from US$218.4 million in 2001 to US$188.5 million in 2002 mainly due to lower
taxable profits under the Brazilian Corporate Law financial statements. Our
statutory tax rate in each year was 34%. Net income.As a result of the foregoing factors, our net income
decreased 32.2% from US$328.4 million in 2001 to US$222.6 million in 2002. Net
income decreased as a percentage of net sales. In 2001, net income was 11.2%
of net sales as compared to 8.8% in 2002. 5B. Liquidity and Capital Resources 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. We believe that
these sources of funds will be sufficient to fund our future liquidity needs,
to continue to develop the EMBRAER 170/190 jet family, make other planned
capital expenditures and pay dividends. However, 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 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. Working Capital and Net Cash Provided by Operating Activities We had a working capital surplus of US$871.2 million at December 31, 2002
and US$900.3 million at December 31, 2003. Working capital slightly increased.
We had increased inventories of US$292.5 million as a result of increased
inventories for the EMBRAER 170/190 jet family due to the postponement of the
certification of the EMBRAER 170 and the production of the pre-series aircraft
for the EMBRAER 170/190 jet family, partially offset by reduced production of
the ERJ 145 regional jet family. Total inventories of EMBRAER 170/190
pre-series aircraft increased from US$56.6 million in 2002 to US$112.6 million
in 2003 and included, as of December 31, 2003, six EMBRAER 170 and two EMBRAER
175 pre-series aircraft. As of December 31, 2003, we had also commenced
production of the first EMBRAER 190 pre-series aircraft. In addition, we had a
US$379.5 million decrease in accounts receivable due to the receipt of proceeds
from financing provided by BNDES to our customers. We generated net cash provided by operating activities of US$239.6 million
in 2003, as compared to net cash provided by operating activities of US$575.7
million in 2002 and net cash used in operating activities of US$207.4 million
in 2001. Net cash provided by operating activities decreased in 2003 as a
result of the decrease of US$300.8 million in our accounts receivable, an
increase of US$234.4 million in our inventories and a decrease in our operating
income. At December 31, 2003, advances from customers totaled US$559.2
million, 80.2% of which represented current liabilities. Net Cash Used in Investing Activities Our net cash used in investing activities was US$72.7 million in 2003
compared to US$104.2 million in 2002 and US$162.8 million in 2001. The
decrease in 2003 was mainly due to a decrease in investments in property, plant
and equipment. 45




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Capital Expenditures We recorded additions to property, plant and equipment of US$64.8 million
in 2003, US$111.0 million in 2002 and US$143.8 million in 2001. These
expenditures related to construction of facilities, improvements to our plant
and production facilities and modifications for the production of new aircraft
models. We currently expect investments in property, plant and equipment to total
approximately US$64.0 million in 2004 and an additional US$81.0 million in
2005, primarily related to the production of the EMBRAER 170/190 jet family, as
well as our defense aircraft and corporate jets. Cash Provided by (Used in) Financing Activities and Total Debt Our net cash provided by (used in) financing activities increased from net
cash used in financing activities of US$352.4 million in 2002 to net cash
provided by financing activities of US$403.8 million in 2003. The increase was
primarily due to a decrease in repayments of loans and a decrease in payments
of dividends and interest on shareholders equity. Our net cash provided by
(used in) financing activities decreased from net cash provided by financing
activities of US$134.4 million in 2001 to net cash used in financing activities
of US$352.4 million in 2002. At December 31, 2003, we had total debt of US$1,043.7 million under our
financing arrangements described below, 50.4% of which consisted of long-term
debt and 49.6% of which consisted of short-term debt. In comparison, we had
total debt of US$552.6 million at December 31, 2002 and US$771.7 million at
December 31, 2001, consisting of 55.8% and 31.8% of long-term debt,
respectively. Our total debt increased from 2002 to 2003 largely due to new
borrowings. Total debt consists of amounts recorded as loans on our balance sheet and
excludes non-recourse and recourse debt associated with customer financing
arrangements transacted through special purposes entities, or SPEs. In
structured financings, an SPE purchases 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
purchase through an SPE, and a portion of the credit risk remains with that
third party. Under U.S. GAAP, leasing transactions made through an SPE were
required to be consolidated if the equity contribution of independent third
parties was less than 3% of the fair value of the SPEs assets. Some of the
SPEs, through which we sell aircraft, were formed without any equity
contribution and, therefore, are consolidated. In 2003, the Financial
Accounting Standards Board, or FASB, issued Interpretation No. 46, or FIN 46,
Consolidation of Variable Interest Entities, an interpretation of ARB 51,
which was subsequently modified by FIN 46R. FIN 46 and FIN 46R provide a new
framework for identifying variable interest entities, or VIEs, and determining
when a company should include the assets, liabilities, non-controlling
interests and results of activities of a VIE in its consolidated financial
statements. See   Recent Accounting Pronouncements below for a further
discussion of FIN 46 and FIN 46R. The effect of consolidating our SPEs resulted in non-recourse debt at
December 31, 2003, reflected as a separate line item on our balance sheets, of
US$1,492.4 million and collateralized accounts receivable of US$1,750.9
million. We have no actual obligation for US$1,492.4 million of this
non-recourse debt other than potentially under existing financial guarantees.
The non-recourse debt is collateralized by the collateralized accounts
receivable and by the financed aircraft and, as a result, we do not anticipate
a net cash outflow related to our non-recourse debt in the future. The
remaining US$258.5 million of debt is recourse to us as a result of pending
equity contributions and is secured by a pledge of a deposit with a financial
institution. These financing transactions do not materially affect our income
statement and cash flow data since the terms of the leases and the loans are
substantially the same. See Note 8 to our consolidated financial statements. 46




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##### Table of Contents



Credit Facilities and Lines of Credit Long-term facilities We maintain credit facilities with BNDES in a total amount of US$61.4
million outstanding at December 31, 2003, of which US$19.9 million is related
to the development of the ERJ 145, and with FINEP in a total amount of US$5.0
million outstanding at December 31, 2003, primarily to fund development costs
of the AL-X . The total amounts borrowed under the BNDES and FINEP credit
facilities are due October 2008 and November 2009, respectively. Amounts
borrowed from BNDES are secured by first, second and third mortgages on our
properties in Brazil, as well as first priority mortgages on seven EMB 120
Brasília aircraft. The interest rates on these facilities are either fixed at
5.5% per annum or range from TJLP plus 3.0% to TJLP plus 5.5% per annum. For
BNDES borrowings, we also paid fees at the rate of 0.35% of the sales price of
420 ERJ 145s sold between January 1, 1997 and August 1, 2002. We have a credit facility with the Tokyo Branch of The Chase Manhattan
Bank under which we borrowed the Japanese yen equivalent of US$150.0 million,
principally to fund our purchase of aircraft component parts, of which US$104.1
million remains outstanding. This loan matures in December 2006 and bears an
interest rate equal to the twelve-month Japanese interbank deposit rate, or
JIBOR, plus 1.1% per annum. On September 20, 2002, we secured a US$100.0
million credit facility with Mitsui & Co., Ltd. and borrowed the full amount
available thereunder, of which US$100.9 million remains outstanding as of
December 31, 2003. This loan matures in 2009 and bears interest at an interest
rate of LIBOR plus 2.2%. The facility is guaranteed by Unibanco  União de
Bancos Brasileiros SA. The facility provides that if we fail to maintain a
minimum of 100 firm orders during the duration of the facility, Mitsui & Co.
Ltd has the right to declare all amounts outstanding under this facility due
and payable. In addition, the facility provided that Mitsui had a similar
right if we failed to obtain certification of the EMBRAER 170 prior to December
2003. The facility was amended in November 2003 to provide for the extension
to March 2004 of the deadline for certification of the EMBRAER 170, which was
ultimately obtained in February 2004. We also have a US$100.0 million credit
facility with Santander Central Hispano Benelux S.A. to fund our purchases of
wings and other equipment from Gamesa. As of December 31, 2003, US$96.1
million was outstanding under this facility and we have additional availability
of US$4.8 million through March 2004. Amounts outstanding under this facility
bear interest at a fixed rate of 4.49% per annum. In July 2003, we signed a
credit agreement with Sumitomo Mitsui Banking Corp. and other lenders providing
for a term loan of US$200.0 million, at a rate of LIBOR plus 2.97% per annum,
to purchase materials for the manufacture of the EMBRAER 170/190 jet family.
We borrowed the full amount under this facility in July 2003, of which US$200.7
million remains outstanding as of December 31, 2003. We have various other
loans and credit agreements with aggregate outstanding borrowings of US$109.6
million at December 31, 2003. In May 2004, we signed a mandate letter with the
International Finance Corporation for a possible financing through a syndicated
facility of up to US$100 million. Each of our long-term financing arrangements includes customary covenants
and restrictions, including those that require us to maintain defined debt
liquidity and interest expense coverage ratios, with which we were in
compliance at December 31, 2003 and none of which are expected to have a
material effect on our business. See Note 18 to our consolidated financial
statements for further information on these financing arrangements. Short-term facilities We obtain short-term financing primarily from Brazilian banks in the form
of advances against exchange contracts that we enter into with those banks
relating to payments we are entitled to receive within a period of not more
than 360 days prior to delivery of aircraft. At December 31, 2003, we had
US$180.3 million outstanding under these arrangements. In addition, we maintain short-term import financing lines of credit in
Brazil. As of December 31, 2003, US$133.8 million was outstanding under these
lines of credit. We maintain subsidiary lines of credit from time to time to
finance working capital requirements for these subsidiaries. At December 31,
2003, we had US$51.8 million of outstanding debt under these lines of credit.
See Note 18 to our consolidated financial statements for further information on
our short-term financing arrangements. 47




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Capital Contributions and Issuances of Capital Stock During 2003, we received capital contributions in the aggregate amount of
US$4.0 million, representing the issuance of preferred shares upon the exercise
of options. During 2003, we issued 3,056,228 preferred shares at a weighted
average exercise price of R$3.77 per share. In addition, through June 7, 2004,
1,208,498 preferred shares were issued upon the exercise of options at an
average exercise price of R$4.28 per share. Recent Accounting Pronouncements In January 2003, FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, or FIN 46, which clarified the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements,
relating to consolidation of certain entities. FIN 46 requires the
identification of our participation in variable interest entities, or VIEs,
which are defined as entities with a level of invested equity that is not
sufficient to fund future activities to permit them to operate on a standalone
basis or whose equity holders lack certain characteristics of a controlling
financial interest. For entities identified as VIEs, FIN 46 sets forth a model
to evaluate potential consolidation based on an assessment of which party to
the VIE, if any, bears a majority of the exposure to its expected losses or
stands to gain from a majority of its expected returns. FIN 46 also requires
certain disclosures regarding interests in VIEs that are deemed significant,
even if consolidation is not required. In December 2003, FIN 46 was
substantially revised and a new interpretation, FIN 46 (revised), or FIN 46R,
was issued. FIN 46R (i) clarified some FIN 46 requirements, (ii) eased some
implementation problems, and (iii) added new scope exceptions. In addition,
FIN 46R deferred the effective date of the Interpretation for public companies
to the end of the first reporting period ending after March 15, 2004, except
that all public companies must at a minimum apply the provisions of the
Interpretation to entities created after February 1, 2003 that are considered
special-purpose entities, or SPEs, under FASB literature prior to the issuance
of FIN 46R by the end of the first reporting period ending after December 15,
2003. For foreign private issuers who only report on an annual basis, the
effective date of FIN 46R is the beginning of the first annual period after
December 15, 2003. For SPEs created by foreign private issuers after February
1, 2003, however, the effective date is no later than the end of the first
reporting period ending after December 15, 2003. We will adopt FIN 46R in 2004. Such adoption will not have any
significant effect on us, as the VIEs deemed to be within the scope of such
Interpretation are SPEs that have already been consolidated through other
authoritative accounting rules, as further discussed in Note 8. In addition, we use exclusive investment funds to invest in underlying
portfolios managed by third party asset management entities. Such asset
management entities have authority, based on investment strategy guidelines
provided by us, to make overall operating and financial decisions related to
the investment fund, including acquisition and disposition of the underlying
marketable securities. The funds are considered to be VIEs of which we are the
primary beneficiary, as defined by FIN 46R. Upon adoption of FIN 46R in 2004,
we will be required to consolidate the underlying assets of these funds in
Brazil, currently classified as cash and cash equivalents. This consolidation
may cause certain reclassifications, primarily between cash and cash
equivalents and short-term investments. Considering the composition of the
fund portfolio as of December 31, 2003, we believe that adoption of FIN 46R
will not have a material impact on our cash and cash equivalents position. In May 2003, FASB issued Statement of Financial Accounting Standards No.
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. The Statement requires that an issuer classify a
financial instrument within its scope as a liability. The initial adoption of
this accounting pronouncement will not affect our consolidated financial
statements. In December 2003, FASB issued Statement of Financial Accounting Standards
No. 132 (revised 2003), or SFAS 132 (revised 2003), Employers Disclosures
about Pensions and Other Postretirement Benefits  an amendment of FASB
Statements No. 87, 88 and 106. SFAS 132 (revised 2003) is effective for
fiscal years ending after December 15, 2003. However, there is a provision
deferring the effectiveness of this new rule for foreign plans until periods
ending after June 15, 2004, which is applicable to us. SFAS 132 (revised 2003)
replaces the disclosure requirements in SFAS 87, SFAS 88 and SFAS 106. It
addresses disclosures only and does not address measurement and recognition
accounting for pension and postretirement benefits. SFAS 132 (revised 2003)
requires additional 48




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##### Table of Contents



disclosures related to the description of plan assets, including
investment strategies, plan obligations, cash flows and net periodic benefit
cost of defined benefit pension and other defined benefit postretirement plans. 5C. Research and Development 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. The research and development costs incurred
by Embraer are divided into two categories, research and development expense
and additions to fixed assets. The research and development expense is the
cost actually 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 expensed in
the year in which they are incurred. Additions to fixed assets relate solely
to specialized equipment built by us and required for the project. These costs
are treated as additions to property, plant and equipment. We invest significantly in the development of new projects. Total
research and development expenses for 2001, 2002 and 2003, including expenses
related to the development of the EMBRAER 170/190 jet family, were US$99.6
million, US$158.5 million and US$173.2 million, respectively, net of cash
contributions provided by risk-sharing partners. Research and development
costs as a percentage of net sales were 3.4% in 2001, 6.3% in 2002 and 8.1% in
2003. The increases in the percentages in 2002 and 2003 reflect principally
the costs related to the EMBRAER 170/190 jet family. In 2004, we expect our
research and development costs to total approximately US$174.0 million. We do
not record an expense for research and development of defense programs as they
are funded by the Brazilian government and other government customers. Most of
our research and development expenses are associated with a particular program,
whether commercial, corporate or defense. We receive additional funds from risk-sharing partners to fund our cash
costs for our commercial research and development. In addition, the Brazilian
and other governments fund substantially all of our defense research and
development costs under long-term development contracts. 5D. Trend Information The following table summarizes our commercial airline sales order book at
March 31, 2004. Our total firm order backlog at that date, including corporate
jets and defense aircraft, was US$10.9 billion (US$10.6 billion at December 31,
2003). Firm
    
    
    
    
    
    
    
    
    
    Firm OrderOrders
    
    Options
    
    Deliveries
    
    BacklogIn the Commercial Airline MarketEMB 120 Brasília
    
    
    352
    
    
    
    
    
    
    
    352
    
    
    
    ERJ 135
    
    
    122
    
    
    
    2
    
    
    
    105
    
    
    
    17ERJ 140
    
    
    94
    
    
    
    20
    
    
    
    74
    
    
    
    20ERJ 145
    
    
    697
    
    
    
    440
    
    
    
    545
    
    
    
    152EMBRAER 170
    
    
    133
    
    
    
    162
    
    
    
    8
    
    
    
    125EMBRAER 190
    
    
    110
    
    
    
    150
    
    
    
    
    
    
    
    110EMBRAER 195
    
    
    15
    
    
    
    30
    
    
    
    
    
    
    
    15
 49




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##### Table of Contents



The following tables set forth our commercial airline order book at March
31, 2004 by aircraft type, customer and country. ERJ 135: Firm OrderClient
    
    Country
    
    Firm Orders
    
    Deliveries
    
    BacklogAmerican Eagle
    
    USA
    
    
    40
    
    
    
    40
    
    
    
    0British Midland
    
    Great Britain
    
    
    4
    
    
    
    2
    
    
    
    2City Air
    
    Sweden
    
    
    2
    
    
    
    2
    
    
    
    0Express Jet
    
    USA
    
    
    30
    
    
    
    30
    
    
    
    0Flandre Air
    
    France
    
    
    3
    
    
    
    3
    
    
    
    0Pan Européenne
    
    France
    
    
    1
    
    
    
    1
    
    
    
    0Proteus
    
    France
    
    
    3
    
    
    
    3
    
    
    
    0Regional Airlines
    
    France
    
    
    3
    
    
    
    3
    
    
    
    0SA Airlink
    
    South Africa
    
    
    20
    
    
    
    5
    
    
    
    15Jet Magic
    
    Ireland
    
    
    1
    
    
    
    1
    
    
    
    0Republic (Wexford)
    
    USA
    
    
    15
    
    
    
    15
    
    
    
    0TOTAL
    
    
    
    
    122
    
    
    
    105
    
    
    
    17
 ERJ 140: Firm OrderClient
    
    Country
    
    Firm Orders
    
    Deliveries
    
    BacklogAmerican Eagle
    
    USA
    
    
    59
    
    
    
    59
    
    
    
    0Midwest
    
    USA
    
    
    20
    
    
    
    0
    
    
    
    20Republic (Wexford)
    
    USA
    
    
    15
    
    
    
    15
    
    
    
    0TOTAL
    
    
    
    
    94
    
    
    
    74
    
    
    
    20
 ERJ 145: Firm OrderClient
    
    Country
    
    Firm Orders
    
    Deliveries
    
    BacklogAerolitoral
    
    Mexico
    
    
    5
    
    
    
    0
    
    
    
    5Air Caraibes
    
    Guadaloupe
    
    
    2
    
    
    
    2
    
    
    
    0Alitalia
    
    Italy
    
    
    14
    
    
    
    14
    
    
    
    0American Eagle
    
    USA
    
    
    136
    
    
    
    71
    
    
    
    65Axon Airlines
    
    Greece
    
    
    3
    
    
    
    3
    
    
    
    0British Midland
    
    Great Britain
    
    
    11
    
    
    
    9
    
    
    
    2British Regional
    
    Great Britain
    
    
    23
    
    
    
    23
    
    
    
    0Brymon
    
    Great Britain
    
    
    7
    
    
    
    7
    
    
    
    0China Southern
    
    China
    
    
    6
    
    
    
    0
    
    
    
    6Cirrus
    
    Germany
    
    
    1
    
    
    
    1
    
    
    
    0ERA
    
    Spain
    
    
    2
    
    
    
    2
    
    
    
    0Express Jet
    
    USA
    
    
    245
    
    
    
    200
    
    
    
    45Flandre Air
    
    France
    
    
    7
    
    
    
    5
    
    
    
    2GECAS (PB Air)
    
    USA
    
    
    2
    
    
    
    2
    
    
    
    0KLM Exel
    
    Holland
    
    
    2
    
    
    
    2
    
    
    
    0LOT
    
    Poland
    
    
    14
    
    
    
    14
    
    
    
    0Luxair
    
    Luxemburg
    
    
    9
    
    
    
    9
    
    
    
    0Mesa
    
    USA
    
    
    36
    
    
    
    36
    
    
    
    0
 50




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##### Table of Contents



Firm OrderClient
    
    Country
    
    Firm Orders
    
    Deliveries
    
    BacklogPortugalia
    
    Portugal
    
    
    8
    
    
    
    8
    
    
    
    0Proteus
    
    France
    
    
    11
    
    
    
    8
    
    
    
    3Regional Airlines
    
    France
    
    
    17
    
    
    
    14
    
    
    
    3Rheintalflug
    
    Austria
    
    
    3
    
    
    
    3
    
    
    
    0Rio-Sul
    
    Brazil
    
    
    16
    
    
    
    16
    
    
    
    0Sichuan Airlines
    
    China
    
    
    5
    
    
    
    5
    
    
    
    0Skyways AB
    
    Sweden
    
    
    4
    
    
    
    4
    
    
    
    0SWISS
    
    Switzerland
    
    
    25
    
    
    
    25
    
    
    
    0Trans States
    
    USA
    
    
    15
    
    
    
    15
    
    
    
    0Republic (Wexford)
    
    USA
    
    
    68
    
    
    
    47
    
    
    
    21Total
    
    
    
    
    697
    
    
    
    545
    
    
    
    152
 EMBRAER 170: Firm OrderClient
    
    Country
    
    Firm Orders
    
    Deliveries
    
    BacklogAir Caraibes
    
    Guadaloupe
    
    
    2
    
    
    
    0
    
    
    
    2Alitalia
    
    Italy
    
    
    6
    
    
    
    1
    
    
    
    5Cirrus
    
    Germany
    
    
    1
    
    
    
    0
    
    
    
    1GECAS
    
    USA
    
    
    5
    
    
    
    3
    
    
    
    2LOT
    
    Poland
    
    
    6
    
    
    
    0
    
    
    
    6Republic Airways
    
    USA
    
    
    13
    
    
    
    0
    
    
    
    13SWISS
    
    Switzerland
    
    
    15
    
    
    
    0
    
    
    
    15US Airways
    
    USA
    
    
    85
    
    
    
    4
    
    
    
    81Total
    
    
    
    
    133
    
    
    
    8
    
    
    
    125
 EMBRAER 190: Firm OrderClient
    
    Country
    
    Firm Orders
    
    Deliveries
    
    BacklogJet Blue
    
    USA
    
    
    100
    
    
    
    0
    
    
    
    100Undisclosed
    
    
    
    
    10
    
    
    
    0
    
    
    
    10Total
    
    
    
    
    110
    
    
    
    0
    
    
    
    110
 EMBRAER 195: Firm OrderClient
    
    Country
    
    Firm Orders
    
    Deliveries
    
    BacklogSWISS
    
    Switzerland
    
    
    15
    
    
    
    0
    
    
    
    15Total
    
    
    
    
    15
    
    
    
    0
    
    
    
    15
 For additional information regarding trends in our business, see Item 4B.
Business Overview  Business Strategies and Item 5A. Operating Results 
Current Conditions and Future Trends in the Airline Industry. For risks
affecting our business, see Item 3D. Risk Factors. 5E. Off-Balance Sheet Arrangements We participate in a number of off-balance sheet arrangements, principally
relating to repurchase, trade-in and trade-up obligations and financial and
residual value guarantees. We also have a number of swap transactions that are
described in Item 11. Quantitative and Qualitative Disclosures about Market
Risk. 51




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Repurchase, Trade-in and Trade-up Obligations We may have to repurchase a number of our aircraft. Under the relevant
purchase contracts, the price per aircraft of any required repurchase is less
than the original purchase price of the aircraft and less than our estimate at
that time of the market value of the relevant aircraft type in future years
(based on third party appraisals of aircraft valuations). If we are required
to repurchase all of the relevant aircraft under our repurchase obligation,
which covers the period from 2004 to 2006, we could be required to pay up to
approximately US$500 million for these aircraft. Based on our current
estimates and third party appraisals, we believe that any repurchased aircraft
could be sold without any material gain or loss. We were not required to
repurchase any aircraft in 2003. In connection with the signing of a purchase contract for new aircraft, we
may provide trade-in and or trade-up options to our customers. These options
provide a customer with the right to trade in or trade up existing aircraft
upon the purchase of a new aircraft. At December 31, 2003, six commercial
aircraft were subject to trade-in options, and additional aircraft may become
subject to trade-in options upon delivery. The trade-in price is determined in
the manner discussed above for commercial jets. In addition, one corporate jet
customer has trade-up options relating to 11 aircraft, which provide that if
and when we launch a new corporate jet model, this customer has the right to
trade up to the new model. The trade-up price is determined as a percentage of
the original purchase price of our corporate jets. We may be required to
accept trade-ins or trade-ups at prices that are 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 or trade-up could be sold
without any material gain or loss. In 2003, we were not required to accept any
aircraft for trade-in or trade-up. 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 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. Assuming
all customers 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 residual value guarantees and we
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$1.4 billion as of December 31, 2003. For further discussion of
these off-balance sheet arrangements, see Note 34 of our consolidated financial
statements. We have deposited US$192.7 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, 2003) and from other offsetting collections,
such as cash deposits, would exceed our exposure by US$253 million. Our residual value guarantees typically ensure that in the 15th year after
delivery, the relevant aircraft will have a residual market value of 10% to 27%
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. For a discussion of the risks related to our repurchase, trade-in and
trade-up obligations and our financial and residual value guarantee
obligations, see Item 3D. Risk Factors  Risk Relating to Embraer  Our
aircraft sales are subject to cancellation provisions, repurchase, trade-in and
trade-up options and financial and residual value guarantees that may reduce
our cash flow or require us to make significant cash disbursements in the
future. We continually re-evaluate our risk under our guarantees and repurchase,
trade-in and trade-up 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 52




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the credit rating of customers. See Note 34 to our consolidated financial
statements for a further discussion of these off-balance sheet arrangements. 5F. Tabular Disclosure of Contractual Obligations The following table and discussion provide additional disclosure regarding
our material contractual obligations and commercial commitments as of December
31, 2003. Contractual Obligations
    
    Total
    
    Less than 1 year
    
    1  3 years
    
    3  5 years
    
    More than 5 yearsLoans
    
    US$
    1,043.7
    
    
    US$
    517.0
    
    
    US$
    206.5
    
    
    US$
    201.9
    
    
    US$
    118.3Capital lease obligations
    
    
    8.1
    
    
    
    5.3
    
    
    
    2.8
    
    
    
    
    
    
    
    Operating leases
    
    
    9.6
    
    
    
    2.2
    
    
    
    2.5
    
    
    
    0.9
    
    
    
    4.0Purchase obligations
    
    
    409.3
    
    
    
    409.3
    
    
    
    
    
    
    
    
    
    
    
    Other long-term liabilities
    
    
    1,810.9
    
    
    
    102.1
    
    
    
    341.4
    
    
    
    306.2
    
    
    
    1,061.2Total
    
    US$
    3,281.6
    
    
    US$
    1,035.8
    
    
    US$
    553.1
    
    
    US$
    509.0
    
    
    US$
    1,183.5
 The above table does not reflect contractual commitments related to
repurchase, trade-in and trade-up options and financial and residual value
guarantees discussed in Item 5E. Off-Balance Sheet Arrangements above. See
Item 3D. Risk Factors  Risk Relating to Embraer  Our aircraft sales are
subject to cancellation provisions, repurchase, trade-in and trade-up options
and financial and residual value guarantees that may reduce our cash flow or
require us to make significant cash disbursements in the future. Purchase obligations consist of accounts payable to suppliers and
insurance payables. Other long-term liabilities include non-recourse debt in the total amount
of US$1,390.3 million that relates to obligations of our consolidated SPEs.
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. 
 ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 6A. Directors and Senior Management We are managed by our Conselho de Administração, or board of directors,
composed of at least nine and at most eighteen members, and our Diretoria, or
committee of officers, composed of at least four members (each an executive
officer). We have a permanent Conselho Fiscal, or audit board, which is
composed of five members. 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 bylaws provide that the Chief Executive Officer of Embraer is
automatically a member of the board of directors. As a result, Maurício Novis
Botelho, currently President and Chief Executive Officer of Embraer, is a
member of the board of directors. Our controlling shareholders, Cia. Bozano,
PREVI and SISTEL, have entered into a shareholders agreement which provides
that when they appoint members of our board of directors at shareholders
meetings, they will each appoint two representatives (and alternates), and
together they will vote to elect two representatives (and alternates) of the
European Aerospace and Defense Group and one representative (and alternate) of
the Brazilian government. This representative of the Brazilian government is
in addition to the representative that the Brazilian government is entitled to
appoint directly as the holder of a common share of a special class, the
golden share. See Item 7A. Major Shareholders  Voting Rights 
Shareholders Agreement for more information on the shareholders agreement.
In addition, our bylaws provide that our employees are entitled to two
representatives (and alternates) on our board of directors, who are elected at
the annual shareholders meeting. 53




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All members of the board of directors serve three-year terms. The term of
the mandate of the current members of the board expires in April 2007. Set
forth below are the names, ages, positions and brief biographical descriptions
of the members of the board of directors at April 26, 2004. Name
    
    Age
    
    Position
    
    Year First ElectedLuiz Carlos Siqueira Aguiar
    
    
    41
    
    
    Chairman of the Board of Directors
    
    
    2004Vitor Sarquis Hallack
    
    
    51
    
    
    Deputy Chairman of the Board of Directors
    
    
    1995Henrique Pizzolato
    
    
    51
    
    
    Member of the Board of Directors
    
    
    2003Carlyle Wilson
    
    
    75
    
    
    Member of the Board of Directors
    
    
    2000Carlos Alberto Cardoso Moreira
    
    
    44
    
    
    Member of the Board of Directors
    
    
    2004Wilson Carlos Duarte Delfino
    
    
    57
    
    
    Member of the Board of Directors
President and Chief Executive Officer
    
    
    2004Maurício Novis Botelho
    
    
    61
    
    
    and Member of the Board of Directors
    
    
    2000Neimar Dieguez Barreiro
    
    
    59
    
    
    Member of the Board of Directors
    
    
    2004Rubens Antonio Barbosa
    
    
    65
    
    
    Member of the Board of Directors
    
    
    2004Isaac Marcel de Picciotto
    
    
    60
    
    
    Member of the Board of Directors
    
    
    2003Christian Paul Maurice Gras
    
    
    46
    
    
    Member of the Board of Directors
    
    
    2004Paulo Cesar de Souza Lucas
    
    
    44
    
    
    Member of the Board of Directors
    
    
    1999Claudemir Marques de Almeida
    
    
    51
    
    
    Member of the Board of Directors
    
    
    2004
 Luiz Carlos Siqueira Aguiar. Mr. Aguiar has been an executive officer of
PREVI since February 2003. From August 2000 to February 2003, he was an
officer of Banco do Brasil. He also served as Deputy Manager of Banco do
Brasil in New York from February 1997 to August 2000. He was previously a
member of the board of directors of Seguradora Brasileira de Crédito a
Exportação, a Brazilian trade finance insurance company, from May 2001 to
February 2003. Since April 2003 and July 2003, respectively, he has served as
Deputy Chairman of the board of directors of Companhia Paulista de Força e Luz
 CPFL, a utility company, and as member of the Financing Committee of
Companhia Vale do Rio Doce  CVRD, a mining company. Mr. Aguiar was elected as
a board member and chairman of the board in April 2004, as a representative of
PREVI, and his business address is Praia do Botafogo, 501, 4th floor, 22250-040
Rio de Janeiro, RJ, Brazil. Vitor Sarquis Hallack.Mr. Hallack has been with the Bozano Group since
1993. He is an executive officer of Cia. Bozano and a board member and an
executive officer of Bozano Holdings Ltd. From April 1998 to May 2000, he was
an executive officer of Banco Bozano Simonsen S.A. Prior to joining Cia.
Bozano, Mr. Hallack was the officer in charge of new business development and
the chief financial officer of Companhia Vale do Rio Doce  CVRD, a mining
company, from December 1990 to March 1993. Mr. Hallack is a representative of
Cia. Bozano, and his business address is Rua Visconde de Ouro Preto, 5, 10th
floor, 22250-180 Rio de Janeiro, RJ, Brazil. Henrique Pizzolato.Mr. Pizzolato has been the Marketing and
Communications Officer for Banco do Brasil since February 2003. From June 1998
to May 2002, he was the Director of Social Security at PREVI. He was also a
member of the Board of Banco do Brasil from 1993 to 1996. In addition, Mr.
Pizzolato was a member of the board of directors of Telecentrosul and Brasil
Telecom, telecommunications companies, from 1999 to 2000. He is a
representative of PREVI, and his business address is SBS Quadro 1, Bloco C,
Lote 32, Edifício Sede 3, 19th floor, 70073-901 Brasilia, DF, Brazil. Carlyle Wilson.Mr. Wilson has been with the Bozano group since 1972.
Mr. Wilson is an executive officer of Cia. Bozano and a board member of Bozano
Holdings Ltd. Since 1992, Mr. Wilson has been a board member of Berneck
Aglomerados, a wood fiber-board manufacturing company. In addition, since
1980, Mr. Wilson has been a board member of Bozano, Simonsen Centros Comerciais
S.A., a shopping center administration company, and since 1986 he has been a
board member of GD Empreendimentos Imobiliários S.A., a real estate company.
From January 1995 to January 2000, Mr. Wilson was an alternate board member of
Embraer. Mr. Wilson is a representative of Cia. Bozano, and his business
address is Rua Visconde de Ouro Preto, 5, 10th floor, 22250-180 Rio de Janeiro,
RJ, Brazil. 54




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##### Table of Contents



Carlos Alberto Cardoso Moreira.Mr. Moreira has been an Executive Officer
of Investments and Financing at SISTEL since June 2000. He served as Officer
of Institutional Clients for Banco BMC S/A in São Paulo from June 1992 to
November 1999 and as Resident Vice President of Citibank N.A. in São Paulo from
May 1988 to May 1992. In addition, Mr. Moreira is a member of the board of
directors of the World Trade Center/SP Enterprise, a real estate company, and a
member of the board of directors of Companhia Paulista de Força e Luz  CPFL, a
utility company. Mr. Moreira is a representative of SISTEL, and his business
address is SEP Sul, Quadra 702/902  Conj. B, Bloco A, Ed. Gal. Alencastro, 2nd
floor, 70390-025 Brasília, DF, Brazil. Wilson Carlos Duarte Delfino.Mr. Delfino has been the acting President
and Chief Executive Officer of SISTEL since January 2004, and has also served
as Executive Officer of Planning, Controlling, and Administrative Offices of
SISTEL since March 2000. Previously, Mr. Delfino served as Assistant to the
Executive Officer responsible for the Coordination of the Committee of
Investments of SISTEL from September 1993 to September 1994 and as Manager of
the Investment Analysis Department of SISTEL from October 1994 to March 2000.
He has also been a member of the board of directors of Paranapanema, a mining
company, since April 1998. Mr. Delfino is a representative of SISTEL, and his
business address is the same as Mr. Moreiras above. Maurício Novis Botelho.Mr. Botelho has been President and Chief
Executive Officer of Embraer since September 1995, as well as an executive
officer and/or chairman of the board of several of Embraers subsidiaries. Mr.
Botelho served as chief executive officer of OTL  Odebrecht Automação &
Telecomunicações Ltda., also known as OTL and later named Stelar Telecom, a
telecommunications company, from 1988 to 1995. He also served as chief
executive officer of CMW Equipamentos S.A., or CMW, an industrial automation
company, from 1985 to 1995. He was also the chief executive officer of STL 
Engenharia de Sistemas Ltda., also known as STL, a project engineering company,
from 1985 to 1995, a partner in Soluções Integradas PROLAN Ltda., also known as
PROLAN, a corporate network company, from 1994 to 1995, and executive
vice-president of TENENGE  Técnica Nacional de Engenharia Ltda., or TENENGE, a
construction company, during 1992. During 1995, Mr. Botelho was an executive
officer of Cia. Bozano. Mr. Botelho is a board member pursuant our bylaws,
which provides that our Chief Executive Officer is automatically member of the
board of directors, and his business address is the address of our principal
executive offices. Neimar Deiguez Barreiro.Mr. Barreiro has been a Brigadier Major in the
Brazilian Air Force since July 2001 and the 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,
through the governments ownership of the common share of a special class, the
golden share, and his business address is Esplanada dos Ministérios, Bloco M,
3rd floor, room 05, 70045-900 Brasília, DF, Brazil. Rubens Antonio Barbosa.Mr. Barbosa served as the Brazilian Ambassador to
the United States from 1999 to 2004. From 1994 to 1999, he served as the
Brazilian Ambassador to the Court of St. James. Mr. Barbosa also served as the
President of the Association of Coffee Producing Countries  APPC from 1994 to
1999 in London, and has held several positions in the Brazilian governments
Foreign Affairs Division, including, most recently, General Subsecretary for
Regional Integration, External Commerce and Economic Affairs for the Ministry
of External Relations from December 1991 to December 1993 and Brazilian
Coordinator for Mercosul-Southern Cone Common Market from August 1991 to
December 1993. Mr. Barbosa is the representative of the Brazilian government
and was elected by our shareholders. His business address is Av. Brigadeiro
Faria Lima, 2055, 9th floor, conjunto 92, 01452-001 São Paulo, SP, Brazil. Isaac Marcel de Piccioto.Mr. Piccioto has been the Corporate Vice
President Strategy for the Business Group Airborne Systems at Thales
since 2001. Prior to that, he occupied several management positions at
Thales from 1990 to 2000. He was Vice President International Business
Development at Philips from 1988 to 1990. From 1974 to 1986, Mr. Piccioto was
Corporate Vice President International Marketing, Export Sales Director,
Director for Europe, North America and Asia Pacific at Matra. Mr. Piccioto is
a representative of the European Aerospace and Defense Group, and his business
address is 2, Avenue Gay Lussac, 78851 Elancourt Cedex, France. 55




