TAM S.A. 20-F 2011
Documents found in this filing:
As filed with the Securities and Exchange Commission on May 13, 2011
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Av. Jurandir, 856, Lote 4, 1° andar
Federative Republic of Brazil
Securities registered or to be registered pursuant to Section 12(b) of the Act:
* Not for trading purposes, but only in connection with the trading on the New York Stock Exchange of American Depositary Shares representing those Preferred Shares.
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:
TAM Capital Inc. U.S.$300,000,000 7.375% Senior Guaranteed Notes due 2017,
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.
55,816,683 Common Shares
Indicate by check mark if the registrant is a well‑known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. ¨ Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S‑T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non‑accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b‑2 of the Exchange Act.
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
If "Other" has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. ¨ Item 17 ¨ Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act). ¨ Yes x No
Page A. Selected Financial Data B. Capitalization and Indebtedness. 8 C. Reasons for the Offer and Use of Proceeds D. Risk Factors A. History and Development of the Company B. Business Overview.. 21 C. Organizational Structure. 49 D. Property, Plant and Equipment 50 A. Operating Results B. Liquidity and Capital Resources C. Research and Development, Patents and Licenses, etc. D. Trend Information E. Off‑balance Sheet Arrangements F. Tabular Disclosure of Contractual Obligations. 68 A. Directors and Senior Management B. Compensation C. Board Practices D. Employees E. Share Ownership. 77 A. Major Shareholders B. Related Party Transactions C. Interests of Experts and Counsel A. Consolidated Statements and Other Financial Information B. Significant Changes A. Offer and Listing Details B. Plan of Distribution C. Markets D. Selling Shareholders. 93
A. Selected Financial Data
B. Capitalization and Indebtedness. 8
C. Reasons for the Offer and Use of Proceeds
D. Risk Factors
A. History and Development of the Company
B. Business Overview.. 21
C. Organizational Structure. 49
D. Property, Plant and Equipment 50
A. Operating Results
B. Liquidity and Capital Resources
C. Research and Development, Patents and Licenses, etc.
D. Trend Information
E. Off‑balance Sheet Arrangements
F. Tabular Disclosure of Contractual Obligations. 68
A. Directors and Senior Management
C. Board Practices
E. Share Ownership. 77
A. Major Shareholders
B. Related Party Transactions
C. Interests of Experts and Counsel
A. Consolidated Statements and Other Financial Information
B. Significant Changes
A. Offer and Listing Details
B. Plan of Distribution
D. Selling Shareholders. 93
In this annual report (the "Annual Report"), "TAM S.A." refers to TAM S.A., a sociedade anônima de capital aberto organized under the laws of Brazil, "Multiplus" or "Multiplus Fidelidade" refers to Multiplus S.A., a sociedade anônima de capital aberto organized under the laws of Brazil, "TAM Linhas Aéreas" or "TLA" refer to TAM Linhas Aéreas S.A., a sociedade anônima de capital fechado organized under the laws of Brazil, "Pantanal" refers to Pantanal Linhas Aéreas S.A., a sociedade anônima de capital fechado organized under the laws of Brazil, "TAM Viagens" refers to Fidelidade Viagens e Turismo Limited, a sociedade limitada organized under the laws of Brazil, "TAM Mercosur" refers to Transportes Aéreos Del Mercosur S.A., a sociedade anônima de capital fechado organized under the laws of Paraguay, "TP Franchising" refers to TP Franchising Limited, a sociedade limitada organized under the laws of Brazil, "TAM Milor" refers to TAM Milor - Táxi Aéreo, Representações, Marcas e Patentes S.A., a sociedade anônima de capital aberto organized under the laws of Brazil, "TAM Capital" refers to TAM Capital Inc., "TAM Capital 2" refers to TAM Capital 2 Inc., "TAM Financial 1" refers to Tam Financial Services 1 Limited and "TAM Financial 2" refers to Tam Financial Services 2 Limited, and each of TAM Capital, TAM Capital 2, TAM Financial 1 and TAM Financial 2 is an exempted company incorporated with limited liability in the Cayman Islands. The terms "we," "our" and "us" refer to TAM S.A., its consolidated subsidiaries and each of the companies mentioned above, which are its controlled subsidiaries. References to "preferred shares" and "ADSs" refer to the non‑voting preferred shares of TAM S.A. and the American depositary shares representing those preferred shares, respectively, except where the context otherwise requires.
In this Annual Report, the term "Brazil" refers to the Federative Republic of Brazil and the phrase "Brazilian government" refers to the federal government of Brazil. The term "ANAC" refers to the National Civil Aviation Agency or Agência Nacional de Aviação Civil, the national aviation agency, which is part of the Brazilian government. The term "Central Bank" refers to the Central Bank of Brazil. The terms "U.S. dollar" and "U.S. dollars" and the symbol "U.S.$" refer to the legal currency of the United States. The terms "real" and "reais" and the symbol "R$" refer to the legal currency of Brazil and the term "centavos" means the 100th part of the real.
This Annual Report contains terms relating to operating performance within the airline industry that are defined as follows:
· "ASK" means available seat kilometers, or the product of the number of seats available in all aircraft multiplied by the distance the seats are flown in kilometers.
· "Average tariff" means the quotient of passenger transport revenue divided by the number of paying passengers transported.
· "BELF" means the break‑even load factor, or the load factor in which revenue equals operating expenses.
· "Block hours" refers to the elapsed time between an aircraft's departure from its airport departure gate and arrival at its airport destination gate.
· "CASK" means cost per ASK, or the quotient of total operating expenses (excluding the fair value of fuel derivatives) divided by the number of available seat kilometers. The result is presented in this Annual Report in centavos per ASK.
· "Load factor" means the percentage of an aircraft occupied by paying passengers on a flight, or the quotient of RPK divided by ASK.
· "RASK" means revenue per ASK, or the quotient of net revenue divided by the number of available seat kilometers. The result is presented in this Annual Report in centavos per ASK.
· "RPK" means revenue passenger kilometer, which corresponds to the product of the number of paying passengers transported multiplied by the number of kilometers flown by those passengers.
· "Yield" means the average amount paid per passenger to fly one kilometer.
PRESENTATION OF FINANCIAL AND OTHER DATA
We prepare our consolidated annual financial statements in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB"). Our financial statements are prepared under the historical cost model and derivative financial instruments are accounted for using the fair value measurement model.
Our audited consolidated annual financial statements as of and for the years ended December 31, 2010, 2009, 2008 and 2007, as included in this Annual Report, have been audited by our independent registered public accounting firm.
In 2008, we adopted IFRS and prepared IFRS consolidated financial statements for the year ended December 31, 2008, which was two years earlier than required by CVM Instruction 457/07. CVM Instruction 457/07 mandated that Brazilian listed companies prepare consolidated financial statements in conformity with the pronouncements issued by the IASB as of and from the year ended December 31, 2010. In accordance with our adoption of IFRS, we elected to adopt certain accounting policies permitted under IFRS, including the policy permitting periodic revaluation of the carrying amount of our flight equipment. Accordingly, our financial statements prepared in accordance with IFRS as of and for the years ended December 31, 2009 and 2008, filed in our annual reports on Form 20-F for those years, were prepared recognizing the periodic revaluation of flight equipment, as permitted under IFRS.
Our non-consolidated individual parent company financial statements as of and for those years, which are not part of our annual reports on Form 20-F, were prepared in accordance with accounting practices adopted in Brazil. In those financial statements, we did not revalue our flight equipment because that accounting policy is not permissible under Brazilian Corporate Law. Accounting practices adopted in Brazil for years ending December 31, 2010 and thereafter ("New Brazilian GAAP") include standards issued by the Brazilian Accounting Pronouncements Committee ("CPC"), which are strictly based on the corresponding standards issued by the IASB. However, certain electable accounting policies allowed under IFRS are not permitted under New Brazilian GAAP, including the option for measuring property, plant and equipment at revalued amounts.
On December 2, 2010, the CVM issued CVM Resolution 647 approving Technical Pronouncement CPC 37 (R1) – First-time Adoption of International Accounting Standards ("CPC 37 (R1)"). CPC 37 (R1) establishes that if an entity presented IFRS consolidated financial statements for any year prior to January 1, 2009 in a manner that was not consistent with New Brazilian GAAP standards, that entity should limit any inconsistency in accounting practices solely to those existing at the time of adoption of IFRS. The CVM also required that Brazilian listed companies that have already published their IFRS consolidated financial statements submit detailed information supporting the maintenance of those differences to the CVM, with the CVM then having the discretion to allow such inconsistency, restrict the continuation of such inconsistency, or eliminate such inconsistency altogether.
On December 16, 2010, the CVM issued CVM Resolution 651 approving Technical Pronouncement CPC 43 (R1) – First-time Adoption of Technical Pronouncements CPC 15 to 41 ("CPC 43 (R1)"). One of the purposes of CPC 43 (R1) is, together with CPC 37 (R1), to facilitate the reconciliation of net income/loss and shareholders equity between non-consolidated individual parent company financial statements prepared in accordance with New Brazilian GAAP and consolidated financial statements prepared in accordance with IFRS. CPC 43 (R1) reaffirms the CPC’s view that it its undesirable to have two sets of financial statements that contain different accounting criteria and different net income/loss and shareholders’ equity. To avoid this result, CPC 43 (R1) permits adjustments to non-consolidated individual parent company financial statements of Brazilian companies, so that, when consolidated, the assets, liabilities, equity, and net income/loss in consolidated financial statements prepared under IFRS reconcile with individual parent company financial statements prepared under New Brazilian GAAP.
On the basis that:
· Brazilian Corporate Law prohibits our individual non-consolidated parent company financial statements from recognizing the effects of flight equipment revaluation, and
· the purpose of CPC 43 (R1) is that no differences should exist between net income/loss and shareholders equity in individual and consolidated financial statements prepared under IRFS and New Brazilian GAAP,
we have elected to change our accounting policy with respect to recognizing the effects of flight equipment revaluation in our consolidated financial statements prepared under IFRS. This will provide consistency with our individual non-consolidated parent company financial statements prepared under New Brazilian GAAP. As a result, the consolidated financial statements prepared in accordance with IFRS and presented herein have been prepared to account for property, plant and equipment at historical cost as permitted by IAS 16.
For comparison purposes, our consolidated annual financial statements as of and for the years ended December 31, 2009, 2008 and 2007 that were filed in our Annual Report on Form 20-F for the year ended December 31, 2009 have been retroactively adjusted in this Annual Report to reflect this change in accounting policy. Please see Note 4 to our audited consolidated annual financial statements as of and for the year ended December 31, 2010 included in this Annual Report for additional information on this change in accounting policy and the retrospective adjustments made to our consolidated annual financial statements as of and for the years ended December 31, 2009, 2008 and 2007.
For ease of presentation, certain financial information contained in this Annual Report has been presented in U.S. dollars. This Annual Report contains translations of various real amounts, before rounding, into U.S. dollars at specified rates solely for your convenience. You should not construe these translations as representations by us that the real amounts actually represent these U.S. dollar amounts or could be converted into U.S. dollars at the rates indicated. Unless otherwise indicated, we have translated the real amounts using a rate of R$1.67 to U.S.$1.00, the U.S. dollar selling rate published by the Central Bank on December 31, 2010. On May 9, 2011, the U.S. dollar selling rate published by the Central Bank was R$1.62 to U.S.$1.00.
The information contained in this Annual Report relating to Brazil and the Brazilian economy is based on data published by the Central Bank, government agencies and other independent sources. Data and statistics regarding the Brazilian civil aviation markets are based on publicly available data published by ANAC. Data and statistics regarding the international civil aviation markets are based on publicly available data published by the International Civil Aviation Organization ("ICAO") and the International Air Transport Association ("IATA"). We also make statements in this Annual Report about our competitive position and market share in, and the market size of, the Brazilian airline industry. We have made these statements on the basis of statistics and other information from third‑party sources that we believe are reliable. Although we have no reason to believe any of this information or these reports are inaccurate in any material respect, we have not independently verified the competitive position, market share and market size or market growth data provided by third parties or by industry or general publications.
Certain figures in this document have been subject to rounding adjustments. Accordingly, figures shown as totals in certain tables may not be an arithmetic aggregation of the figures that precede them.
This Annual Report includes certain forward‑looking statements (particularly in "Item 3. Key Information — D. Risk Factors," "Item 4. Information on the Company — B. Business Overview" and "Item 5. Operating and Financial Review and Prospects"). These forward‑looking statements are based principally on our current expectations and on projections of future events and financial trends that currently affect or might affect our business. In addition to the items discussed in other sections of this Annual Report, there are many significant factors that could cause our financial condition and results of operations to differ materially from those set out in our forward‑looking statements, including factors such as:
· the risk factors set forth in "Item 3. Key Information — D. Risk Factors" generally and with respect to TAM's proposed business combination with Lan Airlines S.A. ("LAN") in particular;
· whether the proposed business combination with LAN is approved by regulators, LAN's shareholders and other third parties, and whether any conditions required in order to obain such approvals have been satisfied or waived;
· economic and political developments in both Brazil and the principal international markets in which we operate;
· our management's expectations and estimates as to future financial performance, financial plans and the impact of competition on our business, including competitive pressures on pricing;
· our level of indebtedness and other payment obligations;
· our plans relating to investments and capital expenditures;
· variations in interest rates, inflation and the exchange rate relating to the real (with respect to both potential depreciation and appreciation of the real);
· existing and future regulations;
· increases in fuel expenses, maintenance expenses and insurance premiums;
· changes in market prices, consumer preferences and competitive conditions;
· cyclical and seasonal variations in our results of operations;
· defects or other mechanical problems in our aircraft;
· developments or changes in the Brazilian civil aviation infrastructure, including air traffic control, airspace and airport infrastructure;
· the implementation of our strategies and growth plans;
· our ability to obtain financing on commercially reasonable terms; and
· changes in fiscal policy and tax laws.
The words "believe," "expect," "continue," "understand," "hope," "estimate," "will," "may," "might," "should," "intend" and other similar expressions are intended to identify forward‑looking statements and estimates. Such statements refer only to the date on which they were expressed, and we assume no obligation to publicly update or revise any such estimates resulting from new information or any other events. As a result of the inherent risks and uncertainties involved, the forward‑looking statements included in this Annual Report may not be accurate and our future results of operations and performance may differ materially from those set out in this Annual Report for a number of different reasons. No forward‑looking statement in this Annual Report is a guarantee of future performance and each estimate involves risks and uncertainties.
Investors are cautioned not to place undue reliance on any forward‑looking statements.
The information set forth in this section should be read in conjunction with our audited consolidated annual financial statements (including the notes thereto) set forth in "Presentation of Financial and Other Data," "Item 18. Financial Statements" and "Item 5. Operating and Financial Review and Prospects."
The summary consolidated annual financial information as of and for the years ended December 31, 2010, 2009, 2008 and 2007, prepared in accordance with IFRS, is derived from our audited consolidated annual financial statements included elsewhere in this Annual Report, which have been audited by our independent registered public accounting firm. At December 31, 2010, we elected to change the accounting policy related to recognition of flight equipment revaluation in its consolidated financial statements. The reason for this change is that Brazilian Corporate Law does not permit the revaluation of assets and, accordingly, our parent company’s financial statements, prepared in accordance with New Brazilian GAAP, cannot include revaluation of assets. In order to avoid differences in the amounts reported on our financial statements and those of our parent company, we made this accounting policy change. For comparison purposes, our consolidated annual financial statements as of and for the years ended December 31, 2009, 2008 and 2007 that were filed in the Annual Report on Form 20-F for the year ended December 31, 2009, filed June 30, 2010, have been retrospectively adjusted in this Annual Report to reflect the revaluation reserve reversal. Please see Note 4 to our audited consolidated annual financial statements as of and for the year ended December 31, 2010 included in this Annual Report for additional information on the change in accounting policy referred to above and the retrospective adjustments made to our consolidated annual financial statements as of and for the years ended December 31, 2009, 2008 and 2007.
For your convenience, the following tables also contain U.S. dollar translations of the real amounts presented at December 31, 2010, translated using the rate of R$1.67 to U.S.$1.00 published by the Central Bank. On May 9, 2011, the U.S. dollar selling rate published by the Central Bank was R$1.62 to U.S.$1.00.
The tables below entitled "Operating Data Computed Using Financial Information Under IFRS" and "Additional Operating Data" also include unaudited operational and other data indicative of performance utilized by certain investors in evaluating companies operating in the global air transportation sector. This unaudited operational data is not included in or derived from our consolidated annual financial statements.
(1) Refers to the total balance of current liabilities plus long-term liabilities.
(1) Except per share information and where otherwise indicated.
(2) In 2008, there was a conversion of common shares to preferred shares by a relevant shareholder.
(3) Retrospectively adjusted (See Note 4 of our audited consolidated annual financial statements included in this Annual Report for additional information on the reversal of our revaluation reserve and the retrospective adjustments made to our consolidated annual financial statements as of and for the years ended December 31, 2009, 2008 and 2007).
(1) Retrospectively adjusted (See Note 4 of our audited consolidated annual financial statements included in this Annual Report for additional information on the reversal of our revaluation reserve and the retrospective adjustments made to our consolidated annual financial statements as of and for the years ended December 31, 2009, 2008 and 2007).
(2) Includes passenger, cargo and other revenue.
(3) Includes passenger revenue.
Until January 1999, there were two legal foreign exchange markets in Brazil, the commercial rate exchange market, or the Commercial Market, and the floating rate exchange market, or the Floating Market. The Commercial Market was reserved primarily for (i) foreign trade transactions and (ii) transactions that generally required prior approval from Brazilian monetary authorities, like the purchase and sale of registered investments by foreign persons and related remittances of funds abroad (including the payment of principal of, and interest on, loans, notes, bonds and other debt instruments denominated in foreign currencies and duly registered with the Central Bank). The Floating Market was for specific transactions that did not require Central Bank approval.
The Central Bank reported both the Commercial Market rate and the Floating Market rate on a daily basis. In January 1999, the Brazilian government announced the unification of the exchange rates for the Brazilian Commercial Market and the Floating Market, leading to a convergence in the pricing and liquidity of both markets.
On March 4, 2005, the Conselho Monetário Nacional (the "CMN") issued Resolution No. 3,265 and Resolution No. 3,266 (each of which became effective on March 14, 2005), which introduced several changes in the Brazilian foreign exchange regime, including (i) the unification of the Commercial Market and the Floating Market, and (ii) the relaxation of rules for the acquisition of foreign currency by Brazilian residents. It is expected that the Central Bank will further regulate foreign exchange transactions, as well as payments and/or transfers of Brazilian currency between Brazilian residents and non‑residents (those transfers, the International Transfers of Reais), including those made through non‑resident accounts.
See "Item 3. Key Information — D. Risk Factors — Risks relating to Brazil — Exchange rate instability may have adverse effects on the Brazilian economy, our business, financial condition, results of operations and prospects and the trading price of our ADSs and preferred shares."
The following tables set forth the Commercial Market rate for the purchase of U.S. dollars expressed in reais per U.S. dollar for the periods and dates indicated:
(1) Represents the daily average rate during each of the relevant periods.
Source: Central Bank.
Source: Central Bank.
Investing in our ADSs or our preferred shares involves a high degree of risk. Before making an investment decision, you should carefully consider the risks set forth below. Our business, financial condition and results of operations may be materially adversely affected by any of these risks. The trading price of our ADSs or our preferred shares may decrease due to any of these risks, and you may lose all or part of your investment. The risks described below are those that we currently believe may materially affect us.
Risks Related to TAM's Proposed Combination with LAN
The completion of the proposed combination is subject to many conditions precedent and if these are not satisfied or waived the proposed combination will not be completed.