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Christian Paul Maurice Gras.Mr. Gras has been Senior Vice President for
Latin America for the European Aeronautic, Defense and Space Company since
2003. Previously, he served as Executive Vice President Customer Support of
Eurocopter SAS from September 2000 to December 2002, as Chief Executive
Officer of the American Eurocopter Corporation from 1997 to 2000 and as Chief
Executive Officer of the Eurocopter subsidiary in Mexico and President of
Marketing and Customer Support from 1994 to 1996, all of which are helicopter
manufacturing corporations. Mr. Gras has also served as a board member for
France Trade Advisor (CCE), a trade organization, since 1996. He is a
representative of the European Aerospace and Defense Group, and his business
address is Av. Cidade Jardim, 400, 16th floor, Ed. Dacon, 01454-000 São Paulo,
SP, Brazil. Paulo Cesar de Souza Lucas.Mr. Lucas has participated in our strategic
planning division since 1998 and was the coordinator of Embraers
implementation of the modernization and cost-reduction strategy from 1990 to
1996. Mr. Lucas has been working at Embraer for more than 16 years and is a
representative of our shareholder employees. Mr. Lucas business address is
the address of our principal executive offices. Claudemir Marques de Almeida.Mr. Almeida has been an employee of Embraer
since 1987, and currently holds the position of Aeronautic Supervisor I. He
previously served as a member the board of directors from January 1995 to April
2001. Mr. Almeida is the representative our non-shareholder employees, and his
business address is the address of our principal executive offices. Executive Officers 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 business address of each of our executive
officers is the address of our principal executive offices. The executive officers are elected by the board of directors for a
three-year term, and any executive officer may be removed by the board of
directors before the expiration of his term. Set forth below are the names,
ages, positions and brief biographical descriptions of our executive officers
at April 26, 2004: Year FirstName
    
    Age
    
    Position
    
    ElectedMaurício Novis Botelho
    
    
    61
    
    
    President and Chief Executive Officer
    
    
    1995Antonio Luiz Pizarro Manso
    
    
    59
    
    
    Executive Vice-President Corporate and
Chief Financial Officer
    
    
    1995Satoshi Yokota
    
    
    63
    
    
    Executive Vice-President  Development
and Industry
    
    
    1997Frederico Pinheiro Fleury Curado
    
    
    42
    
    
    Executive Vice-President  Civil Aircraft
    
    
    1997Romualdo Monteiro de Barros
    
    
    55
    
    
    Executive Vice-President  Defense Market
    
    
    1997Horácio Aragonés Forjaz
    
    
    52
    
    
    Executive Vice-President  Corporate
Communications
    
    
    1998Carlos Rocha Villela
    
    
    48
    
    
    Vice-President and General Counsel
    
    
    1999
 Maurício Novis Botelho. For a biographical description of Mr. Botelho,
please see   Board of Directors. Antonio Luiz Pizarro Manso. Mr. Manso has been Executive Vice-President
Corporate since 2001, and Chief Financial Officer of Embraer since 1995. Mr.
Manso is also a director and/or president of several of Embraers subsidiaries.
Mr. Manso was the administrative and financial officer of STL from 1986 to
1995 and of CMW from 1986 to 1995 and served as member of the board of
directors of CMW during 1995. He was also the chief financial officer of OTL
from 1989 to 1995, the financial officer of TENENGE during 1992 and the chief
financial officer of PROLAN from 1994 to 1995. Satoshi Yokota. Prior to becoming Executive Vice-President  Development
and Industry of Embraer in 1997, Mr. Yokota held several other positions at
Embraer, including Programs and Commercial Contracts Officer during 1995 and
1996 and Programs Officer from 1992 to 1995. Mr. Yokota is also the chairman
of the board of directors of ELEB, one of Embraers subsidiaries. 56




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Frederico Pinheiro Fleury Curado. Prior to becoming Executive
Vice-President  Civil Aircraft of Embraer in 1998, Mr. Curado was our
Executive Vice-President  Planning and Organizational Development from 1997
to August 1998. Prior to that, he held several different positions at Embraer
in the areas of manufacturing, procurement, information technology, contracts
and sales. Mr. Curado is also a director and/or secretary of several of
Embraers subsidiaries. Romualdo Monteiro de Barros. Prior to becoming Executive Vice-President
 Defense Market of Embraer in 1997, Mr. Barros was the officer responsible
for business development at OTL, later named Stelar Telecom, a
telecommunications company, from 1994 to 1997. Horácio Aragonés Forjaz. Prior to becoming Executive Vice-President 
Corporate Communications of Embraer in 2001, Mr. Forjaz was Executive
Vice-President  Planning and Organizational Development of Embraer from 1998
to 2001, and prior to 1998, he was our engineering officer. From 1995 to 1997,
Mr. Forjaz was the operational director of Compsis  Computadores e Sistemas
Ltda., a systems engineering and software company, and from 1975 to 1995, he
held several different positions at Embraer in the areas of engineering and
systems design. Carlos Rocha Villela. Prior to becoming Vice-President and General
Counsel of Embraer in 1999, Mr. Villela was the general counsel of Odebrecht
Química S.A., a chemical company, since 1994. Mr. Villela is also a director,
executive officer and/or secretary of several of Embraers subsidiaries. 6B. Compensation For the fiscal year ended December 31, 2003, the aggregate compensation
(including benefits in kind granted) that we paid to members of the board of
directors, the Conselho Fiscal and the executive officers for services in all
capacities was approximately US$5.0 million. In addition, in 2003, we set
aside approximately US$0.4 million for the payment of pension benefits to our
executive officers. The members of our board of directors and Conselho Fiscal
do not receive any such benefits. The board members, Conselho Fiscal members
and executive officers did not receive any compensation (including benefits in
kind) from any of our subsidiaries. At December 31, 2003, none of the board
members, Conselho Fiscal members or executive officers had any financial or
other interests in any transaction involving Embraer which was not in the
ordinary course of our business. In addition, at June 7, 2004, the board members and executive officers
owned an aggregate of 19 common shares and 3,353,690 preferred shares. Stock Option Plan At a special shareholders meeting held on April 17, 1998, we approved a
stock option plan for management and employees, including those of our
subsidiaries, subject to restrictions based on continuous employment with us
for at least two years. The five-year term for the granting of options under
the plan expired on May 31, 2003. Under the terms of the plan, we were authorized to grant options to
purchase up to 25,000,000 preferred shares over the five-year period from the
date of the first grant. As of the end of this five-year period, we had
granted options for an aggregate of 20,237,894 preferred shares, including
662,894 options granted in connection with our preferred stock
dividend in 2002, at a weighted average exercise price of
R$6.17 per share. The options granted to each employee vest as follows: 30%
after three years from the date granted, an additional 30% after four years and
the remaining 40% after five years. Employees may exercise their options for
up to seven years from the date they are granted. At December 31, 2003,
10,252,541 of the total options granted had been exercised, and an additional
1,208,498 options had been exercised as of June 7, 2004. Of the total number
of options granted, options to purchase an aggregate of 7,177,890 preferred
shares have been granted to our executive officers at a weighted average
exercise price of R$5.10 per share, of which 4,920,000 were exercised during
the period from January 1, 2001 through June 7, 2004. 57




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Profit Sharing Plan Pursuant to Brazilian federal law, companies operating in Brazil are
required to share profits with employees beginning from and after fiscal year
1996. However, we understand that no government regulation currently exists
for determining how the profits should be distributed. Prior to 1998, we did
not have a profit sharing plan. However, in light of our continuing financial
recovery since then, we implemented a profit sharing plan in 1998 that ties
employee profit sharing to dividend payments. Every time we pay dividends to our shareholders, we also pay a profit
sharing participation of 25% of the amount of the dividend payment to employees
who have achieved goals established at the beginning of the year. Under the
plan, we may pay additional amounts of up to an additional 5% of such dividend
payment to exceptional employees, on a discretionary basis. We believe that
this policy encourages individual employees to meet our production goals. For the 2001 fiscal year, we distributed US$43.7 million to employees, for
the 2002 fiscal year, we distributed US$25.2 million to employees and for the
2003 fiscal year, we distributed US$20.4 million to employees. 6C. Board Practices All members of our board of directors serve three-year terms and the terms
of all current members expire in April 2007. See Item 6A. Directors and
Senior Management  Board of Directors for the year each of the members of
our board of directors was first elected. The executive officers are elected by the board of directors for a
three-year term, and any executive officer may be removed by the board of
directors before the expiration of his term. See Item 6.A. Directors and
Senior Management  Executive Officers for the year each of our executive
officers was first elected. None of our directors or executive officers is party to an employment
contract providing for benefits upon termination of employment. Conselho Fiscal Under the Brazilian Corporate Law, the Conselho Fiscal is a corporate body
independent of management and a companys external auditors. A Conselho Fiscal
has not typically been equivalent to or comparable with a U.S. audit committee;
its primary responsibility has been to monitor managements activities, review
the financial statements, and report its findings to the shareholders.
However, pursuant to an exemption under the new SEC rules regarding the audit
committees of listed companies, a foreign private issuer is not required to
have a separate audit committee composed of independent directors if it has a
board of auditors established and selected pursuant to home country legal or
listing provisions expressly requiring or permitting such a board and such
board meets certain requirements. Pursuant to this exemption, our Conselho
Fiscal can exercise the required duties and responsibilities of a U.S. audit
committee to the extent permissible under Brazilian Corporate Law. To comply
with the new SEC rules, the board of auditors must meet the following
standards: it must be separate from the full board, its members must not be
elected by management, no executive officer may be a member, and Brazilian law
must set forth standards for the independence of the members. In addition, in
order to qualify for the exemption, the board of auditors must, to the extent
permitted by Brazilian law:  
    
    be responsible for the appointment, retention, compensation
and oversight of the external auditors (including the resolution of
disagreements between management and the external auditors regarding
financial reporting);  
    
    be responsible for establishing procedures for the receipt,
retention and treatment of complaints regarding accounting, internal
accounting controls or auditing matters, and procedures for the
confidential, anonymous submission by employees of concerns
regarding questionable accounting or auditing matters; 58




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
    
    have the authority to engage independent counsel and other
advisors as it determines necessary to carry out its duties; and  
    
    receive appropriate funding from the company for payment of
compensation to the external auditors, for any advisors and ordinary
administrative expenses. As a foreign private issuer, we have decided to modify our Conselho Fiscal
to comply with the exemption requirements. Our board of directors has already
approved the delegation to the Conselho Fiscal of certain additional
responsibilities and the Conselho Fiscal and board of directors are in the
process of considering and approving appropriate amendments to the Conselho
Fiscal charter. Because Brazilian Corporate Law does not permit the board of
directors to delegate responsibility for the appointment, retention and
compensation of the external auditors and does not provide the board or the
Conselho Fiscal with the authority to resolve disagreements between management
and the external auditors regarding financial reporting, the Conselho Fiscal
cannot fulfill these functions. Therefore, in addition to its oversight
responsibilities, the Conselho Fiscal may only make recommendations to the
board of directors with respect to the appointment, retention and compensation
of the external auditors, and with regard to resolution of disagreements
between management and the external auditors, the Conselho Fiscal may only make
recommendations to management and the board. Under the Brazilian Corporate Law, the Conselho Fiscal may not contain
members who are members of the board of directors or the executive committee,
or who are employees of Embraer or employees of a controlled company or of a
company of this group, or a spouse or relative of any member of our management.
In addition, the Brazilian Corporate Law requires that Conselho Fiscal members
receive a remuneration at least 10% of the average amount paid to each
executive officer. The Brazilian Corporate Law requires a Conselho Fiscal to
be composed of a minimum of three and a maximum of five members and their
respective alternates. We have a permanent Conselho Fiscal composed of five members who are
elected at the annual shareholders meeting, with terms lasting until the next
annual shareholders meeting after their election. Under the Brazilian
Corporate Law, holders of preferred shares have the right to elect separately
one member of the Conselho Fiscal. Also, under the Brazilian Corporate Law,
minority groups of shareholders that hold at least 10% of the voting shares
also have the right to elect separately one member of the Conselho Fiscal. In
any event, however, the common shareholders have the right to elect the
majority of the members of the Conselho Fiscal. Set forth below are the names, ages
and positions of the members of our Conselho Fiscal and their respective
alternates, as of April 26, 2004. Name
    
    Age
    
    Position
    
    Year First ElectedJorge Khalil Miski


    44

    Effective member
    
    
    2004Anderson de Sá Almeida

    35

    
    Alternate
    
    
    2004Geraldo Humberto de Araujo(1)

    52
    
    Effective member
    
    
    2004Tarcísio Luiz Silva Fontenele(1)

    41

    
    Alternate
    
    
    2001José Mauro Laxe Vilela(2)

    56

    
    Effective member
    
    
    2003Alberto Carlos Monteiro dos Anjos(2)

    41

    
    Alternate
    
    
    2003Taiki Hirashima

    63

    
    Effective member
    
    
    2004Emerson Luis Juncom

    30

    
    Alternate
    
    
    2004Celene Carvalho de Jesus(3)

    48

    
    Effective member
    
    
    2003Nilo Ribeiro Calvalcanti Filho(3)

    50

    
    Alternate
    
    
    2003
   (1)
    
    Employed by SISTEL.(2)
    
    Employed by Cia. Bozano.(3)
    
    Employed by PREVI. Special Committee In
April 2004, our board of directors established a Special
Committee with a term of 18 months with the first task of reviewing the
boards policies regarding the compensation and profit sharing for our
executive officers and making recommendations for the revision of such
policies. The committee is composed of two members of our board of directors
and one alternate member of our board of directors. The members of the 59




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Special Committee and their alternates are as follows: Vitor
Sarquis Hallack (alternate: Carlyle Wilson), Wilson Carlos Duarte Delfino
(alternate: Carlos Alberto Cardoso Moreira) and Maysa Oliveira da Volta
(alternate: Luiz Carlos Siqueira Aguiar). 6D. Employees We employed a total of 11,048, 12,227 and 12,941 people at December 31,
2001, 2002 and 2003, respectively. Approximately 93.4% of our workforce is
employed in Brazil. Of the total workforce at December 31, 2003, 47.2% are
directly involved in the production process, 23.6% are engaged in research and
development, 7.7% are administrative employees involved in support of the
production process and 21.5% are other administrative employees. Most of our
technical staff is trained at leading Brazilian engineering schools, including
the Instituto Tecnológico Aeronáutico, known as the ITA, located in São José
dos Campos. A small percentage of our employees belong to one of two different
labor unions, the Sindicato dos Metalúrgicos(Union of Metallurgical Workers)
or the Sindicato dos Engenheiros do Estado de São Paulo(Union of Engineers of
the State of São Paulo). Overall, union membership as a percentage of total
workforce has declined significantly in past years. At December 31, 2003,
approximately 81% of our employees were non-union. We believe that relations
with our employees are good. We actively support the training and professional development of our
employees. We have established a program at our facility in São José dos
Campos to provide newly graduated engineers with specialized training in
aerospace engineering. In addition, we provide a masters in business
administration course for our administrative personnel at our executive
offices, conducted by Fundação Getúlio Vargas, a business administration
university in São Paulo. 6E. Share Ownership At June 7, 2004, the board members and executive officers owned an
aggregate of 19 common shares and 3,353,690 preferred shares. None of the
officers or directors individually own more than 1% of the outstanding common
shares or preferred shares. As of June 7, 2004, our executive officers also
owned options to purchase an aggregate of 2,257,890 preferred shares at
per-share purchase prices ranging from R$1.65 to R$23.00. As of the same date,
none of our directors owned any options to purchase shares of common or
preferred stock. See Item 6B. Compensation  Stock Option Plan for a description of our
stock option plan applicable to our management and employees, including those
of our subsidiaries. 60




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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 7A. Major Shareholders We have total authorized capital of 1,500,000,000 shares, with a total
aggregate of 716,489,108 shares issued and outstanding at June 7, 2004. Of
this total, 242,544,448 are common shares (including one special golden share
held by the Brazilian government) and 473,944,660 are non-voting preferred
shares. The following table sets forth share ownership information for each of
our shareholders that beneficially owns 5% or more of any class of our equity
securities and for our executive officers and board members at June 7, 2004,
including 3,911,025 preferred shares underlying the options exercisable within
60 days of the date of this annual report. Common Shares
    
    Preferred Shares
    
    Total SharesShares
    
    (%)
    
    Shares
    
    (%)
    
    Shares
    
    (%)PREVI(1)
    
    
    57,594,479
    
    
    
    23.8
    
    
    
    60,872,078
    
    
    
    12.7
    
    
    
    118,466,557
    
    
    
    16.4SISTEL(2)
    
    
    48,508,890
    
    
    
    20.0
    
    
    
    2,175,725
    
    
    
    **
    
    
    
    50,684,615
    
    
    
    7.0Cia. Bozano(3)(4)
    
    
    48,509,220
    
    
    
    20.0
    
    
    
    18,786,588
    
    
    
    3.9
    
    
    
    67,295,808
    
    
    
    9.3Bozano Holdings Ltd.(3)(4)
    
    
    
    
    
    
    
    
    
    
    8,896,920
    
    
    
    1.9
    
    
    
    8,896,920
    
    
    
    1.2BNDESPAR(5)
    
    
    3,734,893
    
    
    
    1.5
    
    
    
    46,929,918
    
    
    
    9.8
    
    
    
    50,664,811
    
    
    
    7.0Dassault Aviation(6)
    
    
    13,744,186
    
    
    
    5.7
    
    
    
    1,953,132
    
    
    
    **
    
    
    
    15,697,318
    
    
    
    2.2Thales(6)
    
    
    13,744,186
    
    
    
    5.7
    
    
    
    1,953,132
    
    
    
    **
    
    
    
    15,697,318
    
    
    
    2.2EADS(6)
    
    
    13,744,186
    
    
    
    5.7
    
    
    
    1,953,132
    
    
    
    **
    
    
    
    15,697,318
    
    
    
    2.2SNECMA(6)
    
    
    7,276,332
    
    
    
    3.0
    
    
    
    1,034,010
    
    
    
    **
    
    
    
    8,310,342
    
    
    
    1.2União Federal/Brazilian Government(7)
    
    
    1,850,495
    
    
    
    **
    
    
    
    499,415
    
    
    
    **
    
    
    
    2,349,910
    
    
    
    **Officers and directors as a group(8)
    
    
    19
    
    
    
    **
    
    
    
    4,452,057
    
    
    
    **
    
    
    
    4,452,076
    
    
    
    **Other(9)
    
    
    33,837,562
    
    
    
    14.0
    
    
    
    329,114,551
    
    
    
    68.8
    
    
    
    362,952,113
    
    
    
    50.3Total
    
    
    242,544,448
    
    
    
    
    
    
    
    478,620,658
    
    
    
    
    
    
    
    721,165,106Percentage of total shares outstanding
    
    
    
    
    
    
    33.6
    
    
    
    
    
    
    
    66.4
    
    
    
    
    
    
    
    100.0
   **
    
    Less than 1%.(1)
    
    Banco do Brasil Employee Pension Fund, also known as PREVI, was founded
in 1904 as a pension fund for the employees of Banco do Brasil S.A, which
is controlled by the Brazilian government.(2)
    
    SISTEL Social Security Foundation, also known as SISTEL, was founded in
1977 as part of the Telebrás system, which, prior to its recent
privatization, consisted of the Brazilian government-owned
telecommunications companies.(3)
    
    The above table does not reflect any exchangeable notes issued by BNDES
that may be currently owned by Bozano Holdings Ltd.(4)
    
    Cia. Bozano and Bozano Holdings Ltd. are owned and controlled by Julio
Bozano. All preferred shares owned by Cia. Bozano and Bozano Holdings
Ltd. have been pledged in favor of Banco Santander Central Hispano, S.A.
in connection with its acquisition from Cia. Bozano of substantially all
of the capital stock of Banco Meridional S.A.(5)
    
    BNDESPAR is a wholly owned subsidiary of Banco Nacional de
Desenvolvimento Econômico e Social  BNDES, the government-owned national
development bank of Brazil.(6)
    
    Member of the European Aerospace and Defense Group.(7)
    
    The Brazilian government also holds the golden share.(8)
    
    The number of preferred shares includes 1,098,367 preferred shares
underlying options which are exercisable within 60 days of the date of
this annual report.(9)
    
    The number of preferred shares includes 2,812,658 preferred shares
underlying options which are exercisable within 60 days of the date of
this annual report. Other than as discussed in Item 4. Information on the Company  History
and Development of the Company, there have been no significant changes in
percentage ownership by any major shareholder in the past three years. On June 24, 2004, we had 23,271 holders, either directly or through ADSs,
of preferred shares, and 3,725 holders of record of common shares. On June 24,
2004, an aggregate of 265,558,156 preferred shares were held, either directly
or through ADSs, by 189 record holders, including DTC, in the United States. 61




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Voting Rights Voting Rights of the Common Shares Each common share entitles the holder thereof to one vote at our annual
and special shareholders meetings. Shareholders Agreement Each of Cia. Bozano, PREVI and SISTEL, our controlling shareholders, has
agreed to comply with the terms of a shareholders agreement entered into on
July 24, 1997, as amended, which governs matters relating to their equity
ownership of Embraer for a ten-year term and can be successively renewed for
five-year terms. According to the shareholders agreement, when appointing the
members of our board of directors at shareholders meetings, our controlling
shareholders have agreed to appoint two representatives (and alternates) of
each one of the controlling shareholders and to vote together to elect two
representatives (and alternates) of the European Aerospace and Defense Group
and one representative (and alternate) of the Brazilian government. Our controlling shareholders have also agreed in the shareholders
agreement that the Chairman of our board of directors will be chosen by
agreement among them every 18 months and that the Chairman shall be one of
their representatives. In the event that our controlling shareholders cannot
agree on who will be the Chairman of the board, the order in which their
representatives will take turns as Chairman shall be decided by lottery. In accordance with the shareholders agreement, our controlling
shareholders may not sell, assign, contribute as capital, pledge or in any
other way transfer, dispose of or create a lien on the common shares tied to
control of Embraer held by them, except as provided for in the shareholders
agreement or if the transaction is previously authorized in writing by the
other parties. According to the shareholders agreement, if any controlling
shareholder wishes to sell, assign, transfer or in any way dispose of part or
all of its common shares tied to control of Embraer, whether or not together
with other shares of Embraer of any kind or class, the other controlling
shareholders shall have a right of first refusal to acquire the shares being
offered. The shareholders agreement provides that our controlling shareholders
shall meet or shall manifest their position by fax or any other electronic
means in connection with any shareholders meeting or meeting of the board of
directors, as the case may be, when any of the following matters involving us
or any of our subsidiaries shall be decided:  
    
    amendment to the bylaws, except when required by law;  
    
    increase of capital by subscription, creation of a new class
of shares, change in the characteristics of the existing shares or
reduction of capital;  
    
    issuance of debentures convertible into shares, subscription
warrants and options for the purchase of shares;  
    
    merger or spin-off;  
    
    liquidation, dissolution and voluntary acts of financial reorganization;  
    
    acquisition or sale of participation in other companies,
except special purpose companies that are necessary or desirable in
our business of selling aircraft;  
    
    establishment of a dividend policy which differs from that
provided for in the bylaws as the minimum dividend;  
    
    approval of new investments and/or financing and/or sale of
investments in an amount higher than that agreed upon by the parties
from time to time; 62




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
    
    approval and change of long-term business plans;  
    
    determination of the remuneration of, and participation in our profits by, our managers;  
    
    selection, hiring and firing of our executive officers;  
    
    choosing our external auditors;  
    
    granting liens on, or guarantees in favor of, real or
personal property or obligations of management except for those
necessary or desirable in our business of manufacturing and selling
aircraft;  
    
    sale of a substantial part of our permanent assets; and  
    
    use of profits. The shareholders agreement also states that our controlling shareholders
will vote in favor of maintaining and increasing our strategic relationship
with the Brazilian Armed Forces, particularly with the Brazilian Air Force, in
order to assure that we continue to prioritize our relationship with Brazil,
without prejudice to our other corporate interests. Golden Share The golden share is held by the Federative Republic of Brazil. The golden
share is entitled to the same voting rights as the holders of common shares.
In addition, the golden share entitles the holder thereof to veto rights over
the following corporate actions:  
    
    change of our name and corporate purpose;  
    
    amendment to and/or extension of our logo;  
    
    creation and/or alteration of military programs (whether or not involving Brazil);  
    
    third party training in technology for military programs;  
    
    discontinuance of the supply of military airplane maintenance and replacement parts;  
    
    transfer of share control; and  
    
    any change to the list of corporate actions over which the
golden share carries veto power, to the structure and composition of
the board of directors, and to the rights conferred to the golden
share. Voting Rights of the Preferred Shares Preferred shares do not entitle the holder to vote except as set forth
below. However, holders of preferred shares are entitled to attend meetings of
shareholders and to participate in the discussion of matters submitted for
consideration. The Brazilian Corporate Law requires that non-voting preferred shares
which are entitled to receive fixed or minimum dividends shall acquire voting
rights in the event a company fails to pay, from one to three consecutive
fiscal years as established in the bylaws, the fixed or minimum dividend to
which such shares are entitled. Because our preferred shares are not entitled
to fixed or minimum dividends, they cannot acquire voting rights under this
rule. However, our preferred shares are entitled to their share of any
mandatory dividend distributions that we make. See Item 8A. Consolidated
Statements and Other Financial Information  Dividends and Dividend Policy 
Amounts Available for Distribution. 63




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Any change in the preference or rights of preferred shares, or the
creation of a class of shares having priority or preference over preferred
shares, requires approval by at least half of all outstanding voting shares and
either (1) prior approval of holders of a majority of the outstanding preferred
shares at a special meeting of holders of preferred shares or (2) subsequent
ratification by holders of a majority of the outstanding preferred shares. In
such special meetings, each preferred share will entitle the holder thereof to
one vote. Pursuant to the recent amendments to the Brazilian Corporate Law,
shareholders that together hold preferred shares representing at least 10% of
our total share capital are entitled to appoint a member of our board of
directors. To date, none of our directors has been appointed by our preferred
shareholders. 7B. Related Party Transactions We have engaged in a number of transactions with our subsidiaries and the
Brazilian government, as described below. According to the shareholders
agreement, our controlling shareholders will not permit us to engage in
transactions or arrangements with any of our affiliates on a basis or terms
less favorable to us than would be obtainable at that time from an unaffiliated
third party in an arms-length transaction or other arrangement. Brazilian Government The Brazilian government, principally through the Brazilian Air Force, has
participated in the development of Embraer since its inception. For the years
ended December 31, 2001, 2002 and 2003, the Brazilian government accounted for
approximately 1.5%, 1.6% and 3.8% of our net sales, respectively. We expect to
continue to be the primary source of new aircraft and spare parts and services
for the Brazilian government. For a description of our transactions with the
Brazilian government, see Item 4B. Business Overview  Defense Business. The Brazilian government plays a key role as:  
    
    a source for research and development debt financing through
technology development institutions such as FINEP and BNDES; and  
    
    an export support agency through BNDES. See Item 4B. Business Overview  Aircraft Financing Arrangements, Item
3D. Risk Factors  Risks Relating to Embraer  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 and Item 3D. Risk Factors  Risks Relating to Embraer 
Brazilian government budgetary constraints could reduce amounts available to
our customers under government-sponsored financing programs. We maintain credit facilities with BNDES and FINEP, primarily to fund
development costs of the ERJ 145 and AL-X, of which US$61.4 million and US$5.0
million was outstanding, respectively, at December 31, 2003. Amounts borrowed
from BNDES are secured by first, second and third mortgages on Embraers
properties in Brazil, as well as first priority mortgages on seven EMB 120
Brasília aircraft. The interest rates under our FINEP credit facility range
from TJLP plus 3.0% to TJLP plus 5.5% per annum. The interest rates under our
BNDES credit facility are either fixed at 5.5% per annum or range from TJLP
plus 3.3% to TJLP plus 4.4%, plus fees at the rate of 0.35% of the sales price
of 420 ERJ 145s sold between January 1, 1997 and August 1, 2002. The Brazilian government has been an important source of export financing
for our customers through the BNDES-eximprogram, administered by BNDES. In
addition, Banco do Brasil S.A., which is owned by the Brazilian government,
administers the ProEx program, which enables some of our customers to receive
the benefit of interest discounts. In connection with a private offering of exchangeable notes by BNDES
completed on June 19, 2001, we became party to a registration rights agreement
pursuant to which we agreed, among other things, to register resales of the
ADSs and underlying preferred shares relating to the exchangeable notes. We
agreed to indemnify the initial 64




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purchasers of these notes and holders selling under our resale
registration statement against certain liabilities under the Securities Act, or
to contribute to payments that they may be required to make in respect of those
liabilities. In February and March of 1999, we sold a total of 83,330 debentures with a
principal amount of R$1,800 per debenture with a term of seven years, mostly to
BNDESPAR, a wholly owned subsidiary of BNDES. We coupled each debenture with
100 detachable subscription warrants issued in five series. Each warrant
entitled its holder to subscribe for ten preferred shares or, under some
limited circumstances, ten common shares of Embraer. In February 2000, holders
exercised 833,500 of these subscription warrants, resulting in our issuing
8,335,000 preferred shares at an issue price of R$2.1998 per share. After that
date, BNDESPAR became the only holder of subscription warrants. In July 2000,
BNDESPAR exercised 105,700 of the subscription warrants, resulting in our
issuing 1,057,000 preferred shares at an issue price of R$2.4769 per share. On
May 3, 2001, BNDESPAR exercised its remaining 7,393,800 warrants in exchange
for 73,938,000 preferred shares at an issue price of R$2.4769 per share. We have entered into numerous financing transactions with the Brazilian
government-owned Banco do Brasil S.A. and its affiliates. At December 31,
2001, 2002 and 2003, we maintained cash investments of US$69.5 million, US$84.1
million and US$534.0 million, respectively, with Banco do Brasil S.A. and
several of its affiliates. We also had outstanding borrowings from Banco do
Brasil S.A. and several of its affiliates, which at December 31, 2001, 2002 and
2003 equaled US$182.3 million, US$212.7 million and US$375.2 million,
respectively. In addition, BB Banco de Investimento, S.A., an affiliate of
Banco do Brasil S.A., was an underwriter in a secondary offering in Brazil,
completed on June 19, 2001, in which some of our shareholders sold an aggregate
of 6,900,000 of our preferred shares. European Aerospace and Defense Group Thales, a member of the European Aerospace and Defense Group, is
also a joint venture partner with the General Electric Company in a company
called GE Capital Aviation Training Limited, or GECAT. We have entered into an
agreement with GECAT whereby GECAT provides training for the EMBRAER 170/190
jet family on a non-exclusive basis. We pay GECAT for the training services
provided by GECAT to our customers for the EMBRAER 170/190 jet family and for
each component of the system supplied by GECAT to provide such training, which
system includes flight simulators, courseware, training media, computer-based
training and training courses. In March 2002, we formed a consortium with Dassault, Thales and
SNECMA to bid on the development and manufacture of up to 24 fighter jets for
the Brazilian Air Force. The planned jet, the Mirage 2000 BR, is modeled on
the Dassault Mirage 2000-5 supersonic jet. As leaders of the consortium, we
would have coordination and management responsibilities in the program. As a
result of this consortium and as part of our strategic alliance agreement,
Dassault would transfer to us the technology for the Mirage, enabling us to
have full control over the project technology as well. The selection of the
winner of the bid has not yet been made. We have also entered into commercial transactions with the European
Aerospace and Defense Group for the purchase of certain equipment and services
in the ordinary course of our business in the total amount of US$6.9 million in
2001, US$11.8 million in 2002 and US$14.5 million in 2003. See Note 30 to our consolidated financial statements for more information
regarding related party transactions. 7C. Interests of Experts and Counsel Not applicable. 
 ITEM 8. FINANCIAL INFORMATION 8A. Consolidated Statements and Other Financial Information See Item 3A. Selected Financial Data and Item 18. Financial
Statements. 65




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Legal Proceedings We have some individual labor lawsuits, several of which have already been
settled, but we are awaiting the decision of the Brazilian labor courts on
others. We do not believe that any liabilities related to these individual
lawsuits will have a material adverse effect on our financial condition or
results of operations. We have challenged the constitutionality of the nature of and
modifications in rates and the increase in the calculation base of certain
Brazilian taxes and social charges in order to obtain writs of mandamus or
injunctions to avoid payments or recover past payments. Interest on the total
amount of unpaid taxes and social charges accrues monthly based on the Selic
rate, the key lending rate of the Central Bank, and we make an accrual as part
of the interest income (expense) item of our statements of income. As of
December 31, 2003, we had obtained preliminary injunctions for not paying or
recovering past payments in the total amount, including interest, of US$302.6
million, which is included as a liability on our balance sheet. See Item 3D.
Risk Factors  Risks Relating to Embraer  We may have to make significant
payments as a result of unfavorable outcomes of pending challenges to certain
taxes and social charges and Note 16 to our consolidated financial statements
for a further discussion of these challenges. In addition, we are involved in other legal proceedings, including tax
disputes, all of which are in the ordinary course of business. Our management
does not believe that any of these other proceedings, if adversely determined,
would materially or adversely affect our business, financial condition or
results of operations. See Note 17 to our consolidated financial statements
for a further discussion of the legal proceedings we face. Dividends and Dividend Policy Amounts Available for Distribution At each annual shareholders meeting, the board of directors is required
to recommend how net profits for the preceding fiscal year are to be allocated.
For purposes of the Brazilian Corporate Law, net profits are defined as net
income after income taxes and social contribution taxes for such fiscal year,
net of any accumulated losses from prior fiscal years and any amounts allocated
to employees and managements participation in our profits. In accordance
with the Brazilian Corporate Law and our bylaws, the amounts available for
dividend distribution are the amounts equal to our net profits less any amounts
allocated from such net profits to:  
    
    the legal reserve;  
    
    a contingency reserve for anticipated losses; and  
    
    an unrealized revenue reserve. We are required to maintain a legal reserve, to which we must allocate 5%
of net profits for each fiscal year until the amount for such reserve equals
20% of our paid-in capital. However, we are not required to make any
allocations to our legal reserve in respect of any fiscal year in which it,
when added to our other established capital reserves, exceeds 30% of our
capital. Net losses, if any, may be charged against the legal reserve. At
December 31, 2003, the balance of our legal reserve was US$87.4 million, which
was equal to 9.8% of our paid-in capital at December 31, 2003. The Brazilian Corporate Law also provides for two additional,
discretionary allocations of net profits that are subject to approval by the
shareholders at the annual meeting. First, a percentage of net profits may be
allocated to a contingency reserve for anticipated losses that are deemed
probable in future years. Any amount so allocated in a prior year must be
either reversed in the fiscal year in which the loss was anticipated if such
loss does not in fact occur, or written off in the event that the anticipated
loss occurs. Second, if the amount of unrealized revenue exceeds the sum of:  
    
    the legal reserve;  
    
    the investment and working capital reserve; 66




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
    
    retained earnings; and  
    
    the contingency reserve for anticipated losses, such excess may be allocated to an unrealized revenue reserve. Under the
Brazilian Corporate Law, unrealized revenue is defined as the sum of:  
    
    price-level restatement of balance sheet accounts;  
    
    the share of equity earnings of affiliated companies; and  
    
    profits from installment sales to be received after the end of the next succeeding fiscal year. According to our bylaws and subject to shareholder approval, our board of
directors may allocate at least 5% of our net income to an investment and
working capital reserve. The purpose of the investment and working capital
reserve is to make investments in fixed assets or increase our working capital.
This reserve may also be used to amortize our debts. We may also grant a
participation in our net income to our management and employees. However, the
allocation to the investment and working capital reserve or the participation
of our management and employees cannot reduce the mandatory distributable
amount (discussed below). The balance of the investment and working capital
reserve plus the balance of other profit reserves (except the contingency
reserve for anticipated losses and the unrealized revenue reserve) may not be
higher than our capital. Otherwise, the amount in excess of our capital must
be used to increase our capital or be distributed as a cash dividend. The
balance of the investment and working capital reserve may be used:  
    
    in the deduction of accumulated losses, whenever necessary;  
    
    in the distribution of dividends, at any time;  
    
    in the redemption, withdrawal, purchase or open market
repurchase of shares, as authorized by law; and  
    
    to increase our capital, including by means of an issuance of
new shares. The amounts available for distribution may be further increased by a
reversion of the contingency reserve for anticipated losses constituted in
prior years but not realized, or further increased or reduced as a result of
the allocations of revenues to or from the unrealized revenue reserve. The
amounts available for distribution are determined on the basis of financial
statements prepared in accordance with the Brazilian Corporate Law method. Mandatory Distribution The Brazilian Corporate Law generally requires that the bylaws of each
Brazilian corporation specify a minimum percentage of the amounts available for
distribution by such corporation for each fiscal year that must be distributed
to shareholders as dividends, also known as the mandatory distributable amount.
Under our bylaws, the mandatory distributable amount has been fixed at an
amount equal to not less than 25% of the amounts available for distribution, to
the extent amounts are available for distribution. On May 5, 1997, Law No.
9,457 became effective, granting holders of preferred stock not carrying a
right to fixed or minimum dividends, such as our preferred shares, a statutory
right to receive dividends in an amount per share of at least 10% more than the
amount per share paid to holders of common stock. The mandatory distribution is based on a percentage of adjusted net
income, not lower than 25%, rather than a fixed monetary amount per share. The
Brazilian Corporate Law, however, permits a publicly held company, such as
Embraer, to suspend the mandatory distribution of dividends if the board of
directors and the audit committee report to the shareholders meeting that the
distribution would be inadvisable in view of the companys financial condition.
This suspension is subject to approval of holders of common shares. In this
case, the board of directors shall file a justification for such suspension
with the CVM. Profits not distributed by virtue of the 67




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suspension mentioned above shall be attributed to a special reserve and,
if not absorbed by subsequent losses, shall be paid as dividends as soon as the
financial condition of such company permits such payments. As our preferred
shares are not entitled to a fixed or minimum dividend, our ability to suspend
the mandatory distribution of dividends applies to the holders of preferred
shares and, consequently, to the holders of ADSs. Payment of Dividends We are required by the Brazilian Corporate Law and by our bylaws to hold
an annual shareholders meeting by the end of the fourth month after the end of
each fiscal year at which, among other things, the shareholders have to decide
on the payment of an annual dividend. The payment of annual dividends is based
on the financial statements prepared for the relevant fiscal year. Under the
Brazilian Corporate Law, dividends generally are required to be paid within 60
days following the date the dividend was declared, unless a shareholders
resolution sets forth another date of payment, which, in either case, must
occur prior to the end of the fiscal year in which the dividend was declared.
A shareholder has a three-year period from the dividend payment date to claim
dividends (or interest payments) in respect of its shares, after which the
amount of the unclaimed dividends reverts to us. The Brazilian Corporate Law permits a company to pay interim dividends out
of preexisting and accumulated profits for the preceding fiscal year or
semester, based on financial statements approved by its shareholders.
According to our bylaws, the shareholders may declare, at any time, interim
dividends based on the preexisting and accumulated profits, provided the
mandatory dividend has already been distributed to the shareholders. Our
bylaws also permit us to prepare financial statements semiannually and for
shorter periods. Our board of directors may approve the distribution of
dividends calculated with reference to those financial statements, even before
they have been approved by the shareholders. However, such dividends cannot
exceed the amount of capital reserves. In general, shareholders who are not residents of Brazil must register
with the Central Bank to have dividends, sales proceeds or other amounts with
respect to their shares eligible to be remitted outside of Brazil. The
preferred shares underlying our ADSs will be held in Brazil by Banco Itaú S.A.,
also known as the custodian, as agent for the depositary, which will be the
registered owner on the records of the registrar for our shares. Our current
registrar is Banco Itaú. The depositary electronically registered the
preferred shares underlying our ADSs with the Central Bank and, therefore, is
able to have dividends, sales proceeds or other amounts with respect to these
shares eligible to be remitted outside Brazil. Payments of cash dividends and distributions, if any, will be made in
Brazilian currency to the custodian on behalf of the depositary, which will
then convert such proceeds into U.S. dollars and will cause such U.S. dollars
to be delivered to the depositary for distribution to holders of ADSs. Under
current Brazilian law, dividends paid to shareholders who are not Brazilian
residents, including holders of ADSs, will not be subject to Brazilian
withholding income tax, except for dividends declared based on profits
generated prior to December 31, 1995. See Item 10E. Taxation  Brazilian Tax
Consequences. History of Dividend Payments and Dividend Policy and Additional Payments on
Shareholders Equity We did not pay dividends from 1988 through 1997 because we did not have
net profits for any year during that period. On January 16, 1998, we reduced
our capital in order to offset our accumulated deficit. As a result, we were
then able to distribute profits achieved in 1998. Law No. 9,249, dated December 26, 1995, as amended, provides for
distribution of interest on net worth to shareholders as an alternative form of
payment to shareholders. Such interest is limited to the daily pro rata
variation of the TJLP and cannot exceed the greater of:  
    
    50% of net income (after taking into account the provisions
for the Contribuição Social Sobre o Lucro Líquido, or Social
Contribution on Net Profits, or CSLL, but before taking into account
such distribution and any deductions for income taxes) for the
period in respect of which the payment is made; or 68




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
    
    50% of the sum of retained earnings and profit reserves as of
the beginning of the year in respect of which the payment is made. Distribution of interest on net worth may also be accounted for as a tax
deductible expense. Any payment of interest on shareholders equity to holders
of ADSs or preferred shares, whether or not they are Brazilian residents, is
subject to Brazilian withholding income tax at the rate of 15% or 25% if the
beneficiary is resident in a tax haven. See Item 10E. Taxation  Brazilian
Tax Consequences. The amount paid to shareholders as interest on net worth,
net of any withholding tax, may be included as part of any mandatory
distributable amount. Under Brazilian law, we are obligated to distribute to
shareholders an amount sufficient to ensure that the net amount received by
them, after payment by us of applicable Brazilian withholding taxes in respect
of the distribution of interest on net worth, is at least equal to the
mandatory distributable amount. When we distribute interest on net worth, and
that distribution is not accounted for as part of the mandatory distribution,
Brazilian withholding tax will apply. All payments to date were accounted for
as part of the mandatory distribution. The following table sets forth the historical payments of dividends and
historical payments of interest on shareholders equity we made to our
shareholders. Date of approval
    
    Period in which profits were generated
    
    Total amount of Distribution(R$ in millions)
    
    (US$ in millions) (3)September 18, 1998(1)
    
    First two quarters of 1998
    
    
    21.3
    
    
    
    17.9March 30, 1999(1)
    
    Remaining two quarters of 1998
    
    
    33.9
    
    
    
    19.7September 28, 1999(1)
    
    First two quarters of 1999
    
    
    36.8
    
    
    
    19.1January 31, 2000(1)
    
    Remaining two quarters of 1999
    
    
    86.7
    
    
    
    48.1March 24, 2000(2)
    
    First quarter of 2000
    
    
    19.6
    
    
    
    11.2June 16, 2000(2)
    
    Second quarter of 2000
    
    
    19.9
    
    
    
    11.0July 6, 2000(1)
    
    First two quarters of 2000
    
    
    79.6
    
    
    
    44.8September 22, 2000(2)
    
    Third quarter of 2000
    
    
    27.7
    
    
    
    15.0December 15, 2000(2)
    
    Fourth quarter of 2000
    
    
    33.5
    
    
    
    17.1March 16, 2001(1)
    
    Remaining two quarters of 2000
    
    
    107.5
    
    
    
    49.7March 16, 2001(2)
    
    First quarter of 2001
    
    
    33.8
    
    
    
    15.7June 13, 2001(2)
    
    Second quarter of 2001
    
    
    41.4
    
    
    
    18.0September 14, 2001(1)
    
    First two quarters of 2001
    
    
    123.1
    
    
    
    46.1September 14, 2001(2)
    
    Third quarter of 2001
    
    
    48.4
    
    
    
    18.1December 15, 2001(2)
    
    Fourth quarter of 2001
    
    
    57.1
    
    
    
    24.6March 19, 2002(1)
    
    Remaining two quarters of 2001
    
    
    100.0
    
    
    
    43.0March 19, 2002(2)
    
    First quarter of 2002
    
    
    58.9
    
    
    
    25.4June 14, 2002(2)
    
    Second quarter of 2002
    
    
    59.5
    
    
    
    20.9September 13, 2002(2)
    
    Third quarter of 2002
    
    
    66.3
    
    
    
    17.0December 13, 2002(2)
    
    Fourth quarter of 2002
    
    
    70.0
    
    
    
    19.8December 13, 2002(2)
    
    1998 and 1999
    
    
    72.5
    
    
    
    20.5June 16, 2003(2)
    
    First two quarters of 2003
    
    
    76.7
    
    
    
    26.7December 12, 2003(2)
    
    Remaining two quarters of 2003
    
    
    118.5
    
    
    
    41.0March 12, 2004(2)
    
    First quarter of 2004
    
    
    101.0
    
    
    
    34.7
   (1)
    
    Represents dividend payments.(2)
    
    Represents interest on shareholders equity.(3)
    
    Translated from nominal reaisinto U.S. dollars at the
commercial selling rates in effect on the dates that the dividends
were approved. Further, on June 25, 2004, our Board of Directors approved the payment of
interest on shareholders equity for the second quarter of 2004 in the total
amount of R$160.0 million to be paid in Brazil on July 15, 2004, which,
translated using the exchange rate on June 25, 2004, would be equivalent to
US$51.6 million. On March 1, 2002, we issued 88,430,168 preferred shares in the form of a
stock dividend to each holder of common and preferred shares at that date, at
the rate of 0.142106 new preferred shares for each existing share. We intend to declare and pay dividends and/or interest on shareholders
equity, as required by the Brazilian Corporate Law and our bylaws. Our board
of directors may approve the distribution of dividends and/or interest on 69




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shareholders equity, calculated based on our semiannual or quarterly
financial statements. The declaration of annual dividends, including dividends
in excess of the mandatory distribution, requires approval by the vote of the
majority of the holders of our common stock. The amount of any distributions
will depend on many factors, such as our results of operations, financial
condition, cash requirements, prospects and other factors deemed relevant by
our board of directors and shareholders. Within the context of our tax
planning, we may in the future continue to determine that it is to our benefit
to distribute interest on shareholders equity. 8B. Significant Changes No significant changes or events have occurred after the close of the
balance sheet date at December 31, 2003, other than the events already
described in this annual report. For a summary of our announced unaudited financial results for the first
quarter of 2004, see Item 5A. Operating Results  Recent Developments. 
 ITEM 9. THE OFFER AND LISTING 9A. Offer and Listing Details Our ADSs are listed on the New York Stock Exchange, or NYSE, under the
symbol ERJ. In addition, our preferred shares are traded on the São Paulo
Stock Exchange under the symbol EMBR4. Each ADS represents four preferred
shares. The reported high and low closing sale prices in U.S. dollars for the ADSs
on the NYSE for the periods indicated are set forth in the following table: Price in U.S. dollarsper ADSHigh
    
    Low2000:Year end (from July 20)
    
    
    39.75
    
    
    
    18.502001:Year end
    
    
    45.50
    
    
    
    11.452002:First quarter
    
    
    25.01
    
    
    
    19.85Second quarter
    
    
    23.77
    
    
    
    19.09Third quarter
    
    
    21.20
    
    
    
    13.30Fourth quarter
    
    
    16.47
    
    
    
    12.85Year end
    
    
    25.01
    
    
    
    12.852003:First quarter
    
    
    16.27
    
    
    
    9.15Second quarter
    
    
    20.26
    
    
    
    12.38Third quarter
    
    
    22.48
    
    
    
    17.18Fourth quarter
    
    
    35.45
    
    
    
    21.42Year end
    
    
    35.45
    
    
    
    9.152004:First quarter
    
    
    36.81
    
    
    
    28.11Second quarter (through June 24)
    
    
    32.57
    
    
    
    23.28Month ended:December 31, 2003
    
    
    35.45
    
    
    
    29.80January 31, 2004
    
    
    36.81
    
    
    
    28.97February 29, 2004
    
    
    30.30
    
    
    
    28.11March 31, 2004
    
    
    32.49
    
    
    
    28.35April 30, 2004
    
    
    32.57
    
    
    
    25.80May 31, 2004
    
    
    26.70
    
    
    
    23.28June 30, 2004 (through June 24)
    
    
    27.75
    
    
    
    25.96
 70




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The table below sets forth, for the periods indicated, the reported high
and low closing sale prices in nominal reaisfor preferred shares on the São
Paulo Stock Exchange. The preferred shares have not traded every day on which
the São Paulo Stock Exchange was open. The common shares are also listed and
traded on the São Paulo Stock Exchange. Nominal reais perpreferred shareHigh
    
    Low1999:Year end
    
    
    8.15
    
    
    
    1.152000:Year end
    
    
    18.30
    
    
    
    7.202001:Year end
    
    
    25.45
    
    
    
    7.652002:First quarter
    
    
    15.20
    
    
    
    11.66Second quarter
    
    
    15.30
    
    
    
    11.20Third quarter
    
    
    15.19
    
    
    
    12.30Fourth quarter
    
    
    15.00
    
    
    
    12.40Year end
    
    
    15.30
    
    
    
    11.202003:First quarter
    
    
    14.05
    
    
    
    8.10Second quarter
    
    
    14.33
    
    
    
    9.84Third quarter
    
    
    16.47
    
    
    
    12.90Fourth quarter
    
    
    25.70
    
    
    
    15.39Year end
    
    
    25.70
    
    
    
    8.102004:First quarter
    
    
    26.43
    
    
    
    20.30Second quarter (through June 24)
    
    
    23.50
    
    
    
    18.30Month ended:December 31, 2003
    
    
    25.70
    
    
    
    21.70January 31, 2004
    
    
    26.43
    
    
    
    21.10February 29, 2004
    
    
    22.10
    
    
    
    20.43March 31, 2004
    
    
    23.59
    
    
    
    20.30April 30, 2004
    
    
    23.50
    
    
    
    18.51May 31, 2004
    
    
    20.16
    
    
    
    18.30June 30, 2004 (through June 24)
    
    
    21.70
    
    
    
    20.40
 On June 24, 2004, we had 23,271 holders, either directly or through ADSs,
of preferred shares, and 3,725 holders of record of common shares. On June 24,
2004, an aggregate of 265,558,156 preferred shares were held, either directly
or through ADSs, by 189 record holders, including DTC, in the United States. On June 24, 2004, the closing sale price for our preferred shares on the
São Paulo Stock Exchange was R$21.40, which is equivalent to US$27.59 per
ADS. On the same date, the closing sale price for our ADSs on the New York
Stock Exchange was US$27.75. The ADSs are issued under a deposit agreement and
JPMorgan Chase Bank serves as depositary under that agreement. 71




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9B. Plan of Distribution Not applicable. 9C. Markets Trading on the São Paulo Stock Exchange On January 27, 2000, protocols were signed in order to merge the nine
Brazilian stock exchanges. Pursuant to the protocols, publicly traded
Brazilian companies securities are traded on the São Paulo Stock Exchange, and
Brazilian government debt securities are traded on, and privatization auctions
are carried out at, the Rio de Janeiro Stock Exchange. Trading on each
exchange is limited to member brokerage firms and a limited number of
authorized non-members. The CVM and the São Paulo Stock Exchange have
discretionary authority to suspend trading in shares of a particular issuer.
Trading in securities listed on the São Paulo Stock Exchange may be effected
off the exchange, although such trading is limited. The preferred shares are listed and traded on the São Paulo Stock
Exchange. Trades in our preferred shares on the São Paulo Stock Exchange
settle in three business days after the trade date. Delivery of and payment
for shares is made through the facilities of the CBLCCompanhia Brasileira de
Liquidação e Custódia,the clearinghouse for the São Paulo Stock Exchange,
which maintains accounts for member brokerage firms. The seller is ordinarily
required to deliver the shares to the exchange on the second business day
following the trade date. In order to better control volatility, the São Paulo Stock Exchange
adopted a circuit breaker system pursuant to which trading sessions may be
suspended for a period of 30 minutes or one hour whenever the indices of this
stock exchange fall below the limit of 10% and 15%, respectively, in relation
to the index registered in the previous trading session. The São Paulo Stock Exchange is less liquid than the NYSE and other major
exchanges in the world. The São Paulo Stock Exchange had an aggregate market
capitalization of approximately US$201.8 billion at December 31, 2003. In
comparison, the NYSE had a market capitalization of approximately US$12.3
trillion at the same date. Although any of the outstanding shares of a listed
company may trade on the São Paulo Stock Exchange, in most cases fewer than
one-half of the listed shares are actually available for trading by the public,
the remainder being held by small groups of controlling persons, by
governmental entities or by one principal shareholder. At June 7, 2004 we
accounted for approximately 2.3% of the market capitalization of all listed
companies on the São Paulo Stock Exchange. There is also significantly greater concentration in the Brazilian
securities markets than in the NYSE or other major exchanges. During the
one-year period ended December 31, 2003, the ten largest companies listed on
the São Paulo Stock Exchange represented approximately 56.3% of the total
market capitalization of all listed companies and the 10 largest companies
listed on the NYSE represented approximately 19.0% of the total market
capitalization of all listed companies. Trading on the São Paulo Stock Exchange by non-residents of Brazil is
subject to limitations under Brazilian foreign investment legislation. Regulation of Brazilian Securities Markets The Brazilian securities markets are regulated by the CVM, which has
regulatory authority over stock exchanges and the securities markets generally,
and by the Central Bank, which has, among other powers, licensing authority
over brokerage firms and regulates foreign investment and foreign exchange
transactions. Under the Brazilian Corporate Law, a corporation is either public
(companhia aberta), like us, or closely held (companhia fechada). All public
companies, including us, are registered with the CVM and are subject to
reporting requirements. Our shares are listed and traded on the São Paulo
Stock Exchange and may be traded privately subject to limitations. 72




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We have the option to ask that trading in our securities on the São Paulo
Stock Exchange be suspended in anticipation of a material announcement.
Trading may also be suspended on the initiative of the São Paulo Stock Exchange
or the CVM, among other reasons, based on or due to a belief that a company has
provided inadequate information regarding a material event or has provided
inadequate responses to the inquiries by the CVM or the São Paulo Stock
Exchange. The Brazilian securities law, the Brazilian Corporate Law and the
regulations issued by the CVM, the National Monetary Council and the Central
Bank provide for, among other things, disclosure requirements, restrictions on
insider trading and price manipulation, and protection of minority
shareholders. However, the Brazilian securities markets are not as highly
regulated and supervised as the U.S. securities markets or markets in other
jurisdictions. Trading on the São Paulo Stock Exchange by non-residents of Brazil is
subject to limitations under Brazilian foreign investment and tax legislation.
The Brazilian custodian for our preferred shares and the depositary for our
ADSs have obtained an electronic certificate of registration from the Central
Bank to remit U.S. dollars abroad for payments of dividends, any other cash
distributions, or upon the disposition of the shares and sales proceeds
thereto. In the event that a holder of ADSs exchanges ADSs for preferred
shares, the holder will be entitled to continue to rely on the depositarys
electronic certificate of registration for five business days after the
exchange. Thereafter, the holder may not be able to obtain and remit U.S.
dollars abroad upon the disposition of the preferred shares, or distributions
relating to the preferred shares, unless the holder obtains a new electronic
certificate of registration or registers its investment in the preferred shares
under Resolution No. 2,689. 9D. Selling Shareholders Not applicable. 9E. Dilution Not applicable. 9F. Expenses of the Issue Not applicable. 
 ITEM 10. ADDITIONAL INFORMATION 10A. Share Capital Not applicable. 10B. Memorandum and Articles of Association Set forth below is certain information concerning our capital stock, and a
brief summary of certain significant provisions of our bylaws and the Brazilian
Corporate Law. This description does not purport to be complete and is
qualified by reference to our bylaws and to Brazilian law. Corporate Purposes We are a joint stock company with a principal place of business and
jurisdiction in the city of São José dos Campos, São Paulo, Brazil, governed
mainly by our bylaws and the Brazilian Corporate Law. Our corporate
purpose, as stated in our bylaws, is to (1) design, manufacture and market
aircraft and aerospace materials and their respective accessories, components
and equipment in accordance with the highest technology and quality standards,
(2) promote and carry out technical activities related to the production and
maintenance of aerospace materials, (3) contribute towards the education of
technical personnel required for the aerospace industry and (4) conduct
technological, industrial and commercial activities and services related to the
aerospace industry. 73




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Description of Capital Stock General At December 31, 2003, our capital stock consisted of a total of
716,045,583 outstanding shares, without par value, of which 242,544,448 were
common shares, including one special class of common share known as the golden
share, held by the Brazilian government, and 473,501,135 were preferred
shares. Our bylaws authorize the board of directors to increase the capital
stock up to 500,000,000 common shares and up to 1,000,000,000 preferred shares
without seeking specific shareholder approval. All our outstanding shares are
fully paid. Our shareholders must approve at a shareholders meeting any
capital increase that exceeds the above-referenced authorized amounts. Under
the Brazilian Corporate Law, however, the number of non-voting preferred shares
may not exceed two-thirds of the total number of shares. According to the
edital(invitation to bid) issued by the Brazilian government in connection
with our privatization in 1994, non-Brazilians may not hold in excess of 40% of
our common shares. There is no similar restriction on ownership of our
preferred shares. Common Shares Each common share entitles the holder thereof to one vote at our annual
and special shareholders meetings. The Brazilian Corporate Law and our bylaws
require that all our shareholders meetings be called by publication of a
notice in the Diário Oficial do Estado de São Paulo, the official government
publication of the State of São Paulo, and in a newspaper of general
circulation in the city in which our principal place of business is located,
currently São José dos Campos, at least fifteen days prior to the meeting. The
quorum to hold shareholders meetings on first call is generally 25% of the
shares entitled to vote, and on second call the meetings can be held with the
presence of any number of the shares entitled to vote. According to the Brazilian Corporate Law, the common shares are entitled
to dividends in proportion to their share of the amount available for
distribution, subject to any preference of the preferred shares. See Item 8A.
Consolidated Statements and Other Financial InformationDividends and Dividend
Policy for a more complete description of payment of dividends on our shares.
In addition, upon any liquidation of the company, the common shares are
entitled to return of capital in proportion to their share of our net worth,
also subject to the preference of the preferred shares. Preferences of Preferred Shares According to our bylaws, the preferred shares are non-voting except under
limited circumstances and, upon any liquidation of the Company, are entitled to
priority over the common shares in the return of capital in proportion to their
share of our net worth. In addition, according to our bylaws, the preferred
shares are not entitled to fixed or minimum dividend payments. However, under
the Brazilian Corporate Law, preferred shares not entitled to fixed or minimum
dividend payments are entitled to receive dividends in an amount per share that
is 10% greater than the dividends payable on our common shares. See Item 8A.
Consolidated Statements and Other Financial InformationDividends and Dividend
Policy for a more complete description of mandatory annual distributions on
our preferred stock. Golden Share The golden share is held by the Federative Republic of Brazil. For a
discussion of the rights to which the golden share is entitled, see Item 7A.
Major ShareholdersVoting RightsGolden Share. Voting Rights of the Preferred Shares Preferred shares do not entitle the holder to vote except as set forth
below. However, holders of preferred shares are entitled to attend meetings of
shareholders and to participate in the discussion of matters submitted for
consideration. 74




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The Brazilian Corporate Law requires that non-voting preferred shares
which are entitled to receive fixed or minimum dividends shall acquire voting
rights in the event a company fails to pay, from one to three consecutive
fiscal years as established in the bylaws, the fixed or minimum dividend to
which such shares are entitled. Because our preferred shares are not entitled
to fixed or minimum dividends, they cannot acquire voting rights under this
rule. However, our preferred shares are entitled to their share of any
mandatory dividends distributions that we make. See Item 8A. Consolidated
Statements and Other Financial InformationDividends and Dividend
PolicyAmounts Available for Distribution. Any change in the preference or rights of preferred shares, or the
creation of a class of shares having priority or preference over preferred
shares, requires approval by at least half of all outstanding voting shares and
either (1) prior approval of holders of a majority of the outstanding preferred
shares at a special meeting of holders of preferred shares or (2) subsequent
ratification by holders of a majority of the outstanding preferred shares. The
meeting may be called by publication of a notice in the Diário Oficial do
Estado de São Pauloand in a newspaper of general circulation in the city in
which our principal place of business is located, currently São José dos
Campos, at least fifteen days prior to the meeting. In such special meetings,
each preferred share will entitle the holder thereof to one vote. Conversion Rights The shareholders may authorize the conversion of the common shares into
preferred shares on a voluntary basis and, in the event that the number of
shares delivered for conversion exceeds the number of shares authorized for
conversion, on a pro ratabasis; provided that, as a result of such conversion,
the number of non-voting shares, such as our preferred shares, remains below
the limit of two-thirds of our capital stock. Form and Transfer As our shares are in registered book-entry form, the transfer of shares is
governed by the rules of Article 35 of the Brazilian Corporate Law. This
Article provides that a transfer of shares is effected by an entry made by
Banco Itaú S.A., also known as the registrar, in its books, by debiting the
share account of the transferor and crediting the share account of the
transferee. Banco Itaú also performs all the services of safe-keeping and
transfer of shares and related services for us. Transfers of shares by a foreign investor are made in the same way and
executed by that investors local agent on the investors behalf except that if
the original investment was registered with the Central Bank pursuant to
Resolution No. 2,689, the foreign investor must also seek amendment, if
necessary, through its local agent, of the electronic registration to reflect
the new ownership. The São Paulo Stock Exchange operates as a central clearing system. A
holder of our shares may choose, in its discretion, to participate in this
system and all shares elected to be put into this system will be deposited in
the custody of the São Paulo Stock Exchange (through a Brazilian institution
duly authorized to operate by the Central Bank and having a clearing account
with the São Paulo Stock Exchange). The fact that those shares are held in the
custody of the São Paulo Stock Exchange will be reflected in our register of
shareholders. Each participating shareholder will, in turn, be registered in
our register of beneficial shareholders maintained by the São Paulo Stock
Exchange and will be treated in the same way as registered shareholders. Board of Directors Under the Brazilian Corporate Law, the members of a companys board of
directors must be shareholders of the company. There is no requirement as to
the number of shares an individual must own in order to act as a member of the
board of directors. According to the Brazilian Corporate Law, our officers and directors are
prohibited from voting on, or acting in, matters in which their interests
conflict with ours. 75




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Our bylaws provide that the shareholders are responsible for determining
the global remuneration of the members of our management bodies. Our board of
directors is responsible for dividing such remuneration among the members of
management. There are no specific provisions regarding the directors power to
vote on their compensation in the absence of an independent quorum. With respect to the borrowing powers of the board of directors, the board
of directors has the power to authorize the borrowing of funds, either in the
form of bonds, notes, commercial papers or other instruments of regular use in
the market. Other financing arrangements, including bank loans, may be entered
into by us upon the joint signatures of (i) two executive officers, (ii) one
officer and one attorney-in-fact, or (iii) two attorneys-in-fact. There is no requirement under the Brazilian Corporate Law or our bylaws
that directors retire upon reaching a certain age. In addition, our bylaws do
not provide for the re-election of directors at staggered intervals. For a discussion of our board of directors, see Item 6A. Directors and
Senior ManagementBoard of Directors and Item 6C. Board Practices. Limitations on Share Ownership According to the edital(invitation to bid) issued by the Brazilian
government in connection with our privatization in 1994, non-Brazilians may not
hold in excess of 40% of our common shares. There is no similar restriction on
ownership of our preferred shares. However, foreign investments must be
registered with the Central Bank and/or CVM, as the case may be. See Item
10D. Exchange Controls. In addition, there are no legal limitations on the
rights of non-resident or foreign shareholders to exercise their voting rights
as shareholders. There are no provisions in our bylaws with respect to the disclosure of
share ownership. Notwithstanding, the Brazilian Corporate Law states that a
corporation shall provide information regarding its share registry book to any
person, provided that such information is necessary to protect any rights or
clarify situations involving interests of (i) the requesting person, (ii) a
shareholder or (iii) the securities market. Changes to the Brazilian Corporate Law The Brazilian Congress enacted Law No. 10,303 on October 31, 2001, which
modified several provisions of the Brazilian Corporate Law and became effective
with respect to us in March 2002. According to this law, preferred
shareholders who own at least 10% of the total share capital of a company and
common shareholders who own at least 15% of the total common shares of a
company are each are entitled to elect, in a separate election, a
representative to the board of directors. If preferred shareholders and common
shareholders cannot separately achieve the 10% and 15% levels, respectively,
preferred shareholders and common shareholders who together own at least 10% of
the total share capital of a company will be entitled to elect, in a separate
election, a representative to the board of directors. Law 10,303 also modified
the minimum rights attributed to preferred shares, appraisal rights, share
redemption procedures and requirements for the disclosure of trades by
insiders. Significant Differences between our Corporate Governance Practices and NYSE Corporate Governance Standards We are subject to the NYSE corporate governance listing standards. As a
foreign private issuer, the standards applicable to us are considerably
different than the standards applied to U.S. listed companies. Under the
NYSE rules, we are required only to: (i) have an audit committee or audit
board, pursuant to an applicable exemption available to foreign private
issuers, that meets certain requirements, as discussed below, (ii) provide
prompt certification by our chief executive officer of any material
non-compliance with any corporate governance rules, and (iii) provide a brief
description of the significant differences between our corporate governance
practices and the NYSE corporate governance practice required to be followed by
U.S. listed companies. The discussion of the significant differences between
our corporate governance practices and those required of U.S. listed companies
follows below. 76




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Majority of Independent Directors The NYSE rules require that a majority of the board must consist of
independent directors. Independence is defined by various criteria, including
the absence of a material relationship between the director and the listed
company. Brazilian law does not have a similar requirement. Under Brazilian
law, neither our board of directors nor our management is required to test the
independence of directors before their election to the board. However, both
the Brazilian Corporate Law and the CVM have established rules that require
directors to meet certain qualification requirements and that address the
compensation and duties and responsibilities of, as well as the restrictions
applicable to, a companys executive officers and directors. While our
directors meet the qualification requirements of the Brazilian Corporate Law
and the CVM, we do not believe that our directors would be considered
independent under the NYSE test for director independence. The Brazilian Corporate Law and our bylaws require that our directors be
elected by our shareholders at a general shareholders meeting. Six of our
directors are elected by, and represent, our controlling shareholders, two are
nominated by, and represent, our minority shareholders, one is nominated and
elected by the Brazilian government, as holder of the golden share, one is
nominated by the Brazilian government and elected by our shareholders as
another Brazilian government representative, one is our chief executive
officer, acting ex officiopursuant to our bylaws, and the two remaining
directors, nominated by the employees, are elected by our shareholders as
employee representatives on our board. Executive Sessions NYSE rules require that the non-management directors must meet at
regularly scheduled executive sessions without management. The Brazilian
Corporate Law does not have a similar provision. According to the Brazilian
Corporate Law, up to one-third of the members of the board of directors can be
elected from management. Maurício Novis Botelho, our president and chief
executive officer, is a member of our board of directors. The remaining
non-management directors are not expressly empowered to serve as a check on
management and there is no requirement that those directors meet regularly
without management. As a result, the non-management directors on our board do
not typically meet in executive session. Nominating/Corporate Governance Committee NYSE rules require that listed companies have a Nominating/Corporate
Governance Committee composed entirely of independent directors and governed by
a written charter addressing the committees required purpose and detailing its
required responsibilities, which include, among other things, identifying and
selecting qualified board member nominees and developing a set of corporate
governance principles applicable to the company. We are not required under
applicable Brazilian law to have a Nominating Committee/Corporate Governance
Committee, and accordingly, to date, have not established such a committee.
Pursuant to our bylaws, our nominees for director are selected by the
controlling shareholders, minority shareholders, the Brazilian government and
our employees, as described above in Majority of Independent Directors. The
directors are then elected by our shareholders at a general shareholders
meeting. Our corporate governance practices are adopted by the entire board. Compensation Committee NYSE rules require that listed companies have a Compensation Committee
composed entirely of independent directors and governed by a written charter
addressing the committees required purpose and detailing its required
responsibilities, which include, among other things, reviewing corporate goals
relevant to CEO
compensation, evaluating CEO performance and approving CEO compensation levels
and recommending to the board non-CEO compensation, incentive-compensation and
equity-based plans. We are not required under applicable Brazilian law to have
a Compensation Committee. Under the Brazilian Corporate Law, the total amount
available for compensation of our directors and executive officers and for
profit-sharing payments to our executive officers is established by our
shareholders at the annual general meeting. The board of directors is then
responsible for determining the individual compensation and profit-sharing of
each executive officer, as well as the compensation of our board and committee
members. In making such determinations, the board reviews the performance of
the executive officers, including the performance of our CEO. Maurício Novis
Botelho, our chief 77




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executive officer and member of our board of directors, typically excuses
himself from discussions regarding his performance and compensation. In
April 2004, our board of directors established a Special
Committee with a term of 18 months with the first task of reviewing the
boards policies regarding the compensation and profit sharing for our
executive officers and making recommendations for the revision of such
policies. As it is a temporary committee, it does not operate pursuant to a
written charter. For a further discussion of our Special Committee, see Item 6C. Board PracticesSpecial Committee. Audit Committee NYSE rules require that listed companies have an audit committee that (i)
is composed of a minimum of three independent directors who are all financially
literate, (ii) meets the SEC rules regarding audit committees for listed
companies, (iii) has at least one member who has accounting or financial
management expertise and (iv) is governed by a written charter addressing the
committees required purpose and detailing its required responsibilities.
However, as a foreign private issuer, we need only to comply with the
requirement that the audit committee, or audit board in our case, meet the SEC
rules regarding audit committees for listed companies. The Brazilian Corporate
Law requires companies to have a non-permanent Conselho Fiscal composed of
three to five members who are elected at the general shareholders meeting.
The Conselho Fiscal operates independently from management and from a companys
external auditors. Its main function is to monitor the activities of
management, examine the financial statements of each fiscal year and provide a
formal report to our shareholders. We have a permanent Conselho Fiscal that consists of five members and five
alternates and which has ordinary meetings every two months. The members of
our Conselho Fiscal are all financially literate and one member has accounting
expertise that qualifies him as an audit committee financial expert. We
believe that our Conselho Fiscal, as proposed to be modified, will meet the
requirements for the exemption available to foreign private issuers under the
SEC rules regarding audit committees of listed companies. In addition, the
Conselho Fiscal operates under a written charter that is in the process of
being amended and which we believe will substantially meet the NYSEs
requirements for audit committee charters. For a further discussion of our
Conselho Fiscal, see Item 6C. Board PracticesConselho Fiscal. Shareholder Approval of Equity Compensation Plans NYSE rules require that shareholders be given the opportunity to vote on
all equity compensation plans and material revisions thereto, with limited
exceptions. Under the Brazilian Corporate Law, shareholders must approve all
stock option plans. In addition, any issuance of new shares that exceeds our
authorized share capital is subject to shareholder approval. Corporate Governance Guidelines NYSE rules require that listed companies adopt and disclose corporate
governance guidelines. We have not adopted any formal corporate governance
guidelines beyond those required by applicable Brazilian law. We have adopted
and observe a disclosure policy, our Policy on Publicizing Acts or Relevant
Facts, which requires the public disclosure of all relevant information
pursuant to guidelines set forth by the CVM, as well as an insider trading
policy, our Policy on Securities Transactions, which, among other things,
establishes black-out periods and requires insiders to inform management of all
transactions involving our securities. Code of Business Conduct and Ethics NYSE rules require that listed companies adopt and disclose a code of
business conduct and ethics for directors, officers and employees, and promptly
disclose any waivers of the code for directors or executive officers.
Applicable Brazilian law does not have a similar requirement. However, in
April 2004, we adopted a Code of Ethics and Conduct applicable to our officers,
directors and employees worldwide, including at the subsidiary level. We
believe this code substantially addresses the matters required to be addressed
pursuant to the NYSE rules. A copy of our Code of Ethics and Conduct has been
filed as Exhibit 11.1 to this annual report. For a further discussion of our
Code of Ethics and Conduct, see Item 16B. Code of Ethics. 78




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Internal Audit Function NYSE rules require that listed companies maintain an internal audit
function to provide management and the audit committee with ongoing assessments
of the companys risk management processes and system of internal control. Our
internal audit function is the responsibility of our financial department under
the supervision of our controller and our chief financial officer. Our
financial department is supported in its internal audit function by our quality
control department, which is responsible for the evaluation and effectiveness
of our internal procedures and reporting systems. 10C. Material Contracts Joint Venture with Liebherr International AG We entered into a joint venture with Liebherr International AG to develop
and manufacture landing gear and high precision hydraulic equipment and provide
related services for Embraer and other clients around the world. In connection
with this joint venture, we formed a new subsidiary, ELEB, to which we
transferred all of our landing gear manufacturing activities, the employees and
some liabilities related to those activities on December 1, 1999. On May 22,
2000, Liebherr International AG, acting in coordination with its subsidiary,
Liebherr Aerospace Lindenberg GmbH, and through its Brazilian affiliate,
purchased 40% of the capital stock of ELEB. Liebherr-Aerospace SAS is our
risk-sharing partner responsible for designing, developing and manufacturing
the landing gear assemblies for the new EMBRAER 170/190 jet family. 10D. Exchange Controls There are no restrictions on ownership of our preferred shares by
individuals or legal entities domiciled outside Brazil. However, the right to
convert dividend payments and proceeds from the sale of preferred shares into
foreign currency and to remit such amounts outside Brazil is subject to
restrictions under foreign investment legislation which generally requires,
among other things, the registration of the relevant investment with the
Central Bank. Under Resolution No. 2,689, foreign investors registered with the CVM may
buy and sell shares on the São Paulo Stock Exchange without obtaining a
separate certificate of registration for each transaction. Investors under
these regulations are also generally entitled to favorable tax treatment. Annex V to Resolution No. 1,289, as amended, of the National Monetary
Council, also known as the Annex V Regulations, provides for the issuance of
depositary receipts in foreign markets in respect of shares of Brazilian
issuers. In connection with both equity offerings of our preferred shares, an
electronic registration was issued in the name of the depositary with respect
to the ADSs and is maintained by the custodian on behalf of the depositary.
This electronic registration was carried out through the Central Bank
Information System-SISBACEN. Pursuant to the registration, the custodian and
the depositary are able to convert dividends and other distributions with
respect to the preferred shares represented by ADSs into foreign currency and
remit the proceeds outside Brazil. In the event that a holder of ADSs
exchanges such ADSs for preferred shares, the holder will be entitled to
continue to rely on the depositarys registration for five business days after
the exchange. Thereafter, a holder must seek to obtain its own electronic
registration. Unless the preferred shares are held pursuant to Resolution No.
2,689 by a duly registered investor or a holder of preferred shares who applies
for and obtains a new certificate of registration, that
holder may not be able to convert into foreign currency and remit outside
Brazil the proceeds from the disposition of, or distributions with respect to,
the preferred shares. In addition, if the foreign investor resides in a tax
haven jurisdiction or is not an investor registered under Resolution No.
2,689, the investor will be subject to less favorable Brazilian tax treatment
than a holder of ADSs. See Item 3D. Risk FactorsRisks Relating to the Preferred Shares and the
ADSsIf holders of ADSs exchange the ADSs for preferred shares, they risk
losing the ability to remit foreign currency abroad and Brazilian tax
advantages and Item 10E. TaxationBrazilian Tax Consequences. 79