TAM's proposed combination with LAN will involve an exchange offer (the "exchange offer"). See the section titled "Item 4. Information on the Company - Business Overview - Proposed Combination with LAN" for a description of the exchange offer and the corporate steps to effect the proposed combination. The commencement of the exchange offer is subject to certain conditions, including receipt of all required regulatory approvals (including the required approvals from the CVM, the Superintendencia de Valores y Seguros(the Chilean Securities and Insurance Supervisor, or "SVS"), and the SEC) and approval of the proposed combination by the holders of LAN common shares. In addition, the exchange offer is subject to the conditions that the exchange offer be accepted by (i) the holders of at least 66 2/3 % of the outstanding shares of TAM not owned by TAM - Empreendimentos e Participações S.A. ("TEP" or the "TAM controlling shareholder") and its affiliates (which is the minimum threshold required to permit the delisting of TAM stock from the BM&FBOVESPA S.A. - Bolsa de Valores, Mercadorias e Futuros, or BM&FBovespa, after completion of the proposedcombination), and (ii) the holders of a sufficient number of TAM shares so that the sum of (A) the total number of TAM shares that have accepted the exchange offer and (B) the number of TAM shares owned by TAM’s controlling shareholder is more than 95% of the outstanding TAM shares (which is the minimum threshold required to permit a statutory squeeze-out under Brazilian law of all TAM shares that do not accept the exchange offer after completion of the proposed combination). Certain of these conditions may not be waived without the written agreement of TAM's controlling shareholder and Costa Verde Aeronáutica and Inversones Mineras del Cantábrico (the "LAN controlling shareholders") and neither the TAM controlling shareholder nor the LAN controlling shareholders have any obligation to waive any conditions not satisfied on or prior to the expiration of the exchange offer. Therefore, even if TAM is willing to waive an unsatisfied condition, TAM may be unable to complete the exchange offer if LAN's or TAM's controlling shareholders refuse to waive the condition. In addition, the obligation of TAM’s controlling shareholder under an implementation agreement and an exchange offer agreement, both agreements by and among TAM, the TAM controlling shareholder and Maria Cláudia Oliveira Amaro, Maurício Rolim Amaro, Noemy Almeida Oliveira Amaro and João Francisco Amaro (the "Amaro family") on the one hand and LAN and the LAN controlling shareholders on the other hand (the "transaction agreements") to contribute its TAM shares into the proposedcombination prior to the completion of the exchange offer is subject to certain conditions relating to the operations and business of LAN and certain other events outside of LAN's and TAM's control. Further, the mergers are subject to the condition that the holders of no more than 2.5% of the outstanding LAN common shares exercise their appraisal rights under Chilean law. If any of these conditions are not satisfied or waived, the proposedcombination will not be completed.
The proposed combination cannot be completed unless TAM and LAN receive consents and clearances from regulatory authorities and such authorities could impose conditions that could adversely affect TAM and/or the combined companies.
Before the proposedcombination may be completed, applicable waiting periods must expire or terminate under antitrust and competition laws and various approvals or consents must be obtained from regulatory entities, including the Tribunal de Defensa de la Libre Competencia (the Chilean Tribunal of the Defense of Free Competition), or the "TDLC". See the section entitled "Item 4. Information on the Company – Business Overview – Proposed Combination with LAN" below for a discussion of the status of the review of the proposed combination by the TDLC. In deciding whether to grant antitrust or regulatory clearances, the relevant governmental entities will consider, among other things, the effect the proposedcombination will have on competition and operations within their relevant jurisdictions. The terms and conditions of the approvals that are granted may impose requirements, limitations or costs or place restrictions on the conduct of the combined companies’ businesses. The transaction agreements expressly provide that neither LAN nor TAM are required to sell, hold separate or otherwise encumber any of TAM's respective assets or to take the other actions specified therein in order to obtain such approvals and thus either company may refuse to complete the proposedcombination on the basis of those regulatory conditions. There can be no assurance that regulators will not impose conditions, terms, obligations or restrictions or that such conditions, terms, obligations or restrictions will not have the effect of delaying completion of the proposedcombination or imposing additional material costs on, or materially limiting the revenues of, the combined companiesfollowing the proposedcombination. In addition, it is a condition to TAM's and LAN’s obligation to complete the proposed combination that no governmental authority shall have issued any law or order making the proposed combination illegal or materially limiting or impairing the ownership or operation of any material part of the combined companies.
Any delay in completing the proposed combination may reduce or eliminate the benefits TAM expects to be achieved as a result of the proposed combination.
In addition to the required regulatory clearances, the proposedcombination is subject to a number of other conditions beyond TAM's control that may prevent, delay or otherwise materially adversely affect its completion. TAM cannot predict whether or when these other conditions will be satisfied. Furthermore, the requirements for obtaining the required clearances and approvals could delay the completion of the proposed combination for a significant period of time or prevent it from occurring. Any delay in completing the proposed combination could limit the ability of the combined companies to realize some or all of the synergies that TAM expects to achieve if the proposedcombination is successfully completed within its expected time frame.
Failure to complete the proposed combination could negatively impact TAM's stock price and future business and financial results.
If the proposedcombination is not completed, TAM's ongoing businesses may be adversely affected, and TAM would be subject to several risks, including the following:
If the proposedcombination is not completed, TAM cannot assure its stockholders that these risks will not materialize and will not materially adversely affect TAM's business, financial results and stock price.
The transaction agreements contain provisions that could discourage a potential competing acquirer of TAM.
The transaction agreements require TAM's board of directors to recommend that TAM's shareholders tender their shares as part of the proposed combination and does not permit TAM's board of directors to withdraw or adversely modify that recommendation. The transaction agreements also contain "no shop" provisions that prohibit TAM from soliciting, initiating or encouraging any competing third party proposals, including acquisitions of TAM's equity securities or material assets, and there are no exceptions to these provisions. In addition, if the transaction agreements are terminated under certain circumstances, TAM may be required to pay to LAN a termination fee of U.S.$200 million and to reimburse LAN for up to U.S.$25 million of expenses incurred by LAN in connection with the transaction agreements and the proposed combination. These provisions could discourage a potential third-party acquiror that might have an interest in acquiring all or a significant portion of TAM from considering or proposing that acquisition, even if it were prepared to pay consideration with a value per share higher than the benefits TAM shareholders may receive from the proposedcombination, or might result in a potential third-party acquiror proposing to pay a lower price to the TAM shareholders than it might otherwise have proposed to pay because of the added expense of the U.S.$225 million termination fee and expense reimbursement that may become payable in certain circumstances.
Uncertainties associated with the proposed combination may cause a loss of management personnel and other key employees that could adversely affect TAM, LAN and/or the combined companies.The success of the operations of TAM, LAN and the combined companies is dependent, among other things, on the experience and industry knowledge of their senior management and other key employees and their ability to execute their business plans. In order to be successful, TAM, LAN and the combined companies must be able to retain their senior management and other key employees and their ability to attract highly qualified personnel in the future. Current and prospective employees of TAM and LAN may experience uncertainty about their roles within the combined companies following completion of the proposed combination, which may have an adverse effect on the ability of TAM, LAN and/or the combined companies to retain or attract senior management and other key employees. Competition for highly qualified personnel in the various locations and business segments in which TAM and LAN operate is intense. No assurances can be given that TAM, LAN or, after completion of the proposed combination, the combined companies will be able to retain or attract senior management and other key employees to the same extent that TAM and LAN have previously been able to do so.
TAM has and will continue to incur significant costs and expenses in connection with the proposed combination and integration of the business operations of TAM and LAN.
TAM has incurred and expects to continue to incur substantial expenses in connection with the proposed combination and the integration of TAM and LAN. Non-recurring expenses expected to be incurred by TAM and LAN in connection with the proposed combination in 2011 are anticipated to be significant. These costs and expenses include financial advisory, legal and accounting fees and expenses, reorganization and restructuring costs, severance/employee benefit-related expenses, filing fees, printing expenses and other related charges. Some of these costs are payable regardless of whether the proposed combination is completed. There are also a large number of processes, policies, procedures, operations, technologies and systems that must be integrated in connection with the proposed combination. While both TAM and LAN have assumed that a certain level of expenses would be incurred in connection with these transactions, there are many factors beyond TAM's control that could affect the total amount or the timing of the integration expenses.
There may also be additional unanticipated significant costs in connection with the combination that TAM may not recoup. These costs and expenses could, particularly in the near term, exceed the savings that TAM expects the combined companiesto achieve from the elimination of duplicative expenses and the realization of economies of scale, other efficiencies and cost savings. Although TAM expects that these savings will offset these transaction- and combination-related costs over time, this net benefit may not be achieved in the near term or at all.
TAM and LAN may be unable to fully realize the anticipated benefits of the proposed combination.
The proposed combination involves bringing together two large and complex businesses that currently operate as independent public companies. The combined companies will be required to devote significant management attention and resources to integrating certain aspects of the business practices and operations of TAM and LAN. The success of the proposed combination will depend, in part, on the combined companies' ability to realize anticipated revenue synergies, cost savings and growth opportunities by combining the businesses of TAM and LAN. TAM hopes to generate synergies resulting from the consolidation of capabilities, rationalization of operations and headcount, greater efficiencies from increased scale and market integration, experience of product and service offerings and organic growth. There is a risk, however, that TAM and LAN may not be able to combine their respective businesses in a manner that permits the combined companies to realize these revenue synergies, cost savings and growth opportunities in the time, manner or amounts it currently expects, or at all. Potential difficulties the combined companies may encounter as part of the integration process include, among other things:
· the inability to successfully combine the businesses of TAM and LAN in a manner that permits the combined companies to achieve the full revenue and cost synergies anticipated to result from the proposed combination;
· complexities associated with managing the combined companies;
· the need to implement, integrate and harmonize various business-specific operating procedures and systems, as well as the financial, accounting, information and other systems of TAM and LAN;
· potential loss of key employees as a result of implementing the proposed combination; and
· potential unknown liabilities and unforeseen increased expenses or delays associated with the exchange offer, the mergers and the other combination transactions, including one-time cash costs to integrate the two airlines that may exceed the one-time cash costs that TAM and LAN currently anticipate.
In addition, TAM and LAN have operated and, until the completion of the proposedcombination, will continue to operate independently. It is possible that the integration process could result in the disruption of, or the loss of momentum in, each company’s ongoing businesses, which could adversely affect each company’s ability to maintain good relationships with its customers, suppliers, employees and other constituencies or achieve the anticipated benefits of the proposed combination or could increase costs or reduce each company’s earnings or otherwise adversely affect the businesses, financial condition, results of operations and/or prospects of the combined companies following the completion of the exchange offer and mergers. Even if they are achieved, actual revenue synergies, cost savings and efficiency and operational benefits may be lower and may take a longer time to achieve than TAM currently expects.
The integration of two large companies also presents significant management challenges. In order to achieve the anticipated benefits of the proposed combination of TAM and LAN, the operations of the two companies will need to be reorganized and their resources will need to be combined in a timely and flexible manner. There can be no assurance that TAM and LAN will be able to implement these steps as anticipated or at all. If TAM or LAN fail to achieve the planned restructuring effectively within the time frame that is currently contemplated or to the extent that is currently planned, or if for any other reason the expected synergies fail to materialize, the proposed combination may not produce the benefits TAM currently anticipates.
The proposed combination will involve a delisting exchange offer under Brazilian law pursuant to which there will be a statutory squeeze-out if applicable requirements are met.
TAM's proposed combination with LAN will involve an exchange offer to be structured as a delisting exchange offer under Brazilian law. See the section entitled "Item 4. Information on the Company – Business Overview – Proposed Combination with LAN" for a description of the exchange offer and the corporate steps to effect the proposed combination. If the number of TAM shares validly tendered as part of the exchange offer is sufficient so that the sum of (A) the total number of TAM shares that have accepted the exchange offer and (B) the number of TAM shares owned by the TAM controlling shareholder is more than 95% of TAM's outstanding shares, LAN will conduct a statutory squeeze-out under Brazilian law of all TAM shares that do not accept the exchange offer after completion of the proposed combination. If this statutory squeeze-out occurs, a holder of non-tendered shares would be forced to sell its shares to LAN and receive cash in an amount equal to the product of (i) the number of LAN common shares that it would have received pursuant to the exchange offer in respect of its non-tendered shares, and (ii) the closing price of the LAN common shares on the Santiago Stock Exchange (Bolsa de Comercio de Santiago) on the day on which the exchange offer is completed.
Risks relating to Brazil
The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. Brazilian political and economic conditions have a direct impact on our business, financial condition, results of operations and prospects as well as the trading price of our ADSs and preferred shares.
The Brazilian economy has been characterized by the significant involvement of the Brazilian government, which often changes monetary, credit, fiscal and other policies to influence Brazil's economy. The Brazilian government's actions to control inflation and effect other policies have involved wage and price controls, depreciation of the real, controls over remittance of funds abroad, intervention by the Central Bank to affect base interest rates and other measures. We have no control over, and cannot predict, what measures or policies the Brazilian government may take in the future. Our business, financial condition, results of operations and prospects and the trading price of our ADSs and preferred shares may be adversely affected by changes in Brazilian governmental policies, as well as general economic factors, including, without limitation:
· Brazilian economic growth;
· interest rates;
· variations in exchange rates;
· exchange control policies;
· fiscal policy and changes in tax laws;
· liquidity of domestic capital and lending markets;
· government control of production activities and oil refining; and
· other political, diplomatic, social and economic developments in or affecting Brazil.
We cannot predict what future fiscal, monetary, social security or other policies will be adopted by current or future Brazilian governments, or whether these policies will result in adverse consequences to the Brazilian economy, to our business, results of operations, financial condition or prospects, or to the trading prices of our ADSs and preferred shares.
In October 2010, presidential elections took place in Brazil. Uncertainties in relation to the implementation by the new government of changes relating to the monetary, tax and pension funds policies as well as to the relevant legislation may contribute to economic instability. This may increase market volatility of Brazilian securities. It is not possible to predict whether the government that was elected in October 2010 or any succeeding governments will have an adverse effect on the Brazilian economy, and, consequently, on our business, results of operations, financial condition or prospects, or on the trading prices of our ADSs and preferred shares.
In addition, possible political crises may affect the confidence of investors and the public in general, which may result in economic deceleration and affect the trading prices of securities issued by Brazilian companies.
Exchange rate instability may have adverse effects on the Brazilian economy, our business, financial condition, results of operations and prospects and the trading price of our ADSs and preferred shares.
As a result of inflationary pressures, the Brazilian currency has depreciated frequently over the past decade. Throughout this period, the Brazilian government has implemented various economic plans and used various exchange rate policies, including sudden devaluations, periodic mini‑devaluations (during which the frequency of adjustments has ranged from daily to monthly), exchange controls, dual exchange rate markets and a floating exchange rate system. Although long‑term depreciation of the real is generally linked to the rate of inflation in Brazil, depreciation of the real occurring over shorter periods of time has resulted in significant variations in the exchange rate between the real, the U.S. dollar and other currencies. In 2002, the real fell 34.3% against the U.S. dollar, caused in part by political uncertainties involving the presidential election in Brazil and the global economic recession. Notwithstanding the fact that the real appreciated 13.4%, 9.5% and 17.2% against the U.S. dollar in 2005, 2006 and 2007 respectively, from mid‑2008 through the end of that year, the real depreciated 31.9% against the U.S. dollar as a result of the ongoing global financial crisis. However, in 2009, the real appreciated 25.5% against the U.S. dollar, as reported by the Central Bank and in 2010, the real appreciated 4.3% against the U.S. dollar. On December 31, 2010, the exchange rate was R$1.666 per U.S. dollar and on March 17, 2011, the exchange rate was R$1.676 per U.S. dollar. We cannot assure you that the real will not depreciate or appreciate substantially against the U.S. dollar in the future.
The majority of our revenues are denominated in reais, and a significant portion of our operating expenses (such as fuel, aircraft and engine maintenance, aircraft leasing and insurance payments, parts and engines) are denominated in, or linked to, the U.S. dollar or other foreign currencies. In the event that we are unable to adjust our prices or to obtain protection through hedging transactions, adepreciation in the real would reduce our profit margins and/or cause operating losses as a result of increased expenses. Devaluations in the real against the U.S. dollar or other foreign currencies also create inflationary pressures, which can restrict our access to foreign financial markets and lead to government intervention (including the implementation of recessionary policies to curb aggregate demand). Exchange rate instability may adversely affect our business, financial condition, results of operations and the trading price of our ADSs and preferred shares.
Inflation and certain measures by the Brazilian government to curb inflation have historically adversely affected the Brazilian economy and Brazilian securities market, and high levels of inflation in the future would adversely affect our business, financial condition, results of operations and prospects and the trading price of our ADSs and preferred shares.
Brazil has historically experienced extremely high rates of inflation. Inflation and some of the measures taken by the Brazilian government in an attempt to curb inflation have had significant negative effects on the Brazilian economy generally. Inflation, policies adopted to curb inflationary pressures and uncertainties regarding possible future governmental intervention have contributed to economic uncertainty and heightened volatility in the Brazilian securities market.
Since the introduction of the real in 1994, Brazil's inflation rate has been substantially lower than in previous periods. However, inflationary pressures persist. According to the General Price Index (Índice Geral de Preços‑Mercado, or IGP‑M), Brazilian inflation rates were 3.8%, 7.7%, 9.8%, -1.7% and 11.4% in 2006, 2007, 2008, 2009 and 2010 respectively. According to the National Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo, or "IPCA"), Brazilian inflation rates were 3.1%, 4.5%, 5.9%, 4.3% and 5.9% in 2006, 2007, 2008, 2009 and 2010 respectively.
Brazil may experience high levels of inflation in the future. Inflationary pressures may lead to the Brazilian government intervening in the economy and introducing policies that could adversely affect our business, financial condition, results of operations and prospects and the trading price of our ADSs and preferred shares.
In the event that Brazil experiences high inflation in the future, we may not be able to adjust the prices we charge our passengers to offset the impact of inflation on our expenses. This would lead to decreased net income. Inflationary pressures may also adversely affect our ability to access foreign financial markets, causing adverse effects on our capital expenditure plans.
Developments and the perceptions of risks in other countries, including other emerging markets, the United States and Europe, may adversely affect the Brazilian economy, our business, financial condition, results of operations and prospects and the market price of Brazilian securities, including the trading price of our ADSs and preferred shares.
The market for securities issued by Brazilian companies is influenced by economic and market conditions in Brazil and, to varying degrees, market conditions in other Latin American and emerging markets, as well as the United States and Europe. Although economic conditions are different in each country, the reaction of investors to developments in one country may have a material adverse effect on the market value of Brazilian companies' securities. Crises in another emerging market country, the United States or Europe could decrease investor demand for Brazilian securities, including our notes, ADSs and preferred shares. This may adversely affect the trading value of our ADSs and preferred shares, and any decline in trading value would impede our access to capital markets and financing for future operations.
The recent global financial crisis has had significant consequences worldwide and in Brazil, causing stock and credit market volatility, credit unavailability, interest rate increases, a general economic slowdown, volatile exchange rates and inflationary pressure, which may adversely affect the market price of Brazilian securities, including our ADSs and preferred shares. If the Brazilian economy experiences a sustained recession, or if Brazil experiences significant political disruptions, our business, financial condition and results of operations could be materially and adversely affected.
Variations in interest rates may have adverse effects on our business, financial condition, results of operations and prospects and the trading price of our ADSs and preferred shares.
We are exposed to the risk of interest rate variations, principally in relation to the Long Term Interest Rate (Taxa de Juros de Longo Prazo, or TJLP), with respect to loans denominated in reais, the Interbank Deposit Rate, or DI Rate, and with respect to operating and finance leases denominated in U .S. dollars, the London Interbank Offer Rate, or LIBOR.