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Preemptive Rights Each of our shareholders has a general preemptive right to subscribe for
shares, or securities convertible into shares, in the event of any capital
increase, in proportion to its shareholding, except in the event of the grant
and exercise of any option to acquire shares of our capital stock. A period of
at least 30 days following the publication of notice of the issuance of shares
or securities convertible into shares is allowed for exercise of the right, and
the right is negotiable. According to the Brazilian Corporate Law and our
bylaws, the board of directors may, in its discretion, eliminate the preemptive
rights of the shareholders in the event that we issue shares, debentures
convertible into shares, or subscription warrants that will be offered either
through a stock exchange or in a public offering, or through an exchange of
shares in a public offering, the purpose of which is to acquire control of
another company, as established by law. In the event of a capital increase by means of the issuance of new shares,
holders of ADSs, or of preferred shares, would, except under the circumstances
described above, have preemptive rights to subscribe to any class of our newly
issued shares. However, a holder may not be able to exercise the preemptive
rights relating to the preferred shares underlying the ADSs unless a
registration statement under the Securities Act is effective with respect to
those shares to which the rights relate or an exemption from the registration
requirements of the Securities Act is available. See Item 3D. Risk
FactorsRisks Relating to the Preferred Shares and the ADSsHolders of our ADSs
might be unable to exercise preemptive rights with respect to the preferred
shares. Redemption and Right of Withdrawal According to our bylaws, our common shares and preferred shares are not
redeemable. The Brazilian Corporate Law provides that, under limited circumstances, a
shareholder has the right to withdraw his equity interest from the company and
to receive payment for the portion of shareholders equity attributable to his
equity interest. This right of withdrawal may be exercised by dissenting or
non-voting shareholders of Embraer (including any holder of preferred shares)
in the event that at least half of all voting shares outstanding authorize us
to:  
    
    create preferred shares or to increase disproportionately an
existing class of preferred shares relative to the other class of
 shares, unless such action is provided for or authorized by the
bylaws;  
    
    modify a preference, privilege or condition of redemption or
amortization conferred on one or more classes of preferred shares,
or to create a new class with greater privileges than the existing
classes of preferred shares;  
    
    reduce the mandatory distribution of dividends;  
    
    change our corporate purpose;  
    
    merge into or consolidate with another company, subject to
the conditions set forth in the Brazilian Corporate Law;  
    
    transfer all of our shares to another company or receive
 shares of another company in order to make the company whose shares
were transferred a wholly owned subsidiary of such other company,
known as incorporação de ações;  
    
    acquire control of another company at a price which exceeds
the limits set forth in the Brazilian Corporate Law;  
    
    participate in a centralized group of companies as defined
under the Brazilian Corporate Law and subject to the conditions set
forth therein; or 80




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
    
    conduct a spin-off that results in (a) a change of our
corporate purposes, except if the assets and liabilities of the
spun-off company are contributed to a company that is engaged in
substantially the same activities, (b) a reduction in the mandatory
dividend or (c) any participation in a centralized group of
companies, as defined under the Brazilian Corporate Law. In addition, in the event that the entity resulting from a merger, or
incorporação de ações, as described above, or a consolidation or a spin-off of
a listed company fails to become a listed company within 120 days of the
shareholders meeting at which such decision was taken, the dissenting or
non-voting shareholders may also exercise their right of withdrawal. Only holders of shares adversely affected by the changes mentioned in the
first and second bullet points above may withdraw their shares. The right of
withdrawal lapses 30 days after publication of the minutes of the relevant
shareholders meeting. In the first two cases mentioned above, however, the
resolution is subject to the prior approval or subsequent ratification by
holders of a majority of the outstanding preferred shares, which must be
obtained at a special meeting held within one year. In such cases, the 30-day
term is counted from the date the minutes of the special meeting are published.
We would be entitled to reconsider any action giving rise to withdrawal rights
within ten days following the expiration of such rights if the withdrawal of
shares of dissenting shareholders would jeopardize our financial stability. The Brazilian Corporate Law contains provisions that restrict withdrawal
rights and allow companies to redeem their shares at their economic value,
subject to certain requirements. As our bylaws currently do not provide that
our shares would be redeemable at their economic value, our shares would be
redeemable at their book value, determined on the basis of the last balance
sheet approved by the shareholders. If the shareholders meeting giving rise
to withdrawal rights occurs more than 60 days after the date of the last
approved balance sheet, a shareholder may demand that its shares be valued on
the basis of a new balance sheet that is as of a date within 60 days of such
shareholders meeting. According to the Brazilian Corporate Law, in events of consolidation,
merger, incorporação de ações,participation in a group of companies, and
acquisition of control of another company, the right to withdraw does not apply
if the shares in question meet certain tests relating to market liquidity and
float. Shareholders would not be entitled to withdraw their shares if the
shares are a component of a general stock index in Brazil or abroad and shares
held by persons unaffiliated with the controlling shareholder represent more
than half of the outstanding shares of the relevant type or class. 10E. Taxation This summary contains a description of certain Brazilian and U.S. federal
income tax consequences of the purchase, ownership and disposition of preferred
shares or ADSs by a holder, also called a U.S. holder, that is the beneficial
owner of preferred shares or ADSs and that is a citizen or resident alien of
the United States or a U.S. domestic corporation or that otherwise will be
subject to U.S. federal income tax on a net income basis in respect of
preferred shares or ADSs, but it does not purport to be a comprehensive
description of all of the tax considerations that may be relevant to a decision
to purchase preferred shares or ADSs. In particular, this summary deals only
with U.S. holders that will hold preferred shares or ADSs as capital assets and
does not address the tax treatment of U.S. holders that own or are treated as
owning 10% or more of our voting shares or that may be subject to special tax
rules, such as banks, insurance companies, dealers in securities or currencies,
individual retirement and other tax
deferred accounts, tax-exempt organizations, persons that will hold
preferred shares or ADSs as a position in a straddle, a hedging transaction
or a conversion transaction for tax purposes, and persons that have a
functional currency other than the U.S. dollar. Further, if a partnership
(including for this purpose any entity treated as a partnership for U.S.
federal income tax purposes) is a beneficial owner of preferred shares or ADSs,
the treatment of a partner in a partnership will generally depend upon the
status of the partner and upon the activities of the partnership. A holder of
preferred shares or ADSs that is a partnership and partners in such partnership
should consult their tax advisors. This summary is based upon the tax laws of
Brazil and the United States as in effect on the date of this annual report,
which are subject to change, possibly with retroactive effect, and to differing
interpretations. 81




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Although there presently is no income tax treaty between Brazil and the
United States, the tax authorities of the two countries have had discussions
that may culminate in such a treaty. No assurance can be given, however, as to
if or when a treaty will enter into force or how it will affect the U.S.
holders of preferred shares or ADSs. Brazilian Tax Consequences General.The following discussion summarizes the material Brazilian tax
consequences of the acquisition, ownership and disposition of preferred shares
or ADSs, as the case may be, by a holder that is not domiciled in Brazil, also
called a non-Brazilian holder, for purposes of Brazilian taxation and, in the
case of a holder of preferred shares, which has registered its investment in
preferred shares at the Central Bank as a U.S. dollar investment. Pursuant to Brazilian law, investors may invest in the preferred shares
under Resolution No. 2,689, of January 26, 2000, of the National Monetary
Council. The rules of Resolution No. 2,689 allow foreign investors to invest
in almost all financial assets and to engage in almost all transactions
available in the Brazilian financial and capital markets, provided that some
requirements are fulfilled. In accordance with Resolution No. 2,689, the
definition of foreign investor includes individuals, legal entities, mutual
funds and other collective investment entities domiciled or headquartered
abroad. Pursuant to the rules, foreign investors must: (1) appoint at least one
representative in Brazil with powers to perform actions relating to the foreign
investment; (2) complete the appropriate foreign investor registration form;
(3) register as a foreign investor with the CVM; and (4) register the foreign
investment with the Central Bank. Securities and other financial assets held by foreign investors pursuant
to Resolution No. 2,689 must be registered or maintained in deposit accounts or
under the custody of an entity duly licensed by the Central Bank or the CVM.
In addition, securities trading is restricted to transactions carried out in
the stock exchanges or organized over-the-counter markets licensed by the CVM. Taxation of Dividends.Dividends, including stock dividends and other
dividends paid in property, paid by us to the depositary in respect of the
ADSs, or to a non-Brazilian holder in respect of the preferred shares, are
currently not subject to income withholding tax, provided that they are paid
out of profits generated as of January 1, 1996 (or out of reserves derived
therefrom). We do not have retained earnings generated prior to January 1,
1996 (or reserves out of such earnings). Taxation of Gains.According to Law No. 10,833, enacted on December 29,
2003, the disposition of assets located in Brazil by a non-Brazilian holder,
whether to another non-Brazilian holder or to a Brazilian holder, may be
subject to taxation in Brazil. Although we believe that the ADSs do not fall within the definition of
assets located in Brazil for the purposes of Law No. 10,833/03, considering the
general and unclear scope this new law and the lack of any judicial court
rulings in respect thereof, we are unable to predict whether such understanding
will ultimately prevail in the courts of Brazil. The deposit of preferred shares in exchange for ADSs may be subject to
Brazilian capital gains tax at the rate of 15% or 25%, in case of a
non-Brazilian holder located in a tax haven jurisdiction (as defined below), if
the amount previously registered with the Central Bank as a foreign investment
in the preferred shares is lower than (1)
the average price per preferred share on a Brazilian stock exchange on
which the greatest number of such shares were sold on the day of deposit or (2)
if no preferred shares were sold on that day, the average price on the
Brazilian stock exchange on which the greatest number of preferred shares were
sold in the fifteen trading sessions immediately preceding such deposit. In
such a case, the difference between the amount previously registered and the
average price of the preferred shares, calculated as above, will be considered
a capital gain. Such taxation is not applicable in case of investors
registered under Resolution No. 2,689 which are not located in a tax haven
jurisdiction (as defined below). The withdrawal of ADSs in exchange for
preferred shares is not subject to Brazilian tax. On receipt of the underlying
preferred shares, the non-Brazilian holder registered under Resolution No.
2,689 will be entitled to register the U.S. dollar value of such shares with
the Central Bank as described below in 82




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Registered Capital. However, if this non-Brazilian holder does not
register under Resolution No. 2,689, it will be subject to the less favorable
tax treatment described below. Non-Brazilian holders are generally subject to income tax imposed at a
rate of 15% on gains realized on sales or exchanges of the preferred shares, if
the transaction is carried out outside of any Brazilian stock, future or
commodities exchange. Gains realized by a non-Brazilian holder upon redemption
of preferred shares will be treated as a gain from the disposition of such
shares to a Brazilian resident occurring outside of any Brazilian stock, future
and commodities exchange and, accordingly, will be subject to tax at a rate of
15%. In both cases, if the non-Brazilian holder is resident or domiciled in a
tax haven jurisdiction (as defined below), the income tax rate will be 25%. Non-Brazilian holders are subject to income tax imposed at a rate of 20%
on gains realized on sales or exchanges in Brazil of preferred shares that
occur on the Brazilian exchanges unless such a sale is made by a non-Brazilian
holder which is not resident in a tax haven jurisdiction (as defined below)
and (1) such sale is made within five business days of the withdrawal of such
preferred shares in exchange for ADSs and the proceeds thereof are remitted
abroad within such five-day period or (2) such sale is made under Resolution
No. 2,689 by registered non-Brazilian holders who obtain registration with the
CVM. In these two cases, the gains realized are exempt from income tax. The
gain realized is the difference between the amount in reaisrealized on the
sale or exchange and the acquisition cost measured in reais, without any
correction for inflation, of the shares sold. The gain realized as a result
of a transaction that occurs other than on the São Paulo Stock Exchange will be
the positive difference between the amount realized on the sale or exchange and
the acquisition cost of the preferred shares, both such values to be taken into
account in reais; there are grounds, however, to hold that the gain realized
should be calculated based on the foreign currency amount registered with the
Central Bank, such foreign currency amount to be translated into reaisat the
commercial market rate on the date of such sale or exchange. There is no
assurance that the current preferential treatment for holders of the ADSs and
some non-Brazilian holders of the preferred shares under Resolution No. 2,689
will continue or will not change in the future. Any exercise of preemptive rights relating to the preferred shares will
not be subject to Brazilian taxation. Any gain on the sale or assignment of
preemptive rights relating to our preferred shares by the depositary on behalf
of holders of our ADSs will be subject to Brazilian income taxation according
to the same rules applicable to the sale or disposition of preferred shares. Taxation on Interest on Shareholders Equity.Any payment of interest on
shareholders equity (see Item 8A. Consolidated Statements and Other Financial
InformationDividends and Dividend PolicyHistory of Dividend Payments and
Dividend Policy and Additional Payments on Shareholders Equity) to holders of
ADSs or preferred shares, whether or not they are Brazilian residents, is
subject to Brazilian withholding tax at the rate of 15% at the time Embraer
records such liability, whether or not the effective payment has been made at
that time. In the case of non-Brazilian residents that are resident in a tax
haven jurisdiction (as defined below), the applicable rate for income tax is
25%. Current Brazilian Corporate Law establishes that a notional interest
charge attributed to shareholders equity can either be accounted for as part
of the mandatory dividend or not. In the event that the payment of such
interest is accounted for as part of the mandatory dividend, we would be
required to pay an additional amount to ensure that the net amount received by
the shareholders, after the income tax, is at least equal to the
minimum mandatory
dividend. The distribution of interest attributed to shareholders equity
would be proposed by our board of directors and subject to subsequent
declaration by the shareholders at a general meeting. Taxation of Foreign Exchange Transactions(IOF/Câmbio).Pursuant to
Decree No. 4,494 of December 3, 2002, the conversion into Brazilian currency of
proceeds received by a Brazilian entity from a foreign investment
in the Brazilian securities market (including those in connection with an
investment in preferred shares or the ADSs and those under Resolution No.
2,689) and the conversion into foreign currency of proceeds received by a
non-Brazilian holder is subject to a tax on exchange transactions known as IOF,
the rate of which is currently 0%. However, according to Law No. 8,894/94, the
Minister of Finance has the power to increase the IOF/Câmbio rate at any time
to a maximum of 25%, but only in relation to future exchange transactions. Taxation on Bonds and Securities Transactions(IOF/Títulos).Law No.
8,894/94 created the Tax on Bonds and Securities Transactions, or IOF/Títulos,
which may be imposed on any transactions involving bonds and securities, even
if these transactions are performed on the Brazilian stock, futures or
commodities exchange. The 83




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applicable rate of this tax is currently 0% for most transactions,
although the executive branch may increase such rate up to 1.5% per day, but
only with respect to future transactions. Other Brazilian Taxes.There are no Brazilian inheritance, gift or
succession taxes applicable to the ownership, transfer or disposition of
preferred shares or ADSs by a non-Brazilian holder, except for gift and
inheritance taxes which are levied by some states of Brazil on gifts made or
inheritances bestowed by individuals or entities not resident or domiciled in
Brazil within such state to individuals or entities resident or domiciled
within such state in Brazil. There are no Brazilian stamp, issue,
registration, or similar taxes or duties payable by holders of preferred shares
or ADSs. Transactions on Bank Accounts(CPMF).As a general rule, the
Contribuição Provisória sobre Movimentação Financeira,the tax on transactions
on bank accounts, or CPMF, is imposed on any debit to bank accounts.
Therefore, transactions by the depositary or by holders of preferred shares
that involve the transfer of Brazilian currency through Brazilian financial
institutions could be subject to the CPMF tax. Currently, the funds
transferred to Brazil to acquire shares on the Brazilian stock exchange are
exempted from the CPMF. When a non-Brazilian holder transfers the proceeds
from the sale or assignment of preferred shares by an exchange transaction, the
CPMF tax is levied on the amount to be remitted abroad in reais. If we have to
perform any exchange transaction in connection with ADSs or preferred shares,
we will also be subject to the CPMF tax. The CPMF tax is generally imposed on
bank account debits, at the current rate of 0.38%. The CPMF tax will be in
effect until December 31, 2007. In the event we perform any exchange
transaction in connection with ADSs or preferred shares, we will be responsible
for collecting the CPMF tax. Beneficiaries Resident or Domiciled in Tax Havens or Low Tax
Jurisdictions.Law No. 9,779, dated as of January 1, 1999, states that, with
the exception of limited prescribed circumstances, income derived from
operations by a beneficiary resident or domiciled in a country considered a tax
haven is subject to withholding income tax at the rate of 25%. Tax havens are
considered to be countries which do not impose any income tax or which impose
such tax at a maximum rate of less than 20%, or where the internal legislation
imposes restrictions on the disclosure of the shareholders composition or the
ownership of the investment. Accordingly, if the distribution of interest
attributed to shareholders equity is made to a beneficiary resident or
domiciled in a tax haven jurisdiction, the applicable income tax rate will be
25% instead of 15%. Capital gains are not subject to this 25% tax, except if
the transaction is conducted on the Brazilian stock exchange. See Taxation
of Gains. Registered Capital.The amount of an investment in preferred shares held
by a non-Brazilian holder who obtains registration under Resolution No. 2,689,
or by the depositary representing such holder, is eligible for registration
with the Central Bank; such registration (the amount so registered being called
registered capital) allows the remittance outside Brazil of foreign currency,
converted at the commercial market rate, acquired with the proceeds of
distributions on, and amounts realized with respect to dispositions of, such
preferred shares. The registered capital for each preferred share purchased as
part of the international offering, or purchased in Brazil after that date, and
deposited with the depositary will be equal to its purchase price in U.S.
dollars. The registered capital for a preferred share that is withdrawn upon
surrender of an ADS will be the U.S. dollar equivalent of:  
    
    the average price of a preferred share on the Brazilian stock
exchange on which the greatest number of such shares were sold on
the day of withdrawal; or  
    
    if no preferred shares were sold on that day, the average
price on the Brazilian stock exchange on which the greatest number
of preferred shares were sold in the 15 trading sessions immediately
preceding such withdrawal. The U.S. dollar value of the average price of preferred shares is
determined on the basis of the average of the U.S. dollar/realcommercial
market rates quoted by the Central Bank information system on that date (or, if
the average price of preferred shares is determined under the second option
above, the average of such average quoted rates on the same 15 dates used to
determine the average price of preferred shares). A non-Brazilian holder of preferred shares may experience delays in
effecting such registration, which may delay remittances abroad. Such a delay
may adversely affect the amount, in U.S. dollars, received by the 84




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non-Brazilian holder. See Item 3D. Risk FactorsRisks Relating to
BrazilExchange rate instability may result in uncertainty in the Brazilian
economy and the Brazilian securities markets and could lower the market value
of the preferred shares and the ADSs. U.S. Federal Income Tax Consequences In general, for U.S. federal income tax purposes, U.S. holders that are
beneficial owners of ADSs will be treated as the beneficial owners of the
preferred shares represented by those ADSs. Taxation of Dividends.Distributions with respect to the preferred shares
or the ADSs (other than distributions in redemption of the preferred shares
subject to Section 302(b) of the U.S. Internal Revenue Code of 1986 (also
called the Code) or in a liquidation of Embraer) (including distributions of
notional interest charges attributed to shareholders equity, as described
above in Brazilian Tax ConsequencesTaxation on Interest on Shareholders
Equity) will, to the extent made from current or accumulated earnings and
profits of Embraer as determined under U.S. federal income tax principles,
constitute dividends for U.S. federal income tax purposes. Whether such
current or accumulated earnings and profits will be sufficient for all such
distributions on the preferred shares or ADSs to qualify as dividends for U.S.
federal income tax purposes depends on the future profitability of Embraer and
other factors, many of which are beyond our control. To the extent that such a
distribution exceeds the amount of Embraers earnings and profits, it will be
treated as a non-taxable return of capital to the extent of the U.S. holders
adjusted tax basis in the preferred shares or ADSs, and thereafter as capital
gain (provided that the preferred shares or ADSs are held as capital assets).
As used below, the term dividend means a distribution that constitutes a
dividend for U.S. federal income tax purposes. Cash dividends (including
amounts withheld in respect of Brazilian taxes) paid with respect to:  
    
    the preferred shares generally will be includible in the
gross income of a U.S. holder as ordinary income on the day on which
the dividends are received by the U.S. holder; or  
    
    the preferred shares represented by ADSs generally will be
includible in the gross income of a U.S. holder as ordinary income
on the day on which the dividends are received by the depositary; and, in either case, these dividends will not be eligible for the dividends
received deduction allowed to corporations, but may be taxed at a preferential
rate, as discussed in the next paragraph. Subject to certain exceptions for short-term and hedged positions, the
amount of dividends received by certain U.S. holders (including individuals)
prior to January 1, 2009 with respect to the ADSs will be subject to taxation
at a maximum rate of 15% if the dividends represent qualified dividend
income. Dividends paid on the ADSs will be treated as qualified dividend
income if (i) the ADSs are readily tradable on an established securities market
in the United States and (ii) we were not in the year prior to the year in
which the dividend was paid, and are not in the year in which the dividend is
paid, a passive foreign investment company (PFIC), foreign personal holding
company (FPHC) or foreign investment company (FIC). The ADSs are listed on
the New York Stock Exchange, and may qualify as readily tradable on an
established securities market in the United States so long as they are so
listed, but no assurances can be given that the ADSs will be or remain readily
tradable. Based on our audited financial statements as well as relevant market
and shareholder data, we believe that we were not a PFIC, FPHC or FIC for
United States federal income tax purposes with respect to our 2003 taxable
year. In addition,
based on our audited financial statements and current expectations
regarding the value and nature of our assets, the sources and nature of our
income, and relevant market and shareholder data, we do not anticipate becoming
a PFIC, FPHC or FIC for our 2004 taxable year. However, because these
determinations are based on the nature of our income and assets from time to
time, as well as involving the application of complex tax rules, and since our
view is not binding on the courts or the IRS, no assurances can be provided
that we will not be considered a PFIC, FPHC, or FIC for the current, or any
past or future tax year. The potential application of the PFIC rules to our
operations is further discussed below. Based on existing guidance, it is not entirely clear whether dividends
received with respect to the preferred shares will be treated as qualified
dividends, because the preferred shares are not themselves listed on a United
States exchange. In addition, the United States Treasury Department has
announced its intention to promulgate 85




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rules pursuant to which holders of ADSs or preferred stock and
intermediaries through whom such securities are held will be permitted to rely
on certifications from issuers to establish that dividends are treated as
qualified dividends. Because such procedures have not yet been issued, we are
not certain that we will be able to comply with them. You should consult your
own tax advisors regarding the availability of the reduced dividend tax rate in
the light of your own particular circumstances. Dividends paid in reaiswill be includible in the income of a U.S. holder
in a U.S. dollar amount calculated by reference to the exchange rate in effect
on the day they are received by the U.S. holder, in the case of preferred
shares, or the depositary, in the case of preferred shares represented by ADSs,
regardless of whether the payment is in fact converted to U.S. dollars. If dividends paid in reaisare converted into U.S. dollars on the day they
are received by the U.S. holder or the depositary, as the case may be, U.S.
holders should not be required to recognize foreign currency gain or loss in
respect of the dividend income. Generally, any gain or loss resulting from
currency exchange fluctuations during the period from the date the dividend
payment is included in the gross income of a U.S. holder through the date such
payment is converted into dollars (or otherwise disposed of) will be treated as
U.S. source ordinary income or loss. However, U.S. holders should consult
their own tax advisors regarding the treatment of any foreign currency gain or
loss if any reaisreceived by the U.S. holder or the depositary are not
converted into U.S. dollars on the date of receipt. Dividends received by most U.S. holders will constitute foreign source
passive income or, in the case of some U.S. holders such as banks, financial
services income for U.S. foreign tax credit purposes. Subject to limitations
under U.S. federal income tax law concerning credits or deductions for foreign
taxes, the Brazilian withholding tax will be treated as a foreign income tax
eligible for credit against a U.S. holders U.S. federal income tax liability
(or at a U.S. holders election, may be deducted in computing taxable income).
The rules with respect to foreign tax credits are complex and U.S. holders are
urged to consult their tax advisors regarding the availability of the foreign
tax credit under their particular circumstances. The Internal Revenue Service,
or IRS, has expressed concern that intermediaries in connection with depository
arrangements may be taking actions that are inconsistent with the claiming of
foreign tax credits by U.S. persons who are holders of depositary shares.
Accordingly, investors should be aware that the discussion above regarding the
availability of foreign tax credits for Brazilian withholding tax on dividends
paid with respect to preferred shares represented by ADSs could be affected by
future action taken by the IRS. Section 305 of the Code provides special rules for the tax treatment of
preferred stock. According to the U.S. Treasury Regulations under that
section, the term preferred stock generally refers to stock which enjoys
limited rights and privileges (generally associated with specified dividend and
liquidation priorities), but does not participate in corporate growth to any
significant extent. While the preferred shares have some preferences over our
common shares, the preferred shares are not fixed as to dividend payments or
liquidation value; thus, it is not entirely clear whether the preferred shares
will be treated as preferred stock or common stock within the meaning of
section 305 of the Code. If the preferred shares are treated as common stock
for purposes of section 305, distributions to U.S. holders of additional shares
of such common stock or preemptive rights relating to such common stock
with respect to their preferred shares or ADSs that are made as part of a pro
ratadistribution to all our shareholders likely will not be treated as
dividend income for U.S. federal income tax purposes. On the other hand, if
the preferred shares are treated as preferred stock within the meaning of
section 305, then, in addition to being taxable on cash distributions as
described above, a U.S. holder will be taxable on distributions of additional
 shares or preemptive rights (including amounts withheld in respect of any
Brazilian taxes). In that event, the amount of such distribution (and the
basis of the new shares or preemptive rights so received) will equal the fair
market value of the shares or preemptive rights on the date of distribution. Taxation of Capital Gains.Deposits and withdrawals of preferred shares
by U.S. holders in exchange for ADSs will not result in the realization of gain
or loss for U.S. federal income tax purposes. Gain or loss realized by a U.S. holder on the sale, redemption or other
disposition of preferred shares or ADSs will be subject to U.S. federal income
taxation as capital gain or loss in an amount equal to the difference between
such U.S. tax holders adjusted basis in the preferred shares or the ADSs and
the amount realized on the disposition. Capital gains of individuals derived
with respect to capital assets held for more than one year may be 86




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eligible for various reduced rates of taxation. For example, for capital
assets held for over one year and sold or exchanged on or after May 2, 2003 but
in taxable years beginning before January 1, 2009, the maximum rate of tax
generally will be 15% (rather than the higher rates of tax generally applicable
to items of ordinary income). The deductibility of capital losses is subject
to limitations. Any gain or loss realized by a U.S. holder will generally be
treated as a U.S. source gain or loss. If a Brazilian withholding tax is imposed on the sale or disposition of
preferred shares or ADSs (see Brazilian Tax Consequences), the amount realized by a U.S. holder will
include the gross amount of the proceeds of such sale or disposition before
deduction of the Brazilian withholding tax. The availability of U.S. foreign
tax credits for these Brazilian taxes and any Brazilian taxes imposed on
distributions that do not constitute dividends for U.S. tax purposes is subject
to various limitations and involves the application of rules that depend on a
U.S. holders particular circumstances. U.S. holders are urged to consult
their own tax advisors regarding the application of the foreign tax credit
rules to their investment in, and disposition of, preferred shares or ADSs. Passive Foreign Investment Companies.If, during any taxable year of a
non-U.S. corporation, 75% or more of the corporations gross income consists of
certain types of passive income, or the average value during a taxable year
of the passive assets of the corporation (generally assets that generate
passive income) is 50% or more of the average value of all the corporations
assets, the corporation will be treated as a PFIC under U.S. federal income tax
law. If a corporation is treated as a PFIC, a U.S. holder may be subject to
increased tax liability upon the sale of preferred shares or ADSs, or upon the
receipt of certain dividends, unless such U.S. holder makes an election to be
taxed currently on its pro rataportion of the corporations income, whether or
not such income is distributed in the form of dividends, or otherwise makes a
mark-to-market election with respect to the corporations stock as permitted
by the Code. In addition, as discussed above, a U.S. holder would not be
entitled to (if otherwise eligible for) the preferential reduced rate of tax
payable on certain dividend income. As stated above, although no assurances
can be given, based on our operations and business plans and the other items
discussed above, we do not believe that we are currently a PFIC, and do not
expect to become a PFIC for our 2004 taxable year. Information Reporting and Backup Withholding.Information reporting
requirements will apply to dividends in respect of the preferred shares or ADSs
or the proceeds received on the sale, exchange, or redemption of the preferred
shares or ADSs paid within the United States (and, in some cases, outside of
the United States) to U.S. holders other than some exempt recipients (such as
corporations), and a 28% backup withholding may apply to such amounts if the
U.S. holder fails to provide an accurate taxpayer identification number or to
report interest and dividends required to be shown on its federal income tax
returns. The amount of any backup withholding from a payment to a U.S. holder
will be allowed as a credit against the U.S. holders U.S. federal income tax
liability, provided that the required information is furnished to the IRS. 10F. Dividends and Paying Agents Not applicable. 10G. Statements by Experts Not applicable. 10H. Documents on Display We are subject to the periodic reporting and other informational
requirements of the Exchange Act. Accordingly, we are required to file reports
and other information with the U.S. Securities and Exchange Commission, or the
SEC. You may inspect and obtain copies, at prescribed rates, of reports and
other information filed by us with the SEC at its Public Reference Room
maintained at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain
information on the operation of the Public Reference Room by calling the SEC in
the United States at 1-800-SEC-0330. You may also inspect and copy this
material at the offices of the New York Stock Exchange, Inc., 20 Broad Street,
New York, New York 10005. 87




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##### Table of Contents



We file our annual report on Form 20-F, including our financial
statements, and other reports, including our reports on Form 6-K,
electronically with the SEC. These filings are available at www.sec.gov. We
also file financial statements and other periodic reports electronically with
the CVM at their website, www.cvm.gov.br. Copies of our annual reports on Form
20-F and documents referred to in this annual report and our bylaws will be
available for inspection upon request at our headquarters at Av. Brigadeiro
Faria Lima, 2170, 12227-901 São José dos Campos, São Paulo, Brazil. 10I. Subsidiary Information Not required. 88




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##### Table of Contents



ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to various market risks, primarily related to potential
loss arising from adverse changes in interest rates and foreign currency
exchange rates. We have established policies and procedures to manage
sensitivity to interest rate and foreign currency exchange rate risk. These
procedures include the monitoring of our levels of exposure to each market
risk, including an analysis based on a forecast of future cash flows, the
funding of variable rate assets with variable rate liabilities, and limiting
the amount of fixed rate assets which may be funded with floating rate
liabilities. We may also use derivative financial instruments to mitigate the
effects of interest rate fluctuations and to reduce our exposure to exchange
rate risk, but not for speculative purposes. The following sections address
the significant market risks associated with our financial activities. Interest Rate Risk Our exposure to market risk for interest rate fluctuations principally
relates to changes in the market interest rates of our U.S. dollar-denominated
and real-denominated monetary liabilities, principally our short- and long-term
debt obligations. Increases and decreases in prevailing interest rates
generally translate into increases and decreases in interest expense.
Additionally, the fair values of interest rate-sensitive instruments are also
affected by general market conditions. Our short- and long-term debt obligations totaled US$1,043.7 million at
December 31, 2003 and were denominated in U.S. dollars, Brazilian reais,
Japanese yen and Euros. Of the total amount of debt denominated in U.S.
dollars, US$878.1 million, approximately US$523.1 million was fixed rate. The
remaining floating rate U.S. dollar-denominated debt was indexed to either
six-month or 12-month LIBOR. All of our Brazilian reais-denominated debt,
totaling US$23.0 million at December 31, 2003, bears interest at a variable
rate based on the TJLP, the long-term interest rate in Brazil. The TJLP ranged
from 11.0% per annum to 12.0% per annum during 2003. Of the US$134.1 million
of Japanese yen-denominated debt, US$30.0 million was fixed rate. The
remaining floating rate debt was indexed to the Japanese interbank deposit
rate, or JIBOR. All of our Euro-denominated debt, totaling US$8.6 million at
December 31, 2003, was fixed rate. The table below provides information about our short- and long-term debt
obligations as of December 31, 2003 that are sensitive to changes in interest
rates and foreign currency exchange rates. Weightedaverage
    
    Total
    
    Outstanding amount by year of maturityinterest
    
    outstanding
    
    
    
    Totalrate 2003
    
    amount
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    Fair Value(in thousands, except percentages)Short-term
debt and current portion of long-term debtU.S. dollars (LIBOR indexed)
    
    
    4.52
    %
    
    US$
    25,705
    
    
    US$
    25,705
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    US$
    25,782U.S. dollars (fixed rate)
    
    
    5.72
    
    
    
    408,174
    
    
    
    408,174
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    405,215Reais(TJLP indexed)
    
    
    14.66
    
    
    
    9,803
    
    
    
    9,803
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,376Euro (fixed rate)
    
    
    3.48
    
    
    
    8,571
    
    
    
    8,571
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,414Japanese yen (JIBOR indexed)
    
    
    1.14
    
    
    
    34,736
    
    
    
    34,736
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,196Japanese yen (fixed rate)
    
    
    1.67
    
    
    
    30,026
    
    
    
    30,026
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    28,398Total short-term debt
    
    
    
    
    
    US$
    517,015
    
    
    US$
    517,015
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    US$
    509,381Long-term debtU.S. dollars (LIBOR indexed)
    
    
    4.52
    %
    
    US$
    329,308
    
    
    
    
    
    
    US$
    33,662
    
    
    US$
    45,228
    
    
    US$
    85,228
    
    
    US$
    70,190
    
    
    US$
    95,000
    
    
    US$
    337,116U.S. dollars (fixed rate)
    
    
    5.72
    
    
    
    114,896
    
    
    
    
    
    
    
    25,169
    
    
    
    22,930
    
    
    
    28,083
    
    
    
    15,642
    
    
    
    23,072
    
    
    
    112,320Reais(TJLP indexed)
    
    
    14.66
    
    
    
    13,172
    
    
    
    
    
    
    
    7,854
    
    
    
    2,280
    
    
    
    1,624
    
    
    
    1,136
    
    
    
    278
    
    
    
    11,955Japanese yen (JIBOR indexed)
    
    
    1.14
    
    
    
    69,353
    
    
    
    
    
    
    
    34,676
    
    
    
    34,676
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    64,282Japanese yen (fixed rate)
    
    
    1.67
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total long-term debt
    
    
    
    
    
    
    526,729
    
    
    
    
    
    
    
    101,361
    
    
    
    105,114
    
    
    
    114,935
    
    
    
    86,968
    
    
    
    118,350
    
    
    
    525,673Total debt
    
    
    
    
    
    US$
    1,043,744
    
    
    US$
    517,015
    
    
    US$
    101,361
    
    
    US$
    105,114
    
    
    US$
    114,935
    
    
    US$
    86,968
    
    
    US$
    118,350
    
    
    US$
    1,035,054
 In order to manage our interest rate risk on our monetary liabilities, we
have entered into a number of swaps, which effectively convert our fixed and
floating interest rate U.S. dollar-denominated debt and fixed and floating
interest rate yen-denominated debt into CDI-based reais-denominated
obligations. Specifically, as of December 31, 2003, we had effectively
converted US$10.6 million of our U.S. dollar floating interest rate debt,
US$189.6 million of our U.S. dollar fixed interest rate debt and the yen
equivalent of US$30.0 million of our yen fixed interest rate debt into
CDI-based reais, totaling the equivalent of US$230.2 million of CDI-based 89




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##### Table of Contents



reais-denominated obligations. The weighted average interest rate of
these CDI-based obligations for 2003 was 16.94%. Through these swaps, we have
also effectively converted the yen equivalent of US$104.1 million of our
yen-denominated floating interest rate debt to an equivalent amount of U.S.
dollar obligations with a fixed interest rate of 4.31% per annum. These swaps
did not affect the maturity or amortization schedule of our existing debt. These swaps are not accounted for as hedging transactions under U.S. GAAP;
they are recorded at fair value on our balance sheet, and we recognized an
unrealized loss of US$49.8 million as of December 31, 2003 as part of interest
income (expense), net. For further information about the terms of these swap
transactions, including notional amount, maturity date and fair value gains and
losses, see Note 31 to our consolidated financial statements. We do not currently have any derivative instruments that limit our
exposure to changes in the TJLP because we believe that our total exposure,
combined with the relatively low volatility of the TJLP, is unlikely to have a
material effect on our company. The table below provides information about our short- and long-term debt
obligations as of December 31, 2003, after considering the effects of the
above-mentioned derivative transactions. Weightedaverage
    
    Total
    
    Outstanding amount by year of maturityinterest
    
    outstanding
    
    
    
    Totalrate 2003
    
    amount
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    Fair Value(in thousands, except percentages)Short-term debt and current portion of long-term debtU.S. dollars (LIBOR indexed)
    
    
    4.45
    %
    
    US$
    25,228
    
    
    US$
    25,228
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    US$
    25,304U.S. dollars (fixed rate)
    
    
    5.10
    
    
    
    300,107
    
    
    
    300,107
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    295,499Reais (CDI indexed)
    
    
    16.92
    
    
    
    173,306
    
    
    
    173,306
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    170,795Reais (TJLP indexed)
    
    
    14.66
    
    

    
    9,803
    
    
    
    9,803
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,376Euro (fixed rate)
    
    
    3.48
    
    
    
    8,571
    
    
    
    8,571
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,408Japanese yen (JIBOR indexed)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Japanese yen (fixed rate)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total short-term debt
    
    
    
    
    
    US$
    517,015
    
    
    US$
    517,015
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    US$
    509,382Long-term debtU.S. dollars (LIBOR indexed)
    
    
    4.45
    %
    
    US$
    319,130
    
    
    
    
    
    
    US$
    23,484
    
    
    US$
    45,228
    
    
    US$
    85,228
    
    
    US$
    70,190
    
    
    US$
    95,000
    
    
    US$
    326,899U.S. dollars (fixed rate)
    
    
    5.10
    
    
    
    137,335
    
    
    
    
    
    
    
    46,923
    
    
    
    44,684
    
    
    
    15,160
    
    
    
    7,496
    
    
    
    23,072
    
    
    
    131,777Reais (CDI indexed)
    
    
    16.92
    
    
    
    57,091
    
    
    
    
    
    
    
    23,100
    
    
    
    12,923
    
    
    
    12,923
    
    
    
    8,146
    
    
    
    
    
    
    
    55,041Reais (TJLP indexed)
    
    
    14.66
    
    
    
    13,172
    
    
    
    
    
    
    
    7,854
    
    
    
    2,280
    
    
    
    1,624
    
    
    
    1,136
    
    
    
    278
    
    
    
    11,955Japanese yen (JIBOR indexed)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Japanese yen (fixed rate)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total long-term debt
    
    
    
    
    
    
    526,728
    
    
    
    
    
    
    
    101,361
    
    
    
    105,115
    
    
    
    114,935
    
    
    
    86,968
    
    
    
    118,350
    
    
    
    525,672Total debt
    
    
    
    
    
    US$
    1,043,743
    
    
    US$
    517,015
    
    
    US$
    101,361
    
    
    US$
    105,115
    
    
    US$
    114,935
    
    
    US$
    86,968
    
    
    US$
    118,350
    
    
    US$
    1,035,054
 In addition, as of December 31, 2003, US$344.4 million of our U.S. dollar
indexed liabilities were exposed to LIBOR fluctuations. By February 2004, we
had effectively converted 87.1% of this amount to U.S. dollar-denominated
liabilities with a fixed interest rate. Foreign Currency Risk In managing our foreign currency risk, we focus on balancing our non-U.S.
dollar-denominated assets against our non-U.S. dollar-denominated liabilities
plus shareholders equity in relation to our forecasts of future cash flows.
Beyond the foreign currency exposure related to our debt obligations as
summarized above, we also have other assets and liabilities denominated in
currencies other than the U.S. dollar. These assets and liabilities are
primarily cash and cash equivalents, accounts receivable and payable, deferred
income taxes, dividends and certain other assets and liabilities and are
primarily denominated in Brazilian reais. The effects on such assets and
liabilities of the appreciation or devaluation of these currencies against the
U.S. dollar result in foreign exchange gains (losses). The table below provides information about our assets and liabilities
exposed to foreign currency risk as of December 31, 2003, as well as the
related derivative transactions outstanding at the same date. 90




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##### Table of Contents



Total
    
    Outstanding amount by year of maturityoutstanding
    
    
    
    Totalamount
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    Fair Value(in thousands, except percentages)ASSETSCash and cash equivalentsIn Reais
    
    US$
    893,351
    
    
    US$
    893,351
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    US$
    893,351In Euro
    
    
    5,380
    
    
    
    5,380
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,380Trade accounts receivableIn Reais
    
    
    10,306
    
    
    
    10,306
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,306In Euro
    
    
    38,227
    
    
    
    38,227
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38,227Deferred income taxesIn Reais
    
    
    173,554
    
    
    
    97,099
    
    
    
    76,455
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    173,554Other assetsIn Reais
    
    
    164,812
    
    
    
    106,934
    
    
    
    57,878
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    164,812In Euro
    
    
    4,012
    
    
    
    3,418
    
    
    
    594
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,012Total
Assets in Reais
    
    US$
    1,242,023
    
    
    US$
    1,107,690
    
    
    US$
    134,333
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total Assets in Euro
    
    US$
    47,619
    
    
    US$
    47,025
    
    
    US$
    594
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    LIABILITIESLoansIn Reais
    
    US$
    22,975
    
    
    US$
    9,803
    
    
    US$
    7,854
    
    
    US$
    2,280
    
    
    US$
    1,624
    
    
    US$
    1,136
    
    
    US$
    278
    
    
    US$
    21,331In Euro
    
    
    8,571
    
    
    
    8,571
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,414In Japanese Yen
    
    
    134,114
    
    
    
    64,762
    
    
    
    34,676
    
    
    
    34,676
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    124,876Accounts payable to suppliersIn Reais
    
    
    13,501
    
    
    
    13,501
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,501In Euro
    
    
    19,255
    
    
    
    19,255
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,255Customer advancesIn Reais
    
    
    16,179
    
    
    
    16,179
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,179Other accounts payable &
accrued liabilitiesIn Reais
    
    
    82,795
    
    
    
    76,804
    
    
    
    5,991
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    82,795In Euro
    
    
    6,305
    
    
    
    6,305
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,305Taxes and social charges payableIn Reais
    
    
    326,299
    
    
    
    311,977
    
    
    
    14,322
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    326,299In Euro
    
    
    2,455
    
    
    
    2,455
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,455Accrued taxes on incomeIn Reais
    
    
    521
    
    
    
    521
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    521In Euro
    
    
    1,089
    
    
    
    1,089
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,089Accrued dividendsIn Reais
    
    
    36,561
    
    
    
    36,561
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36,561ContingenciesIn Reais
    
    
    30,643
    
    
    
    8,750
    
    
    
    21,893
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30,643Total Liabilities inReais
    
    US$
    529,474
    
    
    US$
    474,096
    
    
    US$
    50,060
    
    
    US$
    2,280
    
    
    US$
    1,624
    
    
    US$
    1,136
    
    
    US$
    278
    
    
    
    Total Liabilities in Euro
    
    US$
    37,675
    
    
    US$
    37,675
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total Liabilities in Japanese
Yen
    
    US$
    134,114
    
    
    US$
    64,762
    
    
    US$
    34,676
    
    
    US$
    34,676
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total exposure inReais
    
    US$
    712,549
    
    
    US$
    633,594
    
    
    US$
    84,273
    
    
    US$
    (2,280
    )
    
    US$
    (1,624
    )
    
    US$
    (1,136
    )
    
    US$
    (278
    )
    
    
    Total exposure in Euro
    
    US$
    9,944
    
    
    US$
    9,350
    
    
    US$
    594
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total exposure in Japanese Yen
    
    US$
    (134,114
    )
    
    US$
    (64,762
    )
    
    US$
    (34,676
    )
    
    US$
    (34,676
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    DERIVATIVE INSTRUMENTSCross-currency interest rate
swap contracts(Yen v. R$)Notional amount
    
    US$
    26,118
    
    
    US$
    26,118
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    US$
    (7,240
    )Average interest paid in Reais
    
    86.2% of CDIAverage interest received in Yen
    
    
    1.67
    %Cross-currency interest rate
swap contracts(Yen v. US$)Notional amount
    
    US$
    110,666
    
    
    US$
    36,931
    
    
    US$
    36,867
    
    
    US$
    36,868
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    US$
    2,269Average interest paid in US$
    
    
    4.31
    %Average interest received in Yen
    
    JIBOR + 1.05
    %Cross-currency interest rate
swap contracts(US$ v. R$)Notional amount
    
    US$
    190,163
    
    
    US$
    134,722
    
    
    US$
    22,646
    
    
    US$
    12,468
    
    
    US$
    12,468
    
    
    US$
    7,859
    
    
    
    
    
    
    US$
    (44,888
    )Average interest paid in Reais
    
    75.1% of CDIAverage
interest received in US$
    
    
    6.30
    %Net exposure of assets/liabilitiesIn Reais
    
    US$
    496,268
    
    
    US$
    472,754
    
    
    US$
    61,627
    
    
    US$
    (14,748
    )
    
    US$
    (14,092
    )
    
    US$
    (8,995
    )
    
    US$
    (278
    )
    
    
    In Euro
    
    US$
    9,944
    
    
    US$
    9,350
    
    
    US$
    594
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    In Japanese Yen
    
    US$
    (2,670
    )
    
    US$
    1,713
    
    
    US$
    (2,191
    )
    
    US$
    (2,192
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 
 ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES Not applicable. 91




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##### Table of Contents



PART II 
 ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES No matters to report. 
 ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS No matters to report. 
 ITEM 15. CONTROLS AND PROCEDURES Our president and chief executive officer, Maurício Novis Botelho, and our
executive vice-president corporate and chief financial officer, Antonio Luiz
Pizarro Manso, after evaluating, together with management, the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31, 2003, the end
of the period covered by this report, have concluded that, as of such date, our
disclosure controls and procedures were adequate and effective to ensure that
material information relating to us and our consolidated subsidiaries would be
made known to them by others within our company and our consolidated
subsidiaries. There were no changes in our companys internal control over financial
reporting that occurred during the period covered by this annual report that
have materially affected, or are reasonably likely to materially affect, our
companys internal control over financial reporting. 
 ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT Our board of directors has determined that Taiki Hirashima, a member of
our Conselho Fiscal, is an audit committee financial expert as defined by
current SEC rules. For a discussion of the role of our Conselho Fiscal, see
Item 6C. Board PracticesConselho Fiscal. 
 ITEM 16B. CODE OF ETHICS Our board of directors has adopted a Code of Ethics and Conduct applicable
to our directors, officers and employees worldwide, including our principal
executive officer, principal financial officer and controller. A copy of our
Code of Ethics and Conduct has been filed as Exhibit 11.1 to this annual
report. 
 ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES The following table sets forth by category of service the total fees for
services performed by Deloitte Touche Tohmatsu during the fiscal years ended
December 31, 2003 and December 31, 2002: 2003
    
    2002(in thousands)Audit Fees
    
    US$
    1,022
    
    
    US$
    952Audit-Related Fees
    
    
    375
    
    
    
    167Tax Fees
    
    
    556
    
    
    
    306All Other Fees
    
    
    
    
    
    
    Total
    
    US$
    1,953
    
    
    US$
    1,425
 Audit Fees Audit fees in 2003 and 2002 consisted of the aggregate fees billed by
Deloitte Touche Tohmatsu in connection with the audit of our annual financial
statements under Brazilian GAAP, which are published in Brazil, and our annual
financial statements under U.S. GAAP and for the review of our financial
information included in 92




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##### Table of Contents



our annual report on Form 20-F, reviews of quarterly
financial statements, which are submitted on Form 6-K, and statutory audits of
our subsidiaries. Audit-Related Fees Audit-related fees in 2003 and 2002 consisted of the aggregate fees billed
by Deloitte Touche Tohmatsu in connection with the review of our internal
control system and assistance in complying with the requirements of the
Sarbanes-Oxley Act of 2002. Tax Fees Tax fees in 2003 and 2002 consisted of the aggregate fees billed by
Deloitte Touche Tohmatsu in connection with services for tax compliance, tax
planning and tax advice, mainly comprised of the review of income tax returns
in the several jurisdictions in which we operate and assistance with other tax
filings in foreign jurisdictions, as well as assistance to our tax committee to
ensure compliance with Brazilian tax requirements. All Other Fees We did not pay any other fees to Deloitte Touche Tohmatsu in 2003 and 2002
other than those described above. Pre-Approval Policies and Procedures Our board of directors approves all audit, audit-related services, tax
services and other services provided by Deloitte Touche Tohmatsu. Any services
provided by Deloitte Touche Tohmatsu that are not specifically included within
the scope of the audit must be pre-approved by board of directors in advance of
any engagement. Pursuant to Rule 2-01 of Regulation S-X, audit committees are
permitted to approve certain fees for audit-related services, tax services and
other services pursuant to a de minimisexception prior to the completion of an
audit engagement. In 2003, none of the fees paid to Deloitte Touche Tohmatsu
were approved pursuant to the de minimisexception. 93




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PART III 
 ITEM 17. FINANCIAL STATEMENTS We have responded to Item 18 in lieu of responding to this item. 
 ITEM 18. FINANCIAL STATEMENTS Our consolidated financial statements, together with the Independent
Auditors Report thereon, are filed as part of this annual report and are
located following the signature page hereof. 
 ITEM 19. EXHIBITS ExhibitNumber
    
    Description1.1
    
    Bylaws of Embraer (English translation).2.1
    
    Shareholders Agreement dated July 24, 1997, as amended, together with an
English translation, incorporated herein by reference to Exhibit 9.1 to
Embraers Registration Statement No. 333-12220.2.2
    
    Form of Deposit Agreement among Embraer, Morgan Guaranty Trust Company of
New York, as depositary, and the Holders from time to time of American
Depositary Shares issued thereunder, including the Form of American
Depositary Receipts, incorporated herein by reference to Exhibit 4.1 to
Embraers Registration Statement No. 333-12220.2.3
    
    The registrant hereby agrees to furnish to the Commission, upon request,
copies of certain instruments defining the rights of holders of long-term
debt of the kind described in Item 2(b)(i) of the Instructions as to
Exhibits in Form 20-F.4.1*
    
    Shareholders Agreement executed by Embraer and Liebherr International AG
on May 22, 2000, incorporated herein by reference from Exhibit 10.5 to
Embraers Registration Statement No. 333-12220.4.2
    
    Lease Agreement, as amended, between the Paris Airport and Embraer, dated
as of January 1, 1999, together with an English translation, incorporated
herein by reference from Exhibit 10.6 to Embraers Registration Statement
No. 333-12220.4.3
    
    Lease Agreement, as amended, between Howard County and Embraer Aircraft
Corporation, dated as of April 21, 1998, incorporated herein by reference
from Exhibit 10.6 to Embraers Registration Statement No. 333-12220.8.1
    
    List of Embraers subsidiaries.11.1
    
    Code of Ethics and Conduct.12.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.12.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.13.1
    
    Section 1350 Certification of Chief Executive Officer.13.2
    
    Section 1350 Certification of Chief Financial Officer.
 94




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##### Table of Contents



ExhibitNumber
    
    Description23.1
    
    Consent of Deloitte Touche Tohmatsu.
   *
    
    Embraer has been granted confidential treatment for portions of this
Exhibit. Accordingly, portions thereof have been omitted and were filed
separately with the Commission. 95




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##### Table of Contents



SIGNATURES The Registrant hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf. EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.Date: June 30, 2004
    
    By:
    
    /s/ Antonio Luiz Pizarro MansoName: Antonio Luiz Pizarro MansoTitle: Executive Vice-President Corporate and Chief Financial OfficerDate: June 30, 2004
    
    By:
    
    /s/ Carlos Rocha VillelaName: Carlos Rocha VillelaTitle: Vice-President and General Counsel




---



INDEX TO FINANCIAL STATEMENTS PageIndex to Financial Statements
    
    
    F-1Report of Independent Registered Public Accounting Firm
    
    
    F-3Consolidated Balance Sheets at December 31, 2002 and 2003
    
    
    F-4Consolidated Statements of Income and Comprehensive Income for the
Years Ended December 31, 2001, 2002 and 2003
    
    
    F-6Consolidated Statements of Cash Flows for the
Years Ended December 31, 2001, 2002 and 2003
    
    
    F-7Consolidated Statements of Shareholders Equity for the
Years Ended December 31, 2001, 2002 and 2003
    
    
    F-8Notes to Consolidated Financial Statements for the
Years Ended December 31, 2001, 2002 and 2003
    
    
    F-10
  F-1




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##### Table of Contents



Embraer
- Empresa Brasileira
de Aeronáutica S.A. Consolidated Financial Statements
for the Years Ended
December 31, 2001, 2002 and 2003 and
Independent Auditors Report Deloitte Touche Tohmatsu Auditores Independentes F-2




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of
Embraer - Empresa Brasileira de Aeronáutica S.A.
São Paulo - SP - Brazil We have audited the accompanying consolidated balance sheets of Embraer -
Empresa Brasileira de Aeronáutica S.A. and subsidiaries (the Company) as of
December 31, 2003 and 2002, and the related consolidated statements of income
and comprehensive income, cash flows and shareholders equity for each of the
years in the three-year period ended December 31, 2003. These consolidated
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statements presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Embraer - Empresa Brasileirtica S.A. and subsidiaries as of
December 31, 2003 and 2002, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 2003,
in conformity with accounting principles generally accepted in the United
States of America. As discussed in Note 36 to the consolidated financial statements, the
statements of cash flows for the years ended December 31, 2002 and 2001 have
been restated. As discussed in note 3(p) to the consolidated financial statements, effective
January 1, 2001 the Company changed its method of accounting for derivative
financial instruments to conform to Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Financial Instruments and Hedging
Activities, as amended. Deloitte Touche Tohmatsu Auditores Independentes
São Paulo, Brazil March 5, 2004 F-3




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. 
 CONSOLIDATED BALANCE SHEETS
(In thousands of U.S. dollars, unless otherwise stated) At December 31,Notes
    
    2002
    
    2003ASSETSCURRENT ASSETSCash and cash equivalents
    
    
    5
    
    
    
    656,822
    
    
    
    1,265,820Trade accounts receivable, net
    
    
    6
    
    
    
    735,927
    
    
    
    356,401Collateralized accounts receivable
    
    
    8
    
    
    
    68,872
    
    
    
    102,110Inventories
    
    
    9
    
    
    
    864,800
    
    
    
    1,158,060Deferred income tax assets
    
    
    26
    
    
    
    90,014
    
    
    
    102,533Other assets
    
    
    10
    
    
    
    96,688
    
    
    
    349,080Total current assets
    
    
    
    
    
    
    2,513,123
    
    
    
    3,334,004NON-CURRENT ASSETSCustomer and commercial financing
    
    
    7
    
    
    
    59,401
    
    
    
    155,003Collateralized accounts receivable
    
    
    8
    
    
    
    873,046
    
    
    
    1,648,849Inventories
    
    
    9
    
    
    
    15,518
    
    
    
    14,770Property, plant and equipment, net
    
    
    12
    
    
    
    436,715
    
    
    
    402,663Investments
    
    
    11
    
    
    
    28,008
    
    
    
    36,814Deferred income taxes
    
    
    26
    
    
    
    72,827
    
    
    
    95,984Other assets
    
    
    10
    
    
    
    286,826
    
    
    
    267,911Total non-current assets
    
    
    
    
    
    
    1,772,341
    
    
    
    2,621,994TOTAL ASSETS
    
    
    
    
    
    
    4,285,464
    
    
    
    5,955,998
 The accompanying notes are an integral part of these financial statements. F-4




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. CONSOLIDATED BALANCE SHEETS
(In thousands of U.S. dollars, unless otherwise stated) At December 31,Notes
    
    2002
    
    2003LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESLoans
    
    
    18
    
    
    
    244,526
    
    
    
    517,014Non-recourse and recourse debt
    
    
    8
    
    
    
    68,872
    
    
    
    360,645Capital lease obligation
    
    
    19
    
    
    
    7,949
    
    
    
    5,283Accounts payable to suppliers
    
    
    
    
    
    
    323,115
    
    
    
    404,065Customer advances
    
    
    15
    
    
    
    409,258
    
    
    
    448,648Other accounts payable and accrued liabilities
    
    
    14
    
    
    
    297,463
    
    
    
    336,185Taxes and social charges payable
    
    
    16
    
    
    
    199,857
    
    
    
    314,788Contingencies
    
    
    17
    
    
    
    5,244
    
    
    
    8,750Accrued taxes on income
    
    
    26
    
    
    
    49,218
    
    
    
    1,724Accrued dividends
    
    
    23
    
    
    
    36,431
    
    
    
    36,561Total current liabilities
    
    
    
    
    
    
    1,641,933
    
    
    
    2,433,663LONG-TERM LIABILITIESLoans
    
    
    18
    
    
    
    308,110
    
    
    
    526,728Non-recourse debt
    
    
    8
    
    
    
    873,046
    
    
    
    1,390,314Capital lease obligation
    
    
    19
    
    
    
    4,895
    
    
    
    2,772Customer advances
    
    
    15
    
    
    
    95,625
    
    
    
    110,539Contribution from suppliers
    
    
    13
    
    
    
    235,445
    
    
    
    234,958Taxes and social charges payable
    
    
    16
    
    
    
    16,117
    
    
    
    18,889Other accounts payable and accrued liabilities
    
    
    14
    
    
    
    2,794
    
    
    
    34,406Contingencies
    
    
    17
    
    
    
    9,093
    
    
    
    21,893Total long-term liabilities
    
    
    
    
    
    
    1,545,125
    
    
    
    2,340,499MINORITY INTEREST
    
    
    
    
    
    
    8,226
    
    
    
    12,611Contingencies, see Note 17SHAREHOLDERS EQUITY
    
    
    22Statutory capital-Preferred (no par value, 1,000,000,000 shares
authorized; 470,429,907 shares issued and
outstanding at December 31, 2002; 2003 -
473,501,135 shares)
    
    
    
    
    
    
    684,078
    
    
    
    688,039Common (no par value, 500,000,000 shares
authorized; 242,544,447 shares issued and
outstanding at December 31, 2002 and 2003)
    
    
    
    
    
    
    207,014
    
    
    
    207,014Special Common share (R$1 par value, 1 share
authorized, issued and outstanding at
December 31, 2002 and 2003)
    
    
    
    
    
    
    
    
    
    
    Additional paid-in capital
    
    
    
    
    
    
    8,353
    
    
    
    8,353Legal reserve
    
    
    
    
    
    
    76,172
    
    
    
    87,368Retained earnings
    
    
    
    
    
    
    123,399
    
    
    
    180,741Accumulated other comprehensive loss
    
    
    
    
    
    
    (8,836
    )
    
    
    (2,290
    )Total shareholders equity
    
    
    
    
    
    
    1,090,180
    
    
    
    1,169,225TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    
    
    
    
    
    4,285,464
    
    
    
    5,955,998
 The accompanying notes are an integral part of these financial statements. F-5




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. 
 CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands of U.S. dollars, unless otherwise stated) For the years ended December 31,Notes
    
    2001
    
    2002
    
    2003GROSS SALESForeign market
    
    
    
    
    
    
    2,902,936
    
    
    
    2,493,313
    
    
    
    2,052,828Domestic market
    
    
    
    
    
    
    62,702
    
    
    
    58,342
    
    
    
    105,825Sales deductions
    
    
    
    
    
    
    (38,643
    )
    
    
    (25,855
    )
    
    
    (15,193
    )NET SALES
    
    
    
    
    
    
    2,926,995
    
    
    
    2,525,800
    
    
    
    2,143,460Cost of sales and services
    
    
    
    
    
    
    (1,769,234
    )
    
    
    (1,531,720
    )
    
    
    (1,335,032
    )GROSS PROFIT
    
    
    
    
    
    
    1,157,761
    
    
    
    994,080
    
    
    
    808,428OPERATING INCOME/(EXPENSES)Selling expenses
    
    
    
    
    
    
    (212,057
    )
    
    
    (211,015
    )
    
    
    (206,246
    )Research and development
    
    
    
    
    
    
    (99,566
    )
    
    
    (158,499
    )
    
    
    (173,216
    )General and administrative
    
    
    
    
    
    
    (120,787
    )
    
    
    (109,673
    )
    
    
    (114,743
    )Employee profit sharing
    
    
    
    
    
    
    (43,746
    )
    
    
    (25,222
    )
    
    
    (20,399
    )Other operating expense, net
    
    
    27
    
    
    
    (30,537
    )
    
    
    (20,498
    )
    
    
    (29,060
    )Equity in income from affiliates
    
    
    11
    
    
    
    310
    
    
    
    389
    
    
    
    51INCOME FROM OPERATIONS
    
    
    
    
    
    
    651,378
    
    
    
    469,562
    
    
    
    264,815Interest income (expense), net
    
    
    20
    
    
    
    47,502
    
    
    
    80,456
    
    
    
    (140,755
    )Foreign exchange loss, net
    
    
    28
    
    
    
    (148,637
    )
    
    
    (135,647
    )
    
    
    (16,500
    )Other non-operating income (expense), net
    
    
    29
    
    
    
    (8,426
    )
    
    
    (1,394
    )
    
    
    711INCOME BEFORE INCOME TAXES
    
    
    
    
    
    
    541,817
    
    
    
    412,977
    
    
    
    108,271Income tax benefit (expense)
    
    
    26
    
    
    
    (218,394
    )
    
    
    (188,502
    )
    
    
    27,990INCOME BEFORE MINORITY INTEREST
    
    
    
    
    
    
    323,423
    
    
    
    224,475
    
    
    
    136,261Minority interest
    
    
    
    
    
    
    (423
    )
    
    
    (1,883
    )
    
    
    (217
    )INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING
CHANGE
    
    
    
    
    
    
    323,000
    
    
    
    222,592
    
    
    
    136,044CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX
    
    
    
    
    
    
    5,440
    
    
    
    
    
    
    
    NET INCOME
    
    
    
    
    
    
    328,440
    
    
    
    222,592
    
    
    
    136,044OTHER COMPREHENSIVE INCOMECumulative translation adjustment
    
    
    
    
    
    
    2,998
    
    
    
    (7,263
    )
    
    
    6,546COMPREHENSIVE INCOME
    
    
    
    
    
    
    331,438
    
    
    
    215,329
    
    
    
    142,590EARNINGS PER SHARE
    
    
    24Basic-Common
    
    
    
    
    
    
    0.4796
    
    
    
    0.2998
    
    
    
    0.1788Preferred
    
    
    
    
    
    
    0.5276
    
    
    
    0.3298
    
    
    
    0.1967Diluted-Common
    
    
    
    
    
    
    0.4575
    
    
    
    0.2976
    
    
    
    0.1779Preferred
    
    
    
    
    
    
    0.5033
    
    
    
    0.3274
    
    
    
    0.1957WEIGHTED AVERAGE SHARES (in thousands of shares)Basic-Common
    
    
    
    
    
    
    242,544
    
    
    
    242,544
    
    
    
    242,544Preferred
    
    
    
    
    
    
    402,035
    
    
    
    454,414
    
    
    
    471,228Diluted-Common
    
    
    
    
    
    
    242,544
    
    
    
    242,544
    
    
    
    242,544Preferred
    
    
    
    
    
    
    433,386
    
    
    
    459,415
    
    
    
    474,840
 The accompanying notes are an integral part of these financial statements. F-6




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##### Table of Contents



EMBRAER
- EMPRESA BRASILEIRA DE AERONÁUTICA S.A. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of U.S. dollars, unless otherwise stated) For the years ended December 31,2001
    
    2002
    
    2003(Restated - Note 36)CASH FLOWS - OPERATING ACTIVITIESNet income
    
    
    328,440
    
    
    
    222,592
    
    
    
    136,044Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation
    
    
    46,417
    
    
    
    55,602
    
    
    
    58,877Allowance for doubtful accounts
    
    
    6,938
    
    
    
    1,436
    
    
    
    4,531Provision for inventory obsolescence
    
    
    12,968
    
    
    
    22,061
    
    
    
    (18,042
    )Loss on permanent asset disposals
    
    
    966
    
    
    
    1,119
    
    
    
    1,113Deferred income and social contribution tax
    
    
    41,333
    
    
    
    21,054
    
    
    
    (35,676
    )Interest accrued in excess of interest paid (paid in excess of accrued)
    
    
    (1,073
    )
    
    
    (9,684
    )
    
    
    15,504Equity in unconsolidated subsidiary
    
    
    (310
    )
    
    
    (388
    )
    
    
    (51
    )Minority interests
    
    
    423
    
    
    
    1,883
    
    
    
    217Cumulative effect of accounting change
    
    
    (5,440
    )
    
    
    
    
    
    
    Foreign exchange loss, net
    
    
    148,637
    
    
    
    135,647
    
    
    
    16,500Other
    
    
    (9,351
    )
    
    
    (7,245
    )
    
    
    10,624Changes in assets and liabilities:Trade accounts receivable
    
    
    (452,473
    )
    
    
    (193,837
    )
    
    
    300,836Inventories
    
    
    (434,571
    )
    
    
    138,890
    
    
    
    (234,434
    )Other assets
    
    
    (166,732
    )
    
    
    (153,573
    )
    
    
    (246,336
    )Accounts payable to suppliers
    
    
    24,739
    
    
    
    57,522
    
    
    
    35,737Other accounts payable and accrued liabilities
    
    
    72,929
    
    
    
    111,192
    
    
    
    54,221Accrued taxes on income
    
    
    8,098
    
    
    
    5,047
    
    
    
    (47,857
    )Contribution from suppliers
    
    
    1,945
    
    
    
    91,830
    
    
    
    (487
    )Customers advances
    
    
    117,521
    
    
    
    13,024
    
    
    
    54,304Taxes and social charges payable
    
    
    51,118
    
    
    
    62,306
    
    
    
    117,703Contingency
    
    
    90
    
    
    
    (825
    )
    
    
    16,306Net cash provided by (used in) operating activities
    
    
    (207,388
    )
    
    
    575,653
    
    
    
    239,634CASH FLOWS - INVESTING ACTIVITIESSales of property, plant and equipment
    
    
    
    
    
    
    790
    
    
    
    2,395Business acquisitions
    
    
    
    
    
    
    (13,178
    )
    
    
    Additions to property, plant and equipment
    
    
    (143,828
    )
    
    
    (111,030
    )
    
    
    (64,765
    )Additions to Held to maturity investments
    
    
    (18,932
    )
    
    
    (24,046
    )
    
    
    (10,297
    )Proceeds from Held to maturity investments
    
    
    
    
    
    
    43,248
    
    
    
    Net cash used in investing activities
    
    
    (162,760
    )
    
    
    (104,216
    )
    
    
    (72,667
    )CASH FLOWS - FINANCING ACTIVITIESRepayment of loans
    
    
    (1,175,797
    )
    
    
    (1,071,452
    )
    
    
    (427,246
    )Proceeds from borrowings
    
    
    1,495,119
    
    
    
    862,036
    
    
    
    902,955Dividends and/or interest on capital paid
    
    
    (179,491
    )
    
    
    (134,421
    )
    
    
    (67,483
    )Proceeds from the issuance of shares
    
    
    1,761
    
    
    
    1,194
    
    
    
    3,960Payments on capital lease obligations
    
    
    (7,213
    )
    
    
    (9,792
    )
    
    
    (8,395
    )Net cash provided by (used in) financing activities
    
    
    134,379
    
    
    
    (352,435
    )
    
    
    403,791Effect of exchange rate changes on cash
    
    
    (204,160
    )
    
    
    (211,482
    )
    
    
    38,240Net increase (decrease) in cash and equivalents
    
    
    (439,929
    )
    
    
    (92,480
    )
    
    
    608,998Cash and equivalents, beginning of the period
    
    
    1,189,231
    
    
    
    749,302
    
    
    
    656,822Cash and equivalents, end of the period
    
    
    749,302
    
    
    
    656,822
    
    
    
    1,265,820SUPPLEMENTAL CASH FLOW DISCLOSURESCash paid during the year for:Income taxes
    
    
    166,891
    
    
    
    79,860
    
    
    
    52,821Interest
    
    
    34,358
    
    
    
    32,396
    
    
    
    29,920Non-cash financing and investing transactions:Conversion of debentures to capital
    
    
    81,927
    
    
    
    
    
    
    
    Assets acquired as capital lease
    
    
    11,019
    
    
    
    6,010
    
    
    
    3,606
 The accompanying notes are an integral part of these financial statements. F-7




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##### Table of Contents



EMBRAER
- EMPRESA BRASILEIRA DE AERONÁUTICA S.A. 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(In thousands of U.S. dollars, unless otherwise stated) Statutory capital
    
    
    
    
    
    
    
    
    
    AccumulatedCommon
    
    Preferred
    

Additionalpaid-in capital -
    
    Legal
    
    Retainedearnings
    
    othercomprehensiveShares
    
    Amount
    
    Shares
    
    Amount
    
    stock option
    
    reserve
    
    (restricted)
    
    loss
    
    TotalBALANCE ON DECEMBER 31, 2000
    
    
    242,544,448
    
    
    
    50,263
    
    
    
    370,928,339
    
    
    
    296,629
    
    
    
    7,279
    
    
    
    35,061
    
    
    
    400,699
    
    
    
    (4,571
    )
    
    
    785,360Capital increase:In cash
    
    
    
    
    
    
    
    
    
    
    6,084,220
    
    
    
    1,761
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,761Debentures converted into capital
    
    
    
    
    
    
    
    
    
    
    91,156,035
    
    
    
    81,927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    81,927Stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,074
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,074Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    328,440
    
    
    
    
    
    
    
    328,440Legal reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,101
    
    
    
    (24,101
    )
    
    
    
    
    
    
    Dividends / Interest on equity
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (181,204
    )
    
    
    
    
    
    
    (181,204
    )Currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,998
    
    
    
    2,998BALANCE ON DECEMBER 31, 2001
    
    
    242,544,448
    
    
    
    50,263
    
    
    
    468,168,594
    
    
    
    380,317
    
    
    
    8,353
    
    
    
    59,162
    
    
    
    523,834
    
    
    
    (1,573
    )
    
    
    1,020,356Capital increase:In cash
    
    
    
    
    
    
    
    
    
    
    2,261,313
    
    
    
    1,194
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,194Capitalization of reserves
    
    
    
    
    
    
    156,751
    
    
    
    
    
    
    
    302,567
    
    
    
    
    
    
    
    
    
    
    
    (459,318
    )
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    222,592
    
    
    
    
    
    
    
    222,592Legal reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,010
    
    
    
    (17,010
    )
    
    
    
    
    
    
    Dividends / Interest on equity
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (146,713
    )
    
    
    
    
    
    
    (146,713
    )Expired dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    14Currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,263
    )
    
    
    (7,263
    )BALANCE ON DECEMBER 31, 2002
    
    
    242,544,448
    
    
    
    207,014
    
    
    
    470,429,907
    
    
    
    684,078
    
    
    
    8,353
    
    
    
    76,172
    
    
    
    123,399
    
    
    
    (8,836
    )
    
    
    1,090,180
 (Continues) F-8




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY (In thousands of U.S. dollars, unless otherwise stated)
    
    
    
    (Continued)
 Statutory capital
    
    
    
    
    
    
    
    
    
    AccumulatedCommon
    
    Preferred
    

Additionalpaid-in capital -
    
    Legal
    
    Retainedearnings
    
    othercomprehensiveShares
    
    Amount
    
    Shares
    
    Amount
    
    stock option
    
    reserve
    
    (restricted)
    
    loss
    
    TotalBALANCE ON DECEMBER 31, 2002
    
    
    242,544,448
    
    
    
    207,014
    
    
    
    470,429,907
    
    
    
    684,078
    
    
    
    8,353
    
    
    
    76,172
    
    
    
    123,399
    
    
    
    (8,836
    )
    
    
    1,090,180Capital increase
    
    
    
    
    
    
    
    
    
    
    3,071,228
    
    
    
    3,961
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,961Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136,044
    
    
    
    
    
    
    
    136,044Legal reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,196
    
    
    
    (11,196
    )
    
    
    
    
    
    
    Dividends / Interest on equity
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (67,517
    )
    
    
    
    
    
    
    (67,517
    )Expired dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    11Currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,546
    
    
    
    6,546BALANCE ON DECEMBER 31, 2003
    
    
    242,544,448
    
    
    
    207,014
    
    
    
    473,501,135
    
    
    
    688,039
    
    
    
    8,353
    
    
    
    87,368
    
    
    
    180,741
    
    
    
    (2,290
    )
    
    
    1,169,225
 The accompanying notes are an integral part of these financial statements. F-9




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##### Table of Contents



EMBRAER
- EMPRESA BRASILEIRA DE AERONÁUTICA S.A. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  1.
    
    THE COMPANY AND ITS OPERATIONSEmbraer - Empresa Brasileira de Aeronáutica S.A. (the Company) is a
publicly held company incorporated under the laws of the Federative Republic
of Brazil. Originally formed in 1969 by the Brazilian government, the
Company was privatized in 1994.The Company has grown from a government-controlled company established to
develop and produce aircraft for the Brazilian Air Force into a public
company that produces aircraft for commercial, corporate and defense
purposes. Through its evolution, the Company has obtained, developed and
enhanced its engineering and technological capabilities through its own
development of products for the Brazilian Air Force and through joint
product development with foreign companies on specific projects. The Company
has applied these capabilities that it gained from its defense business to
develop its commercial aircraft business.The Company has wholly-owned consolidated subsidiaries located in Brazil,
the United States, France, the United Kingdom and Australia, mainly engaged
in sales marketing and post sales/maintenance services activities.In March 2002, the Company concluded the acquisition of a business located
in Nashville, Tennessee, U.S.A., which is mainly engaged in providing
aircraft maintenance services. This transaction was accounted for as a
business acquisition; total consideration paid amounted to $13,178, which
was fully allocated into the assets and liabilities acquired, without
recognition of goodwill.2.
    