Beginning in 2003, as inflationary pressures eased, the CMN, the highest monetary regulatory body in the Brazilian government, decreased the TJLP. At December 31, 2008, the TJLP was 6.25% and at December 31, 2009, the TJLP was 6.0%. As of December 31, 2010, the TJLP was 6.0%. The DI Rate at December 31, 2008 was 13.6% and at December 31, 2009, the DI Rate was 8.55%. At December 31, 2010, the DI Rate was 10.6%. The LIBOR at December 31, 2008 was 1.4% and at December 31, 2009, it was 0.3%. At December 31, 2010, the LIBOR was 0.3%. Significant increases in consumption, inflation or other macroeconomic pressures may lead to an increase in these rates, which may have an adverse effect on our business.
In addition, our repayments under many of our operating and finance leases are linked to LIBOR, and we are exposed to the risk of variations in LIBOR. At December 31, 2010, the estimated future payments due on our operating and finance lease contracts linked to LIBOR amounted to U.S.$3.0 billion.
If the TJLP, the DI Rate or LIBOR was to increase, our loan repayments would increase, and we might not be able to adjust the prices we charge to offset increased payments. If we are unable to adequately adjust our prices, our revenues would not offset the increased loan expenses, adversely affecting our results of operations. Accordingly, interest rate increases may adversely affect our business, financial condition, results of operations and prospects and the trading price of our ADSs and preferred shares.
Risks Relating to our Business and the Brazilian Aviation Industry
The airline industry is particularly sensitive to changes in economic conditions and continued negative economic conditions that would likely continue to negatively impact our results of operations and our ability to obtain financing on acceptable terms.
Our operations, and the airline industry in general, are particularly sensitive to changes in economic conditions. Unfavorable economic conditions, such as high unemployment rates, a constrained credit market and increased business operating expenses, can reduce spending for both leisure and business travel. Unfavorable economic conditions can also impact our ability to raise fares to counteract increased fuel, labor, and other expenses. An increasingly unfavorable economic environment would likely negatively impact our results of operations. We continue to be cautious of current domestic economic conditions.
Factors such as continuing unfavorable economic conditions, a significant decline in demand for air travel, or continuing instability of the credit and capital markets could result in pressure on our borrowing costs, operating results and financial condition and would affect our growth and investment plans. These factors could also negatively impact our ability to obtain financing on acceptable terms and our liquidity in general.
The regulatory structure of Brazilian civil aviation is undergoing change and we have not yet been able to evaluate the results of this change on our business and results of operations.
Scheduled air transportation services are considered public utilities in Brazil and are subject to extensive regulation by the Brazilian government. Over recent years, the Brazilian regulatory authorities have taken a more proactive role in monitoring the development of the Brazilian civil aviation market. For example, in an effort to prevent excess supply, the authorities have established rigorous criteria for air transport companies to follow when creating new routes or increasing flight frequencies. Various legislative initiatives have taken place, including the drafting of a bill to amend the Brazilian Aeronautics Code, Law No. 7,565 of December 19, 1986, the establishment of ANAC, the national aviation agency that replaced the Departamento de Aviação Civil, or "DAC", as the principal regulatory body for Brazilian civil aviation, and the Civil Aviation Secretariat (Secretaria de Aviação Civil), or SAC, created on March 18, 2011 pursuant to Provisory Measure (Medida Provisória) No. 527, or Provisory Measure No. 527. See "Item 4. Information on the Company — B. Business Overview — Regulation of the Brazilian Civil Aviation Industry — Rights to Operate Air Routes — Future legislation."
Operation of air transportation services, as well as airport infrastructure, is an exclusive right of the Brazilian government, which may choose to provide these services directly or through third parties by means of concessions or permits. Our concession to operate public air transportation was obtained on December 9, 1996, and is valid until December 9, 2011. We cannot assure you that we will be able to automatically renew our concession. See "Item 4. Information on the Company — B. Business Overview — Regulation of the Brazilian Civil Aviation Industry — Overview — Air transportation services concession."
Our growth plans include expanding into new markets, increasing flight frequency and expanding our fleet, which consisted of 151 aircraft at the end of 2010. ANAC has actively monitored the developments of Brazil's airline market and has taken restrictive measures to help restore greater stability in the industry. Accordingly, our capacity to grow is dependent on receiving the necessary authorizations from ANAC and the Bureau of International Relations (Superintendência de Relações Internacionais, or "SRI"). We cannot assure you that we will obtain all necessary authorizations in the future and any failure to do so would require us to re‑evaluate our strategies.
The Brazilian civil aviation structure may change significantly in the future and we may not be able to anticipate or evaluate how this change will affect our business and results of operations. We cannot assure you that these or other changes in Brazilian civil aviation regulations will not have an adverse effect on our business or results of operations. Any change that requires us to focus a significant level of resources on compliance with new aviation regulations, for example, would result in additional expenditure on compliance and consequently adversely affect our results of operations.
In addition, our ability to increase prices to offset an increase in our fixed expenses may be adversely affected in the event that the Brazilian civil aviation authorities impose price control restrictions on air transportation services. If we are unable to adequately increase prices to offset increases in fixed expenses, this would adversely affect our results of operations. Changes in the regulations issued by the Brazilian government or the occurrence of any of the above factors may increase our expenses, limit our capacity to expand our routes or adversely affect our business and results of operations.
Competition in both the domestic and international civil aviation markets is increasing, and the Brazilian government may intervene in the domestic market.
We face intense competition in both the domestic and international markets. The Brazilian government has the power to authorize or deny the entry of new participants into the domestic market in which we operate, as well as the power to assume air transportation operations. Accordingly, each year we face increased competition from existing and new participants, including new low cost carriers on some of our domestic routes. The air transportation sector is highly sensitive to price discounting, particularly as a result of the arrival of low‑cost airlines and some airlines use of predatory pricing policies. Other factors, such as flight frequency, schedule availability, brand recognition, and quality of offered services (such as loyalty programs, VIP airport lounges, in‑flight entertainment and other amenities) also have a significant impact on market competitiveness. In addition, it does not require significant investment to acquire an airline concession in Brazil and, as a result, the barriers to entering the domestic market are low. We cannot assure you that the Brazilian government will not assume control of the air transport operations or that existing or new competitors in our markets will not offer lower prices, more attractive services or increase their routes capacities in an effort to obtain greater market share. In the event that any of the foregoing events occur, we cannot assure you that the price of our fares, passenger demand or our profit margins will not be negatively affected. Any negative impact on our fares would lead to decreased net revenues and may require us to focus on cost‑saving programs.
In 2010, ANAC approved the deregulation of international airfares for flights departing from Brazil to the U.S. and Europe, removing the prior minimum fares that applied to these routes in stages. In addition, in 2010, the National Civil Aviation Council (Conselho de Aviação Civil), or "CONAC", approved the continuity of bilateral agreements providing for open skies policies with other South American countries and a new open skies policy with the United States, and began negotiations for an open skies policy with Europe. These regulations will likely increase competition in the market and we cannot assure you that our results will not be adversely impacted as a result.
Until 2010, landing fees charged by Brazilian airports were standardized, regardless of how busy the airport was. In February 2011, the Brazilian government announced that it will increase landing fees at the busiest airports. Accordingly, competitors who operate from airports that have traditionally been less busy obtain cost advantages, which could adversely affect our results of operation.
The Brazilian Government is studying an increase to the regulatory limitation on foreign capital investments in Brazilian airline companies from 20% to 49% of voting capital. The Brazilian Congress is already discussing certain draft bills related to this increase, which may be voted upon and/or approved with Provisory Measure No. 527. We cannot predict the effects of this regulation on the competitive environment, our industry or on us.
Substantial fluctuations in fuel prices or decreased availability of sufficient quantities of fuel may harm the Brazilian civil aviation market and our business if we cannot pass those cost increases on to passengers through our fares or our fuel hedging arrangements become more expensive.
Fuel expenses represent a significant portion of operating expenses for airlines in general, and fuel prices have risen significantly in recent periods. For the year ended December 31, 2010, fuel expenses represented 32.4% of our operating expenses.
Historically, fuel prices in Brazil have been subject to significant variations in international prices, which in turn vary as a result of global political issues and global supply and demand. The availability of fuel is also subject to periods of market scarcity and surplus and is affected by the demand for gasoline and other petroleum derivatives. Therefore, it is not possible to predict the cost and availability of fuel in the future with any degree of certainty. In the event that the supply of fuel is reduced for any reason, we may need to increase our prices or reduce our scheduled services, which would adversely affect our net revenues.
Fuel prices reached record levels during the middle of 2008, but decreased substantially in the second half of that year. However, in 2009, this trend reversed and fuel prices became more volatile. In 2010, fuel prices increased by approximately 14% in Brazil, following the global trend of price correction after 2009´s high volatility. Jet fuel expenses have been subject to wide fluctuations as a result of increases in demand, sudden disruptions in global supply, as well as market speculation. In addition, some of our competitors may be able to obtain fuel on better terms (with respect to both price and quality). Significant increases in fuel expenses (or in the relative price we pay for fuel compared to our competitors) may harm our financial condition and results of operations in the event that it is not possible for us to pass on price increases to passengers through our fares (or in the event that competitors can decrease their prices relative to ours and take market share from us).
Substantial fluctuations in fuel prices or decreased availability of sufficient quantities of fuel may harm the Brazilian civil aviation market and our business if we cannot pass those cost increases on to passengers through our fares or our fuel hedging arrangements become more expensive. Since 2006, we have routinely hedged our future fuel requirements. However, there can be no assurance that, at any given point in time, our hedge contracts will provide any particular level of protection against increased fuel costs (or that our counterparties will be able to perform under our hedge contracts, such as in the case of a counterparty's bankruptcy). Additionally, a deterioration in our financial condition could negatively affect our ability to enter into new hedge contracts in the future. The Financial Risk Management Policy initially established in 2006 was revised in 2009 so as to reflect the evolution in the understanding of risk by the Company. Thus, the hedging horizon was expanded to five years (quarterly rolling) with minimum levels of protection set at 20% for the first 12 months and 10% for the following 12 months with a maximum of 60% during the whole period, compared to the previous minimum of 30% and maximum of 80%.
The decrease in fuel prices in the latter half of 2008 had the effect of increasing the costs associated with our fuel hedging arrangements, so that we recorded a liability of R$1.1 billion at December 31, 2008 as a result of those arrangements. In 2010, fuel prices increased thereby increasing our fuel price variation costs. In 2011, fuel prices have shown volatility and our fuel hedging transactions and adjustments to our price margins might not be sufficient to protect us from fuel price variations, in which case our results of operations could be significantly and adversely affected.
Airlines have significant fixed expenses that may harm our ability to attain our strategic goals.
As is the case with other airlines, we have high fixed expenses (arising principally from aircraft lease agreements). We expect to incur additional fixed expenses and contractual debt as we lease or acquire new aircraft and other equipment to implement our growth strategy. As of December 31, 2010, we had firm commitments to purchase 91 aircraft, with an aggregate manufacturer's list price of approximately U.S.$9.16 billion. Additionally, in 2011, we announced the order of 32 Airbus A320 family aircraft and two Boeing 777-300ER aircraft. Out of this order, 22 of the Airbus A320 family aircraft are for the new model A320neo. These aircraft will be delivered between 2016 and 2018. The engine option will be announced at a later date. We will require substantial capital from external sources to meet our future financial commitments. Volatility in global financial markets may make it difficult for us to obtain financing for new aircraft on favorable terms.
As a function of our fixed expenses, we may (i) have limited ability to obtain additional financing for working capital and other purposes, (ii) be required to dedicate a significant part of our cash flow to fixed expenses resulting from operating and finance leases for aircraft, (iii) incur higher interest or leasing expenses in the event that interest rates increase or (iv) have a limited ability to plan for, or react to, changes in our businesses, the civil aviation sector generally and overall macroeconomic conditions.
We depend significantly on automated systems and any breakdown in these systems may harm our business and results of operations.
We depend on automated systems to operate our businesses, including our sales system, automated seat reservation system, fleet and network management system, telecommunications system and website. Significant or repeated breakdowns of our automated systems may impede our passengers and travel agencies' access to our products and services, which may cause them to purchase tickets from other airlines, adversely affecting our net revenues. Any interruption in our automated systems may result in the loss of important information and increase our expenses, which may cause a negative public perception of our airline and reduce demand for our services.
A failure to implement our growth strategy may harm our results of operations and the trading price of our ADSs and preferred shares.
Our growth strategy in the domestic and international markets, and the consolidation of our leadership in those markets, includes, among other objectives, increasing the number of markets we serve and increasing the frequency of the flights we provide. These objectives are dependent on obtaining approvals for operating new routes from local regulators and obtaining adequate access to the necessary airports. Guarulhos airport in São Paulo and Juscelino Kubitschek airport in Brasília are highly congested, and passenger utilization is near, or at, maximum capacity. In addition, Congonhas airport in São Paulo and Santos Dumont airport in Rio de Janeiro are subject to slot restrictions that limit both the number of landings and take‑offs and the times at which landings and take‑offs may be scheduled. Other airports may also reach maximum passenger capacity in the future or impose slot restrictions, which would adversely affect our growth strategy. Any factor preventing or delaying our access to airports or routes which are vital to our growth strategy (including our ability to maintain our current slots and obtain additional slots at certain airports) may restrict the expansion of our operations and, consequently, adversely affect our growth strategy.
TAM, together with its controlling shareholder, TEP, and the Amaro family, entered into agreements to combine with LAN, and its respective controlling shareholders to effect a proposed business combination of LAN and TAM. For additional risks related to this proposed business combination, see "– Risks Related to TAM's Proposed Combination with LAN" above.
Our insurance expenses may increase significantly as a result of a terrorist attack, harming our financial condition and results of operations.
Insurance companies may significantly increase insurance premiums for airlines and reduce the amount of insurance coverage available to airlines for civil liability in respect of damage resulting from acts of terrorism, war, or similar events, as was the case following the terrorist attacks of September 11, 2001 in the United States.
In response to substantial increases in insurance premiums to cover risks related to terrorist attacks following the events of September 11, 2001 in the United States, the Brazilian government enacted legislation, authorizing the Brazilian government to assume civil liability to third parties for any injury to persons or goods on the ground caused by terrorist attacks or acts of war against Brazilian airlines operating in Brazil or abroad. However, the Brazilian government may, at its sole discretion, suspend the assumption of liability at any time, provided that it gives seven days' notice of the suspension. If the Brazilian government suspended its assumption of liability, the Brazilian airlines are required to reassume the liability and contract for insurance in the market.
Airline insurers may reduce their coverage or increase their premiums in case of terrorist attack, seizures, aircraft accident and the Brazilian government's termination of its assumption of liability or other events affecting civil aviation in Brazil or abroad. If there are significant reductions in insurance coverage, our potential liability would increase substantially. If there are significant increases in insurance premiums, our operating expenses would increase, adversely affecting our results of operations.
We may not succeed in obtaining all aircraft and parts on time, which may result in a suspension of the operations of certain of our aircraft because of unscheduled or unplanned maintenance.
At December 31, 2010, we had firm orders outstanding with Airbus for an additional 56 Airbus A320 aircraft, 2 Airbus A330 aircraft, and 27 Airbus A350 aircraft, together with an additional 5 options for Airbus A350 aircraft. We also had firm orders outstanding with Boeing for 6 B777 aircraft. Additionally, in 2011, we announced the order of 32 Airbus A320 family aircraft and two Boeing 777-300ER aircraft. Out of this order, 22 of the Airbus A320 family aircraft are for the new model A320neo. These aircraft will be delivered between 2016 and 2018. Any disruption or change in the manufacturers' delivery schedules for these new aircraft will affect our operations and would negatively affect our financial condition and results of operations because we would not be able to accommodate increased passenger demand. Our ability to obtain these new aircraft from Airbus or Boeing may be affected by several factors, including (i) Airbus or Boeing may refuse to, or be financially limited in its ability to, fulfill the obligations it assumed under the aircraft delivery contracts, (ii) the occurrence of a fire, strike or other event affecting Airbus' or Boeing's ability to fulfill its contractual obligations in a complete and timely fashion and (iii) any inability on our part to obtain aircraft financing or any refusal by Airbus or Boeing to provide financial support. Our operations may also be affected by any failure or inability of Airbus or Boeing (or other suppliers) to supply sufficient replacement parts in a timely fashion, which may cause the suspension of operations of certain aircraft because of unscheduled or unplanned maintenance. Any such suspension of operations would decrease passenger revenue and adversely affect our financial condition.
The reputation and financial results of airlines may be harmed by any accident or incident involving their aircraft.
Any accident or incident involving the aircraft of any airline may require repair or replacement of the damaged aircraft and temporary or permanent loss of service, in addition to significant expenses arising from indemnities payable to injured passengers and third parties. We believe that the level of insurance we have contracted for accidents is consistent with market practice. However, we may incur losses in the event that our insurance is insufficient to cover the damage from an accident. Any requirement to pay amounts not covered by our insurance may harm our business and results of operations. Any accident or incident involving one of our aircraft, even if completely covered by insurance, may affect our image and generate a public perception that we are less safe or reliable than other airlines, which would harm our passenger demand, our revenues and our market position. In addition, any accident or incident relating to an aircraft operated by another airline, but which involves one of the same models of aircraft we have in our fleet may generate a public perception that the particular model of aircraft is unsafe, which may also harm passenger demand for our services, our revenues and, consequently, our results of operations.
Our business may be adversely affected by downturns in the airline industry caused by terrorist attacks, war or outbreak of disease, which may alter travel behavior or increase expenses.
Demand for air transportation may be adversely affected by terrorist attacks, war or political or social instability, epidemics, natural disasters and other similar events that are out of our control. Any of these events in the markets in which we operate could have a material impact on our business, financial condition and results of operations. Furthermore, such events could have a prolonged effect on air transportation and on certain expenses including insurance and airport fees.
For example, the terrorist attacks in the United States on September 11, 2001 severely and adversely impacted the worldwide airline industry. Airline traffic in the United States fell dramatically after the attacks and decreased, albeit less severely, throughout Latin America. Our revenues depend on the number of passengers traveling on our flights. Therefore, any future terrorist attacks or threat of attacks, whether or not involving commercial aircraft, any increase in hostilities relating to reprisals against terrorist organizations or otherwise and any related economic impact could result in decreased passenger traffic and materially and negatively affect our business, financial condition and results of operations.
In addition, the escalation of military activity in the Middle East and the public concerns about the possibility of an outbreak of disease (such as the H1N1 virus) could negatively impact the public's willingness to travel by air. We cannot determine if and when such an event will occur and whether the event will decrease demand for air travel, thus materially and negatively affecting our business, financial condition and results of operations.
Our operations are often affected by factors beyond our control, including airport congestion, weather conditions and increased safety measures.
Like other airlines, we are subject to delays caused by factors beyond our control, including airport congestion, adverse weather conditions and increased safety measures. Delays have the effects of leaving passengers dissatisfied, reducing aircraft utilization (the average number of hours per day an aircraft is in operation) and increasing expenses, which may affect our profitability. Adverse weather conditions may cause cancellations of, or significant delays in, our flights. Cancellations or delays resulting from airport congestion, adverse weather conditions and safety related measures may decrease our revenues and harm our reputation as a punctual airline, which could lead to decreased passenger demand for our services.
In 2010, a volcanic eruption in Iceland affected our operations in London, Paris, Frankfurt and Milan between April 15th and April 21st. We had to cancel 56 flights, which represented approximately 2% of our international flights scheduled for that month. While this volcanic eruption had only a small effect on our operations, if a volcanic eruption occurs that requires us to cancel a large number of flights, our revenues may be adversely affected. We cannot guarantee that further cancellations will not happen due to the same or other volcanic eruptions.
Problems with air traffic control systems or other technical failures could interrupt our operations and materially affect our business.
Our operations, including our ability to deliver customer service, are dependent on the effective operation of our equipment, including our aircraft, maintenance systems and reservation systems. Our operations are also dependent on the effective operation of domestic and international air traffic control systems and the air traffic control infrastructure in the markets in which we operate. Equipment failures, personnel shortages, air traffic control problems and other factors that could interrupt operations could adversely affect our operations and financial results and our reputation.