    PRESENTATION AND CONSOLIDATION OF FINANCIAL STATEMENTS  (i)
    
    The financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of
America (US GAAP), which differ in certain respects from accounting
principles applied by the Company in its financial statements prepared
in accordance with accounting practices adopted in Brazil (BR GAAP).(ii)
    
    The consolidated financial statements include the accounts of the
Company and all majority-owned subsidiaries in which the Company
directly or indirectly has either a majority of the equity of the
subsidiary or otherwise has management control. Intercompany balances
and transactions have been eliminated.(iii)
    
    A substantial portion of the Companys sales is destined for
export and a high level of financing is denominated in U.S. dollars
(US$). The Company presents its financial statements in accordance
with Statement of Financial Accounting Standards (SFAS) No. 52 -
Foreign Currency Translation. The Companys Board of Directors
(Conselho de Administração) and management have historically
considered the U.S.dollar as its functional currency as this has been,
and remains in their opinion, the currency in which the Company
principally operates. Accordingly, the Companys management has
concluded that the functional currency is currently the U.S. dollar. F-10




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  (iv)
    
    For US GAAP purposes, the Company has elected the U.S.dollar as its
reporting currency, as it believes such presentation is more meaningful
to readers.(v)
    
    For subsidiaries for which the particular functional currency is
other than the U.S.dollar, asset and liability accounts are translated
into the Companys reporting currency using rates in effect at the date
of the balance sheet and income and expense items are translated using
weighted average exchange rates. Resulting translation adjustments are
reported in a separate component of shareholders equity, as a
cumulative translation adjustment - CTA.(vi)
    
    The Company has reclassified certain prior-year amounts to conform
to this years presentation.  3.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  a)
    
    Cash and cash equivalentsCash and cash equivalents consist of highly liquid instruments, such as
certificates of deposit, time deposits, treasury notes and other money
market instruments, which have original maturities of three months or
less at the time of purchase.b)
    
    Allowance for doubtful accountsThe allowance for doubtful accounts is recorded based on an analysis of
accounts receivable in an amount considered sufficient to cover probable
losses on receivables.c)
    
    InventoriesInventories are stated at the lower of average production or acquisition
cost or market value. Inventories of work-in-process and finished goods
are reduced, when applicable, to net realizable value after deduction
for costs, taxes and selling expenses. Inventories of raw materials are
reduced to market value based on the average cost compared with the
average cost of replacement. An allowance is established for potential
losses when items are determined to be obsolete or are held in
quantities that are in excess of projected usage based on managements
estimate of net realizable values.Exchange Pool inventories are segregated and placed into the Exchange
Pool for exclusive use by customers who participate in the program. Costs
to refurbish parts are expensed as incurred. The Exchange Pool inventory
is depreciated using the straight-line method over an estimated useful
life of 7 to 10 years and an estimated residual value of 20% to 50%,
which the Company believes approximates the usage and change in value of
the Exchange Pool each year. The Exchange Pool inventory is classified as
long-term in the consolidated balance sheets. F-11




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  d)
    
    Customer and commercial financingCustomer and commercial financing consists of notes receivable
originated from financed aircraft sales, and used aircraft assets either
under operating leases or available for lease.Notes receivable are stated at cost and reduced by valuation allowance,
when deemed to be appropriate, which is determined by the Company
considering customer credit rating and any collateral attached to this
receivable, if applicable.Aircraft under operating leases are recorded at cost, net of accumulated
depreciation, which is calculated as 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. Income from
operating leases is recognized ratably over the lease term. Rental
income for leased aircraft amounted to $4,950, $3,774 and $5,569 for
2001, 2002 and 2003, respectively.The Company reviews aircraft under operating leases for impairment when
events or circumstances indicate that the carrying amount of these
assets may not be recoverable. An asset under operating lease is
considered impaired when the expected undiscounted cash flow over the
remaining useful life is less than the book value. Various assumptions
are used when determining the expected undiscounted cash flow. These
assumptions include lease rates, lease term(s), periods in which the
asset may be held in preparation for a follow-on lease, maintenance
costs, remarketing costs and the life of the asset. The determination of
expected lease rates is generally based on outside publications and
observing similar aircraft in the secondary market. The Company uses
historical information and current economic trends to determine the
remaining assumptions. When impairment is indicated for an asset, the
amount of impairment loss is the excess of carrying value over fair
value.Used aircraft available for lease are stated at their acquisition cost.
The Company performs a comparison between the individual aircraft cost
and its estimated market value, based on appraisal estimates for each
aircraft, recording any deficiencies as other operating expenses.e)
    
    Property, plant and equipmentProperty, plant and equipment are stated at cost including applicable
construction-period interest. Materials allocated to specific projects
are added to construction-in-progress and, in accordance with the
provisions of SFAS No. 34, Capitalization of Interest Costs, interest
incurred on borrowings is capitalized to the extent that borrowings do
not exceed construction-in-progress. The credit is a reduction of
interest expense. Interest costs capitalized in 2001, 2002 and 2003 were
immaterial.Assets acquired through capital lease arrangements are capitalized and
depreciated over the expected useful lives of the assets, in accordance
with SFAS No. 13. F-12




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The costs incurred for the development of computer software for internal
use are capitalized in accordance with Statement of Position (SOP) No.
98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use.Depreciation is calculated using the straight-line method over the
estimated useful lives of the assets as described in Note 12.
Improvements to existing property that significantly extend the useful
life or utility of the asset are capitalized, while maintenance and
repair costs are charged to expense as incurred.As of January 1, 2002, the Company adopted SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. Long-lived assets
deemed held for sale are stated at the lower of cost or fair value.
Long-lived assets held for use are subject to an impairment assessment
if the carrying value is no longer recoverable based upon the
undiscounted future cash flows of the asset. The amount of the
impairment is the difference between the carrying amount and the fair
value of the asset. No impairment on fixed assets was recorded in 2001,
2002 or 2003.f)
    
    Marketing and advertising expensesThe Company expenses the costs of advertising as incurred. Advertising
expense amounted to $12,969, $9,540 and $6,577 for 2001, 2002 and 2003,
respectively. These amounts are reported in the consolidated statement
of operations as selling expenses.g)
    
    InvestmentsThe Company uses the equity method of accounting for its long-term
investments for which it owns more than 20% but less than 50% of the
investees voting stock and therefore has the ability to exercise
significant influence over operating and financial policies of the
investee. The equity method requires periodic adjustments to the
investment account to recognize the Companys proportionate share in the
investees results, reduced by receipt of investee dividends.Certain investments are accounted for under SFAS No. 115, Accounting
for Certain Investments in Debt and Equity Securities. Investments in
marketable securities classified as held-to-maturity are those
securities which the Company has the ability and intent to hold until
maturity and are reported at amortized cost. Trading debt securities are
marked to market and effects of change in value are recorded in the
income statement. The Companys held-to-maturity securities represent
investments in Brazilian government securities and it has not
experienced, nor does it expect to have, any other than temporary
impairment on such securities.h)
    
    Product warrantiesWarranty expense related to aircraft and parts is recognized as a
selling expense at the time of sale based on estimated amounts of
warranty costs anticipated to be incurred, typically expressed as a
percentage of revenue. These estimates are based on factors that
include, among other things, historical warranty claims and cost
experience, warranty F-13




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  coverage available from suppliers, type and duration of warranty
coverage, and the volume and mix of aircraft sold and in service. The
warranty period typically ranges from two years for spare parts up to
five years for aircraft components.Certain sales contracts contain provisions for guarantees of certain
minimum levels of aircraft performance subsequent to delivery based on
predetermined operational targets. If the aircraft subject to such
guarantees do not achieve the minimum average performance indices after
delivery, the Company may be obligated to reimburse its customers for
the implied incremental operational and service costs incurred based on
formulas defined in the related agreements. Losses related to such
performance guarantees are recorded at the time such losses are known,
or when circumstances indicate that the aircraft is not expected to meet
the minimum performance requirements, based on managements estimate of
the Companys ultimate obligation under the guarantee. In some cases,
the Company may be obligated to make modifications to the products after
the delivery due to introduction of improvements or performance of the
aircraft. The costs related to these modifications are accrued when they
are known.Provision for warranties is included in other accounts payable and
accrued liabilities (Note 14).i)
    
    Provisions for contingenciesLosses for contingencies related to labor, tax, civil and commercial
litigation are recorded when they are determined to be probable and can
be reasonably estimated. These estimates are based on legal advice and
managements estimate as to the likely outcome of the outstanding
matters and the estimated amount of loss at the balance sheet date.In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of the Indebtedness of Others, which
clarifies the requirements of SFAS No. 5, Accounting for
Contingencies, relating to a guarantors accounting for and disclosures
of certain guarantees issued. FIN 45 requires enhanced disclosures for
certain guarantees. It also requires certain guarantees that are issued
or modified after December 31, 2002, including third-party guarantees,
to be initially recorded on the balance sheet at fair value. For
guarantees issued on or before December 31, 2002, liabilities are
recorded when and if payments become probable and estimable. FIN 45 has
the general effect of delaying recognition for a portion of the revenue
for product sales that are accompanied by certain third-party
guarantees. The financial statement recognition provisions became
effective prospectively beginning January 1, 2003. During 2003, the fair
value of guarantees recorded by the Company was not material. F-14




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  j)
    
    Post-retirement benefitsThe Company participates in a defined contribution pension plan that
provides pension benefits for its employees. Expense is recognized as
the amount of the required contribution for the period and is recorded
on the accrual basis.Certain wholly-owned subsidiaries in the United States of America
sponsor defined benefit pension and medical benefits plans. The Company
accounts for those benefits according to SFAS No. 87 and SFAS No. 106,
respectively. The net periodic cost of the Companys defined benefit
pension and other post-retirement plans is determined using the
projected unit credit method and several actuarial assumptions, the most
significant of which are the discount rate, the long-term rate of asset
return, and medical trend (rate of growth for medical costs).k)
    
    Employee profit sharing planThe Company maintains a profit sharing plan linked to dividend payments
to shareholders and to action plans and specific goals, established and
agreed upon yearly, that provides employees of the Company and its
subsidiaries the right to share in the Companys profits. The amounts
recorded for profit sharing expense are accrued in accordance with the
variable compensation policy approved by the Board of Directors in April
1996.l)
    
    Revenue recognitionThe Company recognizes revenues from the regional and corporate segments
when the aircraft is delivered to customers.In the defense segment, operations consist principally of performing
work under long-term development contracts for the Brazilian and foreign
governments; the Company recognizes revenues in accordance with the
percentage of completion (POC) method. Certain contracts contain
provisions for the re-determination of price based upon future economic
conditions. Anticipated losses on contracted sales in the defense
aircraft segment are recognized when they become known and are recorded
based on managements estimate of such losses.The Company maintains a pool of spare parts for exclusive use by
customers (the Exchange Pool). Customers may withdraw for use an
equivalent functioning part, as defined, from the Exchange Pool in
exchange for an unserviceable part, as needed. Revenues under the
Exchange Pool program 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. During 2001,
2002 and 2003, the Company recognized $8,320, $9,604 and $10,990,
respectively, in revenue related to the Exchange Pool, which is included
in net sales in the accompanying consolidated statements of income
(other related businesses segment). F-15




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  m)
    
    Research and developmentResearch and development costs are expensed when incurred and are
recorded net of amounts contributed by risk-sharing suppliers. Amounts
received from risk-sharing suppliers as contributions for research and
development activities are classified as contribution from suppliers and
recognized as revenue only when the Company has met its obligations
under the provisions of the related supply agreements. Net research and
development expense was $99,566, $158,499 and $173,216 for 2001, 2002
and 2003, respectively.n)
    
    Stock compensationSFAS No. 123, Accounting for Stock-Based Compensation (SFAS No. 123),
encourages, but does not require, companies to record compensation cost
for stock-based employee compensation plans at fair value. The Company
has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees (APB No. 25), and
related interpretations. Accordingly, the Company records an expense in
an amount equal to the excess of the quoted market price over the option
exercise price on the grant date.o)
    
    Income taxesIncome taxes in Brazil are comprised of federal income tax and social
contribution, as recorded in the Companys statutory accounting records.
There is no state or local income tax in Brazil. The income tax
statutory rates applicable for the years ended December 31, 2001, 2002
and 2003 are presented as follows: Federal income tax rate
    
    
    25.0
    %Social contribution
    
    
    9.0
    %Composite tax rate
    
    
    34.0
    %
  For the purposes of these financial statements, the Company has applied
SFAS No. 109, Accounting for Income Taxes, for all years presented.
The effects of adjustments made to reflect the US GAAP requirements, as
well as the differences between the tax basis and the amounts included
in the BR GAAP have been recognized as temporary differences for the
purpose of recording deferred income taxes, except that, in accordance
with paragraph 9(f) of SFAS No. 109, deferred taxes have not been
recorded for differences relating to certain assets and liabilities that
are remeasured from Brazilian reaisto US$ at historical exchange rates
and that result from changes in exchange rates or indexing to inflation
in local currency for tax purposes. F-16




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  p)
    
    Derivative financial instrumentsEffective January 1, 2001, the Company accounts for derivative financial
instruments pursuant to SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended. This standard requires
that all derivative instruments be recognized in the financial
statements and measured at fair value regardless of the purpose or
intent for holding them. Changes in the fair value of derivative
instruments are recognized periodically in either income or
shareholders equity (as a component of accumulated other comprehensive
income), depending on their use and designation. The Companys
derivative financial instruments have not qualified for hedge accounting
designation for purposes of SFAS No. 133. Changes in the fair value of
these derivative financial instruments are recorded in income and are
classified as a component of interest income (expense), net in the
consolidated statements of income (Note 20).The adoption of SFAS No. 133 in 2001 resulted in a transition gain of
$5,440, net of related deferred income taxes of $2,802, which was
recorded as a cumulative effect of an accounting change in the
consolidated statements of income.q)
    
    Comprehensive incomeSFAS No. 130, Reporting Comprehensive Income, establishes standards
for reporting and display of comprehensive income and its components in
financial statements. It requires that all items that are required to be
recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the
same prominence as other financial statements. Comprehensive income of
the Company consists of net income and the effects of foreign currency
translation adjustments.r)
    
    Compensated absencesThe liability for future compensation for employee vacations earned is
fully accrued as benefits are earned. F-17




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  4.
    
    RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - NOT YET ADOPTED  
    
    In January 2003, FASB issued Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46), which
clarified the application of Accounting Research Bulletin No. 51,
Consolidated Financial Statements, relating to consolidation of
certain entities. FIN 46 requires the identification of the
Companys participation in variable interest entities (VIEs), which
are defined as entities with a level of invested equity that is not
sufficient to fund future activities to permit them to operate on a
standalone basis or whose equity holders lack certain
characteristics of a controlling financial interest. For entities
identified as VIEs, FIN 46 sets forth a model to evaluate potential
consolidation based on an assessment of which party to the VIE, if
any, bears a majority of the exposure to its expected losses or
stands to gain from a majority of its expected returns. FIN 46 also
requires certain disclosures regarding interests in VIEs that are
deemed significant, even if consolidation is not required. In
December 2003, FIN 46 was substantially revised and a new
interpretation, FIN 46 (revised) (FIN 46R), was issued. FIN 46R
(i) clarified some FIN 46 requirements, (ii) eased some
implementation problems, and (iii) added new scope exceptions. In
addition, FIN 46R deferred the effective date of the Interpretation
for public companies to the end of the first reporting period ending
after March 15, 2004, except that all public companies must at a
minimum apply the provisions of the Interpretation to entities
created after February 1, 2003 that are considered special-purpose
entities (SPEs) under FASB literature prior to the issuance of FIN
46R by the end of the first reporting period ending after December
15, 2003. For foreign private issuers who only report on an annual
basis, the effective date of FIN 46R is the beginning of the first
annual period after December 15, 2003. For SPEs created by foreign
private issuers after February 1, 2003, however, the effective date
is no later than the end of the first reporting period ending after
December 15, 2003.The Company will adopt FIN 46R in 2004. Such adoption will not have
any significant effect on the Company, as the VIEs deemed to be within
the scope of such Interpretation are SPEs that have already been
consolidated through other authoritative accounting rules, as further
discussed in Note 8.In addition, the Company uses exclusive investment funds to invest in
underlying portfolios managed by third party asset management
entities. Such asset management entities have authority, based on
investment strategy guidelines provided by the Company, to make
overall operating and financial decisions related to the investment
fund, including acquisition and disposition of the underlying
marketable securities. The funds are considered to be VIEs of which
the Company is the primary beneficiary, as defined by FIN 46R. Upon
adoption of FIN 46R in 2004, the Company will be required to
consolidate the underlying assets of these funds in Brazil, currently
classified as cash and cash equivalents. This consolidation may cause
certain reclassifications, primarily between cash and cash equivalents
and short-term investments. Considering the composition of the fund
portfolio as of December 31, 2003, the Company believes that adoption
of FIN 46R will not have a material impact on its cash and cash
equivalents position. F-18




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  
    
    In May 2003, FASB issued SFAS No. 150, Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity. SFAS No. 150 establishes standards for how
an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The Statement
requires that an issuer classify a financial instrument within its
scope as a liability. The initial adoption of this accounting
pronouncement will not affect the consolidated financial statements
of the Company.  
    
    On December 23, 2003, FASB issued Statement of
Financial Accounting Standards No. 132 (revised 2003),
Employers Disclosures about Pensions and Other Postretirement
Benefits-an amendment of FASB Statements No. 87, 88 and 106
(SFAS 132 (revised 2003)). SFAS 132 (revised 2003) is effective
for fiscal years ending after December 15, 2003. However, there
is a provision deferring the effectiveness of this new rule for
foreign plans until periods ending after June 15, 2004, which is
applicable to the Company.  SFAS 132 (revised 2003) replaces the disclosure requirements in SFAS
87, SFAS 88 and SFAS 106. SFAS 132 (revised 2003) addresses
disclosures only and does not address measurement and recognition
accounting for pension and post-retirement benefits. SFAS 132 (revised
2003) requires additional disclosures related to the description of
plan assets, including investment strategies, plan obligations, cash
flows and net periodic benefit cost of defined benefit pension and
other defined benefit postretirement plans.  5.
    
    CASH AND CASH EQUIVALENTS At December 31,2002
    
    2003Cash and bank accountsIn Brazilian Reais
    
    
    3,430
    
    
    
    4,096In US$
    
    
    21,818
    
    
    
    67,016In other currencies
    
    
    860
    
    
    
    3,062Cash equivalentsDenominated in US$(i)
    
    
    258,120
    
    
    
    302,115Denominated in Brazilian Reais(ii)
    
    
    372,594
    
    
    
    889,341Denominated in other currencies
    
    
    
    
    
    
    190656,822
    
    
    
    1,265,820
  (i)
    
    Represents time deposits and overnight funds deposited overseas by
consolidated subsidiaries; the average annualized interest for the year
ended December 31, 2003 was 1.09% (2002 - 1.95%).  (ii)
    
    Mainly represented by money market funds at several financial
institutions, basically comprised of debt instruments. These funds are
generally exclusively for the benefit of F-19




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EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  the Company and administrated by third parties who charge a monthly
commission fee. The target returns are specified with each financial
institution based on a percentage of the CDI (The Brazil Interbank
Deposit Rate). In 2003, the weighted average annualized interest income
rate was 24.29% (2002 - 19.22%) compared to 23.25% of the CDI (2002 -
19.11%) in the same period.  6.
    
    TRADE ACCOUNTS RECEIVABLE At December 31,2002
    
    2003Foreign customers, mainly related to aircraft sales
    
    
    618,511
    
    
    
    317,744Brazilian Air Force
    
    
    12,704
    
    
    
    25,287Domestic customers
    
    
    3,858
    
    
    
    4,654Accounts receivable-BNDES (i)
    
    
    125,344
    
    
    
    32,975760,417
    
    
    
    380,660Less allowance for doubtful accounts receivable
    
    
    24,490
    
    
    
    24,259735,927
    
    
    
    356,401
  (i)
    
    Refers to funds retained by BNDES, pending completion of the export
documentation. Unbilled accounts receivable totaled $39,618 (2002 - $4,304) and refers to
revenues from long-term contracts recognized under the percentage of
completion method.The allowance for doubtful accounts is summarized as follows: 2001
    
    2002
    
    2003Beginning balance
    
    
    17,239
    
    
    
    23,700
    
    
    
    24,490Write-offs
    
    
    (477
    )
    
    
    (646
    )
    
    
    (4,762
    )Additions
    
    
    6,938
    
    
    
    1,436
    
    
    
    4,531Ending balance
    
    
    23,700
    
    
    
    24,490
    
    
    
    24,259
  7.
    
    CUSTOMER AND COMMERCIAL FINANCINGCustomer and commercial financing at December 31 consisted of the following: At December 31,2002
    
    2003Notes receivable
    
    
    46,012
    
    
    
    12,315Operating lease equipment, at cost, less accumulated depreciation of
$11,554 and $11,601 as at December 31, (i)
    
    
    32,362
    
    
    
    143,71078,374
    
    
    
    156,025Current portion (classified as other assets)
    
    
    18,973
    
    
    
    1,022Long-term portion
    
    
    59,401
    
    
    
    155,003
 F-20




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  (i)
    
    Operating lease equipment includes used turboprop and jet aircraft
which are either under operating lease agreements or available for
re-lease.  Future minimum operating lease payments receivable under non-cancelable
lease agreements are as follows: Year
    
    20032004
    
    
    9,8632005
    
    
    9,2862006
    
    
    9,2412007
    
    
    8,3412008
    
    
    7,297Total
    
    
    44,028
  8.
    
    COLLATERALIZED ACCOUNTS RECEIVABLE AND NON-RECOURSE AND RECOURSE DEBTSome of the Companys sales transactions are structured financings through
which an SPE purchases the aircraft, pays the Company 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 the aircraft purchase
through an SPE, and a portion of the credit risk remains with the third
party. The Company may provide financial guarantees and/or residual value
guarantees in favor of the financial institution.The Company has been consolidating certain SPEs owned by third parties that
lack the minimum amount of equity capital investment (capital at risk) as
defined in the EITF Topic D-14 and EITF 90-15. Upon issuance of FIN 46 and
FIN 46R, basic conditions requiring consolidation of such entities were
maintained and therefore no significant effect is expected by the Company
upon adoption as a result of the requirements of these interpretations
issued by the FASB.Generally, the underlying lease transactions qualify as sales-type leases
and, as a result, the consolidation of these SPE  ́s resulted in an amount of
investments in minimum lease payments receivable, gross of unearned income,
of $1,606,578 and $2,284,008, and a net amount of $941,918 and $1,750,959 as
of December 31, 2002 and 2003, respectively, which are being presented as
collateralized accounts receivable.Such consolidation has also resulted in an amount of non-recourse debt of
$803,517 and $1,492,424 and an amount of recourse debt of $138,401 and
$258,535 as of December 31, 2002 and 2003, respectively. The non-recourse
debt is served by part of the minimum lease payments receivable and
guaranteed by a mortgage on the financed aircraft. F-21




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The maturities under the collateralized accounts receivable are summarized
as follows: At December 31,Year
    
    2002
    
    20032003
    
    
    68,872
    
    
    
    2004
    
    
    67,262
    
    
    
    102,1102005
    
    
    90,171
    
    
    
    176,1772006
    
    
    85,140
    
    
    
    165,2392007
    
    
    86,398
    
    
    
    145,3752008
    
    
    87,656
    
    
    
    160,824Beyond 2009
    
    
    456,419
    
    
    
    1,001,234941,918
    
    
    
    1,750,959
  9.
    
    INVENTORIES At December 31,2002
    
    2003Finished goods
    
    
    61,229
    
    
    
    52,754Work-in-process (i)
    
    
    266,810
    
    
    
    495,267Raw materials
    
    
    451,366
    
    
    
    513,746Inventory in transit
    
    
    74,768
    
    
    
    60,867Advances to suppliers
    
    
    102,796
    
    
    
    105,608Exchange pool
    
    
    23,199
    
    
    
    25,818Other
    
    
    7,419
    
    
    
    7,122Allowances for obsolescence and depreciation of exchange pool
inventories
    
    
    (107,269
    )
    
    
    (88,352
    )880,318
    
    
    
    1,172,830Less- Current portion
    
    
    864,800
    
    
    
    1,158,060Long-term portion
    
    
    15,518
    
    
    
    14,770
  (i)
    
    Including ten pre-series aircraft (2002 - eight aircraft) of the
EMBRAER 170/190 family, which were in construction or in use under the
certification campaign.  The allowance for obsolescence is summarized as follows: 2001
    
    2002
    
    2003Allowance:Beginning balance
    
    
    90,152
    
    
    
    101,004
    
    
    
    107,269Additions, net of reversions
    
    
    12,968
    
    
    
    22,061
    
    
    
    2,856Write-off
    
    
    (2,116
    )
    
    
    (15,796
    )
    
    
    (21,773
    )Ending balance
    
    
    101,004
    
    
    
    107,269
    
    
    
    88,352
 F-22




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  10.
    
    OTHER ASSETS At December 31,2002
    
    2003Guarantee deposits (i)
    
    
    187,356
    
    
    
    473,962Credits with suppliers (ii)
    
    
    21,113
    
    
    
    11,156Prepaid expenses (iii)
    
    
    8,465
    
    
    
    11,337Value-added tax credits
    
    
    11,403
    
    
    
    9,960Advances to employees
    
    
    5,049
    
    
    
    6,460Export credit insurance
    
    
    28,071
    
    
    
    22,578Compulsory loans, guarantee and other deposits
    
    
    9,547
    
    
    
    4,261Commission advances
    
    
    5,293
    
    
    
    4,520Judicial deposits
    
    
    5,357
    
    
    
    13,079Insurance premium paid
    
    
    8,851
    
    
    
    21,781Unrealized gains on derivatives
    
    
    71,776
    
    
    
    2,629Other
    
    
    21,233
    
    
    
    35,268383,514
    
    
    
    616,991Less- Current portion
    
    
    96,688
    
    
    
    349,080Long-term portion
    
    
    286,826
    
    
    
    267,911
  (i)
    
    Guarantee deposits are mainly represented by:  (a)
    
    $192,765 refers to amounts deposited in an escrow account
as collateral for financing and residual value guarantees of
certain aircraft sold (see note 34). 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. 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 the
Company.(b)
    
    $258,451 relates to amounts deposited with a third party
financial institutional as a pledge under a specific sales
financing structure.  (ii)
    
    Credits with suppliers represent price discounts, rebates and free
aircraft parts to be received from suppliers in connection with
purchases made.(iii)
    
    Prepaid expenses represent credits for parts and the training of
pilots, mechanics and flight attendants granted to customers in
connection with the sale of aircraft. Such credits are stated in the
sales contract in terms of number of aircraft sold and are included in
the overall sales price of the aircraft. The actual delivery of such
parts and services may be different from that of the aircraft. The
amounts reflect the cost of such concessions provided in advance of the
aircraft delivery. These amounts will be recognized as selling expense
over the related period of the sales contract as aircraft deliveries
are made with the corresponding revenue. F-23




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  11.
    
    INVESTMENTS At December 31,2002
    
    2003Trading debt
securities - Debentures
    
    
    
    
    
    
    10,683Held-to-maturity investments in National Treasury
Notes - NTNs(i)
    
    
    23,263
    
    
    
    25,655Investment accounted for under the equity method
Expressprop LLC (ii)
    
    
    4,745
    
    
    
    4,79628,008
    
    
    
    41,134(-) Less-Current portion (classified as other assets)
    
    
    
    
    
    
    4,320Long-term portion
    
    
    28,008
    
    
    
    36,814
  (i)
    
    Refers to receivables, represented by National Treasury Notes,
acquired by the Company from customers, related to the equalization of
interest rates to be paid by Programa de Financiamento às Exportações-
PROEX between the 11th and 15th year after the sale of the related
aircraft, recorded at cost. The interest earned is added to the balance
and recorded as interest income, as the Company has the intent to hold
these securities until maturity.(ii)
    
    Embraer owns 25% of the Expressprop LLC capital stock. This
affiliate provides support for the sale of used EMB 120 Brasília
aircraft. The Companys investment is accounted for under the equity
method and, as such, income from affiliates represents the Companys
share of net income or loss. The net income of this affiliate was
$1,241, $1,552 and $204 for 2001, 2002 and 2003, respectively.  12.
    
    PROPERTY, PLANT AND EQUIPMENT, NET Estimated
    
    2002
    
    2003useful life
    
    
    
    
    
    Accumulated
    
    
    
    
    
    
    
    
    
    Accumulated(years)
    
    Cost
    
    depreciation
    
    Net
    
    Cost
    
    depreciation
    
    NetLand
    
    
    
    
    
    
    2,489
    
    
    
    
    
    
    
    2,489
    
    
    
    2,499
    
    
    
    
    
    
    
    2,499Buildings and land
improvements
    
    
    10 to 48
    
    
    
    134,831
    
    
    
    42,158
    
    
    
    92,673
    
    
    
    173,428
    
    
    
    50,535
    
    
    
    122,893Installations
    
    
    10 to 31
    
    
    
    80,482
    
    
    
    49,652
    
    
    
    30,830
    
    
    
    80,235
    
    
    
    52,412
    
    
    
    27,823Machinery and equipment
    
    
    5 to 17
    
    
    
    158,078
    
    
    
    102,844
    
    
    
    55,234
    
    
    
    166,827
    
    
    
    112,128
    
    
    
    54,699Tooling
    
    
    10
    
    
    
    101,489
    
    
    
    26,970
    
    
    
    74,519
    
    
    
    112,905
    
    
    
    32,214
    
    
    
    80,691Furniture and fixtures
    
    
    5 to 10
    
    
    
    17,642
    
    
    
    8,760
    
    
    
    8,882
    
    
    
    17,967
    
    
    
    10,605
    
    
    
    7,362Vehicles
    
    
    5 to 14
    
    
    
    4,560
    
    
    
    2,807
    
    
    
    1,753
    
    
    
    4,645
    
    
    
    3,291
    
    
    
    1,354Aircraft (*)
    
    
    5 to 20
    
    
    
    80,328
    
    
    
    9,666
    
    
    
    70,662
    
    
    
    39,597
    
    
    
    11,806
    
    
    
    27,791Computers and peripherals
    
    
    5
    
    
    
    84,209
    
    
    
    47,455
    
    
    
    36,754
    
    
    
    83,987
    
    
    
    57,885
    
    
    
    26,102Software
    
    
    5
    
    
    
    50,466
    
    
    
    17,848
    
    
    
    32,618
    
    
    
    62,579
    
    
    
    28,610
    
    
    
    33,969Others
    
    
    5
    
    
    
    5,870
    
    
    
    2,569
    
    
    
    3,301
    
    
    
    6,545
    
    
    
    1,259
    
    
    
    5,286Construction in progress
    
    
    
    
    
    
    27,000
    
    
    
    
    
    
    
    27,000
    
    
    
    12,194
    
    
    
    
    
    
    
    12,194747,444
    
    
    
    310,729
    
    
    
    436,715
    
    
    
    763,408
    
    
    
    360,745
    
    
    
    402,663
 (*) These aircraft are used for external demonstration and for internal
use purposes. F-24




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  13.
    
    CONTRIBUTION FROM SUPPLIERSThe Company has agreements with certain key suppliers for the participation
in research and development activities. Certain of the supply agreements
require that such suppliers provide cash contributions to the Company as
compensation for their participation as suppliers in such programs. As part
of the related supply agreements, these contributions are subject to the
Company meeting certain performance milestones, including successful
certification of the aircraft, first delivery and minimum number of aircraft
deliveries. The Company records such contributions as a liability when
received and as income when contractual milestones are achieved.14.
    
    OTHER ACCOUNTS PAYABLE AND ACCRUED LIABILITIES At December 31,2002
    
    2003Due to Brazilian Air Force (i)
    
    
    2,239
    
    
    
    2,028Product warranties (ii)
    
    
    72,211
    
    
    
    79,724Product improvement liabilities (ii)
    
    
    43,228
    
    
    
    42,971Commercial rebates (iii)
    
    
    6,839
    
    
    
    4,064Customer credits (iii)
    
    
    24,775
    
    
    
    13,095Technical assistance and training (iii)
    
    
    25,557
    
    
    
    16,169Accrued payroll and related charges
    
    
    30,252
    
    
    
    39,009Accrued employee profit sharing
    
    
    18,510
    
    
    
    12,458Post-retirement benefits (Note 21)
    
    
    3,766
    
    
    
    2,517Unrealized losses on derivatives
    
    
    22,117
    
    
    
    52,488Reserve for losses under contractual obligations
    
    
    6,010
    
    
    
    1,514Insurance
    
    
    4,603
    
    
    
    5,283Provision related to financial guarantees (Note 34)
    
    
    14,372
    
    
    
    67,466Other
    
    
    25,778
    
    
    
    31,805300,257
    
    
    
    370,591Less-Current portion
    
    
    297,463
    
    
    
    336,185Long-term portion
    
    
    2,794
    
    
    
    34,406
  (i)
    
    Amounts payable to the Brazilian Air Force represent materials
related to the delivery of AM-X aircraft.(ii)
    
    Represent accruals for product liability programs including
warranty and contractual obligations to implement improvements in
aircraft sold to meet contractual performance indices.(iii)
    
    Amounts represent accruals for customer sales concessions and
allowances including spare parts, commercial rebates and services
related to technical assistance and training of mechanics and crews. F-25




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  15.
    
    CUSTOMER ADVANCES At December 31,2002
    
    2003Denominated in:US$
    
    
    483,880
    
    
    
    543,402Brazilian reais
    
    
    21,003
    
    
    
    15,785504,883
    
    
    
    559,187Less-Current portion
    
    
    409,258
    
    
    
    448,648Long-term portion
    
    
    95,625
    
    
    
    110,539
  The foreign currency advances denominated in Brazilian reaisare presented
in US$ in the above chart at the exchange rates prevailing at the respective
balance sheet dates. The allocation between current and long-term portions
is based on the contractual terms for delivery of the related aircraft.16.
    
    TAXES AND SOCIAL CHARGES PAYABLE At December 31,2002
    
    2003Refinanced INSS (social charges on payroll)
    
    
    14,421
    
    
    
    16,288Current taxes (other than those related to income taxes)
    
    
    14,677
    
    
    
    14,802Contingent tax and social charges (i)
    
    
    186,876
    
    
    
    302,587215,974
    
    
    
    333,677Less-Current maturities
    
    
    199,857
    
    
    
    314,788Long-term portion
    
    
    16,117
    
    
    
    18,889
  (i)
    
    The Company is challenging in court the merit and constitutionality
aspects of several taxes and social charges and has obtained writs of
mandamus or injunctions to avoid payments of such taxes. While awaiting
a final decision on each of those charges, the Company is recognizing
as expense the total amount of the obligation and accruing interest
calculated by the SELIC (Target rate of the Central Bank in Brazil)
over those liabilities, as would be required if the Company is
unsuccessful in defending its judicial actions. SELIC represented a
nominal variation of 23.22% in 2003 (2002 - 19.18%). The main subject
taxes and social charges are described as follows:  
    
    The Company is taking action in court against certain
changes in the rates and rules for the calculation of the PIS
(Social Integration Program) and COFINS (Social Fund)
contributions, determined by Law 9,718/98 as from January 1, 1999.
The Company obtained a preliminary injunction to prevent payment of
the related tax and has accrued since then the total amount of
$114,916 (2002 - $67,145). F-26




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  
    
    The Company is required to pay the government a tax called SAT
(Workers Compensation Insurance) at a rate of 3% of wages. In December
1998, the Company obtained a preliminary injunction to reduce the tax
rate payment from 3% to 1%, and the difference has been accrued in the
amount of $17,628 (2002 - $9,574).  
    
    In April 1999, the Company obtained a writ of mandamus to
offset social charges payments (INSS - National Institute of Social
Security), which were made in August, September and October 1989,
against future payments due to a rate increase from 10% to 20%,
which has been considered unconstitutional. The amount of $40,386
(2002 - $28,245) is recorded as an accrued liability.  
    
    Income tax and social contribution tax on income - The
Company is claiming the suspension of the social contribution tax
on export sales and the right to offset income and social
contribution taxes with IPI (VAT) credits on the acquisition of
non-taxable or zero rate raw materials. The amount of such taxes
accrued as at December 31, 2003 amounted to $55,388 (2002 -
$17,432).  
    
    The Company administratively requested the compensation of
VAT credits generated from the acquisition of consumable materials
used in the production of finished products for export to be offset
with other taxes. The amount of contingent taxes accrued is $64,838
(2002 - $42,550).  17.
    
    CONTINGENCIESBased on a case by case analysis of each issue and consultation with its
outside legal counsel, the Company set up provisions for probable losses for
its legal proceedings involving tax, labor and civil lawsuits as following: At December 31,2002
    
    2003Labor contingencies (i)
    
    
    3,262
    
    
    
    13,209Tax contingencies (ii)
    
    
    10,051
    
    
    
    16,059Civil
    
    
    1,024
    
    
    
    1,37514,337
    
    
    
    30,643Less-Current portion
    
    
    5,244
    
    
    
    8,750Long-term portion
    
    
    9,093
    
    
    
    21,893
  (i)
    
    The labor lawsuits relate to claims brought by unions on behalf of
employees or by individuals, in which former employees are individually
claiming overtime, productivity premiums, reinstatement, allowances,
and retroactive salary increases and adjustments. F-27




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  A lawsuit claiming a retroactive salary increase was brought by the
union in June 1991 in the name of all employees of the Company at
November 1990. The objective of the claim is to make the salary increase
granted by the Company in January and February 1991 retroactive to
November and December 1990, through an agreement with the employees
union. As of December 31, 2003, approximately 97% of current and former
employees have agreed to settlements. Another claim brought relates to
monetary restatements of Plano Collorand Plano Verãoover the FGTS
penalty paid by the Company for employees dismissed between December
1988 and April 1990.(ii)
    
    This provision relates to various tax contingencies including a
deficiency notice received from the Federal Revenue Department, certain
social contributions whose applicability are currently being challenged
and certain nationalization taxes calculated based upon concessionary
acts.  18.
    