Technical and operational problems in the Brazilian air traffic control systems since the last quarter of 2006 have led to extensive flight delays, higher than usual flight cancellations and increased airport congestion. This negatively affected our punctuality and operating results. The Brazilian government and air traffic control authorities have taken measures to improve the Brazilian air traffic control systems, but if the changes undertaken by the Brazilian government and regulatory authorities do not prove successful, these air traffic control‑related difficulties might recur or worsen, which may have a material adverse effect on our business, our results of operations and our growth strategy.
The successful execution of our strategy is partly dependent on us maintaining a high daily aircraft utilization rate, making us especially vulnerable to delays.
In order to successfully execute our strategy, we need to maintain a high daily aircraft utilization rate, which is a measure of the number of block hours that we use our aircraft per day. Achieving a high daily aircraft utilization rate allows us to maximize the amount of revenue that we generate from each aircraft and is achieved, in part, by reducing turnaround times at airports and developing schedules that enable us to fly more hours on average per day. Our aircraft utilization rate could be adversely affected by a number of factors that we cannot control, including air traffic and airport congestion, interruptions in the service provided by air traffic controllers, adverse weather conditions and delays by third‑party service providers in respect of matters such as fueling and ground handling. In addition, high aircraft utilization rates increase the risk that, if an aircraft falls behind schedule, it could remain behind schedule for up to two days. Such delays could result in a disruption in our operating performance, leading to customer dissatisfaction due to any resulting delays or missed connections.
Risks Relating to our ADSs and Preferred Shares
We have a stable group of principal shareholders with the power to manage our business, and the interests of these persons may conflict with those of other shareholders.
Our principal shareholders, TEP and the Amaro family together, collectively control 85.4% of our common stock and have the power to, among other things, (i) elect the majority of our directors and (ii) control the results of any proposal requiring shareholder approval (including transactions with related parties, corporate re‑organization, sales of assets and the timing and conditions of payment of any future dividends, subject to the minimum mandatory dividend distribution requirements under Brazilian corporation law). Our principal shareholders have the power to approve transactions that might not be in the interests of other shareholders and may prevent or frustrate any attempts to remove our current directors or executive officers.
Our preferred shares do not carry general voting rights.
Our preferred shares and, consequently, our ADSs do not carry general voting rights except in relation to certain specific matters and under specific circumstances. See "Item 10. Additional Information — B. Memorandum and Articles of Association." Our principal shareholders, who hold the majority of common shares with voting rights and control us, are therefore able to approve corporate measures without the approval of holders of our preferred shares.
Accordingly, you will not have control over the approval of corporate measures such as appointment of directors, approval of significant transactions or changes in our capital structure.
The economic value of your investment may be diluted.
In the event that we need to obtain capital for our operations by issuing new shares, any such issuance may be made at a value below the book value of our preferred shares on the relevant date. In that event, the then holders of our ADSs and preferred shares would suffer an immediate and significant dilution of their investment.
The sale of significant quantities of ADSs or preferred shares may cause the stock market price of our ADSs and preferred shares to decline.
In the event that we or our shareholders elect to sell a significant number of our ADSs or preferred shares, or in the event that the market perceives that we have the intention of any such sale, the stock market price of our preferred shares or ADSs could decline significantly unless there are high levels of demand to purchase our ADSs or preferred shares.
Brazilian securities markets are relatively volatile and illiquid. Therefore you may not be able to sell the preferred shares underlying the ADSs at the price and time you desire.
Investing in securities that trade in emerging markets, such as Brazil, often involves greater risk than investing in securities of issuers in the United States, and such investments are generally considered to be more speculative in nature. The Brazilian securities market is substantially smaller, less liquid and can be more volatile than major securities markets in the United States. There is also significantly greater concentration in the Brazilian securities market than in major securities markets in the United States. Accordingly, although you are entitled to withdraw the preferred shares underlying the ADSs from the depository at any time, you may not be able to sell the preferred shares underlying the ADSs at the price and time you wish.
Changes in Brazilian tax laws may have an adverse impact on the taxes applicable to a disposition of our preferred shares or ADSs.
Law No. 10,833 of December 29, 2003 provides that the disposition of assets located in Brazil by a non‑resident to either a Brazilian resident or a non‑resident is subject to taxation in Brazil, regardless of whether the disposition occurs outside or within Brazil. This provision results in the imposition of income tax on the gains arising from a disposition of our preferred shares by a non‑resident of Brazil to another non‑resident of Brazil. There is no judicial guidance as to the application of Law No. 10,833 of December 29, 2003 and, accordingly, we are unable to predict whether Brazilian courts may decide that it applies to dispositions of our ADSs between non‑residents of Brazil. However, in the event that the disposition of assets is interpreted to include a disposition of our ADSs, this tax law would result in the imposition of withholding taxes on the disposition of our ADSs by a non‑resident of Brazil to another non‑resident of Brazil.
Because any gain or loss recognized by a U.S. Holder (as defined in "Item 10. Additional Information — E. Taxation — United States") will generally be treated as a U.S. source gain or loss unless such credit can be applied (subject to applicable limitations) against tax due on the other income treated as derived from foreign sources, such U.S. Holder would not be able to use the foreign tax credit arising from any Brazilian tax imposed on the disposition of our preferred shares.
The Brazilian government may impose exchange controls and significant restrictions on remittances of reais abroad, which would adversely affect your ability to convert and remit dividends, distributions or the proceeds from the sale of our preferred shares and our capacity to make dividend payments to non‑Brazilian investors and would reduce the market price of our preferred shares or ADSs.
The Brazilian government may restrict the remittance abroad of proceeds of investments in Brazil and the conversion of the real into foreign currencies. The Brazilian government last imposed such remittance restrictions for a brief period in 1989 and early 1990. In the event that the Brazilian government determines that the Brazilian foreign currency reserves need to be maintained, it may impose temporary charges on any overseas remittance of up to 50% of the value of the remittance. We cannot assure you that the Brazilian government will not take similar measures in the future. The return of any such restrictions would hinder or prevent your ability to convert dividends, distributions or the proceeds from any sale of our preferred shares into U.S. dollars and to remit U.S. dollars abroad and our capacity to make dividend payments to non‑Brazilian investors. The imposition of any such restrictions would have a material adverse effect on the stock market price of our preferred shares or ADSs.
If you surrender your ADSs and withdraw preferred shares, you risk losing the ability to remit foreign currency abroad and certain Brazilian tax advantages.
As an ADS holder, you benefit from the electronic certificate of foreign capital registration obtained by the custodian for our preferred shares underlying the ADSs in Brazil, permitting the custodian to convert dividends and other distributions with respect to the preferred shares into non‑Brazilian currency and remit the proceeds abroad. If you surrender your ADSs and withdraw preferred shares, you will be entitled to continue to rely on the custodian's electronic certificate of foreign capital registration for only five business days from the date of withdrawal. Thereafter, upon the disposition of distributions relating to the preferred shares, unless you obtain your own electronic certificate of foreign capital registration, or you qualify under Brazilian foreign investment regulations that entitle some foreign investors to buy and sell shares on Brazilian stock exchanges without obtaining separate electronic certificates of foreign capital registration, you would not be able to remit abroad non‑Brazilian currency. In addition, if you do not qualify under the foreign investment regulations, you will generally be subject to less favorable tax treatment of dividends and distributions on, and the proceeds from any sale of, our preferred shares.
If you attempt to obtain your own electronic certificate of foreign capital registration, you may incur expenses or suffer delays in the application process, which could delay your ability to receive dividends or distributions relating to our preferred shares or the return of your capital in a timely manner. The depositary's electronic certificate of foreign capital registration may also be adversely affected by future legislative changes.
If we do not maintain a registration statement and no exemption from the Securities Act is available, U.S. Holders of ADSs will be unable to exercise preemptive rights with respect to our preferred shares.
We will not be able to offer our preferred shares to U.S. holders of ADSs pursuant to preemptive rights granted to holders of our preferred shares in connection with any future issuance of our preferred shares unless a registration statement under the Securities Act is effective with respect to such preferred shares and preemptive rights, or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement relating to preemptive rights with respect to our preferred shares, and we cannot assure you that we will file a registration statement. If a registration statement is not filed and an exemption from registration does not exist, JPMorgan Chase Bank, N.A., as depositary, will attempt to sell the preemptive rights, and you will be entitled to receive the proceeds of the sale. However, these preemptive rights will expire if the depositary does not sell them, and U.S. holders of ADSs will not realize any value from the granting of such preemptive rights.
TAM S.A. is a holding company founded in May 1997 under the name CIT — Companhia de Investimentos em Transportes for the specific purpose of participating in, managing and consolidating shareholdings in airlines. In November 1997, we implemented a corporate restructuring that increased CIT — Companhia de Investimentos em Transportes'stake in TAM Taxi Aéreo Marília S.A. ("TAM Marília"), a sociedade anônima de capital fechado organized under the laws of Brazil. We also changed our corporate name to TAM — Companhia de Investimentos em Transportes. In September 2002, we again changed our corporate name to TAM S.A. We currently hold ownership interests in TAM Linhas Aéreas, TAM Mercosur, TP Franchising, Multiplus and Pantanal. TAM Linhas Aéreas holds an ownership interest in TAM Viagens, TAM Capital, TAM Capital 2, TAM Financial 1, TAM Financial 2 and TAM Milor, which was acquired in July 2010 and merged into TAM Linhas Aéreas in March 2011.
TAM S.A. is a sociedade anônima de capital aberto organized and operating under the laws of Brazil. Our headquarters are located at Avenida Jurandir, 856, Lote 4, 1º andar, CEP 04072‑000, São Paulo, SP, Brazil. Our telephone number is +55 11 5582 9715.
TAM Marília was founded in January 1961 in the interior of the state of São Paulo, where the late Captain Rolim Amaro worked as a pilot. In 1971, Captain Rolim Amaro became an executive partner and minority shareholder of TAM Marília. TAM Transportes Aéreos Regionais ("TAM Regionais") was founded in May 1976 and was TAM Marília's first scheduled airline, with 67% of its capital stock held by Captain Rolim Amaro. In 1978, Captain Rolim Amaro became the major shareholder of TAM Marília, holding 98% of its capital stock.
In 1986, Captain Rolim Amaro incorporated TAM Linhas Aéreas, launching its operations through Brasil‑Central Linha Aérea Regional S.A. (which was created to operate in the country's northern and central‑western regions). In the same year, Brasil‑Central Linha Aérea Regional S.A. was granted a concession to operate at Guarulhos International Airport and became TAM Transportes Aéreos Meridionais S.A., Brazil's second largest domestic airline.
In 1993, we launched the TAM Loyalty Program (the first airline loyalty program in Brazil) in order to incentivize existing customers to fly with us more often and to attract new customers. In 1998, we inaugurated our first international flight between São Paulo and Miami. In 1999, we initiated flights to Paris through a codeshare agreement with Air France.
In 1998, we acquired Itapemirim Transportes Aéreos Regionais (whose corporate name was changed to Interexpress Transportes Aéreos Regionais S.A., or "Interexpress Transportes Aéreos Regionais") and then acquired Helisul Linhas Aéreas S.A. (whose corporate name was changed to TAM Express S.A., or "TAM Express").
In 1999, TAM Express and Interexpress Transportes Aéreos Regionais merged into TAM Linhas Aéreas, resulting in greater integration, operational efficiency and a consequent reduction in expenses. As a continuation of this restructuring process, and as a result of the need to unify our regional, national and international operations, TAM Transportes Aéreos Meridionais S.A. was merged into TAM Linhas Aéreas in November 2000.
On February 6, 2003, we signed a protocol of understanding with Varig S.A. ("Varig") for code sharing operations as a preliminary stage in a possible merger between the two companies. This was primarily intended to eliminate overlapping flights and to rationalize supply in the market. As a result of signing this protocol of understanding, we were able to reorganize our aircraft fleet, negotiate the return of 19 Fokker 100 aircraft and reduce our operating expenses.
On February 15, 2005, as it became clear that the proposed merger would not take place, both parties (Varig and TAM S.A.) submitted detailed plans to the Conselho Administrativo de Defesa Econômica, or CADE, to cancel the codeshare arrangement. On February 23, 2005, the codeshare agreement was cancelled (with the approval of the CADE) and all of our codeshare operations with Varig had to be terminated by May 24, 2005. We ceased all codeshare operations with Varig on May 2, 2005.
On June 17, 2005, we completed our initial equity offering of preferred shares, offering a total of 30,190,000 preferred shares to institutional investors in the United States and institutional and other investors elsewhere. On July 19, 2005, we and the selling shareholders in the equity offering issued a further 281,600 preferred shares pursuant to an over‑allotment option granted to the underwriters in that offering.
On March 15, 2006, we completed a follow‑on equity offering of preferred shares in Brazil and our initial public offering of ADSs in the United States and elsewhere outside Brazil. This offering of preferred shares and ADSs was registered with the SEC and the ADSs are listed on the New York Stock Exchange. We became a reporting company under the Securities Exchange Act of 1934, or the Exchange Act. We offered 2,660,103 ADSs and 2,339,897 preferred shares, while the selling shareholders in that offering sold 21,209,462 ADSs and 9,408,636 preferred shares. On April 11, 2006, we and the selling shareholders in that offering sold an additional 1,103,000 ADSs pursuant to an over‑allotment option granted to the underwriters in that offering.
TAM Mercosur operates scheduled air transportation operations and is headquartered in Asunción, Paraguay. TAM Mercosur, which operates in Paraguay, Argentina, Brazil, Chile, Uruguay and Bolivia, was founded in March 1993 under the name Líneas Aéreas Paraguayas S.A. ("LAPSA") and all of its capital stock was initially held by the government of Paraguay. The Paraguayan government currently holds 5.02% of TAM Mercosur's capital stock. In January 1997, LAPSA's corporate name was changed to Transportes Aéreos del Mercosur S.A. In September 2003, upon approval of TransAmérica's dissolution and liquidation, we acquired all shares of TAM Mercosur held at the time by TransAmérica (which consisted of 94.98% of its capital stock). In the year ended December 31, 2010, TAM Mercosur's net operating revenues represented 1.4% of our total consolidated net operating revenues.
TAM Viagens is a limited company (sociedade limitada) and tourism operator controlled by TAM Linhas Aéreas. Through TAM Viagens, we package and sell tourism travel and corporate events in Brazil and abroad.
In 2007, TAM Linhas Aéreas incorporated TAM Capital as a wholly‑owned subsidiary, organized under the laws of the Cayman Islands, for the purpose of issuing U.S.$300 million 7.375% senior guaranteed notes due 2017 on April 25, 2007. On December 18, 2007 we completed an exchange offer pursuant to which holders of 99.2% of the notes issued on April 25, 2007 exchanged their notes for new notes that were registered under the Securities Act of 1933, as amended, and otherwise carried identical terms.
In 2007, TAM Linhas Aéreas incorporated TAM Financial 1, a wholly‑owned subsidiary organized under the laws of the Cayman Islands, for the purpose of raising funds for pre‑delivery payments of four Boeing 777 aircraft. In that same year, TAM Linhas Aéreas also incorporated TAM Financial 2, a wholly‑owned subsidiary organized under the laws of the Cayman Islands, whose main activities include aircraft acquisition and financing.
In 2008, we began operating the Boeing 777-300ER, our largest passenger capacity aircraft. The Boeing 777‑300ER currently transports up to 365 passengers on our routes connecting Brazil, Germany, England and Chile. These Boeing aircraft were financed by a structured deal with a financial guarantee from the Export‑Import Bank of the United States ("Ex‑Im Bank") and included the participation of four international financial institutions: Calyon, Natixis, Private Export Funding Corporation (Pefco) and Société Générale. In that same year, we finalized the phase‑out program of the Fokker 100 (100‑seat aircraft) from our fleet and returned our MD‑11s, older and less efficient aircraft that we had used to operate some of our long haul routes.
In 2009, TAM Linhas Aéreas incorporated TAM Capital 2, a wholly‑owned subsidiary organized under the laws of the Cayman Islands, for the purpose of issuing U.S.$300 million 9.5% senior guaranteed notes due 2020 on October 22, 2009.
In 2009, we also incorporated a new company, Multiplus, which established a network of loyalty programs that allows TAM customers to accrue loyalty points from a wide array of product and service providers. In February 2010, Multiplus conducted an initial public offering of its common shares, which reduced our ownership in Multiplus from 100% to 73%. See "Item 4 — Information on the Company — B. Business Overview — Competitive Advantages" and "Item 4 — Information on the Company — C. Organizational Structure". As of December 31, 2010, we held 73% of Multiplus' common shares.
In December 2009, we announced and reported to the CVM and other appropriate authorities that we had agreed to purchase all shares of the regional airline company, Pantanal. This acquisition represented an important step towards transforming TAM into a diversified business in the civil aviation field, and aligned with TAM's objective to seek out new and attractive opportunities for growth. On March 15, 2010, this acquisition was approved by ANAC. As operation of air transportation services, as well as airport infrastruture, is an exclusive right of the Brazilian government, we need a concession or permit to operate Pantanal. On March 30, 2010, we received a concession to operate Pantanal, which is valid until 2020.
On May 13, 2010, TAM became a full member of the Star Alliance, the largest global alliance in commercial aviation based on the number of members and geographical coverage. During 2008, our integration into the Star Alliance began with experts from TAM, its mentor in the alliance, United, and the Star Alliance, teaming up to ensure we complied with the requirements set by the Star Alliance. These requirements include, for example, compatibility with StarNet, the Star Alliance's IT backbone, implementing the Star Alliance IT platform and implementing common guidelines for loyalty programs and customer service. As a result of our successful integration, we now share products and services in the 1,160 airports and 181 countries served by the Star Alliance members. Star Alliance services include baggage check‑in to final destinations, easier connections and the convenience of more than 970 lounges. Another benefit for our passengers is the integration of all Star Alliance members' frequent flyer programs, which allows the accrual of points/miles among all members, provides more redemption options and offers additional benefits for the top tier members, like priority boarding and baggage delivery.
On July 13, 2010, our Board of Directors approved the acquisition, through our subsidiary TAM Linhas Aéreas, of all of the outstanding shares of TAM Milor held by individuals that are also shareholders of TAM. TAM Milor is the holder of the brand "TAM" and other related TAM trademarks, which we, TAM Linhas Aéreas and certain other related companies use. TAM Milor was merged into TLA in March 2011.
In January 2011, TAM, together with its controlling shareholders, TEP and the Amaro family, entered into agreements with LAN, and its respective controlling shareholders to effect a proposed business combination of LAN and TAM. This merger remains subject to governmental, regulatory and shareholders' approval. See " - B. Business Overview - Proposed Combination with LAN " below.
On March 29, 2011, TAM signed a term sheet with TRIP Linhas Aéreas S.A. ("TRIP") announcing ongoing negotiations between the two companies to identify possible expansion opportunities through the development of a strategic alliance agreement that would be complementary to TAM's existing codeshare agreement with TRIP. Pursuant to the signed term sheet, TAM will seek to acquire a minority stake (31%) of TRIP's capital stock. We believe this potential transaction will help TAM capture additional market growth in medium density route markets.
During 2010, we invested R$84.6 million in fixed assets, primarily due to aircraft acquisition. We also increased our intangible assets by R$234 million, primarily due to acquiring new rights to airport slots as result of the Pantanal acquisition in March 2010, and due to the acquisition of the "TAM" brands through our acquisition of TAM Milor. The TAM Milor acquisition totaled R$98.4 million. During 2009, we invested R$335 million in fixed assets, primarily due to aircraft acquisition and replacement parts for our fleet, and R$135 million in intangible assets. During 2008, we invested R$637 million in fixed assets for aircraft acquisition and replacement parts for our fleet, and R$133 million in intangible assets.