    LOANSSummary At December 31,Description
    
    Maturity
    
    Currency
    
    Annual interest rate - %
    
    2002
    
    2003Foreign CurrencyMaterials acquisition
    
    
    2009
    
    
    U.S. dollar
    
    4.12 to 12.42; LIBOR plus 3.25 to 5.50
    
    
    99,709
    
    
    
    273,571Japanese yen
    
    1.66 to 1.68; JIBOR plus 1.05
    
    
    152,137
    
    
    
    134,114Export financing
    
    
    2004
    
    
    U.S. dollar
    
    LIBOR plus 1.50
    
    
    10,330
    
    
    
    10,209Advances on foreign exchange
contracts
    
    
    2004
    
    
    U.S. dollar
    
    3.49 to 8.60
    
    
    80,256
    
    
    
    180,264Project development
    
    
    2008
    
    
    U.S. dollar
    
    LIBOR + 3.00; BNDES basket of Currencies plus 3.00
    
    
    12,092
    
    
    
    8,158Working capital
    
    
    2004
    
    
    Euro
    
    3.00 to 7.00
    
    
    2,754
    
    
    
    8,5712010
    
    
    U.S. dollar
    
    LIBOR plus 2.97 to 3.90
    
    
    147,076
    
    
    
    365,794Property and equipment additions
    
    
    2015
    
    
    U.S. dollar
    
    5.45 to 10.15
    
    
    24,161
    
    
    
    40,086Sub-total
    
    
    
    
    
    
    
    
    
    
    528,515
    
    
    
    1,020,767Local CurrencyProject development
    
    
    2009
    
    
    
    
    TJLP plus 1.00 to 5.50
    
    
    22,635
    
    
    
    21,199Property and equipment additions
    
    
    2007
    
    
    
    
    TJLP plus 3.30 to 4.30
    
    
    1,486
    
    
    
    1,776Sub-total
    
    
    
    
    
    
    
    
    
    
    24,121
    
    
    
    22,975Total debt
    
    
    
    
    
    
    
    
    
    
    552,636
    
    
    
    1,043,742Less Current maturities
    
    
    
    
    
    
    
    
    
    
    244,526
    
    
    
    517,014Long-term portion
    
    
    
    
    
    
    
    
    
    
    308,110
    
    
    
    526,728
 LIBOR means London Interbank Offered Rate The annualized TJLP (Government nominal long-term interest rate), fixed
quarterly, was 11% at December 31, 2003 (2002 - 10%) JIBOR means Japanese Interbank Offered Rate F-28




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The foreign currency exchange rates (expressed in units per US$1.00) related
to the above debt instruments were as follows: At December 31,2002
    
    2003Brazilian reais
    
    
    3.5333
    
    
    
    2.8892Euro
    
    
    1.0475
    
    
    
    1.2635Japanese yen
    
    
    118.8690
    
    
    
    107.1740
  The following summarizes the maturities of long-term debt loans including
accrued interest: Year
    
    20032005
    
    
    101,3612006
    
    
    105,1152007
    
    
    114,9352008
    
    
    86,9682009 and thereafter
    
    
    118,349526,728
  The table below provides the weighted average interest rates on loans
divided by currency as of December 31, 2003. 2003U.S. dollars
    
    
    5.19
    %Brazilian reais
    
    
    14.66
    %Japanese yen
    
    
    1.26
    %Euro
    
    
    3.48
    %
  Of the total $1,043.7 indebtedness of the Company, $170,366
is collateralized. Of this collateralized amount, $25,877 is related
to mortgages on real estate, $3,480 is related to mortgages on
machinery, equipment and inventories, $100,924 is guaranteed with
bank guarantees, $35,346 is related to mortgages on seven EMB-120
Brasília aircraft and $4,739 is supported by a pledge of bank investments.Restrictive clausesLoan agreements with certain financial institutions, representing $440,459
at December 31, 2003, $371,734 of which was classified as long-term, are
subject to restrictive clauses, in connection with usual market practices,
which establish that the ratio between total debt and EBITDA (earnings
before interest, taxes, depreciation and amortization - measured using BR
GAAP figures) cannot be higher than 3:1, and the debt service coverage based
on the ratio between EBITDA and net financial expenses must be higher than
3:1. F-29




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  In addition, there are other general restrictions related to financial
leverage levels, subsidiaries level of indebtedness, new pledges of assets,
significant changes in shareholder control of the Company, sale of assets,
dividend payments in case of financing defaults and transactions with
affiliates. For a specific financing contract, there is also a requirement
that the Company have at least 100 firm orders of new aircraft in its
backlog and a requirement to obtain the Embraer 170 certification prior to
December 31, 2003. This provision was amended to extend the deadline for
certification to March 31, 2004. As of December 31, 2003, the Company was in
compliance with all the covenants and restrictive clauses.19.
    
    OPERATING AND CAPITAL LEASE OBLIGATIONSThe Company and its subsidiaries lease certain land, equipment, computers
and peripherals under non-cancelable agreements classified as operating
leases. Rental expense for leased properties under operating leases was
$659, $2,118 and $2,558 for 2001, 2002 and 2003, respectively.Future minimum operating lease payments under non-cancelable lease
agreements are as follows: Year
    
    20032004
    
    
    2,2142005
    
    
    1,7622006
    
    
    7022007
    
    
    4402008
    
    
    445Thereafter
    
    
    4,0429,605
  The installations of Embraer Aircraft Customer Services Inc. - EACS are
located on land leased under a lease extending through the year 2020. The
lease includes a clause which obligates EACS to make investments, totaling
$10 million. This obligation has been fully satisfied and the investment,
recorded as property plant and equipment, has been depreciated over the
lease term.Obligations under capital leases mainly relate to the lease of software and
equipment with terms ranging from 2003 to 2006 and implicit interest rates
which range from 7.3% to 10.0%. The related software and equipment is being
depreciated over 5 years. Future minimum lease payments under this lease
agreement, including implicit interest, are as follows: F-30




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  Year
    
    20032004
    
    
    5,9452005
    
    
    2,3112006
    
    
    1,051Total
    
    
    9,307Less-Implicit interest
    
    
    1,252Capital lease obligation
    
    
    8,055Less-Current portion
    
    
    5,283Long-term portion
    
    
    2,772
  20.
    
    INTEREST INCOME (EXPENSE), NETThe following summarizes the components of interest income and expense: For the year endedDecember 31,2001
    
    2002
    
    2003Interest expense:Interest and commissions on loans
    
    
    (33,694
    )
    
    
    (27,597
    )
    
    
    (44,659
    )Interest on taxes, social charges and
contributions under litigation (Note 16)
    
    
    (7,231
    )
    
    
    (22,719
    )
    
    
    (57,215
    )Interest and premium on debentures
    
    
    (627
    )
    
    
    
    
    
    
    CPMF (tax on bank account transactions)
    
    
    (12,651
    )
    
    
    (12,063
    )
    
    
    (12,227
    )Interest on refinanced taxes
    
    
    (987
    )
    
    
    (903
    )
    
    
    (450
    )Amortization of deferred credit insurance
    
    
    (2,111
    )
    
    
    (2,291
    )
    
    
    (4,655
    )Royalties to BNDES on aircraft sold (i)
    
    
    (5,512
    )
    
    
    (1,417
    )
    
    
    Structured financing costs
    
    
    (2,118
    )
    
    
    (5,401
    )
    
    
    (4,767
    )Tax on interest on foreign loan
    
    
    (1,089
    )
    
    
    (967
    )
    
    
    (1,961
    )Other
    
    
    (4,665
    )
    
    
    (8,609
    )
    
    
    (3,761
    )(70,685
    )
    
    
    (81,967
    )
    
    
    (129,695
    )Interest income:Temporary cash investments
    
    
    131,310
    
    
    
    82,097
    
    
    
    94,562Interest on NTN, customers accounts receivable and
guarantee deposits
    
    
    15,467
    
    
    
    15,637
    
    
    
    11,652Discount on payments in advance
    
    
    1,372
    
    
    
    732
    
    
    
    3,841Other
    
    
    7,732
    
    
    
    5,128
    
    
    
    4,271155,881
    
    
    
    103,594
    
    
    
    114,326Monetary and exchange variations, net of
gain/(loss) on derivatives
    
    
    (37,694
    )
    
    
    58,829
    
    
    
    (125,386
    )Interest income (expense), net
    
    
    47,502
    
    
    
    80,456
    
    
    
    (140,755
    )
 F-31




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  (i)
    
    Relates to a commission fee agreed to be paid to BNDES as a
percentage of each ERJ 145 aircraft sold between January 1, 1997 and
December 31, 2005, limited to 420 aircraft, reached in 2002.  21.
    
    POST-RETIREMENT BENEFITSDefined Contribution pension planThe Company and certain subsidiaries sponsor a defined contribution pension
plan for their employees. The plan is a private, defined contribution plan
where participation is optional. The plan is administered by a Brazilian
pension fund controlled by Banco do Brasil, which is a Company related
party. The Companys and its subsidiaries contributions to the plan in
2001, 2002 and 2003 were $4,494, $5,169 and $ 5,737, respectively.Defined Benefit plansEmbraer Aircraft Holding Inc. - EAH, and some of its subsidiaries, sponsor a
defined benefit plan for their employees, which includes a pension plan and
a post-retirement health care plan. The pension plan (Plan) was amended
and restated, effective January 1, 2002, for changes effected by the
Economic Growth and Tax Relief Reconciliation Act of 2001 - (EGTRRA). The
amended and restated plan provides that an employee is not eligible to
participate in the Plan if the employee was not first employed by the
Company prior to October 1, 2001. In addition, the name of the Plan was
changed to the Embraer Aircraft Holding, Inc. Defined Benefit Pension Plan
(formerly named the Embraer Aircraft Corporation Defined Benefit Pension
Plan). All employees currently enrolled in these plans will be eligible to
receive benefits as defined in the respective plans. Retirement benefits are
based on compensation levels and the number of years of covered service. The
Company makes contributions to the plans as required to meet Internal
Revenue Service funding standards.On September 12, 2003 the pension plan was amended to freeze all accrued
benefits and cease all accruals effective December 31, 2003 (the
Curtailment), as a result there exists a curtailment ratio of 100%. The
Curtailment reduced the projected benefit obligation by $7,728 down to the
accumulated benefit obligation as of December 31, 2003. This reduction was
applied to eliminate the unrecognized transition obligation, the
unrecognized service cost and the unrecognized new actuarial loss. The
remaining balance was applied to reduce the net periodic benefit cost, which
resulted in a positive accrued benefit cost of $608 for the year ended
December 31, 2003.The expected cost of providing post-retirement medical benefits to an
employee and the employees beneficiaries and covered dependents are accrued
during the years that employees render the necessary service. F-32




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The change in benefit obligation for the years ended December 31, 2001, 2002
and 2003 is as follows: Pension benefits
    
    Post-retirement benefits2001
    
    2002
    
    2003
    
    2001
    
    2002
    
    2003Benefit obligation - beginning of year
    
    
    9,443
    
    
    
    10,365
    
    
    
    16,236
    
    
    
    3,877
    
    
    
    4,768
    
    
    
    4,750Service cost
    
    
    1,420
    
    
    
    1,501
    
    
    
    2,020
    
    
    
    421
    
    
    
    359
    
    
    
    575Interest cost
    
    
    654
    
    
    
    819
    
    
    
    955
    
    
    
    280
    
    
    
    260
    
    
    
    336Plan amendments
    
    
    
    
    
    
    324
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    (691
    )Effect of curtailment
    
    
    
    
    
    
    
    
    
    
    (7,728
    )
    
    
    
    
    
    
    
    
    
    
    Actuarial (gain) loss
    
    
    (891
    )
    
    
    3,702
    
    
    
    (1,233
    )
    
    
    255
    
    
    
    (518
    )
    
    
    67Participant contributions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12Benefits paid to participants
    
    
    (261
    )
    
    
    (475
    )
    
    
    (2,291
    )
    
    
    (65
    )
    
    
    (119
    )
    
    
    (136
    )Benefit obligation - end of year
    
    
    10,365
    
    
    
    16,236
    
    
    
    7,965
    
    
    
    4,768
    
    
    
    4,750
    
    
    
    4,913
  The change in plan assets for the years ended December 31, 2001, 2002 and
2003 is as follows: Pension benefits
    
    Post-retirement benefits2001
    
    2002
    
    2003
    
    2001
    
    2002
    
    2003Fair value of plan assets - beginning
of year
    
    
    4,980
    
    
    
    6,010
    
    
    
    8,245
    
    
    
    2,046
    
    
    
    2,009
    
    
    
    1,798Employer contributions
    
    
    1,218
    
    
    
    3,000
    
    
    
    1,219
    
    
    
    
    
    
    
    
    
    
    
    Actual return on plan assets
    
    
    73
    
    
    
    (290
    )
    
    
    1,400
    
    
    
    28
    
    
    
    (92
    )
    
    
    254Participant contributions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12Benefits paid to participants
    
    
    (261
    )
    
    
    (475
    )
    
    
    (2,291
    )
    
    
    (65
    )
    
    
    (119
    )
    
    
    (136
    )Fair value of plan assets - end of year
    
    
    6,010
    
    
    
    8,245
    
    
    
    8,573
    
    
    
    2,009
    
    
    
    1,798
    
    
    
    1,928
  The components of accrued benefit cost at December 31, 2001, 2002 and 2003
are as follows: Pension benefits
    
    Post-retirement benefits2001
    
    2002
    
    2003
    
    2001
    
    2002
    
    2003Funded status
    
    
    (4,355
    )
    
    
    (7,991
    )
    
    
    608
    
    
    
    (2,759
    )
    
    
    (2,952
    )
    
    
    (2,985
    )Unrecognized transition obligation
    
    
    86
    
    
    
    49
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unamortized prior service cost
    
    
    361
    
    
    
    640
    
    
    
    
    
    
    
    (31
    )
    
    
    (24
    )
    
    
    (669
    )Unrecognized net loss
    
    
    1,922
    
    
    
    6,350
    
    
    
    
    
    
    
    933
    
    
    
    633
    
    
    
    539Prepaid/(accrued) benefit cost
    
    
    (1,986
    )
    
    
    (952
    )
    
    
    608
    
    
    
    (1,857
    )
    
    
    (2,343
    )
    
    
    (3,115
    )
  The prepaid/(accrued) benefit cost as of December 31, 2001, 2002 and 2003 is
included in other accounts payable and accrued liabilities in the
accompanying balance sheets. F-33




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The weighted average assumptions at December 31, 2001, 2002 and 2003 are as
follows: Pension benefits (%)
    
    Post-retirement benefits (%)2001
    
    2002
    
    2003
    
    2001
    
    2002
    
    2003Average discount rate
    
    
    7.50
    
    
    
    6.75
    
    
    
    6.25
    
    
    
    7.75
    
    
    
    7.25
    
    
    
    6.50Expected return on plan assets
    
    
    7.75
    
    
    
    7.75
    
    
    
    7.75
    
    
    
    7.75
    
    
    
    7.75
    
    
    
    7.75Rate of compensation increase
    
    
    5.50
    
    
    
    5.50
    
    
    
    5.50
    
    
    
    5.50
    
    
    
    5.50
    
    
    
    5.50
  The components of net periodic benefit cost as of December 31, 2001, 2002
and 2003 were as follows: Pension benefits
    
    Post-retirement benefits2001
    
    2002
    
    2003
    
    2001
    
    2002
    
    2003Service cost
    
    
    1,420
    
    
    
    1,501
    
    
    
    2,020
    
    
    
    421
    
    
    
    359
    
    
    
    575Interest cost
    
    
    654
    
    
    
    819
    
    
    
    955
    
    
    
    279
    
    
    
    260
    
    
    
    336Expected return on plan assets
    
    
    (410
    )
    
    
    (491
    )
    
    
    (671
    )
    
    
    (156
    )
    
    
    (151
    )
    
    
    (134
    )Amortization of transition obligation
    
    
    38
    
    
    
    37
    
    
    
    38
    
    
    
    
    
    
    
    
    
    
    
    Amortization of prior service cost
    
    
    25
    
    
    
    45
    
    
    
    44
    
    
    
    (7
    )
    
    
    (7
    )
    
    
    (46
    )Amortization of loss
    
    
    105
    
    
    
    57
    
    
    
    309
    
    
    
    47
    
    
    
    25
    
    
    
    41Effect of Curtailment
    
    
    
    
    
    
    
    
    
    
    (2,856
    )
    
    
    
    
    
    
    
    
    
    
    Net periodic benefit cost/(benefit)
    
    
    1,832
    
    
    
    1,968
    
    
    
    (161
    )
    
    
    584
    
    
    
    486
    
    
    
    772
  The net benefit cost (benefit) is included in selling, general and
administrative expenses in the accompanying consolidated statements of
income.For measurement purposes, an annual rate of increase in the per capita cost
of covered health and dental care benefits of 9%, 14% and 10% was assumed
for 2001, 2002 and 2003, respectively. The rate was assumed to remain at 9%
through 2004, and then decrease gradually to 5% for 2009.Assumed health care cost trend rates have a significant effect on the
amounts reported for the post-retirement medical benefit plan. A one
percentage point change in assumed health care cost trend rates would have
the following effects: One percentage pointIncrease
    
    DecreaseEffect on total of service and interest cost components
    
    
    180
    
    
    
    (147
    )Effect on the post-retirement benefit obligation
    
    
    1,443
    
    
    
    (160
    )
 F-34




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  22.
    
    SHAREHOLDERS EQUITYThe Companys preferred shares do not have voting rights but have priority
in capital redemption and, in accordance with present corporate law, have
the right to dividends in an amount 10% greater than those payable to the
common shares. In connection with the 4th Series Debenture, as stipulated in
the debenture indenture, $28,090 of the statutory preferred share capital is
legally designated as a capital reserve due to the conversion of such
Debentures.The Extraordinary Shareholders Meeting on March 1, 2002 approved the
addition of $223,169 to capital from the reserve for investments and working
capital, with the issuance of 88,430,168 preferred shares in a form of stock
dividend, allocated to all common and preferred shareholders, in proportion
to their participation in capital at that date, at the rate of 0.142106 new
preferred share for each existing share.As a result of the stock dividend, shareholders of the Company on March 1,
2002 received the distribution of the additional preferred shares based on
the proportion mentioned above. All per share amounts and number of shares
outstanding in this report have been restated for the stock dividend.Special common share - golden shareOne special common share (golden share) is held by the Brazilian
government. As holder of the golden share, the Brazilian government is
entitled to the same voting rights as the other holders of common shares. In
addition, the golden share carries veto power over the following actions:  
    
    Change of the Company name and corporate purpose.  
    
    Amendment to and/or extension of the Company logo.  
    
    Creation or alteration of military programs, whether or not
involving the Federative Republic of Brazil.  
    
    Third party training in technology for military programs.  
    
    Discontinuance of supply of military airplane maintenance and replacement parts.  
    
    Transfer of share control.  
    
    Any change to the list of corporate actions over which the golden
share carries veto power, to the structure and composition of the Board
of Directors, and to the rights attributed to the golden share. F-35




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  Legal reserveBrazilian corporations are required to allocate 5% of annual net income to a
legal reserve until that reserve equals 20% of capital, or that reserve plus
other capital reserve equals 30% of capital; thereafter, allocations to this
reserve are not mandatory. This reserve can only be used to increase share
capital or to offset accumulated losses.Retained earnings (restricted)Retained earnings are statutorily restricted by a reserve for discretionary
appropriations (Reserve for Investments and Working Capital), which was
ratified by the Companys shareholders for plant expansion and other capital
projects. The amount restricted is based on an approved capital budget
presented by management. After completion of such projects, the Company may
elect to retain the amounts in this reserve until the shareholders vote to
transfer all or a portion of the reserve to capital or to retained earnings,
from which a cash dividend may then be paid.At their annual meeting, the Companys shareholders approved the
appropriation of 100% of net income for the year, after allocation to the
legal reserve and for dividend distribution, as a reserve for investments
and working capital, mainly designated for:  
    
    Research and development - Development of the EMBRAER 170/190
family, new versions and modifications for the ERJ 145 family and
Legacy corporate jet.  
    
    New technologies, processes and management models in order to
improve the Companys results, competencies and productivity, and
investments in subsidiaries.  23.
    
    DIVIDENDSBrazilian law permits the payment of cash dividends only from retained
earnings and certain reserves registered in the Companys statutory
accounting records. At December 31, 2003, the earnings and reserves
available for distribution as dividends, upon approval by the Companys
shareholders, were $180,741. The dividends are calculated using the
Brazilian GAAP figures and are paid in Brazilian reais.In conformity with the Companys bylaws, shareholders are entitled to
minimum dividends equivalent to 25% of annual net income computed in
accordance with the BR GAAP. The Companys preferred shares do not have
voting rights but have priority in capital redemption and, in accordance
with present corporate law, have the right to dividends in an amount 10%
greater than those payable to the common shares. F-36




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The Company has elected to pay interest on shareholders capital, calculated
on a quarterly basis in accordance with article 9 of Law No. 9,249/95 based
on the TJLP, for deductibility purposes in computing income and social
contribution taxes, and charged directly to shareholders equity for
reporting purposes, in compliance with CVM Instruction No. 207/96. The
amount paid to shareholders as interest on net worth, net of any withholding
tax, may be included as part of any mandatory distributable dividends
amount.  The composition of dividends paid is as follows: Amounts
    
    Dividends per share(in Thousands)
    
    Common
    
    PreferredApproval date
    
    US$ (*)
    
    R$
    
    US$
    
    R$
    
    US$
    
    R$2001:March 16, 2001 - dividends
    
    
    51,448
    
    
    
    107,471
    
    
    
    0.0786
    
    
    
    0.1641
    
    
    
    0.0864
    
    
    
    0.1805March 16, 2001 - interest on capital
    
    
    15,661
    
    
    
    33,853
    
    
    
    0.0239
    
    
    
    0.0517
    
    
    
    0.0263
    
    
    
    0.0569June 13, 2001 - interest on capital
    
    
    17,963
    
    
    
    41,404
    
    
    
    0.0240
    
    
    
    0.0554
    
    
    
    0.0264
    
    
    
    0.0609September 14, 2001 - dividends
    
    
    53,418
    
    
    
    123,124
    
    
    
    0.0709
    
    
    
    0.1635
    
    
    
    0.0781
    
    
    
    0.1799September 14, 2001 - interest on
capital
    
    
    18,102
    
    
    
    48,354
    
    
    
    0.0240
    
    
    
    0.0642
    
    
    
    0.0264
    
    
    
    0.0706December 15, 2001 - interest on
capital
    
    
    24,612
    
    
    
    57,109
    
    
    
    0.0326
    
    
    
    0.0757
    
    
    
    0.0359
    
    
    
    0.0833Total dividends in 2001
    
    
    181,204
    
    
    
    411,3152002:March 19, 2002 - dividends
    
    
    43,100
    
    
    
    100,010
    
    
    
    0.0571
    
    
    
    0.1326
    
    
    
    0.0628
    
    
    
    0.1459March 19, 2002 - interest on capital
    
    
    25,353
    
    
    
    58,910
    
    
    
    0.0335
    
    
    
    0.0778
    
    
    
    0.0368
    
    
    
    0.0855June 14, 2002 - interest on capital
    
    
    20,929
    
    
    
    59,530
    
    
    
    0.0276
    
    
    
    0.0786
    
    
    
    0.0304
    
    
    
    0.0864September 13, 2002 - interest on
capital
    
    
    17,022
    
    
    
    66,300
    
    
    
    0.0224
    
    
    
    0.0874
    
    
    
    0.0247
    
    
    
    0.0961December 13, 2002 - interest on
capital
    
    
    19,804
    
    
    
    69,974
    
    
    
    0.0261
    
    
    
    0.0921
    
    
    
    0.0287
    
    
    
    0.1013December 13, 2002 - interest on
capital
    
    
    20,505
    
    
    
    72,450
    
    
    
    0.0270
    
    
    
    0.0954
    
    
    
    0.0297
    
    
    
    0.1049Total dividends in 2002
    
    
    146,713
    
    
    
    427,1742003:June 16, 2003 - interest on capital
    
    
    26,503
    
    
    
    76,700
    
    
    
    0.0349
    
    
    
    0.1009
    
    
    
    0.0386
    
    
    
    0.1103December 12, 2003 - interest on capital
    
    
    41,014
    
    
    
    118,500
    
    
    
    0.0537
    
    
    
    0.1552
    
    
    
    0.0591
    
    
    
    0.1707Total dividends in 2003
    
    
    67,517
    
    
    
    195,200
 (*)
    
    Dividends are calculated and paid in Brazilian reais. Amounts in
US$ were converted using the exchange rate in effect at each approval
date.
 F-37




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  24.
    
    EARNINGS PER SHAREBecause the preferred and common shareholders have different dividend,
voting and liquidation rights, basic and diluted earnings per share have
been calculated using the two-class method. The two-class method is an
earnings allocation formula that determines earnings per share for preferred
and common shares according to the dividends to be paid as required by the
Companys bylaws and participation rights in undistributed earnings.
Effective January 1, 1997, preferred shareholders are entitled to receive
per-share dividends of at least 10% greater than the per-share dividends
paid to common shareholders. Undistributed earnings, therefore, have been
allocated to common and preferred shareholders on a 100 to 110 basis,
respectively, based upon the weighted average number of shares outstanding
during the period to total shares (allocation percentage). Because the
allocation percentage for each class differs for basic and diluted earnings
per share, allocated undistributed earnings differ for each calculation.Basic earnings per common share is computed by dividing net income available
to common shareholders by the weighted average number of common shares
outstanding during the period. Net income available to common shareholders
is computed by deducting distributed and undistributed net income available
to preferred shareholders from net income. Net income available to preferred
shareholders is the sum of the preferred stock dividends and the preferred
shareholders portion of undistributed net income. Undistributed net income
is computed by deducting total dividends (the sum of preferred and common
stock dividends, including the premiums accrued related to redeemable
preferred stock) from net income.Diluted earnings per share is computed similarly to basic earnings per share
except that the outstanding shares are increased to include the number of
additional shares that would have been outstanding if the potential dilutive
 shares attributable to stock options and convertible debt with warrants had
been issued during the respective periods, utilizing the treasury stock
method. In computing the effect of convertible debt, the net income
available for distribution is adjusted to add back the interest recognized
in the period associated with convertible debt. All share and per share
amounts have been restated for the effects of the issuance on March 1, 2002,
in the form of a preferred share dividend, of 0.142106 new preferred shares
for each existing preferred or common share. F-38




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The computation of basic and diluted earnings per share is as follows: In thousands, except per share data and percentagesAt December 31, 2001
    
    At December 31, 2002
    
    At December 31, 2003Common
    
    Preferred
    
    Total
    
    Common
    
    Preferred
    
    Total
    
    Common
    
    Preferred
    
    TotalBasic numerator:Actual dividends declared/paid
    
    
    64,181
    
    
    
    117,023
    
    
    
    181,204
    
    
    
    47,932
    
    
    
    98,781
    
    
    
    146,713
    
    
    
    21,522
    
    
    
    45,995
    
    
    
    67,517Basic allocated undistributed earnings (a)
    
    
    52,150
    
    
    
    95,086
    
    
    
    147,236
    
    
    
    24,790
    
    
    
    51,089
    
    
    
    75,879
    
    
    
    21,844
    
    
    
    46,683
    
    
    
    68,527Allocated net income available for common and preferred shareholders
    
    
    116,331
    
    
    
    212,109
    
    
    
    328,440
    
    
    
    72,722
    
    
    
    149,870
    
    
    
    222,592
    
    
    
    43,366
    
    
    
    92,678
    
    
    
    136,044Basic denominator:Weighted average shares
    
    
    242,544
    
    
    
    402,035
    
    
    
    
    
    
    
    242,544
    
    
    
    454,414
    
    
    
    
    
    
    
    242,544
    
    
    
    471,228Basic earnings per share
    
    
    0.4796
    
    
    
    0.5276
    
    
    
    
    
    
    
    0.2998
    
    
    
    0.3298
    
    
    
    
    
    
    
    0.1788
    
    
    
    0.1967Diluted numerator:Actual dividends declared/paid
    
    
    64,181
    
    
    
    117,023
    
    
    
    181,204
    
    
    
    47,932
    
    
    
    98,781
    
    
    
    146,713
    
    
    
    21,522
    
    
    
    45,995
    
    
    
    67,517Diluted allocated undistributed earnings (a)
    
    
    49,861
    
    
    
    98,002
    
    
    
    147,863
    
    
    
    24,607
    
    
    
    51,272
    
    
    
    75,879
    
    
    
    21,730
    
    
    
    46,797
    
    
    
    68,527114,042
    
    
    
    215,025
    
    
    
    329,067
    
    
    
    72,539
    
    
    
    150,053
    
    
    
    222,592
    
    
    
    43,252
    
    
    
    92,792
    
    
    
    136,044Allocated net income available for common and preferred shareholders
    
    
    110,753
    
    
    
    217,687
    
    
    
    328,440
    
    
    
    72,186
    
    
    
    150,406
    
    
    
    222,592
    
    
    
    43,252
    
    
    
    92,792
    
    
    
    136,044Interest expense on convertible debt (b)
    
    
    211
    
    
    
    416
    
    
    
    627
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Allocated diluted net income available for common and preferred shareholders
    
    
    110,964
    
    
    
    218,103
    
    
    
    329,067
    
    
    
    72,186
    
    
    
    150,406
    
    
    
    222,592
    
    
    
    43,252
    
    
    
    92,792
    
    
    
    136,044Diluted denominator:Weighted average shares outstanding
    
    
    242,544
    
    
    
    402,035
    
    
    
    
    
    
    
    242,544
    
    
    
    454,414
    
    
    
    
    
    
    
    242,544
    
    
    
    471,228Dilutive effects of convertible debt (b)
    
    
    
    
    
    
    24,646
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Dilutive effects of stock options (b)
    
    
    
    
    
    
    6,705
    
    
    
    
    
    
    
    
    
    
    
    5,001
    
    
    
    
    
    
    
    
    
    
    
    3,612Diluted weighted average shares (c)
    
    
    242,544
    
    
    
    433,386
    
    
    
    
    
    
    
    242,544
    
    
    
    459,415
    
    
    
    
    
    
    
    242,544
    
    
    
    474,840Diluted earnings per share
    
    
    0.4575
    
    
    
    0.5033
    
    
    
    
    
    
    
    0.2976
    
    
    
    0.3274
    
    
    
    
    
    
    
    0.1779
    
    
    
    0.1957
  (a)
    
    The Company calculates earnings per share on common and preferred shares
under the two-class method. Effective January 1, 1997, preferred
shareholders are entitled to receive per share dividends of at least 10%
greater than the per share dividends paid to common shareholders.
Undistributed earnings, therefore, from January 1, 1997 forward have been
allocated to common and preferred shareholders on a 100 to 110 basis,
respectively, based upon the weighted average number of shares outstanding
during the period to total shares (allocation percentage). Because the
allocation percentage for each class differs for basic and diluted
earnings per share purposes, allocated undistributed earnings differ for
such calculations.  (b)
    
    For purposes of computing diluted earnings per share, the convertible
debt (including subscription warrants) and outstanding stock options are
assumed to be converted into common and preferred shares using the
treasury stock method. The related interest expense related to the
convertible debt is added back to arrive at allocated diluted net income
available for common and preferred shareholders.  (c)
    
    The effect of the preferred stock dividend is reflected retroactively for
all of the periods presented for purpose of computing basic and diluted
Earnings per Share EPS. F-39




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  25.
    
    STOCK COMPENSATIONOn April 17, 1998, the Companys shareholders approved a stock option plan
for management and employees, including those of the Companys subsidiaries,
subject to restrictions based on continuous employment with the Company for
at least two years. The Administration Committee, which was appointed by the
Board of Directors on the same date, is responsible for managing the plan.Under the terms of the plan, options for 25,000,000 preferred shares were
authorized to be granted up to May 2003. Options were granted with an
exercise price equal to the weighted average price of the Companys
preferred shares traded on the BOVESPA (São Paulo Stock Exchange) in the 60
trading days prior to the grant date, increased or decreased by 30%, as
defined by the Administration Committee. Such percentage is deemed to offset
unusual fluctuations in the market price during this 60-day period. These
options generally vest 30% after three years, 30% after four years, and 40%
after 5 years, if the employee is still employed by the Company on each
date. The options expire seven years from the date of grant. The right to
grant options under the plan terminated five years after the date of the
first grant.As of December 31, 2003, the Administration Committee had made seven grants,
equivalent to 400 lots of 50,000 shares each, totaling 19,575,000 preferred
shares, net of 425,000 shares which were forfeited, as the grantees are no
longer employees of the Company.During 2001, the Company granted options with exercises prices below the
market value of the underlying stock on the date of grant which resulted in
total non-cash compensation of $1,074. In June and November 2001, 4,935,000
options were exercised, in the total amount of $1,761. During 2002 and 2003,
2,261,313 and 3,056,228 options were exercised, in the total amount of
$1,194 and $3,961, respectively.In connection with the 14.2106% stock dividend approved at the Extraordinary
Shareholders Meeting on March 1, 2002, the Administration Committee granted
an additional 25,576 options to purchase preferred shares to holders of
vested options as of the record date. In addition, all non-vested option
holders were offered an additional grant of 14.2106% of the number options
held. The total number of additional options granted was 637,318, with an
exercise price of R$14.99 (which was higher than the market price of the
preferred stock on the date of grant).Information regarding options granted to management and employees is shown
in the following table (options in thousands): F-40




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
 2001
    
    2002
    
    2003Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    average
    
    
    
    
    
    averageexercise
    
    
    
    
    
    exercise
    
    
    
    
    
    exerciseThousands
    
    price
    
    Thousands
    
    price
    
    Thousands
    
    priceof options
    
    (R$)
    
    of options
    
    (R$)
    
    of options
    
    (R$)Outstanding at beginning of year
    
    
    17,800
    
    
    
    4.07
    
    
    
    14,815
    
    
    
    7.63
    
    
    
    13,132
    
    
    
    8.98Granted
    
    
    2,050
    
    
    
    23.00
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Adhesion of
the bonus (March 1st)
    
    
    
    
    
    
    
    
    
    
    663
    
    
    
    14.99
    
    
    
    
    
    
    
    Exercised
    
    
    (4,935
    )
    
    
    1.19
    
    
    
    (2,261
    )
    
    
    1.76
    
    
    
    (3,056
    )
    
    
    3.77Canceled or expired
    
    
    (100
    )
    
    
    23.00
    
    
    
    (85
    )
    
    
    8.73
    
    
    
    (91
    )
    
    
    13.51Outstanding at end of year
    
    
    14,815
    
    
    
    7.63
    
    
    
    13,132
    
    
    
    8.98
    
    
    
    9,985
    
    
    
    10.55Exercisable at end of year
    
    
    180
    
    
    
    1.65
    
    
    
    812
    
    
    
    3.56
    
    
    
    2,032
    
    
    
    6.78
  The weighted average grant date fair values of options granted in 2001, the
last year in which options were granted, was $5.83. The estimated fair
values of the options were computed using the Black-Scholesoption pricing
model based on the U.S. dollar to Brazilian real exchange rates in effect on
the date of grant and using the following weighted average assumptions: 5
years of expected option life; 60% of expected volatility; 3% of dividend
yield and 13.4% of risk-free interest rate.  The following table summarizes information about stock options outstanding
at December 31, 2003 (options in thousands): Number of
    
    
    
    
    
    Weightedoutstanding
    
    
    
    
    
    averagestock
    
    
    
    
    
    remainingExercise
    
    options (in
    
    Options
    
    contractualprice (R$)
    
    thousands)
    
    exercisable
    
    life (years)0.75
    
    
    120
    
    
    
    120
    
    
    
    1.41.65
    
    
    1,668
    
    
    
    467
    
    
    
    2.35.22
    
    
    1,060
    
    
    
    360
    
    
    
    2.98.11
    
    
    3,470
    
    
    
    706
    
    
    
    3.413.70
    
    
    1,160
    
    
    
    285
    
    
    
    3.914.99
    
    
    607
    
    
    
    94
    
    
    
    3.923.00
    
    
    1,900
    
    
    
    
    
    
    
    4.49,985
    
    
    
    2,032
 F-41




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The following table summarizes information about outstanding stock options
by anticipated vesting date and outstanding at December 31, 2003 (options in
thousands): Weighted
    
    Number ofaverage
    
    outstandingexercise
    
    stock optionsGrant dates
    
    Vesting date
    
    Expiration date
    
    price (R$)
    
    (thousands)May 1998 and 1999
    
    May 2002
    
    May 2005 and 2006
    
    
    1.65
    
    
    
    45November 1998 and 1999
    
    November 2002
    
    November 2005 and 2006
    
    
    5.51
    
    
    
    176May 1998, 1999 and 2000
    
    May 2003
    
    May 2005, 2006 and 2007
    
    
    6.52
    
    
    
    1,007November 1998, 1999 and 2000
    
    November 2003
    
    November 2005, 2006 and 2007
    
    
    7.67
    
    
    
    804May 1999, 2000 and 2001
    
    May 2004
    
    May 2006, 2007 and 2008
    
    
    8.64
    
    
    
    3,088November 1999 and 2000
    
    November 2004
    
    November 2006 and 2007
    
    
    8.56
    
    
    
    1,138May 2000 and 2001
    
    May 2005
    
    May 2007 and 2008
    
    
    12.25
    
    
    
    2,297November 2000
    
    November 2005
    
    November 2007
    
    
    13.85
    
    
    
    565May 2001
    
    May 2006
    
    May 2008
    
    
    22.03
    
    
    
    865Total
    
    
    
    
    
    
    
    
    
    
    9,985
  The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock option plan. Accordingly, compensation cost has
been recognized for grants of stock options based on market prices and grant
prices at the date of grant. Had compensation cost for the Companys
stock-based compensation plans been determined in accordance with the
provisions of SFAS No. 123 Accounting for Stock-based Compensation, the
Companys U.S. GAAP net income and earnings per share would have been
changed to the pro forma amounts indicated below: 2001
    
    2002
    
    2003Net income under U.S. GAAP - as reported
    
    
    328,440
    
    
    
    222,592
    
    
    
    136,044Net income under U.S. GAAP - pro forma
    
    
    318,151
    
    
    
    222,592
    
    
    
    136,044EARNINGS PER SHAREBasic - as reported:Common
    
    
    0.4796
    
    
    
    0.2998
    
    
    
    0.1788Preferred
    
    
    0.5276
    
    
    
    0.3298
    
    
    
    0.1967Basic - pro forma:Common
    
    
    0.4646
    
    
    
    0.2998
    
    
    
    0.1788Preferred
    
    
    0.5111
    
    
    
    0.3298
    
    
    
    0.1967Diluted - as reported:Common
    
    
    0.4575
    
    
    
    0.2976
    
    
    
    0.1779Preferred
    
    
    0.5033
    
    
    
    0.3274
    
    
    
    0.1957Diluted - pro forma:Common
    
    
    0.4432
    
    
    
    0.2976
    
    
    
    0.1779Preferred
    
    
    0.4875
    
    
    
    0.3274
    
    
    
    0.1957
  The pro forma amounts reflected above are not representative of the
effects on reported earnings per share in future years. F-42




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  26.
    