For more information on our capital investments, see below "Item 5 — Operating and Financial Review and Prospects — B. Liquidity and Capital Resources".
We provide scheduled air transportation in both the domestic market and the international market through our operating subsidiaries, TAM Linhas Aéreas and TAM Mercosur, and since March 2010, through Pantanal. According to data provided by ANAC, we are the leading airline in the domestic market, with a 43.3% market share as of December 2010 and a 41.2% and 50.3% market share as of December 2009 and December 2008, respectively, as measured in RPKs. We offer flights throughout Brazil. We serve, together with our commercial partners, the largest number of destinations in Brazil, out of all Brazilian airlines. We operate scheduled passenger and cargo air transport routes to 49, and through regional alliances with other airlines, we serve an additional 44 domestic airports. In total we serve 93 domestic airports. We also directly serve 19 international airports, and provide connections to other destinations through commercial agreements with United Airlines, Lufthansa, TAP, LAN and other airlines. We offer convenience to our passengers by offering frequent and direct flights to and from all major domestic airports at competitive prices. In 2010, we transported approximately 29.3 million passengers on domestic flights compared to 25.8 million in 2009 representing a 13.5% increase, which aligned with our 13.5% domestic supply growth in the same period. In 2008, we transported approximately 25.6 million passengers in the domestic market. In the international market, we transported 5.2 million passengers in 2010 compared to 4.6 million passengers in 2009, representing a 14.4% growth, partly due to a 6.0% international supply growth and a load factor increase of 6.6%. By comparison, in 2008, we transported 4.5 million passengers in the international market. In 2010, we averaged 831 take-offs per day compared to an average of 781 take-offs per day and 751 take‑offs per day in 2009 and 2008, respectively. In order to meet domestic demand, we primarily cater to the business market, but also operate in the leisure and cargo markets, which complement our primary operations and allow us to maximize the use of our aircraft.
At December 31, 2010, we operated with a fleet of 151 aircraft, consisting primarily of Airbus models A340, A330, A321, A320 and A319, as well as Boeing models B777 and B767, and we had 28,193 employees. As of the same date, TAM Linhas Aéreas consisted of 146 aircraft, as set forth in the table below, including 3 Airbus A320 subleased to TAM Mercosur, and 1 Airbus A320 and 2 Airbus A319 subleased to Pantanal.
Since our incorporation, we believe that we have demonstrated a history of sustained growth and a proven ability to adapt to developments in the civil aviation industry in Brazil and around the world. According to IATA, Brazil is the fourth largest domestic aviation market in the world (in number of scheduled passengers transported) and has one of the busiest shuttle services in the world (São Paulo – Rio de Janeiro).
We believe that we have a strong corporate culture, grounded by principles set forth by our founder, Captain Rolim Adolfo Amaro, that permeates all levels of our company and continues to guide the day‑to‑day activities of our management. In order to ensure that we act in accordance with best practices and provide value‑added service to our passengers, we seek to embed our culture in our employee training, and believe that our entire staff is a product of this practice. Our mission is to be the people's favorite airline company, through joy, creativity, respect and responsibility, and we consistently transmit this mission statement to our employees.
Our vision is to make our customers happy by working with a "spirit of serving". We seek to achieve this goal by offering comprehensive service that gives passengers superior value for their money. We are able to do this by continuing to reduce expenses and by improving the return on capital invested.
Proposed Combination with LAN
On August 13, 2010, we jointly announced with LAN that we had entered into a non-binding Memorandum of Understanding relating to the proposed all-stock transaction that would combine the holdings of TAM and LAN under a single parent entity.
On January 18, 2011, we, the TAM controlling shareholder and the Amaro family entered into the transaction agreements with LAN and the LAN controlling shareholders, which set forth the terms and conditions of a proposed business combination of TAM and LAN.
On the terms and subject to the conditions set forth in the transaction agreements (including the minimum conditions discussed in this section below), all or substantially all of the outstanding voting common shares of TAM will be acquired by a new Chilean corporation ("Holdco 1") and all or substantially all of the outstanding non-voting preferred shares of TAM will be acquired by LAN if the series of transactions and corporate restructurings described below are successfully completed.
· The Amaro family will create a new Chilean corporation ("TEP Chile") that will be wholly owned by them;
· TEP Chile will acquire and hold at least 80% of the voting stock of Holdco 1, which will have no economic rights in Holdco 1 (other than nominal dividend rights);
· LAN will acquire no more than 20% of the voting stock of Holdco 1;
· LAN will acquire and hold 100% of the non-voting stock of Holdco 1, which will have all of the economic rights in Holdco 1 (other than the nominal dividend rights of the voting stock of Holdco 1);
· Holdco 1 will acquire and hold all or substantially all of the voting common shares of TAM;
· LAN will acquire and hold all or substantially all of the non-voting preferred shares of TAM; and
· TAM, TEP Chile, Holdco 1, LAN and the LAN controlling shareholders will enter into the shareholder agreements relating to the holding of shares in, and the governance of, and relationships between, TAM, Holdco 1, LAN and their respective subsidiaries.
Pursuant to and subject to the terms of the transaction agreements, the parties will form a new Chilean corporation ("Holdco 2") that will commence a delisting exchange offer to acquire all of the voting common shares of TAM and all of the non-voting preferred shares of TAM (in each case other than any such shares owned indirectly by the Amaro family) in exchange for the same number of shares of common stock of Holdco 2.
At or prior to the completion of the exchange offer:
· the Amaro family will contribute to TEP Chile all of the voting common shares of TAM and non-voting preferred shares of TAM beneficially owned by them;
· TEP Chile will pay nominal consideration for all of the voting shares of Holdco 1 and will contribute all of the voting common shares of TAM it receives from the Amaro family to Holdco 1 in exchange for all of the non-voting shares of Holdco 1;
· TEP Chile will contribute (i) all of the non-voting shares of Holdco 1, (ii) 6.2% of the voting shares of Holdco 1 and (iii) all of the non-voting preferred shares of TAM it receives from the Amaro family to a new Chilean corporation ("Sister Holdco") in exchange for all of the shares of common stock of Sister Holdco (other than one share held by a nominee of TEP Chile);
· each of Holdco 2 and Sister Holdco will merge with and into LAN (together, the "mergers," and individually, the "Holdco 2 Merger" and the "Sister Holdco Merger," respectively), with LAN being the surviving company of each such merger; and
· in the mergers, each share of common stock of Holdco 2 and each share of common stock of Sister Holdco will be converted into the right to receive 0.9 of a LAN common share.
As a result of the exchange offer and Holdco 2 merger, each holder of a voting common share of TAM and each holder of a non-voting preferred share of TAM that sells such shares in the exchange offer will ultimately receive 0.9 of a LAN common share for each share they sell. Similarly, as a result of the foregoing transactions and the Sister Holdco merger, the Amaro family will ultimately receive 0.9 of a LAN common share for each voting common share of TAM and each non-voting preferred share of TAM that they own.
The commencement of the exchange offer is subject to certain conditions set forth in the transaction agreements, including receipt of all required regulatory approvals and approval of the proposed combination by the holders of LAN common shares. The commencement of the exchange offer is also subject to certain conditions set forth in the transaction agreements, including minimum tender conditions and conditions to the Amaro family’s obligation to contribute their TAM shares as described above. In addition, the mergers are subject to the condition that the holders of no more than 2.5% of the outstanding LAN common shares exercise their appraisal rights under Chilean law. As a result, no assurance can be given that the proposed combination will be completed.
If the proposed combination is completed, then:
· the LAN common shares will be listed in Brazil on the Bovespa in the form of BDRs;
· the LAN common shares will continue to be listed in Chile on the SSE and in the United States on the NYSE in the form of ADRs;
· subject to satisfaction of the minimum tender conditions described above, all TAM shares (whether voting common shares or non-voting preferred shares) will be delisted from the Bovespa in Brazil and the NYSE in the United States; and
· LAN will change its name to "LATAM Airlines Group S.A."
On January 28, 2011, in response to a petition filed by a Chilean consumer association, Conadecus, the Tribunal de Defensa de la Libre Competencia, or the "TDLC," determined to submit the proposed combination between TAM and LAN to a voluntary review procedure that is available under the Chilean antitrust laws upon the request of the Fiscalía Nacional Económica or someone with a legitimate interest. This voluntary review procedure could delay the implementation of the proposed combination because TAM and LAN cannot complete the proposed combination until the TDLC renders its final decision at the end of this process. On April 5, 2011, LAN, together with TAM, submitted a presentation in support of the proposed combination.
On March 1, 2011, ANAC authorized the transfers of the shares of TAM and its subsidiaries that are necessary to implement the proposed combination. However, the proposed combination remains subject to other regulatory and shareholder approvals.
We believe that our principal competitive advantages are:
· Value‑added service at competitive prices. We believe that we offer the best combination in the domestic market of a network of destinations and frequent flights, with value‑added service, high on‑time rates and competitive prices, based on:
· broad domestic network of destinations: our own domestic network serves 49 airports in Brazil, many of which are direct flights, offering greater convenience to our clients. Through our regional alliances with TRIP Linhas Aéreas S.A. ("TRIP") and NHT Linhas Aéreas Ltda ("NHT"), our network extends to a further 44 airports in Brazil;
· convenient schedules with high on‑time arrival rates: we always work to maintain a high percentage of on‑time flights, in order to offer the best service possible;
· efficient network of international destinations and supporting domestic service: we currently serve 19 international airports (11 in South America, 3 in North America and 5 in Europe) that are in high demand by the Brazilian public. We also serve various other destinations in North America, Europe, and other continents through agreements with several international carriers;
· special services: we have developed special services to meet specific demands and optimize the use of our aircraft, such as by offering night and holiday flights at promotional rates.
· Focus on cost management. We are an airline with low operating expenses. In 2003, we implemented a restructuring project that initiated a cultural change within us, making our employees aware of cost management. We continuously seek opportunities to reduce expenses focusing our efforts on reducing operating, commercial and administrative expenses. Our overall CASK decreased from R$17.40 in 2008 to R$14.76 in 2009 and decreased to R$14.54 in 2010 and our CASK excluding fuel decreased from R$10.52 in 2008 to R$10.53 in 2009 and decreased to R$9.72 in 2010. In 2010, this was partly due to the reversal of an additional tariff of R$364,854 that occurred in September. Otherwise, some of our principal cost savings arise from:
· efficient use of our aircraft: we maintained the average load factor of our aircraft and the daily average block hours per aircraft by optimizing our network of destinations and our fleet. In 2010, the average load factor of our aircraft was 71.9% and the block hours per aircraft was 12.9 hours, compared to 68.2% and 12.5 hours in 2009 and 71.0% and 12.5 hours in 2008;
· modern and flexible fleet: we have one of the newest fleets in the domestic market, with an average age of 6.4 years at December 31, 2010. Our use of a modern fleet allows us to reduce operating and maintenance expenses. We primarily operate Airbus narrow‑bodied aircraft in the domestic and South American markets and Airbus and Boeing wide‑bodied aircraft in the long haul routes, providing us with the flexibility required to serve routes of different passenger densities. We believe that all of our aircraft are equipped with the most advanced equipment and technology, ensuring greater reliability, comfort and safety. In 2010, we added 5 A319, 5 A320, 2 A321 and 2 A330 to our fleet;
· proprietary maintenance team: we have our own maintenance team trained to service all aircraft in our fleet quickly and at labor expenses that we believe are lower than that of our competitors. We also have our own maintenance center in the city of São Carlos (in the interior of the state of São Paulo) which performs all hull maintenance on our aircraft and also provides maintenance services for other airlines. By using our own maintenance center, we have been able to reduce the maintenance time of our aircraft and, consequently, obtain more efficient use of our aircraft; and
· use of technology in operating processes: at the end of 2009, we implemented the Amadeus Altéa platform, which is used by other Star Alliance members and which helped us reach a new level of web sales, largely because the related FlexPricer Amadeus search engine provides a more customer-friendly method for finding and purchasing tickets by presenting fare and date comparisons. Our web sales increased 31% from 2009 to 2010.
· Innovative services and products combined with a strong brand and our "espírito de servir" (spirit of serving). Our corporate culture is based on providing value‑added services to our passengers. We consistently seek to make travel a more convenient and comfortable experience for our passengers and believe that we have successfully positioned our brand so as to associate it with superior service, aircraft and technologically‑advanced operations. We strive to be a company that is focused on our passengers, translating our "spirit of service" into all operations, and we believe this is evidenced by:
· high on‑time arrival rates and frequent flights;
· a modern fleet equipped with interiors specifically designed to afford greater comfort to our passengers, such as a wider middle seat (one of the widest middle seats of all the Airbus model aircraft);
· a polite approach to our passengers, including courteous flight crew and attendants and our red carpet welcoming to all passengers at airports and aircraft;
· video and audio entertainment on domestic flights, in addition to offering free in‑flight meals and magazines;
· self‑service options for check‑in in major airports; and
· open channels of communication with our passengers through our call center, our "Talk to the President" program and online service chat sessions at our portal.
· TAM Loyalty Program. We were the first airline in Brazil to offer a loyalty program, and there are currently over 8 million members in the TAM Loyalty Program. We regard our loyalty program as a strong relationship tool and believe that it is the most flexible loyalty program in the market because it imposes no restrictions on flights or the number of seats available when members are redeeming accumulated points in the domestic or South American market. Members may accumulate points quickly and easily by flying on TAM or partner airlines, making purchases through TAM Loyalty Program‑affiliated credit cards or using services and products at Multiplus Fidelidade partner establishments. In addition, the TAM Loyalty Program strengthens lines of communications with our passengers. The TAM Loyalty Program is currently operated by our subsidiary, Multiplus, on our behalf and the TAM Loyalty Program is one of several coalition partners of the Multiplus Fidelidade network of loyalty programs.
· Multiplus Fidelidade. In 2009, we launched a new program, Multiplus Fidelidade, designed to create an even broader network in which customers can earn TAM Loyalty Program points. Multiplus Fidelidade is an expansion of our loyalty program concept and acts as a tool to assist in the integration of partner companies into our loyalty network. The program permits the accrual of points for redemption from products or services purchased with our partners. We believe this expansion of our loyalty network helps to capture and retain customers and increase sales. We believe this program is a source of value generation and after its initial public offering, the company increased its corporate governance, dedicating a team that, we believe, will improve even more those sales. At the close of 2010, Multiplus had 151 partner establishments, of which 14 were coalition partners, including the TAM Loyalty Program, and the remainder were accrual partners. Of the 14 coalition partners, seven joined in 2010.
· An experienced management team and motivated professionals. To further our mission, we hire and retain motivated professionals. We consider the talent, skill and dedication of our employees as a key competitive edge. We are focused on keeping our employees satisfied and motivated by providing them with ongoing professional development, ensuring their safety and adopting a people‑oriented approach to management. In our recruiting and selection process we deliberately look for employees with the potential to fit the "TAM" profile. People hired attend an orientation to educate them about our corporate history, the founder's principles, and our fundamental values, mission and culture. Management also invests in our employees through the Commander Rolim Amaro Training Academy, and providing opportunities for internal transfers.
Some of our key motivational tools include:
"Employee of the Month" and "Employees of the Year" programs; breakfasts with team managers; graduation ceremonies for flight attendants; a Quality of Life program; barbecues for technical crews and the TAM Ethics Channel, a program that allows employees to write comments, suggestions or concerns about us in confidence and receive answers on an individual basis.
In addition to these motivational tools, we have an internal webcast which is a new way to guarantee that our strategic information is communicated to all employees across the world. Employees can access these webcast sessions via the internet or intranet.
Our compensation policy for executives is variable. For all other employment levels, the compensation policy is profit sharing, reflecting employee needs and the market, within the bounds of current legislation and the terms and conditions of the Airline Ground Crew and Pilots Union's collective labor agreements.
Our strategic goal is to maintain our strong position in the domestic and international passenger markets and to attain high levels of profitability in both markets. We will seek to pursue this goal by offering comprehensive service that delivers superior value to our passengers as we work to reduce expenses and increase our return on invested capital. To reach these objectives, our strategies are:
· Continue providing superior customer service. One of our key strategies is to offer differentiated and high‑quality service. Relying on a strong and reliable network, we consistently seek to make travel more convenient and comfortable for our passengers and to perfect our service and strengthen our commitment to passengers.
· Increase revenue and profitability and serve a greater number of passengers at a competitive price. We will seek to continue to provide what we believe is a service that delivers the best value to our customers in the domestic market, offering more convenient and higher quality services at competitive prices. Our goal is to increase revenues, as well as profitability, through:
· expansion of business traveller market: consolidating and expanding our traditional passenger base of business travellers, who we believe represent approximately 70% of demand for our domestic flights, through measures focusing on business travellers and sales channels that traditionally serve that market;
· growth in our tourism and leisure travel operations: we believe that the tourism and leisure markets are complementary to our core market of business travellers. In order to use our fleet more efficiently, our strategy involves capturing additional demand in the tourism and leisure market through specific promotions for flying at off-peak hours during the day, besides holidays and local events (for example, festivals and city anniversaries, among others) using our scheduled operations. We also serve leisure travelers by (i) the operation of charter flights, and (ii) the sale of tourism packages through TAM Viagens (an indirect subsidiary controlled by TAM Linhas Aéreas). TAM Viagens recorded a gross revenue of R$478 million, R$451 million and R$412 million at December 31, 2010 2009 and 2008, respectively, representing approximately 4.1%, 4.4% and 3.8% of our consolidated revenues for the same periods. We believe that through our subsidiary, TAM Viagens, we also own the second-largest tourism and leisure travel operator in the country;
· selective expansion in international markets: in the last three years, our international operations have consistently grown as a percentage of our total revenues. In the year ended December 31, 2010, international flights represented 38.5% of our ASKs. Our strategy involves maintaining our leadership in the international market and selectively identifying new international destinations to serve our customers; and
· expansion of our cargo business: we have focused on greater utilization of cargo space in our aircraft to develop our cargo business line, while maintaining our commitment to further improve service to our passengers. Our cargo transportation business line represented R$1,112.7 million or 9.4% of our consolidated revenues at December 31, 2010, compared to R$936.3 million or 9.2% of our consolidated revenues at December 31, 2009 and R$1,009 million or 9.2% of our consolidated revenues at December 31, 2008.
· Reduce our operating expenses, optimize the use of our fleet and streamline our processes. We believe that successfully implement of our strategy we need to reduce expenses and improve how we invest. We are pursuing this strategy by:
· maintaining a standardized, efficient and flexible fleet: we will continue to optimize the size of our fleet, in order to keep maintenance and operating expenses for our fleet at a low level. In 2006, we announced our decision to phase out our entire fleet of Fokker 100 aircraft by mid‑2008 and we met that target. As a result of this decision, we have been exclusively using Airbus A320 family aircraft in the domestic market since mid‑2008, excluding the five ATR-42 from Pantanal. We maintain a high aircraft utilization and to maintain a flexible fleet with aircraft capable of easily adapting to the differing levels of demand from route to route; and
· increasing productivity by redesigning operational processes and using technology: since the implementation of our restructuring project in 2003, we have applied a cost reduction policy aimed at increasing our productivity through new information technology tools, redesigning operational processes and redeployment of labor and outsourcing activities which are not related to our core strategy. We also hope to obtain economies of scale by increased growth in our operations.
· LATAM - In January 2011, TAM, together with its controlling shareholders, TEP and the Amaro family, entered into agreements with LAN, and its respective controlling shareholders to effect a proposed business combination of LAN and TAM. This merger remains subject to governmental, regulatory and shareholder approval.
Products and Services
Our principal product is the scheduled air transportation of passengers. In addition, we also have products targeted specifically towards the development of domestic and international tourism. We also provide cargo transportation operations.