    INCOME TAXESThe following is an analysis of the income tax expense: For the year ended December 31,2001
    
    2002
    
    2003Current
    
    
    (177,061
    )
    
    
    (167,448
    )
    
    
    (7,686
    )Deferred-Temporary differences-Additions
    
    
    35,301
    
    
    
    (5,535
    )
    
    
    28,653Tax loss carryforwardsUtilized to offset taxable income for the year
    
    
    (75,577
    )
    
    
    (10,651
    )
    
    
    9,261Change in valuation allowance
    
    
    (1,057
    )
    
    
    (4,868
    )
    
    
    (2,238
    )Total deferred
    
    
    (41,333
    )
    
    
    (21,054
    )
    
    
    35,676Income tax (expense)/benefit
    
    
    (218,394
    )
    
    
    (188,502
    )
    
    
    27,990
  The following is a reconciliation of the reported income tax expense
(benefit) and the amount calculated by applying the combined statutory tax
rate: For the year ended December 31,2001
    
    2002
    
    2003Income before taxes as reported in the accompanying
consolidated financial statements
    
    
    541,817
    
    
    
    412,977
    
    
    
    108,271Combined statutory income tax rate
    
    
    34
    %
    
    
    34
    %
    
    
    34
    %Tax expense at statutory income tax rate
    
    
    184,218
    
    
    
    140,412
    
    
    
    36,812Permanent differences:Nondeductible expenses
    
    
    3,911
    
    
    
    2,299
    
    
    
    4,130Translation effects
    
    
    65,397
    
    
    
    83,110
    
    
    
    (49,730
    )Dividends paid as interest on capital
    
    
    (25,778
    )
    
    
    (35,453
    )
    
    
    (22,956
    )Change in valuation allowance on deferred tax assets
    
    
    1,057
    
    
    
    4,868
    
    
    
    2,238Reversal of tax incentives
    
    
    (14,980
    )
    
    
    (12,822
    )
    
    
    (180
    )Income tax rate differences
    
    
    
    
    
    
    3,085
    
    
    
    Other
    
    
    4,569
    
    
    
    3,003
    
    
    
    1,696Income tax expense (benefit) as reported in the
income statement
    
    
    218,394
    
    
    
    188,502
    
    
    
    (27,990
    )
 F-43




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The Companys deferred tax assets and liabilities are comprised of income
tax losses carryforwards and effects resulted from temporary differences as
follows: At December 31,2002
    
    2003Deferred tax assets on:Income tax losses carryforwards (i)
    
    
    11,559
    
    
    
    20,821Temporary differences:Accrual for product warranties and improvements
    
    
    39,326
    
    
    
    42,100Accrued taxes, other than taxes on income
    
    
    28,622
    
    
    
    50,223Deferred charges, principally research and development
    
    
    44,358
    
    
    
    14,265Other accrued expenses not deductible for tax purposes
    
    
    25,226
    
    
    
    53,770Difference in bases of property, plant and equipment
    
    
    27,881
    
    
    
    28,193Inventory allowances
    
    
    14,343
    
    
    
    15,895Pension accrual
    
    
    1,141
    
    
    
    846Other
    
    
    10,244
    
    
    
    13,443Valuation allowance (ii)
    
    
    (9,922
    )
    
    
    (12,160
    )Total deferred tax assets
    
    
    192,778
    
    
    
    227,396Deferred income tax liabilities on:Temporary differences:Difference in bases of property, plant and equipment
    
    
    (22,542
    )
    
    
    (23,032
    )Other
    
    
    (7,395
    )
    
    
    (5,847
    )Total deferred tax liabilities
    
    
    (29,937
    )
    
    
    (28,879
    )Net deferred tax asset
    
    
    162,841
    
    
    
    198,517
  (i)
    
    The income tax losses carryforwards have the following composition: At December 31,2002
    
    2003Brazilian entities
    
    
    2,714
    
    
    
    9,159Foreign subsidiaries
    
    
    8,845
    
    
    
    11,662Total
    
    
    11,559
    
    
    
    20,821
  Tax losses originated from the Brazilian entities are not subject to
expiration dates but utilization is limited to 30% of the taxable income
for each period.(ii)
    
    Valuation allowance relates to tax loss carryforwards of foreign
subsidiaries, which cannot be offset against taxable income in Brazil.Management believes that the recorded valuation allowance reduces
deferred tax assets to an amount that is more likely than not to be
realized. Based on internal studies and projections, management believes
that the present net amounts should be realized within five years. F-44




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  27.
    
    OTHER OPERATING EXPENSE, NETOther operating expense, net is composed of the following income (expense)
items: For the year endedDecember 31,2001
    
    2002
    
    2003Production process improvements
    
    
    (7,564
    )
    
    
    
    
    
    
    (13,647
    )Product modifications
    
    
    (3,672
    )
    
    
    (961
    )
    
    
    (99
    )Pre-operational cost of Gavião Peixoto
    
    
    (1,916
    )
    
    
    (3,856
    )
    
    
    (858
    )Education, training and professional development (i)
    
    
    (7,929
    )
    
    
    (12,963
    )
    
    
    (13,316
    )Restructuring costs (ii)
    
    
    (4,521
    )
    
    
    
    
    
    
    Provision for contingencies
    
    
    (1,930
    )
    
    
    (6,185
    )
    
    
    (4,368
    )Market value adjustments on used aircraft
    
    
    
    
    
    
    (464
    )
    
    
    (10,434
    )Contractual fines
    
    
    4,004
    
    
    
    4,117
    
    
    
    17,237Expense reimbursement
    
    
    988
    
    
    
    4,692
    
    
    
    2,249Insurance recoveries
    
    
    1,431
    
    
    
    88
    
    
    
    666Other
    
    
    (9,428
    )
    
    
    (4,966
    )
    
    
    (6,490
    )(30,537
    )
    
    
    (20,498
    )
    
    
    (29,060
    )
  (i)
    
    Refers to training and professional development provided to Company
employees.  (ii)
    
    Restructuring costs relate to the cost of employee terminations
resulting from adapting the work force to production postponements.  28.
    
    FOREIGN EXCHANGE GAIN/ (LOSS), NETForeign exchange gains and losses result from the remeasurement of the
balance sheet accounts from the local currency to the functional currency as
follows: For the year endedDecember 31,2001
    
    2002
    
    2003Assets:Cash and cash equivalents
    
    
    (204,160
    )
    
    
    (211,482
    )
    
    
    38,240Accounts receivable
    
    
    (717
    )
    
    
    (3,574
    )
    
    
    3,394Other
    
    
    (5,334
    )
    
    
    (17,698
    )
    
    
    3,550Foreign exchange gain/ (loss) on assets, net
    
    
    (210,211
    )
    
    
    (232,754
    )
    
    
    45,184Liabilities:Accounts payable
    
    
    26,038
    
    
    
    62,492
    
    
    
    (45,208
    )Income taxes
    
    
    (371
    )
    
    
    4,208
    
    
    
    (363
    )Dividends
    
    
    11,165
    
    
    
    (256
    )
    
    
    (161
    )Provisions
    
    
    15,809
    
    
    
    17,777
    
    
    
    (11,026
    )Other
    
    
    8,933
    
    
    
    12,886
    
    
    
    (4,926
    )Foreign exchange gain/ (loss) on liabilities, net
    
    
    61,574
    
    
    
    97,107
    
    
    
    (61,684
    )Foreign exchange loss, net
    
    
    (148,637
    )
    
    
    (135,647
    )
    
    
    (16,500
    )
 F-45




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  29.
    
    OTHER NON-OPERATING INCOME (EXPENSE), NETOther non-operating income (expenses) is comprised of the following: For the year endedDecember 31,2001
    
    2002
    
    2003Profit (loss) on sale of fixed assets
    
    
    (142
    )
    
    
    (145
    )
    
    
    688Provision for losses on tax incentive investments
    
    
    (8,567
    )
    
    
    (733
    )
    
    
    (349
    )Other
    
    
    283
    
    
    
    (516
    )
    
    
    372(8,426
    )
    
    
    (1,394
    )
    
    
    711
  30.
    
    TRANSACTIONS WITH RELATED PARTIESBrazilian GovernmentPREVI, one of the Companys controlling shareholders, is controlled by Banco
do Brasil, which is controlled by the Brazilian government. As a result, the
Company considers Banco do Brasil to be a related party, as well as the
Brazilian Air Force and BNDES, which are also controlled by the Brazilian
government.The Brazilian government, principally through the Brazilian Air Force, has
participated in the development of Embraer since its inception. For the
years ended December 31, 2001, 2002 and 2003, the Brazilian Air Force
accounted for approximately 1.5%, 2.1% and 4.4% of the Companys net sales,
respectively. The Company expects to continue to be the primary source of
new aircraft and spare parts and services for the Brazilian government.BNDES and Banco do Brasil have several transactions with the Company, mainly
represented by support in debt financing and other ordinary bank
transactions, such as being the depositary for part of the Companys cash
equivalents and a provider of certain credit line facilities. F-46




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The transactions with such related parties are summarized as follows: At December 31, 2003Brazilian
    
    Banco doAir Force
    
    Brasil S.A.
    
    BNDES
    
    TotalAssetsCash and cash equivalents
    
    
    
    
    
    
    534,061
    
    
    
    
    
    
    
    534,061Accounts receivable
    
    
    25,287
    
    
    
    
    
    
    
    
    
    
    
    25,287Other assets
    
    
    
    
    
    
    258,451
    
    
    
    
    
    
    
    258,451LiabilitiesLoans and recourse debt
    
    
    
    
    
    
    375,206
    
    
    
    66,714
    
    
    
    441,920Customer advances
    
    
    95,588
    
    
    
    
    
    
    
    
    
    
    
    95,588Accounts payable
    
    
    2,028
    
    
    
    
    
    
    
    
    
    
    
    2,028Results of operations (for the year
ended December 31, 2003)Net sales
    
    
    106,967
    
    
    
    
    
    
    
    
    
    
    
    106,967Interest income
    
    
    
    
    
    
    27,786
    
    
    
    
    
    
    
    27,786Interest expense
    
    
    
    
    
    
    6,921
    
    
    
    4,018
    
    
    
    10,939
 At December 31, 2002Brazilian
    
    Banco doAir Force
    
    Brasil S.A.
    
    BNDES
    
    TotalAssetsCash and cash equivalents
    
    
    
    
    
    
    84,079
    
    
    
    
    
    
    
    84,079Accounts receivable
    
    
    12,704
    
    
    
    
    
    
    
    
    
    
    
    12,704Other assets
    
    
    
    
    
    
    138,346
    
    
    
    
    
    
    
    138,346LiabilitiesLoans and recourse debt
    
    
    
    
    
    
    212,692
    
    
    
    36,205
    
    
    
    248,897Customer advances
    
    
    99,290
    
    
    
    
    
    
    
    
    
    
    
    99,290Accounts payable
    
    
    2,239
    
    
    
    
    
    
    
    
    
    
    
    2,239Results of operations (for the year ended
December 31, 2002)Net sales
    
    
    53,167
    
    
    
    
    
    
    
    
    
    
    
    53,167Interest income
    
    
    
    
    
    
    14,307
    
    
    
    
    
    
    
    14,307Interest expense
    
    
    
    
    
    
    2,927
    
    
    
    3,853
    
    
    
    6,780
 F-47




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##### Table of Contents



EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
 At December 31, 2001Brazilian
    
    Banco doAir Force
    
    Brasil S.A.
    
    BNDES
    
    TotalResults of
operations (for the
year ended December
31, 2001)Net sales
    
    
    45,703
    
    
    
    
    
    
    
    
    
    
    
    45,703Interest income
    
    
    
    
    
    
    21,036
    
    
    
    
    
    
    
    21,036Interest expense
    
    
    
    
    
    
    4,277
    
    
    
    4,600
    
    
    
    8,877
  European Aerospace and Defense GroupWe also entered into commercial transactions with other shareholders,
Thales, Dassault Aviation, EADS and SNECMA, which together form the
European Aerospace and Defense Group (EADG). EADG holds approximately 20%
of our outstanding voting shares and the right to appoint two members to our
Board of Directors. Such transactions represented the purchase of certain
equipment and services in the ordinary course of our business and amounted
to $6,914, $11,796 and $14,474 for 2001, 2002 and 2003, respectively.31.
    
    FINANCIAL INSTRUMENTS AND RISK MANAGEMENTOverviewThe Company is primarily engaged in the assembly and sale of aircraft to
various markets throughout the world. More than 90% of the Companys sales
are exported and are U.S. dollar denominated, which is the Companys
functional currency. Nevertheless, a significant part of the Companys labor
costs and other local overheads are Brazilian reais -denominated.
Therefore, the Company maintains certain monetary assets and liabilities,
mainly represented by recoverable and payable taxes, cash equivalents and
loans in Brazilian reais, targeting to balance its non - U.S. dollar -
denominated assets against its non- U.S. dollar -
 denominated liabilities
plus shareholders equity in relation to its forecasts of future cash flows.The Companys primary market risks include fluctuations in interest rates
and foreign currency exchange rates. The Company has established policies
and procedures to manage sensitivity to interest rate and foreign currency
exchange rate risk. These procedures include monitoring the Companys level
of exposure to each market risk, including the analysis of the amounts based
on a forecast of future cash flows, the funding of variable rate assets with
variable rate liabilities, and limiting the amount of fixed rate assets
which may be funded with floating rate liabilities. These procedures may
also include the use of derivative financial instruments to mitigate the
effects of interest rate fluctuations and to reduce the exposure to exchange
rate risk. F-48




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EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The Company may also use derivatives to implement its risk management
strategy. By using derivative instruments the Company exposes itself to
credit risk, as further discussed in Note 32.Interest rate risk managementInterest rate risk is the risk that the Company will incur economic losses
due to adverse changes in interest rates. This interest rate exposure
principally relates to changes in the market interest rates affecting the
Companys loans.The Companys U.S. dollar denominated debt bears interest at fixed or
variable interest rates based on 6 month or 12 month LIBOR. The Companys
foreign currency debt is primarily denominated in Brazilian reaisand
Japanese yen. The Brazilian real -denominated debt bears interest at a
variable rate based on TJLP, the long-term interest rate in Brazil, and the
Japanese yen - denominated debt bears interest at fixed rates or variable
rates based on JIBOR.The Companys interest rate risk management strategy may use derivative
instruments to reduce earnings fluctuations attributable to interest rate
volatility.Exchange rate risk managementExchange rate risk is the risk that changes in foreign currency exchange
rates may cause the Company to incur losses, leading to a reduction in
assets or an increase in liabilities amounts. The Companys primary
exposures to foreign currency exchange fluctuations are the Brazilian
real/U.S. dollar and Japanese yen/U.S. dollar exchange rates. As previously
discussed in the overview section of this Note, the Company aims to hedge
its exposure in foreign currencies through (i) balancing its non- U.S.
dollar 
 denominated assets against its non-U.S. dollar - denominated
liabilities and (ii) using derivative instruments. The Company typically
uses derivatives such as foreign currency forward and swap contracts to
implement this strategy. F-49




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EMBRAER  EMPRESA BRASILEIRA DE AERONÁUTICA S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  Derivative financial instrumentsDerivative instruments outstanding as of December 31 are as follows: 2003GainAgreed
    

(Loss)Notional
    
    Maturity
    
    average
    
    FairPurpose
    
    Type
    
    amount
    
    date
    
    rate
    
    ValueImport financing
    
    Swap (interest + JPY
into R$ + % CDI)
    
    
    26,118
    
    
    
    2004
    
    
    86.17%
of CDI
    
    
    (7,240
    )Import financing
    
    Swap (interest + US$
into R$ + % CDI)
    
    
    190,163
    
    
    2004 to 2006
    
    75.07%
of CDI
    
    
    (44,888
    )Import financing
    
    Swap ( JIBOR + JPY
into US$ + fixed
interest rate)
    
    
    110,666
    
    
    2004 to 2008
    
    4.44% per year
    
    
    2,269Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (49,859
    )
 2002GainAgreed
    
(Loss)Notional
    
    Maturity
    
    average
    
    FairPurpose
    
    Type
    
    amount
    
    date
    
    rate
    
    ValueImport financing
    
    Swap ( interest +
JPY into R$ + %
CDI)
    
    
    124,862
    
    
    
    2006
    
    
    76.59%
of CDI
    
    
    20,200Import financing
    
    Swap (interest + US$
into R$ + % CDI)
    
    
    167,519
    
    
    
    2009
    
    
    89.84%
of CDI
    
    
    38,206Import financing
    
    Swap (JIBOR + JPY
into US$ + fixed
interest rate)
    
    
    26,564
    
    
    
    2006
    
    
    5.80% per year
    
    
    (222
    )Accounts receivable
    
    Non Deliverable
Forward (NDF) -
US$ into R$
    
    
    59,984
    
    
    
    2003
    
    
    
    
    
    (8,525
    )Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    49,659
 F-50




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EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  32.
    
    CONCENTRATION OF CREDIT RISKCredit risk is the risk that the Company may incur losses if counterparties
to the Companys contracts do not pay amounts owed to the Company. The
Companys primary credit risk derives from the sales of aircraft,
spare-parts and related services to its customers, including the financial
obligations related to these sales discussed in Notes 8 and 34.Financial instruments which may potentially subject the Company to
concentrations of credit risk include (i) cash and cash equivalents, (ii)
trade and other accounts receivable, (iii) advances to suppliers and (iv)
financial derivatives contracts. The Company limits its credit risk
associated with cash and cash equivalents by placing its investments with
investment grade rated institutions in short-term securities and mutual
funds. With respect to trade accounts receivable, the Company limits its
credit risk by performing ongoing credit evaluations. All such customers are
meeting current commitments, are operating within established credit limits
and are considered by management to represent an acceptable credit risk
level. The Company believes no additional credit risk beyond amounts
provided for collection losses is inherent in the Companys trade accounts
receivable. Advances to suppliers are made only to select long-standing
suppliers. The financial condition of such suppliers is analyzed on an
ongoing basis to limit credit risk. The Company addresses credit risk
related to derivative instruments by restricting the counterparties of such
derivative to major financial institutions.The Company may also have credit risk related to the sale of aircraft while
its customers are finalizing the financing structures for their purchases
from the Company. To minimize these risks, customer credit analyses are
continuously monitored and the Company works closely with the financial
institutions to help facilitate customer financing.33.
    
    FAIR VALUE OF FINANCIAL INSTRUMENTSThe following estimated fair value amounts have been determined using
available market information and appropriate valuation methodologies.
However, considerable judgment is required to interpret market data and to
develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could
realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
the estimated fair values.The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to
estimate that value. Potential income tax ramifications related to the
realization of unrealized gains and losses that would be incurred in an
actual sale or settlement have not been taken into consideration. F-51




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EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The carrying amounts for cash and cash equivalents, trading debt securities,
accounts and notes receivable and current liabilities approximates with
their fair values. Held to maturity investments fair value is estimated
using a discounted cash flows methodology. The fair value of long-term debt
is based on the discounted value of contractual cash flows. The discount
rate is estimated using the rates currently offered for debt with similar
characteristics and remaining maturities.The estimated fair values of financial instruments are as follows: 2002
    
    2003Carrying
    
    Fair
    
    Carrying
    
    Fairamounts
    
    value
    
    amounts
    
    valueFinancial assets:Cash and cash equivalents
    
    
    656,822
    
    
    
    656,822
    
    
    
    1,265,820
    
    
    
    1,265,820Trading debt securities
    
    
    
    
    
    
    
    
    
    
    10,683
    
    
    
    10,683Trade accounts receivable, net
    
    
    735,927
    
    
    
    735,927
    
    
    
    356,401
    
    
    
    356,401Guarantee deposits
    
    
    187,356
    
    
    
    187,356
    
    
    
    473,714
    
    
    
    473,714Held to maturity investments
    
    
    23,263
    
    
    
    18,005
    
    
    
    25,655
    
    
    
    26,549Derivatives
    
    
    71,776
    
    
    
    71,776
    
    
    
    2,629
    
    
    
    2,629Financial liabilities:Accounts payable to suppliers
    
    
    323,115
    
    
    
    323,115
    
    
    
    404,065
    
    
    
    404,065Loans
    
    
    552,636
    
    
    
    536,153
    
    
    
    1,043,742
    
    
    
    1,035,054Derivatives
    
    
    22,117
    
    
    
    22,117
    
    
    
    52,488
    
    
    
    52,488
  34.
    
    OFF-BALANCE SHEET ARRANGEMENTSIn the normal course of business, the Company participates in certain
off-balance sheet arrangements, including guarantees, repurchase obligations
and trade-in and trade-up commitments, as discussed below:GuaranteesFinancial guarantees are triggered if customers do not perform their
obligation to serve 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, the Company usually is the agent for the guaranteed party for
the refurbishment and remarketing of the underlying asset. The Company 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. F-52




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EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  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, the Company shall bear the
difference between the specific guaranteed amount and the actual fair market
value. The Companys exposure is mitigated by the fact that, in order to
benefit from the guarantee, the guaranteed party has to make the underlying
assets meet tight specific return conditions.The following table provides quantitative data regarding the Companys
guarantees to third parties. The maximum potential payments represent the
worst-case scenario, and do not necessarily reflect the expected results
by the Company. Estimated proceeds from performance guarantees and
underlying assets represent the anticipated values of assets the Company
could liquidate or receive from other parties to offset its payments under
guarantees. At December 31,Description
    
    2002
    
    2003Maximum financial guarantees
    
    
    1,175,015
    
    
    
    1,229,811Maximum residual value guarantees
    
    
    624,032
    
    
    
    627,015Mutually exclusive exposure (*)
    
    
    (362,184
    )
    
    
    (392,123
    )Provisions and liabilities recorded
    
    
    (14,372
    )
    
    
    (67,466
    )Off-balance sheet exposure
    
    
    1,422,491
    
    
    
    1,397,237Estimated proceeds from performance guarantees and
underlying assets
    
    
    1,748,496
    
    
    
    1,650,321
  (*)
    In the event both guarantees were issued for the same underlying
asset, the residual value guarantees can only be exercised if the
financial guarantees have expired without having been triggered, and
therefore, their distinct effects have not been combined to calculate
the maximum exposure. As discussed in Note 10, at December 31, 2002 and 2003, the Company
maintained escrow deposits in the total amount of $187,356 and $192,765,
respectively, in favor of third parties for whom it has provided financial
and residual value guarantees in connection with certain aircraft sales
financing structures. Aircraft Repurchase Options The Company is contingently liable for repurchasing a number of aircraft
sold under sales contracts that provide the customer with the right to sell
the aircraft back to the Company in the future, according to defined price
rules. These put options may become exercisable at various times from 2004
to 2006 and can be exercised at the customers sole discretion. The put
price per aircraft under the contract is less than the original sales price
of the aircraft and less than managements estimation for the future market
value of the relevant aircraft during the exercise period as assessed at the
date of sale. If the Company is required to repurchase all of the relevant
aircraft under the Companys repurchase obligations, the Company may be
required to pay up to approximately $500 million for these aircraft. Based
on the Companys current estimation and third-party appraisals related to
the forecasted fair values F-53




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EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
 of the aircraft, management believes that at December 31, 2002 and 2003, any
repurchased aircraft could be sold in the market without a material gain or
loss. Aircraft Trade-In/ Trade-up Options In connection with the signing of a purchase contract for new aircraft, the
Company may provide trade-in and or trade-up options to its customers.
These options provide a customer with the right to trade-in or trade-up
existing aircraft upon the purchase of a new aircraft. At December 31,
2003, six commercial aircraft were subject to trade-in options, and
additional aircraft may become subject to trade-in options upon delivery.
The trade-in price is determined in the manner discussed above for
commercial jets. In addition, one corporate jet customer has trade-up
options relating to 11 aircraft, which provide that if and when the Company
launches a new corporate jet model, this customer has the right to trade-up
to the new model. The trade-up price is determined as a percentage of the
original purchase price of the Companys corporate jets. Product warranties The Company provides product warranties in conjunction with certain product
sales. Generally, aircraft sales are accompanied by a standard warranty for
systems, accessories, equipment, parts, and software manufactured by the
Company. Warranty expense related to aircraft and parts is recognized at the
time of sale based on estimated amounts of warranty costs anticipated to be
incurred, typically expressed as a percentage of revenue. These estimates
are based on factors that include, among other things, historical warranty
claim and cost experience, warranty coverage available from suppliers, type
and duration of warranty coverage, and the volume and mix of aircraft sold
and in service. The warranty period typically ranges from two to five years. Certain sales contracts contain provisions for guarantees of certain minimum
levels of aircraft performance subsequent to delivery based on predetermined
operational targets. If the aircraft subject to such guarantees do not
achieve the minimum performance indices after delivery, the Company may be
obligated to reimburse its customers for the implied incremental operational
and service costs incurred based on formulas defined in the related
agreements. Losses related to such performance guarantees are recorded at
the time such losses are known, or when circumstances indicate that the
aircraft is not expected to meet the minimum performance requirements, based
on managements estimate of the Companys ultimate obligation under the
guarantee. F-54




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EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
 The following table summarizes changes in product and performance provisions
during 2003, which are included in other accounts payable and accrued
liabilities: Reductions for
    
    AtAt December
    
    
    
    
    
    payments
    
    December(US$ millions)
    
    31, 2002
    
    Additions
    
    made/reversions
    
    31, 2003Product warranties
    
    
    72,211
    
    
    
    53,694
    
    
    
    (46,181
    )
    
    
    79,724Product improvement
liabilities
    
    
    43,228
    
    
    
    12,330
    
    
    
    (12,587
    )
    
    
    42,971
  35.
    
    SEGMENT INFORMATIONThe Company is organized based on the products and services it offers. Under
this organizational structure, the Company operates in the following four
principal segments: commercial airline, defense, corporate and other related
businesses.Commercial airline segmentThe Commercial airline segments operations principally involve the
development, production and marketing of commercial jet aircraft and
providing related support services, principally to the regional airline
industry worldwide. The Companys products in the commercial airline segment
are organized around product families, including the ERJ 135/140/145 family,
the EMBRAER 170/190 family and the EMB 120 Brasília.The ERJ 145 family is composed of the ERJ 135, ERJ 140 and ERJ 145 aircraft,
certified to operate with 37, 44 and 50 seats, respectively. These aircraft
share approximately 96% of common parts and components. The Company relies
on a limited number of customers for a substantial portion of its total net
sales. The Companys largest customers for these aircraft are ExpressJet and
American Eagle.The Company is continuing to develop a new family of commercial jets
composed of the EMBRAER 170 for 78 passengers, EMBRAER 175 for 86
passengers, EMBRAER 190 for 106 passengers and EMBRAER 195 for 118
passengers. As of December 31, 2003, the Company had 245 firm orders for
this aircraft family. The first model to reach full development is the
EMBRAER 170, the final certification of which occurred in February 2004.The EMB 120 Brasília is a 30-seat turboprop aircraft that has been operating
since 1985. As of December 31, 2003, 352 of these aircraft had been
delivered.The commercial airline segment is subject to both operational and external
business environment risks. Operational risks that can seriously disrupt the
Companys ability to make timely delivery of its commercial jet aircraft and
meet its contractual commitments F-55




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  include execution of internal performance plans, regulatory certifications
of the Companys commercial aircraft by the U.S. Government and foreign
governments, collective bargaining labor disputes and performance issues
with key suppliers and subcontractors.The Companys principal operations are in Brazil, with some key suppliers
and subcontractors located in the United States, Europe and South America.
External business environment risks include adverse governmental export and
import policies, factors that result in significant and prolonged disruption
to air travel worldwide, and other factors that affect the economic
viability of the commercial airline industry. Examples of factors relating
to external business environment risks include the volatility of aircraft
fuel prices, global trade policies, worldwide political stability and
economic growth, acts of aggression that impact the perceived safety of
commercial flight and a competitive industry environment.Defense segmentOperations in the defense segment principally involve research, development,
production, modification and support of military defense aircraft, products
and related systems. Although some military defense aircraft products are
contracted in the commercial environment, the Companys primary customer is
the Brazilian Air Force. In the defense segment, the Company has the
following products:  
    
    The EMB 312, in two platforms, the basic Tucano and the
Super-Tucano - EMB 314. Also, the Super Tucano is being used as a
platform of the AL-X, aircraft developed for the Brazilian Air Force.  
    
    The AM-X, an advanced ground attack jet, developed and manufactured
through an industrial cooperation agreement between Brazil and Italy.  
    
    A modified platform of the ERJ 145 has been developed (EMB 145
AEW&C - Airborne Early Warning and Control aircraft, EMB 145 RS -
Remote Sensing aircraft and EMB 145 MP - Marine Remote Sensing
aircraft) for use by the Brazilian, Mexican and Greek governments.  The Brazilian Air Force is the largest customer of the Companys defense
aircraft products. A decrease in defense spending by the Brazilian
government due to defense spending cuts and general budgetary constraints or
other factors could materially adversely affect the Companys defense sales
and defense research and development.Corporate segmentThe Company developed a line of corporate jets, based on the ERJ 135
regional jet. The Legacy, as the corporate jet is named, is being the
marketed by the Company to businesses, including fractional ownership
companies, in two versions - the executive version and corporate shuttle
version. F-56




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  Other related businessesThe other related businesses segment relates mainly to (i) after-sales
customer support services, including maintenance and training, (ii) aircraft
operating leases and (iii) the manufacture and marketing of spare parts for
the Companys aircraft. In addition, the Company sells structural parts and
mechanical and hydraulic systems to certain specified customers. The Company
also manufactures, on a limited basis and upon customer request, general
aviation propeller aircraft and crop dusters.Significant customersDuring 2001, 2002 and 2003, the Company had significant customers which each
represented more than 10% of sales for the respective year. The percentages
below show the percentage of total net sales and accounts receivable for
each customer. Net Sales (%)
    
    Accounts receivable (%)2001
    
    2002
    
    2003
    
    2002
    
    2003Commercial AirlineContinental/ExpressJet
    
    
    23.1
    
    
    
    37.3
    
    
    
    32.9
    
    
    
    36.4
    
    
    
    American Eagle
    
    
    14.5
    
    
    
    17.5
    
    
    
    17.2
    
    
    
    
    
    
    
    Republic/Chautauqua
    
    
    15.7
    
    
    
    6.8
    
    
    
    12.6
    
    
    
    1.4
    
    
    
    52.4
  BacklogAt December 31, 2003 the Company had $10.6 billion in backlog representing
542 aircraft among all segments.Segment financial informationThe information in the following tables is derived directly from the
Companys internal financial reports used for corporate management purposes.
The expenses, assets and liabilities attributable to corporate activities
are not fully allocated to the operating segments.Other unallocated costs include corporate costs not allocated to the
operating segments and include the costs attributable to stock-based
compensation. Unallocated capital expenditures and depreciation relate
primarily to shared services assets. F-57




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The following table provides geographic information regarding net sales. The
geographic allocation is based on the location of the operator of the
aircraft. Year ended December 31,Net sales by geographic area
    
    2001
    
    2002
    
    2003The Americas without Brazil-Commercial Airline
    
    
    1,800,700
    
    
    
    1,772,226
    
    
    
    1,457,814Defense
    
    
    6,900
    
    
    
    13,257
    
    
    
    106,643Corporate
    
    
    72,600
    
    
    
    86,579
    
    
    
    139,203Other related businesses
    
    
    93,200
    
    
    
    78,186
    
    
    
    94,7151,973,400
    
    
    
    1,950,248
    
    
    
    1,798,375Brazil-Commercial Airline
    
    
    18,100
    
    
    
    
    
    
    
    Defense
    
    
    43,100
    
    
    
    40,534
    
    
    
    102,494Other related businesses
    
    
    18,900
    
    
    
    20,063
    
    
    
    18,47580,100
    
    
    
    60,597
    
    
    
    120,969Europe-Commercial Airline
    
    
    644,500
    
    
    
    290,548
    
    
    
    68,597Defense
    
    
    74,000
    
    
    
    73,478
    
    
    
    52,560Corporate
    
    
    
    
    
    
    58,307
    
    
    
    36,152Other related businesses
    
    
    64,000
    
    
    
    43,189
    
    
    
    65,260782,500
    
    
    
    465,522
    
    
    
    222,569Others-Commercial Airline
    
    
    89,200
    
    
    
    47,592
    
    
    
    Defense
    
    
    
    
    
    
    
    
    
    
    718Other related businesses
    
    
    1,795
    
    
    
    1,841
    
    
    
    82990,995
    
    
    
    49,433
    
    
    
    1,547Total
    
    
    2,926,995
    
    
    
    2,525,800
    
    
    
    2,143,460
 F-58




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
 The following table presents income statement information by operating
segment. Year ended December 31,Operating income
    
    2001
    
    2002
    
    2003Net sales-Commercial Airline
    
    
    2,552,499
    
    
    
    2,110,266
    
    
    
    1,526,373Defense
    
    
    123,999
    
    
    
    127,269
    
    
    
    262,411Corporate
    
    
    72,599
    
    
    
    144,886
    
    
    
    175,355Other related businesses
    
    
    177,898
    
    
    
    143,379
    
    
    
    179,3212,926,995
    
    
    
    2,525,800
    
    
    
    2,143,460Cost of sales and services-Commercial Airline
    
    
    (1,536,812
    )
    
    
    (1,243,925
    )
    
    
    (924,938
    )Defense
    
    
    (105,210
    )
    
    
    (79,504
    )
    
    
    (205,793
    )Corporate
    
    
    (47,012
    )
    
    
    (104,561
    )
    
    
    (124,377
    )Other related businesses
    
    
    (80,200
    )
    
    
    (103,730
    )
    
    
    (79,924
    )(1,769,234
    )
    
    
    (1,531,720
    )
    
    
    (1,335,032
    )Gross profit-Commercial Airline
    
    
    1,015,687
    
    
    
    866,341
    
    
    
    601,435Defense
    
    
    18,789
    
    
    
    47,765
    
    
    
    56,618Corporate
    
    
    25,587
    
    
    
    40,325
    
    
    
    50,978Other related businesses
    
    
    97,698
    
    
    
    39,649
    
    
    
    99,3971,157,761
    
    
    
    994,080
    
    
    
    808,428Operating expenses-Commercial Airline
    
    
    (258,553
    )
    
    
    (335,584
    )
    
    
    (345,704
    )Defense
    
    
    (23,380
    )
    
    
    (15,747
    )
    
    
    (15,719
    )Corporate
    
    
    (9,290
    )
    
    
    (28,375
    )
    
    
    (38,568
    )Other related businesses
    
    
    (61,426
    )
    
    
    (31,164
    )
    
    
    (34,116
    )Unallocated corporate expenses
    
    
    (153,734
    )
    
    
    (113,648
    )
    
    
    (109,506
    )(506,383
    )
    
    
    (524,518
    )
    
    
    (543,613
    )Income from operations
    
    
    651,378
    
    
    
    469,562
    
    
    
    264,815
 F-59




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
 The following tables present other information about the Companys operating
segments: At December 31,Property, plant and equipment, net
    
    2002
    
    2003Commercial Airline
    
    
    39,930
    
    
    
    34,748Defense
    
    
    46,396
    
    
    
    41,200Other related businesses
    
    
    7,285
    
    
    
    8,799Unallocated
    
    
    343,104
    
    
    
    317,916Total
    
    
    436,715
    
    
    
    402,663
 At December 31,Trade accounts receivable, net
    
    2002
    
    2003Commercial Airline
    
    
    655,617
    
    
    
    282,260Defense
    
    
    31,447
    
    
    
    52,822Other related businesses
    
    
    48,863
    
    
    
    21,319Total
    
    
    735,927
    
    
    
    356,401
 At December 31,Customer advances
    
    2002
    
    2003Commercial Airline
    
    
    193,788
    
    
    
    316,357Defense
    
    
    221,657
    
    
    
    188,304Corporate
    
    
    41,122
    
    
    
    16,350Other related businesses
    
    
    48,316
    
    
    
    38,176Total
    
    
    504,883
    
    
    
    559,187
  36.
    
    RESTATEMENT OF CONSOLIDATED STATEMENTS OF CASH FLOWSSubsequent to the issuance of the Companys consolidated financial
statements for the years ended December 31, 2001 and 2002, management
determined that certain cash flows had been misclassified in the
consolidated statements of cash flows for the years ended December 31, 2001
and 2002. Cash flows from operating activities, investing activities and
financing activities have been restated to reflect the adjustments in our
consolidated statements of cash flows. These changes did not impact the
total amount of cash and cash equivalents reported in 2001 and 2002. F-60




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##### Table of Contents



EMBRAER - EMPRESA BRASILEIRA DE AERONÁUTICA S.A. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
(In thousands of U.S. dollars, unless otherwise stated) 
  The principal misclassifications relate to (i) the effect of exchange rate
changes on cash, which had been classified in cash flows from operating
activities, and (ii) the payment of interest, which had been reflected in
cash flows from financing activities. Other minor reclassifications have
been made in order to better conform our presentation to typical cash flow
item characteristics. The effects on the consolidated statements of cash
flows of all adjustments are detailed as follows: 2001
    
    2002As previously
    
    As
    
    As previously
    
    Asreported
    
    restated
    
    reported
    
    restatedNet cash provided by (used in) operating
activities
    
    
    (263,160
    )
    
    
    (207,388
    )
    
    
    507,683
    
    
    
    575,653Net cash used in investing activities
    
    
    (275,172
    )
    
    
    (162,760
    )
    
    
    (200,790
    )
    
    
    (104,216
    )Net cash provided by (used in) financing
activities
    
    
    98,403
    
    
    
    134,379
    
    
    
    (399,373
    )
    
    
    (352,435
    )Effect of exchange rate changes on
cash
    
    
    
    
    
    
    (204,160
    )
    
    
    
    
    
    
    (211,482
    )
 * * * F-61