We set out below a breakdown of our gross revenues by type of service rendered for the periods indicated:
(1) Since January 1, 2010 points to TAM’s flying customers are issued under the Multiplus Fidelidade loyalty program. Points were issued under the TAM Loyalty Program through December 31, 2009. Points issued, both under the Multiplus Fidelidade loyalty program and the TAM Loyalty Program, are valid for two years from the date when issued and revenue with respect to those points is recognized when the points are redeemed for awards (which in the case of award tickets, is when the participant flies using an award ticket), which may be after two years from when the points was issued.
Sales and Distribution
We are continuously developing direct and indirect distribution channels for air fare ticket sales. We plan to increase direct sales (which at December 31, 2010 represented approximately 24.9% of our total ticket sales) by targeting the leisure market and by making it easier for our passengers to purchase tickets, principally through the internet and our call center. We were the first airline in Latin America to sell tickets on the internet. Through our website, registered users may purchase tickets online, receive customer service, make reservations up to one hour before departure and access information relating to the TAM Loyalty Program. As part of our plan to increase direct sales through the internet, in 2006 we launched a new "fare profile" system for sales of domestic tickets. We offer five fare profiles, "Promo," "Light," "Flex," "Max" and "Top," which significantly increased our direct sales in the first month after its introduction. In 2010, we adopted the same strategy for the international market in order to focus on more attractive sectors. The bundles available are "Access," "Flex," "Plus," "Classic," "Executive" and "First." In November 2009, we migrated our reservation platform to Amadeus Altéa, which we believe offers greater conveniences to our passengers. In 2009, 78.4% of our sales were through travel agencies and 21.6% were through direct channels, of which 13.8% were through the website. In 2010, 75.1% of our sales were through travel agencies and 24.9% were through direct channels, of which 17.3% were through the website.
Our call center allows passengers an alternative means to make reservations and purchase tickets. Our call center is available 24 hours a day. We also sell tickets through our network of stores located in the main cities of Brazil and at each airport from which we operate.
Indirect sales are those made through corporate travel agencies, agencies with registrations and pre‑approved credit and travel operators. Currently, there are approximately 5,651 travel agencies authorized to sell our tickets in Brazil.
We use our proprietary e‑TAM portal to integrate our entire sales chain, from the time of reservation to passenger boarding, consolidating indirect sales in our Brazilian distribution chain. Data obtained from the e‑TAM portal allows us to offer a set of customized services, based on the "one‑to‑one" concept. In the last 12 months of operation, 92.4% of indirect channel reservations made in Brazil were made through the e‑TAM portal.
We believe that about 70% of our passenger traffic consists of business travelers and employees of large and medium‑sized companies with whom we have travel agreements. To further develop our business relationship with our corporate clients, we have signed agreements with hotel chains and car rental companies to offer our customers complete corporate transportation and accommodation packages. Our advertisements run primarily in media vehicles such as internet sites, radio spots, local newspaper advertisements, magazines and outdoor billboards. In 2010, we observed a new trend in our passenger’s profile. We believe many of our new airline passengers have transitioned to us from bus travel, especially travelers previously covering more than 800 kilometers on bus. To help target this new passenger profile, in August 2010, we launched a new retail campaign, that includes selling tickets at Casas Bahia, marketing and selling new products, and the production of a new advertising campaign with the singer, Ivete Sangalo.
Pricing Policy, Revenue and Yield Management
In general, prices charged in the Brazilian domestic market by airlines are freely set by the airlines, with ANAC responsible for monitoring the prices. No discounts greater than 65% of the total price may be granted without ANAC's approval five days in advance of the date such discounts will be offered to consumers. Brazilian airlines are freely able to set their prices. See "Item 4. Information on the Company — B. Business Overview — Regulation of the Brazilian Civil Aviation Industry — Rights to Operate Air Routes — Prices."
We believe that our current pricing policy is dynamic. Focusing on maximizing profitability, we aim to define particular niches within the market to better serve projected demand. Pricing availability is based on traffic projections and is accompanied by closely monitored performance indicators. Our pricing policy focuses specifically on our indirect distribution channels (GDS system and e‑TAM portal) and direct channels (our website, reservation call center and stores).
We seek to achieve the greatest possible competitiveness for each origin/destination in relation to the competition, keeping in mind at all times our product's added value in terms of flight frequency, schedules, the TAM Loyalty Program and our on‑time record.
We continuously analyze market opportunities with the intention of stimulating demand for specific routes and periods. Lower prices are offered for one‑time promotions (such as national or regional holidays) and as incentives to take flights at particular times (such as night flights). These prices generally carry restrictions, such as the requirement to purchase a round‑trip, a minimum stay at the destination, or the requirement that the ticket be issued within 24 hours, and generally earn reduced points for the TAM Loyalty Program.
As determined by Portaria ANAC Nº 1887/SRE, dated of October 25, 2010, airlines operating domestic and/or international passenger flights must register all information regarding fares that were sold until the last day of the previous month with ANAC.
The price a passenger is willing to pay may vary depending upon factors such as destination, month of the year, day of the week and departure schedule. Revenue and yield management is the process by which (based on historical data and statistical projection models) airlines establish the number of seats to be offered for each price category over time, in order to maximize total operating revenue for each flight. We believe that efficient yield management is the key to success in the air transportation market in Brazil and abroad.
We believe that we have an efficient and accurate system for collecting data on reservations, departures and revenue. The system also monitors levels of overbooking and recommends discounts for future departures. Data relating to reservations and departure is collected daily, forming reservation profiles for each flight and allowing specific recommendations from flight to flight. The system allows our analysts to ascertain whether flights are above or below historic reservation levels and decide whether to close the discount classes or offer more space for passengers who generate higher revenues. Accordingly, our yield management practices allow us to anticipate and react quickly to market changes.
We currently have a team of analysts dedicated to revenue and price management. These professionals are divided by market sector and have particular knowledge of specific routes in order to better understand features which are specific to each route (such as holidays, high and low season, peak schedules and days and the competitive environment).
Air Transportation Operations
Scheduled domestic operations
We currently operate an average of 735 daily flights to 49 airports in Brazil. Through our regional alliances with TRIP and NHT we serve an additional 44 domestic airports.
Passenger traffic in the domestic market represented approximately 50% of our gross revenues in 2010, 53.9% of our revenues in 2009 and 56.4% in 2008. Our RPKs in the domestic market increased 17.2% in 2010, 6.4% in 2009 and 10.6% in 2008. The RPKs in the total domestic market increased 23.5% in 2010, 18.9% in 2009 and 7.6% in 2008.
In 2010, according to data provided by INFRAERO, we recorded the highest number of passengers boarded in 20 of the 42 airports operated by INFRAERO that we serve. The table below sets forth the airports we serve in Brazil, our average number of departures per day at those airports and the number of passengers who took our flights in 2010:
(1) Figures relate to departures on TAM aircraft only.
(2) Figures relate to TAM Issued tickets (and include departures on non-TAM
Scheduled international operations
We operate an average of 97 daily international flights to Buenos Aires, Santiago, Asunción, Montevideo, Lima, Ciudad del Este, Santa Cruz de la Sierra, Cochabamba, Caracas, La Paz, Bogotá, Miami, Orlando, New York, London, Paris, Frankfurt, Madrid and Milan. We have codeshare agreements with LAN Group, Pluna, United Airlines, Air Canada, TAP, Lufthansa, Air China, Swiss International, Continental, All Nippon, US Airways and British Midland Airways Limited, or BMI, allowing our passengers to make connections to destinations throughout the world, in addition to other services, such as simplified check‑in, luggage shipping and access to VIP lounges. We offer the ability to earn and redeem points through the TAM Loyalty Program on all Star Alliance member flights besides LAN.
International passenger traffic represented 27.8% of our gross revenue in 2010, 26.4% in 2009 and 25.9% in 2008. Our RPKs from international flights grew 15.6% in 2010, 12.5% in 2009 and 40.2% in 2008, successive increases that have resulted primarily from increased capacity on selected routes that presented substantial traffic throughout the year. Our share of the international market operated by Brazilian carriers was 87.6%, 89.9% and 75.2% in 2010, 2009 and 2008, respectively, successive increases that have resulted primarily from a decrease in Varig's long haul international flights as result of its liquidation.
Cargo transportation operations
We also earn revenues through cargo transportation operations. These operations represented 9.4% of our gross revenue in 2010 and 9.2% of our gross revenue in 2009 and 2008. TAM Cargo is our freight business unit, reporting directly to our Commercial and Planning Vice President. We do not operate exclusive cargo aircraft; however, we sell the empty space available in the belly of passenger aircraft, both in domestic and international markets.
We are continuously improving our cargo terminal operating structures, products and processes, resulting in faster receipt of packages and better branding. In 2009, we implemented a new cost saving and advanced tracking system, which allows shippers to track in detail and in real-time the entire path of their freight. In 2010, we enlarged our infrastructure even more and in November, we began to operate the domestic cargo terminal in Petrolina (PE). Since November, we began offering a new way to send and receive cargo in and to Pernambuco and the Northeast, a strategic region for our business. In 2010, we also introduced the Big Box, an innovative packaging specially developed for transportation of parcels. This product increases our operational excellence in airline cargo, improves the ergonomics of our cargo operations, provides benefits for employees and contributes to cost control. We intend to meet our customers' needs by growing our operations, both by increasing the freight of small packages, which have higher yields, and in large volume freight, such as industrials and perishable cargo.
In the international cargo segment, we are continuously improving our management systems, resulting in quicker processing and better revenue monitoring. These improvements help us analyze market behavior to enhance our accuracy and decision making with respect to the shipments. We are entering into Special Prorate Agreements (SPA) with several airline companies, allowing us to send shipments worldwide, increasing volumes sold and TAM Cargo's brand awareness.
Travel and tourism operations
We also have a travel and tourism operation, TAM Viagens. In 2010, 2009 and 2008, this business represented 4.1%, 4.4% and 3.8% of our total revenues respectively. TAM Viagens offers complete packages including air tickets, ground transportation, hotels, tours and several tourism services. Nowadays, it is one of the largest tour operators in Brazil and has 77 of its own stores, which deals with more than 5,000 agencies all over the country, offering products to more than 750 tourist destinations.
Our main objective is to attract passengers flying for tourism and leisure purposes to occupy seats that would otherwise be empty during certain flights, either off‑peak flights, or flights during low season – as the Brazilian market has the characteristic of being predominantly composed by business passengers that fly during specific periods of the day. Our tour operator also has fundamental importance in promoting and selling tickets for newly launched flights. We have commercial offices in the U.S. and Argentina, where we focus our sales efforts on promoting trips to Brazil.
In 2010, TAM Viagens became part of the Multiplus coalition and began accepting and giving points for the sales of packages. We have also completed the process of opening TAM Viagens franchise stores and our subsidiary, TP Franchising, operates the expansion and quality control of the related franchisees. We expect to have 200 retail shops open by the end of 2011. Under our franchise model, the franchisee is responsible for all operating expenses ,including the store opening. As a result, each additional TAM Viagens franchise store increases the reach of our operations at no additional cost, further improving our margins.
TAM Loyalty Program
The TAM Loyalty Program was the first loyalty program launched by a Brazilian airline and represents a key element in our marketing strategy. We believe our program is the most flexible in the market because it imposes no restrictions on flights or the number of seats available when members are redeeming accumulated points. The TAM Loyalty Program has more than 8 million members and approximately 13 million free flights have been distributed since its creation in 1993. Beginning in 2009, we launched Multiplus Fidelidade, a loyalty network that integrates the TAM Loyalty Program and allows our members to accumulate points, not just by flying with TAM, but also by flying with partner airlines, making purchases through TAM Loyalty Program‑affiliated credit cards or using services and products at Multiplus Fidelidade partner establishments. The TAM Loyalty Program is currently operated by our subsidiary, Multiplus, on our behalf and the TAM Loyalty Program is one of several coalition partners of the Multiplus Fidelidade network of loyalty programs. Multiplus Fidelidade is described below. Banco Itaú Unibanco S.A., or Itaú Unibanco, offers credit cards that allow holders to earn Multiplus Fidelidade points, and credit cards are available in both MasterCard and Visa designations. TAM Loyalty Program customers are classified in four different categories (white, blue, red and black) and qualification for a particular category is based on miles flown. The rate at which points accumulate varies depending on membership tier. The white card is the base level of membership and cardholders accrue points each time they fly. Blue and red cardholders receive progressively greater benefits and increased points for miles flown, allowing the holders to accrue redeemable points for free travel more quickly. We launched the black card in 2009 to create additional benefits and conveniences for our most frequent flyers, such as granting black cardholders access to a dedicated customer service group to help meet all of their needs.
Points earned by TAM Loyalty Program members must be redeemed for tickets within two years, and historically approximately 22.6% of points expire without being redeemed. This two year period for redemption limits the growth in liabilities arising from the TAM Loyalty Program and Multiplus Fidelidade, assuming a stable trend in relation to the number of passengers we carry. See "Item 5. Operating and Financial Review and Prospects — A. Operating Results — Critical Accounting Estimates and Judgments — Revenue Recognition".
In 2009, we launched Multiplus Fidelidade, a program designed to create a broader network in which our customers can earn points through the TAM Loyalty Program. Multiplus Fidelidade is a coalition of loyalty programs that permits the accrual of points for redemption from products and services offered by many different partner companies, not just ours. We believe this expanded network helps to capture and retain customers and increase sales. It is attractive to our less frequent flyers because it allows them to accrue loyalty points in many ways besides flying. We believe Multiplus Fidelidade is a source of value generation and after its initial public offering, the company increased its corporate governance, dedicating a team that, we believe, will improve even more those sales. At the end of 2010, Multiplus had 151 partner establishments, of which 14 were coalition partners, including the TAM Loyalty Program, and the remainder were accrual partners. Of the 14 coalition partners, seven joined in 2010.
Communications with our passengers
Our "Talk to the CEO" initiative was introduced to encourage passengers to send us suggestions, compliments and complaints. TAM´s customers can contact us by telephone, e-mail, fax, letter and other social medias. Our 0800 123 200 hotline number is available 24 hours a day, 7 days a week. Once an issue is raised by a passenger, we research and analyze it, and keep the customer informed about the solution. In 2010, the service generated 510,000 responses from our passengers (including suggestions, compliments and complaints), compared to 350,000 in 2009 and 179,564 in 2008. In 2010, TAM launched a new communication platform, Customer Relations 2.0. This new platform focuses on responding the contacts received by social medias, such as twitter, facebook, blogs, etc. The customer relations service is also available in 13 countries in North America, South America and Europe.
Our fleet policy focuses on achieving the highest levels of safety, quality, efficient scheduling and high on‑time arrival rates, as well as rationalizing maintenance expenses. Currently, our fleet consists of advanced technology jet aircraft, yielding cost benefits that allow us to achieve high results in efficiency indices and safety standard qualifications. See "— Safety."
The two Airbus "families" operating in our fleet are the A330‑200 and the A340‑500 aircraft (wide‑bodied aircraft used for long‑distance flights), and the A321, A320‑200 and A319‑100 aircraft (narrow‑bodied aircraft used for medium and short‑distance flights). The aircraft in these families differ by number of seats, allowing us flexibility when making commercial decisions regarding passenger demand for flights. The A321, A320 and A319 models are considered to be among the most comfortable aircraft operating in Brazil in their category, with the ability to operate at low cost on routes with up to five hours of flying time. They are also the only Brazilian narrow‑bodied fleet to have fly‑by‑wire flight controls, with computers receiving and analyzing each pilot command, making flights more accurate and efficient. Airbus family aircraft also have the benefit of standardized maintenance and operations, allowing pilots and technicians to fly and work on different models after minimum additional training. All our aircraft are equipped with the best and most advanced equipment and software options offered by the manufacturer, giving us what we believe is one of the most advanced aircraft fleets in the world.
We have constant data communication capability between each of our aircraft and all of our departments on the ground, even when flying. For these communications, we developed a proprietary system, called DMS (Datalink Management System), that allows us to manage all information sent in real time by the ACARS (Aircraft Communication Addressing and Reporting System) installed in our fleet. Using the aircraft DMS, pilots may send text messages to any of our sectors. The messages are transmitted via satellite and appear on the DMS user screen in real time. In addition to communicating with the pilot, these resources also allow remote online monitoring of aviation systems, such as computer functions, landing and departure times, fuel consumption and engine performance parameters. As a result, any operating variance may be analyzed by our maintenance technicians even before an aircraft arrives at its destination. This technology yields savings in maintenance costs and also significantly improves our efficiency and safety.
The quality of our technical services is regularly audited by Brazilian and international authorities, manufacturers and insurance companies. Our codeshare agreements with United Airlines and Lufthansa also require that we meet the maintenance and safety compliance requirements of the competent international aviation authorities.
The advantages of our modern technology, combined with our excellent operating and maintenance standards for our aircraft, yield high equipment utilization rates and reliability levels ("technical dispatch capacity"). Our fleet maintains a high technical dispatch capacity index according to IATA standards. This index measures the on‑time departure capacity of aircraft without taking into consideration external factors such as bad weather. In 2010, we had an average fleet operational reliability index of 98.7% (compared to 98.6% and 98.8% in 2009 and 2008, respectively) for our fleet in operation, the reference point used in auditing our technical services. Aircraft, engine and equipment manufacturers audit our data according to IATA's unified standard.
TAM Linhas Aéreas has RBAC (Brazilian Aviation Approval Regulation) certifications 121 and 145 for maintenance operations and services. It also has FAA and EASA 145 certification for maintenance services, which are performed at the São Carlos maintenance center in São Paulo.
In 1998, we received a U.S. Federal Aviation Regulation (FAR 129) operating certification, and in 1999, we received a European certification from the Direction Générale de L'Aviation Civile — DGAC, allowing us to begin operating scheduled commercial flights to European and U.S. cities. In addition to the destinations in which we now operate scheduled flights, such as Miami, New York, Orlando, Paris, London, Madrid, Milan and Frankfurt, these certifications also permit us to apply to operate additional scheduled flights to cities such as Washington, Indianapolis, Lisbon, Barcelona, Zurich, Amsterdam, and Moscow.
All of these certifications, obtained as a result of our modern maintenance facilities and the high technical quality of our maintenance, rank us among the top airlines in global aviation standards. Since 2000, we have had the Extended Twin Engine Operations (ETOPS) certification of 180 minutes for Airbus A330 model aircraft, proving that we are in compliance with the most stringent global aviation standards in this respect. We also have state-of-the-art equipment in Brazil, such as the Future Air Navigation Systems (FANS), which increases safety in congested air space and achieves fuel savings by using more direct routes.
The following table illustrates our fleet composition over the last three years:
TAM Mercosur's fleet consists of 3 Airbus A320 aircraft (sub‑leased from TAM Linhas Aéreas) and Pantanal’s fleet consists of 1 Airbus A320 and 2 Airbus A319 (sub-leased from TAM Linhas Aéreas), also Pantanal has 5 ATR-42 aircraft in its fleet.
The average age of the TAM Linhas Aéreas fleet is one of the lowest in global aviation: 6.3 years for Airbus A319/320/321 model aircraft, and 6.5 years for Airbus A330/340 model aircraft. With 151 aircraft in operation, the overall average age of our fleet was 6.4 years at the end of 2010.
The following table sets forth the historical and projected development of our operational fleet at December 31 in each of the years indicated:
(1) Our fleet projection is based on the following: we currently have firm orders with Airbus for 58 Airbus aircraft (56 aircraft narrow body family A320 and two A330) for delivery through 2013. In addition, we have firm orders for 27 Airbus A350XWB models 800 and 900, with options for five more, with delivery between 2014 and 2018. We currently have firm orders placed with Boeing for six B777-300ER aircraft, of which four are expected to be delivered in 2012 and two in 2013. In 2010, we made firm orders with Airbus for an additional 20 Airbus A320 family to be delivered in 2014 and 2015, and converted 5 of our 10 A350 options existing at December 31, 2009 into firm orders with deliveries through 2018.
We phased out our entire fleet of Fokker 100 aircraft in 2008, at which point we started operating only Airbus A320 family aircraft in the domestic market.
In November 2006, we entered into an agreement with Airbus pursuant to which we agreed to lease 31 A319/A320/A321 family aircraft, with 20 additional options and six A330 aircraft, with four additional options. On January 2008, the options under the 2006 agreement were converted into firm orders. In February 2007, we entered into an agreement with Boeing pursuant to which we agreed to lease four Boeing 777 aircraft, with an additional four options that were converted to firm orders in 2008, when we also signed a firm order for two additional aircraft. In July 2007, we entered into an agreement with Airbus pursuant to which we agreed to lease 20 Airbus A319/A320/A321 aircraft. In December 2007, we entered into an agreement with Airbus pursuant to which we agreed to lease 22 Airbus A350‑900 aircraft, plus 10 options. In 2010, we converted five of those 10 A350 options into firm orders, and we made firm orders with Airbus to purchase an additional 20 A320 aircraft.
As of December 31, 2010, we had firm commitments to purchase 91 aircraft, with an aggregate manufacturer's list price of approximately U.S.$9.16 billion. Additionally, in 2011, we announced the order of 32 Airbus A320 family aircraft and two Boeing 777-300ER aircraft. Out of this order, 22 of the Airbus A320 family aircraft are for the new model A320neo. These aircraft will be delivered between 2016 and 2018. The engine option will be announced at a later date.
TAM Linhas Aéreas currently leases all of its aircraft using long‑term lease agreements and Pantanal Linhas Aéreas leases two aircraft and owns three. We believe that leasing, rather than owning, aircraft gives us greater flexibility because it allows us to change the composition of our fleet relatively quickly in the event that we need to do so.
Of our total fleet of 151 aircraft at the end of 2010, 144 of our aircraft were subject to operating leases, four to finance leases and three were owned by Pantanal Linhas Aéreas. However, for accounting purposes, 75 of TAM Linhas Aéreas’ lease contracts are classified as finance leases.
Operating leases require us to make periodic payments, but do not include aircraft purchase options at the end of the agreement. The payments are denominated in U.S. dollars and the majority of these payments are subject to interest based on LIBOR. Pursuant to the terms of these agreements, aircraft are returned under agreed conditions at the end of the lease. The lessor retains ownership of the aircraft. We are responsible for maintaining and contracting insurance for the aircraft during the leasing period.
Finance leases are capitalized at the lease's commencement at the lower of the fair value of the leased property and the present value of the minimum lease payments. Each lease payment is allocated between liability and finance charges. The corresponding lease obligations, net of finance charges, are recorded as financial liabilities. The interest due on the finance lease is recorded on the income statement over the lease period to produce a constant interest rate on the remaining balance of the financial liability.
We rigorously follow the maintenance plans proposed by the aircraft manufacturers and approved by the competent Brazilian and international aviation authorities. Accordingly, maintenance carried out on our aircraft may be divided into three general categories: (i) line maintenance, (ii) heavy maintenance and (iii) component repair and overhaul. Line maintenance includes daily inspections and minor corrective actions, along with "A" checks, all of which are performed between flights or overnight and do not require changes to our scheduled operations.
Heavy maintenance includes more complex aircraft inspections, including aircraft modifications and corrective actions, and may require removal of aircraft from operations during periods ranging from four days to four weeks, depending on the complexity of the maintenance.
Engine maintenance contracts cover all significant engine maintenance activities. We pay for services rendered pursuant to our engine maintenance contracts on an as‑incurred basis. The basis on which maintenance expenses are considered incurred is dependent on the nature of the services provided under our engine maintenance contracts:
· contracts under which amounts are payable to the maintenance provider, and are recognized in the income statement, based on actual maintenance activities performed by the maintenance providers. The expenses incurred reflect the actual time required to perform maintenance and the material costs used in the maintenance activities. These maintenance contracts are referred to as "time and materials" contracts; and
· contracts under which maintenance expenses are payable to the maintenance provider based on hours flown. These maintenance contracts are referred to as "power by the hour" contracts. We accrue a liability and record an expense for maintenance under these contracts on the basis of hours flown. These payments are made to maintenance providers when the engines undergo a maintenance shop visit based on an agreed hourly rate. Our "power by the hour" contracts also provide for a relatively small administrative fee that is paid and expensed monthly (this fee represents less than 5% of amounts paid under all of our "power by the hour" contracts considered together).
We have entered into a number of agreements with suppliers and service providers in order to assist with our maintenance requirements, of which the following are material:
· a general terms agreement between TAM Linhas Aéreas and GE Engine Services Distribution, L.L.C., or GE, dated May 7, 2001, pursuant to which TAM Linhas Aéreas has agreed to purchase certain spare engines and support equipment for both the spare engines it has purchased from GE and certain engines that have already been installed on its operating fleet. The agreement also provides that GE may provide non‑standard maintenance training courses upon request of TAM Linhas Aéreas. The agreement provides that GE will charge for any such courses on an "as incurred" basis. The agreement has no fixed termination date;
· an engine maintenance agreement between TAM Linhas Aéreas and MTU Motoren‑und Turbinen‑Union München GmbH, or MTU, dated September 14, 2000, or the TAY Agreement, pursuant to which MTU has agreed to provide certain maintenance, refurbishment, repair and modification services with respect to approximately 105 aircraft engines. This agreement was amended by means of a novation and amendment between TAM Linhas Aéreas and Rolls‑Royce Brazil Ltda. or Rolls‑Royce, dated November 8, 2001, pursuant to which Rolls‑Royce replaced MTU as contract counterparty. The agreement provides that Rolls‑Royce may subcontract services to be performed and that it will not be held liable for damages to or losses of TAM Linhas Aéreas or third parties due to the performance of the services contracted under the agreement, unless caused by willful misconduct or negligence of Rolls‑Royce. The agreement provides that service orders placed by TAM Linhas Aéreas are to be charged based on a fixed rate specified for each type of service and subject to an escalation formula. TAM Linhas Aéreas is required to make payments based on actual services performed. This agreement terminates on June 30, 2015;
· an engine maintenance agreement between TAM Linhas Aéreas and MTU Maintenance Hannover GmbH, or MTU Hannover, dated September 14, 2000, pursuant to which MTU Hannover has agreed to provide certain maintenance, refurbishment, repair and modification services with respect to certain V2500‑A5 engines. The agreement provides that MTU Hannover may subcontract to third parties and that MTU Hannover will not be held liable for damages to or losses of TAM Linhas Aéreas or third parties due to the performance or non‑performance of the services contracted, unless caused by willful misconduct or negligence of MTU Hannover. The agreement provides that service orders placed by TAM Linhas Aéreas will be charged on actual services performed, based on hourly rates for engine/module repair work and on a fixed price for test runs, including fuel and oil, subject to an escalation formula. This agreement terminates on June 30, 2014; and
· an engine maintenance agreement between TAM Linhas Aéreas and United Technologies Inc., Pratt and Whitney Division, or Pratt and Whitney, dated September 14, 2000, pursuant to which Pratt and Whitney has agreed to perform maintenance, modification and/or overhaul of engines, engine modules and their parts and components. Pratt and Whitney has a limited exclusivity right for maintenance services of engines and modules pursuant to the terms of this agreement. This exclusivity provision requires TAM Linhas Aéreas to obtain prior written authorization from Pratt and Whitney before sending the equipment to another maintenance service supplier, with an exception in the case of delay or non‑performance of services by Pratt and Whitney. The services to be provided by Pratt and Whitney are charged based on a fixed rate specified for each type of service, subject to an escalation formula. TAM Linhas Aéreas is required to make payments based on actual services performed. This agreement terminated on September 14, 2010.
We are certified to conduct maintenance on each type of aircraft in our fleet. Line maintenance is performed at all bases at which we operate, but mainly at the airports in São Paulo, Congonhas and Guarulhos. We also conduct heavy maintenance and component repair and overhaul at our main maintenance center in São Carlos, which is 250 kilometers northwest of São Paulo. The São Carlos maintenance center is approximately 4.6 million square meters in size and is fully certified by ANAC, EASA, FAA, TC - Canada and other Latin American aeronautical authorities to perform heavy maintenance ("C" & "D") on most of our fleet, including the Airbus A330, A320, A318, A319 and A321, ATR 42, Boeing 767 and Fokker 100, as well as over 2,500 different aeronautical components and parts for Fokker 100 and several parts for all Airbus aircraft and many of our Boeing aircraft. Our maintenance center completed its ANAC 145 certification for Boeing 767 aircraft at the end of 2008, and the first inspections began in 2009. Our maintenance center currently has over 1,150 direct employees (for core maintenance activities) and approximately 300 indirect employees (providing support functions, such as security, facility maintenance and cleaning). Line maintenance and supply chain activities include approximately 100 additional employees.
All maintenance that is conducted in‑house presents significant cost savings and strategic advantages. As we are qualified to perform most line maintenance, heavy maintenance and component repair and overhaul services, we substantially reduce the need to send aircraft and parts overseas, decreasing downtimes and avoiding the costs of aircraft ferry-flights, parts logistics and import‑export taxes. For those parts requiring maintenance at costs that are not economically efficient, due to complexity or low volume repairs, we have implemented, where possible, long‑term, optimized maintenance agreements with engine manufacturers.
As required by our codeshare agreements with several airlines, including Lufthansa, United, TAP, Air Canada and LAN, we have the IATA Operational Safety Audits (IOSA) maintenance certification. Further, our maintenance division also has required certifications from each country in which we fly our aircraft (for example, the FAR 129 certification required by the United States).
In addition to the manufacturers (Airbus, Boeing, Rolls Royce, GE, Pratt & Whitney) training, we train our engineers and technicians at our own training center, which is fully certified under ANAC 147, and which uses the same equipment and software that the manufacturers use. We refer to our training center as the "TAM Service Academy".
Besides maintenance on our own aircraft, we also perform maintenance for third party aircraft and flight components, including maintenance for certain of our competitors, within the ranges of our certifications. We are party to several line maintenance support contracts, pursuant to which we provide maintenance on Airbus aircraft, as well as heavy and component support for Brazilian and foreign airlines. We also have a total care maintenance contract for the President of Brazil's A319 ACJ. Our maintenance services are consistently growing, helping us to dilute our fixed expenses, as well as increase our revenues.
A significant part of our aircraft and vehicle maintenance expenses are indexed to the U.S. dollar. For a description and analysis of the effect of exchange rate variations on our income, including fleet maintenance expenses, see "Item 11. Quantitative and Qualitative Disclosures about Market Risk — Exchange rate risk."
Fuel is the largest component of our operating expenses, representing 33% of our operating expenses in 2010.
Fuel consumed in Brazil represents approximately 85% of our total consumption and is acquired through the following distributors: Air BP, BR Aviation (Petrobrás) and Shell Aviation (which acquired the Cosan business, formerly known as Exxon Mobil, in 2009). We purchase fuel abroad from Air BP, Petrobrás, Exxon Mobil, J&D Oil Field, Shell, Morgan Stanley, Repsol YPF, World Fuel Services, Q8 and Air Total. Supply contracts for fuel in Brazil are normally made for a two to three year period and current contracts expire at the end of 2012. Supply contracts at our international bases normally have a term of one or two years. The great majority of our fuel is purchased under "into‑plane" terms, meaning that the supplier is responsible for delivering the fuel directly into the tanks of our aircraft. The fuel prices in the contracts we sign normally consist of three components: (i) the reference price from regional refinery, (ii) the supplier logistics and operational margin (differential) and (iii) airport storage/hydrant fees and taxes. Refineries kerosene price is subject to international market variations (offer/demand) in the reference price of crude oil and refineries' margins. The supplier differential is the portion charged by the supplier, which normally consists of a fixed amount per volume negotiated and committed to be charged during the contractual period, and reflects the cost of fuel procurement, distribution, storage, and refueling, as well as a profit margin. Airport taxes and fees vary by airport. We have a department responsible for negotiating fuel purchase contracts and, as a result of the high volumes of fuel we purchase, we believe that we are normally able to obtain more favorable terms than most of our competitors.
To reduce our exposure to international fuel price and exchange rate variations, in 2006 we began to enter into arrangements intended to hedge a minimum of 30% and a maximum of 80% of our projected fuel consumption. Due to new market and macroeconomic conditions, we decided to modify this policy. We now hedge our fuel requirements up to a five year period with between 20% and 60% of our future fuel requirements hedged over the first 12 months, and 10% to 60% hedged over the second 12 months. For a description and analysis of the effect of volatility in fuel prices on our income, see "Item 11. Quantitative and Qualitative Disclosures about Market Risk — Risks relating to variations in the price of oil." Another important cost reduction initiative involving fuel is our "fuel tanker" program, pursuant to which we refuel aircraft in regions where fuel prices are relatively low. This initiative has more of an effect in Brazil, where the local taxes for each state cause significant variances in final fuel price. We have also formed a multidisciplinary work group, involving each of our departments responsible for fuel, engineering, control, operations, dispatching and financing, to develop other measures to reduce spending and fuel consumption by our fleet.
We adopt the highest safety standards in the world. We comply with Brazilian and foreign aviation regulations, including those issued by the ICAO (International Civil Aviation Organization), the FAA – Federal Aviation Administration (U.S. aviation authority) and the EASA – European Aviation Safety Agency (EASA). As an international airline, we are a member of the IATA, and sit on the Regional Flight Safety Committee (RCG). We are also a member of the Flight Safety Foundation (the largest nongovernmental organization for flight safety) and the Flight Safety Committee (a committee comprised of all Brazilian airlines).
Our priority is to provide safe air transportation. Our founder, Commander Rolim Amaro, passed down one of our key corporate mottos: "Safety comes first to the client." We are devoted to flight safety and adopt modern certification and system standards. For example:
· In 2002, we were the first Brazilian company to implement the FOQA (Flight Operations Quality Assurance) system, a system used for the systemic analysis of flights and the prevention of operating failures that may affect the safety of a flight, which subsequently became a benchmark for other Brazilian companies;
· In 2004, the European Union Aviation Authority granted us the EASA 145 certification for our aircraft maintenance and repair facility located in São Carlos and we have been recertified annually since then;
· In July 2006, we became a member of the United Kingdom Flight Safety Committee (UKFSC), an association of organizations and professionals dedicated to improving flight safety standards in commercial aviation in the United Kingdom. In 2006, we also became a member of the Steering Committee of the Emergency Response and Planning Task Force (ERPTF) of IATA;
· In 2007, we were the first company in Latin America to implement the AQD (Aviation Quality Database) system for safety database management, which analyzes operating risks and implements the SMS (Safety Management System) in conformity with Brazilian and foreign regulations;
· In 2009, the U.S. aviation authority (FAA) granted us the FAR 145 certification for our aircraft maintenance and repair facility located in São Carlos;
· In January 2010, we ratified the IOSA certification that IATA granted us in 2007 and validated in 2008. The IOSA certification is the most complete and recognized international operational safety certificate. The IOSA certification requires an independent evaluation system focused on the operational management and control systems of airlines. The IOSA audit encompasses over 940 requirements related to operational safety, such as management system, flight operations, operational dispatch, ramp operations, airports, maintenance, cargo operation, operational safety and training for each area associated with operations. With IOSA registration renewal, we met a pre-requisite for joining the Star Alliance;
· In February 2010, we were certified by the Argentine National Civil Aviation Administration for the rendering of maintenance services on Airbus A318, A319 and A320 aircraft registered in Argentina, along with their components;
· In March 2010, we were certified by Ecuador aeronautical authority (Direccion General de Aviation Civil) to perform maintenance service on Airbus A318, A319, A320, A321 and Fokker-100 aircraft registered in Ecuador, along with their components; and
· In August 2010, we were certified by Transport Canada Civil Aviation (TCCA) to perform maintenance service on aircraft registered in Canada.
Brazilian civil aviation follows the highest safety standards in the world. Brazil is classified as a Category 1 (the highest category) country in terms of the flight safety standards established by ICAO. Category 1 is the highest.
We maintain insurance policies as required by law and the terms of our aircraft leasing agreements. The scope of these policies includes all risk coverage for aircraft hulls, including war risks and third party legal liability for passengers, cargo, baggage and injuries to third parties on the ground. Our current policies, which will be in force through December 19, 2011, follow practices adopted by the international civil aviation industry.
We have also contracted for asset insurance against the risk of theft, fire, flood, electrical damage and similar events for equipment and buildings we own or for which we are responsible, including airport areas where we have operations. Similarly, we have contracted for vehicle insurance against the risk of robbery, theft, fire and civil liability against third parties for all vehicles we own or for which we are responsible.
We have also contracted for liability insurance in respect of our directors and officers and the existing policy is due to expire on March 30, 2012.
We invest significantly in information technology systems that enhance our operating processes, allow us to provide higher quality services to our passengers, grant us greater flexibility and increase the speed of our operations.
In 2004, we introduced the e‑TAM portal, a tool that integrates our entire sales chain, from the time of reservation through to passenger boarding. Moreover, data obtained from the e‑TAM portal allows us to offer our passengers a set of customized services. The great majority of our domestic reservations made in Brazil are made through the portal environment. The use of the e‑TAM portal allows us to reduce the cost of reservations and ticket issuance by consolidating the GDSs previously used for almost all our reservations. Currently, GDS is used more for international tickets issued in Brazil and for tickets issued abroad.
We were the first Brazilian airline to develop and install self‑service check‑in kiosks in airports. With over 167 units in Brazil's major airports, the kiosks allow passengers who purchase e‑tickets to check‑in and select their seat in less than ten seconds, reducing lines in the check‑in halls and on board the aircraft. In 2010, 2009 and 2008 approximately 3,270,531, 6,220,208 and 5,888,474 passengers, respectively, checked in through the self‑service kiosks.
In October 2003, we signed a general services agreement with Sabre Travel International Limited, pursuant to which we were granted a license (relating to the provision of maintenance services) for electronic reservation technology and database backup. This agreement was intended to remain in force for ten years, unless early terminated by either party. In March 2009, we announced that we were exercising our right to early terminate the contract and that early termination became effective in March 2010.
In July 2009, we signed an agreement with Amadeus IT Group SA, pursuant to which we were granted a license to operate our core processes using their software. This agreement shall expire ten years from the date we began to use the Amadeus platform, November 15, 2009, unless terminated early in accordance with the termination clause.
The TAM Loyalty Program and "special services" system are also important tools for obtaining profile information on our passengers. The TAM Loyalty Program allows us to monitor the activity of passengers registered with the program, recording information on each passenger flight in addition to personal information and preferences (such as preferred seat, special meal requests and other data obtained through our contacts or customer surveys). The "special services" system allows the crew to input data on preferences of our passengers directly to our database. This data is also used to study passengers, offer promotions and new services and define our advertising message.
Our DOV‑line tracing system monitors all aircraft baggage and cargo, following the location of items inside the aircraft, for proper weight balancing. A balanced aircraft is critical for a safe flight and has the added benefit of reducing fuel consumption. The DOV‑line tracing system also manages crew distribution.
The Brazilian passenger air transportation market is subject to seasonality, as there is always higher demand for air transportation services in the second half of the year. However, this seasonality is partially mitigated by the fact that we have a higher concentration of business travel than the market average (and business travel is less sensitive to seasonality). Our other operations do not vary significantly as a result of seasonality.
Airlines in Brazil compete primarily in terms of routes, price, flight frequency, service reliability, brand recognition and benefits offered to passengers, such as loyalty programs and customer service. We believe our market leadership and the TAM Loyalty Program enhance our competitive performance in many of these areas.
Our competitors, both actual and potential, include Brazilian airlines, airlines operating on regional air routes and new participants in the market who operate primarily on regional transportation networks. Our principal competitor is Gol. In previous years, Varig had been one of our major competitors. However, Varig filed for bankruptcy protection in Brazil and the United States in June 2005. Varig's assets and operations were sold to various investors over the course of 2006 and, on December 14, 2006, Varig ceased operations altogether. On December 15, 2006, a new company, VRG Linhas Aéreas S.A., initiated operations on some of the routes previously used by Varig. On March 24, 2007, Gol announced that it had entered into an agreement to acquire VRG Linhas Aéreas S.A. In compliance with applicable CADE requirements, Gol and Varig operated as separate airlines until CADE's final approval of the acquisition on June 25, 2008. On October 19, 2008, the route networks of both companies were integrated.
To a much less degree, we also face competition from a number of significantly smaller airlines operating in the domestic market. In 2010, 13 different airlines together shared the 17.7% of the domestic market that is not served by TAM and Gol (who together share approximately 82.3% of the domestic market).
ANAC's resolution provides that 80% of new airport slots are distributed to existing airlines, with these slots being divided evenly (without regard to market shares). New slots are only available to airlines that have a history of punctuality, no pending proceedings with ANAC and a positive shareholders' equity. The remaining 20% of slots are available to new entrants. See "— Regulation of the Brazilian Civil Aviation Industry — Rights to Operate Air Routes — Policy on slots."
The table below shows the history of market participation on domestic routes, calculated by reference to RPKs, for the major Brazilian airlines, for the periods indicated (based on data provided by ANAC):
We also face competition, albeit to a lesser degree, from land transportation companies such as road transport companies.
The international market is substantially more competitive than the domestic market. In the international market, there are many international airlines that are larger than us and more experienced. To ensure sustained market competitiveness, airlines are dependent on partnerships and codeshare agreements in the international market.
With respect to international flights, airlines compete primarily on the basis of routes, services, price and mileage and frequent flyer programs. We offer 96 daily international flights to Buenos Aires, Santiago, Asunción, Montevideo, La Paz, Bogota, Ciudad del Este, Santa Cruz de la Sierra, Cochabamba, Caracas, Lima, Miami, New York, Orlando, London, Paris, Frankfurt, Madrid and Milan. We have codeshare agreements with LAN Group, Pluna, United Airlines, Air Canada, TAP, Lufthansa, BMI, Air China, Swiss International, Continental, All Nippon and US Airways, allowing our passengers to make connections throughout the world, in addition to other services such as simplified check-in, luggage shipping and access to VIP lounges. We also have interline agreements allowing us to offer our passengers a wide range of destinations around the world. On October 7, 2008, we publicly announced that we were joining the Star Alliance, the largest global alliance in commercial aviation. We became a full member of the Star Alliance on May 13, 2010.
In the international market, our main competition is from major international airlines that serve the markets in which we operate. Our average international market share in 2010 was 87.6% (measured by RPK among Brazilian companies). According to ANAC, Brazilian airlines were responsible for approximately 35% of international passengers transported in 2009. We believe that in 2010, Brazilian airlines transported 35% of those passengers to and from Brazil. The table below shows the history of market participation on international routes, calculated by reference to RPKs, among only the Brazilian airlines, for the periods indicated (based on data provided by ANAC):
To help compete effectively in the international market, in January 2011, TAM, together with its controlling shareholders, TEP and the Amaro family, entered into agreements with LAN, and its respective controlling shareholders to effect a proposed business combination of LAN and TAM. This merger remains subject to governmental and regulatory approval.
Overview of the Industry
According to INFRAERO, Brazil is the fourth largest domestic aviation market in the world (in number of scheduled passengers transported), covering a vast area (greater than the continental United States) with a population of approximately 190.7 million people in 2010 (according to the Brazilian Geography and Statistics Institute – Instituto Brasileiro de Geografia e Estatística, or IBGE). We believe that the São Paulo (Congonhas) — Rio de Janeiro (Santos Dumont) shuttle route is one of the busiest shuttle routes in the world. According to ANAC, more than 3.3 million passengers were transported on this route in 2009. Growth of the Brazilian commercial aviation industry is closely related to growth of Brazilian GDP. According to INFRAERO, the Brazilian commercial aviation industry transported approximately 69.7 million passengers in the domestic market in 2010.
Brazilian civil aviation follows the highest established standards of operational safety in the world. Brazil is classified as Category 1 under the aviation safety standards established by the ICAO, the same classification as the United States and Canada.
Airlines operating in the Brazilian commercial aviation market can be divided into the following four categories:
· domestic airlines, which provide public transportation service on a scheduled basis within Brazil and operate mainly with large aircraft between the major cities of Brazil;
· regional airlines, which provide public transportation service on a scheduled basis within Brazil, generally connecting smaller cities to bigger cities in Brazil. Typically, regional airlines operate with smaller aircraft, such as turbo-props;
· charter airlines, which provide transportation service on a non‑scheduled basis; and
· international airlines, which provide international transportation services on a scheduled basis to and from Brazil.
The market for scheduled airline service in Brazil includes two main types of passengers: those traveling on business and those traveling for leisure. Business passengers generally place more importance on factors such as frequency of flights, reliability, availability of direct flights, extent of area served and value‑added services. These passengers are also becoming increasingly sensitive to price. Leisure passengers generally place more importance on price and tend to be more flexible regarding the scheduling of their trips.
The business travel sector is the largest and most profitable segment of the air transport industry in Brazil. We believe that the number of business trips is significantly greater than the proportion of domestic business trips in the international civil aviation market. In Brazil, small and medium‑sized companies (which comprise a large proportion of our customer base) place significant importance on receiving good service from their airline, while maintaining a balance between quality, frequency of flights and low prices.
In 2009, the ten busiest airports accounted for 69% of all domestic traffic in terms of departures and arrivals, according to ANAC's annual report.
The domestic civil aviation market is principally served by TAM and Gol/VRG, who together represented 82.3% of all domestic routes in 2010, in terms of RPK. According to ANAC, in 2010, our share of the domestic market was 42.8%, while that of Gol/VRG was 39.5%. The remaining market share, approximately 17.7%, was served by 13 different airlines. This market profile is consistent with the historical make‑up of the domestic market, which has traditionally seen a small number of airlines holding the vast majority of domestic market share and a much larger number of airlines (the identity of whom has continuously changed over the years as different airlines have entered and left the market) holding the remaining portion.
On June 17, 2005, Varig became the first Brazilian company to file for an in‑court reorganization under Law No. 11,101 of February 9, 2005, which we refer to as the New bankruptcy law, in the courts of the State of Rio de Janeiro. Previously, the Brazilian Aeronautical Code provided that concessionaires of public air transportation were not allowed to apply for in‑court reorganization. During this period of in‑court reorganization, Varig faced a drastic deterioration in its financial and operational condition. It ceased operation of several flights and withdrew from important domestic and international markets. On December 18, 2005, the creditors' assembly of Varig approved its in‑court reorganization plan, but this plan was amended by the creditors on May 9, 2006 in order to permit a judicial disposal of Varig's flight operating unit. On July 17, 2006, the flight operating unit of Varig was sold in a public bid process held by the Judiciary of the State of Rio de Janeiro to VarigLog Linhas Aéreas S.A., a former subsidiary of Varig that was also sold on November 11, 2005 pursuant to the in‑court reorganization plan. On March 24, 2007, VarigLog and Gol announced that Gol had entered into an agreement to acquire VRG Linhas Aéreas S.A., which is VarigLog's subsidiary and operates Varig's routes. In compliance with applicable CADE requirements, Gol and Varig operated as separate airlines until October 19, 2008 when they integrated their networks, which was after CADE's final approval of the acquisition on July 25, 2008.
Trends In the Domestic Market
In the past 35 years, the domestic market has generally grown in terms of RPK, except during times of significant economic recession (such as the oil crisis, the debt‑moratorium crisis in the 1980s and the economic recession and political instability of the early 1990s).
Since the year 2000, the annual air‑traffic passenger growth rate, in terms of RPK, was 11.1%, compared to an annual available capacity growth rate in terms of ASK, of 9.4%. The average load factor in the period was 65.2%. Domestic passenger traffic and available capacity rates for the period between 2000 and 2010 are set out in the following table:
(1) Percentages refer to percentage change from previous year.
(2) In 2010 ANAC change the methodology of the data
Historically, growth in domestic civil aviation demand has generally exceeded growth in GDP. From 2000 to 2010, domestic civil aviation RPK grew 11.1% per year, while the annual GDP growth rate in the same period was 3.7%, according to ANAC and IBGE.
The variable factors that have the greatest influence on the commercial aviation market are the price of fuel and variations in exchange rates, because fuel is the most important element of expenses for airlines, and most elements of the market (including fuel) are tied to the U.S. dollar.
The influence of the Brazilian government on the industry, through industry regulations, has also had a significant impact on the performance of airlines operating in the market. From 1986 to 1993, the Brazilian government imposed more rigid control over local civil aviation activities because of high inflation levels which led to a series of economic crises in Brazil during that entire period. The Brazilian government mainly monitored airline air fares and supervised the use and expansion of their routes. In 1994, after successful efforts to control inflation and stabilize the Brazilian economy, the Brazilian government (acting through the aviation authorities) began to deregulate civil aviation activities, principally by gradually reducing government control over the airlines' local activities. Even though Brazilian civil aviation is still a regulated sector, ANAC's current rules are significantly more flexible than the regulations which were previously in effect. Further, the relevant authorities have frequently issued basic and essential regulations in order to harmonize the Brazilian regulatory environment with international, more modern models.
We believe the current regulatory regime has favored the financial performance of Brazilian civil aviation. As a result of imposing a more rational supply of services and ending implicit subsidies to less competitive airlines, we believe that the Brazilian government has enabled more competitive airlines such as TAM and Gol to better utilize their aircraft in an environment of healthy competition, which in turn has led to improved average returns in the domestic market. Such regulatory system is undergoing certain structural changes. See "Item 3. Key Information — D. Risk Factors — Risks Relating to the Civil Aviation Industry and our Business — The regulatory structure of Brazilian civil aviation is undergoing change and we have not yet been able to evaluate the results of this change on our business and results of operations" and "— Regulation of the Brazilian Civil Aviation Industry — Rights to Operate Air Routes — Future legislation."
Regulation of the Brazilian Civil Aviation Industry
Scheduled air transportation services are considered public services in Brazil and, accordingly, are subject to extensive regulation by the High Command of Aeronautics of the Ministry of Defense, or the High Command of Aeronautics, CONAC, ANAC and the recently created SAC. Scheduled air transportation services are also regulated by the Brazilian federal constitution and by the Brazilian Aeronautical Code.
The Brazilian Aeronautical Code sets out the principal rules relating to airport infrastructure and operations, flight protection and safety, certification of airlines, aircraft leasing structure, liability, transfers, registration and licensing, training of crews, concessions, inspection and control of airlines, public and private air cargo transport services, airlines' civil liability and penalties for violations.
CONAC is the Brazilian President's advisory body. Its board of advisors includes the Minister of Defense, the Minister of Civil Affairs, the Minister of Finance, the Minister of Development, Industry and Foreign Trade, the Minister of Foreign Relations, the Minister of Tourism and the Command of the High Command of Aeronautics. CONAC has the authority to establish policies for the Brazilian civil aviation industry that are adopted and carried out by the High Command of Aeronautics and ANAC. CONAC establishes general rules related to adequate representation of Brazil in treaties, conventions and other matters related to international air transportation, airport infrastructure, the granting of additional funds to be used to benefit airlines and airports (based on strategic, economic and leisure considerations), the coordination of civil aviation operations, air safety, concessions for the operation of airline services and permits for the provision of related commercial services. Pursuant to Provisory Measure No. 527, the President of CONAC shall be the same person that serves as the Secretary of SAC.
ANAC is the main civil aviation authority in Brazil and, pursuant to Provisory Measure No. 527, now reports directly to SAC. Prior to Provisory Measure No. 527, ANAC reported directly to the Ministry of Defense. ANAC is an independent regulatory agency associated with, but not under the control of, the Ministry of Defense and operates as an independent agency for an indefinite term. ANAC principally has the authority to: (i) regulate, inspect and supervise services rendered by airlines operating in Brazil, (ii) grant concessions, permits and authorizations for air transport operations and airport infrastructure services, (iii) represent the Brazilian government before international civil aviation organizations, (iv) control, register and inspect civil aircraft, and (v) ensure that air transportation services are provided under free market principles.
SAC is a new civil aviation and airport infrastructure regulatory authority created by Provisory Measure No. 527, issued by the Brazilian President on March 18, 2011. SAC is an advisory body, equivalent to a Ministry, to the Brazilian President, and holds the civil aviation powers and responsibilities previously vested with the Ministry of Defense. SAC's main objective is to facilitate the development of Brazil's airport infrastructure. Provisory Measure No. 527 is valid for a period of 60 days and is renewable for one additional 60 day period until the Brazilian Congress reviews and votes on the Measure. As part of Provisory Measure No 527's reorganization of civil aviation powers and responsibilities, ANAC will report directly to SAC, instead of the Ministry of Defense.
The Brazilian government has recognized and approved the three main international conventions related to world commercial air transportation operations: the Chicago Convention of 1944, the Geneva Convention of 1948 and the Montreal Convention of 1999.
Recently, in February 2009, the Federal Government approved the new Civil Aviation National Policy (Política Nacional de Aviação Civil or "PNAC"). Although the PNAC does not establish any immediate measure, it contains the main guidelines for the national civil aviation system. It encourages the Ministry of Defense, CONAC and ANAC to issue regulations on strategic matters such as safety, competition, environmental, and consumers' issues, as well as to inspect, review and evaluate the activities of all operating companies.
Air transportation services concession
The Brazilian federal constitution grants the Brazilian government the exclusive authority to explore air transportation services and airport infrastructure and provides that the government can render these services either directly or indirectly through third parties (by means of concessions or permits). According to the Brazilian Aeronautical Code and regulations issued by the High Command of Aeronautics, any operation of scheduled air transportation services requires a concession granted by the High Command of Aeronautics. The terms of each concession must be formalized by means of a concession agreement entered into with ANAC. Any company seeking a concession must meet certain economic, financial, technical, operational and administrative requirements established by ANAC. In addition, all companies seeking a concession must (i) be legal entities constituted in Brazil, (ii) obtain an Air Transport Operation Approval Certification (CHETA), and (iii) comply with certain restrictions regarding ownership of its shares or quotas. See "— Rights to Operate Air Routes — Restrictions against the ownership of shares in airlines operating under concessions."
ANAC has the authority to revoke a concession in the event of any failure by an airline to comply with the rules of the Brazilian Aeronautical Code, supplemental laws and regulations and the terms of the applicable concession agreement.
Article 122 of Law No. 8,666 of June 21, 1993 provides that concessions must be regulated by specific procedures stipulated in the Brazilian Aeronautical Code. The Brazilian Aeronautical Code and the regulations issued by ANAC do not expressly establish any bidding procedures in relation to concessions. Accordingly, it is not currently necessary to conduct bidding prior to awarding concessions for the operation of air transportation services (such as ours), as would be required in the case of other public services generally regulated by laws applicable to public concessions.
Our concession to operate scheduled air transportation of passengers, cargo and mail at a national level was obtained on December 9, 1996 through the issuance of Ordinance 816/GM5 and the execution of the relevant concession agreement, which will remain valid until December 9, 2011. Although we can offer no guarantee that we will be able to renew our concession, we do not currently foresee any problems in relation to this renewal.
The registration of aircraft in Brazil is governed by the Brazilian Aeronautical Code. The Brazilian Aeronautical Code provides that no aircraft is authorized to fly in Brazilian airspace or to land in or take‑off from Brazilian territory without being duly registered. In order to remain registered with a Brazilian registration number, an aircraft must have both a certificate of registration and an airworthiness certificate (certificado de aeronavegabilidade), each of which is issued by RAB after a technical inspection by ANAC. The certificate of registration issued by ANAC attributes Brazilian nationality to the aircraft and proves for its enrollment with the proper authorities. The airworthiness certificate is generally valid for six years from the date on which ANAC conducted its inspection of the aircraft and provided authorization for it to fly over Brazilian airspace (subject to continued compliance with certain technical requirements and conditions). The registration of any aircraft can be cancelled in the event that the authorities verify that such aircraft is not in compliance with the requirements for registration (in particular any failure to adapt the aircraft to any safety requirements specified by ANAC or by the Brazilian Aeronautical Code).
All agreements relating to aircraft registered in Brazil, including sale and purchase agreements, financial commercial leasing agreements, mortgages (and amendments to any such agreements) must be submitted to the Brazilian Aeronautical Registry (RAB) for the purpose of publishing the transactions contemplated thereby and updating aircraft registration.
Rights to Operate Air Routes
ANAC has the authority to grant Brazilian airlines the right to operate any new route. Any airline seeking to operate a new route must submit studies proving both the technical and economic feasibility of the proposed route (in form satisfactory to ANAC) and must fulfill certain conditions in relation to the awarding of those routes. In respect of awarding any new route or approving any change to existing routes, ANAC evaluates the infrastructure capacity of the airports from which the route will be operating and the increase in demand and competition between airlines. In addition, approval for operation of a route is made subject to the condition that the route must be operated on a scheduled basis. The operation of a route by any airline can be cancelled in the event that the airline (i) fails to initiate operation of the route within 15 days of receiving authorization, (ii) fails to maintain at least 75% of the flights established in the respective National Air Transport Schedule (hotran) for a period of 90 days, or (iii) suspends operations for more than 30 days. ANAC's approval of new routes or changes to existing routes is given in the course of an administrative proceeding and does not require any amendment to the applicable concession agreement.
Once awarded, the routes must be immediately reflected in the hotran (the report of the itinerary of all routes an airline operates), which will then become an integral part of each airline's database at ANAC. The hotran not only establishes the routes but also the arrival and departure times at certain airports, none of which can be changed without the prior approval of ANAC. Brazilian civil aviation laws and regulations provide that an airline may not sell or transfer routes to another airline.
Recently, ANAC has imposed schedule restrictions to several Brazilian airports from which we operate. Operating restrictions, including the prohibition of international flights' operations and the prohibition of civil aircraft's operation after 11:00 p.m. and before 6:00 a.m, were imposed for Congonhas Airport, one of the busiest Brazilian airports and the most important airport for our operations. No assurance can be given that these or other government measures will not have a material adverse effect on our business and results of operations.
International airlines are those with points of departure in Brazilian territory and points of arrival in foreign territory, operated by Brazilian companies previously designated by the Brazilian government and operated in accordance with the terms of bilateral agreements with foreign governments. The rights to international routes between major cities (as well as the corresponding landing rights) are derived from bilateral air transportation agreements negotiated between the government of Brazil and foreign governments. Pursuant to the terms of those agreements, each government grants the other the right to designate one or more domestic airlines to operate scheduled service between certain destinations in each country.
Requests for new international routes or changes in existing routes must be submitted by each interested Brazilian airline to SRI, which evaluates each request based on the provisions of the applicable bilateral agreement, the availability of existing routes between the two countries and the general policies of the Brazilian aviation authorities. Following such evaluation, SRI may take any steps required in relation to qualification of the international route.
Ordinance No. 569/GC5 of September 5, 2000 provides that international air transportation services may be cancelled in the event that such services are (i) not implemented or operated for more than six months, (ii) interrupted for more than six months, pursuant to Note No. 001 / GM5 / ADM enacted by the Cabinet of the Aeronautics' High Command or January 9th, 1987, (iii) the airline is proven to be incapable of performing the service, or (iv) the airlines fails to comply with the agreements, laws and regulations of the High Command of Aeronautics.
Any airline's international route frequency rights may be terminated if the airline fails to maintain at least 80% of flights provided for in its air transportation schedule HOTRAN for any 180‑day period or suspends its operation for a period exceeding 180 days.
Policy on slots